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Build-A-Bear Workshop Inc. (NYSE:BBW)

Q4 2012 Earnings Call

February 14, 2013 9:00 am ET

Executives

Mary Lou Fiala - Chairman

Maxine Clarke – Chief Executive Officer

Tina Klocke – Chief Operations and Financial Officer

Analysts

James Fronda – Sidoti & Co.

Tom Filandro – Susquehanna Financial Group

Operator

Greetings and welcome to the Build-A-Bear Workshop Fourth Quarter Fiscal 2012 Results conference call. At this time all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Alison Malkin of ICR. Thank you, Ms. Malkin. You may begin.

Alison Malkin – ICR

Thank you, good morning. Thank you for joining us. With me today are Maxine Clarke, Chief Executive Bear; Tina Klocke, Chief Operations and Financial Bear, and Mary Lou Fiala, Chairman of the Board of Directors, who will give concluding remarks.

Before I turn the call over to management, I want to remind members of the media who may be on our call today to contact us after this conference call with your questions. We ask that you limit your questions to one question and one follow-up. This way, we can get to everyone’s questions during this one-hour call. Feel free to re-queue if you have further questions. Please note the call is being recorded and broadcast live via the Internet. The earnings release is available on the Investor Relations portion of our corporate website and a replay of both our call and webcast will be available later today on the IR site.

Before we get started, I will remind everyone that forward-looking statements are inherently subject to risks and uncertainties. Our actual results could differ materially from those currently anticipated due to a number of factors, including those set forth in the risk factors section in the annual report on Form 10-K, and we undertake no obligation to revise any forward-looking statement.

Now I would like to turn the call over to Maxine Clarke. Maxine?

Maxine Clarke

Thank you Alison and good morning everyone. Two weeks ago I announced my plan to retire as Chief Executive Bear of Build-A-Bear Workshop. With our multi-year turnaround strategies to position our company for long-term profitable growth in place and beginning to gain traction, I feel it is the right time to attract a new chief executive to take the company forward.

When I founded Build-A-Bear Workshop, my vision was to redefine retail, and I am proud that 16 years later our company has become a favorite brand of families worldwide. The Board of Directors is actively working to identify my successor. In the interim, I remain focused on Build-A-Bear Workshop and I will continue to work as a member of the Board of Directors when the transition is complete.

Turning to the fourth quarter, while the overall results were not what we wanted, the priorities we implemented combined to deliver positive comparable store sales of 1.5% in North America. We attribute this to the actions we’ve taken on the real estate side with store closures and remodels, as well as the rebalancing that we’ve made in our marketing program and product assortment. In the quarter, we added branding to our marketing television advertising in our U.S. markets. The ads began airing in late October, and attribute a significant improvement in trends, leading to positive comps in North America in November and December and for the quarter. In fact, in the U.S. where we had the benefit of the ads, comp sales were up 2.4%, an improvement of 14 points from the third quarter comp results, and this trend has continued into the first quarter. And I feel that we had the right balance in our merchandise, which featured Rudolph, Clarice, and Grinch alongside our own proprietary holiday products.

In the U.K., comparable store sales declined 11.4%, reflecting the challenging economic environment; however, we believe we can improve by adjusting our marketing and product initiatives similarly to what we’ve done in North America.

Our e-commerce sales rose 14% for the quarter and 8% for the year. The investment that we’ve made to improve the design and features of our website has translated to stronger conversion on the site.

We are in the midst of a multi-year turnaround plan. I want to emphasize that our company today has a strong base of profitable stores that we are working to make stronger. Putting that in perspective, our top 200 company-owned stores had an average 20% unit level EBITDA, and we believe by the end of 2014 our portfolio will be more profitable as stores benefit from our key initiatives.

In 2012, we made progress on these six key initiatives including, first, our new store design. We opened our first six newly designed stores with very strong guest response. We continued to have sales increases of 30% or more. The remodeled stores are driving repeat and new guest visits and maintaining strong average transaction value. We continue to expect to remodel 40 to 50 additional store locations over the next two years to build on the destination appeal of our stores.

Second, we continued to execute our store closure plans in conjunction with natural lease events to improve productivity and profitability. This includes transferring a portion of the sales from the closed stores to other locations in the same markets. We expect to have a total of 50 to 60 closures in the next two years. This comes on top of the 22 stores we closed in 2011 and 2012. The pace of closures is increasing. In 2013, we have already closed 13 of the approximately 35 stores planned to close for the year.

