10-K 1 babw_10k-122912.htm FORM 10-K babw_10k-122912.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 

FORM 10-K

(Mark One)
x
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 29, 2012
 
OR
 
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from              to             
 
Commission file number: 001-32320
 

BUILD-A-BEAR WORKSHOP, INC.
(Exact Name of Registrant as Specified in Its Charter)

Delaware
43-1883836
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
1954 Innerbelt Business Center Drive
St. Louis, Missouri
63114
(Address of Principal Executive Offices)
(Zip Code)
 
(314) 423-8000
(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
 
New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ¨  Yes     x  No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ¨  Yes     x  No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   x  Yes     ¨  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   x  Yes     ¨  No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨     Smaller reporting company  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    ¨  Yes    x   No
There is no non-voting common equity. The aggregate market value of the common stock held by nonaffiliates (based upon the closing price of $4.78 for the shares on the New York Stock Exchange on June 29, 2012) was $58,084,108 as of June 30, 2012.
As of March 8, 2013, there were 17,150,840 issued and outstanding shares of the registrant’s common stock.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s Proxy Statement for its May 9, 2013 Annual Meeting are incorporated herein by reference.


 
 

 
 
BUILD-A-BEAR WORKSHOP, INC.
INDEX TO FORM 10-K
 
     Page
Forward-Looking Statements
 1
Part I
 
Item 1.
Business
 2
Item 1A.
Risk Factors
 9
Item 1B.
Unresolved Staff Comments
 16
Item 2.
Properties
 17
Item 3.
Legal Proceedings
 19
Item 4.
Mine Safety Disclosure
 19
Part II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 20
Item 6.
Selected Financial Data
 23
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 25
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
 42
Item 8.
Financial Statements and Supplementary Data
 42
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 
Item 9A.
Controls and Procedures
 42
Item 9B.
Other Information
 43
Part III
 
Item 10.
Directors, Executive Officers and Corporate Governance
 43
Item 11.
Executive Compensation
 45
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 45
Item 13.
Certain Relationships and Related Transactions and Director Independence
 46
Item 14.
Principal Accountant Fees and Services
 46
Part IV
 
Item 15.
Exhibits and Financial Statement Schedules
 47
   
Exhibit Index
 69
Signatures
 74
 
 
 

 
 
FORWARD-LOOKING STATEMENTS
 
This Annual Report on Form 10-K contains certain statements that are, or may be considered to be, “forward-looking statements” for the purpose of federal securities laws, including, but not limited to, statements that reflect our current views with respect to future events and financial performance. We generally identify these statements by words or phrases such as “may,” “might,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “intend,” “predict,” “future,” “potential” or “continue,” the negative or any derivative of these terms and other comparable terminology. These forward-looking statements, which are subject to risks, uncertainties and assumptions about us, may include, among other things, projections or statements regarding:
 
 
our future financial performance;
 
 
our anticipated operating and growth strategies;
 
 
our future capital expenditures;
 
 
our anticipated rate of store closures, relocations and openings;
 
 
our anticipated costs related to store closures, relocations and openings, and
 
 
our franchisees’ anticipated rate of international store openings.
 
These statements are only predictions based on our current expectations and projections about future events. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or achievements expressed or implied by these forward-looking statements, including those factors discussed under the caption entitled “Risk Factors” as well as other places in this Annual Report on Form 10-K.
 
We operate in a competitive and rapidly changing environment.  New risk factors emerge from time to time and it is not possible for management to predict all the risk factors, nor can it assess the impact of all the risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, you should not place undue reliance on forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K, as a prediction of actual results.
 
You should read this Annual Report on Form 10-K completely and with the understanding that our actual results may be materially different from what we expect.  Except as required by law, we undertake no duty to update these forward-looking statements, even though our situation may change in the future.  We qualify all of our forward-looking statements by these cautionary statements.
 
 
1

 
PART I
 
ITEM  1.         BUSINESS
 
Overview
 
Build-A-Bear Workshop, Inc., a Delaware corporation, was formed in 1997 and is the leading, and only international company providing a “make your own stuffed animal” interactive retail-entertainment experience.  As of December 29, 2012, we operated 351 company-owned retail stores in the United States, Canada, the United Kingdom and Ireland, including 283 traditional and eight non-traditional Build-A-Bear Workshop® stores in the United States and Canada and 60 traditional Build-A-Bear Workshop stores in the United Kingdom and Ireland.  In addition, franchisees operated 91 Build-A-Bear Workshop stores in other international locations. Our core concept is based on our guests making, personalizing and customizing their own stuffed animals, and capitalizes on what we believe is the relatively untapped demand for experience-based shopping as well as the widespread appeal of stuffed animals.
 
We offer an extensive and coordinated selection of merchandise, including over 30 different styles of animals to be stuffed, sounds and scents that can be added to the stuffed animals and a wide variety of clothing, shoes and accessories, as well as other brand appropriate toy and novelty items.  Our concept appeals to a broad range of age groups and demographics, including children, teens, parents and grandparents. We believe that our stores, which are primarily located in malls, are destination locations and draw guests from a large geographic reach.  Our stores average approximately 2,600 square feet in size and have a highly visual and colorful appearance, including custom-designed fixtures featuring teddy bears and other themes relating to the Build-A-Bear Workshop experience.  In 2012 we opened the first six stores in our new highly interactive design, which features a bold new look and enhanced experience.
 
We also market our products and build our brand awareness and equity in our countries of operation through national multi-media marketing programs that target our core demographic guests, principally children and their parents.  The programs incorporate consistent messaging across a variety of media, and are designed to increase our brand awareness and store traffic and attract more first-time and repeat guests.  In addition to supporting our e-commerce, our Web sites, buildabear.com® and bearville.comTM, promote brand connection and in-store products and events.
 
Since opening our first store in St. Louis, Missouri in October 1997, we have sold over 110 million stuffed animals.
 
Description of Operations
 
Guests who visit Build-A-Bear Workshop stores enter a teddy bear themed environment consisting of eight stuffed animal making stations: Choose Me, Hear Me, Stuff Me, Stitch Me, Fluff Me, Dress Me, Name Me, and Take Me Home®.  In our new store design, we have added an additional Love Me station to our signature process.  To attract our target guests, we have designed stores that are open and inviting, with an entryway that spans the majority of our storefront, and highly visual with colorful teddy bear themes and displays that create a “theme park” destination in the mall.  The duration of a guest’s experience can vary greatly depending on his or her preferences.  While most guests choose to participate in the full animal-making process and all eight stations, a process which we believe averages 45 minutes, guests can also visit a Build-A-Bear Workshop store and purchase items such as clothing, accessories, our Bear Buck$® and Cub Cash® gift cards, Bearville Outfitters® game cards or pre-made animals in only a few minutes.  We also offer a wide variety of animals and accessories on our e-commerce Web site, buildabear.com®.
 
We offer an extensive and coordinated selection of merchandise including over 30 varieties of animals to be stuffed, as well as a wide variety of other clothing and accessory items for the animals.  Our clothing is inspired by human fashion and includes authentic details such as functional buttons, working pockets, belt loops and zippers and has child-friendly, easy-to-dress details such as an opening for the stuffed animal’s tail and adjustable closures to help fit any size animal.  We enhance the authentic nature of a number of our products with strategic product licensing relationships with brands that are in demand with our guests such as officially sanctioned NFL®, NBA®, MLB® and the NHL™ team apparel, Skechers® shoes and Justice® clothing.  We also tap into pop culture that is relevant to our guests by featuring merchandise such as a Victoria Justice bear and accessories and Alvin and the Chipmunks® and SmurfTM stuffed characters.
 
While our concept is a unique combination of experience and product, we selectively promote seasonal products with special offers and discounts intended to maximize sales at peak traffic periods in the year.  We also offer frequent shopper discounts associated with our Stuff Fur Stuff® club loyalty program and strategically use coupons and gift-with-purchase promotions to drive traffic to our stores.
 
 
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As a retailer whose signature product is a stuffed animal that is typically purchased as a toy or gift, our sales are highest in our fourth quarter which ends on the Saturday nearest December 31 each year, followed by the first quarter.  The timing of holidays and school vacations can impact our quarterly results.  Our European-based stores have historically been more heavily weighted in the fourth quarter as compared to our North American stores.  We cannot ensure that this will continue to be the case.
 
Strategy
 
We are in the midst of a multi-year turnaround plan that builds on a strong base of profitable stores.  In 2012, our top 200 company-owned stores had an average 20 percent store level contribution.  We believe that our store base will be more profitable by the end of 2014 as we benefit from our initiatives.
 
To improve the productivity of our company-owned stores, we have three key strategic initiatives to improve our store sales and profitability: first, in North America, we are closing stores, primarily in multi-store markets where we can transfer a portion of sales to other stores in the same markets; second, also in North America, we are updating our brand experience by remodeling additional stores in our newly imagined design; and third, in both North America and in Europe, we plan to grow our base store business with improved merchandise selection and availability as well as rebalancing our marketing messaging to speak to our brand experience and product vs. product and promotion.
 
We expect to build the appeal of our stores and improve our store productivity and profitability by closing select stores, relocating and downsizing other stores and remodeling and opening select stores in a new design.  We believe that we can optimize stores in multi-store markets with fewer locations that have higher sales volumes.  In fiscal 2012, we closed ten stores in accordance with natural lease events such as expirations and lease termination options, primarily in multi-store markets, transferring a percentage of sales to other stores in the same markets.  We also relocated and downsized 11 stores within existing malls which we anticipate will lead to higher productivity metrics in these locations.  We opened five new stores across geographies, compared to 2011 when we opened nine new stores across geographies.  We currently expect to close an additional 50 to 60 stores in in fiscal 2013 and 2014 to reach an optimal store count of 225 to 250 Build-A-Bear Workshop stores in North America.  We believe our potential in the United Kingdom and Ireland is 60 to 70 stores.  In 2012, we also introduced a new store design which we believe enhances our interactive experience and better showcases our products.  In 2012, we successfully opened six locations in the new design and expect to have 40 to 50 additional locations by the end of 2014, primarily through remodels and relocations.
 
Our concept is a unique combination of experience and product, both of which are keys to our growth.  In terms of product innovation, we believe that the focus on larger, limited edition animal introductions that launch approximately once a month creates a sense of urgency to shop and drives traffic to our stores, increases conversion and improves sales.  We plan to further increase conversion and average transaction value by offering additional toy products and other branded products that are in demand with our core demographics yet consistent with our brand attributes of creativity and imaginative play.  We will use our national multi-media marketing programs to increase store traffic by promoting our interactive experience and seasonal product launches and to increase shopping frequency with guests who are members in our loyalty program.  We believe our signature store experience is a competitive advantage and the full integration of product, marketing and operations enhances our guests’ brand interaction.  We will continue to grow online engagement at bearville.com, as well as grow our e-commerce business.  We also plan to drive sales increases related to gift-giving occasions, such as birthdays and Christmas, by promoting our products and gift cards.
 
In response to an emerging trend of kids’ interaction and play in the online space, we maintain our virtual world, bearville.com.  The website is designed to complement and continue our in-store experience and enhance our core brand values.  By the end of 2012, there have been nearly 24 million accounts created.  This site drives interaction with core demographic segments and creates loyalty with these guests while also encouraging and promoting future store visits.  As kid’s play patterns have evolved into mobile technology, we launched the Build-A-Bear® App for mobile devices where users gain access to mobile-exclusive content and bearville.com games.  To date, there have been over 1.2 million downloads.  In 2013, we plan to continue to update and enhance our mobile App presence.
 
 Product Development
 
Through our in-house design and product development team, we have developed a coordinated, creative and broad merchandise assortment, including a variety of animals, clothing, shoes and accessories.  We believe our merchandise is an integral part of our concept and that the proprietary design of many of the products we offer is a critical element of our success, while the authentic and fashionable nature of our products greatly enhances our brand’s appeal to our guests.  Our product development team regularly monitors current fashion and cultural trends in order to create products that are most appealing to our guests, often reflecting similar styling to the clothes our guests wear themselves.  We test our products on an ongoing basis to ensure guest demand supports order quantities.  Through our focused vendor relationships, we are able to source our merchandise in a manner that is cost-effective, maximizes our speed to market and facilitates rapid reorder of our best-selling items.
 
Our stuffed animal skins and clothing are produced from high quality man-made materials or natural fibers such as cotton, and the stuffing is made of a high-grade polyester fiber. We believe all of our products in our stores and online at buildabear.com meet Consumer Product Safety Commission requirements including the Consumer Product Safety Improvement Act (CPSIA) for Children’s Products. We also comply with American Society for Testing and Materials (ASTM), EN71 (European standards) and Canadian specifications for toy safety in all material respects. Our products are tested through independent third-party testing labs for compliance with toy safety standards. We believe we comply with governmental toy safety requirements specific to each country where we have stores. Packaging and labels for each product indicate to our guests the age grading for the product and any special warnings in accordance with guidelines established by the Consumer Product Safety Commission.
 
 
3

 
 
Our products have earned the Good Housekeeping Seal of Approval. The Good Housekeeping Seal, introduced in 1909, is earned by products that pass Good Housekeeping Institute review and is one of America’s most trusted consumer icons assuring consumers of a quality product.  Seal-backed products are covered by Good Housekeeping’s two-year money-back warranty.
 
In order to increase store visits and give guests additional reasons for purchasing at our stores, we expect to expand our product assortment and our leadership in the toy industry by offering additional products other than our core plush animals and related items that are consistent with our interactive and hands-on experience, some of which are proprietarily developed and some that come from other toy and accessory companies.  We believe the addition of complementary toy and accessory products will allow us to increase our sales and overall profitability.
 
Marketing

We believe there is value in promoting and advertising the Build-A-Bear Workshop store and brand as a family-friendly destination that provides fun, affordable experiences appealing to a broad range of age groups and demographics.  This gives us a competitive advantage and is critical to our business strategy.  Our advertising expenditures were $23.0 million (6.1% of net retail sales) in fiscal 2012, $19.3 million (5.0% of net retail sales) in fiscal 2011 and $18.5 million (4.8% of net retail sales) in fiscal 2010, reflecting the continuation and further refinement of marketing initiatives. We believe our adjusted marketing strategies contributed to a significant improvement in sales trend in the fourth quarter of fiscal 2012 in the United States with comparable store sales increasing 2.4%, a significant improvement from the third quarter sales decline of 11.6%.  We will continue to adjust our marketing programs and expenditures as we move forward
 
In 2013, our goal is to continue to build top of mind brand awareness through fully integrated marketing programs.  Television advertising is a key strategy to reach and acquire new guests and gives existing guests new reason to visit.  Since February 2004, we have aired nationally televised advertisements in the United States.  In the fourth quarter of 2010, we expanded our television advertising to the United Kingdom.  In 2012, we rebalanced our advertising strategy in the United States to showcase the unique Build-A-Bear Workshop brand and experience in addition to featuring new products and selected seasonal promotions.
 
Build-A-Bear Workshop has a community of highly engaged advocates, both adults, primarily moms, and kids.  In 2012, we continued to expand our use of social media to reach and market to these brand advocates.  As of March 8, 2013, nearly 2.5 million Facebook users have “liked” the Build-A-Bear Workshop brand, we had nearly 40,000 Twitter followers, 8 million views on YouTube and over 1.2 million downloads of our Build-A-Bear App. Digital media and social media have allowed us to measure success of products, events, and other initiatives and to gather their feedback so we can focus on the programs that our guests value most highly.  In 2013, the digital space will continue to be an important component in our marketing efforts because it is an important part of where our guests spend time and engage with brands they support.  Since the digital space is constantly changing; we continue to evolve our online strategies to maximize our relevance.  Our child-centric Web site, bearville.com, is targeted at kids, primarily ages six to fourteen and continues to be a tool to increase brand engagement, promote our brand and raise awareness of in-store products and events. Our mobile app is also an important brand touch point for both moms and kids and we continue to increase our capabilities and presence in mobile technology.
 
