BUILD-A-BEAR WORKSHOP INC (BBW) FY 2025 MD&A

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.