BBW 10-Q Quarter ended May 5, 2018

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended May 5 , 201 8

OR

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)

(314) 423-8000

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No   ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No   ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 14(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No   ☒

As of June 7, 2018, there were 15,022,680 issued and outstanding shares of the registrant’s common stock.

BUILD-A-BEAR WORKSHOP, INC.

INDEX TO FORM 10-Q

BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES

(Dollars in thousands, except share and per share data)

BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES

AND COMPREHENSIVE INCOME

See accompanying notes to condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

Notes to Condensed Consolidated Financial Statements

Cautionary Notice Regarding Forward-Looking Statements

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties, and we undertake no obligation to update these statements except as required by the federal securities laws. 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 the Company’s annual report on Form 10-K for the year ended December 30, 2017, as filed with the SEC, and include the following:

Overview

We are the only global company that offers an interactive “make your own stuffed animal” retail entertainment experience under the Build-A-Bear Workshop brand, in which guests participate in the stuffing, fluffing, dressing, accessorizing and naming of their own teddy bears and other stuffed animals. As of May 5, 2018, we operated 352 stores globally and had 96 franchised stores operating internationally under the Build-A-Bear Workshop brand. In addition to our stores, we sell products on our company-owned ecommerce sites, third party ecommerce marketplaces, franchisee sites and through third party retail locations under wholesale agreements.

Our company has been executing a multi-year turnaround plan that was initiated in 2013 to improve both sales and profitability with the goal of achieving sustained profitability. In the first quarter of 2018, we continue to evolve and execute our strategic plan with key initiatives in the areas outlined below, which are intended to drive long-term shareholder value:

• Development of our experiential retail model to diversify and expand the impact and reach of our brand globally

• Simultaneously, we expect to also leverage the power of our brand and intellectual properties to build margin accretive revenue streams

• Improve long-term profitability through the execution of these strategies as well as disciplined expense management and on-going efforts in process and systems upgrades.

We operate in three segments that share the same infrastructure, including management, systems, merchandising and marketing, and generate revenues as follows:

Selected financial data attributable to each segment for the thirteen week periods ended May 5, 2018 and April 29, 2017 and the five week period ended February 3, 2018 are set forth in the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Strategy

We expect to improve consolidated sales and profit through the following key initiatives:

Retail Stores :

The table below sets forth the number of Build-A-Bear Workshop corporately-managed stores in North America, Europe and Asia for the periods presented:

During 2018, we expect to continue to make improvements to an aged store fleet by leveraging the new Discovery format in conjunction with select natural lease events. For the thirteen weeks ended May 5, 2018, 32% of our store base was in an updated Discovery design.  We also expect to close certain stores in accordance with natural lease events as an ongoing part of our real estate management and day-to-day operational plans. Current plans include expansion into more non-traditional locations, made possible in part by concourse shops. Concourse shops are stand-alone retail units that occupy approximately 200 square feet designed to be operated in open, concourse areas of malls or other covered pedestrian areas. We currently expect to have 40 to 45 concourse shops open by the end of fiscal 2018.

International Franchise Revenue :

Our first franchisee location was opened in November 2003. All franchised stores have similar signage, store layout, merchandise characteristics and guest experience as our corporately-managed stores. As of May 5, 2018, we had nine master franchise agreements, which typically grant franchise rights for a particular country or group of countries, covering an aggregate of 17 countries.

The number of franchised stores opened and closed for the periods presented below are summarized as follows:

In the ordinary course of business, we anticipate signing additional master franchise agreements and terminating other such agreements. We believe there is a market potential for approximately 300 international stores outside of the United States, Canada, the United Kingdom and Ireland. We continue to expect franchisees to leverage the new formats that have been developed for our corporately-managed operations and sourcing changes that have significantly reduced the capital and expenses required to open stores. We expect to continue to develop market expansion through both new and existing franchisees in 2018 and beyond. For example, our new China franchise partner operates two locations and plans up to 10 more locations in fiscal year 2018.

