ITEM 1. BUSINESS
The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. This Form 10-K includes forward-looking statements that could differ from actual future results. Statements that are predictive in nature, that depend upon or refer to future events or conditions or that include words such as "expects," "anticipates," "intends," "plans," "believes," "estimates," "thinks" and similar expressions are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, including the factors described above, that may cause our actual results and performance to be materially different from any future results or performance expressed or implied by these forward- looking statements. Although we believe that these statements are based upon reasonable assumptions, we cannot assure you that our goals will be achieved. These forward-looking statements are made as of the date of this Form 10-K, and we assume no obligation to update or revise them or provide reasons why actual results may differ. Factors that might cause such a difference include, but are not limited to, those discussed in "Risk Factors" and elsewhere in this Form 10-K.
COMPANY OVERVIEW
We design, develop and produce a distinctive line of contemporary women's apparel and accessories. We market our products under the bebe, bebe moda and bbsp brand names through our 101 specialty retail stores located in 23 states, Canada, the United Kingdom and our on-line store at www.bebe.com. While we attract a broad audience, our target customers are 18- to 35-year-old women who seek current fashion trends interpreted to suit their lifestyle needs. The "bebe look," with an unmistakable hint of sensuality, appeals to a hip, sophisticated, body-conscious woman who takes pride in her appearance. The bebe customer is a discriminating consumer who demands value in the form of quality at a competitive price. Our broad product offering includes suits, tops, pants, skirts, dresses, logo and other activewear, outerwear, and handbags and other accessories. We design and develop most of our merchandise in-house. The merchandise is then manufactured to our specifications. The balance is developed primarily in conjunction with third-party apparel manufacturers or, in some cases, selected directly from these manufacturers' lines.
Founded by Manny Mashouf, our current Chairman, President and Chief Executive Officer, we opened our first store in San Francisco, California in 1976. We believe that we are positioned to sustain significant new store growth over the next several years. In the last few years, we have significantly strengthened our management team and have implemented several strategic initiatives that have contributed to our recent strong performance. These strategic initiatives address all aspects of our operations and in particular the merchandising, planning, manufacturing and distribution functions. Our merchandising initiatives focus primarily on expanding our product line to include a broader selection of tops, pants, dresses, accessories and logo items. While the traditional bebe product offering spoke to the "nine to five" needs of a young professional woman, the expanded product line provides head-to-toe lifestyle dressing at a competitive price that easily adapts from day into evening. Also, the logo portion of the product line, which highlights the bebe logo on a variety of active and casual styles, enhances brand awareness while providing younger, "aspirational" customers an entry to the bebe product line at lower price points. The strategic initiatives that relate to the planning, manufacturing and distribution functions focus primarily on implementing more sophisticated procedures. Also, these initiatives involve a more disciplined approach to our business operations.
We reinforce our brand with a distinctive lifestyle image advertising campaign, using prominent fashion photographers. We believe that our emphasis on non-product specific lifestyle advertising promotes brand awareness and attracts customers who are intrigued by the playfully sensual and evocative imagery. We communicate the images to consumers through a variety of advertising vehicles including
fashion magazines, bus shelters, in-store displays and customer mailings. We further enhance the bebe brand image by designing our stores to create an upscale, inviting boutique environment.
OPERATING STRATEGY
While the market for women's apparel is extremely large, we believe that our distinctive, contemporary point of view addresses an underserved market segment and presents us with opportunities for future growth. Our objective is to become a global brand, offering quality merchandise that enhances the spirit and playful sensuality of the contemporary woman. The principal elements of our operating strategy to achieve this objective are as follows:
1. PROVIDE DISTINCTIVE FASHION THROUGHOUT A BROAD PRODUCT LINE. Fashion from throughout the world inspires our merchandisers. They interpret contemporary ideas for silhouettes, fabrications and colors into products and styles to meet the everyday lifestyle needs of the bebe customer. While many of our styles and products are represented season after season with variations in color, fabric or trim, our merchandisers are committed to bringing newness into the merchandise mix in response to emerging trends. We carefully plan our product lines to represent a broad selection of sleek, fashionable goods, with particular emphasis on career wear, related separates and day-into-evening styles. Our product line is further supported by a broad selection of accessories that help our customers create a distinctive ensemble, while logo-embellished items provide an entry point for younger, aspirational customers.
2. VERTICALLY INTEGRATE DESIGN, PRODUCTION, MERCHANDISING AND RETAIL FUNCTIONS. We believe that our vertical integration of processes from design to market coupled with our financial discipline enable us to produce distinctive quality merchandise of exceptional value. Once the merchandise team conceives a line, we maintain flexibility in our sourcing by subcontracting production of our own designs, developing exclusive products in conjunction with third-party apparel manufacturers, or selecting exclusive merchandise directly from manufacturers' lines. This approach also enables us to respond quickly to changing fashion trends, while reducing our risk of excess inventory.
3. MANAGE MERCHANDISE MIX. We believe that a disciplined approach to merchandising and a proactive inventory management program is critical to our success. By actively monitoring sell-through rates and managing the mix of categories and products in our stores, we believe that we are able to respond to emerging trends in a timely manner, minimize our dependence on any particular category, style or fabrication, and preserve a balanced, coordinated presentation of merchandise within each store.
4. CONTROL DISTRIBUTION OF MERCHANDISE. We believe that distributing our products through bebe stores and our on-line web-site greatly enhances our brand image. This controlled distribution strategy enables us to display the full assortment of our products, control the pricing, visual presentation and flow of goods, test new products and reinforce the brand's identity in the eyes of our customers.
5. ENHANCE BRAND IMAGE. Through an edgy, high-impact, visual advertising campaign using print, outdoor, in-store and direct mail communication vehicles, we attract customers who are intrigued by the playfully sensual and evocative imagery of the bebe lifestyle. We also offer a line of merchandise branded with the distinctive bebe logo to increase brand awareness. Within our stores and through our on-line virtual store, we seek to create an upscale, inviting environment that further enhances the bebe brand and builds customer loyalty and demand for bebe merchandise. Furthermore, we train our sales associates to be responsive and knowledgeable and encourage them to reflect the bebe image.
GROWTH STRATEGY
We plan to grow our operations in a controlled manner, primarily through the opening of new stores. We intentionally slowed our store expansion in fiscal 1997 and 1998 while we implemented our strategic operational initiatives. We believe that we are now positioned to accelerate our store opening program.
With seventeen stores opened in fiscal 1999, we currently plan to open approximately twenty stores in each of fiscal 2000 and 2001, the majority of which will be in existing markets. We continually review our store base and have identified two under-performing stores that we may consider closing during fiscal 2000.
In addition to our domestic expansion, we are expanding internationally primarily through licensing arrangements. We have entered into license agreements with companies in Mexico, Greece, Israel and Singapore. Under the terms of these agreements, licensees will open bebe stores that will be stocked with inventory purchased from us.
Additionally, we are reviewing the need to upgrade our on-line virtual store to simplify and enhance our customers' on-line shopping experience and expect to invest in such upgrades to further capitalize on the encouraging performance of our on-line sales.
We also plan to grow by extending current product lines, introducing new product categories, and incrementally improving the operational aspects of our business. In fiscal 1999, we introduced footwear, lingerie and swimwear lines. Our Vice President of Licensing continually explores opportunities for licensing the bebe name. To date, we have entered into licensing agreements for footwear, eyewear and watches. Under the terms of these agreements, the licensees will manufacture and distribute products branded with the bebe logo to be sold at bebe stores and other retailers.
To support the introduction of new product categories in recent years as well as to handle higher sales volumes, we have developed a store prototype that is larger than the average of 3,000 square feet for our existing stores. Our new store prototype is approximately 3,000 to 5,000 square feet. However, in selected markets, we may open larger flagship stores. As opportunities arise, we also may expand certain existing stores.
MERCHANDISING
Our merchandising strategy is to provide current, timely fashions in a broad selection of categories to suit the lifestyle needs of our customers. We market all of our merchandise under the bebe or bebe moda brand names. We design and develop most of our merchandise in-house and contract to have the merchandise manufactured to our specifications. In some cases, we select merchandise directly from third-party apparel manufacturers' lines. We do not have long-term contracts with any third party apparel manufacturers and purchase all of the merchandise from such manufacturers by purchase order. Such merchandise always carries our "bebe," "bebe moda" or "bbsp" labels and in most instances is supplied to us on an exclusive basis.
PRODUCT CATEGORIES. After building a strong suiting business in the early 1990s, we diversified our product line in response to a decrease in demand for our suiting in fiscal 1996. We significantly increased the breadth of our product offerings by expanding categories such as related separates, dresses, leather, logo and accessories. We also began to plan and monitor our business by product classifications during fiscal 1997 and 1998. As we have increased volume in these expanded categories, we depend less on our suiting. While each category's contribution as a percentage of total net sales varies seasonally, each of the product classifications is represented throughout the year.
We regularly evaluate new categories that may be appropriate for introduction. In fall 1998, we introduced an intimate apparel product line, and in spring 1999, we introduced a footwear product line that was developed by our footwear licensee. We have also entered into licensing agreements where licensees will manufacture and distribute eyewear and watches branded with the bebe logo to be sold at bebe stores and other retailers. Finally, we believe licensing opportunities exist for other product categories such as fragrance and swimwear.
PRODUCT DEVELOPMENT. We take a disciplined approach to the product development process. This allows our merchants to gain as much information as possible concerning product sell-through and current fashion trends before making fabric or product purchase commitments. We control the process with a
detailed product development calendar which highlights key color selection, fabric order, pattern development and production order deadlines. We establish the deadlines to ensure an adequate flow of inventory into the stores. While the product development calendar is established on a seasonal basis, we make commitments semi-monthly based on current sales and fashion trends. This enhances our ability to react promptly to customer demand. Merchandising teams and designers work together to continuously develop new styles to be presented at monthly product review and selection meetings. These new styles incorporate variations on existing styles in an effort to capitalize further on the more popular silhouettes or, to a lesser extent, entirely new styles and fabrications that respond to emerging trends or customer preferences.
