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

Overview

Bed Bath & Beyond Inc. and subsidiaries (the “Company”) operates specialty retail stores nationwide.  The Company’s objective is to be a customer’s first choice for products and services in the categories offered, in the markets in which the Company operates.

The Company’s strategy is to achieve this objective through excellent customer service, an extensive breadth and depth of assortment, everyday low prices, introduction of new merchandising offerings and development of our infrastructure.

Operating in the highly competitive retail industry, the Company, along with other retail companies, is influenced by a number of factors including, but not limited to, general economic conditions, consumer preferences and spending habits, competition from existing and potential competitors, unusual weather patterns and the ability to find suitable locations at reasonable occupancy costs to support the Company’s expansion program.

For the three and six months ended August 28, 2004, the Company’s consolidated net sales increased by 14.6% and 18.4%, respectively, as compared to the corresponding periods last year.  These increases were primarily attributable to the continuing Bed Bath & Beyond (“BBB”) store expansion program, the inclusion of the results of Christmas Tree Shops, Inc. (“CTS”) which was acquired in June 2003 and an increase in comparable store sales.  CTS, whose comparable store sales were slightly negative for the three and six months ended August 28, 2004, will be included in the total Company’s comparable store sales calculation starting in the third quarter of fiscal 2004.

Comparable store sales (which excluded CTS sales) for the fiscal three and six months of 2004 increased by approximately 4.8% and 4.9%, respectively. The increase in comparable store sales 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 with an emphasis on responding to customer feedback.

A store is considered a comparable store when it has been open for twelve full months following its grand opening period (typically four to six weeks).  Stores relocated or expanded are excluded from comparable store sales if the change in square footage would cause meaningful disparity in sales over the prior period.  In the case of a store to be closed, such store’s sales are not considered comparable once the store closing process has commenced.

For the three and six months ended August 28, 2004, the Company’s consolidated net earnings increased by 23.5% and 30.6%, respectively, as compared to the corresponding periods last year.  These increases were primarily a result of relative increases in gross profit as a percentage of net sales and relative decreases in selling, general and administrative expenses (“SG&A”) as a percentage of net sales.

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Results of Operations

Net Sales

Net sales for the three months ended August 28, 2004 were approximately $1.3 billion, an increase of $162.5 million or approximately 14.6% over net sales of approximately $1.1 billion for the corresponding quarter last year.  For the six months ended August 28, 2004, net sales were approximately $2.4 billion, an increase of $369.6 million or approximately 18.4% over net sales of approximately $2.0 billion for the corresponding six months of last year.

The increase in net sales for the three and six months ended August 28, 2004 was attributable to the Company’s new store sales, approximately 59.9% and 46.7%, respectively, and CTS’ sales (acquired on June 19, 2003), approximately 10.2% and 28.0%, respectively. The balance of the increase was primarily attributable to the increase in comparable store sales.  The increase in comparable store sales for the fiscal three and six months of 2004 was 4.8% and 4.9%, respectively. The increases in comparable store sales are 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 with an emphasis on responding to customer feedback.

Sales of domestics merchandise and home furnishings for the Company accounted for approximately 52% and 48% of net sales, respectively, for both the three months ended August 28, 2004 and August 30, 2003.

Gross Profit

Gross profit for the three and six months ended August 28, 2004 was $530.8 million and $987.6 million, or 41.7% and 41.6% of net sales, respectively.  Gross profit for the three and six months ended August 30, 2003 was $459.1 million and $826.3 million, or 41.3% and 41.2% of net sales, respectively.  The increase in gross profit as a percentage of net sales for the three and six months ended August 28, 2004 was driven primarily by the reduction of inventory acquisition costs which resulted in part from favorable shifts in the sales mix attributable to the Company’s current merchandise offerings, as well as the Company’s procurement initiatives to improve gross profit.

