BUILD-A-BEAR WORKSHOP INC (BBW)

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 contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in “Risk Factors” and elsewhere in this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report on Form 10-K.

Business Overview

Build-A-Bear Workshop, Inc., a Delaware corporation, was formed in 1997 as a mall-based, experiential specialty retailer where children and their families could create their own stuffed animals by participating in the stuffing, fluffing, dressing, accessorizing, and naming of their own teddy bears and other plush toys. We believe the hands-on and interactive nature of our experience locations, our personal service model and engaging digital shopping experiences result in guests forming an emotional connection with our brand. Over the last 27 years, with more than 250 million furry friends sold to guests around the world, Build-A-Bear has become a brand with high consumer awareness, positive affinity, and strong retail influence. We are leveraging this brand strength to grow our brick-and-mortar retail footprint beyond traditional malls through a range of store sizes, formats and locations including tourist destinations. We are also growing through our websites, which focus on gift-giving, collectible merchandise, and licensed products. In addition to growing our corporately-managed store and e-commerce footprint, we are also growing through third-party-operated and franchised stores, particularly for our international expansion. Our ongoing digital transformation, which touches our e-commerce business, consumer loyalty program and digital marketing and content, has led to omni-channel growth over the past several years. Build-A-Bear's pop-culture and multi-generational appeal have played a key role in growing our total addressable market beyond children by adding teens and adults with entertainment and sports licensing, collectible and gifting offerings, as well as by introducing new products and adding categories beyond plush.

We primarily operate through a vertical retail channel with corporately-managed stores that feature a unique combination of experience and product in which guests can “make their own stuffed animals.” We also operate e-commerce sites that focus on gift-giving, collectible merchandise and licensed products that appeal to consumers that have an affinity for characters from a range of entertainment, sports, art, and gaming properties. Our engaging digital purchasing experiences include our online “Bear-Builder,” an age-gated, adult-focused “Bear Cave” and the “HeartBox” gift site. Our retail stores also act as mini distribution centers that provide efficient omnichannel support for our growing digital demand. The primary consumer target for our brick-and-mortar locations is families with children, while our e-commerce sites focus on collectors and gift givers that are primarily tweens, teens and adults.

We also sell product and provide our unique “Bear Builder” experience through the two additional channels of partner-operated and franchise-operated stores. Additionally, we offer products in non-plush consumer categories via outbound licensing agreements with leading manufacturers.

Our strategy includes leveraging our brand strength to continue to strategically evolve our brick-and-mortar retail footprint beyond traditional malls with a versatile range of formats and locations including tourist destinations, expand into international markets primarily via our partner-operated and franchise store models, and grow our e-commerce business. By leveraging our brand strength and owned intellectual properties through the creation of engaging short-form and long-form content for kids and adults, we endeavor to develop a circle of continuous engagement to increase purchase occasions and to continue to broaden the consumer base beyond children by adding tweens, teens and adults with entertainment and sports licensing, plus collectible and gifting offerings.

As of February 1, 2025, we had 368 corporate-managed stores globally, 138 locations operating through our "third-party retail" model in which we sell our products on a wholesale basis to other companies that then in turn execute our retail experience, and 83 franchised stores operating internationally under the Build-A-Bear Workshop brand. In addition to our stores, we sold product on our company-owned e-commerce sites.

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We operate in three segments that share the same infrastructure, including management, systems, merchandising and marketing, and generate revenues as follows:

Selected financial data attributable to each segment for fiscal 2024, 2023 and 2022 are presented in Note 15 — Segment Information to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Our year-over-year results discussed below are impacted by fiscal 2024 and fiscal 2022 being 52-week periods compared to fiscal 2023 which had an additional week because it was a 53-week period.

Our consolidated net income was $51.8 million in fiscal 2024 compared to net income of $52.8 million in fiscal 2023 and $48.0 million in fiscal 2022. We believe that we have a concept that has broad demographic appeal which, for North American stores open for the entire year averaged net retail sales per store of $1.2 million in fiscal 2024, 2023 and 2022.

We ended fiscal 2024 with no borrowings under our credit agreement and with $27.8 million in cash, cash equivalents and restricted cash after investing $19.3 million in capital projects throughout the year. In fiscal 2024 the company utilized $31.0 million in cash to repurchase 1,021,004 shares.  During the year, the Company repurchased shares under two separate stock repurchase programs.  The company repurchased 758,301 shares utilizing $20.2 million in cash under the Company's $50.0 million stock repurchase program that was authorized by its Board of Directors on August 31, 2022 (the "August 2022 Stock Repurchase Program").  On September 11, 2024, the Company announced that its Board of Directors terminated the August 2022 Stock Repurchase Program and authorized a new share repurchase program of up to $100 million (the “September 2024 Stock Repurchase Program”).  The company repurchased 262,703 shares utilizing $10.8 million in cash under the September 2024 Stock Repurchase Program.  From the end of fiscal 2024 through April 14, 2025, the Company utilized $4.2 million to repurchase 108,503 shares under the stock buyback program, leaving $85.0 million available under the September 2024 Stock Repurchase Program.

On March 13, 2024, we announced that our Board of Directors approved a new quarterly dividend program to evolve its strategic use of capital.  During fiscal 2024, the company declared and paid quarterly dividends totaling $11.0 million.  Additionally, the Board of Directors declared a quarterly cash dividend of $0.22 per share on the issued and outstanding common stock of the company, which was paid on April 10, 2025, to all stockholders of record as of March 27, 2025.

Recent Events and Trends Regarding Tariffs and International Trade

Since we import the vast majority of our products from vendors outside the U.S., we face uncertainty and risks related to tariffs and other trade policies that could negatively impact our Company.  Tariffs and other non-tariff trade practices can adversely affect our business in multiple ways including increased costs of our products. While we have taken steps since 2020 to diversify our supply chain and reduce China sourcing by shifting primarily to Vietnam, we remain subject to substantial potential exposure to tariffs. Specifically, the latest tariffs implemented by the U.S. would have significant impact on our cost structure and product margins. Additionally, the uncertainty about trade policy, tariff rates, and other changes in practices affecting international trade, including whether such tariffs or other measures will be withdrawn, or modified in the future, makes it difficult for us to operate optimally. Depending on the level and longevity of the tariff disruption, we will continue to adjust our pricing while monitoring the impact of inflation and consumer confidence, on both a micro and macro basis.

Following is a description and discussion of the major components of our statement of operations:

Revenues

Net retail sales, commercial revenue and international franchising: See Note 3 — "Revenue" to the consolidated financial statements for additional accounting information.

We use net retail sales per square foot as a performance measure for our business. The following table details net retail sales per square foot for stores open throughout the fiscal year for the periods presented:

:

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Costs and Expenses

Cost of merchandise sold: Cost of merchandise sold is driven primarily by our retail segment. Cost of merchandise sold – retail includes the cost of the merchandise, including royalties paid to licensors of third party branded merchandise, store occupancy cost, including store depreciation and store asset impairment charges (if not disclosed separately due to materiality) (See Note 6 — "Property and Equipment, net" to the consolidated financial statements for additional accounting information regarding store asset impairment), cost of warehousing and distribution, packaging, stuffing, damages and shortages, and shipping and handling costs incurred in shipment to customers. Retail gross profit is defined as net retail sales less the cost of merchandise sold - retail. For the commercial segment, cost of merchandise includes the cost of merchandise sold to third-party retailers on a wholesale basis for sale within their stores. For the franchise segment, cost of merchandise includes the sale of furniture, fixtures, and supplies to our franchise partners.

Selling, general and administrative expense (“SGA”): These expenses include store payroll and benefits, advertising, credit card fees, store supplies and normal store pre-opening and closing expenses as well as central office general and administrative expenses, including costs for management payroll, benefits, incentive compensation, travel, information systems, accounting, insurance, legal and public relations. These expenses also include depreciation of central office assets and the amortization of other assets. Certain store expenses such as credit card fees historically have increased or decreased proportionately with net retail sales. In addition, bad debt expenses and recoveries and accounts receivable related charges are recorded in SGA.

Stores

Corporately-Managed Locations:

The number of Build-A-Bear Workshop stores in the U.S. and Canada (collectively, North America) and the U.K. and Ireland (collectively, Europe) for the last three fiscal years is summarized as follows:

During fiscal 2024, our retail business model continued to evolve to address changing shopping patterns by diversifying our locations, formats and geographies. We are updating our store portfolio with our Discovery format, which represented 52% of our store base as of February 1, 2025. During fiscal 2024, we executed eight planned net new store openings in North America, with seven being opened under the Discovery format. Temporary locations generally have lease terms of two to eighteen months. These specific sites are designed to capitalize on short-term opportunities. In the future, we expect to close certain stores in accordance with natural lease events as an ongoing part of our real estate management and day-to-day operational plans.

Third-Party Retail Locations:

The number of third-party retail locations opened and closed for the periods presented below is summarized as follows:

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Through our third-party retail model, there were 138 stores in operation at the end of fiscal year 2024 with relationships that included Carnival Cruise Line, Great Wolf Lodge Resorts, Landry's, and Girl Scouts of the USA. The third-party retail model is capital light for us, with the partner company building out and operating the workshops including providing the real estate location and covering the cost of labor and inventory, which is purchased on a wholesale basis. These locations are heavily-weighted to the hospitality industry, which allow us to further advance our focus on experience location expansion in non-traditional and tourist areas, as well as shop-in-shop arrangements within other retailers’ stores.

International Franchise Locations:

Our first franchisee location was opened in November 2003. All franchised stores generally have similar signage, store layout and merchandise assortments as our corporately-managed stores. As of February 1, 2025, we had five master franchise agreements, which typically grant franchise rights for a particular country or group of countries, covering an aggregate of eight countries.

The number of international, franchised stores opened and closed for the periods presented below is summarized as follows:

As of February 1, 2025, the distribution of franchised locations among these countries was as follows:

In the ordinary course of business, we anticipate signing additional master franchise agreements in the future and terminating other such agreements. We source fixtures and other supplies for our franchisees from China which significantly reduces the capital and lowers the expenses required to open franchises. We are leveraging new formats that have been developed for our corporately-managed locations such as concourses and shop-in-shops with our franchisees.

Results of Operations

Fiscal 2024 Overview

Our performance continues to reflect the success of our strategy which has allowed us to put the building blocks in place to develop a powerful platform to support our initiatives to deliver consistent profitable growth. We believe our elevated omnichannel business model, which includes a highly profitable e-commerce and experiential retail store base, complimented by diversified revenue streams and disciplined expense and balance sheet management, puts us in a solid position for continued future success. We delivered a full year pre-tax profit of $67.1 million, which was the highest in our company’s 27-year history. In response to a variety of external pressures including changes in consumer shopping habits resulting in the rapid rise of the digital economy and shifting mall traffic patterns, we remained focused on accelerating and expanding our key initiatives by investing in and executing plans to improve operations and profitability. We believe that the majority of our positive performance was driven by the disciplined execution of our strategic initiatives, including leveraging our financial management to invest in growth initiatives, to contribute to an increase in total revenue of $10.3 million in fiscal 2024. We ended the year with cash and cash equivalents of $27.8 million with no outstanding borrowings on our credit facility. During fiscal 2024, the Company returned $42.0 million to shareholders through $31.0 million in share repurchases and $11.0 million in dividends.

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The following table sets forth, for the periods indicated, selected statement of operations data expressed as a percentage of total revenues, except where otherwise indicated. Percentages may not total due to immaterial rounding:

Fiscal Year Ended February 1, 2025 Compared to Fiscal Year Ended February 3, 2024

Fiscal 2024 had 52 weeks compared to fiscal 2023 which was impacted by an additional week as it was a 53-week period.

Total revenues. Net retail sales were $460.3 million for fiscal 2024, compared to $456.2 million for fiscal 2023, an increase of $4.2 million or 0.9%, compared to the prior year. The components of this increase are as follows:

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The retail revenue increase was primarily the result of an increase in sales from corporately-operated retail locations through growth in the number of transactions, as our traffic outpaced national retail traffic data, and the opening of a net nine new corporately-managed locations in the fiscal year. The increased sales were partially offset by impact of the 53rd week in 2023 and a decrease in web demand for the year.

Commercial revenue was $31.4 million for fiscal 2024 compared to $25.4 million for fiscal 2023, an increase of $6.0 million or 23.5%, primarily due to increased sales volume from our commercial accounts through our third-party retail model.

Revenue from international franchising was $4.7 million for fiscal 2024 compared to $4.5 million for fiscal 2023. This $0.2 million or 3.4% increase was primarily due to having more stores in operation in 2024 compared to the same period in 2023.

Retail gross margin. Retail gross margin was $253.1 million in fiscal 2024 compared to $249.3 million in fiscal 2023, an increase of $3.8 million or 1.5%. As a percentage of net retail sales, retail gross margin increased to 55.0% for fiscal 2024 from 54.7% for fiscal 2023, or 30 basis points as a percentage of net retail sales. The increase in gross margin was the result of lower merchandise and freight costs partially offset by higher occupancy expenses.

Selling, general and administrative. Selling, general and administrative expenses were $206.2 million or 41.5% of consolidated revenue for fiscal 2024 as compared to $199.0 million or 40.9% of consolidated revenue for fiscal 2023. The increase in overall expense was driven by higher store-level wages due to minimum wage increases and higher outside services.  These higher expenses were partially offset by decreased advertising expense.

Interest expense (income), net. For fiscal 2024, we had $0.9 million of interest income compared to $0.9 million of interest income in fiscal 2023.

Provision for income taxes. The provision for income taxes was $15.4 million in fiscal 2024 compared to $13.5 million in fiscal 2023. The 2024 effective rate of 22.9% differed from the statutory rate of 21% primarily due to state income tax expense partially offset by the benefit of the foreign-derived intangible income (FDII) deduction. The 2023 effective rate of 20.4% differed from the statutory rate of 21% primarily due to the reversal of the valuation allowance in the U.K. partially offset by state income tax expense.

Fiscal Year Ended February 3, 2024 Compared to Fiscal Year Ended January 28, 2023

Fiscal 2023 was impacted by an additional week as it was a 53-week period, which is compared to 52 weeks in fiscal 2022.

Total revenues. Net retail sales were $
456.2 million for fiscal
2023, compared to $
446.2 million for
fiscal
2022
, an increase
of $10.0
million or 2.2%,
compared to the prior year. The components of this increase are as follows:

The retail revenue increase was primarily the result of the 53rd week in the fiscal year, new store openings, and an increase in gift card breakage recorded, partially offset by a decrease in digital sales.

Commercial revenue was $25.4 million for fiscal 2023 compared to $18.5 million for fiscal 2022, an increase of $6.9 million or 37.2% primarily due to increased sales volume from our commercial accounts through our third-party retail model.