In addition, a detailed merchandising plan supports the product development process. This merchandising plan includes sales, inventory and profitability targets for each product classification. The plan is reconciled with our store sales plan, a compilation of individual store sales projections. We update the merchandising plan on a semi-monthly basis to reflect current sales and inventory trends. The plan is then distributed throughout the merchandising department. We use the updated merchandising plan to adjust production orders as needed to meet inventory and sales targets. If we miscalculate consumer demand for our products, we may be faced with significant excess inventory and fabric for some products and missed opportunities for others. Weak sales and resulting markdowns could cause our profitability to be impaired.
MARKETING
In recent years, we have initiated an extensive image advertising program which addresses the lifestyles and aspirations of our target customers. Through an edgy, high-impact, visual advertising campaign, we attract customers who are intrigued by the playfully sensual and evocative imagery. We believe that our emphasis on non-product specific lifestyle advertising promotes brand awareness and supports numerous product line expansion opportunities. An outside advertising agency works with our internal Marketing Department to create a lifestyle advertising campaign. This campaign, which emphasizes a forward-looking view of fashion, is communicated to consumers through a variety of means including fashion magazines, bus shelters, in-store displays and customer mailings. In addition, our Public Relations Department communicates directly with fashion editors and supplies them with a continuous flow of product information. On occasion, we have co-sponsored promotional events with fashion magazines, such as ELLE, GLAMOUR, MARIE CLAIRE, VOGUE and VANITY FAIR.
STORES
STORE LOCATIONS AND ENVIRONMENT. As of June 30, 1999, we operated 101 stores in 23 states. Our stores average approximately 3,000 square feet and are primarily located in regional shopping malls and free-standing street locations. Our stores are designed to create a clean, upscale boutique environment, featuring hardwood or marble floors and recessed lighting. Glass exteriors allow passersby to see easily into the store. The open floor design allows customers to readily view the majority of the merchandise on display while store fixtures allow for the efficient display of garments and accessories.
We provide the stores with specific merchandise display directions on a weekly or bi-weekly basis from the corporate office based on currently available merchandise receipts. Our in-store product presentation utilizes a variety of different fixtures to highlight the product line's breadth and versatility. Complete outfits are displayed throughout the store using garments from a variety of product categories. By emphasizing outfits in this manner, we allow the customer to see how different pieces can be combined to create multiple ensembles.
EXPANSION OPPORTUNITIES. In fiscal 1998, we, together with a real estate consulting firm, developed a profile of current customers and applied the profile to the largest 150 metropolitan areas in the United States. We currently operate bebe stores in approximately 40 of these top geographic market areas and have identified additional geographic markets that we believe can support one or more bebe stores. Also, we believe that there is a significant opportunity to expand the number of stores in most of the markets within which bebe stores are currently located. We, together with our real estate consultant, also have
identified specific mall and street locations within each market to be considered for new bebe store locations. In selecting a specific site, we look for high traffic locations primarily in regional shopping centers and in free-standing street locations. We evaluate proposed sites based on the traffic pattern, co-tenancies, average sales per square foot achieved by neighboring stores, lease economics and other factors considered important within the specific location.
We opened seventeen new stores in fiscal 1999 and plan to open approximately twenty stores in each of fiscal 2000 and 2001, the majority of which will be in existing markets. Our new store prototype is approximately 3,000 to 5,000 square feet, although in certain selected markets we may open larger stores. Additionally, we may open larger stores in selected markets that will be designed to enhance further the bebe image.
During fiscal 1999, the average new store size was approximately 3,481 square feet. New store construction costs (before tenant allowances) averaged $422,000. The average gross inventory investment was $135,000 while pre-opening costs, which are expensed as incurred, averaged less than $30,000 per store. Our stores typically have achieved profitability at the store operating level within the first full quarter of operation; however, we cannot assure that our stores will do so in the future. Actual store growth and future store profitability and rates of return will depend on a number of factors that include, but are not limited to, individual store economics and suitability of sites that become available. Because of their higher cost structure, flagship stores are not expected to achieve operating margins comparable to our other stores.
In addition to opening new stores, we expanded or relocated six existing stores to larger spaces within the same malls during fiscal 1999. We believe that as awareness of bebe's brand name increases, product lines expand and stores mature, additional expansions may be appropriate.
Our ability to expand will depend on a number of factors, including the availability of desirable locations, the negotiation of acceptable leases and our ability to manage expansion and to source adequate inventory. We cannot assure you that we will be able to achieve our planned expansion on a timely and profitable basis. Furthermore, we cannot assure you that store openings in existing markets will not result in reduced net sales volumes and profitability in existing stores in those markets.
OUTLET STORES. As of June 30, 1999, eight of our 101 stores were located in outlet malls throughout the United States. We originally used these outlet stores to dispose of slow-moving inventory in order to promote a better merchandise presentation within the specialty stores. More recently, we have rounded out the inventory of our outlet stores with casual logo styles at full price and, to a lesser extent, garments specifically bought or produced for the outlet stores.
During fiscal 1999, the average new outlet store size was approximately 3,026 square feet. New store construction costs (before tenant allowances) averaged approximately $212,579, and the average inventory investment was approximately $159,208. Of the seventeen stores opened in fiscal 1999, two were outlet stores. Of the twenty stores planned to be opened in fiscal 2000, four are expected to be outlet stores.
STORE CLOSURES. In 1996, we initiated a program to monitor more vigorously the financial performance of our stores and, from time to time, have closed in the past and will close in the future, stores that we do not consider to be viable. Many of the store leases contain early termination options that allow us to close the stores in certain specified years of the leases if certain minimum sales levels are not achieved. We closed two stores during fiscal 1999. We have reviewed our existing store base and have identified two under-performing stores that we are considering closing prior to the end of fiscal 2000.
STORE OPERATIONS
Store operations are organized into five regions and twenty districts. Each region is managed by a regional manager, and each district is managed by a district manager. Each regional manager is typically
responsible for three to four districts, and each district manager is typically responsible for three to six stores. Each store is typically staffed with two to four managers in addition to hourly sales associates.
We seek to instill enthusiasm and dedication in our store management personnel and sales associates through incentive programs and regular communication with the stores. Sales associates receive commissions on sales with a guaranteed minimum compensation. Store managers receive base compensation plus incentive compensation based on sales. Regional and district managers receive base compensation plus incentive compensation based on meeting profitability benchmarks.
We have well-established store operating policies and procedures and use an in-store training regimen for all new store employees. The Visual Merchandising staff provides the stores with merchandise presentation instructions, which include photographs of fixture presentations on a weekly basis. In addition, we provide detailed product descriptions to sales associates to enable them to gain familiarity with our product offerings. We offer our sales associates a discount on bebe merchandise to encourage them to wear our apparel and reflect the bebe image while on the selling floor.
As part of our focus on better procedures and controls, we established a Loss Prevention Department in fiscal 1997 to develop and implement better programs for controlling losses. The results in fiscal 1998 and 1999 have been encouraging. These programs include installing electronic article surveillance systems in all stores, monitoring returns, voids, employee sales and deposits, and educating store personnel on loss prevention.
SOURCING, QUALITY CONTROL AND DISTRIBUTION
All of our merchandise is marketed under the bebe or bebe moda brand names. Much of this merchandise is designed and developed in-house and manufactured to our specifications. The balance is developed primarily in conjunction with third-party apparel manufacturers. In some cases, we select merchandise directly from these manufacturers' lines. When we contract out for the production of merchandise, we primarily use facilities located in California, and, to a lesser degree, foreign manufacturers. These facilities produce garments based on designs, patterns and detailed specifications produced by us.
We use computer aided design systems to develop our patterns and production markers as part of our product development process. We fit test sample garments before production to make sure the patterns are accurate. After our distribution facility receives the garments, a percentage of receipts are inspected and fit tested a second time. Recently, we implemented a formalized quality control program that involves inspection of merchandise and fabrics upon receipt at our distribution center. Garments that do not pass inspection are returned to the manufacturer for rework or accepted at reduced prices for sale in our outlet stores.
All of the merchandise for our domestic stores is received, inspected, processed, warehoused and distributed through our distribution center that is adjacent to our corporate offices. Details about each receipt are supplied to merchandise planners who determine how the product should be distributed among the stores based on current inventory levels, sales trends and specific product characteristics. Advance shipping notices are electronically communicated to the stores and any goods not shipped are stored for replenishment purposes. Merchandise typically is shipped to the stores on a weekly basis using common carriers; however, during peak selling periods shipments may be made twice or even three times a week.
We do not have any long-term contracts with any manufacturer or supplier and place all of our orders by purchase order. If we fail to obtain sufficient quantities of manufacturing capacity or raw materials, it would have a harmful effect on our business, financial condition and results of operations. We have received in the past, and may receive in the future, shipments of products from manufacturers that fail to conform to our quality control standards. In such event, unless we are able to obtain replacement products in a timely manner, we may lose sales which could harm our operating results.
COMPETITION
The retail and apparel industries are highly competitive and are characterized by low barriers to entry. We expect competition in our markets to increase. The primary competitive factors in our markets are:
- brand name recognition;
- product styling;
- product presentation;
- product pricing;
- store ambiance;
- customer service; and
- convenience.