 We also leverage our database of nearly 4.5 million active members of our Stuff Fur Stuff club loyalty program.  The program offers shoppers the opportunity to earn awards based on purchases as well as receive other member-only benefits.  In 2008, we launched a version of the program in the United Kingdom that did not include reward certificates, but served to gather guest data and maintain contact with our guests.  In 2012, we refreshed our Stuff Fur Stuff program to increase guest retention metrics.  Members earn awards for every 50 points, including, for the first time our guests in the United Kingdom. The guest and transactional data that is collected provides insight into the overall purchasing history of members including visit frequency, items purchased and amounts spent on each visit and cumulatively over time.  We continue to leverage this information and our database to market products, promotions and store events.
 
Licensing and Strategic Relationships

We have developed licensing and strategic relationships with some of the leading retail and cultural organizations in North America and Europe.  We believe that our guest base and brand strength make us an attractive partner and our customer research and insight allow us to focus on strategic relationships with other companies.  We plan to continue to add partnerships with companies that have strong, family-oriented brands and provide us with attractive marketing and merchandising opportunities.  These relationships for specific products are generally reflected in contractual arrangements for limited terms that are terminable by either party upon specified notice.
 
 
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Product and Merchandise Licensing. We have key strategic relationships with select companies, including Disney®, Sanrio®, Skechers, Justice, Star Wars, MLB, NBA, NFL, the NHL®, and World Wildlife Fund US and Canada, in which we feature their brands on products sold in our stores.  These strategic relationships allow both parties to generate awareness of their brands.  We have also offered selected character and media-oriented products including Sanrio’s Hello Kitty, Disney’s Muppets, Minnie Mouse and Shake It Up themed bears, Fremantle’s Rebecca Bonbon, Fox Studio’s Ice Age, and holiday classics Rudolph the Red-Nosed Reindeer and the Grinch.
 
Promotional Arrangements. We have also developed promotional arrangements with select organizations.  Our arrangements with Major League Baseball teams, including the Chicago Cubs®, St. Louis Cardinals and Pittsburg Pirates® have featured stuffed animal giveaways at each club’s ballpark on a day in which our brand is highly promoted within the stadium.  In 2012, we partnered with McDonald’s® for the fourth time to feature limited edition, collectible mini Build-A-Bear Workshop animals in Happy Meals®.  We also have had arrangements featuring product sampling, cross promotions and shared media with companies such as Dairy Queen in North America and Betty Crocker’s Fruit Roll-ups.  We continued to partner with teen celebrity, Victoria Justice, who was our brand ambassador through July 2012.  The arrangement also featured Victoria Justice 4 BABW branded merchandise available in our stores.  In October 2012, we announced our next brand ambassador, pop star, Cody Simpson.
 
Third Party Licensing. We have continued a series of licensing arrangements with leading manufacturers to develop a collection of lifestyle Build-A-Bear Workshop branded products including children’s furniture, fruit snacks, girls play sets and novelty toys.  We believe that each of these initiatives has the potential to enhance our brand, raise brand awareness, and drive increased revenues and profitability.  We select companies for licensing relationships that we believe are leaders in their respective sectors and that understand and share our strategic vision for offering guests exciting and interactive merchandise.  We have policies and practices in place intended to ensure that the products manufactured under the Build-A-Bear Workshop brand adhere to our quality, value and usability standards.  We have entered into or maintained licensing arrangements for our branded products with leading manufacturers including Playmates Toys, Pulaski Furniture, ConAgra Foods and Enterplay.
 
Industry and Guest Demographics
 
While Build-A-Bear Workshop offers consumers an interactive and personalized experience, our tangible products are stuffed animals, including our flagship product, the teddy bear, a widely adored icon for over 100 years.  According to data published by the Toy Industry Association and The NPD Group, sales of the traditional toy market were $21.2 billion in the United States (excluding video games) in 2010 with plush and doll sales having a combined 18.7% share of the traditional toy market.  According to further estimates provided by The NPD Group, worldwide toy sales topped $83.3 billion dollars in 2010.
 
Our guests are diverse, spanning broad age ranges and socio-economic categories.  Major guest segments include families with children, primarily ages three to twelve, grandparents, aunts and uncles, teen girls who occasionally bring along their boyfriends, and child-centric organizations looking for interactive entertainment options such as scouting organizations and schools.  Based on information compiled from our guest database for 2012, the average age of the recipient of our stuffed animals at the time of purchase is nine years old and children aged one to fourteen are the recipients of approximately 80% of our stuffed animals.
 
According to the estimates by the United States Census Bureau, in 2009 there were over 62 million children age 14 and under in the United States.  The size of this population group is projected to remain relatively stable over the next decade.  Industry sources estimate direct spending by children in the United States at over $50 billion annually and that parents and family members spend an additional $170 billion annually on children. In addition, children influence billions of dollars in other family spending.
 
Employees and Training
 
In January 2013, we were recognized by FORTUNE Magazine for the fifth consecutive year as one of the 100 Best Companies to Work For in the United States.  We believe that this honor is the result of our commitment to providing a great experience for our diverse team of associates as well as our guests.  We have a distinctive culture that we believe encourages contribution and collaboration.  We take great pride in our culture and feel it is critical in encouraging creativity, communication, and strong store performance.  All store managers receive comprehensive training through our Bear University program, which is designed to promote a friendly and personable environment in our stores and a consistent experience across our stores.
 
We extensively train our associates on the bear-building process and the guest experience.  In fiscal 2012, we hired approximately 3.5% of applicants for store manager positions.  We focus on employing and retaining people who are friendly and committed to guest service.  Our high employee retention rates contribute to the consistency and quality of the guest experience.  Our store teams are evaluated and compensated not only on sales results but also the results from our regular guest satisfaction surveys.  Each store has a recognition fund so that exceptional guest service can be immediately recognized and rewarded.  We are committed to providing compensation structures that recognize individual accomplishments as well as overall team success.
 
 
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As of December 29, 2012, we employed approximately 1,000 full-time and 3,400 part-time employees.  We divide our store base into three geographic regions, with the United Kingdom and Ireland representing one of those regions.  The regions are led by our Chief Operations and Financial Bear; our North American operations are led by our Chief Workshop Bear – North America and there are three Regional Workshop Managing Directors.  Bearitory Leaders are responsible for each of our 31 store districts, or bearitories, consisting of on average, 11 stores.  Historically, our stores generally have had a full-time Chief Workshop Manager, and three additional managers who are full-time or part-time, depending upon the volume at the specific location, in addition to part-time hourly Bear Builder® associates.  In 2011 and 2012, as part of our cost savings initiatives, we adjusted our store staffing model to reduce fixed costs and provide flexibility to better match staffing levels to peak sales times.  This resulted in significant savings in store payroll, while still maintaining our high levels of overall guest satisfaction.  In addition to the approximately 4,000 employees at our store locations, we employ approximately 230 associates in general administrative functions at our World Bearquarters in St. Louis, Missouri, approximately 70 associates at our Bearhouse distribution center in Groveport, Ohio, and approximately 20 associates in our European Bearquarters in Windsor, England.  The number of part-time employees at all locations fluctuates depending on our seasonal needs.  We are committed to innovation and invention and generally have confidentiality agreements with our employees and consultants.  Store managers and Bearquarters associates pass specific profile assessments.  None of our employees are represented by a labor union, and we believe our relationship with our employees is good.
 
International Franchises
 
In 2003, we began to expand Build-A-Bear Workshop stores outside of the United States, opening company-owned stores in Canada and our first franchised location in the United Kingdom.  As of December 29, 2012, there were 91 Build-A-Bear Workshop franchised stores located in 14 countries. All stores outside of the U.S., Canada, the United Kingdom and Ireland are currently operated by third party franchisees under separate master franchise agreements covering each territory.  Master franchise rights are typically granted to a franchisee for an entire country or group of countries for a specified term.  The terms of these master franchise agreements vary by country but typically provide that we receive an initial, one-time development fee and continuing royalties based on a percentage of the franchisees’ stores sales.  The terms of these agreements range up to 25 years with a franchisee option to renew for an additional term if certain conditions are met.  All franchised stores have similar signage, store layout and merchandise characteristics to our company-owned stores.
 
Our goal is to have well-capitalized franchisees with expertise in retail operations or franchising and real estate in their respective country.  We collaborate with our franchisees in the development of their business, marketing and store growth plans.  We review all franchisees’ orders for merchandise which are made in the same factories that produce products for our company-owned stores and advise our franchisees concerning their operational and business practices in an effort to ensure they are in compliance with our standards.  We expect our current franchisees to open approximately eight to twelve new stores in fiscal 2013.
 
Sourcing and Inventory Management
 
We do not own or operate any manufacturing facilities.  Our animal skins, stuffing, clothing and accessories are produced by factories located primarily in China.  We purchased approximately 80% of our inventory in fiscal 2012, approximately 81% in fiscal 2011 and approximately 73% in fiscal 2010 from three long standing vendors.  After specifying the details and requirements for our products, our vendors contract orders with multiple manufacturing facilities in China that are approved by us in accordance with our quality control and labor standards.  We believe that our supplier factories are compliant with the International Council of Toy Industries (ICTI) CARE certification.
 
The CARE (Caring, Awareness, Responsible, Ethical) Process is the ICTI program to promote ethical manufacturing, in the form of fair labor treatment, as well as employee health and safety, in the toy industry supply chain worldwide.  The program’s initial focus is in China, where 70 percent of the world’s toy volume is manufactured.  In order to obtain this certification, each factory completed a rigorous evaluation performed by an accredited ICTI agent.  Our vendors can be used interchangeably as each has a sourcing network for multiple product categories and can expand its factory network as needed.  Our relationships with our vendors generally are on a purchase order basis and do not provide a contractual obligation to provide adequate supply or acceptable pricing on a long-term basis.
 
The average time from the beginning of production to arrival of the products into our stores is approximately 90 to 120 days.  Our weekly tracking and reporting tools give us the capability to adjust to shifts in demand. Through an ongoing analysis of selling trends, we regularly update our product assortment by increasing quantities of productive styles and eliminating less productive items.  Our distribution centers provide further logistical efficiencies for delivering merchandise to our stores.
 
 
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Distribution and Logistics
 
We own our 350,000 square-foot distribution center near Columbus, Ohio which serves the majority of our stores in the United States and Canada.  We also engage a third-party warehouse in southern California to service our West Coast stores.  The contract has a one year term and is renewable.  In Europe, we contract with a third-party distribution center in Selby, England under an agreement that ends in December 2014.  This agreement contains clauses that allow for termination if certain performance criteria are not met.
 
Transportation from the warehouses to the stores is managed by several third-party logistics providers.  In the United States, Canada and Europe, merchandise is shipped by a variety of distribution methods, depending on the store and seasonal inventory demand.  Key delivery methods are direct trucks through third-party pool points, ‘LTL’ (less-than truck load) deliveries, and direct parcel deliveries.  Shipments from our third-party distribution centers are scheduled throughout the week in order to smooth workflow and stores that are part of the same shipping route are grouped together to reduce freight costs.  All items in our assortment are eligible for distribution, depending on allocation and fulfillment requirements, and we typically distribute merchandise and supplies to each store once a week on a regular schedule, which allows us to consolidate shipments in order to reduce distribution and shipping costs.  Back-up supplies, such as Cub Condo® carrying cases and stuffing for the animals, are often stored in limited amounts at local pool points.
 
Management Information Systems and Technology
 
Optimizing technology is a key business strategy.  We are committed to utilizing and leveraging digital advancements to gain a competitive edge and improve guest experiences.  We regularly evaluate strategic information technology initiatives focused on competitive differentiation, support of corporate strategy and reinforcement of our internal support systems.  In 2012, we launched our new store design that combines our signature in-store experience with innovative digital technology that enhances our guests’ experiences and adds interactive and customization features to our stuffed animal making process.
 
We have developed award-winning, proprietary software including our new Digital Sound Station, party scheduling system and domestic and international versions of our Name Me kiosk, which populates our Find-A-Bear® identification system.  Data from these systems are used to support key decisions in all areas of our business, including merchandising, allocation and operations.  Our innovation continues in our new store design which begins with an interactive storefront where guests can engage and play with the digital signage.  The new Love Me station gives our guests the ability to customize the inside of their animal with special personality attributes displayed as emoticons on an interactive table.  The redesigned Fluff Me station, includes a digital bath tub that recognizes items as they are placed on it and reacts with sensory effects such as virtual bubbles that appear when play soap is placed on the surface.  Finally, at our updated Name Me station guests use a viewfinder that reveals the customized attributes that have been added to the animal throughout the process.
 
We believe our information and operational systems to be best in class that incorporate a broad range of purchased and internally developed technologies; each is built on a foundation of sound business processes and supports guest relationship management, marketing, financial, retail operations, real estate, merchandising, e-commerce and inventory management processes, with a goal to deliver solid business results.  Our employees can securely access these systems over a company-wide network.  Sales, daily deposit and guest information are automatically collected from the stores’ point-of-sale terminals and kiosks on a near real time basis. All data captured is secured, Payment Card Industry compliant and protected by a solid disaster recovery plan.  Our critical systems are reviewed on a regular basis to evaluate security and disaster recovery.
 
Competition
 
We view the Build-A-Bear Workshop experience as a distinctive combination of entertainment and retail with limited direct competition.  Because our signature product is a stuffed animal, we compete with toy retailers, such as Wal-Mart, Toys “R” Us, Target, Kmart and other discount chains.  Build-A-Bear Workshop was ranked by Playthings Magazine as the ninth largest toy retailer for retailers with continuing operations, based on 2008 revenues.  Since we develop proprietary products, we also compete indirectly with a number of companies that sell stuffed animals in the United States, including, but not limited to, Ty, Fisher Price, Mattel, Ganz, Russ Berrie, Applause, Boyd’s, Hasbro, Commonwealth, Gund and Vermont Teddy Bear.  Since we sell a product that integrates merchandise and experience, we also view our competition as any company that competes for family time and entertainment dollars, such as movie theaters, amusement parks and arcades, other mall-based entertainment venues and online entertainment.  Being a mall-based retailer, we also compete with other mall-based retailers for prime mall locations, including various apparel, footwear and specialty retailers.
 
We are aware of several small companies that operate “make your own” teddy bear and stuffed animal stores or kiosks in retail locations, but we believe none of those companies offer the breadth and depth of the Build-A-Bear Workshop experience or operate as a national or international retail company.
 
We also believe that there is an emerging trend within children’s play patterns towards mobile internet and online play.  According to Emarketer.com, kids aged 8 to 11 reported that they spend between one and two hours online each day.  We believe our bearville.com Web site competes with other companies and internet sites that vie for children’s attention in the online space including webkinz.com, clubpenguin.com and neopets.com.
 
 
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Intellectual Property and Trademarks
 
As of December 29, 2012, we had obtained over 206 U.S. trademark registrations, including Build-A-Bear Workshop for stuffed animals and accessories for the animals, retail store services and other goods and services, 36 issued U.S. patents with expirations ranging from 2013 through 2020 and over 381 copyright registrations.  In addition, we have five U.S. trademark applications pending.  We have exclusive patent rights from a third party in association with our BUILD-A-SOUND message device and system.  We were granted exclusive licenses to use the device and system covered by the patents in retail stores similar to ours.  While we have the right to sublicense the patent, the licensor has agreed not to grant competing license rights to any of our competitors.  In the event that we or the licensor has reason to believe that a third party is infringing upon the patents, the licensor is generally required to bear the expenses required to maintain and defend the patents.  Our exclusive rights will last until the expiration of the latest patent covered by the agreement, calculated to be 2017, unless the agreement is terminated.
 
