e10vq
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
     
þ   Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended October 1, 2005
     
o   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 of other jurisdiction of incorporation or   (I.R.S. Employer Identification Number)
organization)    
     
1954 Innerbelt Business Center Drive   63114
St. Louis, Missouri   (Zip Code)
(Address of principal executive offices)    
(314) 423-8000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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. þ Yes o No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, $0.01 par value, 20,073,327 shares issued and outstanding as of November 9, 2005
 
 

 


BUILD-A-BEAR WORKSHOP, INC.
INDEX TO FORM 10-Q
                 
            Page
Part I   Financial Information        
 
  Item 1.   Financial Statements (Unaudited)        
 
      Condensed Consolidated Balance Sheets     3  
 
      Condensed Consolidated Statements of Operations     4  
 
      Condensed Consolidated Statements of Cash Flows     5  
 
      Notes to Condensed Consolidated Financial Statements     6  
 
               
 
  Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations     15  
 
               
 
  Item 3.   Quantitative and Qualitative Disclosures About Market Risk     28  
 
               
 
  Item 4.   Controls and Procedures     28  
 
               
Part II   Other Information        
 
               
 
  Item 6.   Exhibits     30  
 
               
    Signatures     31  
 Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Bear
 Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Bear
 Section 1350 Certification by Chief Executive Bear
 Section 1350 Certification by Chief Financial Bear

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ITEM 1. FINANCIAL STATEMENTS
BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
                 
    October 1,     January 1,  
    2005     2005  
    (Unaudited)          
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 51,564     $ 67,327  
Inventories
    34,123       30,791  
Receivables
    6,240       3,792  
Prepaid expenses and other current assets
    9,395       5,320  
Deferred tax assets
    3,142       2,725  
 
           
Total current assets
    104,464       109,955  
 
               
Property and equipment, net
    86,207       75,815  
Other intangible assets, net
    1,329       1,411  
Other assets, net
    4,695       2,056  
 
           
Total assets
  $ 196,695     $ 189,237  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 17,706     $ 25,767  
Accrued expenses
    6,065       13,966  
Other current liabilities
    17,579       22,222  
 
           
Total current liabilities
    41,350       61,955  
 
               
Deferred franchise revenue
    2,095       2,075  
Deferred rent
    31,350       26,426  
Other liabilities
    623       732  
Deferred tax liabilities
    3,508       2,539  
 
               
Stockholders’ equity:
               
Preferred stock, par value $0.01, 15,000,000 shares authorized; no shares issued or outstanding at October 1, 2005 and January 1, 2005
           
Common stock, par value $0.01, 50,000,000 shares authorized; issued and outstanding 20,014,577 and 19,557,784 shares, respectively
    200       196  
Additional paid-in capital
    82,430       77,708  
Retained earnings
    36,104       19,386  
Notes receivable from officers
    (149 )     (1,770 )
Unearned compensation
    (816 )     (10 )
 
           
Total stockholders’ equity
    117,769       95,510  
 
           
Total liabilities and stockholders’ equity
  $ 196,695     $ 189,237  
 
           
See accompanying notes to condensed consolidated financial statements.

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except share and per share data)
                                 
    Thirteen weeks ended     Thirty-nine weeks ended  
    October 1, 2005     October 2, 2004     October 1, 2005     October 2, 2004  
          (restated)           (restated)  
Revenues:
                               
Net retail sales
  $ 83,239     $ 66,213     $ 242,241     $ 201,633  
Franchise fees
    507       191       1,147       498  
Licensing revenue
    271       102       387       102  
 
                       
Total revenues
    84,017       66,506       243,775       202,233  
 
                       
 
                               
Costs and expenses:
                               
Cost of merchandise sold
    43,512       34,822       125,070       104,868  
Selling, general and administrative
    31,113       25,144       88,303       73,776  
Store preopening
    1,281       767       4,398       1,472  
Interest expense (income), net
    (434 )     (72 )     (1,180 )     (170 )
 
                       
Total costs and expenses
    75,472       60,661       216,591       179,946  
 
                       
Income before income taxes
    8,545       5,845       27,184       22,287  
Income tax expense
    3,290       2,342       10,466       8,590  
 
                       
Net income
    5,255       3,503       16,718       13,697  
Cumulative dividends and accretion of redeemable preferred stock
          152             1,137  
Cumulative dividends of nonredeemable preferred stock
          35             263  
 
                       
Net income available to common and participating preferred stockholders
  $ 5,255     $ 3,316     $ 16,718     $ 12,297  
 
                       
Net income allocated to common stockholders
  $ 5,255     $ 140     $ 16,718     $ 412  
Net income allocated to participating preferred stockholders
  $     $ 3,176     $     $ 11,885  
 
                       
 
                               
Earnings per common share:
                               
Basic
  $ 0.26     $ 0.34     $ 0.85     $ 1.25  
 
                       
Diluted
  $ 0.26     $ 0.19     $ 0.83     $ 0.76  
 
                       
 
                               
Shares used in computing common per share amounts:
                               
Basic
    19,874,869       419,156       19,650,364       329,560  
Diluted
    20,234,749       18,528,825       20,194,093       18,099,867  
See accompanying notes to condensed consolidated financial statements.

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
                 
    Thirty-nine weeks ended  
    October 1, 2005     October 2, 2004  
          (restated)  
Cash flows from operating activities:
               
Net income
  $ 16,718     $ 13,697  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    12,821       10,817  
Deferred taxes
    552       (478 )
Tax benefit from exercise of non-qualified options
    2,444       410  
Loss on disposal of property and equipment
    322       269  
Stock-based compensation
    358       584  
Change in assets and liabilities:
               
Inventories
    (3,332 )     (6,862 )
Receivables
    (2,432 )     (961 )
Prepaid expenses and other current assets
    (4,086 )     (965 )
Accounts payable
    (8,158 )     (4,128 )
Accrued expenses and other liabilities
    (10,120 )     4,994  
 
           
Net cash provided by operating activities
    5,087       17,377  
 
           
Cash flows from investing activities:
               
Purchases of property and equipment
    (22,599 )     (11,278 )
Proceeds from sale of property and equipment
    24        
Purchases of other assets
    (885 )     (955 )
Loan to franchisee
    (2,540 )      
 
           
Net cash used in investing activities
    (26,000 )     (12,233 )
 
           
Cash flows from financing activities:
               
Payment of cash dividend
          (10,000 )
Exercise of employee stock options and employee stock purchases
    3,505        
Collection of note receivable from officer
    1,645        
 
           
Net cash provided by (used in) financing activities
    5,150       (10,000 )
 
           
Net decrease in cash and cash equivalents
    (15,763 )     (4,856 )
Cash and cash equivalents, beginning of period
    67,327       20,601  
 
           
Cash and cash equivalents, end of period
  $ 51,564     $ 15,745  
 
           
 
               
Non cash transactions:
               
Cumulative dividends and accretion of redeemable preferred stock
  $     $ 1,137  
Receipt of common stock in lieu of employee tax withholdings
  $ 2,411     $ 540  
See accompanying notes to condensed consolidated financial statements.

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
     The condensed consolidated financial statements included herein are unaudited and have been prepared by Build-A-Bear Workshop, Inc. and its subsidiaries (the “Company”) pursuant to the rules and regulations of the U.S. Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The condensed consolidated balance sheet of the Company as of January 1, 2005 was derived from the Company’s audited consolidated balance sheet as of that date. All other condensed consolidated financial statements contained herein are unaudited and reflect all adjustments which are, in the opinion of management, necessary to summarize fairly the financial position of the Company and the results of the Company’s operations and cash flows for the periods presented. All of these adjustments are of a normal recurring nature. All significant intercompany balances and transactions have been eliminated in consolidation. Because of the seasonal nature of the Company’s operations, results of operations of any single reporting period should not be considered as indicative of results for a full year. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the fiscal year ended January 1, 2005 included in the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission on March 29, 2005.
2. Restatement of Financial Statements
     On February 25, 2005, the Company determined that it would correct its then current method of accounting for rent holidays and landlord allowances in connection with its store and headquarters leases and restate prior period results. Historically, the Company had recognized rent expense for leases on a straight-line basis beginning on the earlier of the store opening date or lease commencement date, which had the effect of excluding the build-out period (rent holiday) from the calculation of the period over which rent is expensed. The Company has corrected this practice to include the build-out period in the period over which rent is expensed to comply with the provisions of FASB Technical Bulletin No. 88-1, “Issues Relating to Accounting for Leases” (“FTB 88-1”). The result of this correction was to increase preopening expense and reduce cost of merchandise sold. Preopening expense increased because the build-out period occurs prior to the opening of the store. Cost of merchandise sold decreased because rent is reduced over the balance of the lease period by an amount equal to the amount that was charged to preopening expense prior to the opening of the store.
     Additionally, the Company had accounted for landlord allowances as a reduction of the cost of leasehold improvements. In accordance with the provisions of FTB 88-1, the Company has corrected this practice and will account for these allowances as lease incentives resulting in a deferred credit to be recognized over the term of the lease as a reduction of rent expense. The term of the lease, as mentioned above, will now include the build-out period. The result of this correction was an increase in leasehold improvements and deferred rent on the balance sheet. The treatment of landlord allowances as lease incentives also resulted in a decrease in preopening expense and an increase in cost of merchandise sold in the statement of operations. Within cost of merchandise sold, store depreciation expense has been increased and rent expense has been decreased.
     These corrections have also resulted in an increase to both net cash provided by operating activities and net cash used in investing activities on the statement of cash flows. There was no impact on the net change in the cash and cash equivalents balance.
     Following is a summary of the effects of these changes on the Company’s consolidated financial statements for the thirteen and thirty-nine weeks ended October 2, 2004 (in thousands, except per share amounts):