As I told you on our last call, our total net retail sales will be impacted by the closures but we expect to improve our profitability. When the closures are complete, we expect an annualized sales impact of 30 to 35 million net of transfer sales. We are forecasting a 2.5 million to 4.0 million benefit to overall store profitability by the end of 2014, which comes from both the closure of unprofitable stores and the transfer of a portion of sales into other profitable locations. We also expect this initiative to improve the sales per square foot on our overall North American store portfolio by approximately 25% as underperforming stores close and remaining stores get the benefit of the transfer sales. By the end of 2014, we will operate fewer stores but we expect those stores to have higher average sales and improved profit levels.

Third, putting an emphasis back on our brand and experience in our marketing. In the fourth quarter, we introduced brand-building TV advertising in the U.S. that features our store experience, and we moved to re-balance our value proposition, emphasizing experience and product versus product and promotion. This led to the improvement in our North American comp trend and also drove increased merchandise margins as we eliminated select promotions. We will continue to re-balance our marketing efforts for this initiative in 2013.

Fourth, we moved our gift program forward particularly in the key fourth quarter when our gift card sales increased by over 30% on a consolidated basis. We believe the brand advertising contributed to the strong sales of gift cards by prompting parents and other relatives to give the gift of our experience. Across geographies, an earlier start to a historically successful gift card promotion also contributed to higher sales.

Fifth, we continue to grow globally. Our franchisees finished the year with 91 stores in 14 countries. We also opened two stores in the U.K. We expect our franchisees to open 8 to 12 stores in 2013. Given the challenging environment in the U.K., we do not expect to open more stores until we see improvements in the economy and our own store performance.

And sixth, we focused on improving cost efficiencies, saving an additional 7.5 million during the year which enabled us to offset product cost increases and support our brand-building marketing advertising. We are continuing to adjust our expense structure to reflect the smaller store base we will have as we close stores.

As we begin 2013, there are a couple of differences to note. Last year, we participated in a major McDonald’s Happy Meal promotion that began early in February, and we benefited from the associated marketing. The promotion was successful for both Build-A-Bear Workshop and McDonald’s, and we will continue to partner with them; but the timing varies each year depending on various promotional scheduled and entertainment offerings. This year, the promotion moves to our fourth quarter. Also, this year’s first quarter will benefit from an earlier Easter, but that will impact the second quarter accordingly.

We expect to show significant progress on our initiatives in 2013 as the groundwork that we have laid takes hold and can impact our business on a larger scale. We remain cautious on the overall environment, particularly in Europe; however, we believe the changes we are making in our real estate portfolio combined with the reinvention of our store experience will drive improved productivity. I also feel that we have a good balance of iconic license and proprietary product to appeal to the broad demographic that shop in our stores. Our marketing will balance messaging of the destination appeal of our store experience with news about our products. We will also use marketing to let people know about store closure and direct them to other locations they can visit. Altogether, we expect these initiatives to move us toward our long-term objectives.

And now Tina will review the financials in more detail.

Tina Klocke

Thanks Maxine and good morning everyone. Let me begin by discussing the non-comparable charges that impacted the fourth quarter and fiscal year. This information is also detailed in a reconciliation table in the press release we issued earlier this morning. Our net loss for the 2012 fourth quarter was 36 million or $2.23 per share. Excluding non-comparable charges, our adjusted net income was 2 million or $0.13 per diluted share. These costs included a 34 million non-cash charge to impair the goodwill associated with our U.K. business, and a $6 million non-cash charge as related to trade credit and store asset impairment and the establishment of a valuation allowance on our foreign net deferred tax assets. This was partially offset by a $500,000 benefit to deferred revenue related to our loyalty program.

With regard to our non-cash goodwill impairment, while we have impaired the goodwill associated with our U.K. business in its entirety, this does not change our long-term outlook for this business segment. For the 2012 fiscal year, excluding all non-comparable charges, our adjusted net loss was 10 million or $0.62 per share.

Now let me go into more detail on the fourth quarter. Total revenues were 118 million compared to 119 million in 2011, a slight decline excluding the impact of foreign exchange. In 2012, total revenues increased by 500,000 from an adjustment to net retail sales related to deferred revenue under our loyalty program. This adjustment in the fourth quarter last year was 1.5 million. Consolidated net retail sales were flat despite closing 10 stores in 2012.

Comp store sales decreased by 1.7 on a consolidated basis, which included a 1.5% increase in North America and 11.4% decline in the U.K. This was driven by a 2.2% improvement in transaction value offset by a 3.8% decline in transactions. Consolidated e-commerce sales rose 14% in the fourth quarter, excluding the impact of foreign exchange, on top of a 3.5% increase in the 2011 fourth quarter.

Retail gross margin was 42.4%, a 90 basis point decrease from last year primarily driven by an 80 basis point decline from asset impairment charges and 50 basis points of de-leverage on fixed occupancy costs. This was partially offset by an increase in merchandise margin due to fewer promotions and discounts and less licensed product than in the prior year.