We believe our copyrights, service marks, trademarks, trade secrets, patents and similar intellectual property are critical to our success, and we intend, directly or indirectly, to maintain and protect these marks and, where applicable, license the intellectual property and the registrations for the intellectual property.  We rely on trademark, copyright and other intellectual property law to protect our proprietary rights to the extent available in any relevant jurisdiction.  We also depend on trade secret protection through confidentiality and license agreements with our employees, subsidiaries, licensees, licensors and others.  We may not have agreements containing adequate protective provisions in every case, and the contractual provisions that are in place may not provide us with adequate protection in all circumstances. Any infringement or misappropriation of our intellectual property rights or breach of our confidentiality or license agreements could result in significant litigation costs, and any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of one or more competitive advantages and decreased revenues. In addition, intellectual property litigation or claims could force us to do one or more of the following: cease selling or using any of our products that incorporate the challenged intellectual property, which would adversely affect our revenue; obtain a license from the holder of the intellectual property right alleged to have been infringed, which license may not be available on reasonable terms, if at all; and redesign or, in the case of trademark claims, rename our products to avoid infringing the intellectual property rights of third parties, which may not be possible and time-consuming if it is possible to do so.
 
Despite our efforts to protect our intellectual property rights, intellectual property laws afford us only limited protection.  A third party could copy or otherwise obtain information from us without authorization.  Accordingly, we may not be able to prevent misappropriation of our intellectual property or to deter others from developing similar products or services.  Further, monitoring the unauthorized use of our intellectual property is difficult.  Litigation has been and may continue to be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others.  Litigation of this type could result in substantial costs and diversion of resources, may result in counterclaims or other claims against us and could significantly harm our results of operations.  In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States.
 
We also conduct business in foreign countries to the extent our merchandise is manufactured or sold outside the United States and we have opened stores outside the United States either directly or indirectly through franchisees.  We filed, obtained or plan to file for registration of marks in foreign countries to the degree necessary to protect these marks, although our efforts may not be successful and there may be restrictions on the use of these marks in some jurisdictions.
 
Segments and Geographic Areas
 
We conduct our operations through three reportable segments consisting of retail, international franchising, and commercial.  The retail segment includes the operating activities of company-owned stores in the United States, Canada, the United Kingdom and Ireland, and other retail operations, including our web-store and non-traditional store locations such as tourist venues, temporary locations and ballpark stores.  The commercial segment includes our transactions with other business partners, mainly comprised of licensing our intellectual property, including entertainment properties, for third-party use and wholesale product sales.  The international franchising segment includes the activities under our franchise agreements with locations in Asia, Australia, Africa, the Middle East, Europe, Mexico and South America.
 
Our reportable segments are primarily determined by the types of customers they serve and the types of products and services that they offer.  Each reportable segment may operate in many geographic areas.  See the financial statements included elsewhere in this Annual Report on Form 10-K for further discussion and financial information related to our segments and the geographic areas in which we operate.
 
 
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Availability of Information
 
We make certain filings with the Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments and exhibits to those reports, available free of charge in the Investor Relations section of our corporate website, http://ir.buildabear.com, as soon as reasonably practicable after they are filed with the SEC.  The filings are also available through the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 or by calling 1-800-SEC-0330. Also, these filings are available on the internet at http://www.sec.gov. Our Annual Reports to shareholders, press releases and investor updates are also available on our website, free of charge, in the Investor Relations section or by writing to the Investor Relations department at World Bearquarters, 1954 Innerbelt Business Center Dr., St. Louis, MO 63114.
 
ITEM 1A.  RISK FACTORS
 
We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could materially affect our operations. The risks, uncertainties and other factors set forth below may cause our actual results, performances or achievements to be materially different from those expressed or implied by our forward-looking statements. If any of these risks or events occur, our business, financial condition or results of operations may be adversely affected.
 
Risks Related to Our Business
 
A decline in general global economic conditions could lead to disproportionately reduced consumer demand for our products, which represent relatively discretionary spending, and have an adverse effect on our liquidity and profitability.
 
Since purchases of our merchandise are dependent upon discretionary spending by our guests, our financial performance is sensitive to changes in overall economic conditions that affect consumer spending.  Consumer spending habits are affected by, among other things, prevailing economic conditions, levels of employment, salaries and wage rates, consumer confidence and consumer perception of economic conditions.  A continued slowdown in the United States, Canadian or European economies or uncertainty as to the economic outlook could reduce discretionary spending or cause a shift in consumer discretionary spending to other products.  Any of these factors would likely result in lower net sales and could also result in excess inventories, which could, in turn, lead to increased merchandise markdowns and related costs associated with higher levels of inventory and adversely affect our liquidity and profitability.  For example, the slower economy in the United States and Europe has caused our sales to decline and led us to slow our growth plans.
 
A decrease in the customer traffic generated by the shopping malls in which we are located, which we depend upon to attract guests to our stores, could adversely affect our financial condition and profitability.
 
While we invest heavily in integrated marketing efforts and believe we are more of a destination location than traditional retailers, we rely to a great extent on customer traffic in the malls in which our stores are located.  In order to generate guest traffic, we generally attempt to locate our stores in prominent locations within high traffic shopping malls.  We rely on the ability of the malls’ anchor tenants, generally large department stores, and on the continuing popularity of malls as shopping destinations.  We cannot control the development of new shopping malls, the addition or loss of anchors and co-tenants, the availability or cost of appropriate locations within existing or new shopping malls or the desirability, safety or success of shopping malls.  In addition, customer mall traffic may be reduced due to a loss of consumer confidence because of the economy, terrorism or war.  If we are unable to generate sufficient guest traffic, our sales and results of operations will be harmed.  A significant decrease in shopping mall traffic could have a material adverse effect on our financial condition and profitability.  For example, we have experienced a decline in transactions at comparable locations over the past several years.
 
If we are unable to generate interest in and demand for our interactive retail experience, including being able to identify and respond to consumer preferences in a timely manner, our financial condition and profitability could be adversely affected.
 
We believe that our success depends in large part upon our ability to continue to attract guests with our interactive shopping experience and our ability to anticipate, gauge and respond in a timely manner to changing consumer preferences and fashion trends.  We cannot assure you that our past success will be sustained or there will continue to be a demand for our “make-your-own stuffed animal” interactive experience, or for our stuffed animals, animal apparel and accessories.  A decline in demand for our interactive shopping experience, our animals, animal apparel or accessories, or a misjudgment of consumer preferences or fashion trends, could have a negative impact on our business, financial condition and results of operations.  For example, in 2008 we announced plans to close the Friends 2B Made concept.  The closure was completed by the end of the fiscal 2009 third quarter with pre-tax charges totaling $3.9 million.  In addition, if we miscalculate the market for our merchandise or the purchasing preferences of our guests, we may be required to sell a significant amount of our inventory at discounted prices or even below costs, thereby adversely affecting our financial condition and profitability.  For example, in 2007, we wrote-off $1.6 million, net of tax, of inventory, including excess Shrek® merchandise.
 
 
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Our future growth and profitability could be adversely affected if our marketing and online initiatives are not effective in generating sufficient levels of brand awareness and guest traffic or if consumer preferences change significantly.
 
We continue to update and evaluate our marketing initiatives, focusing on brand awareness, new product news, timely promotions and rapidly changing consumer preferences.  We may not be able to successfully engage children in our virtual world website, bearville.com, achieve high enough traffic levels nor be able to leverage the site to drive traffic to our stores and choose to discontinue operating the site.  Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our marketing and advertising programs and future marketing and advertising efforts that we undertake, including our ability to:
 
 
create greater awareness of our brand, interactive shopping experience and products;
 
 
identify the most effective and efficient level of spending in each market;
 
 
determine the appropriate creative message and media mix for marketing expenditures;
 
 
effectively manage marketing costs (including creative and media) in order to maintain acceptable operating margins and return on marketing investment;
 
 
select the right geographic areas in which to market;
 
 
convert consumer awareness into actual store visits and product purchases; and
 
 
reach a level of engagement on the virtual world Web site with large numbers of unique visitors with frequent visitation that drives visits to our retail stores resulting in purchases.
 
Our planned marketing expenditures may not result in increased total or comparable store sales or generate sufficient levels of product and brand awareness.  We may not be able to manage our marketing expenditures on a cost-effective basis.
 
If we are unable to increase our comparable store sales trends, our results of operations and financial condition could be adversely affected.
 
Our comparable store sales for 2012 declined 3.3% following a 2.1% decline in 2011, following a 2.0% decline in 2010, a 13.4% decline in fiscal 2009 and a 14.0% decline in fiscal 2008.  We believe that the decrease in 2012 was primarily attributable to a decline in transactions compared to 2011, specifically in the third quarter and the negative economic conditions in the UK that we believe contributed to a decline in consumer spending.  We believe that the decrease in 2011 was primarily attributable to the underperformance of certain licensed movie products in the fourth quarter.  We believe that global economic conditions continued to impact our comparable store sales in 2010.  We believe that the decrease in fiscal 2009 was primarily attributable to the continued economic recession and dramatic decrease in consumer sentiment and the decline in North American shopping mall traffic.  We believe that the decrease in 2008 was primarily attributable to the economic recession and decrease in consumer disposable income, a continued decline in shopping mall customer traffic and changes in media strategies, online entertainment, children’s media consumption and play patterns.  We believe the principal factors that will affect comparable store results include the following:
 
 
the continuing appeal of our concept;
 
 
the effectiveness of our marketing efforts to attract new and repeat guests;
 
 
consumer confidence and general economic conditions;
 
 
the impact of changes in governmental policies on consumer sentiment and discretionary spending levels as happened in the UK
 
 
the impact of store closures, relocations and openings in existing markets;
 
 
the impact of our new store design;
 
 
our ability to anticipate and to respond, in a timely manner, to consumer trends;
 
 
the continued introduction and expansion of our merchandise offerings;
 
 
mall traffic;
 
 
competition for product offerings including in the online space;
 
 
the timing and frequency of national media appearances and other public relations events; and
 
 
weather conditions.
 
As a result of these and other factors, we may not be able to generate or achieve comparable stores sales growth in the future.  If we are unable to do so, our results of operations could be significantly harmed and we may be required to record significant impairment charges.
 
 
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Our strategy requires us to operate a significant number of stores in the United States, Canada, the United Kingdom and Ireland, as well as close, relocate and open store locations in these countries.  If we are not able to operate these stores or to effectively manage the overall portfolio of our stores, it could adversely affect our ability to grow and could significantly harm our profitability.
 
Our future results will largely depend on our ability to operate our stores successfully in the United States, Canada, the United Kingdom and Ireland and optimizing store productivity and profitability by closing select stores, relocating and downsizing other stores and remodeling and opening select stores in a new design.  Through 2008 we had opened over 300 stores and acquired 40 in the UK.  Since then we slowed net store growth considerably with one net closure in both 2009 and 2010 and three net closures in 2011, exclusive of temporary locations.  In 2012, we announced a plan to reduce our store count in North America to 225 to 250 stores.  We plan to achieve this with 50 to 60 additional closures by the end of 2014.  This is in addition to the 10 locations closed in 2012 and 12 locations closed in 2011.  Our ability to manage our portfolio of stores in future years in desirable locations and operate stores profitably, particularly in multi-store markets, is a key factor in our ability to grow successfully.  We cannot assure you as to when or whether desirable locations will become available, the number of Build-A-Bear Workshop stores that we can or will ultimately open, or whether any such new or relocated stores can be profitably operated.  We have not always succeeded in identifying desirable locations or in operating our stores successfully in those locations.  For example, in 2012, 2011 and 2010, we closed two, five and four locations, respectively, prior to the expiration of their respective leases.  Prior to 2010, we had closed four stores since our inception (excluding four stores that we closed in connection with our 2006 acquisition of Amsbra and The Bear Factory in the UK).  We may decide to close other stores in the future.  Our ability to successfully manage our portfolio of stores also depends on our ability to:
 
 
negotiate acceptable lease terms, including desired tenant improvement allowances;
 
 
finance the costs of closing, relocating and opening stores, including, severance and termination fees for store closures and capital expenditures and working capital requirements of the new and relocated stores;
 
 
manage inventory to meet the needs of new and existing stores on a timely basis;
 
 
hire, train and retain qualified store personnel;
 
 
develop cooperative relationships with our landlords; and
 
 
successfully integrate new stores into our existing operations.
 
In July 2005, we opened our flagship store in New York City.  This store is much larger than our typical mall-based stores and as such, we may be unable to generate revenues from this store at a level that justifies keeping the store open.  Closing this store could not only have an adverse impact on our sales if we are unable to establish other retail locations within the market, but, as our flagship store, it could also have an adverse impact on the Build-A-Bear Workshop brand and consumer perception of our brand.
 
Increased demands on our operational, managerial and administrative resources as a result of our store strategy could cause us to operate our business less effectively, which in turn could cause deterioration in our profitability. Additionally, closing multiple stores could have an adverse impact on the Build-A-Bear Workshop brand and consumer perception of our brand.
 
We may not be able to operate our foreign company-owned stores in the United Kingdom and Ireland profitably.
 
In April 2006, we acquired The Bear Factory Limited, a stuffed animal retailer in the United Kingdom owned by The Hamleys Group Limited, and Amsbra Limited, our former United Kingdom franchisee (the UK Acquisition).  Both The Bear Factory and Amsbra had losses prior to our acquisition.  Although we have realized some benefits from these operations as part of our larger company, we may be unable to continue to do so on a consistent basis.  In particular, we face business, regulatory and cultural differences from our domestic business, such as economic conditions, changes in foreign government policies and regulations and potential restrictions and costs to convert and repatriate currency, as well as other risks that we may not anticipate.  We also face difficulties realizing benefits because we have less brand awareness than in the U.S., face higher labor and rent costs, and have different holiday schedules.  In 2007, we terminated our French franchise agreement and opened three company-owned stores in France.  We were unable to operate the stores in France profitably and in 2010, we closed all three of our company-owned stores in France.  Additionally in 2012, we recognized an impairment charge on all of the goodwill associated with our UK acquisition along with the store assets at certain store locations with poor operating results.
 
Our leases in the United Kingdom and Ireland also typically contain provisions requiring rent reviews every five years in which the base rent that we pay is adjusted to current market rates.  These rent reviews require that base rents cannot be reduced if market conditions have deteriorated but can be changed “upwards only”.  We may be required to pay base rents that are significantly higher than we have forecast. For example, past rent reviews have resulted in increases as high as 40% in select locations within the United Kingdom.  As a result of these and other factors, we may not be able to operate our European store locations profitably. If we are unable to do so, our results of operations and financial condition could be harmed and we may be required to record significant additional impairment charges.
 
 
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If we are unable to renew, renegotiate or replace our store leases or enter into leases for new stores on favorable terms, or if we violate any of the terms of our current leases, our growth and profitability could be harmed.
 
We lease all of our store locations.  The majority of our store leases contain provisions for base rent plus percentage rent based on sales in excess of an agreed upon minimum annual sales level.  A number of our leases include a termination provision which applies if we do not meet certain sales levels during a specified period, typically in the third to fourth year and the sixth to seventh year of the lease, which may be at either the landlord’s options or ours.  Furthermore, some of our leases contain various restrictions relating to change of 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 within the malls.  In addition, the lease for our store in the Downtown Disney® District at the Disneyland® Resort in Anaheim, California currently expires in 2013 and we have not reached agreement on renewal terms.  This lease provides that the landlord may terminate the lease at any time, subject to the payment of an early termination fee.  As a result, we cannot assure you that the landlord will not exercise its right to terminate this lease.
 
In addition, most of our other leases will expire within the next ten years and many of our initial leases are near completion and do not contain options to renew.  We may not be offered a lease renewal by our landlord, may not be able to renew leases under favorable economic terms or maintain our existing store location thereby requiring additional capital expenditure to move the store location within the mall.  Those locations may be in parts of the mall that have less traffic or be positioned further from our desired co-tenants and our ongoing sales and profitability results may be negatively affected.  The terms of new leases may not be as favorable, increasing store expenses and impacting overall profitability.  If we execute termination rights, we may have expenses and charges associated with those closures which could negatively impact our profitability.
 
Our merchandise is manufactured by foreign manufacturers and we transact business in various foreign countries; therefore the availability and costs of our products, as well as our product pricing, may be negatively affected by risks associated with international manufacturing and trade and foreign currency fluctuations.
 