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
                                 
    Thirteen weeks ended   Thirty-nine weeks ended
    October 2, 2004   October 2, 2004
    As Previously           As Previously    
    Reported   As Restated   Reported   As Restated
Statement of Operations Data
                               
Cost of merchandise sold
    34,906       34,822       105,052       104,868  
Store preopening
    576       767       1,156       1,472  
Total costs and expenses
    60,555       60,661       179,815       179,946  
Income before income taxes
    5,952       5,845       22,418       22,287  
Income tax expense
    2,383       2,342       8,640       8,590  
Net income
    3,569       3,503       13,778       13,697  
Net income available to common and participating preferred stockholders
    3,382       3,316       12,378       12,297  
Net income allocated to common stockholders
    143       140       415       412  
Net income allocated to participating preferred stockholders
    3,239       3,176       11,963       11,885  
Earnings per common share:
                               
Basic
    0.34       0.34       1.26       1.25  
Diluted
    0.19       0.19       0.76       0.76  
 
                               
Statement of Cash Flows Data
                               
Net cash provided by operating activities
                    14,861       17,377  
Net cash used in investing activities
                    (9,717 )     (12,233 )
3. Recent Accounting Pronouncements
     In December 2004, the Financial Account Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which replaces SFAS No. 123, Accounting for Stock-Based Compensation, (SFAS 123) and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). SFAS 123R eliminates the intrinsic value method under APB 25 as an alternative method of accounting for stock-based awards. SFAS 123R also revises the fair value-based method of accounting for share-based payment liabilities, forfeitures and modifications of stock-based awards and clarifies SFAS 123’s guidance in several areas, including measuring fair value, classifying an award as equity or as a liability and attributing compensation cost to reporting periods. In addition, SFAS 123R amends SFAS No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid, which is included within operating cash flows. SFAS 123R, as amended by a ruling issued by the Securities and Exchange Commission on April 14, 2005, requires all share-based payments to employees, including grants of employee stock options and stock purchases under certain employee stock purchase plans, to be recognized in the financial statements based on their fair values beginning with the first annual reporting period that begins after June 15, 2005, with early adoption encouraged. The Company is required to adopt SFAS 123R for the annual period beginning January 1, 2006 using a modified version of prospective application or may elect to apply a modified version of retrospective application. Both transition options require that compensation expense be recorded for all unvested share-based payment awards at the beginning of the first quarter of adoption of SFAS 123R. Under the retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented as if SFAS 123 had been applied in those periods. There are no prior period restatements under the prospective method. The Company currently plans to adopt SFAS 123R in the first quarter of fiscal 2006, beginning January 1, 2006. The Company has not yet

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
determined the method of adoption to be applied. The Company is currently evaluating the impact of the adoption of this standard on the consolidated financial statements.
     In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements (SFAS 154). SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. SFAS 154 also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The provisions of this Statement are effective for accounting changes and corrections of errors made in fiscal periods beginning after December 15, 2005. The adoption of the provisions of SFAS 154 is not expected to have a material impact on the Company’s financial position or results of operations.
4. Frequent Shopper Program
     The Company has a frequent shopper program for its U.S. stores whereby customers who purchase $100 of merchandise receive $10 off a future purchase. An estimate, based on historical redemption rates, of the amount of revenue to be deferred related to this program is recorded at the time of each purchase as a reduction of net retail sales. The deferred revenue is included in other current liabilities on the consolidated balance sheets and is recognized as net retail sales at the time the discount is redeemed. Management evaluates the redemption rate under this program through the use of frequent shopper cards which have an expiration date after which the frequent purchase discount would not have to be honored. Management reviews these redemption rates and assesses the adequacy of the deferred revenue account at the end of each fiscal quarter. Due to the estimates involved with these assessments, adjustments to the deferral rate are generally made no more often than bi-annually in order to allow time for more definite trends to emerge. Based on this assessment at the end of fiscal 2003, the deferred revenue account was determined to be overstated and was adjusted downward by $1.1 million with a corresponding increase to net retail sales, an increase in net income of $0.7 million, net of income taxes of $0.4 million, and an increase in basic earnings per share of $0.07 for the year ended January 3, 2004. Additionally, the amount of revenue being deferred beginning in fiscal 2004 was decreased by 0.2%, and by another 0.5% beginning with the third quarter of fiscal 2004, to give effect to the change in redemption experience. The changes made to the deferral rate in fiscal 2004 were prospective in nature with no impact on previously reported results of operations. Beginning with the second quarter of fiscal 2005, the amount of revenue being deferred was reduced by 0.1% on a prospective basis from its then current level due to further changes in the Company’s redemption experience. Also during the second quarter of fiscal 2005, the balance in the deferred revenue account was adjusted downward by $78,000 with a corresponding increase to net retail sales and an increase in net income of $48,000, net of income taxes of $30,000. This adjustment increased basic earnings per share by $0.01 for the thirteen weeks ended July 2, 2005, and had no impact on diluted earnings per share for the same period.
5. Stock-based Compensation
     The Company accounts for stock-based compensation in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees. Compensation expense for stock options is measured as the excess, if any, of the fair value of the Company’s common stock at the date of the grant over the amount an employee must pay to acquire the common stock. In the event options or other stock-based compensation are issued at a grant price resulting in compensation, such compensation is deferred as unearned compensation in stockholders’ equity and amortized to expense over the vesting period.

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
     In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, an Amendment of FASB Statement 123, to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company previously adopted the disclosure-only provisions of SFAS 123. The following table illustrates the effect on net earnings and net earnings per share as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation for the thirteen and thirty-nine week periods ended October 1, 2005 and October 2, 2004 (in thousands, except per share data):
                                 
    Thirteen weeks ended     Thirty-nine weeks ended  
    October 1, 2005     October 2, 2004     October 1, 2005     October 2, 2004  
          (restated)           (restated)  
Net income:
                               
As reported
  $ 5,255     $ 3,503     $ 16,718     $ 13,697  
Add stock-based employee compensation expense recorded, net of related tax effects
    88       425       220       484  
Deduct stock-based employee compensation expense under fair value-based method, net of related tax effects
    (80 )     (506 )     (1,031 )     (691 )
 
                       
Pro forma
  $ 5,263     $ 3,422     $ 15,907     $ 13,490  
 
                       
 
                               
Basic earnings per common share:
                               
As reported
  $ 0.26     $ 0.34     $ 0.85     $ 1.25  
 
                       
Pro forma
  $ 0.26     $ 0.33     $ 0.81     $ 1.23  
 
                       
 
                               
Diluted earnings per common share:
                               
As reported
  $ 0.26     $ 0.19     $ 0.83     $ 0.76  
 
                       
Pro forma
  $ 0.26     $ 0.18     $ 0.79     $ 0.75  
 
                       
     For awards with graded vesting, the pro forma disclosures above utilize the accelerated expense attribution method under FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans – An Interpretation of APB Opinions No. 15 and 25.
6. Earnings per Share
     The following table sets forth the computation of basic and diluted earnings per share (in thousands, except share and per share data):

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
                                 
    Thirteen weeks ended     Thirty-nine weeks ended  
    October 1, 2005     October 2, 2004     October 1, 2005     October 2, 2004  
          (restated)           (restated)  
Net income
  $ 5,255     $ 3,503     $ 16,718     $ 13,697  
Cumulative dividends and accretion of redeemable preferred stock
          152             1,137  
Cumulative dividends of nonredeemable preferred stock
          35             263  
 
                       
Net income available to common and participating preferred stockholders
    5,255       3,316       16,718       12,297  
 
                       
Dividends and accretion related to dilutive preferred stock
          187             1,400  
 
                       
 
  $ 5,255     $ 3,503     $ 16,718     $ 13,697  
 
                       
Net income allocated to common stockholders
  $ 5,255     $ 140     $ 16,718     $ 412  
 
                       
Net income allocated to participating preferred stockholders
  $     $ 3,176     $     $ 11,885  
 
                       
Weighted average number of common shares outstanding
    19,874,869       419,156       19,650,364       329,560  
 
                       
Weighted average number of participating preferred shares outstanding
          9,478,448             9,500,210  
 
                       
Weighted average number of common shares outstanding
    19,874,869       419,156       19,650,364       329,560  
Effect of dilutive securities:
                               
Stock options
    345,489       601,667       455,357       383,339  
Restricted stock
    14,391       191,469       88,372       143,601  
 
                       
 
    20,234,749       1,212,292       20,194,093       856,500  
 
                       
 
                               
Dilutive convertible preferred shares:
          17,316,533             17,243,367  
 
                       
Weighted average number of common shares — dilutive
    20,234,749       18,528,825       20,194,093       18,099,867  
 
