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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended May 1, 2004

OR

For the transition period from              to             

Commission file number 0-21406.

Brookstone, Inc.

(Exact name of registrant as specified in its charter)

17 Riverside Street, Nashua, NH 03062

(address of principal executive offices, zip code)

603-880-9500

(Registrant’s telephone number, including area code)

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

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 20,180,951 shares of common stock as of June 7, 2004.

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BROOKSTONE, INC.

Index to Form 10-Q

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BROOKSTONE, INC.

CONSOLIDATED BALANCE SHEET

(In thousands, except share data)

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

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BROOKSTONE, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

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

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BROOKSTONE, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(In thousands)

(Unaudited)

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

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BROOKSTONE, INC.

Notes to Consolidated Financial Statements

The Company has stock option plans in effect that provide for the issuance of non-qualified and incentive stock options. Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation”, as amended by Statement of Accounting Standards No. 148 (“SFAS 148”), permits the Company to follow the measurement provisions of APB Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees”. Stock Options have historically been granted at or above the market price on the date of the grant. The Company has also issued restricted stock awards under its stock option plans. Restricted stock awards are issued at no cost to the recipient of the award, and have restrictions that lapse over four years from date of grant. The market value in excess of cost is charged to income ratably over the period during which these awards vest. No stock option awards were granted during the first fiscal quarter of 2004. Had compensation cost for the Company’s stock-based incentive compensation plans been determined based on the fair value at the grant dates of awards under those plans, consistent with the methodology prescribed by SFAS No. 123, as amended by SFAS No. 148, the Company’s net loss and related loss per share for the quarter ended May 1, 2004 and May 3, 2003 would have been increased to the pro forma amounts indicated below:

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

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

The tables below disclose segment net sales and pre-tax loss for the thirteen-week period ended May 1, 2004 and May 3, 2003 (in thousands).

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Basic and diluted earnings per share (EPS) were calculated for the thirteen-week period ended May 1, 2004 and May 3, 2003 as follows:

For the thirteen-week period ended May 1, 2004, antidilutive shares of 769,891 were excluded from the computations of diluted earnings per share. For the thirteen-week period ended May 3, 2003, antidilutive shares of 379,625 were excluded from the computations of diluted earnings per share.

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

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

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

Under the requirements of FIN46R, variable interest entities are required to be consolidated if the total equity investment at risk is not sufficient to permit the entity to finance its activities without financial support or the equity investors lack certain specified characteristics of a controlling financial interest. The Company has reviewed the requirements of FIN 46R and has determined that the Atlanta Joint Venture qualifies as a Variable Interest Entity (“VIE”) as of its inception date in Fiscal 2001 and that the Company is the primary beneficiary of the VIE. As primary beneficiary, the Company

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consolidated this entity effective for the first fiscal quarter of 2004 which is the Company’s first interim or annual reporting period ending after March 15, 2004 as required by this interpretation. As a result of the consolidation, $636 thousand of the Atlanta joint venture assets, $603 thousand in minority interests and no liabilities are reflected in the Company’s May 1, 2004 balance sheet. Additionally, as a result of the Atlanta joint venture consolidation, the Company’s revenues increased by $1,026 thousand, cost of sales increased $519 thousand, selling and general administrative expenses increased $304 thousand and other party interests in consolidated entities, net of tax increased $64 thousand. The consolidation had no impact on the Company’s consolidated net loss for the first fiscal quarter of 2004.

The Company contributed more than the minimum required amount for the past year to the pension plan. As a result, there is no required contribution during Fiscal 2004 but it is the intent of the Company to contribute approximately $200 thousand to maintain a funded status that is more than the minimal required level under ERISA. The Company made no payments during the first fiscal quarter of 2004.

The components of net periodic pension cost were as follows:

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

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

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BROOKSTONE, INC.

Management’s Discussion and Analysis of

Financial Condition and Results of Operations for

The Thirteen-week Period Ended May 1, 2004

Results of Operations

For the thirteen-week period ended May 1, 2004, net sales increased 27.1% over the comparable period last year, including an incremental increase of 1.7% in same store sales attributable to the Company’s adoption of FASB Interpretation No. 46R. Retail sales for the thirteen-week period increased $14.8 million, or 29.2%, to $65.7 million as compared to $50.8 million for the same period last year. Same store sales increased 20.1% over the comparable period last year generating $10.2 million in increased retail sales. The remaining $4.6 million of the retail sales increase resulted primarily from the opening of 18 new stores less three store closings subsequent to the first quarter of Fiscal 2003. The total number of stores open at the end of the thirteen-week period ended May 1, 2004 was 276 versus 261 at the end of the comparable period in Fiscal 2003. Driving the quarter’s retail sales increases were strong sales performances and successful new product introductions in the Personal Care, Home Comfort, Massage and Travel categories.