We purchase our merchandise from domestic vendors who contract with manufacturers in foreign countries, primarily in China.  Any event causing a disruption of imports, including the imposition of import restrictions or labor strikes or lock-outs, could adversely affect our business.  The flow of merchandise from our vendors could also be adversely affected by financial or political instability in any of the countries in which the goods we purchase are manufactured, especially China, if the instability affects the production or export of merchandise from those countries. We are subject to trade restrictions in the form of tariffs or quotas, or both, applicable to the products we sell as well as to raw material imported to manufacture those products.  Such tariffs or quotas are subject to change.  Our compliance with the regulations is subject to interpretation and review by applicable authorities.  Change in regulations or interpretation could negatively impact our operations by increasing the cost of and reducing the supply of products available to us.  In addition, decreases in the value of the U.S. dollar against foreign currencies, particularly the Chinese renminbi, could increase the cost of products we purchase from overseas vendors.  The pricing of our products in our stores may also be affected by changes in foreign currency rates and require us to make adjustments which would impact our revenue and profit in various markets.
 
We may suffer negative publicity or be sued if the manufacturers of our merchandise ship any products that do not meet current safety standards or production requirements or if our products are recalled or cause injuries.
 
Although we require our manufacturers to meet our product specifications and safety standards and submit our products for testing, we cannot control the materials used by our manufacturers.  If one of these manufacturers ships merchandise that does not meet our required standards, we could in turn experience negative publicity or be sued.
 
Many of our products are used by small children and infants who may be injured from usage if age grading or warnings are not followed.  We may decide or be required to recall products or be subject to claims or lawsuits resulting from injuries.  For example, we have voluntarily recalled four products in the past four years due to possible safety issues.  While the vendors have historically reimbursed us for certain, related expenses, negative publicity in the event of any recall or if any children are injured from our products could have a material adverse effect on sales of our products and our business, and related recalls or lawsuits with respect to such injuries could have a material adverse effect on our financial position.  Additionally, we could incur fines related to consumer product safety issues from the regulatory authorities in the countries in which we operate.  Although we currently have liability insurance, we cannot assure you that it would cover product recalls or related fines, and we face the risk that claims or liabilities will exceed our insurance coverage.  Furthermore, we may not be able to maintain adequate liability insurance in the future.
 
We may not be able to operate successfully if we lose key personnel, are unable to hire qualified additional personnel, or experience turnover of our management team.
 
The success of our business depends upon our senior management closely supervising all aspects of our business, in particular the operation of our stores and the design, procurement and allocation of our merchandise.  Also, because guest service is a defining feature of the Build-A-Bear Workshop experience, we must be able to hire and train qualified managers and Bear Builder associates to succeed.  The loss of certain key employees, our inability to attract and retain other qualified key employees or a labor shortage that reduces the pool of qualified store associates could have a material adverse effect on our business, financial condition and results of operations.  We generally do not maintain key person insurance with respect to our executives.
 
For example, in January 2013, we announced that Ms. Maxine Clark, our Founder and Chief Executive Bear (CEB) would be retiring from her position as CEB of Build-A-Bear Workshop, Inc. and that a search would be conducted to identify her replacement.  Ms. Clark currently intends to remain with the company until a replacement is hired and intends to remain on our Board of Directors.  The success of our business depends on our ability to attract a successor that can continue to drive the execution of the company’s strategic initiatives as well as contribute additional strategic thought leadership to our company.  We may not be able to retain all senior management or associates during the transition period and integration period of the new CEB.
 
 
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We have also announced our plans to close 50 to 60 additional stores by the end of 2014.  To the extent available, managers and associates will be offered opportunities at nearby stores.  This may lead to higher company turnover.  In addition, having fewer stores will limit promotion opportunities in the future for current associates, which may have a negative impact on our ability to retain quality employees, which may in turn have a negative impact on our results of operations.

We rely on a few vendors to supply substantially all of our merchandise, and significant price increases or any disruption in their ability to deliver merchandise could harm our ability to source products and supply inventory to our stores.
 
We do not own or operate any manufacturing facilities.  We purchased approximately 80% of our merchandise in fiscal 2012, approximately 81% in fiscal 2011 and approximately 73% in fiscal 2010 from three vendors.  Our 2010 purchases included a significant purchase of non-proprietary toy products that were incremental to our traditional purchasing.  Excluding these purchases, we purchased approximately 80% of our merchandise from three vendors.  These vendors in turn contract for our orders with multiple manufacturing facilities located primarily in China for the production of merchandise.  Our relationships with our vendors generally are on a purchase order basis and do not provide a contractual obligation to provide adequate supply or acceptable pricing on a long-term basis.  Our vendors could discontinue sourcing merchandise for us at any time.  If any of our significant vendors were to discontinue their relationship with us, or if the factories with which they contract were to suffer a disruption in their production, we may be unable to replace the vendors in a timely manner, which could result in short-term disruption to our inventory flow or quality of the inventory as we transition our orders to new vendors or factories which could, in turn, disrupt our store operations and have an adverse effect on our business, financial condition and results of operations.  For example in 2011, one factory used by one of our vendors closed unexpectedly, causing us to quickly switch factories for one product, affecting the quality and flow of the product.  Additionally, in the event of a significant price increase from these suppliers, we may not be able to find alternative sources of supply in a timely manner or raise prices to offset the increases, which could have an adverse effect on our business, financial condition and results of operations.
 
Our profitability could be adversely affected by high petroleum products prices.
 
The profitability of our business depends to a certain degree upon the price of petroleum products, both as a component of the transportation costs for delivery of inventory from our vendors to our stores and as a raw material used in the production of our animal skins and stuffing.  For example, our results in fiscal 2012, 2011, 2008 and 2007 were impacted by significant increases in fuel surcharges due to higher petroleum products prices.  We are unable to predict what the price of crude oil and the resulting petroleum products will be in the future. We may be unable to pass along to our customers the increased costs that would result from higher petroleum prices.  Therefore, any such increase could have an adverse impact on our business and profitability.
 
If we are not able to franchise new stores outside of the United States, Canada, the United Kingdom and Ireland, if we are unable to effectively manage our international franchises or if the laws relating to our international franchises change, our growth and profitability could be adversely affected and we could be exposed to additional liability.
 
In 2003, we began to expand the Build-A-Bear Workshop brand outside of the United States, opening company-owned stores in Canada and our first franchised location in the United Kingdom.  We have continued to expand outside of our company-owned regions through franchising in a number of countries.  As of December 29, 2012, there were 91 Build-A-Bear Workshop franchised stores located outside of the United States, Canada, the United Kingdom and Ireland.  We cannot assure you that our franchisees will be successful in identifying and securing desirable locations or in operating their stores.  International markets frequently have different demographic characteristics, competitive conditions, consumer tastes and discretionary spending patterns than our existing North American and European markets, which may cause these stores to be less successful than those in our existing markets.  Additionally, our franchisees may experience financing, merchandising and distribution expenses and challenges that are different from those we currently encounter in our existing markets.  The operations and results of our franchisees could be negatively impacted by the economic or political factors in the countries in which they operate or foreign currency fluctuations.  These challenges, as well as others, could have a material adverse effect on our business, financial condition and results of operations.
 
The success of our franchising strategy will depend upon our ability to attract and maintain qualified franchisees with sufficient financial resources to develop and grow the franchise operation and upon the ability of those franchisees to successfully develop and operate their franchised stores.  Franchisees may not operate stores in a manner consistent with our standards and requirements, may not hire and train qualified managers and other store personnel and may not operate their stores profitably.  As a result, our franchising strategy may not be profitable to us.  Moreover, our brand image and reputation may suffer.  When franchisees perform below expectations we may transfer those agreements to other parties or discontinue the franchise agreement.  Furthermore, even if our international franchising strategy is successful, the interests of franchisees might sometimes conflict with our interests.  For example, whereas franchisees are concerned with their individual business strategies and objectives, we are responsible for ensuring the success of the Build-A-Bear Workshop brand and all of our stores.
 
The laws of the various foreign countries in which our franchisees operate govern our relationships with our franchisees.  These laws, and any new laws that may be enacted, may detrimentally affect the rights and obligations between us and our franchisees and could expose us to additional liability.
 
 
13

 
 
Portions of our business are subject to privacy and security risks.  If we improperly obtain, or are unable to protect, information from our guests, in violation of privacy or security laws or expectations, we could be subject to liability and damage to our reputation.
 
Our Web site, bearville.com, features children’s games and in world e-mail and chat system.  In addition, our e-commerce site, buildabear.com, features e-cards and printable party invitations and thank-you notes and provides an opportunity for children under the age of 13 to sign up, with the consent of their parent or guardian, to receive our online newsletter.  We currently obtain and retain personal information about our Web site users, store shoppers and Stuff Fur Stuff loyalty program members.  In addition, we obtain personal information about our guests as part of their registration in our Find-A-Bear identification system.  Federal, state and foreign governments have enacted or may enact laws or regulations regarding the collection and use of personal information, with particular emphasis on the collection of information regarding minors.  Such regulations include or may include requirements that companies establish procedures to:
 
 
give adequate notice regarding information collection and disclosure practices;
 
 
allow consumers to have personal information deleted from a company’s database;
 
 
provide consumers with access to their personal information and the ability to rectify inaccurate information;
 
 
obtain express parental consent prior to collecting and using personal information from children; and
 
 
comply with the Federal Children’s Online Privacy Protection Act.
 
Such regulation may also include enforcement and redress provisions.  While we have implemented programs and procedures designed to protect the privacy of people, including children, from whom we collect information, and our websites are designed to be fully compliant with the Federal Children’s Online Privacy Protection Act, there can be no assurance that such programs will conform to all applicable laws or regulations.  If we fail to fully comply, we may be subjected to liability and damage to our reputation.
 
We have a stringent, comprehensive privacy policy covering the information we collect from our guests and have established security features to protect our guest database and website.  However, our security measures may not prevent security breaches.  We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.  If unauthorized third parties were able to penetrate our network security and gain access to, or otherwise misappropriate, our guests’ personal information, it could harm our reputation and, therefore, our business and we could be subject to liability.  Such liability could include claims for misuse of personal information or unauthorized use of credit cards.  These claims could result in litigation, our involvement in which, regardless of the outcome, could require us to expend significant financial resources.  In addition, because our guest database primarily includes personal information of young children and young children frequently interact with our website, we are potentially vulnerable to charges from parents, children’s organizations, governmental entities, and the media of engaging in inappropriate collection, distribution or other use of data collected from children.  Such charges could adversely impact guest relationships and ultimately cause a decrease in net sales and also expose us to litigation and possible liability.
 
Our virtual world Web site, primarily for children, bearville.com, allows social interaction between users.  While we have security features and chat monitoring, our security measures may not protect users’ identities and our online safety measures may be questioned which may result in negative publicity or a decrease in visitors to our site.  If site users act inappropriately or seek unauthorized contact with other users of the site, it could harm our reputation and, therefore, our business and we could be subject to liability. Internet privacy is a rapidly changing area and we may be subject to future requirements and legislation that are costly to implement and negatively impact our results.
 
We may suffer negative publicity or be sued if the manufacturers of our merchandise violate labor laws or engage in practices that our guests believe are unethical.
 
We rely on our sourcing personnel to select manufacturers with legal and ethical labor practices, but we cannot control the business and labor practices of our manufacturers.  If one of these manufacturers violates labor laws or other applicable regulations or is accused of violating these laws and regulations, or if such a manufacturer engages in labor or other practices that diverge from those typically acceptable in the United States, we could in turn experience negative publicity or be sued.
 
We may suffer negative publicity or a decrease in sales or profitability if the non-proprietary toy products we sell in our stores do not meet our quality standards or fail to achieve our sales expectations.
 
We expect to expand our product assortment to include interactive toy products manufactured by other toy companies.  If sales of such products do not meet our expectations or are impacted by competitors’ pricing, we may have to take markdowns or employ other strategies to liquidate the product. If other toy companies do not meet quality standards or violate any manufacturing or labor laws, we suffer negative publicity and not realize our sales plans.
 
We rely on a company-owned distribution center to service the majority of our stores in North America, and our third-party distribution center providers used in the western United States and Europe may perform poorly.
 
The efficient operation of our stores is dependent on our ability to distribute merchandise to locations throughout the United States, Canada and Europe in a timely manner.  We have a 350,000-square-foot distribution center in Groveport, Ohio.  We rely on this company-owned distribution center to receive, store and distribute merchandise for the majority of our North America stores.  We rely on third parties to manage all of the warehousing and distribution aspects of our business on the West Coast of the United States and in Europe.  Any significant interruption in the operation of the distribution centers due to natural disasters and severe weather, as well as events such as fire, accidents, power outages, system failures or other unforeseen causes could damage a significant portion of our inventory.  These factors may also impair our ability to adequately stock our stores and could decrease our sales and increase our costs associated with our supply chain.
 
 
14

 
 
Our market share may be adversely impacted at any time by a significant number of competitors.
 
We operate in a highly competitive environment characterized by low barriers to entry.  We compete against a diverse group of competitors.  Because we are mall-based, we see our competition as those mall-based retailers that compete for prime mall locations, including various apparel, footwear and specialty retailers.  As a retailer whose signature product is a stuffed animal that is typically purchased as a toy or gift, we also compete with toy retailers, such as Wal-Mart, Toys “R” Us, Target, Kmart and other discount chains, as well as with a number of manufacturers that sell plush toys in the United States and Canada, including, but not limited to, Ty, Fisher Price, Mattel, Ganz, Russ Berrie, Applause, Boyds, Hasbro, Commonwealth, Gund and Vermont Teddy Bear. Since we offer our guests an experience as well as merchandise, we also view our competition as any company that competes for our guests’ time and entertainment dollars, such as movie theaters, restaurants, amusement parks and arcades.  In addition, there are several small companies that operate “make your own” teddy bear and stuffed animal experiences in retail stores and kiosks.  Although we believe that currently none of these companies offers the breadth and depth of the Build-A-Bear Workshop products and experience, we cannot assure you that they will not compete directly with us in the future.
 
Many of our competitors have longer operating histories, significantly greater financial, marketing and other resources, and greater name recognition.  We cannot assure you that we will be able to compete successfully with them in the future, particularly in geographic locations that represent new markets for us.  If we fail to compete successfully, our market share and results of operations could be materially and adversely affected.
 
We also believe that there is an emerging trend within children’s play patterns towards electronic toys, internet and online play.  According to Emarketer.com, kids aged eight to eleven reported that they spend between one and two hours online each day.  We believe our Web site, bearville.com, competes with other companies and internet sites that vie for children’s attention in the online space including webkinz.com, clubpenguin.com and neopets.com.  A growing number of traditional children’s toy and entertainment companies have also developed their own virtual world online play sites including Barbie.com® and McWorld.  We cannot assure you that children’s preferences for our products will remain strong or that our on line Web site for children, bearville.com, will be successful in attracting children to our brand.  If children decide to engage with other products or Web sites, our sales will be negatively impacted and our results will be materially impacted.
 
We may fail to renew, register or otherwise protect our trademarks or other intellectual property and may be sued by third parties for infringement or, misappropriation of their proprietary rights, which could be costly, distract our management and personnel and which could result in the diminution in value of our trademarks and other important intellectual property.
 
Other parties have asserted in the past, and may assert in the future, trademark, patent, copyright or other intellectual property rights that are important to our business.  We cannot assure you that others will not seek to block the use of or seek monetary damages or other remedies for the prior use of our brand names or other intellectual property or the sale of our products or services as a violation of their trademark, patent or other proprietary rights.  Defending any claims, even claims without merit, could be time-consuming, result in costly settlements, litigation or restrictions on our business and damage our reputation.
 
In addition, there may be prior registrations or use of intellectual property in the U.S. or foreign countries for similar or competing marks or other proprietary rights of which we are not aware.  In all such countries it may be possible for any third party owner of a national trademark registration or other proprietary right to enjoin or limit our expansion into those countries or to seek damages for our use of such intellectual property in such countries.  In the event a claim against us were successful and we could not obtain a license to the relevant intellectual property or redesign or rename our products or operations to avoid infringement, our business, financial condition or results of operations could be harmed.  Securing registrations does not fully insulate us against intellectual property claims, as another party may have rights superior to our registration or our registration may be vulnerable to attack on various grounds.
 