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 will not total due to cost of merchandise sold being expressed as a percentage of net retail sales, commercial revenue, international franchising as well as immaterial rounding:

BUILD-A-BEAR WORKSHOP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

Thirteen weeks ended May 5, 2018 compared to thirteen weeks ended April 29, 2017

Total revenues . Net retail sales for the thirteen weeks ended May 5, 2018 were $81.4 million, compared to $88.7 million for the thirteen weeks ended April 29, 2017, a decrease of $7.3 million, or 8.2%. The components of this decrease are as follows:

The revenue decrease included the $0.6 million impact from adoption of the new revenue recognition standard (See Note 1 — Basis of Presentation and Note 2 — Revenue for additional information). In addition, our most productive store closed in January 2018. Toys "R" Us began to conduct liquidation proceedings in the thirteen weeks ended May 5, 2018 which we believed negatively impacted sales at our stores, particularly those in closer proximity to a liquidating Toys "R" Us location. We realized increases in key operational metrics including conversion, dollars-per-transaction and units per transaction in the quarter.

Commercial revenue was $1.0 million for the thirteen weeks ended May 5, 2018 compared to $2.0 million for the thirteen weeks ended April 29, 2017. The $1.0 million decrease related primarily to the nature and timing of the prior year's wholesale orders.

Retail g ross margin. Retail gross margin was $36.0 million for the thirteen weeks ended May 5, 2018 compared to $42.3 million for the thirteen weeks ended April 29, 2017, a decrease of $6.2 million, or 14.8%. As a percentage of net retail sales, retail gross margin was 44.3% for the thirteen weeks ended May 5, 2018 compared to 47.7% for the thirteen weeks ended April 29, 2017. This 340 basis-point gross margin decrease was largely driven by deleverage of fixed occupancy costs and partially offset by a 30 basis-point expansion in merchandise margin.

Selling, general and administrative. Selling, general and administrative expenses ("SGA") were $36.3 million for the thirteen weeks ended May 5, 2018, compared to $39.2 million for the thirteen weeks ended April 29, 2017, a decrease of $2.9 million, or 7.4%. The decrease in SGA was primarily due to lower performance-based compensation expense, reduced advertising spend and a reduction in store preopening expenses. As a percentage of total revenues, SGA increased to 43.7% for the thirteen weeks ended May 5, 2018, compared to 43.0% for the thirteen weeks ended April 29, 2017, an increase of 70 basis-points.

Interest expense (income), net. Interest expense (income) was less than $0.1 million for both the thirteen weeks ended May 5, 2018 and April 29, 2017, respectively.

Provision for income taxes . Income tax expense was $0.3 million with a tax rate of 45.2% for the thirteen weeks ended May 5, 2018 compared to $1.8 million with a tax rate of 40.6% for the thirteen weeks ended April 29, 2017. The fiscal 2018 effective tax rate differed from the statutory rate of 21% primarily due to a $0.1 million negative tax impact related to vested equity awards. The fiscal 2017 effective tax rate differed from the statutory rate of 34% primarily due to a $0.2 million negative tax impact related to vested equity awards. The statutory rate decreased to 21% as a result of the enactment of the Tax Cut and Jobs Act on December 22, 2017.

Five week s ended February 3, 2018 compared to the four weeks ended January 28, 2017

Total revenues were $30.2 million for the five weeks ended February 3, 2018, as compared to $24.1 million for the four weeks ended January 28, 2017. The increase of $6.1 million, or 25.3%, was primarily driven by one extra week of revenue. Consolidated gross profit was $13.9 million for the five weeks ended February 3, 2018, as compared to $10.0 million for the four weeks ended January 28, 2017, an increase of $3.9 million, or 38.4%. Retail gross margin was $13.5 million for the five weeks ended February 3, 2018 compared to $9.9 million for the four weeks ended January 28, 2017, an increase of $3.6 million, or 37.0%. As a percentage of net retail sales, retail gross margin was 45.7% for the five weeks ended February 3, 2018 compared to 41.2% for the four weeks ended January 28, 2017. This 450 basis-point gross margin increase was primarily driven by the impact of one extra week of revenue on fixed occupancy costs and a 160 basis-point improvement in merchandise margin. Merchandise margin benefited from lower discounts, selective price increases and sourcing efficiencies.

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, but not limited to: (1) changes in general economic conditions and consumer spending patterns; (2) increases or decreases in our existing store and ecommerce sales; (3) fluctuations in the profitability of our stores; (4) changes in foreign currency exchange rates; (5) the timing and frequency of the sales of licensed products tied to major theatrical releases, our marketing initiatives, including national media and other public relations events; (6) the timing of our store openings and closings and related expenses; (7) changes in consumer preferences; (8) the effectiveness of our inventory management; (9) the actions of our competitors or mall anchors and co-tenants; (10) seasonal shopping patterns and holiday and vacation schedules; and (11) weather conditions.