Revenue from international franchising was $4.5 million for fiscal 2023 compared to $3.2 million for fiscal 2022. This $1.3 million or 40.6% increase was primarily due to having more stores in operation in 2023 compared to the same period in 2022.

Retail gross margin. Retail gross margin was $249.3 million in fiscal 2023 compared to $234.7 million in fiscal 2022, an increase of $14.6 million or 6.2%. As a percentage of net retail sales, retail gross margin increased to 54.6% for fiscal 2023 from 52.6% for fiscal 2022, or 200 basis points as a percentage of net retail sales. The increase in gross margin was the result of lower freight expenses in 2023 compared to 2022.

Selling, general and administrative. Selling, general and administrative expenses were $199.0 million or 40.9% of consolidated revenue for fiscal 2023 as compared to $183.9 million or 39.3% of consolidated revenue for fiscal 2022. The increase in overall expense was driven by higher store-level wages due to inflation and the addition of talent and other investments to support growth, including an advertising expense increase of $4.7 million or 23.9% compared to fiscal 2022.

Interest expense (income), net. For fiscal 2023, we had $0.9 million of interest income compared to an immaterial amount of interest expense in fiscal 2022, resulting from higher interest rates.

Provision for income taxes. The provision for income taxes was $13.5 million in fiscal 2023 compared to $13.9 million in fiscal 2022. The 2023 effective rate of 20.4% differed from the statutory rate of 21% primarily due to the reversal of the valuation allowance in the U.K. partially offset by state income tax expense. The 2022 effective rate of 22.5% differed from the statutory rate of 21% primarily due to state income tax expense.

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Non-GAAP Financial Measure - Earnings before Interest, Taxes, Depreciation, and Amortization

We believe that earnings before interest, taxes, depreciation, and amortization ("EBITDA") provides meaningful information about our operational efficiency by excluding the impact of differences in tax jurisdictions and structures, debt levels, and capital investment. Additionally, this measure is the metric used for portions of the Company's incentive compensation structure. This measure is not in accordance with, or an alternative to, GAAP. The most comparable GAAP measure is income before income taxes, or pre-tax income. EBITDA should not be considered in isolation or as a substitution for analysis of our results as reported in accordance with GAAP. Other companies may calculate EBIT and EBITDA differently, limiting the usefulness of the measures for comparisons with other companies. The following table sets forth, for the periods indicated, the components of EBITDA (dollars in millions):

EBITDA for fiscal 2024 was $81.1 million, compared to $79.1 million for fiscal 2023  and $74.4  million in fiscal 2022.   The increase of $2.0 million in fiscal 2024 was driven by retail and commercial margins partially offset by higher SG&A expenses.  The increase in fiscal 2023 was driven by lower freight expense, leverage of warehouse costs, and the impact of the 53rd week in fiscal 2023.

Liquidity and Capital Resources

Our cash requirements are primarily for the opening, remodeling or reformatting of stores, installation and upgrades of information systems and working capital. Over the past several years, we have met these requirements through cash generated from operations.

Operating Activities. Cash flows provided by operating activities were $47.1 million, $64.3 million and $47.3 million in fiscal years 2024, 2023 and 2022, respectively. Cash flows from operating activities decreased in fiscal 2024 as compared to fiscal 2023 primarily driven by increased cash spent on inventory purchases in the second half of fiscal 2024 in anticipation of the uncertainty in cost due to potential tariffs, higher accounts receivable resulting from higher commercial revenue and decreased payables and accrued expenses. Cash flows from operating activities increased in fiscal 2023 as compared to fiscal 2022 primarily driven by a decrease in cash spent on inventory purchases and increased sales volume, resulting in higher net income.

Investing Activities. Cash flows used in investing activities were $19.3 million, $18.3 million and $13.6 million in fiscal years 2024, 2023 and 2022, respectively. The increases in cash used in investing activities when comparing fiscal 2024 to fiscal 2023 and fiscal 2023 to fiscal 2022 were primarily driven by an increased spending on capital expenditures related to information technology projects and new store openings.

Financing Activities. Financing activities used cash of $44.2 million in fiscal 2024, $43.9 million in fiscal 2023 and $25.1 million in fiscal 2022. Cash used in financing activities in fiscal 2024 increased slightly when compared to fiscal 2023 due to increased stock repurchases offset by lower dividends. Cash used in financing activities in fiscal 2023 increased as compared to fiscal 2022, driven primarily by the repurchases of our common stock for $20.5 million throughout fiscal 2023 and dividends paid of $22.1 million.

Capital Resources. As of February 1, 2025, we had a cash balance of $27.8 million, of which 79% was domiciled within the U.S, after investing $19.3 million in capital projects throughout the year.

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We have a revolving credit and security agreement with PNC Bank, as agent, that provides for a secured revolving loan in aggregate principal of up to $25.0 million, subject to a borrowing base formula. As of February 1, 2025, borrowings under the agreement would bear interest at (a) a base rate determined under the agreement, or (b) the borrower's option, at a rate based on SOFR, plus in either case a margin based on average undrawn availability as determined in accordance with the agreement. As of February 3, 2024, we had a borrowing base of $25.0 million. As of February 1, 2025, we had no outstanding borrowings.

During fiscal 2024, we utilized $31.0 million in cash to repurchase 1,021,004 shares under the both the August 2022 Stock Repurchase Program and September 2024 Stock Repurchase Program.  Since the end of fiscal 2024 through April 14, 2025, the Company utilized $4.2 million to repurchase 108,503 shares under the stock buyback program, leaving $85.0 million available under the September 2024 Stock Repurchase Program.

On March 13, 2024, the Company announced the initiation of a quarterly dividend program and during the first, second, third and fourth quarters of fiscal 2024, the Company declared cash dividends of $0.20 per share, totaling $2.9 million, $2.7 million, $2.7 million and $2.7 million, respectively. Additionally, the Board of Directors declared a quarterly cash dividend of $0.22 per share on the issued and outstanding common stock of the Company, which was paid on April 10, 2025, to all stockholders of record as of March 27, 2025.

As of February 1, 2025, we had restricted cash of $0.4 million compared to $0.4 million as of February 3, 2024 and $0.5 million as of January 28, 2023.

Most of our retail stores are located within shopping malls and all are operated under leases classified as operating leases. Our leases in North America tend to be shorter term leases to provide flexibility in aligning stores with market trends. During fiscal 2024, lease extensions began to have longer terms as we have secured longer deals with more favorable terms. Our leases typically require us to pay personal property taxes, our pro rata share of real property taxes of the shopping mall, our own utilities, repairs and maintenance in our store, a pro rata share of the malls’ common area maintenance and, in some instances, merchant association fees and media fund contributions. Many leases contain incentives to help defray the cost of construction of a new store. Typically, a portion of the incentive must be repaid to the landlord if we choose to terminate the lease prior to its contracted term. In addition, some of these leases contain various restrictions relating to change in control of our company. Our leases also subject us to risks relating to compliance with changing mall rules and the exercise of discretion by our landlords on various matters, including rights of termination in some cases. Rents are invoiced monthly and paid in advance.

Our leases in the U.K. and Ireland typically have terms of five or ten years and generally contain a provision whereby every third or fifth year we have the opportunity to exit the lease (the ‘break clause’). The leases typically provide the lessee with the first right for renewal at the end of the lease. We may also be required to make deposits and rent guarantees to secure new leases as we expand. Real estate taxes also change according to government time schedules to reflect current market rental rates for the locations we lease. Rents are invoiced monthly or quarterly and paid in advance.

Capital spending in fiscal 2024 totaled $19.3 million and was primarily used to support our ongoing digital initiatives and new store openings.

We have various contractual or other obligations, including operating lease commitments and obligations under deferred compensation plans. Additional information is provided in the notes to our consolidated financial statements. As of February 1, 2025, we had purchase obligations totaling approximately $98.3 million, of which $27.0 million are due in the next 12 months. We believe our operating cash flows are sufficient to meet our material cash requirements for at least the next 12 months.

We have no off-balance sheet arrangements as of February 1, 2025.

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Inflation

The impact of inflation on the Company's business operations was seen throughout fiscal 2022 and 2023.  Inflation continued to adversely affect our business in fiscal 2024, mainly through rising store labor costs. However, we continue to take mitigating actions, such as select strategic price increases on highly sought-after products and leveraging distribution costs. We expect the inflationary pressures experienced in fiscal 2024 to continue into fiscal 2025, specifically through wage increases and tariffs on inventory purchases.  We continue to monitor the impact of inflation on our business operations on an ongoing basis and may need to adjust our prices further to mitigate the impacts of changes to the rate of inflation during 2024 or in future years. Future volatility of general price inflation and the impact of inflation on costs and availability of materials, costs for shipping and warehousing and other operational overhead could adversely affect our financial results. Inflationary pressures may be exacerbated by higher transportation costs due to war and other geopolitical conflicts, such as the current Russia/Ukraine conflict, tension between China and Taiwan, and the Israel-Hamas conflict. We cannot provide an estimate or range of impact that such inflation may have on our future results of operations. However, if we are unable to recover the impact of these costs through price increases to our guests, or if consumer spending decreases as a result of inflation, our business, results of operations, financial condition and cash flows may be adversely affected. In addition, ongoing inflation in product costs may result in lower gross margin rates if we elect to maintain higher inventory reserves to mitigate anticipated higher costs.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements.

We believe application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

Our accounting policies are more fully described in Note 2 - "Summary of Significant Accounting Policies" to our consolidated financial statements, which appear elsewhere in this Annual Report on Form 10-K. We have identified the following critical accounting estimates:

Long-Lived Asset Impairments

In accordance with ASC 360-10-35, we assess the potential impairment of long-lived assets, which include property, plant and equipment and operating lease right-of-use assets (subsequent to the adoption of ASC 842, Leases) when events or changes in circumstances indicate that the carrying value may not be recoverable. Management's judgments regarding the existence of impairment indicators are based on market conditions and financial performance. Recoverability is measured by comparing the carrying amount of an asset, or asset group, to expected future net cash flows generated by the asset, or asset group. If the carrying amount exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. For operating lease right-of-use assets, we determine the fair value of the lease right-of-use assets by comparing the contractual rent payments to estimated market rental rates. Fair value is calculated as the present value of estimated future cash flows for each asset group.

For purposes of evaluating store assets for impairment, we have determined that each store location is an asset group, inclusive of the right-of-use asset attributable to each store. Factors that we consider important which could individually or in combination trigger an impairment review include, but are not limited to, the following: (1) significant underperformance relative to historical or projected future operating results; (2) significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and (3) significant changes in our business strategies and/or negative industry or economic trends. We assess events and changes in circumstances or strategy that could potentially indicate that the carrying value of long-lived assets may not be recoverable as they occur. Due to the significance of the fourth quarter to individual store locations, we assess store performance quarterly, using rolling twelve-month results (i.e. full fiscal year). We consider a historical and/or projected negative cash flow trend for a store location to be an indicator that the carrying value of that asset group may not be recoverable. Impairment charges related to this assessment are typically included in Store asset impairment as a component of income (loss) before income taxes in the DTC segment. See Note 4 - "Leases" and Note 6 - "Property and Equipment, net" to our consolidated financial statements for further discussion.

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During fiscal 2024, 2023 and 2022, we recorded immaterial impairment charges on long-lived assets. As a measure of sensitivity for fiscal 2024, a hypothetical 10% decrease in the undiscounted future cash flows for the stores would have resulted in immaterial impairments for the year.

Additionally, we consider a more likely than not assessment that an individual location will close prior to the end of its lease term as a triggering event to review the store asset group for recoverability. These assessments are reviewed on a quarterly basis. When indicated, the carrying value of the assets is reduced to fair value, calculated as the estimated future cash flows for each asset group.

In the event that we decide to close any or all of these stores in the future, we may be required to record additional impairments, lease termination fees, severance and other charges. Impairment losses in the future are dependent on a number of factors such as site selection, general economic trends, public health issues (such as a pandemic), and thus could be significantly different than historical results. The assumptions used in future calculations of fair value may change significantly which could result in further impairment charges in future periods.

Revenue Recognition

For the Company’s gift cards, revenue is deferred for single transactions until redemption including any related gift card discounts. Approximately 80% of gift cards are redeemed within three years of issuance and over the last three years, approximately 65% of gift cards issued have been redeemed within the first twelve months. In addition, unredeemed gift cards or breakage revenue is recorded in proportion to the customer’s redemption pattern using an estimated breakage rate based on historical experience. Subsequent to stores reopening following shutdowns caused by COVID, the Company experienced lower redemptions of its gift cards for all periods of outstanding activated cards compared to pre-pandemic redemption patterns (fiscal year 2019 and earlier), which impacts the gift card breakage rate. The Company does not believe that the redemption pattern experienced during the pandemic reflects the pattern in the future and has adjusted the historical redemption data used to calculate the breakage rate. The Company continues to evaluate expected breakage annually and adjusts the breakage rates in the fourth quarter of each year, or other times, if significant changes in customer behavior are detected. Changes to breakage estimates impact revenue recognition prospectively.  Further, given the magnitude of the Company's gift card liability, the changes in breakage rates could have a significant impact on the amount of breakage revenue recognized in future periods. As a matter of sensitivity, a hypothetical 1% change in our gift card breakage rate in fiscal 2024 would have resulted in a change in breakage revenue of $1.1 million.

For certain qualifying transactions, a portion of revenue transactions are deferred for the obligation related to our loyalty program or when a material right in the form of a future discount is granted. In these transactions, the transaction price is allocated to the separate performance obligations based on the relative standalone selling price. The standalone selling price for the points earned for our loyalty program is estimated using the net retail value of the merchandise purchased, adjusted for estimated breakage based on historical redemption patterns. The revenue associated with the initial merchandise purchased is recognized immediately and the value assigned to the points is deferred until the points are redeemed, forfeited or expired. A hypothetical 1% change in redemption patterns our loyalty program would result in a change in deferred revenue of approximately $0.1 million.

In regard to the consolidated balance sheet, contract liabilities for gift cards are classified as gift cards and customer deposits, and contract liabilities related to the loyalty program are classified as deferred revenue and other.

See Note 3 - "Revenue for additional information".

Leases

We determine if an arrangement is a lease at inception. The right-of-use assets and liabilities are recognized at the commencement date based on the present value of lease payments using a discounted cash flow analysis, considering lease terms and our internal borrowing rate, over the lease term for those arrangements where there is an identified asset and the contract conveys the right to control its use. Our lease term includes options to extend or terminate a lease only when it is reasonably certain that we will exercise that option.

The majority of our leases do not provide an implicit rate and therefore, we estimate the incremental borrowing discount rate on a periodic basis. The discount rates used are indicative of a synthetic credit rating based on quantitative and qualitative analysis and adjusted one notch higher to estimate a secured credit rating. For non-U.S. locations, a risk-free rate yield based on the currency of the lease is used to estimate the incremental borrowing rate.