                       
Earnings per share:
                               
Basic:
                               
Per common share
  $ 0.26     $ 0.34     $ 0.85     $ 1.25  
 
                       
Per participating preferred share
  $     $ 0.34     $     $ 1.25  
 
                       
Diluted
  $ 0.26     $ 0.19     $ 0.83     $ 0.76  
 
                       
     In calculating diluted earnings per share for the thirteen and thirty-nine weeks ended October 1, 2005, options to purchase 210,052 shares of common stock were outstanding as of the end of the period, but were not included in the computation of diluted earnings per share due to their anti-dilutive effect. An additional 51,750 shares of restricted common stock were excluded from the calculation of diluted earnings per share because their vesting is contingent on achieving a specified net income level that had not been met as of October 1, 2005. No options or contingently convertible shares were excluded from the diluted earnings per share calculation for the thirteen and thirty-nine weeks ended October 2, 2004.
     On October 28, 2004, the Company and certain selling stockholders sold in an initial public offering (the “offering”) a total of 7,482,000 shares of common stock, of which 5,982,000 shares were sold by selling stockholders and 1,500,000 shares were issued by the Company, at a price of $20.00 per share. The proceeds to the Company from the offering, after underwriting discounts and offering costs, were

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
approximately $25.7 million. In conjunction with the offering, all shares of preferred stock, including shares of preferred stock issuable in exchange for accrued but unpaid dividends, were converted into 17,316,689 shares of common stock.
7. Property and Equipment
     Property and equipment consist of the following (in thousands):
                 
    October 1,     January 1,  
    2005     2005  
Leasehold improvements
  $ 93,080     $ 78,321  
Furniture and fixtures
    18,386       16,932  
Computer hardware
    11,588       10,396  
Computer software
    8,129       7,270  
New store construction deposits
    5,473       2,629  
 
           
 
    136,656       115,548  
Less accumulated depreciation
    50,449       39,733  
 
           
 
  $ 86,207     $ 75,815  
 
           
8. Stockholders’ Equity
     Following is a summary of the significant changes to stockholders’ equity that occurred in the thirty-nine weeks ended October 1, 2005.
     In March 2005, the Company granted 51,750 shares of restricted, non-vested stock to certain executives of the Company. The shares vest ratably over a four year period from the date of grant if a certain net income level is achieved by the Company in fiscal 2005. The executives are entitled to vote these restricted shares and will be eligible for participation in any dividends declared during the vesting period. Based on management’s estimation that this net income level will be achieved in fiscal 2005, the Company is recording compensation expense for these shares over the vesting period. Under the provisions of APB Opinion No. 25 and related interpretations, the compensation related to these shares was adjusted to the market value of the Company’s common stock as of October 1, 2005. They will continue to be adjusted to market value at each reporting date until the contingent performance criterion has been satisfied. At October 1, 2005, the total fair value of these restricted stock grants was approximately $1.1 million. During the thirteen and thirty-nine weeks ended October 1, 2005, the Company recorded compensation expense of approximately $130,000 and $330,000, respectively, related to these restricted stock grants. The remaining unrecorded compensation expense related to these grants is reflected in unearned compensation on the condensed consolidated balance sheet of the Company.
     During the thirty-nine weeks ended October 1, 2005, employees of the Company have exercised options to purchase approximately 411,000 shares of common stock at prices ranging from $0.47 to $9.10 per share. Approximately 81,000 of these shares have been returned to the Company in lieu of the required federal and state tax withholdings associated with the option exercises. The Company recognized a tax benefit of approximately $2.4 million as a result of these exercises. Additionally, on April 1, 2005, the Company received payment in full for an outstanding note receivable from an officer of the Company in the amount of $1.6 million.
     The employees of the Company purchased 74,316 shares of common stock from the Company at purchase prices ranging from $18.70 to $20.00 per share through the Associate Stock Purchase Plan during the thirty-nine weeks ended October 1, 2005.

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. Segment Information
     The Company’s operations are conducted through three reportable segments consisting of retail operations, international and licensing and entertainment. The retail operations segment includes the operating activities of the stores in the United States and Canada and other retail delivery operations, including the Company’s web store and non-mall locations such as sports stadiums. The international segment includes the licensing activities of the Company’s franchise agreements with locations outside of the United States and Canada. The licensing and entertainment segment has been established to market the naming and branding rights of the Company’s intellectual properties for third party use. These operating segments represent the basis on which the Company’s chief operating decision-maker regularly evaluates the business in assessing performance, determining the allocation of resources and the pursuit of future growth opportunities. The operating segments have discrete sources of revenue, different capital structures and have different cost structures. The reporting segments follow the same accounting policies used for the Company’s consolidated financial statements.
     Following is a summary of the financial information for the Company’s reporting segments (in thousands):
                                 
    Retail             Licensing &        
    Operations     International     Entertainment     Total  
Thirteen weeks ended October 1, 2005
                               
Revenues from external customers
  $ 83,239     $ 507     $ 271     $ 84,017  
Income (loss) before income taxes
    8,272       113       160       8,545  
Total assets
    189,629       6,016       1,050       196,695  
Capital expenditures
    6,508                   6,508  
Depreciation and amortization
    4,195       109             4,304  
Thirteen weeks ended October 2, 2004
                               
Revenues from external customers
  $ 66,213     $ 191     $ 102     $ 66,506  
Income (loss) before income taxes (restated)
    5,997       (227 )     75       5,845  
Total assets (restated)
    130,721       2,811       418       133,950  
Capital expenditures (restated)
    5,137       9             5,146  
Depreciation and amortization (restated)
    3,544       148             3,692  
Thirty-nine weeks ended October 1, 2005
                               
Revenues from external customers
  $ 242,241     $ 1,147     $ 387     $ 243,775  
Income (loss) before income taxes
    27,181       (178 )     181       27,184  
Total assets
    189,629       6,016       1,050       196,695  
Capital expenditures
    22,569       30             22,599  
Depreciation and amortization
    12,438       383             12,821  
Thirty-nine weeks ended October 2, 2004
                               
Revenues from external customers
  $ 201,633     $ 498     $ 102     $ 202,233  
Income (loss) before income taxes (restated)
    23,087       (875 )     75       22,287  
Total assets (restated)
    130,721       2,811       418       133,950  
Capital expenditures (restated)
    11,262       16             11,278  
Depreciation and amortization (restated)
    10,437       380             10,817  
     The Company’s reportable segments are primarily determined by the types of products and services that they offer. Each reportable segment may operate in many geographic areas. The Company attributes revenues to geographic areas based on the location of the customer or franchisee. The Company attributes long-lived assets to geographic areas based on the physical location of the assets. The following schedule

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
provides a summary of the Company’s revenue from external customers and long-lived assets attributed to the Company’s country of domicile (United States of America) and foreign countries (in thousands):
                                 
    United States                    
    of America     Canada     Other     Total  
Thirteen weeks ended October 1, 2005
                               
Revenues from external customers
  $ 80,154     $ 3,356     $ 507     $ 84,017  
Property and equipment, net
    83,474       2,733             86,207  
Thirteen weeks ended October 2, 2004
                               
Revenues from external customers
  $ 64,630     $ 1,685     $ 191     $ 66,506  
Property and equipment, net (restated)
    72,747       1,947             74,694  
Thirty-nine weeks ended October 1, 2005
                               
Revenues from external customers
  $ 234,509     $ 8,119     $ 1,147     $ 243,775  
Property and equipment, net
    83,474       2,733             86,207  
Thirty-nine weeks ended October 2, 2004
                               
Revenues from external customers
  $ 197,104     $ 4,631     $ 498     $ 202,233  
Property and equipment, net (restated)
    72,747       1,947             74,694  
10. Long-Term Debt
     On September 27, 2005, the Company amended its previous line of credit (which matured on May 31, 2005) with a bank maintaining their borrowing capacity at $15 million. The amended line of credit has an effective date of May 31, 2005 with a maturity date of September 30, 2007. Borrowings under the amended line of credit (the credit agreement) are not collateralized, but availability under the credit agreement can be limited by the lender based on the Company’s levels of accounts receivable, inventory, and property and equipment. The credit agreement requires the Company to comply with certain financial covenants, including 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. The credit agreement also places certain restrictions on the payment of dividends and entering into additional financing arrangements. The interest rate for borrowings under the credit agreement is the prime rate (6.75% at October 1, 2005) less 0.5%. The credit agreement also includes a commitment fee of 0.125% per annum on any unused balances. There was no outstanding balance under the credit agreement at October 1, 2005 other than a standby letter of credit for $1.1 million. Giving effect to this standby letter of credit, there was $13.9 million available for borrowing under the credit agreement at October 1, 2005.
11. Subsequent Events
     (a) Loan to Franchisee
     On October 4, 2005, the Company entered into a loan agreement (the loan agreement) with Amsbra, Ltd. (Amsbra), an English corporation and a franchisee of the Company. The loan agreement provides for a $4.425 million line of credit to Amsbra, which amount may be borrowed at any time through March 31, 2006. The purpose of the loan agreement is to provide Amsbra with financing opportunities, if necessary, to enable Amsbra to open additional locations of the Company’s stores, as required pursuant to an amendment to the existing franchise agreement between the Company and Amsbra. Amounts outstanding under the loan agreement are collateralized by substantially all of the assets of Amsbra and bear interest at the greater of the prime rate plus 0.075% and 7.0% per annum. No principal or interest payments are required under the loan agreement until January 1, 2008. At that time, fixed monthly payments will be