The timing of store closures, remodels and openings may result in fluctuations in quarterly results based on the revenues and expenses associated with each store location. Expenses related to store closings are typically incurred in stages: when the decision is made to close the store typically associated with a lease event such as an expiration or lease triggered clause; when the closure is communicated to store associates; and at the time of closure. We typically incur most preopening costs for a new store in the three months immediately preceding the store’s opening.

As a retailer that has toy products as part of our revenue model, our sales are highest in our fourth quarter, followed by the first quarter. The timing of holidays and school vacations can impact our quarterly results. We cannot ensure 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. For example, the 2014 fiscal fourth quarter had 14 weeks and the transition period ended February 3, 2018 had five weeks.

Liquidity and Capital Resources

Our cash requirements are primarily for the relocation and remodeling of existing stores in our new design, opening of new stores, information systems and working capital. Over the past several years, we have met these requirements through capital generated from cash flow provided by operations. We have access to additional cash through our revolving line of credit that has been in place since 2000.

Operating Activities. Cash provided by operating activities was $1.4 million for the thirteen weeks ended May 5, 2018, compared to $6.8 million for the thirteen weeks ended April 29, 2017, a decrease of $5.4 million. Generally, changes in cash from operating activities are driven by changes in net income and changes in operating assets and liabilities. This decrease in cash from operating activities over the year ago period was primarily due to the timing of inventory and payroll payments.

Investing Activities. Cash used in investing activities was $3.0 million for the thirteen weeks ended May 5, 2018, as compared to $3.8 million for the thirteen weeks ended April 29, 2017, a decrease of $0.8 million. Cash used in investing activities during the thirteen weeks ended May 5, 2018 primarily related to store construction and upgrades and purchases of information technology infrastructure and the benefit of an insurance claim. Cash used in investing activities during the thirteen weeks ended April 29, 2017 primarily related to store construction and upgrades and purchases of information technology infrastructure.

Financing Activities. Financing activities used cash of $1.2 million for the thirteen weeks ended May 5, 2018, as purchases of our common stock used cash of $0.7 million and exercises of employee stock options, net of shares used for withholding tax payments used $0.4 million. In the thirteen weeks ended April 29, 2017, financing activities used cash of $0.4 million, as exercises of employee stock options, net of shares used for withholding tax payments used $0.4 million. No borrowings were made under our line of credit in either the thirteen weeks ended May 5, 2018 or April 29, 2017.

Five weeks ended February 3, 2018: Cash used by operating activities was $2.9 million for the five weeks ended February 3, 2018. Generally, changes in cash from operating activities are driven by changes in net income and changes in operating assets and liabilities. This decrease in cash from operating activities over the year ago period was primarily due to the timing of inventory and payroll payments. Cash used in investing activities was $1.3 million for the five weeks ended February 3, 2018 and primarily related to store construction and upgrades and purchases of information technology infrastructure. Financing activities used cash of $4.7 million for the five weeks ended February 3, 2018, as purchases of our common stock used cash of $4.7 million.

Capital Resources. As of May 5, 2018, we had a consolidated cash balance of $18.9 million and more than half of this balance was domiciled outside of the United States. We also have a line of credit, which we can use to finance capital expenditures and working capital needs throughout the year. On May 4, 2017, we amended the credit agreement extending the expiration date to December 31, 2018 and increasing the amount of permitted lease and rental payments for personal property from $100,000 to $1.0 million. The bank line provides availability of $35.0 million. Borrowings under the credit agreement are secured by our assets and a pledge of 66% of our ownership interest in certain of our foreign subsidiaries. The credit agreement contains various restrictions on indebtedness, liens, guarantees, redemptions, mergers, acquisitions or sale of assets, loans, transactions with affiliates and investments. It also prohibits us from declaring dividends without the bank’s prior consent, unless such payment of dividends would not violate any terms of the credit agreement. We are also prohibited from repurchasing shares of our common stock unless such repurchase of shares would not violate any terms of the credit agreement; we may not use the proceeds of the line of credit to repurchase shares. Borrowings bear interest at LIBOR plus 1.8%. Financial covenants include maintaining a minimum tangible net worth, maintaining a minimum fixed charge coverage ratio (as defined in the credit agreement) and not exceeding a maximum funded debt to earnings before interest, depreciation and amortization ratio. As of May 5, 2018: (i) we were in compliance with all covenants; (ii) there were no borrowings under our line of credit; and (iii) there was approximately $35.0 million available for borrowing under the line of credit. This balance is expected to fluctuate throughout the remainder of the year and is expected to be repaid before the end of the fiscal year.