Direct marketing sales for the thirteen-week period ended May 1, 2004 increased to $11.8 million as compared to $10.1 million for the same period in Fiscal 2003 on a 9.9% increase in catalog circulation. The $1.7 million increase is comprised of a $1.5 million increase in the Brookstone Brand (Hard-to-Find Tools, Brookstone Catalog, Internet and Corporate Sales) driven primarily by the increase in catalog circulation and a 41.6% sales increase in the Brookstone Internet Site. Gardeners Eden direct marketing sales increased $0.2 million, including the introduction of the internet site, on a 5.0% decrease in catalog circulation.

For the thirteen-week period ended May 1, 2004, gross profit as a percentage of net sales increased 5.5% to 29.8% versus 24.3% for the comparable period last year. Improved product purchase margins and reduced markdowns in Fiscal 2004 resulted in an improvement of 1.8% in gross profit as a percent of net sales. Occupancy costs as a percent of net sales decreased 3.5% primarily resulting from the increase in same store sales. Order postage expense decreased 0.2% as a percent of net sales as a result of costs associated with the delivery of products to customers.

Selling, general and administrative expenses as a percentage of net sales decreased 2.2% for the thirteen-week period ended May 1, 2004 to 39.0% versus 41.2% for the comparable period last year primarily as a result of leveraging the increase in net sales and effective expense management especially in the areas of payroll costs (decrease of 2.4%) and catalog costs (decrease of 0.6%). These decreases were offset by an 0.8% increase in a number of other expenses including professional services, marketing and travel expenses.

Net interest expense for the thirteen-week period ended May 1, 2004 was $236 thousand compared to $131 thousand for the comparable period last year. This increase resulted primarily from lower interest rates earned on investments in Fiscal 2004 as compared to the same period in Fiscal 2003.

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

The Company operates two of its airport locations in Chicago, four airport locations in Atlanta and one airport in Las Vegas under three separate Joint Venture arrangements. The Company has a 70% ownership interest in the Chicago venture, a 49% ownership interest in the Atlanta venture and an 80% ownership in the Las Vegas venture. In Fiscal 2004, all of these joint venture entities are consolidated in the Company’s financial statements. The ownership interest in the revenues and expenses for these joint ventures for the first quarter of 2004 belonging to the Company’s Joint Venture partners (the 30% ownership interest in the Chicago venture, the 51% ownership interest in the Atlanta venture and the 20% ownership interest in the Las Vegas venture) comprises the balance of $100 thousand, net of tax, in other party interests in consolidated entities on the Statement of Operations. Prior to Fiscal 2004, the Atlanta joint venture was accounted for as an equity investment and as such the Joint Venture partner’s interests were not consolidated. See also Notes 9 and 10.

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As a result of the foregoing, the Company reported a net loss of $4.6 million, or $0.23 per basic and diluted share, for the thirteen-week period ended May 1, 2004, as compared to a $6.4 million net loss, or $0.33 per basic and diluted share, for the comparable period last year.

Financial Condition

For the thirteen-week period ended May 1, 2004, net cash used by operating activities totaled $25.2 million, primarily reflecting the net loss, the purchase of inventory and a decrease in other current liabilities resulting primarily from the payment of income taxes ($9.0 million) and the payment of accrued incentive compensation ($6.3 million). Cash used for investment activities during the thirteen-week period of Fiscal 2004, representing the purchase of property and equipment amounted to approximately $7.3 million. Cash provided by financing activities during the thirteen-week period of Fiscal 2004 amounted to $85 thousand primarily as a result of proceeds from the exercise of stock options partially offset by capitalized lease payments.

For the thirteen-week period ended May 3, 2003, net cash used by operating activities totaled $21.3 million, primarily reflecting the net loss and a decrease in other current liabilities resulting primarily from the payment of income taxes and accrued incentive compensation. Cash used for investment activities during the thirteen-week period of Fiscal 2003, representing the purchase of property and equipment amounted to approximately $3.0 million. Cash provided by financing activities during the thirteen-week period of Fiscal 2003 amounted to $433 thousand primarily as a result of proceeds from the exercise of stock options partially offset by capitalized lease payments.