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Income Taxes

We recognize deferred tax assets resulting from tax credit carryforwards and deductible temporary differences between taxable income on our income tax returns and income before taxes under GAAP. Deferred tax assets generally represent future tax benefits to be received when these carryforwards can be applied against future taxable income or when expenses previously reported in our consolidated financial statements become deductible for income tax purposes. A deferred tax asset valuation allowance is required when some portion or all of the deferred tax assets may not be realized. We consider the weight of all available evidence, both positive and negative, in assessing the realizability of the deferred tax assets by each taxing jurisdiction. We evaluate the sustained profitability and three years of cumulative income in each jurisdiction and consider the Company’s ability to carry back its tax losses or credits for refunds, the availability of tax planning strategies, reversals of existing taxable temporary differences and projections of future taxable income.  As we had incurred a cumulative book loss in the U.K. over the three-year period ended February 2, 2019, we evaluated the realizability of our UK deferred tax assets and, accordingly, in the fourth quarter of fiscal 2018, the Company recorded a $3.7 million valuation allowance on its U.K. deferred tax assets.  In the fourth quarter of fiscal 2023, the Company recorded a benefit of $5.1 million for the reversal of the valuation allowance on deferred tax assets expected to be realized in the U.K.  The positive evidence considered in our assessment of the realizability of the deferred tax assets included the generation of significant positive cumulative income in the U.K. for the three-year period ending with fiscal 2023, the implementation of tax planning strategies, and projections of future taxable income.  The Company maintains a valuation allowance in fiscal year 2023 and 2024 in certain other foreign jurisdictions.  Changes in the valuation allowance in fiscal 2024 are primarily related to functional currency fluctuations.

Significant judgment is required in evaluating our uncertain tax positions. We establish accruals for uncertain tax positions when we believe that the full amount of the associated tax benefit may not be realized. In the future, if we prevail in matters for which accruals have been established previously or pay amounts in excess of reserves, there could be an effect on our income tax provisions in the period in which such determination is made. Tax authorities regularly examine the Company’s returns in the jurisdictions in which the Company does business. Management regularly assesses the tax risk of the company’s return filing positions and believes its accruals for uncertain tax benefits are adequate as of February 1, 2025, February 3, 2024, and January 28, 2023.

Recent Accounting Pronouncements

See Note 2 – "Summary of Significant Accounting Policies" for additional information.

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 contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in “Risk Factors” and elsewhere in this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report on Form 10-K.

Business Overview

Build-A-Bear Workshop, Inc. a Delaware corporation, was formed in 1997 as a mall-based, experiential specialty retailer where children and their families could create their own stuffed animals by participating in the stuffing, fluffing, dressing, accessorizing, and naming of their own teddy bears and other plush toys. We believe the hands-on and interactive nature of our experience locations, our personal service model and engaging digital shopping experiences result in guests forming an emotional connection with our brand. Over the last 26 years, with more than 240 million furry friends sold to guests around the world, Build-A-Bear has become a brand with high consumer awareness, positive affinity, and strong retail influence. We are leveraging this brand strength to grow our brick-and-mortar retail footprint beyond traditional malls through a range of store sizes, formats and locations including tourist destinations. We are also growing through our websites, which focus on gift-giving, collectible merchandise, and licensed products. In addition to growing our corporately-managed store and e-commerce footprint, we are also growing through third-party operated and franchised stores, particularly for our international expansion. Our ongoing digital transformation, which touches our e-commerce business, consumer loyalty program and digital marketing and content, has led to omni-channel growth over the past several years. Build-A-Bear's pop-culture and multi-generational appeal have played a key role in growing our total addressable market beyond children by adding teens and adults with entertainment and sports licensing, collectible and gifting offerings, as well as by introducing new products and adding categories beyond plush.

We primarily operate through a vertical retail channel with corporately-managed stores that feature a unique combination of experience and product in which guests can “make their own stuffed animals.” We also operate e-commerce sites that focus on gift-giving, collectible merchandise and licensed products that appeal to consumers that have an affinity for characters from a range of entertainment, sports, art, and gaming properties. Our engaging digital purchasing experiences include our online “Bear-Builder,” an age-gated, adult-focused “Bear Cave” and the “HeartBox” gift site. Our retail stores also act as mini distribution centers that provide efficient omnichannel support for our growing digital demand. The primary consumer target for our brick-and-mortar locations is families with children, while our e-commerce sites focus on collectors and gift givers that are primarily tweens, teens and adults.

We also sell product and provide our unique “Bear Builder” experience through the two additional channels of partner-operated and franchise-operated stores. Additionally, we offer products in non-plush consumer categories via outbound licensing agreements with leading manufacturers.

Our strategy includes leveraging our brand strength to continue to strategically evolve our brick-and-mortar retail footprint beyond traditional malls with a versatile range of formats and locations including tourist destinations, expand into international markets primarily via our partner-operated and franchise store models, and grow our e-commerce business. By leveraging our brand strength and owned intellectual properties through the creation of engaging short-form and long-form content for kids and adults, we endeavor to develop a circle of continuous engagement to increase purchase occasions and to continue to broaden the consumer base beyond children by adding tweens, teens and adults with entertainment and sports licensing, plus collectible and gifting offerings.

As of February 3, 2024, we had 359 corporate-managed stores globally, 92 locations operating through our "third-party retail" model in which we sell our products on a wholesale basis to other companies that then in turn execute our retail experience, and 74 franchised stores operating internationally under the Build-A-Bear Workshop brand. In addition to our stores, we sold product on our company-owned e-commerce sites.

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We operate in three segments that share the same infrastructure, including management, systems, merchandising and marketing, and generate revenues as follows:

Selected financial data attributable to each segment for fiscal 2023 and 2022 are presented in Note 15 — Segment Information to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Our year-over-year results discussed below are impacted by an additional week in fiscal 2023 as it was a 53-week period compared to the 52-week period for fiscal 2022.

Our consolidated net income was $52.8 million in fiscal 2023 compared to net income of $48.0 million in fiscal 2022. We believe that we have a concept that has broad demographic appeal which, for North American stores open for the entire year averaged net retail sales per store of $1.2 million in fiscal 2023 and 2022.

We ended fiscal 2023 with no borrowings under our credit agreement and with $44.3 million in cash, cash equivalents and restricted cash after investing $18.3 million in capital projects throughout the year. On August 31, 2022, we announced that our Board of Directors authorized a share repurchase program of up to $50.0 million, and during fiscal 2023, we had utilized $20.5 million in cash to repurchase 896,603 shares under the stock buyback program, leaving $26.1 million authorized outstanding.

On March 13, 2024, we announced that our Board of Directors approved a new quarterly dividend program to evolve its strategic use of capital and declared an initial quarterly dividend of $0.20 per share paid on April 11, 2024 to all shareholders of record as of March 28, 2024. From the end of fiscal 2023 through April 15, 2024, the Company utilized $5.1 million to repurchase $201,198 shares under the stock buyback program, leaving $21.0 million authorized outstanding.

Following is a description and discussion of the major components of our statement of operations:

Revenues

Net retail sales, commercial revenue and international franchising: See Note 3 — "Revenue" to the consolidated financial statements for additional accounting information.

We use net retail sales per square foot as a performance measure for our business. The following table details net retail sales per square foot for stores open throughout the fiscal year for the periods presented:

:

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Costs and Expenses

Cost of merchandise sold: Cost of merchandise sold is driven primarily by our retail segment. Cost of merchandise sold – retail includes the cost of the merchandise, including royalties paid to licensors of third party branded merchandise, store occupancy cost, including store depreciation and store asset impairment charges (if not disclosed separately due to materiality) (See Note 6 — "Property and Equipment, net" to the consolidated financial statements for additional accounting information regarding store asset impairment), cost of warehousing and distribution, packaging, stuffing, damages and shortages, and shipping and handling costs incurred in shipment to customers. Retail gross profit is defined as net retail sales less the cost of merchandise sold - retail. For the commercial segment, cost of merchandise includes the cost of merchandise sold to third-party retailers on a wholesale basis for sale within their stores. For the franchise segment, cost of merchandise includes the sale of furniture, fixtures, and supplies to our franchise partners.

Selling, general and administrative expense (“SGA”): These expenses include store payroll and benefits, advertising, credit card fees, store supplies and normal store pre-opening and closing expenses as well as central office general and administrative expenses, including costs for management payroll, benefits, incentive compensation, travel, information systems, accounting, insurance, legal and public relations. These expenses also include depreciation of central office assets and the amortization of other assets. Certain store expenses such as credit card fees historically have increased or decreased proportionately with net retail sales. In addition, bad debt expenses and recoveries and accounts receivable related charges are recorded in SGA.

Stores

Corporately-Managed Locations:

The number of Build-A-Bear Workshop stores in the U.S. and Canada (collectively, North America) and the U.K. and Ireland (collectively, Europe) for the last two fiscal years is summarized as follows:

During fiscal 2023, our retail business model continued to evolve to address changing shopping patterns by diversifying our locations, formats and geographies. We are updating our store portfolio with our Discovery format, which represented 47% of our store base as of February 3, 2024. During fiscal 2023, we executed 9 planned new store openings in North America, with six being opened under the Discovery format, one of which was in a tourist site. Temporary locations generally have lease terms of two to eighteen months. These specific sites are designed to capitalize on short-term opportunities. In the future, we expect to close certain stores in accordance with natural lease events as an ongoing part of our real estate management and day-to-day operational plans.

Third-Party Retail Locations:

The number of third-party retail locations opened and closed for the periods presented below is summarized as follows:

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Through our third-party retail model, there were 92 stores in operation at the end of fiscal year 2023 with relationships that included Carnival Cruise Line, Great Wolf Lodge Resorts, Landry's and Girl Scouts of the USA. The third-party retail model is capital light for us, with the partner company building out and operating the workshops including providing the real estate location and covering the cost of labor and inventory, which is purchased on a wholesale basis. These locations are heavily-weighted to the hospitality industry, which allow us to further advance our focus on experience location expansion in non-traditional and tourist areas, as well as shop-in-shop arrangements within other retailers’ stores.

International Franchise Locations:

Our first franchisee location was opened in November 2003. All franchised stores generally have similar signage, store layout and merchandise assortments as our corporately-managed stores. As of February 3, 2024, we had five master franchise agreements, which typically grant franchise rights for a particular country or group of countries, covering an aggregate of eight countries.

The number of international, franchised stores opened and closed for the periods presented below is summarized as follows:

As of February 3, 2024, the distribution of franchised locations among these countries was as follows:

In the ordinary course of business, we anticipate signing additional master franchise agreements in the future and terminating other such agreements. We source fixtures and other supplies for our franchisees from China which significantly reduces the capital and lowers the expenses required to open franchises. We are leveraging new formats that have been developed for our corporately-managed locations such as concourses and shop-in-shops with our franchisees.

Results of Operations

Fiscal 2023 Overview

Our performance continues to reflect the success of our strategy which has allowed us to put the building blocks in place to develop a powerful platform to support our initiatives to deliver consistent profitable growth. We believe our elevated omnichannel business model, which includes a highly profitable e-commerce and experiential retail store base, complimented by diversified revenue streams and disciplined expense and balance sheet management, puts us in a solid position for continued future success. We delivered a full year pre-tax profit of $66.3 million, which was the highest in our company’s 26-year history. In response to a variety of external pressures including changes in consumer shopping habits resulting in the rapid rise of the digital economy and shifting mall traffic patterns, we remained focused on accelerating and expanding our key initiatives by investing in and executing plans to improve operations and profitability. We believe that the majority of our positive performance was driven by the disciplined execution of our strategic initiatives, including leveraging our financial management to invest in growth initiatives, to contribute to a 3.9% increase in total revenue to $486.1 million in fiscal 2023. We ended the year with cash and cash equivalents of $44.3 million with no outstanding borrowings on our credit facility. During fiscal 2023, the Company returned over $42 million to shareholders through $20.5 million in share repurchases and $22.0 million special dividend.

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The following table sets forth, for the periods indicated, selected statement of operations data expressed as a percentage of total revenues, except where otherwise indicated. Percentages may not total due to immaterial rounding:

Fiscal Year Ended February 3, 2024 Compared to Fiscal Year Ended January 28, 2023

Fiscal 2023 was impacted by an additional week as it was a 53-week period, which is compared to 52 weeks in fiscal 2022.

Total revenues. Net retail sales were $456.2 million for fiscal 2023, compared to $446.2 million for fiscal 2022, an increase of $10.0 million or 2.2%, compared to the prior year. The components of this increase are as follows:

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The retail revenue increase was primarily the result of the 53rd week in the fiscal year, new store openings, and an increase in gift card breakage recorded, partially offset by a decrease in digital sales.

Commercial revenue was $25.4 million for fiscal 2023 compared to $18.5 million for fiscal 2022, an increase of $6.9 million or 37.2% primarily due to increased sales volume from our commercial accounts through our third-party retail model.

Revenue from international franchising was $4.5 million for fiscal 2023 compared to $3.2 million for fiscal 2022. This $1.3 million or 40.6%  increase was primarily due to having more stores in operation in 2023 compared to the same period in 2022.

Retail gross margin. Retail gross margin was $249.3 million in fiscal 2023 compared to $234.7 million in fiscal 2022, an increase of $14.6 million or 6.2%. As a percentage of net retail sales, retail gross margin increased to 54.6% for fiscal 2023 from 52.6% for fiscal 2022, or 200 basis points as a percentage of net retail sales. The increase in gross margin was the result of lower freight expenses in 2023 compared to 2022.

Selling, general and administrative. Selling, general and administrative expenses were $199.0 million or 40.9% of consolidated revenue for fiscal 2023 as compared to $183.9 million or 39.3% of consolidated revenue for fiscal 2022. The increase in overall expense was driven by higher store-level wages due to inflation and the addition of talent and other investments to support growth, including an advertising expense increase of $4.7 million or 23.9% compared to fiscal 2022.

Interest expense (income), net. For fiscal 2023, we had $0.9 million of interest income compared to an immaterial amount of interest expense in fiscal 2022, resulting from higher interest rates.

Provision for income taxes. The provision for income taxes was $13.5 million in fiscal 2023 compared to $13.9 million in fiscal 2022. The 2023 effective rate of 20.4% differed from the statutory rate of 21% primarily due to the reversal of the valuation allowance in the U.K. partially offset by state income tax expense. The 2022 effective rate of 22.5% differed from the statutory rate of 21% primarily due to state income tax expense.