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BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
required in an amount which will allow for all principal and accrued interest to be repaid by December 2011. As of October 1, 2005, advances of $2.5 million had been made to Amsbra in contemplation of the completion of the loan agreement. These advances, which are included in other assets on the condensed consolidated balance sheet as of October 1, 2005, became subject to the provisions of the loan agreement upon its completion on October 4, 2005.
     (b) Acceleration of Stock Options
     On October 21, 2005, the Compensation Committee of the Board of Directors of the Company approved the accelerated vesting of all unvested stock options which were granted prior to March 9, 2005. These options have exercise prices ranging from $20.00 to $34.65 per share. Options to purchase 174,056 shares of the Company’s stock became exercisable on October 21, 2005 as a result of this acceleration, including 71,000 shares held by the Company’s named executive officers. Of these options, 173,056 had exercise prices in excess of the current market value at the time of the acceleration of vesting.
     The Compensation Committee’s decision to accelerate the vesting of the accelerated options was based upon the issuance by the Financial Accounting Standards Board of Statement of Financial Accounting Standard No. 123 (Revised 2004), “Share-Based Payment” (SFAS 123R), which will require the Company to record compensation expense for unvested stock options effective January 1, 2006. The acceleration of the vesting of these stock options will enable the Company to avoid compensation charges related to these options in subsequent periods under the provisions of SFAS 123R. In addition, the Compensation Committee considered that because the vast majority of these options had exercise prices in excess of the current market value, they were not fully achieving their original objectives of incentive compensation and employee retention. Accordingly, the Compensation Committee believed that the acceleration would have a positive effect on employee morale.
     The future compensation expense that would have been recorded upon adoption of SFAS 123R, but is eliminated as a result of the acceleration of the vesting of these options, is approximately $1.8 million ($1.1 million net of tax). This amount will instead be reflected in pro forma footnote disclosures to the 2005 financial statements.

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ITEM 2. 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. These risks and uncertainties include, without limitation, those detailed under the caption “Risk Factors” in our annual report on Form 10-K for the year ended January 1, 2005, as filed with the Securities and Exchange Commission, and the following: we may be unable to generate comparable store sales growth; our marketing initiatives may not be effective in generating sufficient levels of brand awareness and guest traffic; we may be unable to open new stores or may be unable to effectively manage our growth; we may be unable to effectively manage our international franchises or laws relating to those franchises may change; we may be unable to generate interest in and demand for our interactive retail experience, or to identify and respond to consumer preferences in a timely fashion; customer traffic may decrease in the shopping malls where we are located, on which we depend to attract guests to our stores; general economic conditions may deteriorate, which could lead to reduced consumer demand for our products; our market share could be adversely affected by a significant number of competitors; we may lose key personnel, be unable to hire qualified additional personnel, or experience turnover of our management team; the ability of our principal vendors to deliver merchandise may be disrupted; the availability and costs of our products could be adversely affected by risks associated with international manufacturing and trade; our profitability could be adversely affected by high petroleum products prices; third parties that manage our warehousing and distribution functions may perform poorly; fluctuations in our quarterly results of operations could cause the price of our common stock to substantially decline; we may fail to renew, register or otherwise protect our trademarks or other intellectual property; we may have disputes with, or be sued by, third parties for infringement or misappropriation of their proprietary rights; we may be unable to renew or replace our store leases, or enter into leases for new stores, on favorable terms, or may violate the terms of our current leases; we may experience failures in our communications or information systems; terrorism or the uncertainty of future terrorist attacks or war could reduce consumer confidence and mall traffic; we may become subject to challenges relating to overtime pay or other regulations relating to our employees; we may suffer negative publicity or be sued due to violations of labor laws or unethical practices by manufacturers of our merchandise; we may be unable to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 in a timely manner; and we may improperly obtain or be unable to protect information from our guests in violation of privacy or security laws or expectations.
     These risks, uncertainties and other factors may adversely affect our business, growth, financial condition or profitability, or subject us to potential liability, and cause our actual results, performance or achievements to be materially different from those expressed or implied by our forward-looking statements. We do not undertake any obligation or plan to update these forward-looking statements, even though our situation may change.
Overview
     We are the leading and only national 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 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 October 1, 2005, we operated 193 stores in 43 states and Canada and had 20 franchised stores operating internationally under the Build-A-Bear Workshop brand. In addition to our stores, we market our products and build our brand through our website, which simulates our interactive shopping experience, as well as in event-based locations and sports venues.

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     We operate in three reportable segments (retail operations, international and licensing and entertainment) that share the same infrastructure, including management, systems, merchandising and marketing, and generate revenues as follows:
  United States and Canadian retail stores, a webstore and seasonal, event-based locations;
 
  international stores operated under franchise agreements; and
 
  license arrangements with third parties which manufacture and sell to other retailers merchandise carrying the Build-A-Bear Workshop brand.
     Selected financial data attributable to each segment for the thirteen and thirty-nine weeks ended October 1, 2005 and October 2, 2004 are set forth in the notes to our condensed consolidated financial statements included elsewhere in this quarterly report on Form 10-Q.
     Store contribution was 27.0% for the thirty-nine weeks ended October 1, 2005 and 26.8% for the thirty-nine weeks ended October 2, 2004, and total company net income as a percentage of total revenues was 6.9% for the thirty-nine weeks ended October 1, 2005 and 6.8% for the thirty-nine weeks ended October 2, 2004. See “— Non-GAAP Financial Measures” for a definition of store contribution and a reconciliation of store contribution to net income. We believe the store contribution of our average store, coupled with the fact that as of October 1, 2005 we have opened 156 stores since the beginning of fiscal 2001 and improved expense management, primarily through improved labor planning and reductions in store supply and other expenses beginning in 2003, have been the primary reasons for our net income increasing during each of the last five fiscal years, as well as the increase in our net income for the thirty-nine weeks ended October 1, 2005 as compared to the thirty-nine weeks ended October 2, 2004. Additionally, as we have added stores and grown our sales volume, we have increased the quantities of merchandise and supplies we purchase, which has created economies of scale for our vendors, allowing us to obtain reduced costs for these items and increase our profitability.
     We use comparable store sales as a key performance measure for our business. The percentage increase in comparable store sales for the periods presented below is as follows:
                             
Thirteen Weeks Ended   Thirty-nine Weeks Ended
October 1,   October 2,   October 1,   October 2,
2005   2004   2005   2004
  1.3 %     18.8 %     0.0 %     15.6 %
     Comparable store sales increased by 1.3% in the thirteen weeks ended October 1, 2005 compared to the thirteen weeks ended October 2, 2004. For the thirty-nine weeks ended October 1, 2005, comparable store sales increased by less than 0.1% compared to the thirty-nine weeks ended October 2, 2004. We believe these changes from the prior year results can be attributed primarily to the following factors:
  During the fourth quarter of fiscal 2003, we tested, in a limited number of markets, the use of television and online advertising and determined that it was successful in attracting a higher number of new and repeat guests. In the first quarter of fiscal 2004, we implemented this marketing strategy on a national basis and quickly began achieving comparable store sales increases. This marketing strategy has continued throughout fiscal 2005, but has not resulted in similar sales increases in fiscal 2005 as achieved in fiscal 2004. We anticipate continuing this marketing approach for the foreseeable future.
 
  Sales in the thirty-nine weeks ended October 2, 2004 benefited from the positive impact of being featured in one segment of a nationally syndicated television program in the first quarter of fiscal 2004. There was no similar event in the thirty-nine weeks ended October 1, 2005.
Expansion and Growth Potential

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U.S. and Canadian Stores:
     The number of Build-A-Bear Workshop stores in the United States and Canada for the periods presented below can be summarized as follows:
                 
    Thirty-nine weeks ended
    October 1,   October 2,
    2005   2004
Beginning of period
    170       150  
Opened
    23       15  
Closed
          (1 )
 
               
End of period
    193       164  
 
               
     During fiscal 2005, we anticipate opening a total of 30 Build-A-Bear Workshop stores in the United States and Canada. The 2005 new store openings include a flagship store in New York City, which opened on July 1, 2005 and celebrated its official grand opening on July 8, 2005. We believe there is a market potential for approximately 350 Build-A-Bear Workshop stores in the United States and Canada. In fiscal 2003, we began testing in certain markets our initial brand expansion initiative, our proprietary “Friends 2B Made” line of make-your-own dolls and related products. In November 2004, we opened two Friends 2B Made stores adjacent and connected to existing Build-A-Bear Workshop stores. These Friends 2B Made stores are not considered new store openings but rather are considered expansions of Build-A-Bear Workshop stores. In 2005, we opened three additional Friends 2B Made stores adjacent to Build-A-Bear Workshop stores. The Friends 2B Made merchandise is also offered from a separate display fixture in select Build-A-Bear Workshop stores.
Non-Store Locations:
     In fiscal 2004, we began offering merchandise in seasonal, event-based locations such as Citizens Bank Park™, home of the Philadelphia Phillies™ baseball club, as well as at temporary locations such as at the NBA All-Star Jam Session. We expect to expand our future presence at select seasonal, event-based locations contingent on their availability. In fiscal 2005, we have opened two additional event-based locations in baseball stadiums.
International Franchise Revenue:
     Our first franchised location opened in November 2003. The number of international, franchised stores for the periods presented below can be summarized as follows:
                 
    Thirty-nine weeks ended
    October 1, 2005   October 2, 2004
Beginning of period
    12       1  
Opened
    8       5  
Closed
           
 
               
End of period
    20       6  
 
               
     As of October 1, 2005, we had master franchise agreements, which typically grant franchise rights for a particular country or group of countries, covering 12 countries. We anticipate signing additional master franchise agreements in the future. We expect our current and future franchisees to open a total of approximately 20 stores in fiscal 2005. We believe there is a market potential for approximately 350 franchised stores outside of the United States and Canada.

