BUILD-A-BEAR WORKSHOP INC annual report, FY2018

Business context and reporting period

Build-A-Bear Workshop, Inc. filed this Form 10-K for fiscal 2017, the 52 weeks ended December 30, 2017. The specialty retailer sells customizable plush toys through company-operated stores and e-commerce, and earns additional revenue from commercial sales/licensing and international franchising. At year-end it operated 361 company-managed stores and had 102 franchised stores.

Financial performance

Amounts below are in millions of dollars except per-share data and percentages.

Revenue fell 1.7%, while net income rose substantially from the prior year. Management attributed the earnings improvement mainly to lower SG&A, higher gift-card breakage revenue and lower store impairment charges. Retail gross margin rate improved 170 basis points. The filing reports net income, but does not present a separate operating-income figure in the provided statements.

• Consolidated comparable sales declined 6.5% (2016: down 4.4%); store comparable sales fell 7.0%, while e-commerce comparable sales grew 2.8%.
• Commercial revenue increased to $6.0 million from $4.3 million; franchise fees were $2.5 million versus $2.3 million.
• Cash and equivalents were $30.4 million at year-end, down from $32.5 million. Working capital was $40.4 million, up from $27.2 million.
• The company had no borrowings under its $35 million revolving facility, with the full amount available; it reported compliance with covenants. The facility was scheduled to expire December 31, 2018.
• Operating cash flow exceeded capital expenditures by approximately $3.3 million. Financing activities used $4.8 million, including $4.2 million cash spent on share repurchases; total fiscal-year repurchases were $4.7 million.
• Total assets were $198.0 million and stockholders’ equity was $107.3 million. No dividends were paid.

Material changes, outlook and risks

• Management linked the sales decline primarily to lower traditional mall traffic, including during December, and an unusually severe North American hurricane season. New-store contributions partly offset comparable-sales declines.
• Gift-card breakage contributed $8.3 million of 2017 net retail sales, versus $4.5 million in 2016. Breakage estimates depend on redemption patterns; a 100-basis-point change in the estimated rate would change the liability and sales by about $0.5 million.
• Fiscal 2017 tax expense was $5.9 million, including a provisional $1.4 million charge to remeasure deferred tax assets following U.S. tax-law changes. The effective tax rate was 42.7%.
• Management described 2018 as transitional, with priorities including store-portfolio changes, tourism and concourse formats, e-commerce/omnichannel upgrades, product and licensing expansion, and expense discipline. It targeted fiscal 2018 capital expenditures of approximately $15–18 million, but provided no specific revenue or earnings forecast.
• The January 2018 closure of the high-volume Downtown Disney flagship was expected to reduce revenue in the short term as the company repositioned in Los Angeles. Management said it remained focused on revenue growth and improved profitability.
• Adoption of the new revenue standard in fiscal 2018 was expected to create an approximately $12.3 million pretax opening retained-earnings adjustment, with a $3.0 million tax effect, and reduce fiscal 2018 revenue and pretax income by about $3.9 million. The company expected the new lease standard to materially increase reported assets and liabilities when adopted in fiscal 2019.
• Key risks include mall-traffic declines and changing shopping behavior, discretionary consumer demand, foreign exchange, dependence on a small group of suppliers (four vendors represented 79% of 2017 inventory purchases), store lease obligations, product safety, cybersecurity and execution of digital and real-estate initiatives.
• The company disclosed a continuing UK customs-duty dispute: a $3.7 million gross receivable was reserved by $2.9 million, leaving $0.8 million net. It said it was contesting the matter and did not expect a material adverse effect. No other pending litigation was identified as likely to have a material adverse effect.
• After year-end, the company changed its fiscal year-end to the Saturday closest to January 31 and reported additional share repurchases; it stated that approximately $10 million remained available under the repurchase program as of March 15, 2018.

Important facts for investors to verify

• Whether comparable-sales declines and mall-traffic pressure continue, especially during the holiday quarter, and whether e-commerce growth can offset store weakness.
• How much reported earnings and revenue rely on gift-card breakage estimates, and the effects of the new revenue-recognition standard.
• Renewal or replacement terms for the $35 million credit facility before its December 2018 expiration, and the company’s cash needs amid significant lease commitments.
• Execution and returns from the store-format, e-commerce and franchise initiatives, including the impact of the flagship closure.
• Resolution and collectability of the UK customs receivable, final accounting for the tax-law changes, and any additional store impairments or closure costs.

The independent auditor issued an unqualified opinion on the financial statements and internal controls; management also reported effective disclosure controls and internal control over financial reporting as of year-end.