ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

In the first quarter of fiscal 2004, Bed Bath & Beyond Inc.’s (the “Company”) consolidated net sales increased by 23.2% and net earnings increased by 42.7% as compared to the same quarter last year.  These increases were primarily attributable to the continuing Bed Bath & Beyond (“BBB”) expansion program, an increase of comparable store sales of 5.1%, the inclusion of Christmas Tree Shops, Inc. (“CTS”) results which was acquired in June 2003 and the Company’s ability to reduce costs as a percentage of net sales.

Comparable store sales for fiscal first quarter 2004 increased by approximately 5.1% as compared with an increase of approximately 4.4% for fiscal first quarter 2003.  The increase in comparable store sales in the fiscal first quarter reflected a number of factors, including but not limited to, the continued consumer acceptance of the Company’s merchandise offerings and a strong focus on customer service.

The Company plans to continue to expand its operations and invest in its infrastructure to reach its long-term objectives.

Results of Operations

Three Months Ended May 29, 2004 vs. Three Months Ended May 31, 2003

Net sales for the first quarter ended May 29, 2004 were $1.1 billion, an increase of $207.0 million or approximately 23.2% over net sales of $893.9 million for the corresponding quarter last year.  Approximately 36% of the increase was attributable to the Company’s new store sales and 42% of the increase was attributable to CTS sales.  The balance of the increase is primarily attributable to the increase in comparable store sales.  The increase in comparable store sales in the first quarter of 2004 was 5.1% as compared to 4.4% in the first quarter of 2003.  The increase in comparable store sales is due to a number of factors, including but not limited to, the continued consumer acceptance of the Company’s merchandise offerings and a strong focus on customer service.  Approximately 50% and 50% of the Company’s store sales for the fiscal first quarter 2004 were attributable to sales of domestics merchandise and home furnishings, respectively, compared to 54% and 46%, respectively, for the fiscal first quarter 2003.  The change in the product mix is primarily the result of the acquisition of CTS.

Gross profit for the first quarter of 2004 was $456.8 million or 41.5% of net sales, compared with $367.2 million or 41.1% of net sales during the first quarter of 2003.  The increase in gross profit as a percentage of net sales was primarily attributable to improvements in both the markup and markdowns taken.

Selling, general and administrative expenses (“SG&A”) were $328.1 million in the first quarter of 2004 compared with $276.7 million in the corresponding quarter last year and as a percentage of net sales were 29.8% and 31.0%, respectively.  The decrease in SG&A as a percentage of net sales was primarily attributable to a decrease in occupancy costs and other expenses.

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As a result of the foregoing, operating profit increased to $128.7 million, compared with $90.5 million during the first quarter of 2003.

Interest income was $3.1 million for the first quarter of 2004 and 2003.  Although cash and cash equivalents and investment securities increased from the prior year, interest income remained consistent due to a decrease in the average investment interest rate.

The effective tax rate was 37.75% for the first quarter of 2004 and 38.5% for the first quarter of 2003.  The decrease in the effective tax rate is due to a reduction in the weighted average effective tax rate in the taxable jurisdictions in which the Company conducts business.

As a result of the factors described above, net earnings increased to $82.0 million for the first quarter of 2004, compared with $57.5 million in the first quarter of 2003.

Expansion Program

The Company is engaged in an ongoing expansion program involving the opening of new stores in both new and existing markets and the expansion or relocation of existing stores. As a result of this program, the Company operated 592 BBB stores and 31 Harmon stores at the end of the first quarter of 2004, compared with 498 BBB stores and 29 Harmon stores at the end of the corresponding quarter last year. Additionally, the Company acquired 23 CTS stores as of June 19, 2003 and subsequently opened one additional store in the second quarter of 2003 bringing the total number of CTS stores to 24.

At May 29, 2004, Company-wide total square footage was approximately 20.9 million square feet. BBB store space grew to approximately 19.8 million square feet at the end of the first quarter of 2004 from approximately 17.4 million square feet at the end of the first quarter of last year.

During the first quarter of fiscal 2004, the Company opened 17 BBB stores.  Including the stores opened through the first quarter, the Company plans to open approximately 80 to 90 BBB stores by the end of the fiscal year.

Liquidity and Capital Resources

Net cash provided by operating activities in fiscal first quarter 2004 was $60.1 million as compared with $107.7 million in fiscal first quarter 2003.  The decrease in net cash provided by operating activities was primarily attributable to an increase in merchandise inventories (primarily a result of new store space) and a decrease in accrued expenses and other current liabilities (primarily due to the payment of certain obligations related to the acquisition of CTS), partially offset by an increase in net income.

Net cash used in investing activities in fiscal first quarter 2004 was $131.0 million as compared with $48.4 million provided in fiscal first quarter 2003.  This change is primarily the result of an increase in the investment securities purchased and a reduction in the level of investment securities redeemed.  The increase in capital expenditures was primarily attributable to expenditures for furniture, fixtures and leasehold improvements for the 17 new BBB stores opened during the first three months of fiscal 2004, compared to expenditures for furniture, fixtures and leasehold improvements for the eight new BBB stores opened in the corresponding period last year.