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Restatement of Prior Results
     On February 25, 2005, we determined that we would correct our then current method of accounting for rent holidays and landlord allowances in connection with our store and headquarters leases and restate prior period results. Historically, we had recognized rent expense for leases on a straight-line basis beginning on the earlier of the store opening date or lease commencement date, which had the effect of excluding the build-out period (rent holiday) from the calculation of the period over which rent is expensed. We have corrected this practice to include the build-out period in the period over which rent is expensed to comply with the provisions of FASB Technical Bulletin No. 88-1, “Issues Relating to Accounting for Leases” (“FTB 88-1”). The result of this correction was to increase preopening expense and reduce cost of merchandise sold. Preopening expense increased because the build-out period occurs prior to the opening of the store. Cost of merchandise sold was reduced because rent is reduced over the balance of the lease period by an amount equal to the amount that was charged to preopening expense prior to the opening of the store.
     Additionally, we had accounted for landlord allowances as a reduction of the cost of leasehold improvements. In accordance with the provisions of FTB 88-1, we have corrected this practice and will account for these allowances as lease incentives resulting in a deferred credit to be recognized over the term of the lease as a reduction of rent expense. The term of the lease, as mentioned above, will now include the build-out period. The result of this correction was an increase in leasehold improvements and deferred rent on the balance sheet. The treatment of landlord allowances as lease incentives also resulted in a decrease in preopening expense and an increase in cost of merchandise sold in the statement of operations. Within cost of merchandise sold, store depreciation expense has been increased and rent expense has been decreased.
     These corrections have also resulted in an increase to both net cash provided by operating activities and net cash used in investing activities on the statement of cash flows. There was no impact on the net change in the cash and cash equivalents balance.
     Following is a summary of the effects of these changes on our financial statements for the thirteen and thirty-nine weeks ended October 2, 2004 (in thousands, except per share amounts):

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    Thirteen weeks ended   Thirty-nine weeks ended
    October 2, 2004   October 2, 2004
    As Previously           As Previously    
    Reported   As Restated   Reported   As Restated
Statement of Operations Data
                               
Cost of merchandise sold
    34,906       34,822       105,052       104,868  
Store preopening
    576       767       1,156       1,472  
Total costs and expenses
    60,555       60,661       179,815       179,946  
Income before income taxes
    5,952       5,845       22,418       22,287  
Income tax expense
    2,383       2,342       8,640       8,590  
Net income
    3,569       3,503       13,778       13,697  
Net income available to common and participating preferred stockholders
    3,382       3,316       12,378       12,297  
Net income allocated to common stockholders
    143       140       415       412  
Net income allocated to participating preferred stockholders
    3,239       3,176       11,963       11,885  
Earnings per common share:
                               
Basic
    0.34       0.34       1.26       1.25  
Diluted
    0.19       0.19       0.76       0.76  
 
                               
Statement of Cash Flows Data
                               
Net cash provided by operating activities
                    14,861       17,377  
Net cash used in investing activities
                    (9,717 )     (12,233 )
     Results of Operations
     The following table sets forth, for the periods indicated, selected income statement data expressed as a percentage of total revenues, except where otherwise indicated. Percentages may not total due to the cost of merchandise sold being expressed as a percentage of net retail sales and rounding:
                                 
    Thirteen weeks ended   Thirty-nine weeks ended
    October 1,   October 2,   October 1,   October 2,
    2005   2004   2005   2004
Revenues:
                               
Net retail sales
    99.1 %     99.6 %     99.4 %     99.7 %
Franchise fees
    0.6       0.3       0.5       0.2  
Licensing revenue
    0.3       0.2       0.2       0.1  
 
                               
Total revenues
    100.0       100.0       100.0       100.0  
 
                               
Costs and expenses
                               
Cost of merchandise sold (1)
    52.3       52.6       51.6       52.0  
Selling, general and administrative
    37.0       37.8       36.2       36.5  
Store preopening
    1.5       1.2       1.8       0.7  
Interest expense (income), net
    (0.5 )     (0.1 )     (0.5 )     (0.1 )
 
                               
Total costs and expenses
    89.8       91.2       88.8       89.0  
 
                               
Income before income taxes
    10.2       8.8       11.2       11.0  
Income tax expense
    3.9       3.5       4.3       4.2  
 
                               
Net income
    6.3 %     5.3 %     6.9 %     6.8 %
 
                               
Gross margin (%) (2)
    47.7 %     47.4 %     48.4 %     48.0 %
 
(1)   Cost of merchandise sold is expressed as a percentage of net retail sales.

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(2)   Gross margin represents net retail sales less cost of merchandise sold. Gross margin percentage represents gross margin divided by net retail sales.
Thirteen weeks ended October 1, 2005 compared to thirteen weeks ended October 2, 2004
     Total revenues. Net retail sales increased to $83.2 million for the thirteen weeks ended October 1, 2005 from $66.2 million for the thirteen weeks ended October 2, 2004, an increase of $17.0 million, or 25.7%. Net retail sales for new stores contributed a $15.4 million increase in net retail sales. Comparable store sales increased $0.8 million, or 1.3%, and sales from our web store increased by $0.5 million, or 50.8%. Sales from non-store locations and non-comparable stores resulted in a $0.2 million increase in net retail sales. Net retail sales also increased by $0.1 million due to decreased levels of revenue deferrals under our frequent shopper program compared to the prior year period.
     Revenue from franchise fees increased to $0.5 million for the thirteen weeks ended October 1, 2005 from $0.2 million for the thirteen weeks ended October 2, 2004, an increase of $0.3 million. This increase was primarily due to the addition of new franchisees and new franchised stores since the prior year period. Licensing revenue increased to $0.3 million for the thirteen weeks ended October 1, 2005 from $0.1 million for the thirteen weeks ended October 2, 2004.
     Gross margin. Gross margin increased to $39.7 million for the thirteen weeks ended October 1, 2005 from $31.4 million for the thirteen weeks ended October 2, 2004, an increase of $8.3 million, or 26.6%. As a percentage of net retail sales, gross margin increased to 47.7% for the thirteen weeks ended October 1, 2005 from 47.4% for the thirteen weeks ended October 2, 2004, an increase of 0.3%. This increase was primarily due to lower product and packaging costs, as a percentage of net retail sales, resulting from purchasing cost efficiencies related to higher sales volumes, which accounted for a 0.3% increase in gross margin as a percentage of net retail sales. Additionally, lower inventory damages and shortages compared to the prior period resulted in a 0.3% increase in gross margin as a percentage of net retail sales. These improvements were partially offset by higher shipping and transportation costs as a percentage of net retail sales, which accounted for a 0.3% decrease in gross margin as a percentage of net retail sales.
     Selling, general and administrative. Selling, general and administrative expenses were $31.1 million for the thirteen weeks ended October 1, 2005 as compared to $25.1 million for the thirteen weeks ended October 2, 2004, an increase of $6.0 million, or 23.7%. As a percentage of total revenues, selling, general and administrative expenses decreased to 37.0% for the thirteen weeks ended October 1, 2005 as compared to 37.8% for the thirteen weeks ended October 2, 2004, a decrease of 0.8%. The dollar increase was primarily due to having 29 more stores in operation at October 1, 2005 as compared to October 2, 2004, as well as higher central office expenses required to support a larger store base and various expenses related to being a public company. The decrease in selling, general and administrative expenses as a percent of revenue was primarily due to the leveraging of central office general and administrative expenses, primarily payroll, over a larger revenue base resulting in a 1.4% decrease as a percentage of total revenues. In addition, lower stock-based compensation in the current period resulted in a 0.6% decrease as a percentage of total revenues and leveraging of store payroll expense as comparable store sales increased resulted in a 0.3% decrease as a percentage of total revenues. These decreases were partially offset by higher legal, accounting and insurance costs primarily associated with being a public company which resulted in a 0.9% increase as a percentage of total revenues and by increases in advertising and other store expenses of 0.6% as a percentage of total revenues.
     Store preopening. Store preopening expense was $1.3 million for the thirteen weeks ended October 1, 2005 as compared to $0.8 million for the thirteen weeks ended October 2, 2004. These amounts include preopening rent expense of $0.2 million in both the thirteen weeks ended October 1, 2005 and the thirteen weeks ended October 2, 2004. Approximately $0.5 million of this increase was due to preopening costs related to our flagship store and café in New York City, which both had their grand opening events in the third quarter of 2005. Excluding our flagship store and café, seven new stores were opened in both the