We compete with traditional department stores, specialty store retailers, off-price retailers and direct marketers for, among other things, raw materials, market share, retail space, finished goods, sourcing and personnel. Because many of these competitors are larger and have substantially greater financial, distribution and marketing resources than we do, we may lack the resources to adequately compete with them. If we fail to compete in any way, it may have a harmful effect on our business, financial condition and results of operations.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
TRADEMARKS AND SERVICE MARKS. We believe that our trademarks and other proprietary rights are important to our success. We have registered "bebe" and "bebe moda" in the United States and certain foreign jurisdictions. Even though we take actions to establish and protect our trademarks and other proprietary rights, we cannot assure that others will not imitate our products or infringe on our intellectual property rights. In addition, we cannot assure that others will not resist or seek to block the sale of our products as infringements of their trademark and proprietary rights. In certain states, other entities may have rights to names that contain the word "bebe," which could limit our ability to expand in such states.
We are seeking to register our trademarks in targeted international markets that we believe represent large potential markets for our products. In some of these markets, local companies currently have registered competing marks, and/or regulatory obstacles exist that may prevent us from obtaining a trademark for the bebe name or related names. In such countries, we may be unable to use the bebe name unless we purchase the right or obtain a license to use the bebe name. We may not be able to register trademarks in these international markets, purchase the right or obtain a license to use the bebe name on commercially reasonable terms. If we fail to obtain trademark, ownership or license rights, it would limit our ability to expand into certain international markets or enter such markets with the bebe name, and to capitalize on the value of our brand.
LICENSING. We strive to provide our customers with high quality products and to maintain a consistent image in all of our advertising and marketing programs. We currently are evaluating opportunities to expand our product offerings through licensing or joint venture arrangements. Accordingly, we may from time to time selectively enter into licensing or joint venture agreements with third parties. In entering into such licensing and joint venture agreements, we will seek to preserve the integrity of our brand name by closely monitoring the design and quality of the products sold by such licensees or joint venture partners and by controlling the manner in which our products are advertised, marketed and distributed. In addition to distributing such new products through bebe stores, we may elect to distribute these licensed products with the bebe logo through other channels. In fiscal 1998, we hired a Vice President of Licensing to develop this program. We have already entered into license agreements where the licensees will manufacture and distribute footwear, eyewear and watches branded with the bebe logo to be sold at bebe stores and other retailers.
We also believe that opportunities may exist to license the bebe brand name internationally to licensees who will open bebe stores. We have signed a licensing agreement with companies in Mexico, Greece, Israel and Singapore to open and operate retail bebe stores. Under these agreements, we provide the use of our name, store design and advertising images, and the licensee purchases inventory from us.
INFORMATION SERVICES AND TECHNOLOGY
We are committed to utilizing technology to enhance our competitive position. To this end, during fiscal 1998, we hired an experienced Vice President of Information Services and Technology to lead our efforts in this area. Our information systems provide integration of the store, merchandising, distribution and financial systems. The core business systems, which consist of both purchased and internally developed software, run on a UNIX platform and are accessed over a Company-wide network providing corporate employees with access to all key business applications. Daily sales and cash deposit information are electronically collected from the stores' point-of-sale terminals nightly. During this process, we also obtain information concerning inventory receipts and transfers and send to the stores pricing, markdown and shipment notification data. In addition, we collect customer names and addresses to update our customer database. The merchandising staff evaluates the sales and inventory information collected from the stores to make key merchandise planning decisions, including replenishment and markdowns. These decisions enhance our ability to optimize sales while limiting markdowns and minimizing inventory risk by properly marking down slow selling styles, reordering existing styles and effectively distributing new inventory receipts to the stores.
In the past, our investments in information systems have focused on our core store, merchandise and financial accounting systems. Currently, our focus is on upgrading our capabilities and systems associated with our production, merchandise allocation and distribution functions, which have not kept pace with our growth. We made significant investments to improve existing management information systems and implemented new systems during fiscal 1999. Additionally, we have created a year 2000 Task Force, which is implementing a six-phase plan with the objective of ensuring that its management information systems will be Year 2000 Compliant. We believe that this six-phase plan will be completed by October 31, 1999. We cannot assure you that we will be successful with the implementation of these new systems or plans. Failure to implement and integrate such systems or plans could have a harmful effect on our business, financial condition and results of operations.
EMPLOYEES
As of June 30, 1999, we had approximately 1,475 employees, of whom approximately 344 were employed in general and administrative functions at the corporate offices and distribution center. The remaining 1,131 employees were employed in store operations. Of these remaining employees, approximately 352 were full-time employees and 779 were employed on a part-time basis. None of our employees are represented by a labor union, and we believe our relationship with our employees is good.
EXECUTIVE OFFICERS OF THE REGISTRANT
MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY PERSONNEL
The following table sets forth certain information with respect to the executive officers, directors and other officers and key personnel of the Company as of June 30, 1999:
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(1) Executive Officer.
(2) Member, Audit Committee and Compensation Committee.
MANNY MASHOUF founded the Company and has served as Chairman, Chief Executive Officer and President of the Company since the Company's incorporation in 1976. Mr. Mashouf is the husband of Neda Mashouf, a Director of the Company, and the father of Paul Mashouf, the Secretary of the Company.
BARBARA BASS has served as a Director of the Company since February 1997. Since 1993, Ms. Bass has served as the President of the Gerson Bakar Foundation. From 1989 to 1992, Ms. Bass served as President and Chief Executive Officer of the Emporium Weinstock Division of Carter Hawley Hale Stores, Inc., a department store chain. Ms. Bass also serves on the Board of Directors of Starbucks Corporation, DFS Group Limited and The Bombay Company, Inc.
CORRADO FEDERICO has served as a Director of the Company since November 1996. Mr. Federico is President of Solaris Properties and has served as the President of Corado, Inc., a land development firm, since 1991. From 1986 to 1991, Mr. Federico held the position of President and Chief Executive Officer of Esprit de Corp, Inc., a wholesaler and retailer of junior and children's apparel, footwear and accessories ("Esprit"). Mr. Federico also serves on the Board of Directors of Hot Topic, Inc.
PHILIP SCHLEIN has served as a Director of the Company since December 1996. Since April 1985, Mr. Schlein has been a general partner of U.S. Venture Partners, a venture capital firm specializing in retail and consumer products companies. From January 1974 to January 1985, Mr. Schlein served as President and Chief Executive Officer of Macy's California, a division of R. H. Macy & Co, Inc., a department store chain. Mr. Schlein also serves on the Board of Directors of Ross Stores, Inc., ReSound Corporation, Quick Response Services and Burnham Pacific Properties, Inc.
GEORGE ARVAN has served as the Vice President of Sourcing and Production of the Company since September 1997. Prior to his employment with bebe, Mr. Arvan founded New Planet Sourcing, an apparel
sourcing company, and served as its President from September 1996 to September 1997. During the period from 1991 to 1996, Mr. Arvan was the Chief Operating Officer of Berkeley Shirt Company, a men's wholesale apparel company.
KENNETH CHARLES has been employed with the Company since October 1998 as Vice President of Retail Operations. From 1982 to 1998, Mr. Charles was employed by The Limited, Inc., a women's apparel retailer most recently as a Vice President of stores.
KAREN IOLI has served as Vice President of Licensing of the Company since January 1998. From January 1996 to January 1998, Ms. Ioli served as Vice President of Licensing for Mossimo, Inc., an apparel wholesale company. From July 1992 to September 1995, Ms. Ioli was employed by Guess?, Inc., an apparel retail and wholesale company, as Vice President of Licensing.
BLAIR LAMBERT has served as Chief Financial Officer of the Company since June 1996. From 1988 to 1996, Mr. Lambert was employed by Esprit, most recently as Corporate Vice President of Finance. Mr. Lambert is a Certified Public Accountant.
NEDA MASHOUF has served as a Director of the Company since September 1984 and has been employed by the Company since 1984, most recently as Merchandising Advisor. Ms. Mashouf is the wife of Manny Mashouf, the Chairman, President and Chief Executive Officer of the Company.
TIM MILLEN has served as Vice President of Information Services and Technology of the Company since November 1997. From July 1996 to November 1997, Mr. Millen served as Vice President of Information Systems for AZ3 Inc. (d.b.a. BCBG), a women's apparel retail and wholesale company. From August, 1994 to July 1996, Mr. Millen served as Vice President of Management Information Systems for Francine Browner Inc., an apparel wholesale company. From 1991 to 1994, Mr. Millen was an independent information technology consultant, focusing on the retail and wholesale apparel market.
GREG SCOTT has served as the Company's senior merchant since January 1996. From January 1994 to January 1996, Mr. Scott was a Senior Merchant at AnnTaylor, Inc., a women's apparel retail company. From January 1993 to January 1994, Mr. Scott served as a merchant at Henri Bendel, a women's apparel retailer. From September 1985 to January 1993, Mr. Scott was employed by Macy's West, a subsidiary of Federated Department Stores, Inc., most recently as a buyer.
LILLIEMAE STEPHENS has served as General Counsel of the Company since January 1999. From October 1996 to January 1999, Ms. Stephens served as an associate at Gray Cary Ware & Freidenrich LLP.
ITEM 2.
ITEM 2. PROPERTIES
As of June 30, 1999, our 101 stores, all of which are leased, encompassed approximately 302,947 total square feet. The typical store lease is for a 10-year term and requires us to pay a base rent and a percentage rent if certain minimum sales levels are achieved. Many of the leases provide a lease termination option in certain specified years of the lease if certain minimum sales levels are not achieved. In addition, leases for locations typically require us to pay property taxes, utilities and repairs and maintenance. Also, leases for mall locations may include common area maintenance fees.
