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

Q2 2013 Earnings Conference Call

July 25, 2013, 9:00 AM ET

Executives

Allison Malkin - ICR

Maxine Clark - Founder, Director and Chief Executive Bear

Sharon Price John - Chief Executive Officer and Chief President Bear

Tina Klocke - Chief Operations and Financial Bear, Treasurer and Secretary

Analysts

James Fronda -Sidoti

Tucker Golden - Solas Capital

Jon Evans - JWest

Operator

Greetings and welcome to the Build-A-Bear Workshop second quarter fiscal 2013 results conference call. (Operator Instructions) It is now my pleasure to introduce your host, Allison Malkin of ICR. Thank you, Ms. Malkin, you may begin.

Allison Malkin

Good morning. Thank you for joining us. With me today are Maxine Clark, Founder; Sharon Price John, Chief Executive Officer and Chief President Bear; and Tina Klocke, Chief Operations and Financial Bear.

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 question. We ask that you limit your questions to one question and one follow up. This way we can get to everyone's question during the 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 the 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.

And now, I would like to turn the call over to Maxine Clark.

Maxine Clark

Thanks Allison, and good morning, everyone. On today's call, I'll open with an overview of our second quarter and year-to-date performance. Turn the call over to Tina, to review financial details. And then, pass the helm to our new CEO, Sharon John.

Our second quarter results continue to show progress in our multiyear turnaround plan. Our key initiatives in real estate, marketing, product and expense management are driving topline growth and improving our bottomline results.

For the quarter consolidated net retail sales increased by $1.4 million, while operating 31 fewer stores than last year. Our comparable store sales grew by 7.3% on a consolidated basis, with an increase of 8.6% in North America and 1.7% in our European operation. This was the third consecutive quarter of cost increases in North America.

E-commerce was up 5.2% on a consolidated basis. We opened four additional stores in our new design and continue to have same-store sales increases of over 20% in these remodeled locations. Retail gross margin increased by 180 basis points, and we showed an improvement in our operating performance.

On a year-to-date basis, our consolidated comp store sales are up 9%. The key factors that have driven include rebalancing our marketing, to include more brand-building advertising, particularly on TV and more messaging and communications with moms.

We continue to gain efficiencies on our marketing spend by optimizing our investments during peak traffic and seasonal periods. The brand-building ads have had a halo effect, continuing to positively impact our business in subsequent weeks and months. We also see a cumulative benefit, as the messages gain higher awareness and recall with consumers over time.

Our focus on brand-building has gone hand-in-hand with reductions in promotions, which contributed to improved merchandise margin in the quarter. Our product mix both proprietary and licensed has continued to resonate well with our guest. The launch of My Little Pony, in particular, was highly successful and the team will continue to build on this product line throughout the year. Our real estate optimization strategies are also working with our store closures and stores of future remodel delivering the results we plan.

Given that this is my last call as Chief Executive Bear, I just wanted to add a few comments. I am especially pleased to welcome Sharon John, as Chief Executive Officer and Chief President Bear. Sharon is uniquely qualified with her strong track record in the toy industry as well as in children's retail, and we are delighted to have attracted her to our company.

With our turnaround plans gaining traction, the timing is right for Sharon to step in and take Build-A-Bear Workshop forward. She has hit the ground running, adding great energy and fresh ideas, and the team is embracing this challenge of building our company's future.

In the past several weeks, Sharon and I worked closely together to complete the transition. It has been great fun to me to hear her perspective and to share our dreams for the future of the brand. I have tremendous pride in this company and the team that has developed and nurtured our concept and brand, a brand that has become a favorite of families worldwide.

Transitioning a company from one CEO to another, led alone from a Founder to an outside CEO is never easy, but as important stakeholders, I want you to know that this transition has been very smooth. I have great confidence that Sharon is absolutely the right person to elevate the Build-A-Bear brand to new levels and drive the company forward. As a board member and as a large stakeholder in the company's future success, I look forward to working with Sharon and the board to achieve her goals for the company.

Before we hear Sharon's comment, Tina will review our financial results in more detail.