Total SG&A was 43.8% of total revenue. Excluding 3 million in asset impairment charges, SG&A was 41.6% of total revenues compared to 36% last year. The increase in adjusted SG&A as compared to the prior year primarily reflects investment in marketing and store-related costs as part of our long term strategic plan.

Turning now to our full-year results, total revenues were 381 million, a 3% decrease excluding the impact of foreign exchange. Consolidated net retail sales were 375 million, a 3% decrease excluding the impact of foreign exchange. This included 500,000 from an adjustment to net retail sales related to our deferred revenue under our loyalty program and compares to a $1.5 million adjustment in 2011.

On a consolidated basis, comparable store sales declined 3.3% and included a 2% decline in North America and an 8.4% decline in Europe. Consolidated e-commerce sales rose 8% excluding the impact of foreign exchange on top of an 8.5% increase in fiscal 2011. We had growth in both North America and the U.K. Our retail gross margin percent was 38.9% and represented 100 basis point decrease from the prior year driven by de-leverage of fixed costs. Total SG&A for the full year was 166 million or 43.4% of total revenues. Adjusting for the 3 million in non-cash charges, SG&A was 42.6% of total revenues.

We ended the year with a strong consolidated cash balance of 45 million. We have no debt and we did not make any borrowings against our credit facility. During the year, we invested 1.3 million to repurchase 367,000 shares of our common stock. Depreciation and amortization for 2012 was 21 million compared to 24 million in 2011.

As Maxine mentioned, we plan to close approximately 35 stores in 2013, 13 of which have already closed. We also plan to remodel 20 to 25 stores in our new design. For your reference, we have also included a store opening and closing schedule as an exhibit in our press release.

In support of these plans, capital expenditures for 2013 are expected to be between 20 and $25 million. This compares to 17 million in 2012. Depreciation and amortization is expected to be in the range of 20 to 22 million in 2013. Year-end inventory was 47 million, a 7% decline on a per-square foot basis as compared to fiscal 2011.

Now I’ll turn the call over to Mary Lou Fiala.

Mary Lou Fiala

Thank you Tina, and good morning everyone. Speaking on behalf of the Board of Directors, I wanted to provide an update on the transition to a new CEO and to state our support for the strategies that the management team is working on and that Maxine has articulated throughout 2012. But first, I want to take a moment and acknowledge the great work that Maxine has done creating this concept. She’s built an incredible brand that is a favorite of kids and their families around the world. I am pleased that she will continue to impact the future of the company as a board member following the eventual transition to a new CEO.

As it relates to the new CEO, the Board has been actively working to identify the right person to take the company forward. Our objective is to bring in an executive with significant retail experience and a strong financial background who will also add to the strategic vision of the company. We’re giving this our highest priority and attention in order to bring in the right person to lead this company to its full potential.

In the meantime, the Board has been working very closely with the management team on a multi-year turnaround plan, and I’m very confident in this plan and management’s ability to return Build-A-Bear Workshop to profitability and long-term growth. We realize this is not going to happen overnight. With the benefit of hindsight, it’s clear that the concept was over-expanded, particularly in light of the downturn in the global economy; however, despite several difficult comp store sales years, the vast majority of the company’s stores still have strong unit level economics, and going forward management is focused on right-sizing this store base, refreshing stores in an updated design, and adjusting its expense structure to match the reduced store count. The Board supports management in recreating a smaller but much healthier and once again profitable company.

I would now like to turn the call back over the management team for the Q&A. Maxine?

Maxine Clarke

Thanks Mary Lou. Operator, can you please open the call for any questions from our listeners?

Question and Answer Session

Operator

[Operator instructions]

Our first question is coming from James Fronda of Sidoti & Company. Please proceed with your question.

James Fronda – Sidoti & Co.

Yes, how are you? I know that you’re in the midst of the turnaround through refreshing your stores, but is there any specific concept for your bears that you’ll be focused on in 2013 or 2014?

Maxine Clarke

You mean, anything—

James Fronda – Sidoti & Co.

Yeah, you had the holiday concepts for the fourth quarter, but is there anything on an annual basis that you will be looking at?

Maxine Clarke

Well, we change our animals all the time. Tomorrow we’ll launch our Easter collection, and then in a few weeks we’ll launch a new Hello Kitty collection. Every month or so, every couple of weeks actually, at least every month, there’s a whole new collection – not an entire assortment in the whole store, but a limited edition collection that’s available and new. We have some exciting ones coming up particularly that we’ve never done before. One exciting one right after Easter is the first launch ever of make your own My Little Pony.

James Fronda – Sidoti & Co.

