Build-A-Bear Workshop, Inc. — Q3 2016 Form 10-Q
Reporting period: Thirteen and thirty-nine weeks ended October 1, 2016. The company operates company-owned stores and e-commerce, international franchises, and commercial licensing and wholesale businesses. Results are seasonal, with sales typically highest in the fourth quarter.
Financial results
| Metric | Q3 2016 | Q3 2015 | 39 weeks 2016 | 39 weeks 2015 |
|---|---|---|---|---|
| Total revenue | $83.7 million | $85.6 million | $253.9 million | $260.0 million |
| Net income | $1.8 million | $1.1 million | $1.1 million | $7.3 million |
| Diluted EPS | $0.11 | $0.06 | $0.07 | $0.42 |
| Retail gross margin | 43.3% | 45.3% | 44.9% | 45.3% |
| Income before tax | $2.8 million | $1.4 million | $1.8 million | $8.0 million |
Q3 net retail sales fell 2.9% to $81.9 million; commercial revenue rose to $1.3 million, while franchise fees were $0.6 million. Nine-month retail sales declined 2.5% to $249.9 million. Consolidated comparable sales decreased 2.2% in Q3 and 2.6% year to date, versus growth of 2.2% and 4.2% in the respective 2015 periods. E-commerce comparables increased 25.2% in Q3 and 11.9% year to date.
Q3 SG&A decreased 9.3% to $33.4 million, partly reflecting marketing spend shifted to the first half, cost discipline, lower performance compensation, and currency effects; expenses for the strategic review partly offset savings. Nine-month SG&A increased 0.4% to $110.1 million. Store preopening expense rose to $3.0 million year to date from $1.1 million, largely due to more new and remodeled stores. The year-to-date effective tax rate was 42.0%, versus 9.0% in 2015, when a partial release of the domestic deferred-tax valuation allowance reduced the rate.
Cash flow, balance sheet and liquidity
- For the first 39 weeks, operating cash flow was negative $14.3 million, compared with negative $2.7 million a year earlier. The filing attributes the deterioration primarily to lower store contribution and timing of inventory receipts and payments.
- Investing cash outflow was $16.8 million, including $17.6 million of property and equipment purchases. Financing cash outflow was $2.0 million, including $1.5 million of share repurchases.
- Cash declined to $11.8 million at October 1 from $45.2 million at January 2, 2016. Inventory was $59.4 million; current assets were $93.7 million and current liabilities $67.3 million. Stockholders’ equity was $98.7 million.
- No line-of-credit borrowings were outstanding at October 1; the $35 million facility was fully available, and the company reported compliance with its covenants. The secured facility bears interest at LIBOR plus 1.8% and expires December 31, 2017. On November 2, the company drew $3.9 million, expected to be repaid before year-end.
- Management expected fiscal 2016 capital expenditures of approximately $30 million, primarily for stores and IT infrastructure; $18.2 million had been spent through October 1. Management said operating cash flow and credit-agreement borrowings should fund near-term requirements.
Changes, outlook and risks
- Q3 pretax income improved despite lower sales, supported by lower SG&A. Retail gross margin contracted 200 basis points in Q3; management cited weaker merchandise margin from foreign exchange, promotions and merchandise-supply timing, plus occupancy-cost deleverage. Year-to-date retail gross margin was down 40 basis points.
- Management attributed comparable-sales weakness mainly to the prior-year Minions collection’s strong performance. Discovery-format stores performed positively against heritage stores; the company had 43 such stores at October 1 and expected approximately 55 by year-end. It expected about 345 company-owned stores by year-end, including planned openings and closures.
- The company’s MORE strategy includes store refreshes and alternative formats, international expansion, licensed and proprietary products, and e-commerce. It highlighted fourth-quarter Trolls and Star Wars launches and continued development of digital-supported proprietary brands. These are plans, not assurances of results.
- The board’s strategic-alternatives review, announced in May 2016, had no set timetable and might not result in a transaction or business-plan change. Review-related costs affected SG&A.
- Key risks include discretionary consumer demand, mall traffic, comparable-sales execution, foreign exchange and international sourcing, lease and store economics, inventory flow, competition, digital and customer-data risks, and seasonal volatility. The company disclosed no material changes to its other previously reported risk factors.
- A disputed $2.6 million UK customs-duty payment remains included in receivables; the company has recorded a provision for its estimated probable loss, but the provision amount is not stated here. The company disputes the assessment and said it did not expect a material adverse effect.
- Foreign-currency translation reduced comprehensive income by $2.0 million year to date. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether fourth-quarter holiday sales, new licensed products and Discovery stores improve comparable sales and profitability after year-to-date declines.
- Cash use, inventory levels, and whether the November credit-line draw is repaid as expected; also monitor facility covenants and its 2017 expiration.
- Progress and potential costs or outcomes of the strategic-alternatives review.
- Actual full-year capital spending and store openings, remodels and closures versus management’s expectations.
- Resolution and provision adequacy for the UK customs dispute, and the effect of currency movements and the higher effective tax rate.