Selling, General and Administrative Expenses

SG&A for the three and six months ended August 28, 2004 was $341.7 million and $669.8 million, or 26.8% and 28.2% of net sales, respectively.  SG&A for the three and six months ended August 30, 2003 was $303.3 million and $580.0 million, or 27.3% and 28.9% of net sales, respectively.  The decrease in SG&A as a percentage of net sales for the quarter was primarily attributable to a decrease in payroll and payroll related items and occupancy costs, which primarily resulted from the comparable store sales increase.  The decrease in SG&A as a percentage of net sales for the fiscal six months was primarily attributable to a decrease in payroll and payroll related items, occupancy costs and other expenses, which primarily resulted from the comparable store sales increase.

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Operating Profit

Operating profit for the three months ended August 28, 2004 increased to $189.1 million compared to $155.9 million during the comparable period in 2003.   For the six months ended August 28, 2004 operating profit increased to $317.8 million compared to $246.3 million during the comparable period of 2003.  The improvements in operating profit were a result of the increases in total net sales and relative increases in gross profit as a percentage of net sales and relative decreases in SG&A as a percentage of net sales, as discussed above.

Interest Income

Interest income was $3.7 million and $6.8 million for the fiscal three and six month periods of 2004, respectively, compared to $2.2 million and $5.3 million for the fiscal three and six month periods of 2003, respectively.  Interest income increased due to an increase in invested cash and an increase in the Company’s average investment interest rate as a result of the recent upward trend in short term interest rates during the past three months.

Income Taxes

The effective tax rate was 37.75% for the fiscal three and six month periods of 2004 and 38.5% for the fiscal three and six month periods of 2003.  The decrease is due to a reduction in the weighted average effective tax rate resulting from a change in the mix of the business within the taxable jurisdictions in which the Company operates.

Net Earnings

As a result of the factors described above, net earnings increased to $120.0 million for the fiscal three month period of 2004 and $202.1 million for the fiscal six month period of 2004, compared with $97.2 million for the fiscal three month period of 2003 and $154.7 million for the fiscal six month period 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 606 BBB stores, 24 CTS stores and 31 Harmon stores at the end of the fiscal second quarter of 2004, compared with 514 BBB stores, 23 CTS stores and 29 Harmon stores at the end of the corresponding quarter last year.  At August 28, 2004, Company-wide total square footage was approximately 21.3 million square feet.

The Company opened 14 BBB stores during the second quarter of fiscal 2004 which brought the total BBB stores opened to 31 for the fiscal first half of 2004.  The Company plans to open approximately 54 additional BBB stores, in both new and existing markets, two CTS stores and approximately four additional Harmon stores by the end of the fiscal year.

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Liquidity and Capital Resources

Net cash provided by operating activities for the six months ended August 28, 2004 was $243.6 million as compared with $247.4 million in the corresponding period of fiscal 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, partially offset by increases in income taxes payable and accounts payable (primarily due to an increase in merchandise inventory) and an increase in net income.

Inventory per square foot, which was $49.42 as of August 28, 2004 and $50.72 as of August 30, 2003, was relatively flat year over year.  The Company continues to focus on optimizing inventory productivity while maintaining appropriate in-store merchandise levels to support sales growth.

Net cash used in investing activities for the six months ended August 28, 2004 was $224.3 million as compared with $141.8 million used in the corresponding period of fiscal 2003.  This change is primarily the result of a net increase in investment securities and the payment for the acquisition of CTS in the prior year. The increase in capital expenditures was primarily attributable to expenditures for furniture, fixtures and leasehold improvements for the 31 new BBB stores opened during the first six months of fiscal 2004 and information technology enhancements, compared to expenditures for furniture, fixtures and leasehold improvements and information technology enhancements for the 24 new BBB stores opened in the corresponding period last year.

Net cash provided by financing activities for the six months ended August 28, 2004 was $2.0 million as compared with $3.9 million used in the corresponding period of 2003.  The change in the net cash position between fiscal years is primarily attributable to the prepayment of CTS’ debt in the prior year in conjunction with the acquisition.