Poor global economic conditions could have a material adverse effect on our liquidity and capital resources.
 
In 2008 and 2009, the general economic and capital market conditions in the United States and other parts of the world deteriorated significantly.  These conditions adversely affected borrowers’ access to capital and increased the cost of capital.  Although we believe that our capital structure and credit facilities will provide sufficient liquidity, there can be no assurance that our liquidity will not be affected by changes in the capital markets or that our capital resources will at all times be sufficient to satisfy our liquidity needs.  Capital market conditions may affect the renewal or replacement of our credit agreement, which was originally entered into in 2000 and has been extended annually since then and currently expires December 31, 2014.
 
Risks Related to Owning Our Common Stock
 
Fluctuations in our quarterly results of operations could cause the price of our common stock to substantially decline.
 
Retailers generally are subject to fluctuations in quarterly results.  Our operating results for one period may not be indicative of results for other periods, and may fluctuate significantly due to a variety of factors, including:
 
 
the profitability of our stores;
 
 
increases or decreases in comparable store sales;
 
 
changes in general economic conditions and consumer spending patterns;
 
 
15

 
 
 
seasonal shopping patterns, including whether the Easter holiday occurs in the first or second quarter and other school holiday schedules;
 
 
the effectiveness of our inventory management;
 
 
the timing and frequency of our marketing initiatives;
 
 
changes in consumer preferences;
 
 
the continued introduction and expansion of merchandise offerings;
 
 
actions of competitors or mall anchors and co-tenants;
 
 
weather conditions;
 
 
the timing of store closures, relocations and openings and related expenses; and
 
 
the timing and frequency of national media appearances and other public relations events.
 
If our future quarterly results fluctuate significantly or fail to meet the expectations of the investment community, then the market price of our common stock could decline substantially.
 
Fluctuations in our operating results could reduce our cash flow and we may be unable to repurchase shares at all or at the times or in the amounts we desire or the results of the share repurchase program may not be as beneficial as we would like.
 
Our Board of Directors has implemented a $50 million share repurchase program.  The program does not require the Company to repurchase any specific number of shares of our common stock, and may be modified, suspended or terminated at any time without prior notice. Shares repurchased under the program will be subsequently retired.  If our cash flow decreases as a result of decreased sales, increased expenses or capital expenditures or other uses of cash, we may not be able to repurchase shares of our common stock at all or at times or in the amounts we desire.  As a result, the results of the share repurchase program may not be as beneficial as we would like.
 
Our certificate of incorporation and bylaws and Delaware law contain provisions that may prevent or frustrate attempts to replace or remove our current management by our stockholders, even if such replacement or removal may be in our stockholders’ best interests.
 
Our basic corporate documents and Delaware law contain provisions that might enable our management to resist a takeover.  These provisions:
 
 
restrict various types of business combinations with significant stockholders;
 
 
provide for a classified board of directors;
 
 
limit the right of stockholders to remove directors or change the size of the board of directors;
 
 
limit the right of stockholders to fill vacancies on the board of directors;
 
 
limit the right of stockholders to act by written consent and to call a special meeting of stockholders or propose other actions;
 
 
require a higher percentage of stockholders than would otherwise be required to amend, alter, change or repeal our bylaws and certain provisions of our certificate of incorporation; and
 
 
authorize the issuance of preferred stock with any voting rights, dividend rights, conversion privileges, redemption rights and liquidation rights and other rights, preferences, privileges, powers, qualifications, limitations or restrictions as may be specified by our board of directors.
 
These provisions may:
 
 
discourage, delay or prevent a change in the control of our company or a change in our management, even if such change may be in the best interests of our stockholders;
 
 
adversely affect the voting power of holders of common stock; and
 
 
limit the price that investors might be willing to pay in the future for shares of our common stock.
 
ITEM 1B.       UNRESOLVED STAFF COMMENTS
 
Not applicable.
 
 
16

 
 
ITEM 2.         PROPERTIES
 
Stores
 
As of December 29, 2012, we operated 291 retail stores located primarily in major malls throughout the United States, Canada and Puerto Rico, 58 stores located in the United Kingdom and two stores in Ireland in our Retail segment.  Our North American stores generally range in size from approximately 2,000 to 4,000 gross square feet and average approximately 2,800 square feet, while our tourist location stores currently range up to 7,000 square feet and our flagship store in New York City is approximately 20,000 square feet.  Our UK stores range in size from approximately 800 to 2,300 selling square feet and average approximately 1,400 selling square feet.  Our stores are highly visual and colorful featuring a teddy bear theme and larger than life details including a “sentry bear” at the front entry, custom-designed fixtures as well as a customized Build-A-Bear Workshop tile logo in our entryway.  Our stores are designed to be open and inviting so that guests can fully immerse in the shopping experience and actively participate in the creation and customization of their purchase. Our typical store features one or two stuffing machines, three to five Name Me computer stations and numerous displays of fully-dressed stuffed animals throughout the store.  We select malls and make site selections within the mall based upon demographic analysis, market research, site visits and mall dynamics as well as actual past history and mall performance metrics. We have identified additional target sites that meet our criteria for new stores in new and existing markets.  We seek to locate our mall-based stores in areas with maximum customer traffic, often near to or in the center of the mall, as well as offering adjacencies to other children, teen and family retailers.
 
We lease all of our store locations.  Due to our attraction as a family-oriented entertainment destination concept, we continue to have high interest from mall owners and developers to locate a Build-A-Bear Workshop store in their malls.  We believe that we generally have negotiated favorable lease terms including provisions providing for exclusivity of operation of our concept in the mall.  Our stores are located in a variety of shopping center types.  As of December 29, 2012, the distribution of our stores is as follows: 
 
       
Super regional center
    210  
Regional center
    89  
Open air lifestyle center
    17  
Outlet center (1)
    11  
Other (theme, NYC, concession)
    16  
Total traditional stores
    343  
Temporary locations
    4  
Other (ballparks, zoo)
    4  
         
Total company-owned retail locations
    351  
 

(1)
Build-A-Bear Workshop stores in outlet centers are not merchandised with outlet merchandise.
 
Most of our leases have an initial term of ten years and do not have renewal options or clauses although our leases in the United Kingdom are typically covered by laws and regulations that give us priority rights of renewal.  A number of our leases, primarily in North America, provide a lease termination or “kick out” option, which may be mutual, allowing either party to exercise the option in a pre-determined year or years, typically the third or fourth year and sixth or seventh year of the lease, if we do not meet certain agreed upon minimum sales levels.  In addition, 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.  Most of our leases in North America also require the payment of a fixed minimum rent as well as percentage rent based on sales in excess of agreed upon minimum annual sales levels.  Our leases in the United Kingdom and Ireland typically have rent reviews every five years in which the base rental rate is adjusted to current market rates if they are higher than the original rent agreed.

Following is a list of our 351 company-owned stores in the United States, Canada, the United Kingdom and Ireland as of December 29, 2012:
 
State
Number of
Stores
Alabama
5
Alaska
1
Arizona
5
Arkansas
3
California
27
Colorado
6
Connecticut
5
Delaware
1
District of Columbia 1
Florida
20
Georgia
8
Idaho
1
Illinois
9
Indiana
7
Iowa
3
Kansas
2
Kentucky
3
Louisiana
5
Maine
2
Maryland
6
Massachusetts
9
 
 
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State Number of
Stores
Michigan
4
Minnesota
2
Mississippi
2
Missouri
9
Montana
1
Nebraska
1
Nevada
3
New Hampshire
2
New Jersey
11
New Mexico
1
New York
12
North Carolina
9
Ohio
10
Oklahoma
2
Oregon
3
Pennsylvania
11
Puerto Rico
1
Rhode Island
1
South Carolina
3
Tennessee
6
Texas
25
Utah
3
Virginia
9
Washington
5
West Virginia
1
Wisconsin
5
 
 
 
Canadian Province
 
Alberta
3
British Columbia
2
Manitoba
1
Nova Scotia
1
Ontario
9
Quebec
3
Saskatchewan
1
United Kingdom
 
England
50
Scotland
6
Wales
1
Northern Ireland
1
Republic of Ireland
2
 
Non-Store Properties
 
In addition to leasing all of our store locations, we lease approximately 59,000 square feet for our corporate headquarters, or World Bearquarters, in St. Louis, Missouri.  Our World Bearquarters houses our corporate staff, our call center and our on-site training facilities.  The lease was amended, effective January 1, 2008 with a six-year term, and may be extended for two additional five-year terms.  In September 2006, we completed construction of a company-owned warehouse and distribution center, or Bearhouse, in Groveport, Ohio, which is utilized primarily by our Retail segment.  The facility is approximately 350,000 square feet.  In 2007, our web fulfillment site moved to the Bearhouse.
 
 
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In the United Kingdom, we lease approximately 2,000 square feet for our regional headquarters in Windsor, England.  The lease commenced in August 2003.  The lease can be terminated at any time by either party giving notice of termination six months prior to cancellation.
 
ITEM  3.         LEGAL PROCEEDINGS
 
From time to time we are involved in ordinary routine litigation typical for companies engaged in our line of business.  We are involved in several court actions seeking to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. As of the date of this Annual Report on Form 10-K, we are not involved in any pending legal proceedings that we believe would be likely, individually or in the aggregate, to have a material adverse effect on our financial condition or results of operations.
 
ITEM  4.         MINE SAFETY DISCLOSURE
 
Not applicable
 
 
19

 
 
PART II
 
ITEM 5.         MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our common stock is listed on the New York Stock Exchange (NYSE) under the symbol “BBW.” Our common stock commenced trading on the NYSE on October 28, 2004.  The following table sets forth the high and low sale prices of our common stock for the periods indicated.
 
   
Fiscal 2012
   
Fiscal 2011
 
   
High
   
Low
   
High
   
Low
 
First Quarter
  $ 8.73     $ 5.01     $ 8.66     $ 6.00  
Second Quarter
  $ 5.41     $ 4.03     $ 7.00     $ 5.53  
Third Quarter
  $ 5.24     $ 3.82     $ 6.63     $ 4.60  
Fourth Quarter
  $ 4.31     $ 3.10     $ 8.80     $ 4.37  
 
As of March 8, 2013, the number of holders of record of the Company’s common stock totaled approximately 2,541.
 
PERFORMANCE GRAPH
 
The following performance graph compares the 60-month cumulative total stockholder return of our common stock, with the cumulative total return on the Russell 2000® Index and an SEC-defined peer group of companies identified as SIC Code 5600-5699 (the “Peer Group”).  The Peer Group consists of companies whose primary business is the operation of apparel and accessory retail stores. Build-A-Bear Workshop is not strictly a merchandise retailer and there is a strong interactive, entertainment component to our business which differentiates us from retailers in the Peer Group.  However, in the absence of any other readily identifiable peer group, we believe the use of the Peer Group is appropriate.
 
The performance graph starts on December 29, 2007 and ends on December 28, 2012, the last trading day prior to December 29, 2012, the end of our fiscal 2012.  The graph assumes that $100 was invested on December 29, 2007 in each of our common stock, the Russell 2000 Index and the Peer Group, and that all dividends were reinvested.
 
These indices are included only for comparative purposes as required by SEC rules and do not necessarily reflect management’s opinion that such indices are an appropriate measure of the relative performance of our common stock.  They are not intended to forecast the possible future performance of our common stock.
 
 
20

 
 

 
 
21

 
 
ISSUER PURCHASES OF EQUITY SECURITIES
 
Period
 
(a)
Total Number of Shares (or Units) Purchased (1)
   
(b)
 Average Price Paid Per Share (or Unit)
   
(c)
Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (2)
   
(d)
Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs (2)
 
Sep. 30, 2012 – Oct. 27, 2012
    215     $ 4.03       -     $ 8,711,999  
Oct. 28, 2012 – Nov. 24, 2012
    366,741     $ 3.67       366,700     $ 7,364,562  
Nov. 25, 2012 – Dec. 29, 2012
    -     $ -       -     $ 7,364,562  
Total
    366,956     $ 3.67       366,700          
 

(1)
Includes shares of our common stock delivered to us in satisfaction of the tax withholding obligation of holders of restricted shares which vested during the quarter.  Our equity incentive plans provide that the value of shares delivered to us to pay the withholding tax obligations is calculated at the closing trading price of our common stock on the date the relevant transaction occurs.
(2)
On February 28, 2013, we announced the further extension of our $50 million share repurchase program of our outstanding common stock until March 31, 2014.  The program was authorized by our board of directors.  Purchases may be made in the open market or in privately negotiated transactions, with the level and timing of activity depending on market conditions, applicable regulatory requirements, and other factors.  Purchase activity may be increased, decreased or discontinued at any time without notice.  Shares purchased under the program are subsequently retired.  As of March 8, 2013, we had approximately $7.4 million of availability under the program.
 
Recent Sales of Unregistered Securities
 
There were no sales of unregistered securities during the past three years.
 
Dividend Policy
 
No dividends were paid in 2012 or 2011.  We anticipate that we will retain any future earnings to support operations, to finance the growth and development of our business and to repurchase shares of our common stock from time to time and we do not expect, at this time, to pay cash dividends in the future.  Any future determination relating to our dividend policy will be made at the discretion of our board of directors and will depend on a number of factors, including future earnings, capital requirements, financial conditions, future prospects and other factors that the board of directors may deem relevant.  Additionally, under our credit agreement, we are prohibited from declaring dividends without the prior consent of our lender, subject to certain exceptions, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources”.
 
 
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ITEM 6.         SELECTED FINANCIAL DATA
 
Throughout this Annual Report on Form 10-K, we refer to our fiscal years ended December 29, 2012, December 31, 2011, January 1, 2011, January 2, 2010 and January 3, 2009, as fiscal years 2012, 2011, 2010, 2009 and 2008, respectively.  Our fiscal year consists of 52 or 53 weeks, and ends on the Saturday nearest December 31 in each year.  Fiscal years 2012, 2011, 2010 and 2009 included 52 weeks and fiscal year 2008 included 53 weeks.  All of our fiscal quarters presented in this Annual Report on Form 10-K included 13 weeks.  When we refer to our fiscal quarters, or any three month period ending as of a specified date, we are referring to the 13-week period prior to that date.
 
The following table sets forth, for the periods and dates indicated, our selected consolidated financial and operating data.  The balance sheet data as of December 29, 2012 and December 31, 2011 and the statement of operations and other financial data for our fiscal years ended December 29, 2012, December 31, 2011 and January 1, 2011 are derived from our audited financial statements included elsewhere in this Annual Report on Form 10-K.  The balance sheet data as of January 1, 2011, January 2, 2010, and January 3, 2009, and the statement of operations and other financial data for our fiscal years ended January 2, 2010 and January 3, 2009 are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K.  You should read our selected consolidated financial and operating data in conjunction with our consolidated financial statements and related notes and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report on Form 10-K.
 