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Non-GAAP Financial Measure - Earnings before Interest, Taxes, Depreciation, and Amortization

We believe that earnings before interest, taxes, depreciation, and amortization ("EBITDA") provides meaningful information about our operational efficiency by excluding the impact of differences in tax jurisdictions and structures, debt levels, and capital investment. Additionally, this measure is the metric used for portions of the Company's incentive compensation structure. This measure is not in accordance with, or an alternative to, GAAP. The most comparable GAAP measure is income before income taxes, or pre-tax income. EBITDA should not be considered in isolation or as a substitution for analysis of our results as reported in accordance with GAAP. Other companies may calculate EBIT and EBITDA differently, limiting the usefulness of the measures for comparisons with other companies. The following table sets forth, for the periods indicated, the components of EBITDA (dollars in millions):

EBITDA for fiscal 2023 was $79.1 million, compared to $74.4 million for fiscal 2022, an increase of $4.7 million compared to the prior year period. The overall increase in EBITDA was driven by lower freight expense, leverage of warehouse costs, and the impact of the 53rd week in fiscal 2023.

Liquidity and Capital Resources

Our cash requirements are primarily for the opening, remodeling or reformatting of stores, installation and upgrades of information systems and working capital. Over the past several years, we have met these requirements through cash generated from operations.

Operating Activities. Cash flows provided by operating activities were $64.3 million and $47.3 million in fiscal years 2023 and 2022, respectively. Cash flows from operating activities increased in fiscal 2023 as compared to fiscal 2022 primarily driven by a decrease in cash spent on inventory purchases and increased sales volume, resulting in higher net income.

Investing Activities. Cash flows used in investing activities were $18.3 million and $13.6 million in fiscal years 2023 and 2022, respectively. Cash used in investing activities in fiscal 2023 increased as compared to fiscal 2022 primarily driven by an increase in spending on capital expenditures related to information technology projects and new store openings.

Financing Activities. Financing activities used cash of $43.9 million in fiscal 2023 compared to $25.1 million in fiscal 2022. Cash used in financing activities in fiscal 2023 increased as compared to fiscal 2022, driven primarily by the repurchases of our common stock for $20.5 million throughout fiscal 2023 and dividends paid of $22.1 million.

Capital Resources. As of February 3, 2024, we had a cash balance of $44.3 million, of which 81% was domiciled within the U.S, after investing $18.3 million in capital projects throughout the year.

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We have a revolving credit and security agreement with PNC Bank, as agent, that provides for a secured revolving loan in aggregate principal of up to $25.0 million, subject to a borrowing base formula. As of February 3, 2024, borrowings under the agreement would bear interest at (a) a base rate determined under the agreement, or (b) the borrower's option, at a rate based on SOFR, plus in either case a margin based on average undrawn availability as determined in accordance with the agreement. As of February 3, 2024, we had a borrowing base of $25.0 million. As a result of a $250,000 letter of credit against the line of credit at the end of fiscal 2023, approximately $24.7 million was available for borrowing. As of February 3, 2024, we had no outstanding borrowings.

During fiscal 2023, we utilized $20.5 million in cash to repurchase 896,603 shares under the $50.0 million program authorized by our Board of Directors in August 31, 2022. As of April 15, 2024, we have repurchased a total of $26.9 million to purchase 1,149,018 shares, leaving $19.6 million available.

During the first quarter of fiscal 2024, our Board of Directors declared an initial quarterly dividend of $0.20 per share paid on April 11, 2024 to all shareholders of record as of March 28, 2024.

As of February 3, 2024, we had restricted cash of $0.4 million compared to $0.5 million as of January 28, 2023, resulting in an immaterial difference in activity.

Most of our retail stores are located within shopping malls and all are operated under leases classified as operating leases. Our leases in North America tend to be shorter term leases to provide flexibility in aligning stores with market trends. During fiscal 2023, lease extensions began to have longer terms as we have secured longer deals with more favorable terms. Our leases typically require us to pay personal property taxes, our pro rata share of real property taxes of the shopping mall, our own utilities, repairs and maintenance in our store, a pro rata share of the malls’ common area maintenance and, in some instances, merchant association fees and media fund contributions. Many leases contain incentives to help defray the cost of construction of a new store. Typically, a portion of the incentive must be repaid to the landlord if we choose to terminate the lease prior to its contracted term. In addition, some of these leases contain various restrictions relating to change in control of our company. Our leases also subject us to risks relating to compliance with changing mall rules and the exercise of discretion by our landlords on various matters, including rights of termination in some cases. Rents are invoiced monthly and paid in advance.

Our leases in the U.K. and Ireland typically have terms of ten years and generally contain a provision whereby every fifth year the rental rate can be adjusted to reflect the current market rates. The leases typically provide the lessee with the first right for renewal at the end of the lease. We may also be required to make deposits and rent guarantees to secure new leases as we expand. Real estate taxes also change according to government time schedules to reflect current market rental rates for the locations we lease. Rents are invoiced monthly or quarterly and paid in advance.

Capital spending in fiscal 2023 totaled $18.3 million and was primarily used to support our ongoing digital initiatives and new store openings.

We have various contractual or other obligations, including operating lease commitments and obligations under deferred compensation plans. Additional information is provided in the notes to our consolidated financial statements. As of February 3, 2024, we had purchase obligations totaling approximately $84.7 million, of which $26.0 million are due in the next 12 months. We believe our operating cash flows are sufficient to meet our material cash requirements for at least the next 12 months.

We have no off-balance sheet arrangements as of February 3, 2024.

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Inflation

The impact of higher inflation on the Company's business operations was seen throughout fiscal 2022 and continued to adversely affect our business in fiscal 2023, mainly through rising store labor costs. However, we continue to take mitigating actions, such as select strategic price increases on highly sought-after products, and leveraging distribution costs. We continue to monitor the impact of inflation on our business operations on an ongoing basis and may need to adjust our prices further to mitigate the impacts of changes to the rate of inflation during 2023 or in future years. Future volatility of general price inflation and the impact of inflation on costs and availability of materials, costs for shipping and warehousing and other operational overhead could adversely affect our financial results. Inflationary pressures may be exacerbated by higher transportation costs due to war and other geopolitical conflicts, such as the current Russia-Ukraine conflict, tension between China and Taiwan, and the Israel-Hamas conflict. We cannot provide an estimate or range of impact that such inflation may have on our future results of operations. However, if we are unable to recover the impact of these costs through price increases to our guests, or if consumer spending decreases as a result of inflation, our business, results of operations, financial condition and cash flows may be adversely affected. In addition, ongoing inflation in product costs may result in lower gross margin rates if we elect to maintain higher inventory reserves to mitigate anticipated higher costs.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements.

We believe application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

Our accounting policies are more fully described in Note 2 - "Summary of Significant Accounting Policies" to our consolidated financial statements, which appear elsewhere in this Annual Report on Form 10-K. We have identified the following critical accounting estimates:

Long-Lived Asset Impairments

In accordance with ASC 360-10-35, we assess the potential impairment of long-lived assets, which include property, plant and equipment and operating lease right-of-use assets (subsequent to the adoption of ASC 842, Leases) when events or changes in circumstances indicate that the carrying value may not be recoverable. Management's judgments regarding the existence of impairment indicators are based on market conditions and financial performance. Recoverability is measured by comparing the carrying amount of an asset, or asset group, to expected future net cash flows generated by the asset, or asset group. If the carrying amount exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. For operating lease right-of-use assets, we determine the fair value of the lease right-of-use assets by comparing the contractual rent payments to estimated market rental rates. Fair value is calculated as the present value of estimated future cash flows for each asset group.

For purposes of evaluating store assets for impairment, we have determined that each store location is an asset group, inclusive of the right-of-use asset attributable to each store. Factors that we consider important which could individually or in combination trigger an impairment review include, but are not limited to, the following: (1) significant underperformance relative to historical or projected future operating results; (2) significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and (3) significant changes in our business strategies and/or negative industry or economic trends. We assess events and changes in circumstances or strategy that could potentially indicate that the carrying value of long-lived assets may not be recoverable as they occur. Due to the significance of the fourth quarter to individual store locations, we assess store performance quarterly, using rolling twelve-month results (i.e. full fiscal year). We consider a historical and/or projected negative cash flow trend for a store location to be an indicator that the carrying value of that asset group may not be recoverable. Impairment charges related to this assessment are typically included in Store asset impairment as a component of income (loss) before income taxes in the DTC segment. See Note 4 - "Leases" and Note 6 - "Property and Equipment, net" to our consolidated financial statements for further discussion.

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During fiscal 2023 and 2022, we recorded immaterial impairment charges on long-lived assets. As a measure of sensitivity for fiscal 2023, a hypothetical 10% decrease in the undiscounted future cash flows for the stores would have resulted in immaterial impairments for the year.

Additionally, we consider a more likely than not assessment that an individual location will close prior to the end of its lease term as a triggering event to review the store asset group for recoverability. These assessments are reviewed on a quarterly basis. When indicated, the carrying value of the assets is reduced to fair value, calculated as the estimated future cash flows for each asset group.

In the event that we decide to close any or all of these stores in the future, we may be required to record additional impairments, lease termination fees, severance and other charges. Impairment losses in the future are dependent on a number of factors such as site selection, general economic trends, public health issues (such as a pandemic), and thus could be significantly different than historical results. The assumptions used in future calculations of fair value may change significantly which could result in further impairment charges in future periods.

Revenue Recognition

For the Company’s gift cards, revenue is deferred for single transactions until redemption including any related gift card discounts. Approximately 80% of gift cards are redeemed within three years of issuance and over the last three years, approximately 65% of gift cards issued have been redeemed within the first twelve months. In addition, unredeemed gift cards or breakage revenue is recorded in proportion to the customer’s redemption pattern using an estimated breakage rate based on historical experience. Subsequent to stores reopening following shutdowns caused by COVID, the Company experienced lower redemptions of its gift cards for all periods of outstanding activated cards compared to pre-pandemic redemption patterns (fiscal year 2019 and earlier), which impacts the gift card breakage rate. The Company does not believe that the redemption pattern experienced during the pandemic reflects the pattern in the future and has adjusted the historical redemption data used to calculate the breakage rate. The Company continues to evaluate expected breakage annually and adjusts the breakage rates in the fourth quarter of each year, or other times, if significant changes in customer behavior are detected. Changes to breakage estimates impact revenue recognition prospectively.  Further, given the magnitude of the Company's gift card liability, the changes in breakage rates could have a significant impact on the amount of breakage revenue recognized in future periods. As a matter of sensitivity, a hypothetical 1% change in our gift card breakage rate in fiscal 2023 would have resulted in a change in breakage revenue of $1.0 million.

For certain qualifying transactions, a portion of revenue transactions are deferred for the obligation related to our loyalty program or when a material right in the form of a future discount is granted. In these transactions, the transaction price is allocated to the separate performance obligations based on the relative standalone selling price. The standalone selling price for the points earned for our loyalty program is estimated using the net retail value of the merchandise purchased, adjusted for estimated breakage based on historical redemption patterns. The revenue associated with the initial merchandise purchased is recognized immediately and the value assigned to the points is deferred until the points are redeemed, forfeited or expired. A hypothetical 1% change in redemption patterns our loyalty program would result in a change in deferred revenue of approximately $0.1 million.

In regard to the consolidated balance sheet, contract liabilities for gift cards are classified as gift cards and customer deposits, and contract liabilities related to the loyalty program are classified as deferred revenue and other.

See Note 3 - "Revenue for additional information".

Leases

We determine if an arrangement is a lease at inception. The right-of-use assets and liabilities are recognized at the commencement date based on the present value of lease payments using a discounted cash flow analysis, considering lease terms and our internal borrowing rate, over the lease term for those arrangements where there is an identified asset and the contract conveys the right to control its use. Our lease term includes options to extend or terminate a lease only when it is reasonably certain that we will exercise that option.

The majority of our leases do not provide an implicit rate and therefore, we estimate the incremental borrowing discount rate on a periodic basis. The discount rates used are indicative of a synthetic credit rating based on quantitative and qualitative analysis and adjusted one notch higher to estimate a secured credit rating. For non-U.S. locations, a risk-free rate yield based on the currency of the lease is used to estimate the incremental borrowing rate.

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Income Taxes

We recognize deferred tax assets resulting from tax credit carryforwards and deductible temporary differences between taxable income on our income tax returns and income before taxes under GAAP. Deferred tax assets generally represent future tax benefits to be received when these carryforwards can be applied against future taxable income or when expenses previously reported in our consolidated financial statements become deductible for income tax purposes. A deferred tax asset valuation allowance is required when some portion or all of the deferred tax assets may not be realized. We consider the weight of all available evidence, both positive and negative, in assessing the realizability of the deferred tax assets by each taxing jurisdiction. We evaluate the sustained profitability and three years of cumulative income in each jurisdiction and consider the Company’s ability to carry back its tax losses or credits for refunds, the availability of tax planning strategies, reversals of existing taxable temporary differences and projections of future taxable income. As we had incurred a cumulative book loss in the U.K. over the three-year period ended February 2, 2019, we evaluated the realizability of our UK deferred tax assets and, accordingly, in the fourth quarter of fiscal 2018, the Company recorded a $3.7 million valuation allowance on its U.K. deferred tax assets. In the fourth quarter of fiscal 2023, the Company recorded a benefit of $5.1 million for the reversal of the valuation allowance on deferred tax assets expected to be realized in the U.K. The positive evidence considered in our assessment of the realizability of the deferred tax assets included the generation of significant positive cumulative income in the U.K. for the three-year period ending with fiscal 2023, the implementation of tax planning strategies, and projections of future taxable income. The Company maintains a valuation allowance in certain other foreign jurisdictions. Changes in the valuation allowance in fiscal 2023 primarily related to the U.K. valuation reversal, balance sheet adjustments and functional currency fluctuations.

Significant judgment is required in evaluating our uncertain tax positions. We establish accruals for uncertain tax positions when we believe that the full amount of the associated tax benefit may not be realized. In the future, if we prevail in matters for which accruals have been established previously or pay amounts in excess of reserves, there could be an effect on our income tax provisions in the period in which such determination is made. Tax authorities regularly examine the Company’s returns in the jurisdictions in which the Company does business. Management regularly assesses the tax risk of the company’s return filing positions and believes its accruals for uncertain tax benefits are adequate as of February 3, 2024 and January 28, 2023.

Recent Accounting Pronouncements

See Note 2 – "Summary of Significant Accounting Policies" for additional information.

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 contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in “Risk Factors” and elsewhere in this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report on Form 10-K.

Business Overview

Build-A-Bear Workshop started as a mall-based, experiential specialty retailer where children and their families could create their own stuffed animals. Over the last 25 years, Build-A-Bear has become a brand with high consumer awareness and positive affinity with over 225 million furry friends sold to guests around the world. We seek to provide outstanding guest service and experiences across all channels and touch points including our stores, our e-commerce sites, our mobile sites and apps as well as traditional, digital and social media. We believe the hands-on and interactive nature of our experience locations, our personal service model and engaging digital shopping experiences result in guests forming an emotional connection with our brand which has multi-generational appeal that captures today’s zeitgeist including desire for engaging experiences, personalization and “DIY” while being recognized as trusted, giving, and a part of pop culture.