In fiscal 1999, we leased additional space for our administrative offices and distribution center in order to accommodate our future needs. Our corporate headquarters and distribution center are now located in an approximately 70,000 square foot leased facility located at 380 Valley Drive, Brisbane, California, and a 35,000 square foot leased facility located at 400 Valley Drive, Brisbane, California. These leases expires in August 2001 and April 2006, respectively. In addition, we lease approximately 20,000 square feet of warehouse space for fabric inspection, storage and distribution in South San Francisco. The lease expires in August 2001.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we may be involved in litigation relating to claims arising out of our operations. As of the date of this filing, we are not engaged in any legal proceedings that are expected, individually or in the aggregate, to have a harmful effect on our business, financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our shareholders since June 30, 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock trades on the Nasdaq National Market under the symbol "BEBE". The following table sets forth for the period from the company's initial public offering through June 30, 1999 as reported by Nasdaq:
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(1) From the date of our initial public offering on June 17, 1998 to June 30, 1998.
As of September 22, 1999 the number of holders of record of our common stock was approximately 36 and the number of beneficial holders of our common stock was estimated to be in excess of 1,500.
We have never declared or paid any dividends on our common stock and do not intend to pay any dividends on our common stock in the foreseeable future. In addition, our current line of credit arrangements prohibit the payment of cash dividends on our capital stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL AND OPERATING DATA
The following selected financial data of the Company is qualified by reference to, and should be read in conjunction with, the Financial Statements and Notes thereto and the other financial information
appearing elsewhere in this filing. These historical results are not necessarily indicative of results to be expected in the future.
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(1) Based on the sum of average monthly sales per open store for the period.
(2) Based on net sales; stores are considered comparable beginning on the first day of the first month following the first anniversary of their opening.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Financial Statements and Notes thereto included elsewhere in this Form 10-K. 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 That May Affect Results" in this section. Our fiscal year ends on June 30 of each calendar year.
RESULTS OF OPERATIONS
The following table sets forth certain financial data as a percentage of net sales for the periods indicated:
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(1) Cost of sales includes the cost of merchandise, store occupancy costs and buying costs.
(2) Selling, general and administrative expenses primarily consist of non-occupancy store costs, corporate overhead and advertising costs.
YEARS ENDED JUNE 30, 1999 AND 1998
NET SALES. Net sales increased to $201.3 million during the year ended June 30, 1999 from $146.8 million in fiscal 1998, an increase of $54.5 million, or 37.1%. Of this increase, $33.4 million was attributable to the 25% increase in comparable store sales, and $21.1 million was attributable to stores not included in the comparable store sales base. The increase in comparable store sales was attributable to a broader product line offering, strong consumer acceptance of the product line and improvements in the operational aspects of our business.
GROSS PROFIT. Gross profit, which includes the cost of merchandise, buying and occupancy, increased to $105.9 million for the year ended June 30, 1999 from $75.0 million in fiscal 1998, an increase of $30.9 million, or 41.2%. As a percentage of net sales, gross profit increased to 52.6% for the year from 51.1% during fiscal 1998. The increase in gross profit as a percentage of net sales resulted from reduced occupancy costs as a percentage of net sales resulting from higher average store sales and, to a lesser extent, higher merchandise margins. We believe that the gross margins attained during this most recent fiscal year are not sustainable and that gross margins will likely be lower in the current and future periods.
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 $61.1 million during the year ended June 30, 1999 from $46.4 million in fiscal 1998, an increase of $14.7 million, or 31.7%. As a percentage of net sales, these expenses decreased to 30.3% during the year ended June 30, 1999 from 31.6% in fiscal 1998. This reduction as a percentage of net sales was largely due to favorable compensation expense leverage offset by increases in professional fees related to international trademark protection, registration and acquisition.
We recorded deferred compensation of $2.8 million in connection with option grants in June 1997, of which $538,000 was charged to expense for the year ended June 30, 1999. The remaining deferred compensation expense will be amortized over the vesting period of the options. See Note 8 of Notes to Financial Statements.
INTEREST AND OTHER EXPENSE (INCOME), NET. We generated $2.2 million of interest and other income (net of other expenses) during the year ended June 30, 1999 as compared to $838,000 in fiscal 1998 due to increases in average cash balances arising from operating results and proceeds of the Company's initial public offering of shares in June, 1998.
PROVISION FOR INCOME TAXES. The effective tax rate for the year ended June 30, 1999 was 40.5% as compared to 41.0% in fiscal 1998. The lower effective tax rate for fiscal 1999 was primarily attributable to investments in tax advantaged investments. See Note 5 of Notes to Financial Statements.
YEARS ENDED JUNE 30, 1998 AND 1997
NET SALES. Net sales increased to $146.8 million during the year ended June 30, 1998 from $95.1 million in fiscal 1997, an increase of $51.7 million, or 54.3%. Of this increase, $38.5 million was attributable to the 41.3% increase in comparable store sales, and $13.2 million was attributable to stores not included in the comparable store sales base. The increase in comparable store sales was attributable to a broader product line offering, strong consumer acceptance of the product line and improvements in the operational aspects of our business.
GROSS PROFIT. Gross profit, which includes the cost of merchandise, buying and occupancy, increased to $75.0 million for the year ended June 30, 1998 from $41.1 million in fiscal 1997, an increase of $33.9 million, or 82.5%. As a percentage of net sales, gross profit increased to 51.1% for the year from 43.2% during fiscal 1997. The increase in gross profit as a percentage of net sales resulted from higher initial markups and lower markdowns associated with higher sell-through rates, as well as reduced occupancy costs as a percentage of net sales resulting from higher average store sales. In addition, during fiscal 1998, we reviewed our fabric inventory and, for fabrics not directly associated with planned garment production orders, we took a charge against cost of sales and increased our inventory valuation allowance by $1.5 million to reflect more appropriately the net realizable value of such fabrics.
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 $46.4 million during the year ended June 30, 1998 from $32.6 million in fiscal 1997, an increase of $13.8 million, or 42.3%. As a percentage of net sales, these expenses decreased to 31.6% during the year ended June 30, 1998 from 34.3% in fiscal 1997. This reduction as a percentage of net sales was largely a result of economies of scale related to the net sales increases offset in part by an increase in advertising expenses as a percentage of net sales. For the year, advertising expense was $6.7 million, or 4.6% of net sales, compared to $2.9 million, or 3.0% of net sales, in fiscal 1997. We currently plan to maintain approximately the same level of advertising as a percentage of net sales in the future. As previosly mentioned, we recorded deferred compensation of $2.8 million in connection with option grants in June 1997, of which $664,000 was charged to expense for the year ended June 30, 1998. See Note 8 of Notes to Financial Statements.
INTEREST AND OTHER EXPENSE (INCOME), NET. We generated $838,000 of interest and other income (net of other expenses) during the year ended June 30, 1998 as compared to $128,000 in fiscal 1997. We have no borrowings under our line of credit during the year ended June 30, 1998 due to increases in average cash balances arising from our improved operating results compared to net borrowing in the prior fiscal year.
PROVISION FOR INCOME TAXES. The effective tax rate for the year ended June 30, 1998 was 41.0% as compared to 37.4% in fiscal 1997. The higher effective tax rate for fiscal 1998 was primarily attributable to
increased taxable earnings and greater profitability in high tax rate states. See Note 5 of Notes to Financial Statements.
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, we generate a disproportionate amount of our annual net sales in the first half of our fiscal year (which includes the fall and holiday selling seasons) compared to the second half of our fiscal year. If for any reason our sales were below seasonal norms during the first half of our fiscal year, our annual operating results would be harmed. 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.
The following table sets forth certain unaudited statements of operations data for each of the four quarters ended June 30, 1999, as well as such data expressed as a percentage of our total net sales for the periods indicated. This data has been derived from unaudited financial statements that, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) necessary for fair presentation of such information when read in conjunction with our Financial Statements and Notes thereto appearing elsewhere in this annual report on Form 10-K.
LIQUIDITY AND CAPITAL RESOURCES
During the three years ended June 30, 1999, we have satisfied our cash requirements principally through cash flow from operations, borrowings under our revolving lines of credit and term loans. Primary uses of cash have been to purchase merchandise inventory, fund the construction of new stores and to remodel and renovate stores.
Our working capital requirements vary widely throughout the year and generally peak in the first and second fiscal quarters. At June 30, 1999, we had approximately $59.3 million of cash and cash equivalents on hand. In addition, we had a revolving line of credit, under which it could borrow or issue letters of credit up to a combined total of $5.0 million. As of June 30, 1999, there were no borrowings under the line of credit and letters of credit outstanding totaled $2.2 million.
Net cash provided by operating activities in fiscal 1999, 1998 and 1997, was $33.3 million, $19.3 million, and $13.0 million, respectively. The increase in cash provided by operating activities in fiscal 1999 and 1998 compared to 1997 was primarily the result of increases in income from operations and changes in working capital.
Net cash used by investing activities was $12.0 million, $3.6 million and $1.0 million in fiscal 1999, 1998 and 1997, respectively. The primary use of these funds was for the opening of new stores and, to a lesser degree, the implementation of new computer systems within the stores and the corporate office.
We made substantial capital expenditures in connection with the opening and expansion of stores, the implementation of new systems to support store and corporate office functions and the expansion or relocation of our corporate offices and distribution center. Our capital expenditures was $12.9 million in fiscal 1999. We opened seventeen new stores in fiscal 1999. We also expect to open approximately twenty stores in each of fiscal 2000 and 2001, the majority of which will be in existing markets.
During fiscal 1999, new store construction costs (before tenant allowances) averaged $422,000. The average gross inventory investment was $135,000 while pre-opening costs, which are expensed as incurred, was less than $30,000 per store. The average total cost to build new stores will vary in the future, depending on various factors, including local construction expenses, changes in store format and design and tenant improvement allowances.
Net cash provided by financing activities was $1.4 million and $11.8 million in fiscal 1999 and fiscal 1998, respectively. In fiscal 1997, net cash used by financing activities was $4.6 million. In fiscal 1999, net cash provided by financing activities primarily was derived from proceeds from the issuance of common stock arising from stock option exercises. In fiscal 1998, net cash provided by financing activities related primarily to proceeds from the sale of 1.25 million shares in our initial public offering of stock. Net cash used by financing activities in fiscal 1997 primarily related to the repayment of the term note and revolving line of credit.