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.

Seasonality

The Company exhibits less seasonality than many other retail businesses, although sales levels are generally higher in August, November and December and generally lower in February and March.

Critical Accounting Policies

The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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.

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Sales Returns :  Sales returns, which are reserved for based on historical experience, are provided for in the period that the related sales are recorded. Although these estimates have not varied materially from historical provisions, actual experience could vary from our historical experience in the future if the level of sales return activity changes materially.  In the future, if the Company concludes an adjustment to the sales returns accrual is required, the reserve will be adjusted accordingly.

Inventory Valuation :  Merchandise inventories are stated at the lower of cost or market.  BBB’s and Harmon’s inventory cost is calculated using the retail inventory method and CTS’ inventory cost is calculated using the first-in, first-out cost 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.

At any one time, inventories include items that have been written down to the Company’s best estimate of their realizable value.  Factors considered in estimating realizable value include the age of merchandise and anticipated demand.  Actual realizable value could differ materially from this estimate based upon future customer demand or economic conditions.

The Company estimates its reserve for shrinkage throughout the year, based on historical shrinkage.  Actual shrinkage is recorded at year-end based upon the results of the Company’s physical inventory count.  Historically, the Company’s shrinkage has not been volatile.

Impairment of Long-Lived Assets :  The Company reviews long-lived assets for impairment by comparing the carrying value of these 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 has not historically had a material impairment of long-lived assets and the Company does not believe that a material impairment currently exists.  In the future, if events or market conditions affect the estimated cash flows generated by the Company’s long-lived assets to the extent that an asset is impaired, the Company will adjust the carrying value of these assets in the period in which the impairment occurs.

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 which incorporate assumptions marketplace participants would use in making their estimates of fair value.  The Company has historically not recorded an impairment to its goodwill and other indefinitely lived intangible assets and does not believe that a material impairment currently exists.  In the future, if events or market conditions affect the estimated fair value to the extent that an asset is impaired, the Company will adjust the carrying value of the asset in the period in which the impairment occurs.

Vendor Allowances :  The Company receives allowances from vendors in the normal course of business for various reasons including direct cooperative advertising, purchase volume and reimbursement for other expenses.  Annual terms for each allowance include the basis for earning the allowance and payment terms which vary by each agreement.  Prior to the adoption of the FASB’s Emerging Issues Task Force Issue (“EITF”) No. 02-16, “Accounting by a Customer (including a

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Reseller) for certain Consideration Received from a Vendor,” allowances were recorded as either a reduction of inventory cost, an advertising expense or a sales incentive. After adopting EITF 02-16, which was effective for all new vendor allowances, including modifications of existing allowances, entered into after December 31, 2002, all vendor allowances are recorded as a reduction of inventory cost, except for direct cooperative advertising allowances which are specific, incremental and identifiable.  The Company recognizes purchase volume allowances as a reduction of the cost of inventory in the quarter in which milestones are achieved.

Self Insurance :  The Company utilizes a combination of insurance and self insurance for a number of risks including workers compensation, general liability, automobile liability and employee related health care benefits (a portion of which is paid by our employees). Liabilities associated with the risks that we retain are estimated by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions.  Although the Company’s claims experience has not displayed substantial volatility in the past, actual experience could materially vary from our historical experience in the future.  Factors that affect these estimates include but are not limited to: inflation, the number and severity of claims and regulatory changes.  In the future, if the Company concludes an adjustment to self insurance accruals are required, the liability will be adjusted accordingly.

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. The Company can not predict the nature and validity of claims which could be asserted in the future, and future claims could have a material impact on its earnings.

Store Opening, Expansion, Relocation and Closing Costs :  Store opening, expansion, relocation and closing costs, including estimates for markdowns, asset residual values and projected occupancy 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 preferences and 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 the Investor Relations section of 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.