We operate a vertical retail channel with stores that feature a unique combination of experience and product in which guests can “make their own stuffed animals” by participating in the stuffing, fluffing, dressing, accessorizing and naming of their own teddy bears and other stuffed animals. We also operate e-commerce sites that focus on gift-giving, collectible merchandise and licensed products that appeal to consumers that have an affinity for characters from a range of entertainment, sports, art, and gaming properties. Our engaging digital purchasing experiences include our online “Bear-Builder”, the animated “Bear Builder 3D Workshop”, an age-gated adult-focused “Bear Cave” and the “HeartBox” gift site. Our retail stores also act as “mini distribution centers” that provide efficient omnichannel support for our growing digital demand. The primary consumer target for our brick-and-mortar locations is families with children while our e-commerce sites focus on collectors and gift givers that are primarily tweens, teens and adults. We have also extended our business model to develop a circle of continuous engagement by leveraging our brand strength and owned intellectual properties through the creation of engaging content for kids and adults while also offering products at wholesale and in non-plush consumer categories via outbound licensing agreements with leading manufacturers.

Our strategy includes leveraging our brand strength to continue to strategically evolve our brick-and-mortar retail footprint beyond traditional malls with a versatile range of formats and locations including tourist destinations, expand into international markets primarily via a franchise model, and broaden the consumer base beyond children by adding teens and adults with entertainment/sports licensing, collectible and gifting offerings. Build-A-Bear’s pop-culture and multi-generational appeal have also played a key role in our digital transformation with a focus on accelerating our initiatives to expand our digitally-driven, diversified omnichannel capabilities that offer interactive entertainment experiences via both physical and e-commerce engagement, targeting a range of consumer segments and purchasing occasions.

As of January 28, 2023, we had 350 corporate-managed stores globally, 70 locations operating through our "third-party retail" model in which we sell our products on a wholesale basis to other companies that then in turn execute our retail experience, and 68 franchised stores operating internationally under the Build-A-Bear Workshop brand. In addition to our stores, we sold product on our company-owned e-commerce sites.

We operate in three segments that share the same infrastructure, including management, systems, merchandising and marketing, and generate revenues as follows:

Selected financial data attributable to each segment for fiscal 2022 and 2021 are presented in Note 15 — Segment Information to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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Our year-over-year results discussed below are impacted by prior year store closures and operating hour reductions as a result of the pandemic. At the beginning of fiscal 2021, our U.S. store portfolio was open and operating while our stores in the U.K., Ireland and Canada remained temporarily closed due to the pandemic. In April 2021, stores in the U.K. reopened as the government lifted lockdown restrictions resulting in almost all of our stores operating at the end of the 2021 first fiscal quarter with the remaining stores in the U.K. and Ireland opening in the second fiscal quarter thereby ending that period with all stores open in those geographies. The majority of our Canadian stores remained temporarily closed at the beginning of the second quarter with the majority reopening in June 2021 and with all stores ending the second fiscal quarter open. No stores were closed as a result of the pandemic in fiscal 2022.

Our consolidated net income was $48.0 million in fiscal 2022 compared to net income of $47.3 million in fiscal 2021. We believe that we have a concept that has broad demographic appeal which, for North American stores open for the entire year averaged net retail sales per store of $1.2 million and $1.0 million in fiscal 2022 and 2021, respectively.

We ended fiscal 2022 with no borrowings under our credit agreement and with $42.2 million in cash, cash equivalents and restricted cash after investing $13.6 million in capital projects throughout the year. During the third quarter of fiscal 2022, we completed the $25.0 million stock buyback program authorized by our Board of Directors in November 2021. On August 31, 2022, we announced that our Board of Directors authorized a share repurchase program of up to $50.0 million, and during fiscal 2022, we had utilized $24.1 million in cash to repurchase 1,533,503 shares under both stock buyback programs. Additionally, our Board of Directors declared a special cash dividend of $1.50 per share that was paid on April 6, 2023, to all stockholders of record as of March 23, 2023, following a $1.25 per share special cash dividend declared on November 30, 2021 and paid in December 2021 in the prior year.

Following is a description and discussion of the major components of our statement of operations:

Revenues

Net retail sales, commercial revenue and international franchising: See Note 3 — Revenue to the consolidated financial statements for additional accounting information.

We use net retail sales per square foot as a performance measure for our business. The following table details net retail sales per square foot for stores open throughout the fiscal year other than periods of temporary government-mandated closures, for the periods presented:

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Costs and Expenses

Cost of merchandise sold: Cost of merchandise sold is driven primarily by our retail segment. Cost of merchandise sold – retail includes the cost of the merchandise, including royalties paid to licensors of third party branded merchandise, store occupancy cost, including store depreciation and store asset impairment charges (if not disclosed separately due to materiality) (See Note 6 — Property and Equipment, net to the consolidated financial statements for additional accounting information regarding store asset impairment), cost of warehousing and distribution, packaging, stuffing, damages and shortages, and shipping and handling costs incurred in shipment to customers. Retail gross profit is defined as net retail sales less the cost of merchandise sold - retail. For the commercial segment, cost of merchandise includes the cost of merchandise sold to third-party retailers on a wholesale basis for sale within their stores. For the franchise segment, cost of merchandise includes the sale of furniture, fixtures, and supplies to our franchise partners.

Selling, general and administrative expense (“SGA”): These expenses include store payroll and benefits, advertising, credit card fees, store supplies and normal store pre-opening and closing expenses as well as central office general and administrative expenses, including costs for management payroll, benefits, incentive compensation, travel, information systems, accounting, insurance, legal and public relations. These expenses also include depreciation of central office assets and the amortization of other assets. Certain store expenses such as credit card fees historically have increased or decreased proportionately with net retail sales. In addition, bad debt expenses and recoveries and accounts receivable related charges are recorded in SGA.

Stores

Corporately-Managed Locations:

The number of Build-A-Bear Workshop stores in the U.S. and Canada (collectively, North America), the U.K. and Ireland (collectively, Europe) and China for the last two fiscal years is summarized as follows:

During fiscal 2022, our retail business model continued to evolve to address changing shopping patterns by diversifying our locations, formats and geographies. We are updating our store portfolio with our Discovery format, which represented 45% of our store base as of January 28, 2023. During fiscal 2022, we executed 9 planned new store openings in North America, with 6 being opened under the Discovery format and 3 of which were in tourist sites. Temporary locations generally have lease terms of two to eighteen months. These specific sites are designed to capitalize on short-term opportunities. In the future, we expect to close certain stores in accordance with natural lease events as an ongoing part of our real estate management and day-to-day operational plans.

Third-Party Retail Locations:

The number of third-party retail locations opened and closed for the periods presented below is summarized as follows:

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Through our third-party retail model, there were 70 stores in operation at the end of fiscal year 2022 with relationships that included Carnival Cruise Line, Great Wolf Lodge Resorts, Landry's and Beaches Family Resorts. The third-party retail model is capital light for us, with the partner company building out and operating the workshops including providing the real estate location and covering the cost of labor and inventory, which is purchased on a wholesale basis. These locations are heavily-weighted to the hospitality industry, which allow us to further advance our focus on experience location expansion in non-traditional and tourist areas, as well as shop-in-shop arrangements within other retailers’ stores.

International Franchise Locations:

Our first franchisee location was opened in November 2003. All franchised stores have similar signage, store layout and merchandise assortments as our corporately-managed stores. As of January 28, 2023, we had six master franchise agreements, which typically grant franchise rights for a particular country or group of countries, covering an aggregate of 10 countries.

The number of international, franchised stores opened and closed for the periods presented below is summarized as follows:

As of January 28, 2023, the distribution of franchised locations among these countries was as follows:

In the ordinary course of business, we anticipate signing additional master franchise agreements in the future and terminating other such agreements. We source fixtures and other supplies for our franchisees from China which significantly reduces the capital and lowers the expenses required to open franchises. We are leveraging new formats that have been developed for our corporately-managed locations such as concourses and shop-in-shops with our franchisees.

Results of Operations

2022 Overview

Our performance continues to reflect the success of our strategy which has allowed us to put the building blocks in place to develop a powerful platform to support our initiatives to deliver consistent profitable growth. We believe our elevated omnichannel business model, which includes a highly profitable e-commerce and experiential retail store base, complimented by diversified revenue streams and disciplined expense and balance sheet management, puts us in a solid position for continued future success. We delivered a full year pre-tax profit of $61.9 million, which was the highest in our company’s 25-year history. In response to a variety of external pressures including changes in consumer shopping habits resulting in the rapid rise of the digital economy and shifting mall traffic patterns, we remained focused on accelerating and expanding our key initiatives by investing in and executing plans to improve operations and profitability. We believe that the majority of our positive performance was driven by the disciplined execution of our strategic initiatives, including leveraging our financial management to invest in growth initiatives, to contribute to a 13.7% increase in total revenue to $467.9 million in fiscal 2022. We ended the year with cash and cash equivalents of $42.2 million with no outstanding borrowings on our credit facility. During the period of November 30, 2021 through April 10, 2023, we returned over $73 million in value to shareholders through $31.6 million in share repurchases and payments of a $20.2 million special dividend in fiscal 2021 and 2022 and a $21.6 million special dividend in fiscal 2023.

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The following table sets forth, for the periods indicated, selected statement of operations data expressed as a percentage of total revenues, except where otherwise indicated. Percentages may not total due to immaterial rounding:

Fiscal Year Ended January 28, 2023 Compared to Fiscal Year Ended January 29, 2022

Total revenues. Net retail sales were $446.2 million for fiscal 2022, compared to $397.7 million for fiscal 2021, an increase of $48.5 million or 12.2%, compared to the prior year. The components of this increase are as follows:

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The retail revenue increase was primarily the result of an increase in demand for our product and in-person interactive experience (partially offset by a decrease in digital sales), select strategic price increases, and lower promotional activity. The negative foreign currency translation effect is due to the British Pound weakening against the US Dollar during fiscal 2022. This negative foreign currency effect has, in turn, decreased European revenue compared to the fiscal 2021.

Commercial revenue was $18.5 million for fiscal 2022 compared to $11.5 million for fiscal 2021, an increase of $7.0 million or 61.0% primarily due to increased sales volume from our commercial accounts through our third-party retail model.

Revenue from international franchising was $3.2 million for fiscal 2022 compared to $2.3 million for fiscal 2021. This $0.9 million or 38.9% increase was primarily due to having more stores in operation in 2022 compared to the same period in 2021 when some franchisee locations were temporarily closed due to pandemic-related mandated government restrictions.

Retail gross margin. Retail gross margin was $234.7 million in fiscal 2022 compared to $211.3 million in fiscal 2021, an increase of $23.4 million or 11.1% As a percentage of net retail sales, retail gross margin decreased to 52.6% for fiscal 2022 from 53.1% for fiscal 2021, or 50 basis points as a percentage of net retail sales. The decrease in gross margin was the result of increased air and ocean freight costs throughout fiscal 2022 compared to fiscal 2021.

Selling, general and administrative. Selling, general and administrative expenses were $183.9 million or 39.3% of consolidated revenue for fiscal 2022 as compared to $167.3 million or 40.6% of consolidated revenue for fiscal 2021. The increase in overall expense was driven by higher store labor costs to service the increased sales demand within the year. Additionally, the change reflects an increase in variable costs driven by sales growth initiatives inclusive of higher marketing spend, with an advertising expense increase of $3.2 million or 19.5% compared to fiscal 2021, and an increase in incentive compensation expense due to our financial performance.

Interest expense (income), net. For fiscal 2022, we had an immaterial amount of interest expense compared to an immaterial amount of interest income in fiscal 2021, resulting in an immaterial difference in activity.

Provision for income taxes. The provision for income taxes was $13.9 million in fiscal 2022 compared to $3.4 million in fiscal 2021. The $10.5 million increase in the provision for income taxes for fiscal 2022 from fiscal 2021 is due to the full reversal of the Company’s tax valuation allowance in North America of $7.8 million in fiscal 2021. The 2022 effective rate of 22.5% differed from the statutory rate of 21% primarily due to state tax income expense. The 2021 effective rate of 6.8% differed from the statutory rate of 21% primarily due to the tax benefit resulting from the reversal of the $7.8 million valuation allowance in North America.

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Non-GAAP Financial Measure - Earnings before Interest, Taxes, Depreciation, and Amortization

We believe that earnings before interest, taxes, depreciation, and amortization ("EBITDA") provides meaningful information about our operational efficiency by excluding the impact of differences in tax jurisdictions and structures, debt levels, and capital investment. Additionally, this measure is the metric used for portions of the Company's incentive compensation structure. This measure is not in accordance with, or an alternative to, GAAP. The most comparable GAAP measure is income before income taxes, or pre-tax income. EBITDA should not be considered in isolation or as a substitution for analysis of our results as reported in accordance with GAAP. Other companies may calculate EBIT and EBITDA differently, limiting the usefulness of the measures for comparisons with other companies. The following table sets forth, for the periods indicated, the components of EBITDA (dollars in millions):

EBITDA for fiscal 2022 was $74.4 million, compared to $63.0 million for fiscal 2021, an increase of $11.4 million compared to the prior year period. The overall increase in EBITDA was due to increased consolidated revenues, allowing for a leverage of fixed occupancy and payroll costs compared to the prior year.

Liquidity and Capital Resources

Our cash requirements are primarily for the opening, remodeling or reformatting of stores, installation and upgrades of information systems and working capital. Over the past several years, we have met these requirements through cash generated from operations.

Operating Activities. Cash flows provided by operating activities were $47.3 million and $28.1 million in fiscal years 2022 and 2021, respectively. Cash flows from operating activities increased in fiscal 2022 as compared to fiscal 2021 primarily driven by a decrease in cash spent on inventory purchases in fiscal 2022 compared to fiscal 2021.

Investing Activities. Cash flows used in investing activities were $13.6 million and $8.1 million in fiscal years 2022 and 2021, respectively. Cash used in investing activities in fiscal 2022 increased as compared to fiscal 2021 primarily driven by an increase in spending on capital expenditures related to information technology projects and new store openings.

Financing Activities. Financing activities used cash of $25.1 million in fiscal 2022 compared to $22.5 million in fiscal 2021. Cash used in financing activities in fiscal 2022 increased as compared to fiscal 2021, driven primarily by the repurchases of our common stock for $24.1 million throughout fiscal 2022, offset by the payment of a special cash dividend of $19.9 million in fiscal 2021.

Capital Resources. As of January 28, 2023, we had a cash balance of $42.2 million, of which 72% was domiciled within the U.S.

On November 21, 2022, we entered into a Second Amendment to the Revolving Credit and Security Agreement with PNC Bank, National Association, as agent. The Second Amendment amended the Revolving Credit and Security Agreement, dated as of August 25, 2020 as amended by the First Amendment, dated as of December 17, 2021. In light of the upcoming cessation of LIBOR, the Second Amendment (i) changed the interest calculation from a LIBOR based reference rate to secured overnight financing rate (“SOFR”) based reference rate, (ii) updated the mechanics to use a future reference rate in the event that SOFR is no longer available, (iii) updated various provisions regarding compliance with sanctions and anti-money laundering laws, and (iv) implemented certain other technical amendments.