We believe that our cash on hand, together with our cash flow from operation, will be sufficient to meet our capital and operating requirements through fiscal 2000. Our future capital requirements, however, will depend on numerous factors, including without limitation, the size and number of new and expanded stores, investment costs for management information systems, potential acquisitions and/or joint ventures, and future results of operations.
INFLATION
We do not believe that inflation has had a material effect on the results of operations in the recent past. However, we cannot assure that our business will not be affected by inflation in the future.
YEAR 2000 DATE CONVERSION
We have created a Year 2000 Task Force that is implementing a six phase plan with the objective of ensuring that our management information systems will record, store, process, calculate and present calendar dates falling on or after (and if applicable, spans of time including) January 1, 2000 in the same manner, and with the same functionality as it has in years prior to 2000 (collectively, "Year 2000 Compliant"). We have completed a comprehensive review of our information systems and have updated our computer systems and applications in preparation for the year 2000. We are currently in the sixth phase of our plan, the contingency plan, which will be completed by October 31, 1999.
Total expenditures related to identification, testing, conversion, contingency, replacement and upgrading system applications are expected to range from $300,000 to $500,000 during fiscal 1999 and 2000. In certain cases, the conversions to applications which are Year 2000 Compliant have been made in conjunction with planned business system upgrades or enhancements. In the most reasonably likely worst case scenario, our store operating and back end inventory management systems could fail. If these systems
fail, we may be unable to record sales transactions in our stores, which would result in a breakdown in the supply chain. If this occurs, we would have to revert to a number of manual systems for recording sales, ordering product and replenishing our stores. This would likely result in a loss of revenue, and it is not possible to quantify the possible range of such loss.
We have contacted the majority of our vendors and others on whom we rely to confirm that their systems will be converted before January 1, 2000. However, we cannot assure that the systems of other companies on which our systems rely will be Year 2000 Compliant by December 31, 1999. If another company fails to convert, it would have a harmful effect on our systems. In a most reasonably likely worst case scenario, one or more significant suppliers could be unable to continue to adequately supply us after 1999. Our fallback position would be to seek an alternative source of supply. However, we cannot assure that such alternative sources of supply would be available. Such a contingency plan will be in place by the end of October 31, 1999. It is not practical for management to estimate the range of financial loss, if any, which could result from the negative effect that a disruption in supply would have on our business. Furthermore, we cannot assure that any or all of our systems are or will be year 2000 compliant, or that the ultimate costs required to address the year 2000 issue or the impact of any failure to achieve substantial Year 2000 Compliance will not have a harmful effect on our financial condition.
RISK FACTORS
Factors that might cause our actual results to differ materially from the forward looking statements discussed elsewhere in this report, as well as affect our ability to achieve our financial and other goals, include, but are not limited to, the following:
RISKS RELATING TO OUR BUSINESS:
1. IF WE MISCALCULATE THE DEMAND FOR OUR PRODUCTS, OUR SALES AND PROFITABILITY MAY BE HARMED. Our success depends on our ability to balance our inventory of merchandise with the demand for such merchandise. If we miscalculate the demand for our products, we may be faced with significant excess inventory. This would result in excess fabric for some products and missed opportunities for others. This may result in weak sales and markdowns and/or write-offs, which could impair our profitability.
2. IF WE ARE NOT ABLE TO EFFECTIVELY MANAGE OUR GROWTH, OUR PROFITABILITY MAY BE HARMED. Our continued growth depends, to a significant degree, on our ability to identify sites and open and operate new stores on a profitable basis. We expect to open approximately 20 stores in each of fiscal 2000 and 2001. Our plan to expand successfully depends on the following factors:
- the availability of desirable locations;
- the ability to negotiate acceptable leases for such locations;
- the ability to manage the expansion of the store base;
- the ability to source inventory adequate to meet the needs of new stores;
- the ability to operate stores profitably once opened;
- the development of adequate management information systems to support expanded activity;
- the ability to recruit and retain new employees;
- the availability of capital; and
- general economic and business conditions affecting consumer confidence and spending.
In selected markets, we plan to open flagship stores that will be larger and more expensive to operate than existing stores. If these flagship stores do not generate sufficient revenues to cover their higher costs, our financial results could be negatively affected.
We cannot assure that we will achieve our planned expansion on a timely and profitable basis. In addition, most of our new store openings in fiscal 2000 and 2001 will be in existing markets. These openings may affect the existing stores' net sales volumes and profitability. Furthermore, we will need to hire experienced executive personnel to support the planned improvements and expansions of our business. We cannot assure that we will be successful in hiring such personnel in a time frame necessary to manage and support our expansion plans.
3. WE MAY EXPERIENCE A DECLINE IN OUR RATE OF COMPARABLE STORE SALES GROWTH, WHICH COULD AFFECT OUR PROFITABILITY. We do not think that we can sustain the rate of comparable store sales growth achieved in recent periods. We expect that such growth, if any, in the current and future periods will be lower than rates achieved in fiscal 1998 and 1999. During the recent periods of relatively high comparable store sales growth, we experienced favorable merchandise margins primarily because we were able to sell our merchandise with lower markdown rates due in part to the higher growth of same store sales. As comparable store sales growth rates continue to moderate, we anticipate a decline in merchandise margins, which will reduce gross margins. In addition, as newer and expanded stores become a larger percentage of the entire store base, we anticipate that we will see a rise in occupancy cost as a percentage of sales. We anticipate that this rise will further reduce gross margins. In addition, our selling, general and administrative expenses have decreased as a percentage of net sales in recent periods due in part to the rapid growth in net sales. If same store sales growth rates slow, it will be more difficult for us to generate favorable selling, general and administrative expense leverage.
4. IF WE ARE NOT ABLE TO OPERATE ON A PROFITABLE BASIS, OUR STOCK PRICE MAY BE NEGATIVELY AFFECTED. We cannot guarantee that we will remain profitable in the future. In the past 5 years, profitability rates have varied widely from quarter-to-quarter and from year-to-year. In particular, in fiscal 1996, we experienced a significant financial downturn. This was caused partly by problems in obtaining fabrication, misjudging related fashion trends, failing to obtain product deliveries in a timely manner, rapidly expanding our store base, and lacking sufficient controls and personnel to support such expanded activity.
Our future results of operations will depend on the number and timing of new store openings. Also, it will depend on, among other things, our ability to:
- identify and capitalize upon changing fashion trends;
- hire and retain qualified management and other personnel;
- maintain appropriate inventory levels;
- obtain needed raw materials;
- identify and negotiate favorable leases for successful store locations;
- reduce shrinkage; and
- control operating costs.
In addition, future results of operations will depend on factors outside of our control, such as general economic conditions, availability of third party sourcing and raw materials, and actions of competitors.
5. IF WE ARE NOT ABLE TO EFFECTIVELY UPGRADE AND EXPAND OUR MANAGEMENT INFORMATION SYSTEMS, OUR OPERATIONS MAY BE HARMED. We have made significant investments to improve existing management information systems and implement new systems in the areas of production, merchandise allocation and distribution functions. We cannot assure that these enhancements will be successfully implemented. If we fail to implement and integrate such systems, it can have a harmful effect on our results of operations.
6. IF WE ARE UNABLE TO OBTAIN RAW MATERIALS OR FIND PRODUCTION FACILITIES, OUR FINANCIAL CONDITION MAY BE HARMED. We do not own any production facilities and therefore depend on third parties to manufacture our products. Independent manufacturers make merchandise designed by the bebe in-house design team with raw materials purchased from independent mills and other suppliers. We place all of our orders for production of merchandise and raw materials by purchase order and do not have any long-term contracts with any manufacturer or supplier. We compete with approximately 20 other companies for production facilities and raw materials. If we fail to obtain sufficient quantities of raw materials, it would have a harmful effect on our financial condition. For example, in fiscal 1996, we had difficulty obtaining needed quantities of raw materials on a timely basis because of competition with other apparel vendors for raw materials. This resulted in a loss of sales and a decrease in gross profit. Furthermore, we have received in the past, and may receive in the future, shipments of products from manufacturers that fail to conform to our quality control standards. In such event, unless we are able to obtain replacement products in a timely manner, we may lose sales. If we fail to maintain favorable relationships with these production facilities and to obtain an adequate supply of quality raw materials on commercially reasonable terms, it could harm our business and results of operations.
If an independent manufacturer violates labor or other laws, or if their labor practices diverge from those generally accepted as ethical in the United States, it could harm our business and brand image. While we recently adopted a policy to monitor the operations of our independent manufacturers by having an independent firm inspect these manufacturing sites, we cannot control the actions of such manufacturers, nor can we assure that these manufacturers will conduct their businesses using ethical labor practices.
7. WE DEPEND ON THIRD PARTY APPAREL MANUFACTURERS, AND OUR SALES MAY BE NEGATIVELY AFFECTED IF THE MANUFACTURERS DO NOT PERFORM ACCEPTABLY. We develop a significant portion of our merchandise in conjunction with third party apparel manufacturers. In some cases, we select merchandise directly from these manufacturers' lines. We do not have long-term contracts with any third party apparel manufacturers and purchase all of the merchandise from such manufacturers by purchase order. Furthermore, we have received in the past, and may receive in the future, shipments of products from manufacturers that fail to conform to our quality control standards. In such event, unless we are able to obtain replacement products in a timely manner, we may lose sales. We cannot assure that third party manufacturers (1) will not supply similar products to our competitors, (2) will not stop supplying products to us completely or (3) will supply products that satisfy our quality control standards.
