Build-A-Bear Workshop, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016 (52 weeks), compared primarily with fiscal 2015 (52 weeks ended January 2, 2016). This is an annual filing; the fourth quarter was notably weak.
Business context and results
Build-A-Bear operates an interactive stuffed-animal retail business through company-owned stores, e-commerce, commercial sales and international franchises. At year-end it had 346 company-owned stores and 92 franchised stores. The Board began exploring strategic alternatives in May 2016; no timetable or outcome was assured.
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Total revenue | $364.2 million | $377.7 million |
| Net retail sales | $357.6 million | $372.7 million |
| Income before tax | $5.3 million | $17.9 million |
| Net income | $1.4 million | $27.3 million |
| Diluted earnings per share | $0.09 | $1.59 |
| Retail gross margin | 45.2% | 47.1% |
| Operating cash flow | $16.0 million | $32.0 million |
| Capital expenditures | $28.1 million | $24.4 million |
| Cash at year-end | $32.5 million | $45.2 million |
Material changes and financial position
- Revenue declined 3.6%; consolidated comparable sales fell 4.4% after rising 1.0% in 2015. Store comps decreased 4.9%, while e-commerce comps increased 7.2%.
- Management attributed the sales decline chiefly to a double-digit North American comparable-sales decline in Q4. Factors included weaker mall traffic, marketing and licensing shifts, unplanned promotions, fewer gift-card redemptions and missed online sales because systems could not handle increased site traffic.
- Gross margin contracted 190 basis points, primarily from fixed occupancy cost deleverage, store impairments and unfavorable UK currency effects. Store contribution margin fell to 15.9% from 18.2%.
- Net income fell sharply, partly because 2015 included a $9.4 million income-tax benefit from reducing the U.S. deferred-tax valuation allowance. FY 2016 tax expense was $3.9 million, a 74.1% effective rate, including a valuation allowance in certain foreign jurisdictions.
- Operating cash flow nearly halved, with lower store contribution and the timing of inventory receipts and payments cited as factors. Investing used $26.7 million; cash declined $12.7 million year over year.
- Working capital was $27.2 million versus $28.9 million. The company reported no year-end borrowings and $35 million available under its secured revolving facility, which expires December 31, 2017. It obtained a waiver for a 2016 personal-property lease covenant breach and was compliant with other covenants at year-end.
Outlook, risks and unusual items
- Management characterized 2017 as transitional and said it remained focused on returning to positive comparable sales and improving profitability; no specific earnings or revenue guidance was provided.
- Plans call for 20–25 new company-owned locations, including approximately 15 lower-capital concourse shops, and 5–10 closures, for 356–366 company-owned locations at year-end 2017. Franchisees were expected to open about 10 stores. Planned capital expenditures were approximately $20–$25 million.
- In 2016 the company recorded $2.3 million of fourth-quarter impairment charges on assets at 13 stores, plus $0.4 million of other store asset impairments. Its first company-owned China store also incurred an impairment on a substantial portion of its assets.
- Gift-card breakage contributed $4.5 million of revenue in 2016. The company disclosed sensitivity to estimates of gift-card breakage and loyalty-program obligations.
- Currency was material: the pound’s movement was estimated to reduce revenue by about $9.1 million and pre-tax income by about $3.1 million versus 2015. The company did not historically hedge currency risk.
- A UK customs-duty dispute remained unresolved. At year-end the gross receivable was $3.0 million, with a $2.4 million reserve and $0.6 million net receivable; the company continued to contest the assessment.
- Key business risks include mall traffic and discretionary spending, online competition and technology capacity, execution of store and e-commerce upgrades, reliance on a small number of suppliers (four represented 73% of inventory purchases), foreign exchange, and the uncertain strategic-alternatives review. Operating lease obligations totaled $220.0 million; purchase obligations totaled $36.3 million.
Important facts for investors to verify
- Whether management’s planned e-commerce-system upgrades resolve the Q4 capacity issue and support online sales growth.
- Whether comparable sales and store contribution recover, and whether the 2017 store-opening and closure plans deliver acceptable returns.
- The status and terms, if any, of the strategic-alternatives review; the filing provides no outcome or timetable.
- Renewal or replacement of the revolving credit facility before its December 2017 expiration, including covenant terms and borrowing availability.
- Resolution of the UK customs dispute and the collectability of the remaining net receivable.
- The sustainability of reported earnings after considering the $4.5 million gift-card breakage revenue and the unusually high 2016 effective tax rate.