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thirteen weeks ended October 1, 2005 and the thirteen weeks ended October 2, 2004, and we expect to open seven stores during the fourth quarter of fiscal 2005 as compared to six stores opened during the same period in fiscal 2004. Preopening expenses include expenses for stores that opened in the current period as well as some expenses incurred for stores that will be opened in future periods.
     Interest expense (income), net. Interest income, net of interest expense, was $0.4 million for the thirteen weeks ended October 1, 2005 as compared to $0.1 million for the thirteen weeks ended October 2, 2004. This increase was due to higher cash balances in the third quarter of fiscal 2005 as compared to the third quarter of fiscal 2004.
     Provision for income taxes. The provision for income taxes was $3.3 million for the thirteen weeks ended October 1, 2005 as compared to $2.3 million for the thirteen weeks ended October 2, 2004. The effective tax rate was 38.5% for the thirteen weeks ended October 1, 2005 and 40.1% for the thirteen weeks ended October 2, 2004. The primary reason for the decrease in the effective tax rate was the recording of $0.3 million in non-deductible stock-based compensation during the thirteen weeks ended October 2, 2004. There was no similar charge in the thirteen weeks ended October 1, 2005.
Thirty-nine weeks ended October 1, 2005 compared to thirty-nine weeks ended October 2, 2004
     Total revenues. Net retail sales increased to $242.2 million for the thirty-nine weeks ended October 1, 2005 from $201.6 million for the thirty-nine weeks ended October 2, 2004, an increase of $40.6 million, or 20.1%. Net retail sales for new stores contributed a $36.8 million increase in net retail sales. Comparable store sales increased $0.1 million and sales from our web store increased by $1.2 million, or 34.6%. Sales from non-store locations and non-comparable stores resulted in a $1.4 million increase in net retail sales. Net retail sales also increased by $1.1 million due to decreased levels of revenue deferrals under our frequent shopper program compared to the prior year period.
     Revenue from franchise fees increased to $1.1 million for the thirty-nine weeks ended October 1, 2005 from $0.5 million for the thirty-nine weeks ended October 2, 2004, an increase of $0.6 million. This increase was primarily due to the addition of new franchisees and new franchised stores since the prior year period. Licensing revenue increased to $0.4 million for the thirty-nine weeks ended October 1, 2005 from $0.1 million for the thirty-nine weeks ended October 2, 2004.
     Gross margin. Gross margin increased to $117.2 million for the thirty-nine weeks ended October 1, 2005 from $96.8 million for the thirty-nine weeks ended October 2, 2004, an increase of $20.4 million, or 21.1%. As a percentage of net retail sales, gross margin increased to 48.4% for the thirty-nine weeks ended October 1, 2005 from 48.0% for the thirty-nine weeks ended October 2, 2004, an increase of 0.4%. This change was primarily due to lower product and packaging costs, as a percentage of net retail sales, resulting from purchasing cost efficiencies related to higher sales volumes, which accounted for a 0.3% increase in gross margin as a percentage of net retail sales. Additionally, lower inventory damages and shortages compared to the prior period resulted in a 0.1% increase in gross margin as a percentage of net retail sales.
     Selling, general and administrative. Selling, general and administrative expenses were $88.3 million for the thirty-nine weeks ended October 1, 2005 as compared to $73.8 million for the thirty-nine weeks ended October 2, 2004, an increase of $14.5 million, or 19.7%. As a percentage of total revenues, selling, general and administrative expenses were 36.2% for the thirty-nine weeks ended October 1, 2005 as compared to 36.5% for the thirty-nine weeks ended October 2, 2004, a decrease of 0.3%. The dollar increase was primarily due to having 29 more stores in operation at October 1, 2005 as compared to October 2, 2004, as well as higher central office expenses required to support a larger store base and various expenses related to being a public company. Selling, general and administrative expenses decreased as a percentage of revenue primarily due to the leveraging of central office general and administrative expenses, primarily payroll, over a larger revenue base resulting in a 1.2% decrease, and the leveraging of company wide advertising expenditures over a larger revenue base, which resulted in a 0.2% decrease. Lower stock-based compensation in the current period also resulted in a 0.1% decrease in

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selling, general and administrative expenses as a percentage of total revenues. These decreases were partially offset by the de-leveraging of store salaries and other store expenses due to flat comparable store sales, which resulted in a 0.5% increase in selling, general and administrative expenses as a percentage of revenue. Additional increases were caused by higher legal, accounting and insurance costs primarily associated with being a public company which resulted in a 0.7% increase as a percentage of total revenues.
     Store preopening. Store preopening expense was $4.4 million for the thirty-nine weeks ended October 1, 2005 as compared to $1.5 million for the thirty-nine weeks ended October 2, 2004. These amounts include preopening rent expense of $1.4 million in the thirty-nine weeks ended October 1, 2005 and $0.3 million in the thirty-nine weeks ended October 2, 2004. Approximately $2.0 million of this increase, including approximately $0.9 million of preopening rent expense, was due to preopening costs related to our flagship store and café in New York City, which both had their grand opening events in the third quarter of 2005. Excluding our flagship store, seven more new stores were opened in the thirty-nine weeks ended October 1, 2005 than in the thirty-nine weeks ended October 2, 2004 (22 in the thirty-nine weeks ended October 1, 2005 as compared to 15 in the thirty-nine weeks ended October 2, 2004), and we expect to open seven stores during the fourth quarter of fiscal 2005 as compared to six stores opened during the same period in fiscal 2004. Preopening expenses include expenses for stores that opened in the current period as well as some expenses incurred for stores that will be opened in future periods.
     Interest expense (income), net. Interest income, net of interest expense, was $1.2 million for the thirty-nine weeks ended October 1, 2005 as compared to $0.2 million for the thirty-nine weeks ended October 2, 2004. This increase was due to higher cash balances in the thirty-nine weeks ended October 1, 2005 as compared to the thirty-nine weeks ended October 2, 2004.
     Provision for income taxes. The provision for income taxes was $10.5 million for the thirty-nine weeks ended October 1, 2005 as compared to $8.6 million for the thirty-nine weeks ended October 2, 2004. The effective tax rate was 38.5% for both the thirty-nine weeks ended October 1, 2005 and the thirty-nine weeks ended October 2, 2004.
Non-GAAP Financial Measures
     We use the term “store contribution” in this quarterly report on Form 10-Q. Store contribution consists of income before income tax expense, interest, store depreciation and amortization, store preopening expense and general and administrative expense, excluding franchise fees, income from licensing activities and contribution from our webstore 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, net income per store, cash flows provided by operating activities, cash flows provided by operating activities per store, or other income or cash flow data prepared in accordance with 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. Historically, central office general and administrative expenses and preopening expenses have generally increased at a rate less than our total net retail sales increases. Therefore, as we have opened additional new stores and leveraged our central office general and administrative and preopening expenses over this larger store base and sales volume, we have been able to increase our net income in each fiscal year from 2000 to the present.
     The following table sets forth a reconciliation of store contribution to net income (in thousands):

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    Thirty-nine weeks ended  
    October 1, 2005     October 2, 2004  
Net income
  $ 16,718     $ 13,697  
Income tax expense
    10,466       8,590  
Interest expense (income)
    (1,180 )     (170 )
Store depreciation and amortization (1)
    10,075       8,478  
Store preopening expense
    4,398       1,472  
General and administrative expense (2)
    24,367       21,369  
Franchising and licensing contribution (3)
    (374 )     420  
Non-store activity contribution (4)
    (1,303 )     (1,147 )
 
           
Store contribution
  $ 63,167     $ 52,709  
 
           
 
               
Total revenues
  $ 243,775     $ 202,233  
Franchising and licensing revenues
    (1,534 )     (600 )
Revenues from non-store activities (4)
    (7,873 )     (5,093 )
 
           
Store location net retail sales
  $ 234,368     $ 196,540  
 
           
Store contribution as a percentage of store location net retail sales
    27.0 %     26.8 %
 
           
Total net income as a percentage of total revenues
    6.9 %     6.8 %
 
           
 
(1)   Store depreciation and amortization includes depreciation and amortization of all capitalized assets in store locations, including leasehold improvements, furniture and fixtures, and computer hardware and software.
 
(2)   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 and intellectual property. General and administrative expenses also include a central office marketing department, primarily payroll and related benefits expense, but exclude advertising expenses, such as direct mail catalogs and television advertising, which are included in store contribution.
 
(3)   Franchising and licensing contribution includes franchising and licensing revenues and all expenses attributable to the franchising and licensing segments other than 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 licensing is included in the interest expense (income) caption.
 