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As a result, any borrowings under the Credit Agreement will bear interest by reference to, at our option, either (a) a base rate determined under the Credit Agreement, or (b) at a rate based on SOFR, plus in either case a margin based on average undrawn availability as determined in accordance with the Credit Agreement, as such rates and floor were reduced by the First Amendment.

At the closing date of the Second Amendment, we had a $500,000 letter of credit issued and no outstanding indebtedness under the Credit Agreement and the Company is currently in compliance with the Credit Agreement covenants. As of January 28, 2023, the Company had a borrowing base of $25.0 million. As a result of a $500,000 letter of credit against the line of credit at the end of fiscal 2022, approximately $24.5 million was available for borrowing. As of January 28, 2023, the Company had no outstanding borrowings.

We ended fiscal 2022 with $42.2 million in cash, cash equivalents and restricted cash after investing $13.6 million in capital projects throughout the year.

During fiscal 2022, we utilized $24.1 million in cash to repurchase 1,533,503 shares under the $25.0 million program that was authorized by our Board of Directors on November 30, 2021 and the $50.0 million program authorized by our Board of Directors in August 31, 2022, which was authorized after we completed the share repurchase program authorized on November 30, 2021. As of April 10, 2023, we have repurchased a total of $6.6 million under the program that was authorized in August 2022 to purchase 388,762 shares, of which $3.1 million was utilized in fiscal 2023 to repurchase 132,385 shares. Under the plan authorized in August 2022, we have $43.4 million available as of April 10, 2023.

During the first quarter of fiscal 2023, we made a $21.6 million special dividend payment to shareholders for the dividend declared by our Board of Directors on March 8, 2023.

As of January 28, 2023, we had restricted cash of $0.5 million compared to $1.0 million as of January 29, 2022. The decrease in restricted cash is the result of a reduction to our required deposit with the U.K. Customs Authority.

During fiscal 2021, we renegotiated a large portion of our store lease portfolio resulting in a combination of rent reductions, deferments, and abatements in North America, the U.K. and Ireland. These prior year negotiations and new leases, extensions, and modification in fiscal 2022 have increased the percentage of leases with variable rent structures resulting in the increase in variable rent expense in fiscal 2022 compared to fiscal 2021.

Most of our retail stores are located within shopping malls and all are operated under leases classified as operating leases. Our leases in North America have shifted to shorter term leases to provide flexibility in aligning stores with market trends. Our leases typically require us to pay personal property taxes, our pro rata share of real property taxes of the shopping mall, our own utilities, repairs and maintenance in our store, a pro rata share of the malls’ common area maintenance and, in some instances, merchant association fees and media fund contributions. Many leases contain incentives to help defray the cost of construction of a new store. Typically, a portion of the incentive must be repaid to the landlord if we choose to terminate the lease prior to its contracted term. In addition, some of these leases contain various restrictions relating to change in control of our company. Our leases also subject us to risks relating to compliance with changing mall rules and the exercise of discretion by our landlords on various matters, including rights of termination in some cases. Rents are invoiced monthly and paid in advance.

Our leases in the U.K. and Ireland typically have terms of ten years and generally contain a provision whereby every fifth year the rental rate can be adjusted to reflect the current market rates. The leases typically provide the lessee with the first right for renewal at the end of the lease. We may also be required to make deposits and rent guarantees to secure new leases as we expand. Real estate taxes also change according to government time schedules to reflect current market rental rates for the locations we lease. Rents are invoiced monthly or quarterly and paid in advance.

Capital spending in fiscal 2022 totaled $13.6 million and was primarily used to support our ongoing omnichannel strategy and digital initiatives.

We have various contractual or other obligations, including operating lease commitments and obligations under deferred compensation plans. Additional information is provided in the notes to our consolidated financial statements. As of January 28, 2023, we had purchase obligations totaling approximately $87.5 million, of which $27.5 million are due in the next 12 months. We believe our operating cash flows are sufficient to meet our material cash requirements for at least the next 12 months.

We have no off-balance sheet arrangements as of January 28, 2023.

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Inflation

The impact of inflation on the Company's business operations was seen throughout fiscal 2021 and continued to adversely affect our business in fiscal 2022, mainly in freight and other supply chain related costs. However, we continue to take mitigating actions, such as select strategic price increases on highly sought-after products, accelerated purchases of inventory, and leveraging occupancy and distribution costs. We expect the inflationary pressures experienced in fiscal 2022 to continue into fiscal 2023, specifically in supply chain costs and minimum wage increases but do expect to see a reduction of freight costs compared to the prior year. We continue to monitor the impact of inflation on our business operations on an ongoing basis and may need to adjust our prices further to mitigate the impacts of changes to the rate of inflation during 2023 or in future years. Future volatility of general price inflation and the impact of inflation on costs and availability of materials, costs for shipping and warehousing and other operational overhead could adversely affect our financial results. Inflationary pressures may be exacerbated by higher transportation costs due to war and other geopolitical conflicts, such as the current Russia-Ukraine conflict and tension between China and Taiwan. We cannot provide an estimate or range of impact that such inflations may have our future results of operations. However, if we are unable to recover the impact of these costs through price increases to our guests, or if consumer spending decreases as a result of inflation, our business, results of operations, financial condition and cash flows may be adversely affected. In addition, ongoing inflation in product costs may result in lower gross margin rates due to the need to maintain higher inventory reserves.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements.

We believe application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

Our accounting policies are more fully described in Note 2 to our consolidated financial statements, which appear elsewhere in this Annual Report on Form 10-K. We have identified the following critical accounting estimates:

Long-Lived Asset Impairments

In accordance with ASC 360-10-35, we assess the potential impairment of long-lived assets, which include property, plant and equipment and operating lease right-of-use assets (subsequent to the adoption of ASC 842, Leases) when events or changes in circumstances indicate that the carrying value may not be recoverable. Management's judgments regarding the existence of impairment indicators are based on market conditions and financial performance. Recoverability is measured by comparing the carrying amount of an asset, or asset group, to expected future net cash flows generated by the asset, or asset group. If the carrying amount exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. For operating lease right-of-use assets, we determine the fair value of the lease right-of-use assets by comparing the contractual rent payments to estimated market rental rates. Fair value is calculated as the present value of estimated future cash flows for each asset group.

For purposes of evaluating store assets for impairment, we have determined that each store location is an asset group, inclusive of the right-of-use asset attributable to each store. Factors that we consider important which could individually or in combination trigger an impairment review include, but are not limited to, the following: (1) significant underperformance relative to historical or projected future operating results; (2) significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and (3) significant changes in our business strategies and/or negative industry or economic trends. We assess events and changes in circumstances or strategy that could potentially indicate that the carrying value of long-lived assets may not be recoverable as they occur. Due to the significance of the fourth quarter to individual store locations, we assess store performance quarterly, using rolling twelve-month results (i.e. full fiscal year). We consider a historical and/or projected negative cash flow trend for a store location to be an indicator that the carrying value of that asset group may not be recoverable. Impairment charges related to this assessment are typically included in Store asset impairment as a component of income (loss) before income taxes in the DTC segment. See Note 4 - Leases and Note 6 - Property and Equipment, Net to our consolidated financial statements for further discussion.

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During fiscal 2022, we recorded immaterial impairment charges. In fiscal 2021, we recorded no impairment charges on long-lived assets. As a measure of sensitivity for fiscal 2022, a hypothetical 10% decrease in the undiscounted future cash flows for the stores would have resulted in immaterial impairments for the year.

Additionally, we consider a more likely than not assessment that an individual location will close prior to the end of its lease term as a triggering event to review the store asset group for recoverability. These assessments are reviewed on a quarterly basis. When indicated, the carrying value of the assets is reduced to fair value, calculated as the estimated future cash flows for each asset group.

In the event that we decide to close any or all of these stores in the future, we may be required to record additional impairments, lease termination fees, severance and other charges. Impairment losses in the future are dependent on a number of factors such as site selection, general economic trends, public health issues (such as COVID), and thus could be significantly different than historical results. The assumptions used in future calculations of fair value may change significantly which could result in further impairment charges in future periods.

Revenue Recognition

For our gift cards, revenue is deferred for single transactions until redemption including any related gift card discounts. Three-quarters of our gift cards are redeemed within three years of issuance and over the last three years, approximately 60% of gift cards issued have been redeemed within the first twelve months. In addition, unredeemed gift cards or breakage revenue is recorded in proportion to our customers' redemption pattern using an estimated breakage rate based on historical experience. The Company utilizes historical redemption data to develop a model to analyze the amount of breakage expected for gift cards sold to customers and business partners. The Company reviews historical gift card redemption information and considers any changes in redemption patterns as a result of the current economic environment, to assess the reasonableness of projected gift card breakage rates and patterns of redemption. The Company continues to evaluate expected breakage annually and adjusts the breakage rates in the fourth quarter of each year, or other times, if significant changes in customer behavior are detected. Future gift card usage may be different than our historical experience and as a result our estimate of cards not expected to be redeemed is subject to inherent uncertainty. If actual redemption activity differs significantly from our historical experience, our gift card liability and results of operations could be materially impacted, given the significant dollar value of gift cards outstanding. As a matter of sensitivity, a hypothetical 1% change in our gift card breakage rate in fiscal 2022 would have resulted in a change in breakage revenue of $1.0 million.

For certain qualifying transactions, a portion of revenue transactions are deferred for the obligation related to our loyalty program or when a material right in the form of a future discount is granted. In these transactions, the transaction price is allocated to the separate performance obligations based on the relative standalone selling price. The standalone selling price for the points earned for our loyalty program is estimated using the net retail value of the merchandise purchased, adjusted for estimated breakage based on historical redemption patterns. The revenue associated with the initial merchandise purchased is recognized immediately and the value assigned to the points is deferred until the points are redeemed, forfeited or expired. In regard to the consolidated balance sheet, contract liabilities for gift cards are classified as gift cards and customer deposits, and contract liabilities related to the loyalty program are classified as deferred revenue and other.

See Note 3 - Revenue for additional information.

Leases

We determine if an arrangement is a lease at inception. The right-of-use assets and liabilities are recognized at the commencement date based on the present value of lease payments using a discounted cash flow analysis, considering lease terms and our internal borrowing rate, over the lease term for those arrangements where there is an identified asset and the contract conveys the right to control its use. Our lease term includes options to extend or terminate a lease only when it is reasonably certain that we will exercise that option.

The majority of our leases do not provide an implicit rate and therefore, we estimate the incremental borrowing discount rate on a periodic basis. The discount rates used are indicative of a synthetic credit rating based on quantitative and qualitative analysis and adjusted one notch higher to estimate a secured credit rating. For non-U.S. locations, a risk-free rate yield based on the currency of the lease is used to estimate the incremental borrowing rate.

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Income Taxes

We recognize deferred tax assets resulting from tax credit carryforwards and deductible temporary differences between taxable income on our income tax returns and income before taxes under GAAP. Deferred tax assets generally represent future tax benefits to be received when these carryforwards can be applied against future taxable income or when expenses previously reported in our consolidated financial statements become deductible for income tax purposes. A deferred tax asset valuation allowance is required when some portion or all of the deferred tax assets may not be realized. We consider the weight of all available evidence, both positive and negative, in assessing the realizability of the deferred tax assets by each taxing jurisdiction. When evaluating if a valuation allowance is necessary, we evaluate the sustained profitability and three years of cumulative income in each jurisdiction and consider the Company’s ability to carry back its tax losses or credits for refunds, the availability of tax planning strategies, reversals of existing taxable temporary differences and projections of future taxable income. In the fourth quarter of fiscal 2022, we performed an analysis of all available positive and negative evidence. As we had incurred a cumulative book loss in the U.K. over the three-year period ended February 2, 2019, we evaluated the realizability of our UK deferred tax assets and, accordingly, in the fourth quarter of fiscal 2018, the Company recorded a $3.7 million valuation allowance on its U.K. deferred tax assets. Although as of January 28, 2023 the U.K. has three-year cumulative income, we have maintained a full valuation allowance in the U.K. due to a lack of sustained profitability and economic uncertainty in the country.

Significant judgment is required in evaluating our uncertain tax positions. We establish accruals for uncertain tax positions when we believe that the full amount of the associated tax benefit may not be realized. In the future, if we prevail in matters for which accruals have been established previously or pay amounts in excess of reserves, there could be an effect on our income tax provisions in the period in which such determination is made. Tax authorities regularly examine the Company’s returns in the jurisdictions in which the Company does business. Management regularly assesses the tax risk of the company’s return filing positions and believes its accruals for uncertain tax benefits are adequate as of January 28, 2023 and January 29, 2022.

Recent Accounting Pronouncements

See Note 2 – Summary of Significant Accounting Policies for additional information.

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 contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in “Risk Factors” and elsewhere in this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report on Form 10-K.

Business Overview

Build-A-Bear Workshop started as a mall-based, experiential specialty retailer where children and their families could create their own stuffed animals. Over the last nearly 25 years, Build-A-Bear has become a brand with high consumer awareness and positive affinity with over 200 million furry friends made by guests around the world. We seek to provide outstanding guest service and experiences across all channels and touch points including our stores, our e-commerce sites, our mobile sites and apps as well as traditional, digital and social media. We believe the hands-on and interactive nature of our stores, our personal service model and engaging digital shopping experiences result in guests forming an emotional connection with our brand which has multi-generational appeal that captures today’s zeitgeist including desire for experience, personalization and “DIY” while being recognized as trusted, giving, and a part of pop culture.

We operate a vertical retail channel with stores that feature a unique combination of experience and product in which guests can “make their own stuffed animals” by participating in the stuffing, fluffing, dressing, accessorizing and naming of their own teddy bears and other stuffed animals. We also operate e-commerce sites that focus on gift-giving, collectible merchandise and licensed products that appeal to consumers that have an affinity for characters from a range of entertainment, sports, art, and gaming properties. Our engaging digital purchasing experiences include our online “Bear-Builder”, the animated “Bear Builder 3D Workshop”, an age-gated adult-focused “Bear Cave” and the recently introduced “HeartBox” gift site. Our retail stores also act as “mini distribution centers” that provide efficient omnichannel support for our growing digital demand. The primary consumer target for our retail stores is families with children while our e-commerce sites focus on collectors and gift givers that are primarily tweens, teens and adults. We have also extended our business model to develop a circle of continuous engagement by leveraging our brand strength and owned intellectual properties through the creation of engaging content for kids and adults while also offering products at wholesale and in non-plush consumer categories via outbound licensing agreements with leading manufacturers.