8. IF WE ARE NOT ABLE TO EFFECTIVELY UPGRADE AND ENHANCE OUR ON-LINE VIRTUAL STORE WE MAY LOSE ON-LINE SALES AND OUR IMAGE MAY BE HARMED. We plan to make additional significant investments to improve the performance and content of our existing web site over the next fiscal year. We cannot assure you that these enhancements will be successfully implemented. If we fail to implement and integrate such enhancements successfully, our results of operations may be harmed. Moreover, if we cannot develop an effective and engaging web site, potential future revenue that we would have otherwise gained through sales conducted over the internet and our image may be harmed.
9. IF OUR FOREIGN MANUFACTURERS ARE NOT ABLE TO PROVIDE US WITH SUFFICIENT MERCHANDISE TO MEET CUSTOMER DEMAND OR IF OUR IMPORTS ARE DISRUPTED, OUR SALES AND PROFITABILITY MAY BE HARMED. We purchase our raw materials from mills and other suppliers, a significant portion of which is purchased from suppliers outside the United States, primarily in Europe and Asia. We purchase a portion of our merchandise outside the United States, primarily in Israel, China, Hong Kong and Singapore.
We are subject to risks associated with doing business abroad. These risks include:
- adverse fluctuations in currency exchange rates (particularly those of the U.S. dollar against certain foreign currencies);
- changes in import duties or quotas;
- the imposition of taxes or other charges on imports;
- changes in foreign government regulation, political unrest, disruption or delays of shipments; and
- changes in economic conditions in countries in which our suppliers are located.
If any of the foregoing occurs, it could harm our business, financial condition and results of operations.
Bilateral textile agreements between the United States and a number of foreign countries impose constraints on our import operations. These agreements, which have been negotiated bilaterally either under the framework established by the Arrangement Regarding International Trade in Textiles, known as the Multifiber Agreement, or other applicable treaties, limit the amounts and types of merchandise which may be imported into the United States from these countries. Also, these agreements allow the United States to impose restraints at any time on importing merchandise that, under the terms of the agreements, are not currently subject to specified limits.
In addition, our imported products are subject to United States customs duties which make up a material portion of the cost of the merchandise. If customs duties are substantially increased, it would harm our business and results of operations. The United States and the countries in which our products are produced or sold may impose new quotas, duties, tariffs, or other restrictions, or adversely adjust prevailing quota, duty, or tariff levels, any of which could have a harmful effect on our business and results of operations.
Also, manufacturing facilities in China produce a significant portion of our foreign-supplied products. Recently, China and the United States have been in a number of trade disputes. The United States has threatened to impose punitive tariffs and duties on products imported from China and to withdraw China's "most favored nation" trade status. If China loses the most favored nation status, there are changes in the current tariff or duty structures or United States adopts other trade polices or sanctions adverse to China, it could harm our sales and profitability.
9. OUR BUSINESS IS SEASONAL AND OUR QUARTERLY RESULTS MAY FLUCTUATE WHICH MAY HARM OUR STOCK PRICE. Our sales volumes and levels of profitability fluctuate on a quarterly basis. We tend to generate larger sales and, to an even greater extent, profitability levels in the first and second quarters, which include the fall and holiday selling seasons, of our fiscal year. If for any reason sales are below seasonal norms during the first and second quarters of our fiscal year, as they were in fiscal 1996, our quarterly and annual results of operations would be harmed. Our quarterly financial performance may also fluctuate widely as a result of a number of other factors such as:
- the number and timing of new store openings;
- acceptance of product offerings;
- timing of product deliveries;
- actions by competitors; and
- effectiveness of advertising campaigns.
Due to these factors, we believe that quarter to quarter comparisons of our operating results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance.
10. OUR SUCCESS DEPENDS ON OUR KEY EMPLOYEES, THE LOSS OF WHOM COULD DISRUPT OUR BUSINESS. We depend upon the efforts of our key employees, particularly Manny Mashouf, the founder, Chairman,
President and Chief Executive Officer. None of our executive officers are bound by an employment agreement and therefore their employment is at will. Except for Mr. Mashouf, we do not carry "key person" life insurance policies on any of our employees. If we lose the services of Mr. Mashouf or any key officers or employees, it could harm our business and results of operations.
In addition, our success depends to a significant degree on our ability to attract and retain experienced employees. There is substantial competition for experienced personnel, which we expect to continue. We compete for experienced personnel with companies who have greater financial resources than we do. In the past, we have experienced significant turnover of our retail store personnel. If we fail to attract, motivate and retain qualified personnel, it could harm our business and results of operations.
11. IF WE ARE NOT ABLE TO REGISTER OR PROTECT OUR TRADEMARKS, OUR ABILITY TO CAPITALIZE ON THE VALUE OF OUR BRAND NAME MAY BE IMPAIRED. We believe that our trademarks and other proprietary rights are important to our success. We have registered "bebe" and "bebe moda" in the United States and certain foreign jurisdictions. Even though we take actions to establish and protect our trademarks and other proprietary rights, we cannot assure you that others will not imitate our products or infringe on our intellectual property rights. In addition, we cannot assure that others will not resist or seek to block the sale of our products as violative of their trademark and proprietary rights. In certain jurisdictions, other entities may have rights to names that contain the word "bebe," which could limit our ability to expand in such jurisdictions.
We are seeking to register our trademarks in targeted international markets which we believe represents large potential markets for our products. In some of these markets, local companies currently have registered competing marks, and/or regulatory obstacles exist that may prevent us from obtaining a trademark for the bebe name or related names. In such countries, we may be unable to use the bebe name unless we purchase the right or obtain a license to use the bebe name. We may not be able to register trademarks in these international markets, purchase the right or obtain a license to use the bebe name on commercially reasonable terms. If we fail to obtain trademark, ownership or license rights, it would limit our ability to expand into certain international markets or enter such markets with the bebe name, and to capitalize on the value of our brand.
Furthermore in some jurisdictions, despite successful registration of our trademarks, third parties may allege infringement and bring actions against us.
Currently, we are evaluating our opportunities to expand our product offering and extend our geographic reach through licensing or joint venture arrangements. We have limited experience with any such arrangements, and we cannot assure that such arrangements will be successful. Furthermore, while we intend to maintain control of the presentation and pricing of bebe merchandise through the terms of any such agreement, we cannot assure that any licensee or joint venture partner will comply with such contractual provisions. Any deviation from the terms of these contracts may harm our brand image.
12. WE DEPEND ON TWO ADJACENT FACILITIES, THE LOSS OF WHICH COULD SERIOUSLY DISRUPT OUR BUSINESS. Currently, we operate corporate offices and a distribution center in Brisbane, California. Any serious disruption at this facility whether due to fire, earthquake or otherwise would harm our operations and could have a harmful effect on our business and results of operations.
13. YEAR 2000 FAILURES MAY HARM OUR OPERATIONS. Many existing computer programs use only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming change in the century. If not corrected, many computer applications could create erroneous results by or at the year 2000.
We have created a Year 2000 Task Force, which is implementing a six-phase plan with the objective of ensuring that our management information systems will be Year 2000 Compliant. We believe that the final phase of the plan will be completed by October 31, 1999. We cannot assure that this six-phase plan will be successful or that Year 2000 Compliant issues will not arise with respect to products furnished by third party manufacturers or suppliers. This may result in unforeseen costs or delays to us and therefore harm the Company.
RISKS RELATING TO OUR INDUSTRY:
1. WE FACE SIGNIFICANT COMPETITION IN THE RETAIL AND APPAREL INDUSTRY, WHICH COULD HARM OUR SALES AND PROFITABILITY. The retail and apparel industries are highly competitive and are characterized by low barriers to entry. We expect competition in our markets to increase. The primary competitive factors in our markets are:
- brand name recognition;
- product styling;
- product presentation;
- product pricing;
- store ambiance;
- customer service; and
- convenience.
We compete with traditional department stores, specialty store retailers, off-price retailers and direct marketers for, among other things, raw materials, market share, retail space, finished goods, sourcing and personnel. Because many of these competitors are larger and have substantially greater financial, distribution and marketing resources than we do, we may lack the resources to adequately compete with them. If we fail to compete in any way, it could harm our business, financial condition and results of operations.
2. IF WE FAIL TO DEAL WITH THE RISKS INHERENT IN THE FASHION AND APPAREL INDUSTRY, OUR PROFITABILITY AND BRAND IMAGE MAY BE IMPAIRED. The apparel industry is subject to rapidly evolving fashion trends, shifting consumer demands and intense competition. If we misinterpret the current fashion trends or if we fail to respond to shifts in consumer tastes, demand for bebe products, profitability and brand image could be impaired. Also, we cannot assure that our competitors will not carry similar designs, which would undermine bebe's distinctive image and may harm our brand image. Our future success partly depends on our ability to anticipate, identify and capitalize upon emerging fashion trends, including products, styles, fabrics and colors. In addition, our success depends on our ability to distinguish ourselves within the women's apparel market.
3. IF ECONOMIC CONDITIONS DETERIORATE, THEN IT COULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS, SALES AND PROFITABILITY. The retail and apparel industries are subject to substantial cyclical variation. A recession in the general economy or a decline in consumer spending in the apparel industry could harm our financial performance. Consumers generally purchase less apparel and related merchandise during recessionary periods and consumer spending may decline at other times. A prolonged economic downturn could harm our financial condition. We cannot assure that our customers would continue to make purchases during a recession.
RISKS RELATING TO OUR COMMON STOCK:
1. OUR STOCK PRICE MAY FLUCTUATE BECAUSE OF THE SMALL NUMBER OF SHARES WHICH CAN BE PUBLICLY TRADED AND THE LOW AVERAGE DAILY TRADING VOLUMES. The vast majority of our outstanding shares of our common stock are not registered and are subject to trading restrictions. As of September 22, 1999, only 3,444,146 shares of our Common Stock were available to be publicly traded, and as a result, our average daily trading volumes are relatively low, and our stock price is vulnerable to market swings due to large purchases, sales and short sales of our common stock.