Okay. And is there any additional cost savings you’re going to be able to achieve in 2013?

Maxine Clarke

We’re working very much on that and we will have updates for you on that as we keep going forward on our calls, as we’ve done in the past.

James Fronda – Sidoti & Co.

Okay, thank you.

Operator

Thank you. Once again, if you do have a question, please press star, one on your telephone keypad at this time. Our next question is coming from Tom Filandro of Susquehanna Financial Group. Please proceed with your question.

Tom Filandro – Susquehanna Financial Group

Thank you. First, Maxine, I want to wish you all the best with continued success. You’ve been an inspiration to myself and many, many children out there, so kudos to you.

Maxine Clarke

Thank you, Tom.

Tom Filandro – Susquehanna Financial Group

If I can expand a little bit, if you guys could give us some clarity around that question that was just asked on the expense side of the equation, at least give us a sense of the buckets where you see the greatest opportunity. And then my second question is, is there any consideration—with a Board member present, is there any consideration of doing something that is broader in scope in terms of what you offer to the consumer, meaning not just selling skins and accessories, and considering other product opportunities. I know you’ve done a little of that in the past. Those are my two questions. Thank you.

Maxine Clarke

I’ll let Tina get to the cost savings; but on the products, we continue to test new products all the time, Tom, and we want them to be able to be substantial enough and meet our margin requirements. As you know, Build-A-Bear has all proprietary product and our margin is pretty substantial, and so finding products that can take the space in our store and generate the sales and the comparable margin is always a challenge. So we had a successful run when Angry Birds were really very popular, so we were able to sell quite a bit of that and it was a meaningful number. We have a line in about 50 stores of—a new line called Hug a Cub, which is different than the Hug a Cub line we launched about a year and a half ago – much more proprietary, very cute and soft and cuddly and customizable. We’ll see how that goes. And we have our Small Fries, which was a successful introduction and did add value and a new category to our business.

But the one challenge is when a mom walks into Build-A-Bear, she walks in and she spends about $35 a child, and she still spends about that $35 a child. We hope she’ll come back more frequently – that’s the idea. She may still spend $35 this time but she’ll come back another time, and maybe she wouldn’t have come in but she’ll buy that $10 Small Fry for her child. So we’re looking for those kinds of items and things that can complement our brand but also can earn their space and their profitability in the assortment.

Tom Filandro – Susquehanna Financial Group

Understood.

Mary Lou Fiala

Tom, this is Mary Lou. Nice to meet you over the phone. I think in the short term in 2013, management has done a very good job and the Board is excited about the content that is coming in for the next several quarters. So one, we feel good about that. We’re coming into this quarter or year with really a lean inventory, so we don’t have a lot that we have to work through.

I think the biggest change for this year is really the continued focus on the brand advertising versus advertising on just product and price, and the fact that advertising is going to be more to the child so the child is asking to come into the store versus the mom seeing it on TV and feeling there is value with it; so we want to look at both.

I do think the answer to your question on the long term, are there opportunities to move forward, there are; and I think that whether it’s product extensions, growing online, et cetera, that’s going to happen. But this year, our focus is on G&A savings, right-sizing the stores, building those stores a future, and driving traffic into our stores to improve productivity and our comps.

Tom Filandro – Susquehanna Financial Group

Very helpful. I call it the whine factor – when my kids whine to me.

Mary Lou Fiala

Yeah, that’s perfect. That’s exactly what we want. Thanks.

Tina?

Tina Klocke

So Tom, we’ll see some cost pressures from the merchandise margin in the first couple of quarters of the year, and then we feel like we have some room to improve our merchandise margin in the end of the third quarter and the fourth quarter. And again, some of that will be helped by not only better pricing but will also be helped by less discounts.

We’re also looking at, as Mary Lou pointed out, right-sizing the organization for the amount of stores that we have, so there will be savings in just SG&A overall as we close the stores but also as we right-size the headquarters for the amount of stores that we have. And as we do every year, we’ll continue to look at every line item as we have over the last several years to reduce the cost, but the majority will probably come in the SG&A.

Tom Filandro – Susquehanna Financial Group

Got it. Thank you, Tina.

Operator

Once again ladies and gentlemen, if you do have a question, please press star, one on your telephone keypad at this time. One moment, please, while we poll for final questions.

We’re showing no further questions in queue at this time. Are there any additional or closing comments?

Maxine Clarke

Thank you all for your time today, and I’ll look forward to speaking to you on our next call with our first quarter results. Have a great Valentine’s Day, and it’s still not too late to buy a really cute bear at Build-A-Bear Workshop.

Operator

Thank you. Ladies and gentlemen, thank you for your participation. You may now disconnect.

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