Merchandise inventories increased to $70.0 million at May 1, 2004 as compared to $66.9 at January 31, 2004, but rose approximately 16.9% when compared to the quarter ended May 3, 2003. The Company anticipates that inventory levels will continue to be higher in the second fiscal quarter in response to current sales trends experienced by the Company. The Company also anticipates inventory levels to be higher in the third and fourth fiscal quarters of Fiscal 2004 as compared to Fiscal 2003 to support retail store growth.

Other current assets increased approximately 20.4% to $7.5 million from $6.2 million at January 31, 2004 primarily as a result of an increase in insurance premiums and prepaid deposits on store fixtures. Other assets increased $1.8 million to $4.2 million as compared to $2.4 million at January 31, 2004 principally as a result of costs associated with catalogs to be mailed in the beginning of the second quarter.

The Company’s $7.3 million in capital expenditures for the thirteen-week period ended May 1, 2004 were related to construction of the new headquarters building, the continued expansion of the distribution center (Phase III - the replacement of the current material handling system), the opening of three Brookstone stores, the remodel of three Brookstone stores and construction related to stores anticipated to open in the upcoming fiscal quarter. The Company anticipates opening up to 20 new stores, including up to eight airport locations, and to remodel approximately 10 stores in Fiscal 2004, all in the new store format developed in Fiscal 2002. The Company anticipates spending approximately $7.0 million on Phase III of the Distribution Center expansion in Fiscal 2004, of which $2.5 million was spent in the first fiscal quarter, and expects completion of the project by the end of the second fiscal quarter. In late Fiscal 2003, the Company began construction of its new headquarters facility and anticipates the $11.0 million facility to be completed by the third fiscal quarter of 2004. The Company anticipates spending $9.0 million in Fiscal 2004 on the new headquarters, of which $2.9 million was spent in the first fiscal quarter.

The Company maintains a revolving credit agreement to finance inventory purchases, which historically peak in the third quarter in anticipation of the winter holiday selling season. At May 1, 2004 and at May 3, 2003 the Company had no borrowings outstanding under its revolving credit agreement. Amounts due under the facility were secured by the personal property of the Company, tangible or intangible including all stock of Brookstone, Inc.’s subsidiaries, but excluding real property, machinery and equipment encumbered on February 21, 2002, and general intangibles. The security interest in the facility was subject to collateral release conditions dependent upon four consecutive quarters fixed charge coverage ratio of 1.40 to 1.00 and consolidated EBITDA for the four quarters then ended of at least $34.5 million. During the second quarter of 2004, the Company agreed with its lenders to forego its collateral release conditions in exchange for reduced interest rates within its revolving credit agreement (“Amendment No. 2”). The new fixed charge coverage ratios that determine which of three different levels of fees and applicable margin rates are to be charged on applicable borrowings are as follows: the Company may borrow at either the agent bank’s base lending rate plus the applicable percentage (0.250%, 0.000% or 0.000%), or the Eurodollar rate for the applicable period plus the applicable percentage (1.750%, 1.500%, or 1.250%). In addition, the Company is obligated to pay a fee of 0.500%, 0.375% or 0.300% on the unused portion of the commitment, 0.875%, 0.750%, or 0.625% on the documentary letters of credit and 1.875%, 1.625% or 1.375% on the standby letters of credit. Amendment No. 2 also adjusted certain capital expenditure restrictions, including an increase in aggregate spending allowed for the new headquarters facility from $10.0 million to $11.0 million in either Fiscal 2003 or Fiscal 2004.

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The Company believes that cash on hand, anticipated cash generated from operations and available borrowings will be sufficient to finance its capital requirements, including Phase III of the distribution center expansion and the construction of the new headquarters, throughout Fiscal 2004. In conjunction with the expansion of the distribution center, the Company amended the distribution center capital lease, extending the expiration date from October 2013 to March 2024 and reducing the interest rate to prime from prime plus 1% per annum. Presently, the Company is investigating various financing options available as alternatives to funding the construction of the new headquarters. Additionally in Fiscal 2004, the Company anticipates funding approximately $200 thousand for its obligation under its defined pension plan.

Outlook: Important Factors and Uncertainties

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

Item 3: Quantitative and Qualitative Disclosures about Market Risk

The Company’s exposure to interest rate fluctuations is minimal due to the Company’s use of short-term borrowings and cash flows to fund operations and capital improvements rather than long-term borrowings. The Company does not currently use derivative financial instruments, however management is investigating the most advantageous method of financing the new headquarters which may include the limited use of derivative instruments.

Item 4: Controls and Procedures

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

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PART II

Other Information

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Signatures

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

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