2. BECAUSE A PRINCIPAL SHAREHOLDER CONTROLS THE COMPANY, OTHER SHAREHOLDERS MAY NOT BE ABLE TO INFLUENCE THE DIRECTION THE COMPANY TAKES. Manny Mashouf, the Chairman, President and Chief Executive Officer, beneficially owns approximately 86.2% of the outstanding shares of our common stock. As a result, he alone can control the election of directors and the outcome of all issues submitted to the shareholders. This may make it more difficult for a third party to acquire shares, may discourage acquisition bids, and could limit the price that certain investors might be willing to pay for shares of common stock. This concentration of stock ownership may have the effect of delaying, deferring or preventing a change in control of our company.
3. IF WE ISSUE PREFERRED STOCK IN THE FUTURE, IT MAY HARM THE MARKET PRICE OF OUR COMMON STOCK. The Board of Directors has authority to issue up to 1,000,000 shares of preferred stock at $0.001 par value per share. They also can fix the rights, preferences, privileges and restrictions, including voting rights, of these shares without any vote or action by the shareholders. If preferred stock is issued in the future, the rights of the holders of common stock will be subject to, and may be harmed by, the rights of the holders of any preferred stock. If we issue preferred stock, it would provide us with desirable flexibility in connection with possible acquisitions and other corporate purposes. However, it could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of our company, thereby delaying, deferring or preventing a change in control of our company. Furthermore, such preferred stock may have other rights, including economic rights, senior to the common stock. As a result, the issuance of such preferred stock could harm the market value of the common stock. We have no present plan to issue shares of preferred stock.
4. OUR STOCK PRICE MAY BE VOLATILE BECAUSE OF RISKS INHERENT IN THE RETAIL INDUSTRY. The stock market has from time to time experienced extreme price and volume volatility. In addition, the market price of our common stock, like that of the stock of other retail and apparel companies, may be highly volatile due to certain risks inherent in the apparel industry. Factors such as quarter-to-quarter variations in the our net sales and earnings and changes in financial estimates by equity research analysts or other events or factors could cause the market price of the common stock to fluctuate significantly. Further, due to the volatility of the stock market and the prices of stocks of retail and apparel companies generally, the price of the common stock could fluctuate for reasons unrelated to our operating performance.
5. WE DO NOT ANTICIPATE PAYING CASH DIVIDENDS, WHICH MAY AFFECT THE MARKET PRICE OF OUR COMMON STOCK. We intend to retain any future earnings for use in our business and, therefore, do not anticipate paying any cash dividends on common stock in the foreseeable future. Our future dividend policy will depend on our earnings, capital requirements and financial condition. In addition, it will depend on any restrictions imposed by existing credit agreements and other factors considered relevant by the Board of Directors.
6. ALL OF OUR RESTRICTED SECURITIES ARE ELIGIBLE TO BE SOLD, WHICH MAY CAUSE DILUTION OF OUR COMMON STOCK. We have a total of 24,387,733 shares of common stock outstanding. Of these shares, 21,032,997 are held by the existing shareholders as "restricted securities," which means they acquired these securities from our company in a transaction that did not involve a public offering. These shares may be sold in the public market only if they are registered or if they qualify for an exemption from registration under Rule 144 of the Securities Act. At this time, all restricted securities will be eligible to be sold, subject to certain volume and other limitations under Rule 144.
As of June 30, 1999, options to purchase 1,684,894 shares of common stock were outstanding and exercisable, subject to certain vesting and repurchase restrictions.
STOCK PLANS
On June 26, 1997 the Board of Directors adopted the 1997 Stock Plan (the "Stock Plan"). Options granted under the Stock Plan have a ten-year term and may be either incentive stock options, non-qualified stock options, stock purchase rights or stock awards. We have reserved 2,830,000 shares of common stock for issuance under the Stock Plan. The options granted are immediately exercisable, but are subject to repurchase at the original exercise price in the event that the optionee's employment ceases for any reason. Our right of repurchase generally lapses over a four-year period as follows: 20% in each of the first two years after the grant date and 30% in the third and fourth years after the grant date, with full lapse of the repurchase option occurring on the fourth anniversary date. See Note 9 of Notes to Financial Statements.
STOCK PURCHASE PLAN
On April 7, 1998, our 1998 Employee Stock Purchase Plan (the "Plan") was adopted and approved by the shareholders. A total of 750,000 shares of common stock has been reserved for issuance under the Plan. The Plan will allow eligible employees to purchase our common stock in an amount which may not exceed 10% of the employee's compensation. The Plan will be implemented by sequential 24-month offerings. Each offering will generally be comprised of four, six-month purchase periods, with shares purchased on the last day of each purchase period (a "Purchase Date"). The price at which stock may be purchased is equal to 85% of the lower of fair market value of our common stock on the first day of the offering period or the Purchase Date. There were 35,625 shares issued under the Purchase plan in the fiscal year ended June 30, 1999.
PREFERRED STOCK
On April 7, 1998, our shareholders granted the Board of Directors the authority to issue up to 1,000,000 shares of $0.001 par value preferred stock and to fix the rights, preferences, privileges and restrictions including voting rights, of these shares without any further vote or approval by the shareholders. No preferred stock has been issued to date.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information with respect to this item is set forth in "Index to Financial Statements."
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to this item is incorporated by reference from the Registrant's definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the registrant's fiscal year.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to this item is incorporated by reference from the Registrant's definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the registrant's fiscal year.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this item is incorporated by reference from the Registrant's definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the Registrant's fiscal year.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this item is incorporated by reference from the Registrant's definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the Registrant's fiscal year.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)
1. The financial statements listed in the "Index to Financial Statements" at page are filed as a part of this report.
2. Financial statement schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
3. Exhibits included or incorporated herein: See Index to Exhibits.
(b) Reports on Form 8-K.
There were no reports on Form 8-K filed during the last quarter of the fiscal year covered by this report.
SIGNATURES
Pursuant to the requirements of the Exchange Act of 1934, as amended, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Brisbane, State of California, on the 28th day of September 1999.
BEBE STORES, INC.
By: /s/ MANNY MASHOUF ----------------------------------------- Manny Mashouf PRESIDENT AND CHIEF EXECUTIVE OFFICER (PRINCIPAL EXECUTIVE OFFICER)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Manny Mashouf and Blair Lambert, and each of them acting individually, as his true and lawful attorneys-in-fact and agents, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, with full power of each to act alone, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully for all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Exchange Act, this Annual Report on Form 10-K has been signed by the following persons in the capacities and on the dates indicated:
BEBE STORES, INC. YEARS ENDED JUNE 30, 1999, JUNE 30, 1998 AND JUNE 30, 1997
FINANCIAL STATEMENTS:
INDEPENDENT AUDITORS' REPORT
Board of Directors bebe stores, inc.
We have audited the accompanying balance sheets of bebe stores, inc. (dba bebe) as of June 30, 1999 and June 30, 1998 and the related statements of operations, shareholders' equity, and cash flows for each of the three fiscal years ended June 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material respects, the financial position of bebe stores, inc. as of June 30, 1999 and June 30, 1998, and the results of its operations and its cash flows for each of the three fiscal years ended June 30, 1999 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
San Francisco, California July 27, 1999
BEBE STORES, INC.
BALANCE SHEETS
See accompanying notes to financial statements.
BEBE STORES, INC.
STATEMENTS OF OPERATIONS
See accompanying notes to financial statements.
BEBE STORES, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
See accompanying notes to financial statements.
STATEMENTS OF CASH FLOWS
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF THE BUSINESS--bebe stores, inc. (dba bebe), the "Company," designs, develops and produces a distinctive line of contemporary women's apparel and accessories, which it markets under the bebe and bebe moda brand names primarily through its 101 specialty retail stores located in 23 states, the UK and Canada.
USE OF ESTIMATES--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Actual results could differ from those estimates.
CASH AND EQUIVALENTS represent cash and short-term, highly liquid investments with original maturities of three months or less.
MARKETABLE SECURITIES (classified as available-for-sale securities) are reported at fair value. Fair values are based on quoted market prices. Unrealized gains and losses are excluded from earnings and are reported as an increase or decrease in shareholders' equity and comprehensive income.
INVENTORIES, NET are stated at the lower of FIFO (first-in, first-out) cost or market. Cost includes certain indirect purchasing, merchandise handling and storage costs.
EQUIPMENT AND IMPROVEMENTS, NET are stated at cost. Depreciation on equipment is computed using the double declining balance method for items purchased prior to July 1, 1995 and the straight-line method is used for all improvements as well as equipment purchased after July 1, 1995. Equipment and improvements are depreciated over the estimated useful lives of the related assets ranging from three to twelve years.
LEASING COMMISSIONS associated with negotiating new store leases are capitalized in other assets and amortized over the lease term. Accumulated amortization on leasing commissions at June 30, 1999 and 1998 was $317,913 and $249,549, respectively.
LONG-TERM INVESTMENT--The Company owns 48.35% of a limited partnership and accounts for the investment using the equity method. Accordingly, the investment, which is included in other assets, is carried at cost, adjusted for the Company's percentage share of the partnership's cumulative net income or loss.
DEFERRED RENT--Many of the Company's operating leases contain predetermined fixed increases of the minimum rental rate during the initial lease term. For these leases, the Company recognizes the related rental expense on a straight-line basis and records the difference between the amount charged to expense and the rent paid as deferred rent.
STORE PREOPENING COSTS--Costs associated with the opening or remodeling of stores, such as preopening rent and payroll, are charged to expense as incurred.