Our strategy includes leveraging our brand strength to continue to strategically evolve our brick-and-mortar retail footprint beyond traditional malls with a versatile range of formats and locations including tourist destinations, expand into international markets primarily via a franchise model, and broaden the consumer base beyond children by adding teens and adults with entertainment/sports licensing, collectible and gifting offerings. Build-A-Bear’s pop-culture and multi-generational appeal have also played a key role in the Company’s digital transformation with a focus on accelerating our initiatives to expand our digitally-driven, diversified omnichannel capabilities that offer interactive entertainment experiences via both physical and e-commerce engagement, targeting a range of consumer segments and purchasing occasions.

As of January 29, 2022, we had 346 corporate-managed stores globally, 61 locations operating through our "third-party retail" model in which we sell our products on a wholesale basis to other companies that then in turn execute our retail experience, and 72 franchised stores operating internationally under the Build-A-Bear Workshop brand. In addition to our stores, we sold product on our company-owned e-commerce sites.

We operate in three segments that share the same infrastructure, including management, systems, merchandising and marketing, and generate revenues as follows:

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Selected financial data attributable to each segment for fiscal 2021 and 2020 are presented in Note 15 — Segment Information to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

At the beginning of fiscal 2021, our U.S. store portfolio was open and operating while our stores in the U.K., Ireland and Canada remained temporarily closed due to the pandemic. In April 2021, stores in the U.K. reopened as the government lifted lockdown restrictions resulting in almost all of our stores operating at the end of the 2021 first fiscal quarter with the remaining stores in the U.K. and Ireland opening in the second fiscal quarter thereby ending that period with all stores open in those geographies. The majority of our Canadian stores remained temporarily closed at the beginning of the second quarter with the majority reopening in June 2021 and with all stores ending the second fiscal quarter open. Our year-over-year results discussed below are impacted by prior year store closures and operating hour reductions as a result of the pandemic.

Our consolidated net income was $47.3 million in fiscal 2021 compared to net loss of $23.0 million in fiscal 2020. We believe that we have a concept that has broad demographic appeal which, for North American stores open for the entire year averaged net retail sales per store of $1.0 million and $0.6 million in fiscal 2021 and 2020, respectively. We use store contribution as the key performance metric for our retail stores. Consolidated store contribution, which consists of store location net retail sales less cost of product, marketing and store related expenses, as a percentage of net retail sales was 27.3% for fiscal 2021 and 8.5% for fiscal 2020, the latter reflecting the negative impact of COVID. Non-store general and administrative expenses are excluded as are our revenues and expenses associated with e-commerce sites and adjustments to deferred revenue related to gift card breakage and our loyalty program. The diversification of our real estate portfolio and shift to smaller more flexible store formats may result in lower average store revenue but is expected to improve store contribution on a long-term basis. See “Non-GAAP Financial Measures” for a reconciliation of store contribution to net income. The increase in consolidated store contribution as a percent of net retail sales in fiscal 2021 compared to fiscal 2020 was due to increased retail gross margin by 1,240 basis points primarily driven by increased leverage of fixed occupancy costs as a percent of revenue by 1,048 basis points.

We ended fiscal 2021 with no borrowings under our credit agreement and with $32.8 million in cash, cash equivalents and restricted cash after investing $8.1 million in capital projects throughout the year. In November 2021, our Board of Directors authorized a share repurchase program of up to $25 million and as of January 29, 2022, we had utilized $4.4 million in cash to repurchase 245,554 shares under the program. Additionally, we paid a special dividend of $19.9 million to shareholders of record as of December 10, 2021.

Following is a description and discussion of the major components of our statement of operations:

Revenues

Net retail sales, commercial revenue and international franchising: See Note 3 — Revenue to the consolidated financial statements for additional accounting information.

We use net retail sales per square foot as a performance measure for our business. The following table details net retail sales per square foot for stores open throughout the fiscal year other than periods of temporary government-mandated closures, for the periods presented:

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Costs and Expenses

Cost of merchandise sold: Cost of merchandise sold is driven primarily by our retail segment. Cost of merchandise sold – retail includes the cost of the merchandise, including royalties paid to licensors of third party branded merchandise, store occupancy cost, including store depreciation and store asset impairment charges (if not disclosed separately due to materiality) (See Note 6 — Property and Equipment, net to the consolidated financial statements for additional accounting information regarding store asset impairment), cost of warehousing and distribution, packaging, stuffing, damages and shortages, and shipping and handling costs incurred in shipment to customers. Retail gross margin is defined as net retail sales less the cost of merchandise sold - retail. For the commercial segment, cost of merchandise includes the cost of merchandise sold to third-party retailers on a wholesale basis for sale within their stores. For the franchise segment, cost of merchandise includes the sale of furniture, fixtures, and supplies to our franchise partners.

Selling, general and administrative expense (“SGA”): These expenses include store payroll and benefits, advertising, credit card fees, store supplies and normal store pre-opening and closing expenses as well as central office general and administrative expenses, including costs for management payroll, benefits, incentive compensation, travel, information systems, accounting, insurance, legal and public relations. These expenses also include depreciation of central office assets and the amortization of other assets. Certain store expenses such as credit card fees historically have increased or decreased proportionately with net retail sales. In addition, bad debt expenses and accounts receivable related charges are recorded in SGA. Additionally, as a result of COVID, governments enacted relief legislation and stimulus packages to help combat the economic effects of the pandemic through such things as payroll expense reimbursement and business grants, whose effects are recorded within SGA.

Stores

Corporately-managed locations:

The number of Build-A-Bear Workshop stores in the U.S., Canada and Puerto Rico (collectively, North America), the U.K. and Ireland (collectively, Europe) and China for the last two fiscal years is summarized as follows:

During fiscal 2021, our retail business model continued to evolve to address changing shopping patterns by diversifying our locations, formats and geographies. We are updating our store portfolio with our Discovery format, which represented 42% of our store base as of January 29, 2022. During fiscal 2021, we executed 5 planned new store openings in North America, all Discovery format and 4 of which were in tourist sites. Through our third-party retail model, there were 61 stores in operation at the end of the fiscal year with relationships that included Carnival Cruise Line, Great Wolf Lodge Resorts, Landry's and Beaches Family Resorts. As in prior years, we operated in a number of other non-traditional locations as well as shop-in-shop arrangements within other retailers’ stores. Temporary locations generally have lease terms of two to eighteen months. These specific sites are designed to capitalize on short-term opportunities. In the future, we expect to close certain stores in accordance with natural lease events as an ongoing part of our real estate management and day-to-day operational plans.

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International Franchise Locations:

Our first franchisee location was opened in November 2003. All franchised stores have similar signage, store layout and merchandise assortments as our corporately-managed stores. As of January 29, 2022, we had six master franchise agreements, which typically grant franchise rights for a particular country or group of countries, covering an aggregate of 10 countries.

The number of international, franchised stores opened and closed for the periods presented below is summarized as follows:

As of January 29, 2022, the distribution of franchised locations among these countries was as follows:

In the ordinary course of business, we anticipate signing additional master franchise agreements in the future and terminating other such agreements. We source fixtures and other supplies for our franchisees from China which significantly reduces the capital and lowers the expenses required to open franchises. We are leveraging new formats that have been developed for our corporately-managed locations such as concourses and shop-in-shops with our franchisees.

Results of Operations

2021 Overview

Our performance continues to reflect the success of our strategy which has allowed us to put the building blocks in place to develop a powerful platform to support our initiatives to deliver consistent profitable growth. We believe our elevated omnichannel business model, which includes a highly profitable e-commerce and experiential retail store base, complimented by diversified revenue streams and disciplined expense and balance sheet management, puts us in a solid position for continued future success. We delivered a full year pre-tax profit of $50.7 million, which was the highest in our company’s history. In response to a variety of external pressures including changes in consumer shopping habits resulting in the rapid rise of the digital economy and shifting mall traffic patterns, we remained focused on accelerating and expanding our key initiatives by investing in and executing plans to improve operations and profitability. While we believe the majority of our positive performance was driven by the disciplined execution of our strategic initiatives, impact from pent-up demand and government stimulus may have also helped to contribute to a 61.2% increase in total revenue to $411.5 million in fiscal 2021. We ended the year with cash and cash equivalents of $32.8 million with no outstanding borrowings on our credit facility. We returned $24.3 million in value to shareholders through $4.4 million in share repurchases and payment of a $19.9 million special dividend in fiscal 2021.

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The following table sets forth, for the periods indicated, selected statement of operations data expressed as a percentage of total revenues, except where otherwise indicated. Percentages do total due to immaterial rounding:

Fiscal Year Ended January 29, 2022 Compared to Fiscal Year Ended January 30, 2021

Total revenues. Net retail sales were $397.7 million for fiscal 2021, compared to $249.2 million for fiscal 2020, an increase of $148.5 million or 59.6%, driven by an increase in North America of $138.0 million or 62.7% and in Europe of $17.5 million or 51.8%. The components of this increase are as follows:

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The retail revenue increase was primarily the result of the increase in store operating days of corporately-managed stores due to a reduced impact from COVID in fiscal 2021 and consolidated e-commerce sales.

Commercial revenue was $11.5 million for fiscal 2021 compared to $4.4 million for fiscal 2020, an increase of $7.1 million or 159.9% primarily due to increased sales volume from our commercial accounts versus the prior year which was impacted by pandemic driven closures of third-party retail locations serviced by these customers.

Revenue from international franchising was $2.3 million for fiscal 2021 compared to $1.7 million for fiscal 2020. This $0.7 million or 39.0% increase was primarily due to having more stores in operation in 2021 compared to the same period in 2020 when significantly more locations were temporarily closed due to pandemic-related mandated government restrictions.

Retail gross margin. Retail gross margin was $211.3 million in fiscal 2021 compared to $101.4 million in fiscal 2020, an increase of $109.9 million or 108.3% As a percentage of net retail sales, retail gross margin increased to 53.1% for fiscal 2021 from 40.7% for fiscal 2020, or 1,240 basis points as a percentage of net retail sales. The increase in gross margin was the result of growth in total revenues driving increased leverage of fixed occupancy costs of 1,048 basis points compared to the prior year, overall lower promotional activity resulting is less discounts, and strategic price increases on highly sought-after products. These strong results were partially offset by increased air and ocean freight costs.

Impairment of long-lived assets, including right-of-use assets. We incurred no impairment charges in fiscal 2021. This compared to impairment charges of $7.3 million recorded in fiscal 2020.

Selling, general and administrative. Selling, general and administrative expenses were $167.3 million or 40.6% of consolidated revenue for fiscal 2021 as compared to $117.6 million or 46.1% of consolidated revenue for fiscal 2020. The primary increase in overall expense was primarily due to higher labor costs given the re-opening of our store base, the recording of full corporate salaries in fiscal 2021 as opposed to the prior year, and an increase incentive compensation expense due to our financial performance. Additionally, we saw an increase in advertising expense of $8.3 million or 102.5% driven by depressed advertising spend in fiscal 2020 while we were in a cash management position due to COVID.

Interest expense (income), net. For fiscal 2021, we had an immaterial amount of interest income compared to an immaterial amount of interest expense in fiscal 2020, resulting in an immaterial difference in activity.

Provision for income taxes. The provision for income taxes was $3.4 million in fiscal 2021 compared to $2.8 million in fiscal 2020. The 2021 effective rate of 6.8% differed from the statutory rate of 21% primarily due to the tax benefit resulting from the reversal of the valuation allowance in North America of $7.8 million. The 2020 effective rate of (13.9%) differed from the statutory rate of 21% primarily due to no tax benefit being recorded on the pretax loss as a full valuation allowance had been recorded globally. Fiscal 2020 was also impacted by the $3.3 million valuation allowance recorded on the beginning balance of the net deferred tax assets in certain jurisdictions.

Non-GAAP Financial Measures

We use the term “store contribution” throughout this Annual Report on Form 10-K. Store contribution consists of income (loss) before income tax expense, interest, general and administrative expense, excluding income from franchise and commercial activities and contribution from our e-commerce sites, locations, other than periods of temporary government-mandated closures, for the full fiscal year and adjustments to deferred revenue related to our loyalty program and gift card breakage. This term, as we define it, may not be comparable to similarly titled measures used by other companies and is not a measure of performance presented in accordance with U.S. generally accepted accounting principles (“GAAP”). We use store contribution as a measure of our stores’ operating performance.

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Store contribution should not be considered a substitute for net income, net income per store, cash flows provided by operating activities, cash flows provided by operating activities per store, or other income or cash flow data prepared in accordance with U.S. GAAP. Additionally, store-level performance measures are inherently limited in that they exclude certain expenses that are recurring in nature and are necessary to support the operation and development of our stores. We believe store contribution is useful to investors in evaluating our operating performance because it, along with the number of stores in operation, directly impacts our profitability.

The following table sets forth a reconciliation of store contribution to net income (loss) for our corporately-managed stores located in the U.S., Canada and Puerto Rico (collectively “North America”); stores located in the U.K. and Ireland (collectively “Europe”); and China, for our consolidated store base (dollars in thousands). For fiscal 2021, corporately-managed stores included are those that were not newly opened or permanently closed in fiscal 2021. For year-over-year comparison purposes, temporarily closed stores in fiscal 2020 were included in the below table.

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Liquidity and Capital Resources

Our cash requirements are primarily for the opening, remodeling or reformatting of stores, installation and upgrades of information systems and working capital. Over the past several years, we have met these requirements through cash generated from operations.

Operating Activities. Cash flows provided by operating activities were $28.1 million and $13.4 million in fiscal years 2021 and 2020, respectively. Cash flows from operating activities increased in fiscal 2021 as compared to fiscal 2020 primarily driven by increased retail store operating days at corporately-managed stores and sales volume to commercial customers, both due to the reduced impact of COVID in fiscal 2021, resulting in higher net income. This was offset by an increase in cash spent on inventory purchases throughout the year to match increased revenue growth as well as accelerated purchases made in the fourth quarter of fiscal 2021 of core and evergreen merchandise collections to support our business momentum and as part of our efforts to mitigate inflationary and supply chain COVID-related pressures and anticipated continued increases in product and freight costs.

Investing Activities. Cash flows used in investing activities were $8.1 million and $5.0 million in fiscal years 2021 and 2020, respectively. Cash used in investing activities in fiscal 2021 increased as compared to fiscal 2020 primarily driven by reductions in planned capital expenditures in fiscal 2020 as a result of COVID cash management initiatives.

Financing Activities. Financing activities used cash of $22.5 million in fiscal 2021 compared to $0.1 million in fiscal 2020. Cash used in financing activities in fiscal 2021 increased as compared to fiscal 2020, driven primarily by the payment of a special cash dividend of $19.9 million and repurchases of our common stock for $4.4 million, offset by proceeds from stock option exercises.

Capital Resources. As of January 29, 2022, we had a cash balance of $32.8 million, of which 69% was domiciled within the U.S.