   
Fiscal Year
 
   
2012
   
2011
   
2010
   
2009
   
2008
 
   
(Dollars in thousands, except share, per share, per store and per gross square foot data)
 
Statement of income data:
                             
Total revenues
  $ 380,941     $ 394,375     $ 401,452     $ 395,906     $ 468,316  
Costs and expenses:
                                       
Cost of merchandise sold
    230,181       234,227       239,556       247,511       270,918  
Selling, general and administrative
    165,516       162,881       164,618       161,782       188,018  
Goodwill impairment
    33,670       -       -       -       -  
Store closing (1)
    -       -       -       981       2,952  
Losses from investment in affiliate (2)
    -       -       -       9,615       -  
Interest expense (income), net
    3       (81 )     (250 )     (143 )     (799 )
Total costs and expenses
    429,370       397,027       403,924       419,746       461,089  
Income (loss) before income taxes
    (48,429 )     (2,652 )     (2,472 )     (23,840 )     7,227  
Income tax expense (benefit)
    866       14,410       (2,576 )     (11,367 )     2,663  
Net income (loss)
  $ (49,295 )   $ (17,062 )   $ 104     $ (12,473 )   $ 4,564  
Earnings (loss) per common share:
                                       
Basic
  $ (3.02 )   $ (0.98 )   $ 0.01     $ (0.66 )   $ 0.24  
Diluted
  $ (3.02 )   $ (0.98 )   $ 0.01     $ (0.66 )   $ 0.24  
Shares used in computing common per share amounts:
                                       
Basic
    16,331,672       17,371,315       18,601,465       18,874,352       19,153,123  
Diluted
    16,331,672       17,371,315       18,653,012       18,874,352       19,224,273  
 
 
23

 
 
    Fiscal Year  
   
2012
   
2011
   
2010
   
2009
   
2008
 
   
(Dollars in thousands, except share, per share, per store and per gross square foot data)
 
Other financial data:
                             
Retail gross margin ($) (3)
  $ 145,687     $ 154,468     $ 155,128     $ 142,572     $ 190,500  
Retail gross margin (%) (3)
    38.9 %     39.9 %     40.1 %     36.7 %     41.3 %
Capital expenditures, net (4)
  $ 17,268     $ 12,248     $ 14,649     $ 8,148     $ 23,215  
Depreciation and amortization
    21,422       24,232       26,976       28,487       28,883  
                                         
Cash flow data:
                                       
Cash flows provided by operating activities
  $ 14,864     $ 16,010     $ 22,021     $ 23,990     $ 23,615  
Cash flows used in investing activities
  $ (15,096 )   $ (13,318 )   $ (13,766 )   $ (8,898 )   $ (26,629 )
Cash flows provided by (used in) financing activities
  $ (1,224 )   $ (14,587 )   $ (7,216 )   $ -     $ (14,024 )
                                         
Store data (5):
                                       
Number of stores at end of period
                                       
North America - Traditional
    283       287       290       291       292  
North America - Non-traditional
    8       11       15       5       5  
Total North America
    291       298       305       296       297  
Europe
    60       58       54       54       54  
Total stores
    351       356       359       350       351  
Square footage at end of period
                                       
North America - Traditional
    805,770       829,449       841,600       846,373       856,504  
North America - Non-traditional
    12,610       18,956       32,950       4,533       4,533  
Total North America
    818,380       848,405       874,550       850,906       861,037  
Europe (6)
    86,331       83,911       77,520       77,520       77,520  
Total square footage
    904,711       932,316       952,070       928,426       938,557  
Average net retail sales per store - North America (7) (8)
  $ 1,003     $ 1,021     $ 1,030     $ 1,044     $ 1,329  
Net retail sales per gross square foot - North America (8) (9)
  $ 350     $ 354     $ 356     $ 358     $ 445  
Consolidated comparable store sales change (%) (10)
    (3.3 )%     (2.1 )%     (2.0 )%     (13.4 )%     (14.0 )%
                                         
Balance sheet data:
                                       
Cash and cash equivalents
  $ 45,171     $ 46,367     $ 58,755     $ 60,399     $ 47,000  
Working capital
    30,503       37,610       51,671       53,865       38,880  
Total assets
    192,102       241,571       275,794       284,273       300,152  
Total stockholders' equity
    83,137       129,243       157,713       164,780       167,725  
 
(1)
Store closing represents expenses related to the closure of the friends 2B made concept.
(2)
In 2012, $475 of losses from investment in affiliate was included in selling, general and administrative expenses.
(3)
Retail gross margin represents net retail sales less cost of retail merchandise sold, which excludes cost of wholesale merchandise sold.  Retail gross margin percentage represents retail gross margin divided by net retail sales.
(4)
Capital expenditures, net consist of leasehold improvements, furniture and fixtures, land, buildings, computer equipment and software purchases, as well as trademarks, intellectual property, key money deposits and deferred leasing fees.
(5)
Excludes our web store and temporary, seasonal and event-based locations.
(6)
Square footage for stores located in Europe is estimated selling square footage and includes stores in the United Kingdom, Ireland and France.
(7)
Average net retail sales per store represents net retail sales from traditional stores open throughout the entire period in North America divided by the total number of such stores.
(8)
When we refer to average net retail sales per store and net retail sales per gross square foot for any period, we include in those calculations only those traditional stores that have been open for that entire period in North America.  European stores are not included.
(9)
Net retail sales per gross square foot represents net retail sales from stores open throughout the entire period in North America divided by the total gross square footage of such stores.  European stores are not included.
(10)
Comparable store sales percentage changes are based on net retail sales.  Stores are considered comparable beginning in their thirteenth full month of operation.
 
 
24

 
 
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.
 
Overview
 
We are the leading, and only international, company providing a “make your own stuffed animal” interactive entertainment experience under the Build-A-Bear Workshop brand, in which our guests stuff, fluff, dress, accessorize and name their own teddy bears and other stuffed animals.  Our concept, which we developed  primarily for mall-based retailing, capitalizes on what we believe is the relatively untapped demand for experience-based shopping as well as the widespread appeal of stuffed animals.  The Build-A-Bear Workshop experience appeals to a broad range of age groups and demographics, including children, teens, their parents and grandparents.  As of December 29, 2012, we operated 283 traditional stores in the United States, Canada and Puerto Rico, 58 stores in the United Kingdom and two stores in Ireland, and had 91 franchised stores operating in international locations under the Build-A-Bear Workshop brand.  In addition to our stores, we sell our products on our e-commerce Web site, buildabear.com and market our products and build our brand through our “virtual world” Web site, bearville.com, which complements our interactive shopping experience and positively enhances our core brand value.  We also operate non-traditional store locations in a Major League Baseball ballpark, a zoo, a science center, an airport and other temporary locations.
 
We operate in three segments that share the same infrastructure, including management, systems, merchandising and marketing, and generate revenues as follows:
 
 
Company-owned retail stores located in the United States, Canada, Puerto Rico, the United Kingdom and Ireland, a web store and seasonal, event-based locations;
 
 
Transactions with other business partners, mainly comprised of licensing our intellectual property, including entertainment properties, for third-party use and wholesale product sales; and
 
 
International stores operated under franchise agreements.
 
Selected financial data attributable to each segment for fiscal 2012, 2011 and 2010, are set forth in Note 17 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
 
For a discussion of the key trends and uncertainties that have affected our revenues, income and liquidity, see the “— Revenues,” “— Costs and Expenses” and “— Expansion and Growth Potential” subsections of this Overview.
 
We believe that we have developed an appealing retail store concept that, for North American stores open for the entire year, averaged $1.0 million in fiscal 2012, fiscal 2011 and fiscal 2010 in net retail sales per store.  For a discussion of the changes in comparable store sales in fiscal years 2012, 2011 and 2010, see “— Revenues” below.  Store contribution, which consists of income (loss) before income tax expense (benefit); interest; store depreciation, amortization and impairment; goodwill impairment; losses from investment in affiliate, preopening and general and administrative expense, excluding franchise fees, income from commercial activities and contribution from our web store, temporary and seasonal event-based locations, as a percentage of net retail sales, excluding revenue from our web store, temporary and seasonal and event-based locations, was 13.2% for fiscal 2012, 15.2% for fiscal 2011 and 15.3% for fiscal 2010.  Total company net loss as a percentage of total revenues was 12.9% for fiscal 2012 and 4.3% for fiscal 2011.  Total company net income as a percentage of total revenues was 0.0% for fiscal 2010.  See “— Non-GAAP Financial Measures” for a reconciliation of store contribution to net (loss) income.  The net loss in 2012 was primarily attributable to the decrease in comparable store sales and the impairment of the Company’s goodwill related to its UK operations.  The net loss in 2011 was primarily attributable to the decrease in comparable store sales and the recording of a valuation allowance on the Company’s US deferred tax assets.
 
In 2012, our results were negatively impacted by the declining sales in the UK.  In North America, the results reflect the early results of turnaround efforts, increased costs for marketing, newly imagined store design remodels and openings and store closings.  In 2011, our results reflect stabilizing economic trends and modest mall traffic increases but continuing low levels of consumer confidence.  In 2011, our store contribution percentage was essentially flat with 2010, as declining sales were offset by lower store expenses, specifically payroll and supplies.  In 2010, our results reflect the challenging retail environment – economic recession, declining mall traffic, and slowing consumer spending – factors impacting many retailers and particularly our company given the discretionary nature of our products and our experience.
 
 
25

 
 
Our 2013 plan builds on steps taken in 2012 to balance our long term business goals while recognizing the continuing challenges of the retail environment.  We plan to improve store productivity and profitability by strategically closing 50 to 60 stores during the next two years and reducing the square footage of an additional 10 to 15 stores by relocating them within the same malls.  This initiative will allow us to focus on our business and align all operations around our goals of improving our comparable stores sales performance and store productivity, while also building our long term brand value.  We currently expect to transfer, on average, approximately 20% of the sales from the closed stores to other stores in the same markets. In 2013, through March 8, we have closed 15 stores. Our current plans also include the relocation or remodel of approximately 25 locations in 2013 with the complete new design that feature a bold new look and enhanced experience as we continue to lead in the interactive experiential retail space.
 
While Build-A-Bear Workshop in North America will operate fewer stores that we expect will have higher sales volumes and profitability, we will continue to grow internationally, primarily through our franchisees.  We also intend to increase shopping frequency by increasing new guest traffic to its stores, specifically focusing on families with children and intensifying digital engagement to increase visits from our existing guests and by reinforcing our store as a top destination for gifts.  In 2009, we implemented cost reduction initiatives that resulted in approximately $25 million in pre-tax savings.  We were able to maintain these savings in 2010 and 2011 and saved an additional $3 million in 2011.  We achieved an additional $7.5 million in savings in 2012 that were used to support sales-driving marketing initiatives and were partially offset by product cost increases.  We ended fiscal 2012 with no borrowings under our bank loan agreement and with $45 million in cash and cash equivalents after investing $17 million in capital projects and $1 million in share repurchases.
 
Following is a description and discussion of the major components of our statement of operations:
 
Revenues
 
Net retail sales: Net retail sales are revenues from retail sales (including our web store and other non-store locations), are net of discounts, exclude sales tax, include shipping and handling costs billed to customers, and are recognized at the time of sale.  Revenues from gift cards are recognized at the time of redemption.  Our guests use cash, checks, gift cards and third party credit cards to make purchases.  We classify stores as new, non-comparable and comparable stores.  Stores enter the comparable store calculation in their thirteenth full month of operation.  Our web store and temporary, seasonal and event-based locations are not included in our store count or in our comparable store calculations.  Non-comparable stores also result from a store relocation or remodel that results in a significant change in square footage.  The net retail sales for that location are excluded from comparable store sales calculations until the thirteenth full month of operation after the date of the change.
 
We have a loyalty program with a frequent shopper reward feature, the Stuff Fur Stuff club. Members of the program receive one point for every dollar spent and receive awards after reaching certain point thresholds. On a quarterly basis, an estimate of the obligation related to the program, based on actual points and awards outstanding and historical point conversion and award redemption patterns, is recorded as an adjustment to deferred revenue and net retail sales.  At the time of redemption of the award, the deferred revenue obligation is reduced, and a corresponding amount is recognized in net retail sales.  As the awards can be earned or redeemed at any of our store locations, we account for changes in the deferred revenue account at the total company level only.  Therefore, when we refer to net retail sales by location, such as comparable stores or new stores, these amounts do not include any changes in the deferred revenue amount.  See “---Critical Accounting Estimates” for additional details on the accounting for the deferred revenue under our customer loyalty program.
 
 
26

 
 
We use net retail sales per gross square foot and comparable store sales as performance measures for our business. The following table details net retail sales per gross square foot by age of store for the periods presented:

   
Fiscal
2012
   
Fiscal
2011
   
Fiscal
2010
 
Net retail sales per gross square foot - North America (1) (2)
       
Store Age > 5 years (247 stores in 2012, 220 stores in 2011)
  $ 353     $ 362     $ 370  
Store Age 3-5 years (19 stores in 2012, 56 stores in 2011)
  $ 301     $ 315     $ 321  
Store Age <3 years (3 stores in 2012, 4 stores in 2011)
  $ 464     $ 369     $ 317  
All comparable stores
  $ 350     $ 354     $ 356  
 

(1)
Net retail sales per gross square foot represents net retail sales from North American stores open throughout the entire period divided by the total gross square footage of such stores.  Calculated on an annual basis only.
(2)
Excludes our web store, temporary and seasonal and event-based locations.
 
The percentage increase (or decrease) in comparable store sales for the periods presented below is as follows:
 
   
Fiscal
2012
   
Fiscal
2011
   
Fiscal
2010
 
Comparable store sales change - North America (%) (1) (2)
       
Store Age > 5 years (247 stores in 2012, 220 stores in 2011)
    (2.0 )%     (2.1 )%     (0.4 )%
Store Age 3-5 years (19 stores in 2012, 56 stores in 2011)
    (3.2 )%     (5.1 )%     (3.3 )%
Store Age <3 years (3 stores in 2012, 4 stores in 2011)
    2.6 %     1.0 %     (3.8 )%
Total comparable store sales change
    (2.0 )%     (2.5 )%     (1.2 )%
                         
Comparable store sales change - Europe  (%) (1) (2)
    (8.4 )%     (0.2 )%     (5.5 )%
                         
Comparable store sales change - Consolidated  (%) (1) (2)
    (3.3 )%     (2.1 )%     (2.0 )%
 

(1)
Comparable store sales percentage changes are based on net retail sales and stores are considered comparable beginning in their thirteenth full month of operation.
(2)
Excludes our web store, temporary and seasonal and event-based locations.
 
Fiscal 2012 consolidated comparable store sales decreased by 3.3%, including an 8.4% decrease in Europe and a 2.0% decrease in North America (full year comparable store sales are compared to the 52 week period ended Dec. 31, 2011).  We believe the primary drivers of the overall decline in consolidated comparable store sales for the full year were as follows:
 
 
In the first half of 2012, we had benefit from higher redemption rates and transaction value of our holiday gift cards and from a promotion in the United States with McDonald’s Happy Meals® that drove awareness of our brand and brought traffic to our stores resulting in slightly positive comparable store sales in North American through the first twenty-six weeks.
 
 
In the fiscal 2012 third quarter, we experienced a decline in the number of transactions compared to the 2011 third quarter which benefitted from a strong product offering that was tied to a major theatrical release supported by studio marketing and advertising.
 
 
In the fiscal 2012 fourth quarter, we believe our new brand building marketing campaign in the United States along with a return to traditional holiday product offerings resulted in an increase in North American comparable store sales.
 
 
In the United Kingdom, we believe the negative economic conditions contributed to a continued decline in consumer sentiment and a corresponding decline in spending that negatively impacted our comparable store sales throughout the year.
 
 
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Fiscal 2011 consolidated comparable store sales decreased by 2.1%, including a 0.2% decrease in Europe and a 2.5% decrease in North America (full year comparable store sales are compared to the 52 week period ended Jan. 1, 2011).  We believe the overall decline in consolidated comparable store sales for the full year was attributed primarily to the following factors:
 
 
·
Through the third quarter, we had experienced a 0.9% decrease in consolidated comparable store sale.  Growth in third quarter sales, which resulted from improved merchandise assortments and successful promotional events, only partially offset comparable stores sales declines in the first half of the year, which were primarily driven by a decline in transactions and negative consumer sentiment and spending in the UK.
 
 
·
Further sales declines in the fourth quarter, attributable to underperforming licensed movie product, resulted in a decline for the full year.
 
Commercial revenue: Commercial revenue includes the company’s transactions with other businesses, mainly through wholesale and licensing transactions.  Revenue from licensing activities is generally based on a percentage of sales made by licensees to third parties and is recognized at the time the product is shipped by the licensee or at the point of sale.  We have entered into a number of licensing arrangements whereby third parties manufacture and sell to other retailers merchandise carrying the Build-A-Bear Workshop trademark.  Revenue from wholesale product sales includes revenue from merchandise sold at stores operated by third parties under licensing agreements like Landry’s restaurants.  In 2010, it also includes two transactions totaling $6.4 million with no associated gross margin.
 