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Net cash provided by financing activities in fiscal first quarter 2004 was $4.0 million as compared with $12.0 million in fiscal first quarter 2003, which is attributable to a decrease in the proceeds received from the exercise of stock options.

For fiscal 2004, the Company believes that its current operating cash flow, working capital, and cash and cash equivalents on hand will be sufficient to meet its obligations in the ordinary course of business, including capital expenditures and new store openings.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to establish accounting policies and to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on other assumptions that it believes to be relevant under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. In particular, judgment is used in areas such as the provision for sales returns, inventory valuation, impairment of long-lived assets, goodwill and other indefinitely lived intangible assets, vendor allowances and accruals for self insurance, litigation and store opening, expansion, relocation and closing costs. Actual results could differ from these estimates.

Sales Returns: Sales returns, which are reserved for based on historical experience, are provided for in the period that the related sales are recorded.

Inventory Valuation: Merchandise inventories are stated at the lower of cost or market, generally using the retail inventory method. Under the retail inventory method, the valuation of inventories at cost and the resulting gross margins are calculated by applying a cost-to-retail ratio to the retail value of inventories. In addition, the Company estimates a reserve for expected shrinkage throughout the year, based on historical shrinkage. Actual shrinkage is recorded at year-end based on the results of the Company’s physical inventory count. At any one time, inventories include items that have been marked down to the Company’s best estimate of their fair market value. Actual markdowns required could differ from this estimate.

Impairment of Long-Lived Assets: The Company reviews long-lived assets for impairment by comparing the carrying value of the assets with their estimated future undiscounted cash flows when events or changes in circumstances indicate the carrying value of these assets may exceed their current fair values. If it is determined that an impairment loss has occurred, the loss would be recognized during that period. The impairment loss is calculated as the difference between asset carrying values and the present value of the estimated net cash flows. The Company does not believe that any material impairment currently exists related to its long-lived assets.

Goodwill and Other Indefinitely Lived Intangible Assets : The Company reviews goodwill and other intangibles that have indefinite lives for impairment annually and otherwise when events or changes in circumstances indicate the carrying value of these assets might exceed their current fair values. Impairment testing is based upon the best information available, including estimates of fair value

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which incorporate assumptions marketplace participants would use in making their estimates of fair value. The Company does not believe that any material impairment currently exists related to its goodwill and indefinitely lived intangible assets.

Vendor Allowances: The Company receives various types of allowances from our merchandise vendors, which are based on negotiated terms. These allowances are recorded when earned as a reduction of cost of sales or as a reduction of other costs in accordance with the provisions of the Financial Accounting Standards Board’s Emerging Issues Task Force Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.”

Self Insurance : The Company uses self insurance for a number of risks including worker’s compensation, general liability, automobile liability and employee related health care benefits (a portion of which is paid by our employees). Liabilities associated with these risks are estimated by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions.

Litigation : The Company records an estimated liability related to various claims and legal actions arising in the ordinary course of business which is based on available information and advice from outside counsel, where appropriate. As additional information becomes available, the Company reassesses the potential liability related to its pending litigation and revises its estimates as appropriate.

Store Opening, Expansion, Relocation and Closing Costs : Store opening, expansion, relocation and closing costs are charged to earnings as incurred. Prior to the adoption of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which was effective for any exit or disposal activity initiated after December 31, 2002, costs related to store relocations and closings were provided for in the period in which management approved the relocation or closing of a store. Actual costs related to store relocations and closings could differ from these estimates.

Acquisition

On June 19, 2003, the Company acquired CTS.  The results of CTS’ operations have been included in the consolidated financial statements since the date of acquisition. At the date of acquisition, CTS, headquartered in South Yarmouth, Massachusetts, operated 23 stores in 6 states.  CTS is a retailer of giftware and household items selling a broad assortment of domestics merchandise and home furnishings at low prices in many categories including home décor, giftware, housewares, food, paper goods, and seasonal products.

The aggregate all cash purchase price, including the costs of the acquisition, was $194.4 million, net of cash acquired, which included $175.5 million of cash and $18.9 million in deferred payments payable in cash over three years.  In June 2004, the Company paid the first of these deferred payments of $6.7 million.

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Forward Looking Statements

This Form 10-Q may contain forward looking statements.  Many of these forward looking statements can be identified by use of words such as may, will, expect, anticipate, estimate, assume, continue, project, plan, and similar words and phrases.  The Company’s actual results and future financial condition may differ materially from those expressed in any such forward looking statements as a result of many factors that may be outside the Company’s control.  Such factors include, without limitation: general economic conditions, changes in the retailing environment and consumer spending habits, demographics and other macroeconomic factors that may impact the level of spending for the types of merchandise sold by the Company; unusual weather patterns; competition from existing and potential competitors; competition from other channels of distribution; pricing pressures; the ability to find suitable locations at reasonable occupancy costs to support the Company’s expansion program; and the cost of labor, merchandise and other costs and expenses. The Company does not undertake any obligation to update its forward looking statements.

Available Information

The Company makes available as soon as reasonably practicable after filing with the SEC, free of charge, through its website, www.bedbathandbeyond.com, the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, electronically filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.