On December 17, 2021, we entered into a First Amendment to Revolving Credit and Security Agreement with PNC Bank, National Association, as agent. The First Amendment amended the Revolving Credit and Security Agreement dated as of August 25, 2020. The Credit Agreement continues to provide for a senior secured revolving loan in aggregate principal amount of up to $25,000,000, which may be increased by an amount not to exceed $25,000,000. The borrowing base under the Credit Agreement continues to be based on specified percentages of Eligible Credit Card Receivables, Eligible Inventory and, under certain circumstances, Eligible Foreign In-Transit Inventory and, at the discretion of the Agent, Eligible Receivables. The First Amendment eliminated certain eligibility requirements for Eligible Foreign In-Transit Inventory and Eligible Inventory. The Credit Agreement continues to provide for swingline loans of up to $5,000,000 and the issuance of standby or commercial letters of credit of up to $5,000,000.

The First Amendment (i) extended the maturity date of the Credit Agreement to December 17, 2026, (ii) eliminated the minimum interest payment requirement, (iii) reduced the facility fee related to undrawn availability, (iv) reduced the availability requirement under the financial covenant, (v) provided the Company with additional flexibility to make permitted investments, declare dividends, repay intercompany loans or repurchase its stock, (vi) increased the threshold amounts for certain events of default, and (vii) reduced the required frequency of various information and reporting requirements under certain circumstances.

Borrowings under the Credit Agreement continue to bear interest (a) at a base rate determined under the Credit Agreement, or (b) at the Borrower’s option, at a rate based on LIBOR, plus in either case a margin based on average undrawn availability as determined in accordance with the Credit Agreement, but the First Amendment reduced such rates and reduced the LIBOR floor. A $500,000 minimum interest payment requirement has been eliminated and the Facility Fee Percentage, which previously was either 0.50% or 0.375% depending on the Average Undrawn Availability, was reduced to 0.25%.

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The First Amendment revised a covenant to require us to maintain availability (as determined in accordance with the Credit Agreement) at all times equal to or greater than the greater of (a) 10.0% of the Loan Cap and (b) $1,875,000 (subject to increase upon exercise of the Increase Option). The “Loan Cap” is the lesser of (1) $25,000,000 less the outstanding amount of loans and letters of credit under the Credit Agreement and (2) the borrowing base from time to time under the Credit Agreement.

At the closing date of the First Amendment, we had a $750,000 letter of credit issued and no outstanding indebtedness under the Credit Agreement; and, we were in compliance with the Credit Agreement covenants. As of January 29, 2022, the Company had a borrowing base of $22.3 million. As a result of a $750,000 letter of credit against the line of credit at the end of fiscal 2021, approximately $22.5 million was available for borrowing. As of January 29, 2022, the Company had no outstanding borrowings.

We ended fiscal 2021 with $32.8 million in cash, cash equivalents and restricted cash after investing $8.1 million in capital projects throughout the year.

As of January 29, 2022, we have utilized $4.4 million in cash to repurchase 245,554 shares under our $25.0 million program that was authorized by our Board of Directors on November 30, 2021. As of April 11, 2022, we have utilized a total of $12.1 million under the program to purchase 716,760 shares and currently have $12.9 million available under the authorization.

During the fourth quarter of fiscal 2021, we made a $19.9 million special dividend payment to shareholders. The fiscal 2021 ending cash balance also reflected increased investment in working capital.

As of January 29, 2022, we had restricted cash of $1.0 million compared to $1.7 million as of January 30, 2021. The decrease in long-term deposits is the result of a reduction to our required deposit with the U.K. Customs Authority.

During fiscal 2020, we renegotiated a large portion of our store lease portfolio resulting in a combination of rent reductions, deferments, and abatements in North America, the U.K. and Ireland. These prior year negotiations and new leases, extensions, and modification in fiscal 2021 have increased the percentage of leases with variable rent structures resulting in the increase in variable rent expense in fiscal 2021 compared to fiscal 2020.

Most of our retail stores are located within shopping malls and all are operated under leases classified as operating leases. Our leases in North America have shifted to shorter term leases to provide flexibility in aligning stores with market trends. Our leases typically require us to pay personal property taxes, our pro rata share of real property taxes of the shopping mall, our own utilities, repairs and maintenance in our store, a pro rata share of the malls’ common area maintenance and, in some instances, merchant association fees and media fund contributions. Many leases contain incentives to help defray the cost of construction of a new store. Typically, a portion of the incentive must be repaid to the landlord if we choose to terminate the lease prior to its contracted term. In addition, some of these leases contain various restrictions relating to change in control of our company. Our leases also subject us to risks relating to compliance with changing mall rules and the exercise of discretion by our landlords on various matters, including rights of termination in some cases. Rents are invoiced monthly and paid in advance.

Our leases in the U.K. and Ireland typically have terms of ten years and generally contain a provision whereby every fifth year the rental rate can be adjusted to reflect the current market rates. The leases typically provide the lessee with the first right for renewal at the end of the lease. We may also be required to make deposits and rent guarantees to secure new leases as we expand. Real estate taxes also change according to government time schedules to reflect current market rental rates for the locations we lease. Rents are invoiced monthly or quarterly and paid in advance.

Capital spending in fiscal 2021 totaled $8.1 million and was primarily used to support our ongoing omnichannel strategy and digital initiatives.

We have various contractual or other obligations, including operating lease commitments and obligations under deferred compensation plans. Additional information is provided in the notes to our consolidated financial statements. As of January 29, 2022, we had purchase obligations totaling approximately $99.9 million, of which $25.7 million are due in the next 12 months. We believe our operating cash flows are sufficient to meet our material cash requirements for at least the next 12 months.

We have no off-balance sheet arrangements as of January 29, 2022.

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Inflation

The impact of inflation on the Company's business operations was seen throughout fiscal 2021 and began to have an adverse impact on our business in the fourth quarter of the year, mainly in freight and other supply chain related costs. However, due to mitigating actions taken by the Company, such as strategic price increases on highly sought-after products and accelerated purchases of inventory, the impact of general price inflation on our 2021 financial position and results of operations has not been significant. We expect the inflationary pressures experienced at the end of fiscal 2021 to continue into fiscal 2022. We continue to monitor the impact of inflation on our business operations on an ongoing basis and may need to adjust our prices further to mitigate the impacts of changes to the rate of inflation during 2022 or in future years. Future volatility of general price inflation and the impact of inflation on costs and availability of materials, costs for shipping and warehousing and other operational overhead could adversely affect our financial results. Inflationary pressures may be exacerbated by higher transportation costs due to ware and other geopolitical conflicts, such as the current Russia-Ukraine crisis. We cannot provide an estimate or range of impact that such inflations may have our future results of operations. However, if we are unable to recover the impact of these costs through price increases to our customers, or if consumer spending decreases as a result of inflation, our business, results of operations, financial condition and cash flows may be adversely affected. In addition, ongoing inflation in product costs may result in lower gross margins due to a requirement to maintain higher inventory reserves.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements.

We believe application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

Our accounting policies are more fully described in Note 2 to our consolidated financial statements, which appear elsewhere in this Annual Report on Form 10-K. We have identified the following critical accounting estimates:

Long-Lived Asset Impairments

In accordance with ASC 360-10-35, we assess the potential impairment of long-lived assets, which include property, plant and equipment and operating lease right-of-use assets (subsequent to the adoption of ASC 842, Leases) when events or changes in circumstances indicate that the carrying value may not be recoverable. Management's judgments regarding the existence of impairment indicators are based on market conditions and financial performance. Recoverability is measured by comparing the carrying amount of an asset, or asset group, to expected future net cash flows generated by the asset, or asset group. If the carrying amount exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. For operating lease right-of-use assets, we determine the fair value of the lease right-of-use assets by comparing the contractual rent payments to estimated market rental rates. Fair value is calculated as the present value of estimated future cash flows for each asset group.

For purposes of evaluating store assets for impairment, we have determined that each store location is an asset group, inclusive of the right-of-use asset attributable to each store. Factors that we consider important which could individually or in combination trigger an impairment review include, but are not limited to, the following: (1) significant underperformance relative to historical or projected future operating results; (2) significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and (3) significant changes in our business strategies and/or negative industry or economic trends. We assess events and changes in circumstances or strategy that could potentially indicate that the carrying value of long-lived assets may not be recoverable as they occur. Due to the significance of the fourth quarter to individual store locations, we assess store performance quarterly, using rolling twelve-month results (i.e. full fiscal year). We consider a historical and/or projected negative cash flow trend for a store location to be an indicator that the carrying value of that asset group may not be recoverable. Impairment charges related to this assessment are typically included in Store asset impairment as a component of income (loss) before income taxes in the DTC segment. See Note 4 - Leases and Note 6 - Property and Equipment, Net to our consolidated financial statements for further discussion.

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During fiscal
2021, we did not record any impairment charges. In fiscal
2020, we recorded impairment charges on long-live assets totaling $
7.3 million, $
3.5 million for property and equipment and $
3.8 million for right-of-use lease assets. As a measure of sensitivity for fiscal
2021, a hypothetical 10% decrease in the undiscounted future cash flows for the stores would not have resulted in impairments for the year.

Additionally, we consider a more likely than not assessment that an individual location will close prior to the end of its lease term as a triggering event to review the store asset group for recoverability. These assessments are reviewed on a quarterly basis. When indicated, the carrying value of the assets is reduced to fair value, calculated as the estimated future cash flows for each asset group.

In the event that we decide to close any or all of these stores in the future, we may be required to record additional impairments, lease termination fees, severance and other charges. Impairment losses in the future are dependent on a number of factors such as site selection, general economic trends, public health issues (such as the COVID pandemic) and thus could be significantly different than historical results. The assumptions used in future calculations of fair value may change significantly which could result in further impairment charges in future periods.

Revenue Recognition

For our gift cards, revenue is deferred for single transactions until redemption including any related gift card discounts. Three-quarters of our gift cards are redeemed within three years of issuance and over the last three years, approximately 60% of gift cards issued have been redeemed within the first twelve months. In addition, unredeemed gift cards or breakage revenue is recorded in proportion to the customer’s redemption pattern using an estimated breakage rate based on historical experience. The Company utilizes historical redemption data to develop a model to analyze the amount of breakage expected for gift cards sold to customers and business partners. The Company reviews historical gift card redemption information and considers any changes in redemption patterns as a result of the current economic environment, to assess the reasonableness of projected gift card breakage rates and patterns of redemption. The Company continues to evaluate expected breakage annually and adjusts the breakage rates in the fourth quarter of each year, or other times, if significant changes in customer behavior are detected. Future gift card usage may be different than our historical experience and as a result our estimate of cards not expected to be redeemed is subject to inherent uncertainty. If actual redemption activity differs significantly from our historical experience, our gift card liability and results of operations could be materially impacted, given the significant dollar value of gift cards outstanding. As a matter of sensitivity, a hypothetical 1% change in our gift card breakage rate in fiscal 2021 would have resulted in a change in breakage revenue of $1.3 million.

For certain qualifying transactions, a portion of revenue transactions are deferred for the obligation related to our loyalty program or when a material right in the form of a future discount is granted. In these transactions, the transaction price is allocated to the separate performance obligations based on the relative standalone selling price. The standalone selling price for the points earned for our loyalty program is estimated using the net retail value of the merchandise purchased, adjusted for estimated breakage based on historical redemption patterns. The revenue associated with the initial merchandise purchased is recognized immediately and the value assigned to the points is deferred until the points are redeemed, forfeited or expired. In regard to the consolidated balance sheet, contract liabilities for gift cards are classified as gift cards and customer deposits, and contract liabilities related to the loyalty program are classified as deferred revenue and other.

See Note 3 - Revenue for additional information.

Leases

We determine if an arrangement is a lease at inception. The right-of-use assets and liabilities are recognized at the commencement date based on the present value of lease payments using a discounted cash flow analysis, considering lease terms and our internal borrowing rate, over the lease term for those arrangements where there is an identified asset and the contract conveys the right to control its use. Our lease term includes options to extend or terminate a lease only when it is reasonably certain that we will exercise that option.

The majority of our leases do not provide an implicit rate and therefore, we estimate the incremental borrowing discount rate based on information available at lease commencement. The discount rates used are indicative of a synthetic credit rating based on quantitative and qualitative analysis and adjusted one notch higher to estimate a secured credit rating. For non-U.S. locations, a risk-free rate yield based on the currency of the lease is used to estimate the incremental borrowing rate. The weighted average risk-free rates were based on the Treasury BVAL rates curve in Bloomberg. Rates were developed for length of lease term for each year 1 through 10 and for 12, 15, 20, 25, and 30-year terms.

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Income Taxes

We recognize deferred tax assets resulting from tax credit carryforwards and deductible temporary differences between taxable income on our income tax returns and income before taxes under GAAP. Deferred tax assets generally represent future tax benefits to be received when these carryforwards can be applied against future taxable income or when expenses previously reported in our consolidated financial statements become deductible for income tax purposes. A deferred tax asset valuation allowance is required when some portion or all of the deferred tax assets may not be realized. We consider the weight of all available evidence, both positive and negative, in assessing the realizability of the deferred tax assets by each taxing jurisdiction. We consider the Company’s ability to carry back its tax losses or credits for refunds, the availability of tax planning strategies and reversals of existing taxable temporary differences as well as projections of future taxable income.  In the fourth quarter of fiscal 2021, we performed an analysis of all available positive and negative evidence. As we were no longer in a cumulative loss in North America for the three-year period ending January 29, 2022 driven by the record pretax performance of fiscal 2021 and with the expectation that this strong financial performance will continue given our recent strategic initiatives coupled with the fact that almost all available tax attribute carryforwards were utilized in North American in fiscal 2021, the Company recorded a benefit of $7.8 million for the reversal of the beginning-of-the-year valuation allowance in North America. As we had incurred a cumulative book loss in the U.K. over the three-year period ended February 2, 2019, we evaluated the realizability of our UK deferred tax assets and, accordingly, in the fourth quarter of fiscal 2018, the Company recorded a $3.7 million valuation allowance on its U.K. deferred tax assets, and remains in a full valuation allowance, as the U.K. continues to be in a three year cumulative loss.

Significant judgment is required in evaluating our uncertain tax positions. We establish accruals for uncertain tax positions when we believe that the full amount of the associated tax benefit may not be realized. In the future, if we prevail in matters for which accruals have been established previously or pay amounts in excess of reserves, there could be an effect on our income tax provisions in the period in which such determination is made. Tax authorities regularly examine the Company’s returns in the jurisdictions in which the Company does business. Management regularly assesses the tax risk of the company’s return filing positions and believes its accruals for uncertain tax benefits are adequate as of January 29, 2022 and January 30, 2021.

Recent Accounting Pronouncements

See Note 2 – Summary of Significant Accounting Policies for additional information.