Franchise fees: We receive an initial, one-time franchise fee for each master franchise agreement which is amortized to revenue over the life of the respective franchise agreements, which extend for periods up to 25 years.  Master franchise rights are typically granted to a franchisee for an entire country or countries.  Continuing franchise fees are based on a percentage of sales made by the franchisees’ stores and are recognized as revenue at the time of those sales.
 
As of December 29, 2012, we had 91 stores, including 17 opened and five closed in fiscal 2012, operating under franchise arrangements in the following countries:
 
Germany
    21    
Australia
    14    
Mexico
    10    
Japan
    8    
Denmark
    8    
South Africa
    6    
Thailand
    6    
Gulf States (1)
    6    
Singapore
    4    
Norway
    3    
Sweden
    3    
Brazil
    2    
Total
    91    
 
 
(1)
Gulf States agreement includes Kuwait, Bahrain, Qatar, Oman and the United Arab Emirates
 
Costs and Expenses
 
Cost of merchandise sold and retail gross margin: Cost of merchandise sold 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; 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 retail merchandise sold, which excludes cost of wholesale merchandise sold.
 
Selling, general and administrative expense: These expenses include store payroll and benefits, advertising, credit card fees, store supplies and preopening expenses as well as central office general and administrative expenses, including costs for virtual world maintenance, management payroll, benefits, stock-based compensation, travel, information systems, accounting, insurance, normal store closings, legal and public relations.  These expenses also include depreciation and amortization of central office leasehold improvements, furniture, fixtures and equipment as well as the amortization of intellectual property costs.
 
 
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In 2009, we achieved $22 million in savings in selling, general and administrative expenses including marketing, central office payroll and outside services.  We were able to maintain these savings in 2010 and 2011.  In 2012, we saved an additional $4 million in selling general and administrative expenses that were used to support sales driving marketing initiatives.  Other store expenses such as credit card fees and supplies historically have increased or decreased proportionately with net retail sales.
 
We have share-based compensation plans covering the majority of our management groups and our Board of Directors.  We account for share-based payments utilizing the fair value recognition provisions of Accounting Standards Codification (ASC) Section 718 – Stock Compensation.  We recognize compensation cost for equity awards over the requisite service period for the entire award.  In 2012, 2011 and 2010, we recorded stock based compensation of approximately $3.6 million, $4.6 million and $4.8 million, respectively.

 
29

 
 
Stores
 
Company-owned stores:
 
The number of Build-A-Bear Workshop stores in the United States, Canada, Puerto Rico, the United Kingdom, Ireland and France for the last three fiscal years along with the projections for fiscal 2013 can be summarized as follows:
 
   
Fifty-two Weeks Ended December 28, 2013 - Projected
 
   
December 29,
2012
   
Opened
   
Closed
   
December 28,
2013
 
North America
                       
Traditional
    283       2       (34 )     251  
Non-traditional
    8       -       (2 )     6  
      291       2       (36 )     257  
                                 
Europe
    60       -       (1 )     59  
Total
    351       2       (37 )     316  
 
   
Fifty-two Weeks Ended December 29, 2012
 
   
December 31,
2011
   
Opened
   
Closed
   
December 29,
2012
 
North America
                       
Traditional
    287       2       (6 )     283  
Non-traditional
    11       1       (4 )     8  
      298       3       (10 )     291  
                                 
Europe
    58       2       -       60  
Total
    356       5       (10 )     351  
 
   
Fifty-two Weeks Ended December 31, 2011
 
   
January 1,
2011
   
Opened
   
Closed
   
December 31,
2011
 
North America
                       
Traditional
    290       2       (5 )     287  
Non-traditional
    15       2       (6 )     11  
      305       4       (11 )     298  
                                 
Europe
    54       5       (1 )     58  
Total
    359       9       (12 )     356  
 
 
Our long term store real estate goal is to improve our stores’ sales productivity and profitability.  Today we believe that the optimal number of Build-A-Bear Workshop stores in North America is between 225 and 250 and approximately 60 to 70 in the United Kingdom and Ireland for a total of 285 to 320 stores.  We currently expect to reach the optimal level in North America with the closure of 50 to 60 stores in fiscal 2013 and 2014.  Locations to close and the timing of closures are subject to ongoing negotiations and overall economic considerations as we continually reevaluate our market repositioning and optimization plans.

Integral to the success of our real estate optimization strategies is the opening of our new store design which gives certain stores destination appeal and increases productivity in the market.  The new design merges Build-A-Bear Workshop’s iconic hands-on bear-making process with the power of technology to provide an updated, highly interactive experience for our guests.  As of March 8, 2013, we have opened six of these stores, one new store and five remodels or relocations.  We expect to open 25 additional remodeled locations by the end of 2013.  In 2012, we also opened one traditional store and one non-traditional store in North America and two traditional stores in the UK.  The traditional store in North America is a reopening in a mall that had been closed since 2010 due to flooding.

 
30

 
 
We have been aggressively renegotiating rents and executing short term extensions to line up lease dates within markets as part of an overall strategic plan to optimize our store locations and market positioning.  As part of this strategy, we will continue to close underperforming stores in conjunction with natural lease expirations and kick out clauses, primarily in multi-store markets.  In these markets, we currently expect to maintain approximately 20% of the sales from closing stores by transferring customers to other locations in the same market.  We closed 10 and 12 stores in fiscal 2012 and fiscal 2011, respectively.  We currently anticipate closing approximately 35 to 40 stores, including certain non-traditional store locations, in 2013 and approximately 20 additional stores in 2014.  As a result, at the end of fiscal 2013, we anticipate that we will have approximately 310 traditional stores, 251 in North America and 59 in Europe and six non-traditional stores.  In 2013 through March 8, we have closed 15 stores.
 
Non-traditional Store Locations:
 
In 2004 we began offering merchandise in seasonal, event-based locations such as Major League Baseball ballparks.  As of December 29, 2012, we had one location each in a ballpark, a zoo, a science center, an airport and a hospital.  In 2010, we opened our first temporary stores, which generally have lease terms of six to eighteen months and are excluded from our store count.  These locations are intended to capitalize on short-term opportunities in specific locations.  As of December 29, 2012, we operated four temporary stores.
 
Commercial Revenue:
 
In fiscal 2004, we began entering into license agreements pursuant to which we receive royalties on Build-A-Bear Workshop brand products produced and sold by third parties.  These agreements generated revenue of $1.1 million in 2012, $1.8 million in 2011 and $2.8 million in 2010.  Wholesale revenue is primarily generated under agreements with third-parties who operate Build-A-Bear Workshop locations or sell our product in agreed-upon outlets.  These agreements generated revenue of $1.7 million in 2012, $2.1 million in 2011 and $2.0 million in 2010.  In addition to our normal wholesale business, in 2010, we had two wholesale transactions totaling $6.4 million with no gross margin.
 
International Franchise Revenue:
 
Our first franchisee location was opened in November 2003.  The number of international, franchised stores opened and closed for the periods presented below can be summarized as follows:
 
   
Fiscal year
 
   
2012
   
2011
   
2010
 
                         
Beginning of period
    79         63         65    
Opened
    17         19         10    
Closed
    (5 )       (3 )       (12 )  
End of period
    91         79         63    
 
As of December 29, 2012, we had 12 master franchise agreements, which typically grant franchise rights for a particular country or group of countries, covering an aggregate of 16 countries.  In the ordinary course of business, we anticipate signing additional master franchise agreements in the future and terminating other such agreements.  We expect our current franchisees to open eight to twelve stores in fiscal 2013.  We believe there is a market potential for approximately 300 international stores outside of the United States, Canada, the United Kingdom and Ireland, which we expect to be operated primarily by new and existing franchisees.
 
 
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Results of Operations
 
2012 Overview
 
While fiscal 2012 was a challenging year, with an overall decline in comparable store sales, significant impairment charges and a decline in store contribution, we made significant progress on our strategic objectives.  We announced our plans to close 50 to 60 stores by the end of 2014 and introduced our innovative new store design and reintroduced brand building national television advertising in the United States.  In the fourth quarter, we began to see indications that our strategic plans were having the desired impact:
 
 
·
Our first six stores in the new design exceeded sales expectations, increasing an average of 30%;
 
 
·
The ten stores that were closed in 2012 transferred an average of 20% of sales to other stores in the same market;
 
 
·
The television marketing that began in mid-October, contributed to a significant improvement in the sales trend in North America, with fourth quarter comparable store sales increasing 1.5%;
 
 
·
The gift of experience message in our ad campaigns also drove a 30% increase in gift card sales in the peak fourth quarter gifting season.  We expect to  see the benefit of these redemptions in 2013; and
 
 
·
We achieved cost savings of $7.5 million in 2012 which we used to support sales-driving marketing initiatives and to offset product cost increases.
 
Fiscal 2013 will be a year of significant transition as we expect to hire a new chief executive bear and execute significant real estate strategy with the closure of approximately 35 to 40 stores and the remodeling or relocation of approximately 25 stores in our new design.
 
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 will not total due to cost of merchandise sold being expressed as a percentage of net retail sales and commercial revenue and immaterial rounding:
 
   
Fiscal 2012
   
Fiscal 2011
   
Fiscal 2010
 
                   
Revenues:
                 
Net retail sales
    98.3 %     98.1 %     96.4 %
Commercial revenues
    0.7       1.0       2.8  
Franchise fees
    0.9       0.9       0.8  
Total revenues
    100.0       100.0       100.0  
                         
Costs and expenses:
                       
Cost of merchandise sold (1)
    61.0       59.9       60.1  
Selling, general, and administrative
    43.4       41.3       41.0  
Goodwill impairment
    8.8       -       -  
Interest expense (income), net
    0.0       (0.0 )     (0.1 )
Total costs and expenses
    112.7       100.7       100.6  
                         
Loss before income taxes
    (12.7 )     (0.7 )     (0.6 )
Income tax expense (benefit)
    0.2       3.7       (0.6 )
Net income (loss)
    (12.9 )     (4.3 )     0.0  
                         
Retail gross margin (%) (2)
    38.9 %     39.9 %     40.1 %
 
 
(1)
Cost of merchandise sold is expressed as a percentage of net retail sales and commercial revenue.

(2)
Retail gross margin represents net retail sales less cost of retail merchandise sold, which excludes cost of wholesale merchandise sold.  Retail gross margin was $145.7 million, $154.5 million and $155.1 million in 2012, 2011 and 2010, respectively.  Retail gross margin percentage represents retail gross margin divided by net retail sales.
  
 
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Fiscal Year Ended December 29, 2012 (52 weeks) Compared to Fiscal Year Ended December 31, 2011 (52 weeks)
 
Total revenues. Net retail sales were $374.6 million for fiscal 2012, compared to $387.0 million for fiscal 2011, a decrease of $12.5 million.  Comparable store sales decreased $11.6 million in fiscal 2012, or 3.3%.  Other decreases include $4.3 million in sales from non-comparable locations, comprised primarily of relocated and remodeled locations, $1.0 million in deferred revenue adjustment as compared to the prior year, $0.9 million from the impact of foreign exchange rates and $0.6 million in sales from non-store locations which includes temporary locations.  Partially offsetting these decreases are increases of $5.0 million from sales in new stores and $1.0 million in e-commerce sales.
 
Commercial revenue was $2.8 million in fiscal 2012 compared to $3.9 million in fiscal 2011, a decrease of $1.2 million.  This decrease was primarily due to an overall decrease in licensing activity in 2012.  Revenue from international franchise fees increased to $3.6 million for fiscal 2012 from $3.4 million for fiscal 2011, an increase of $0.2 million.  This increase was primarily due to the increase in the number of franchise locations from 79 at the end of fiscal 2011 to 91 at the end of fiscal 2012.
 
Gross margin. Total gross margin, calculated as net retail sales and commercial revenues less cost of merchandise sold, was $147.2 million for fiscal 2012 compared to $156.8 million for fiscal 2011, a decrease of $9.6 million, or 6.1%.  Retail gross margin was $145.7 million in fiscal 2012 compared to $154.5 million in fiscal 2011, a decrease of $8.8 million, or 5.7%.  As a percentage of net retail sales, retail gross margin decreased to 38.9% for fiscal 2012 from 39.9% for fiscal 2011, a decrease of 100 basis points as a percentage of net retail sales (bps).  This decline in margin was primarily attributable to decreased leverage on fixed occupancy costs, including store asset impairment charges and decreased merchandise margin, partially offset by cost savings in distribution and packaging costs.
 
Selling, general and administrative. Selling, general and administrative expenses were $165.5 million for fiscal 2012 as compared to $162.9 million for fiscal 2011, an increase of $2.6 million, or 1.6%.  As a percentage of total revenues, selling, general and administrative expenses were 43.4% for fiscal 2012, compared to 41.3% in fiscal 2011.  The dollar increase was primarily attributable to $3 million in asset impairment charges and investment in marketing and store-related costs as part of our long-term initiatives.  Excluding the impairment charges, selling general and administrative expenses were 42.6% of total revenues.
 
Goodwill impairment. In 2012, the goodwill associated with the UK business was fully impaired, resulting in a $33.7 million non-cash charge.
 
Interest expense (income), net. Interest expense, net of interest income, was $3,000 for fiscal 2012 as compared to $0.1 million of income for fiscal 2011.
 
Provision for income taxes. Income tax expense was $0.9 million in fiscal 2012, compared to $14.4 million for fiscal 2011.  The effective rate was 1.8% in 2012 and 543.4% in 2011.  The fluctuation in the effective rate was primarily attributable to the recording of a valuation allowance in 2011 on the US deferred tax assets.

Fiscal Year Ended December 31, 2011 (52 weeks) Compared to Fiscal Year Ended January 1, 2011 (52 weeks)
 
Total revenues. Net retail sales were $387.0 million for fiscal 2011, compared to $387.2 million for fiscal 2010, a decrease of $0.2 million.  Comparable store sales decreased $7.6 million in fiscal 2011, or 2.1% and sales from non-comparable locations, comprised primarily of relocated and remodeled locations, decreased $3.6 million.  Partially offsetting these decreases are increases of $4.4 million from sales in new stores, $1.0 million in e-commerce sales and of $2.7 million in sales from non-store locations which includes temporary locations.  Other changes, adding $2.9 million to net retail sales, resulted from the impact of foreign currency exchange rates, changes in deferred revenue estimate, offset by redemptions throughout the year, and other revenue.
 
Commercial revenue was $3.9 million in fiscal 2011 compared to $11.2 million in fiscal 2010.  This decrease was primarily due to $6.4 million from two non-recurring wholesale transactions in fiscal 2010.  Excluding these transactions, commercial revenues decreased $0.9 million, primarily due to the 2010 Build-A-Bear Craftshop launch that did not reoccur in 2011.  Revenue from international franchise fees increased to $3.4 million for fiscal 2011 from $3.0 million for fiscal 2010, an increase of $0.4 million.  This increase was primarily due to the increase in the number of franchise locations from 63 at the end of fiscal 2010 to 79 at the end of fiscal 2011.
 
Gross margin. Total gross margin, calculated as net retail sales and commercial revenues less cost of merchandise sold, was $156.8 million for fiscal 2011 compared to $158.9 million for fiscal 2010, a decrease of $2.1 million, or 1.3%.  Retail gross margin was $154.5 million in fiscal 2011 compared to $155.1 million in fiscal 2010, a decrease of $0.7 million or 0.4%.  As a percentage of net retail sales, retail gross margin decreased to 39.9% for fiscal 2011 from 40.1% for fiscal 2010, a decrease of 20 basis points as a percentage of net retail sales (bps).  This decline in margin was primarily attributable to decreased merchandise margin, decreased leverage on fixed occupancy costs and increased purchasing costs offset by cost savings in distribution costs.
 