(4)   Non-store activities include our webstore, seasonal and event-based locations, and our New York City flagship store café.
Seasonality and Quarterly Results
     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: (1) the timing of our new store openings and related expenses; (2) the profitability of our stores; (3) increases or decreases in our comparable store sales; (4) the timing and frequency of our marketing initiatives; (5) changes in general economic conditions and consumer spending patterns; (6) changes in consumer preferences; (7) the effectiveness of our inventory management; (8) the actions of our competitors or mall anchors and co-tenants; (9) seasonal shopping patterns and holiday and vacation schedules; (10) the timing and frequency of national media appearances and other public relations events; and (11) weather conditions.
     The timing of new store openings may result in fluctuations in quarterly results as a result of the revenues and expenses associated with each new store location. We typically incur most preopening costs for a new store in the three months immediately preceding the store’s opening. We expect our growth,

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operating results and profitability to depend in some degree on our ability to increase our number of stores.
     Historically, for stores open more than twelve months, seasonality has not been a significant factor in our results of operations, although we cannot assure you that this will continue to be the case. In addition, 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.
Liquidity and Capital Resources
     Our cash requirements are primarily for the opening of new stores, information systems and working capital. Historically, we have met these requirements through capital generated from the sale and issuance of our securities to private investors, cash flow provided by operations and our revolving line of credit. From our inception to December 2001, we raised at various times a total of $44.9 million in capital from several private investors. In the fourth quarter of fiscal 2004, we raised $25.7 million from the initial public offering of our common stock.
     Operating Activities. Cash flows provided by operating activities were $5.1 million for the thirty-nine weeks ended October 1, 2005 as compared with $17.4 million for the thirty-nine weeks ended October 2, 2004, or a decrease of $12.3 million. This decrease over the year ago period was primarily due to changes in assets and liabilities, excluding cash, which used cash of $28.1 million for the thirty-nine weeks ended October 1, 2005 as compared to using cash of $7.9 million for the thirty-nine weeks ended October 2, 2004, an increase in the use of cash of $20.2 million. The variances in changes in assets and liabilities from the prior year were primarily due to decreases in accounts payable and accrued expenses of $18.3 million in the thirty-nine weeks ended October 1, 2005 versus increases in the same accounts of $0.9 million in the thirty-nine weeks ended October 2, 2004. This change in accounts payable and accrued expenses was the result of paying accrued bonuses of approximately $5.4 million in the thirty-nine weeks ended October 1, 2005 versus paying accrued bonuses of approximately $0.4 million in the same period a year ago as well as increased payments for federal income taxes and fluctuations in the timing of inventory receipts and payments. These decreases in cash flows provided by operating activities were offset by increases over the year ago period in net income, adjusted for the impact of depreciation and amortization, of $5.0 million. The change in deferred taxes for the thirty-nine weeks ended October 1, 2005 provided $0.6 million in cash, and the change in deferred taxes for the thirty-nine weeks ended October 2, 2004 used cash of $0.5 million. Tax benefits from the exercise of non-qualified stock options provided cash of $2.4 million in the thirty-nine weeks ended October 1, 2005 and $0.4 million in the thirty-nine weeks ended October 2, 2004.
     Investing Activities. Cash flows used in investing activities were $26.0 million for the thirty-nine weeks ended October 1, 2005 as compared to $12.2 million for the thirty-nine weeks ended October 2, 2004. Cash used in investing activities relates primarily to 23 new stores opened in the thirty-nine weeks ended October 1, 2005 and 15 opened in the thirty-nine weeks ended October 2, 2004, along with progress payments on stores scheduled to open throughout fiscal 2005. The higher cost per new store in fiscal 2005 is due to the opening of our flagship store in New York City during the thirty-nine weeks ended October 1, 2005. Our flagship store is significantly larger in both size and capital invested than our average store. Cash used in investing activities also included $2.5 million loaned to one of our franchisees during the thirty-nine weeks ended October 1, 2005.
     Financing Activities. Cash flows provided by financing activities were $5.2 million in the thirty-nine weeks ended October 1, 2005 which consisted primarily of proceeds from the exercise of employee stock options and the collection of a note receivable from one of our executive officers. Cash flows used in financing activities of $10.0 million for the thirty-nine weeks ended October 2, 2004 consisted entirely of the payment of a cash dividend to our stockholders. No borrowings were made under our line of credit in either the thirty-nine weeks ended October 1, 2005 or the thirty-nine weeks ended October 2, 2004.

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     Capital Resources. As of October 1, 2005, we had a cash balance of $51.6 million. We also have a $15.0 million unsecured line of credit which expires on September 30, 2007. There were no borrowings outstanding under our line of credit at any time during the thirty-nine weeks ended October 1, 2005.
     Most of our retail stores are located within shopping malls and all are operated under leases classified as operating leases. These leases 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 to fourth year of the lease, if a certain minimum sales volume is not achieved. 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.
     In fiscal 2005, we expect to spend a total of approximately $28 million to $30 million on capital expenditures, primarily for opening a total of 30 new stores, as well as for the continued installation and upgrades of central office information technology systems. In fiscal 2004, the average investment per new store, which includes leasehold improvements, fixtures, equipment and inventory, was approximately $0.6 million. Excluding our New York City flagship store, we anticipate the investment per store in fiscal 2005 will be approximately the same as fiscal 2004.
     We believe that cash generated from operations, along with our $15.0 million unsecured line of credit, will be sufficient to fund our working capital and other cash flow requirements for at least the next 18 months.
Off-Balance Sheet Arrangements
     We do not have any arrangements classified as off-balance sheet arrangements.
Inflation
     We do not believe that inflation has had a material adverse impact on our business or operating results during the periods presented. We cannot provide assurance, however, that our business will not be affected by inflation in the future.
Critical Accounting Policies
     The preparation of financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements.
     We believe application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.
     Our accounting policies and use of estimates are discussed in and should be read in conjunction with the annual consolidated financial statements and notes included in our annual report on Form 10-K, as filed with the Securities and Exchange Commission on March 29, 2005, which includes audited consolidated financial statements for our 2004, 2003 and 2002 fiscal years. We have identified certain critical accounting policies which are described below.

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Inventory
     Inventory is stated at the lower of cost or market, with cost determined on an average cost basis. Historically, we have not conducted sales whereby we offer significant discounts or markdowns, nor have we experienced significant occurrences of obsolete or slow moving inventory. However, future changes in circumstances, such as changes in guest merchandise preference, could cause reclassification of inventory as obsolete or slow-moving inventory. The effect of this reclassification would be the recording of a reduction in the value of inventory to realizable values.
     Throughout the year we record an estimated cost of shortage based on past historical results. Periodic physical inventories are taken and any difference between the actual physical count of merchandise and the recorded amount in our records are adjusted and recorded as shortage. Historically, the timing of the physical inventory has been near the end of the fiscal year so that no material amount of shortage was required to be estimated on activity between the date of the physical count and year-end. However, future physical counts of merchandise may not be at times at or near the end of a fiscal quarter or fiscal year-end, and our estimate of shortage for the intervening period may be material based on the amount of time between the date of the physical inventory and the date of the fiscal quarter or year-end.
Long-Lived Assets
     If facts and circumstances indicate that a long-lived asset, including property and equipment, may be impaired, the carrying value is reviewed. If this review indicates that the carrying value of the asset will not be recovered as determined based on projected undiscounted cash flows related to the asset over its remaining life, the carrying value of the asset is reduced to its estimated fair value.
Revenue Recognition
     Revenues from retail sales, net of discounts and excluding sales tax, are recognized at the time of sale. Guest returns have not been significant. Revenues from gift certificates are recognized at the time of redemption. Unredeemed gift certificates are reflected in other current liabilities on the consolidated balance sheets.
     We have a frequent shopper program whereby guests who purchase $100 of merchandise receive $10 off a future purchase. An estimate, based on historical redemption rates, of the amount of revenue to be deferred related to this program is recorded at the time of each purchase as a reduction of net retail sales. The deferred revenue obligation is reduced, and a corresponding amount is recognized in net retail sales, in the amount of and at the time of redemption of the $10 discount.
     We evaluate the ultimate redemption rate under this program through the use of frequent shopper cards which have an expiration date after which the frequent purchase discount would not have to be honored. The initial card had no expiration date but has not been provided to our guests since May 2002. Beginning in June 2002, cards were issued that had an expiration date of December 31, 2003. In each subsequent year, new cards have been issued in the June to August time frame with expiration dates on December 31 of the year following issuance. We track redemptions of these various cards and use actual redemption rates by card series and historical results to estimate how much revenue to defer. We review these redemption rates and assess the adequacy of the deferred revenue account at the end of each fiscal quarter. Due to the estimates involved in these assessments, adjustments to the deferral rate are generally made no more often than bi-annually in order to allow time for more definite trends to emerge. Based on this assessment at the end of fiscal 2003, the deferred revenue account was adjusted downward by $1.1 million with a corresponding increase to net retail sales. Additionally, the amount of revenue being deferred beginning in fiscal 2004 was decreased by 0.2%, and by another 0.5% beginning with the third quarter of fiscal 2004, to give effect to the change in redemption experience. The changes made to the deferral rate in 2004 were prospective in nature with no impact on previously reported results of