In fiscal 2018, we expect to spend a total of $15 to $18 million on capital expenditures. Capital spending through the thirteen weeks ended May 5, 2018 totaled $3.0 million, on track with our full year plans. Capital spending in fiscal 2018 is expected to primarily support our store activity, including both remodels and new stores and investments in information technology infrastructure.

We believe that cash generated from operations and borrowings under our credit agreement will be sufficient to fund our working capital and other cash flow requirements for the near future. Our credit agreement expires on December 31, 2018.

In August 2017, our Board of Directors authorized a share repurchase program of up to $20 million. This program authorized us to purchase up to $20 million of our common stock in the open market (including through 10b5-1 trading plans), or through privately negotiated transactions. The primary source of funding for the program is expected to be cash on hand. The timing and amount of share repurchases, if any, will depend on price, market conditions, applicable regulatory requirements, and other factors. The program authorizes us to repurchase shares through September 30, 2020, and does not require us to repurchase any specific number of shares, and may be modified, suspended or terminated at any time without prior notice. Shares repurchased under the program will be subsequently retired. Under this program through May 5, 2018, we repurchased approximately 1.1 million shares at an average price of $8.86 per share for an aggregate amount of $10.0 million.

Off-Balance Sheet Arrangements

None.

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 Estimates

The preparation of financial statements in conformity with U.S. GAAP requires the appropriate application of certain accounting policies, 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, including those related to inventory, long-lived assets, revenue recognition and income taxes, are reevaluated on an ongoing basis, 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 critical accounting policies and estimates are discussed in and should be read in conjunction with our Annual Report on Form 10-K, as filed with the Securities and Exchange Commission (SEC) on March 15, 2018, which includes audited consolidated financial statements for our 2017, 2016 and 2015 fiscal years. There have been no material changes to the critical accounting estimates disclosed in the 2017 Form 10-K.

Recent Accounting Pronouncements

See Note 1 – Recently Issued Accounting Pronouncements of the Condensed Consolidated Financial Statements

There have been no material changes to our Quantitative and Qualitative Disclosures About Market Risk as disclosed in our Annual Report on Form 10-K for the year ended December 30, 2017 as filed with the SEC on March 15, 2018.

Our management, with the participation of our President and Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our 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. Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to management, including our certifying officers, as appropriate to allow timely decisions regarding required disclosure. Based on the foregoing evaluation, our management, including the President and Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of May 5, 2018, the end of the period covered by this Quarterly Report.

It should be noted that our management, including the President and Chief Executive Officer and the Chief Financial Officer, does not expect that our 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.

Changes in Internal Control Over Financial Reporting. The Company’s management, with the participation of the Company’s President and Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) to determine whether any changes 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.

During the first quarter of fiscal 2018, we began the implementation of a new enterprise resource planning (ERP) system by transitioning our corporate operations, including corporate general ledger, corporate procurement and payments, and corporate cash management functions to the new ERP system.

We have modified our existing internal controls infrastructure, as well as added other processes and internal controls, to adapt to our new ERP system as well as take advantage of the increased functionality of the new system. The transition of our remaining operations to our new ERP system will occur in phases in fiscal 2018. We believe that the new ERP system and related changes to processes and the design of our internal controls will enhance our internal control over financial reporting while providing us with the ability to scale our business. We believe we have taken the necessary steps to monitor and maintain appropriate internal control over financial reporting during the first 13 weeks of fiscal 2018 and we will continue to evaluate the operating effectiveness of related key controls during subsequent periods.

With the exception of the implementation of our ERP solution, no change in our internal control over financial reporting occurred during the fiscal quarter ended May 5, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there has been no such change during the period covered by this report.

There have been no changes to our Risk Factors as disclosed in our Annual Report on Form 10-K for the year ended December 30, 2017 as filed with the Securities and Exchange Commission on March 15, 2018.

ISSUER PURCHASES OF EQUITY SECURITIES

The following is a list of exhibits filed as a part of the quarterly report on Form 10-Q:

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: June 14, 2018

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