ADVERTISING COSTS--Costs associated with advertising are charged to expense when the advertising first takes place. Advertising costs were $8,357,456, $6,735,543, and $2,861,162 respectively, during fiscal 1999, 1998 and 1997.
INCOME TAXES are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) recognized in the Company's financial statements or tax returns. In estimating future tax consequences, expected future events are considered other than changes in the tax law or rates.
ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS--The carrying values of cash and equivalents, investments, receivables, accounts payable, and long-term debt approximates their estimated fair values.
IMPAIRMENT OF LONG-LIVED ASSETS--The Company adopted Statement of Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF as of June 30, 1997. Whenever events or changes in circumstances have indicated that the carrying amount of its assets might not be recoverable, the Company, using its best estimates based on reasonable and supportable assumptions and projections, has reviewed for impairment the carrying value of long-lived assets.
STOCK-BASED COMPENSATION--The Company accounts for stock-based awards to employees using the intrinsic value-based method under Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. The Company has adopted the disclosure provisions of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION.
EARNINGS PER SHARE--In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128, EARNINGS PER SHARE, which requires dual presentation of basic earnings per share ("EPS") and diluted EPS on the face of all statements of operations issued after December 15, 1997 for all entities with complex capital structures. Basic EPS is computed as net earnings divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options.
NEW ACCOUNTING PRONOUNCEMENTS--In fiscal year 1999, the Company implemented SFAS No. 130, "Reporting Comprehensive Income." Comprehensive income consists of net income or loss for the current period and other comprehensive income (income, expenses, gains and losses that currently bypass the income statement and are reported directly as a separate component of equity). The Company's comprehensive income equals net income plus unrealized gains on marketable securities plus foreign currency translation adjustments for all periods presented. Such components of comprehensive earnings are shown in the Statement of Shareholders' Equity.
The Company also adopted SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, which establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. The Company has one reportable segment given the fact that bebe has one brand with product lines of a similar nature. Revenues of its international retail operations represent less than one percent of bebe's total revenues for fiscal year 1999 and did not exist in years prior.
RECLASSIFICATIONS--Certain reclassifications have been made to the prior year financial statements to conform with the fiscal 1999 financial statement presentation.
REVENUE RECOGNITION--Net sales consist of all product sales, net of returns, paid by check, credit card, cash, gift certificate or store credit. Gift certificates sold are carried as a liability and no sale is recognized until the gift certificate is redeemed. Similarly, customers may receive a store credit in exchange for returned goods. Store credits are carried as a liability until redeemed.
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. INVENTORIES
The Company's inventories consist of:
Included in the valuation allowance at June 30, 1999 and 1998 is a reserve for raw materials not directly associated with planned garment production.
3. CREDIT FACILITIES
Debt consists of the following:
On April 1, 1999, the Company entered into an unsecured commercial line of credit agreement with a bank which provides for borrowings and issuance of letters of credit of up to $5,000,000 and expires on April 1, 2000. The outstanding balance bears interest at either the bank's reference rate (which was 8.5%, as of June 30, 1999 and 1998) or the LIBOR rate plus 1.75 percentage points. As of June 30, 1999 and 1998, there was $2,175,900 and $2,424,432, respectively, outstanding in letters of credit.
The line of credit is secured by certain personal property of the Company, primarily inventories, receivables and trademarks. This credit facility required the Company to comply with several financial covenants, including but not limited to a minimum current ratio, minimum tangible net worth, and maximum liabilities to tangible net worth. In addition, under the line of credit, cash dividends could not be paid without the prior consent of the lending institution. As of June 30, 1999 and 1998, the Company was in compliance with such covenants.
The Company purchased 48.35% of a housing partnership in fiscal 1994. The note payable of $62,791 is the remaining amount due on the purchase. The note will be paid off in increments through fiscal year 2001.
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. CREDIT FACILITIES (CONTINUED) Scheduled maturities of debt outstanding at June 30, 1999 are as follows:
4. OPERATING LEASES
The Company has operating leases for its retail store locations, corporate headquarters, distribution center and certain office equipment. Store leases typically provide for payment by the Company of operating expenses, real estate taxes and additional rent based on a percentage of net sales if a specified net sales target is exceeded. In addition, certain leases have escalation clauses and provide for terms of renewal and/or early termination based on the net sales volumes achieved.
Rent expense for the years ended June 30, 1999, 1998 and 1997 was $19,205,735, $15,509,575 and $13,481,105 respectively. Rent expense includes percentage rent and other lease-required expenses for the years ended 1999, 1998 and 1997 of $7,311,922, $6,307,118, and $4,776,148, respectively.
Future minimum lease payments under operating leases at June 30, 1999 are as follows:
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES
Significant components of the provision (benefit) for income taxes are as follows:
Reconciliation of the federal statutory tax rate with the Company's effective income tax rate is as follows:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting purposes.
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES (CONTINUED) Significant components of the Company's deferred tax assets (liabilities) are as follows:
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The Company had established a valuation allowance for 100% of the net deferred asset related to the United Kingdom operations at June 30, 1999 due to the uncertainty of realizing future tax benefits from its foreign net operating loss carryforward (NOL) and other deferred tax assets.
The Company has a net operating loss carryforward with an indefinite carryforward period to offset future taxable income related to the United Kingdom operations of approximately $75,000.
The Company has committed to the acquisition of low income tax credits from a real estate partnership totaling $134,049 through fiscal 2000. The Company utilized $80,430 of credits during both fiscal 1998 and fiscal 1999 to reduce its federal income taxes payable.
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. EQUIPMENT AND IMPROVEMENTS
Equipment and improvements consist of the following:
7. EMPLOYEE BENEFIT PLAN
In fiscal 1995, the Company implemented a 401(k) pension plan for all eligible employees. Employees are eligible to participate in the plan if they have been employed by the Company for one year, have reached age 21, and work at least 1,000 hours annually. Generally, employees can defer up to 15% of their gross wages up to the maximum limit allowable under the Internal Revenue Code. The employer can make a discretionary matching contribution for the employee. Employer contributions to the plan for the years ended June 30, 1999, 1998 and 1997 were $87,888, $72,503, and $32,688, respectively.
8. STOCK OPTIONS
On June 26, 1997 the Board of Directors adopted the 1997 Stock Plan (the "Stock Plan"). Options granted under the Stock Plan have a ten-year term and may be either incentive stock options, non-qualified stock options, stock purchase rights or stock awards. The Company has reserved 2,830,000 shares of common stock for issuance under the Stock Plan.
The options granted are immediately exercisable, but are subject to repurchase at the original exercise price in the event that the optionee's employment with the Company ceases for any reason. The Company's right of repurchase generally lapses over a four-year period as follows: 20% in each of the first two years after the grant date and 30% in the third and fourth years after the grant date, with full lapse of the repurchase option occurring on the fourth anniversary date.
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS (CONTINUED) The following summarizes all stock option transactions for the year ended June 30, 1999 and 1998.
The options granted in June 1997 resulted in deferred compensation of $2,805,000 (assuming all such options become fully vested) to be amortized over the vesting period of the related options, of which $538,279 and $663,773 was expensed for the years ended June 30, 1999 and 1998, respectively. As of June 30, 1999 there were 682,995 shares available for future grant.
The following table summarizes information about stock options outstanding at June 30, 1999:
The Company accounts for the Stock Plan in accordance with APB Opinion No. 25, under which no compensation cost has been recognized for stock option awards granted at fair market value. Had compensation expense for the Stock Plan been determined based on the fair value at the grant dates for
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS (CONTINUED) awards under the Stock Plan, consistent with the method of SFAS No. 123, the Company's net earnings, basic EPS and diluted EPS would have been reduced to the pro forma amounts indicated below:
The weighted average fair value of options granted during the fiscal year ended June 30, 1999 and 1998 was $7.92 and $2.63, respectively. The fair value of each option grant was estimated on the date of the grant using the minimum value method with the following weighted-average assumptions:
9. LITIGATION
The Company is subject to legal proceedings and claims that arise in the ordinary course of business. Management believes, based on the advice of counsel, that ultimate resolution of these matters will not have a material adverse effect on the financial statements taken as a whole.
10. RELATED PARTY TRANSACTIONS
In March 1995, the Company purchased from Manny Mashouf, the Chairman, President and Chief Executive Officer of the Company, certain residential property for $800,000. In February 1997, the Company sold the property to an unaffiliated third party for $696,000, net of selling costs. During the last three fiscal years, Mr. Mashouf has loaned to or borrowed from the Company various amounts of cash ranging from loans to the Company of up to $500,000 and advances from the Company of up to $150,000. As of June 30, 1999, there were no borrowings due to Mr. Mashouf from the Company or advances owed to the Company by Mr. Mashouf.
11. EARNINGS PER SHARE
Under SFAS No. 128, the Company provides dual presentation of EPS on a basic and diluted basis. The Company's granting of certain stock options resulted in potential dilution of basic EPS. The following
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. EARNINGS PER SHARE (CONTINUED) table summarizes the difference between basic weighted average shares outstanding and diluted weighted average shares outstanding used to compute diluted EPS.
The number of incremental shares from the assumed issuance of stock options is calculated applying the treasury stock method.
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The quarterly financial information presented below reflects all adjustments which, in the opinion of the Company's management, are of a normal and recurring nature necessary to present fairly the results of operations for the periods presented.
BEBE STORES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (CONTINUED)
SCHEDULE
BEBE STORES, INC. VALUATION AND QUALIFYING ACCOUNTS
INDEX TO EXHIBITS
- ------------------------
* Incorporated by reference from exhibits of the same number in Registrant's Registration Statement on Form S-1 (Reg. No. 333-50333), effective June 16, 1998.
** Incorporated by reference from exhibits of the same number in Registrant's Quarterly Report on Form 10-Q filed on February 16, 1999.