Selling, general and administrative. Selling, general and administrative expenses were $162.9 million for fiscal 2011 as compared to $164.6 million for fiscal 2010, a decrease of $1.7 million, or 1.1%.  As a percentage of total revenues, selling, general and administrative expenses were 41.3% for fiscal 2011, compared to 41.0% in fiscal 2010.  The dollar decrease was primarily attributable to higher costs in 2010 of $1.6 million in charges related to the closure of our stores in France and corporate payroll costs primarily related to a bonus that did not reoccur in 2011.  These decreases were partially offset by consulting costs related to continuing efforts to improve efficiencies and reduce expenses.
 
 
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Interest expense (income), net. Interest income, net of interest expense, was $0.1 million for fiscal 2011 as compared to $0.3 million for fiscal 2010.
 
Provision for income taxes. Income tax expense was $14.4 million in fiscal 2011, compared to an income tax benefit of $2.6 million for fiscal 2010.  The effective rate was (543.4)% in 2011 and 104.2% in 2010.  The fluctuation in the effective rate in 2011 was primarily attributable to the recording of a $15.6 million valuation allowance in 2011 on the US deferred tax assets.
 
Non-GAAP Financial Measures
 
We use the term “store contribution” throughout this Annual Report on Form 10-K. Store contribution consists of income before income tax expense, interest, store depreciation, amortization and impairment, goodwill impairment, general and administrative expense, excluding franchise fees, income from licensing activities and contribution from our web store and seasonal and event-based locations.  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.  Store contribution should not be considered a substitute for net income (loss), net income (loss) 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.
 
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.
 
 
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The following table sets forth a reconciliation of store contribution to net income for our company-owned stores located in the United States, Canada and Puerto Rico (North America), stores located in the United Kingdom, Ireland and, prior to 2011, France (Europe) and for our consolidated store base (dollars in thousands):
 
   
Fiscal 2012
   
Fiscal 2011
 
   
North
America
   
Europe
   
Total
   
North
America
   
Europe
   
Total
 
Net income (loss)
  $ (13,955 )   $ (35,340 )   $ (49,295 )   $ (19,232 )   $ 2,170     $ (17,062 )
Income tax expense (benefit)
    (85 )     951       866       13,607       803       14,410  
Interest expense (income)
    63       (60 )     3       56       (137 )     (81 )
Store depreciation, amortization and impairment (1)
    13,436       3,597       17,033       15,233       2,514       17,747  
Goodwill impairment (2)
    -       33,670       33,670       -       -       -  
General and administrative expense (3)
    44,154       4,751       48,905       43,867       5,043       48,910  
Franchising and commercial contribution (4)
    (966 )     -       (966 )     (4,142 )     -       (4,142 )
Non-store activity contribution (5)
    (2,301 )     (1,094 )     (3,395 )     (3,008 )     (1,109 )     (4,117 )
Store contribution
  $ 40,346     $ 6,475     $ 46,821     $ 46,381     $ 9,284     $ 55,665  
                                                 
Total revenues from external customers
  $ 309,141     $ 71,800     $ 380,941     $ 319,810     $ 74,565     $ 394,375  
Franchising and commercial revenues from external customers
    (6,388 )     -       (6,388 )     (7,334 )     -       (7,334 )
Revenues from non-store activities (5)
    (16,848 )     (3,576 )     (20,424 )     (16,765 )     (3,313 )     (20,078 )
Store location net retail sales
  $ 285,905     $ 68,224     $ 354,129     $ 295,711     $ 71,252     $ 366,963  
Store contribution as a percentage of store location net retail sales
    14.1 %     9.5 %     13.2 %     15.7 %     13.0 %     15.2 %
Total net income (loss) as a percentage of total revenues
    (4.5 )%     (49.2 )%     (12.9 )%     (6.0 )%     2.9 %     (4.3 )%
 
   
Fiscal 2010
   
   
North
America
   
Europe
   
Total
   
Net income (loss)
  $ (5,376 )   $ 5,480     $ 104    
Income tax expense (benefit)
    (3,284 )     708       (2,576 )  
Interest expense (income)
    (86 )     (164 )     (250 )  
Store depreciation, amortization and impairment (1)
    16,222       2,949       19,171    
Goodwill impairment (2)
    -       -       -    
General and administrative expense (3)
    48,573       (138 )     48,435    
Franchising and commercial contribution (4)
    (4,291 )     -       (4,291 )  
Non-store activity contribution (5)
    (3,070 )     (972 )     (4,042 )  
Store contribution
  $ 48,688     $ 7,863     $ 56,551    
                           
Total revenues from external customers
  $ 331,392     $ 70,060     $ 401,452    
Franchising and commercial revenues from external customers
    (13,699 )     (590 )     (14,289 )  
Revenues from non-store activities (5)
    (14,345 )     (2,785 )     (17,130 )  
Store location net retail sales
  $ 303,348     $ 66,685     $ 370,033    
Store contribution as a percentage of store location net retail sales
    16.1 %     11.8 %     15.3 %  
Total net income (loss) as a percentage of total revenues
    (1.6 )%     7.8 %     0.0 %  
 
 
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(1)
Store depreciation, amortization and impairment includes depreciation and amortization of all capitalized assets in store locations, including leasehold improvements, furniture and fixtures, and computer hardware and software and store asset impairment charges.
(2)
Goodwill impairment represents the write-off of the goodwill associated with the UK reporting unit.
(3)
General and administrative expenses consist of non-store, central office general and administrative functions such as management payroll and related benefits, travel, information systems, accounting, purchasing and legal costs as well as the depreciation and amortization of central office leasehold improvements, furniture and fixtures, computer hardware and software, including intellectual property and store closing expenses.  General and administrative expenses also include a central office marketing department, primarily payroll and related benefits expense, but exclude advertising expenses, such as television advertising, virtual world costs and direct mail catalogs, which are included in store contribution.
(4)
Franchising and commercial contribution includes franchising and commercial revenues and all expenses attributable to the international franchising and commercial segments including asset impairments and excluding depreciation, amortization and interest expense/income. Depreciation and amortization related to franchising and licensing is included in the general and administrative expense caption. Interest expense/income related to franchising and commercial activities is included in the interest expense (income) caption.
(5)
Non-store activities include our webstores, temporary locations and seasonal and event-based locations.

 
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Seasonality and Quarterly Results
 
The following is a summary of certain unaudited quarterly results of operations data for each of the last two fiscal years.
 
   
Fiscal 2012
   
Fiscal 2011
 
   
First
   
Second
   
Third
   
Fourth
   
First
   
Second
   
Third
   
Fourth
 
(Dollars in millions, except per share data)
 
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
 
                                                 
Total revenues
  $ 96.4     $ 80.4     $ 86.0     $ 118.1     $ 96.0     $ 81.8     $ 97.4     $ 119.1  
Retail gross margin(1)
    38.0       27.7       30.8       49.2       36.6       28.8       38.4       50.7  
Goodwill impairment
    -       -       -       33.7       -       -       -       -  
Net  (loss) income(2)
    (1.0 )     (7.6 )     (4.3 )     (36.4 )     (2.3 )     (6.7 )     0.9       (9.0 )
Earnings (loss) per common share:
                                                         
Basic
    (0.06 )     (0.46 )     (0.26 )     (2.23 )     (0.12 )     (0.37 )     0.05       (0.56 )
Diluted
    (0.06 )     (0.46 )     (0.26 )     (2.23 )     (0.12 )     (0.37 )     0.05       (0.56 )
Number of stores (end of quarter)
    357       354       351       351       357       354       355       356  
 
(1)
Retail gross margin represents net retail sales less cost of retail merchandise sold.
(2)
The fourth quarter of 2012 and 2011 included a $4.7 million and a $15.6 million charge, respectively, related to the recording of a valuation allowance on deferred tax assets.
 
As a toy retailer, our sales are highest in our fourth quarter, followed by the first quarter.  The timing of holidays and school vacations can impact our quarterly results.  Our European-based stores have historically been more heavily weighted in the fourth quarter as compared to our North American stores.  We cannot ensure that this will continue to be the case.
 
Our operating results for one period may not be indicative of results for other periods, and may fluctuate significantly because of a variety of factors, including those discussed under “Risk Factors — Risks Related to Owning Our Common Stock - Fluctuations in our quarterly results of operations could cause the price of our common stock to substantially decline.”
 
The timing of permanent store closures and temporary closures for remodels and relocations may result in fluctuations in quarterly results as a result of the revenues and expenses associated with each store location.  We typically incur most preopening costs for a store in the three months immediately preceding the store’s opening or reopening.  We also incur costs to close stores, typically in the three to six months prior to the closure.
 
For accounting purposes, the quarters of each fiscal year consist of 13 weeks, although we will have a 14-week quarter approximately once every six years.  The fiscal 2008 fourth quarter was a 14-week quarter.  Quarterly fluctuations and seasonality may cause our operating results to fall below the expectations of securities analysts and investors, which could cause our stock price to fall.
 
Liquidity and Capital Resources
 
Our cash requirements are primarily for the opening of new stores, installation and upgrades of information systems and working capital.  Over the past several years, we have met these requirements through capital generated from cash flow provided by operations.  We have access to additional cash through a revolving line of credit that has been in place since 2000.
 
Operating Activities. Cash flows provided by operating activities were $14.9 million in fiscal 2012 and $16.0 million in fiscal 2011 and $22.0 million in fiscal 2010.  Cash flows from operating activities decreased in fiscal 2012 as compared to 2011, primarily due to decreased store contribution.  Cash flows from operating activities decreased in fiscal 2011 as compared to 2010 as accounts payable and accrued expenses increased due to the timing of inventory shipments and payments were offset by higher inventory levels.
 
Investing Activities. Cash flows used in investing activities were $15.1 million in fiscal 2012, $13.3 million in fiscal 2011 and $13.8 million in fiscal 2010.  Cash used in investing activities in 2012 related primarily to the continued installation and upgrades of central office information technology systems, the opening of five new stores, the remodeling or relocation of 14 stores, offset by the maturity of short-term investments.  Cash used in investing activities in 2011 related primarily to the continued installation and upgrades of central office information technology systems, the opening of eight new stores, the relocation of four stores and the purchase of short-term investments, offset by the maturity of those investments.  Cash used in investing activities in 2010 related primarily to the continued installation and upgrades of central office information technology systems, acquisition of intangible assets, the opening of four new stores and 11 temporary locations and the relocation of one store, offset by cash received for the sale of key money from one of our French stores.
 
 
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Financing Activities. Financing activities used cash of $1.2 million, $14.6 million and $7.2 million in 2012, 2011 and 2010, respectively.  Purchases of our stock in fiscal 2012, 2011 and 2010 used cash of $1.3 million, $15.0 million and $7.3 million, respectively.  In fiscal 2011 and 2010, exercises of employee stock options and related tax benefits provided cash of $0.4 million and $0.1 million, respectively.  No employee stock options were exercised in fiscal 2012.
 
Capital Resources. As of December 29, 2012, we had a cash balance of $45.2 million, nearly half of which was domiciled outside of the United States.  We also have a line of credit, which we can use to finance capital expenditures and working capital needs throughout the year.  The credit agreement is with U.S. Bank National Association.  On December 21, 2012, we amended the existing bank line of credit that now provides borrowing capacity of $35 million.  Borrowings under the credit agreement are secured by our assets and a pledge of 65% of our ownership interest in our foreign subsidiaries.  The credit agreement expires on December 31, 2014 and contains various restrictions on indebtedness, liens, guarantees, redemptions, mergers, acquisitions or sale of assets, loans, transactions with affiliates, and investments.  It prohibits us from declaring dividends without the bank’s prior consent, unless such payment of dividends would not violate any terms of the credit agreement.  We are also prohibited from repurchasing shares of our common stock unless such purchase would not violate any terms of the credit agreement; we may not use proceeds of the line of credit to repurchase shares.  Borrowings bear interest at LIBOR plus 1.8%.  Financial covenants include maintaining a minimum tangible net worth, maintaining a minimum fixed charge coverage ratio (as defined in the credit agreement) and not exceeding a maximum funded debt to earnings before interest, depreciation and amortization ratio.  On February 13, 2013, we amended our existing bank line of credit to reduce the fixed charge coverage ratio for the fiscal year ending December 29, 2012, returning to its previous requirement thereafter.  As of December 29, 2012: (i) we were in compliance with these covenants; (ii) there were no borrowings under our line of credit; and (iii) there was a standby letter of credit of approximately $1.1 million outstanding under the credit agreement.  Giving effect to this standby letter of credit, there was approximately $33.9 million available for borrowing under the line of credit.
 
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 typically have a ten-year term and contain provisions for base rent plus percentage rent based on defined sales levels.  Many of the leases contain a provision whereby either we or the landlord may terminate the lease after a certain time, typically in the third or fourth year and sixth or seventh year of the lease, if a certain minimum sales volume is not achieved.  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.  In addition, some of these leases contain various restrictions relating to change of 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.
 
Our leases in the United Kingdom and Ireland typically have terms of ten to fifteen 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. In addition, some of these leases contain various restrictions relating to change of control of our company. Real estate taxes also change according to government time schedules to reflect current market rental rates for the locations we lease.  Rents are charged quarterly and paid in advance.
 
In fiscal 2013, we expect to spend approximately $20 to $25 million on capital expenditures.  Capital spending in fiscal 2012 totaled $17 million.  Capital spending in fiscal 2012 was primarily for continued installation and upgrades of central office information technology systems, the opening of five new stores, the remodeling or relocation of 14 stores.
 
On February 20, 2007, we announced that our board of directors had authorized a $25 million share repurchase program of our outstanding common stock.  On March 10, 2008, we announced an expansion of our share repurchase program to $50 million.  On February 28, 2013, we announced that our share repurchase program had been extended to March 31, 2014.  We currently intend to purchase up to an aggregate of $50 million of our common stock in the open market (including through 10b5-1 plans), through privately negotiated transactions or through an accelerated repurchase transaction.  As of March 8, 2013, approximately 5.9 million shares at an average price of $7.24 per share have been repurchased under this program for an aggregate amount of $42.6 million, leaving $7.4 million of availability under the program. The primary source of funding for the program has been, and is expected to be, cash on hand.  The timing and amount of additional share repurchases, if any, will depend on price, market conditions, applicable regulatory requirements, and other factors.  The program does not require us to repurchase any specific number of shares and may be modified, suspended or terminated at any time without prior notice.  Shares repurchased under the program have been, and will continue to be, subsequently retired.
 
We believe that cash generated from operations and borrowings under our credit agreement will be sufficient to fund our working capital and other cash flow requirements for the near future.  Our credit agreement expires on December 31, 2014.
 
Off-Balance Sheet Arrangements
 
We hold a minority interest in Ridemakerz, LLC, which is accounted for under the equity method.  Ridemakerz has developed a wholesale toy product line and selectively operates interactive retail stores, primarily in tourist locations that allow children and families to build and customize their own personalized cars.  In 2006, we purchased a call option from a group of other Ridemakerz investors for $150,000 for 1.25 million Ridemakerz common units at an exercise price of $1.25 per unit.  Simultaneously, the Company granted a put option to the same group of investors for 1.25 million common units at an exercise price of $0.50 per unit.  The put option was exercised for all 1.25 million shares on February 13, 2012.  We have no further obligations related to our investment in Ridemakerz
 
 
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Contractual Obligations and Commercial Commitments
 
Our contractual obligations and commercial commitments include future minimum obligations under operating leases and purchase obligations.  Our purchase obligations primarily consist of purchase orders for merchandise inventory.  The future minimum payments for these obligations as of December 29, 2012 for periods subsequent to this date are as follows:
 
   
Payments Due by Fiscal Period as of December 29, 2012
 
   
Total
   
2013
   
2014
   
2015
   
2016
   
2017
   
Beyond
 
   
(In thousands)
 
Operating lease obligations
  $ 205,675     $ 45,264     $ 39,229     $ 33,587     $ 25,425     $ 18,518     $ 43,652  
Purchase obligations
    33,251       33,251       -       -       -       -