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operations. Beginning with the second quarter of fiscal 2005, the amount of revenue being deferred was reduced by 0.1% on a prospective basis from its then current level due to further changes in the Company’s redemption experience. Also during the second quarter of fiscal 2005, the balance in the deferred revenue account was adjusted downward by $78,000 with a corresponding increase to net retail sales. A 0.1% adjustment of the ultimate redemption rate at the end of fiscal 2004 for the current cards expiring on December 31, 2004 and December 31, 2005 would have an approximate impact of $0.5 million on the deferred revenue balance and net sales.
Income Taxes
     We provide for income taxes based on our estimate of federal and state income tax liabilities. Our estimates include, but are not limited to, effective state and local income tax rates, allowable tax credits and estimates related to depreciation expense allowable for tax purposes. We usually file our income tax returns several months after our fiscal year-end. We file our tax returns with the advice and consultations of tax consultants. All tax returns are subject to audit by federal and state governments, usually years after the returns are filed, and could be subject to differing interpretation of the tax laws.
     Deferred tax accounting requires that we evaluate net deferred tax assets to determine if these assets will more likely than not be realized in the foreseeable future. This test requires projection of our taxable income into future years to determine if there will be taxable income sufficient to realize the tax assets (future tax deductions). The preparation of the projections requires considerable judgment and is subject to change to reflect future events and changes in the tax laws.
Leases
     We lease all of our store locations and our corporate headquarters. We account for our leases under the provisions of FASB Statement No. 13, Accounting for Leases (SFAS 13) and subsequent amendments, which require that our leases be evaluated and classified as operating or capital leases for financial reporting purposes. All of our store leases are classified as operating leases pursuant to the requirements of SFAS 13. We disburse cash for leasehold improvements and furniture fixtures and equipment to build out and equip our leased premises. We may also expend cash for permanent improvements that we make to leased premises that generally are reimbursed to us by our landlords as construction allowances (also known as tenant improvement allowances) pursuant to agreed-upon terms in our leases. Landlord allowances can take the form of up-front cash, full or partial credits against minimum or percentage rents otherwise payable by us, or a combination thereof. Under the provisions of FASB Technical Bulletin No. 88-1, “Issues Relating to Accounting for Leases,” we account for these landlord allowances as lease incentives resulting in a deferred credit to be recognized over the term of the lease as a reduction of rent expense.
Recent Accounting Pronouncements
     In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which replaces SFAS No. 123, Accounting for Stock-Based Compensation, (SFAS 123) and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). SFAS 123R eliminates the intrinsic value method under APB 25 as an alternative method of accounting for stock-based awards. SFAS 123R also revises the fair value-based method of accounting for share-based payment liabilities, forfeitures and modifications of stock-based awards and clarifies SFAS 123’s guidance in several areas, including measuring fair value, classifying an award as equity or as a liability and attributing compensation cost to reporting periods. In addition, SFAS 123R amends SFAS No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid, which is included within operating cash flows. SFAS 123R, as amended by a ruling issued by the Securities and Exchange Commission on April 14, 2005, requires all share-based payments to employees, including grants of employee stock options and stock

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purchases under certain employee stock purchase plans, to be recognized in the financial statements based on their fair values beginning with the first annual reporting period that begins after June 15, 2005, with early adoption encouraged. We are required to adopt SFAS 123R for our fiscal year beginning January 1, 2006 using a modified version of prospective application or may elect to apply a modified version of retrospective application. Both transition options require that compensation expense be recorded for all unvested share-based payment awards at the beginning of the first quarter of adoption of SFAS 123R. Under the retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented as if SFAS 123 had been applied in those periods. There are no prior period restatements under the prospective method. We currently plan to adopt SFAS 123R in the first quarter of fiscal 2006, beginning January 1, 2006. We have not yet determined the method of adoption to be applied, or the impact of the adoption of this standard on our consolidated financial statements.
     In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements (SFAS 154). SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. SFAS 154 also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The provisions of this Statement are effective for accounting changes and corrections of errors made in fiscal periods beginning after December 15, 2005. The adoption of the provisions of SFAS 154 is not expected to have a material impact on our financial position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     Our market risks relate primarily to changes in interest rates. We bear this risk in two specific ways. First, our revolving credit facility carries a variable interest rate that is tied to market indices and, therefore, our results of operations and our cash flows could have been impacted by changes in interest rates. We had no borrowings outstanding under our revolving credit facility during the thirty-nine weeks ended October 1, 2005. Accordingly, a 100 basis point change in interest rates would result in no material change to our recorded interest expense. The second component of interest rate risk involves the short term investment of excess cash in short term, investment grade interest-bearing securities. These investments are considered to be cash equivalents and are shown that way on our balance sheet. If there are changes in interest rates, those changes would affect the investment income we earn on these investments and, therefore, impact our cash flows and results of operations.
ITEM 4. CONTROLS AND PROCEDURES
     Disclosure Controls and Procedures: The Company’s management, with the participation of the Company’s Chief Executive Bear and Chief Financial Bear, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based on such evaluation, the Company’s Chief Executive Bear and Chief Financial Bear have concluded that, as of the end of such period, the Company’s disclosure controls and procedures provided reasonable assurance that the disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
     Changes in Internal Control Over Financial Reporting: The Company’s management, with the participation of the Company’s Chief Executive Bear and Chief Financial Bear, also conducted an evaluation of the Company’s internal control over financial reporting to determine whether any changes

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occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, there has been no such change during the period covered by this report.
     It should be noted the Company’s management, including the Chief Executive Bear and the Chief Financial Bear, do not expect that the Company’s disclosure controls and procedures or internal controls will prevent all error and all fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
     At the end of fiscal 2005, Section 404 of the Sarbanes-Oxley Act will require the Company’s management to provide an assessment of the design and effectiveness of the Company’s internal control over financial reporting. Additionally, the Company’s independent registered public accounting firm will be required to audit management’s assessment. The Company is in the process of performing the documentation, evaluation and testing of its controls required for management to make this assessment. The Company has not yet completed its assessment and management may identify deficiencies that will need to be addressed and remediated.

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PART II – OTHER INFORMATION
ITEM 6. EXHIBITS
The following is a list of exhibits filed as a part of the quarterly report on Form 10-Q:
     
Exhibit    
No.   Description
3.1
  Third Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q/A (File No. 001-32320)) filed with the Securities and Exchange Commission on December 13, 2004
 
   
3.2
  Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.4 to the Company’s Registration Statement on Form S-1 (File No. 333-118142)) filed with the Securities and Exchange Commission on October 12, 2004
 
   
31.1
  Rule 13a-14(a)/15d-14(a) certification (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by the Chief Executive Bear)
 
   
31.2
  Rule 13a-14(a)/15d-14(a) certification (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by the Chief Financial Bear)
 
   
32.1
  Section 1350 Certification (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by the Chief Executive Bear)
 
   
32.2
  Section 1350 Certification (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by the Chief Financial Bear)

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BUILD-A-BEAR WORKSHOP, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 14, 2005
         
  BUILD-A-BEAR WORKSHOP, INC.
(Registrant)
 
 
  By:   /s/ Maxine Clark    
    Maxine Clark   
    Chairman of the Board and Chief Executive Bear   
 
         
     
  By:   /s/ Tina Klocke    
    Tina Klocke   
    Chief Financial Bear, Treasurer and Secretary   
 

31

exv31w1
 

Exhibit 31.1
Certification of Principal Executive Officer
I, Maxine Clark, Chairman of the Board and Chief Executive Bear of Build-A-Bear Workshop, Inc., certify that:
  1.   I have reviewed this quarterly report on Form 10-Q of Build-A-Bear Workshop, Inc.;
 
  2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
  3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
  4.   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) [Reserved]
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
  5.   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
     
  /s/ Maxine Clark    
  Maxine Clark   
  Chairman of the Board and Chief Executive Bear Build-A-Bear Workshop, Inc. (Principal Executive Officer)   
 
November 14, 2005

 

exv31w2
 

Exhibit 31.2
Certification of Principal Financial Officer
I, Tina Klocke, Chief Financial Bear, Treasurer and Secretary of Build-A-Bear Workshop, Inc., certify that:
  1.   I have reviewed this quarterly report on Form 10-Q of Build-A-Bear Workshop, Inc.;
 
  2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
  3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
  4.   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) [Reserved]
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
  5.   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
     
  /s/ Tina Klocke    
  Tina Klocke   
  Chief Financial Bear, Treasurer and Secretary Build-A-Bear Workshop, Inc. (Principal Financial Officer)   
 
November 14, 2005

 

exv32w1
 

Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
     In connection with the quarterly report of Build-A-Bear Workshop, Inc. (the “Company”) on Form 10-Q for the period ended October 1, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Maxine Clark, Chairman of the Board and Chief Executive Bear of the Company, certify, to the best of my knowledge, pursuant to Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
     (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
     (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
         
     
  /s/ Maxine Clark    
  Maxine Clark   
  Chairman of the Board and Chief Executive Bear Build-A-Bear Workshop, Inc.   
 
Date: November 14, 2005

 

exv32w2
 

Exhibit 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
     In connection with the quarterly report of Build-A-Bear Workshop, Inc. (the “Company”) on Form 10-Q for the period ended October 1, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Tina Klocke, Chief Financial Bear, Treasurer and Secretary of the Company, certify, to the best of my knowledge, pursuant to Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
     (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
     (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
         
     
  /s/ Tina Klocke    
  Tina Klocke.   
  Chief Financial Bear, Treasurer and Secretary Build-A-Bear Workshop, Inc.   
 
Date: November 14, 2005