Tina Klocke

Thanks Maxine, and good morning, everyone. For the second quarter, total revenue was $82 million, up $1.5 million, while operating 31 fewer stores, an increase of 2%, excluding the impact of foreign exchange.

Consolidated comparable store sales increased 7.3%, driven by a 5.3% increase in transaction value and a 1.9% increase in transactions. We had comp sales growth of 8.6% and 1.7% in North America and Europe, respectively.

Our e-commerce business was up 5.2%, excluding the impact of foreign exchange. Retail gross margin improved by 180 basis points to 36.8%. The improvement was primarily driven by leverage and occupancy expense and decreased promotional activity.

SG&A was $37 million, flat with last year. As a percentage of sales, SG&A was 45.1% of revenues compared to $46.1% last year. Included in this year's SG&A were $900,000 in management transition and store closing cost.

Excluding these costs, SG&A as a percent of revenue decreased to 44%, an improvement of 190 basis points. Adjusted net loss was $0.33 per share, an improvement from an adjusted loss of $0.46 per share last year.

For the first six months, total revenues were $186 million, an increase of 5.5%, excluding the impact of foreign exchange. Consolidated comparable store sales rose 9% and included increases of 9.7% in North America and 5.9% in Europe. E-commerce sales rose 6.3%, excluding the impact of foreign exchange.

Retail gross margin was 39.4%, an improvement of 170 basis points compared to last year. The improvement was primarily driven by leverage and occupancy expense and decreased promotional activity, partially offset by higher product costs in this year's first quarter.

SG&A was $81 million or 43.3%, a 40 basis points improvement from the prior year. SG&A includes incremental marketing expenses in the first quarter as well as $3 million in management transition and store closing costs.

Excluding the management transition and store closing costs, SG&A improved by 200 basis points to 41.6%. Adjusted net loss was $3 million or $0.19 per share, an improvement from last year's adjusted net loss of $8 million or $0.49 per share.

We continue to have a strong balance sheet with consolidated cash of $28 million compared to $26 million at the end of the second quarter last year. We have no debt and no borrowings on our credit facility.

Capital expenditures in the quarter were up slightly over last year from $4.5 million to $5 million, primarily for store-related capital and IT infrastructure. Depreciation and amortization was $5 million comparable to last year.

For the full year, we continue to expect capital expenditures to be in the range of $19 million to $22 million, and depreciation and amortization to be approximately $20 million. At quarter end, consolidated inventories totaled $48 million, up $1 million from last year.

Inventory per square foot increased to 11.5%. The increase in inventory supports our higher store sales volume and includes earlier proceeds of new merchandise compared to the prior year.

Now, let me update you on our progress to optimize our North American store base. One of the components in improving our productivity is to remodel stores in the new design. During the quarter, we opened the first four of approximately 25 locations planned for the year.

The stores and their new design continue to generate average same-store sales increases of over 20%. As the rollout continues we are working to gain economies of scale and drive down the capital investments to build the stores.

We also continue to strategically close stores and transfer portion of the sales to other stores in the same market. In the first six months of the year, we have closed 28 stores. We have retained approximately 20% of sales from the closed stores. We expect to close 35 to 40 stores in total, this year.

We continue to focus on cost control and expect to hit our cost savings of $5 million to $10 million for the year, which includes expense reduction initiatives and savings from closed stores. The savings are weighted in the back half of the year, when we realize the full impact of this year's store closings.

And now, I would like to turn the call over to Sharon.

Sharon Price John

Thanks Tina, and good morning, everyone. I am pleased to speak with you today on my first call as CEO of Build-A-Bear Workshop. For those of you, who don't know me, I have more than 20 years of experience in the specialty retail toy and advertising industry. I have built a strong track record of success in positioning children's brands for growth at companies, including Hasbro, Mattel and Stride Rite.

Most recently I was President of the Stride Rite Children's Group, where I build solid team and executed a strategy to streamline the business model and retail footprint. This resulted in industry-leading comparable store sales increases, wholesale growth and an improvement to overall profitability.

I joined Build-A-Bear, because I believe in its tremendous potential. And I am excited to use my skills to evolve the current strategies to return the company to profitability and build a platform for sustained growth.

In my first few weeks as CEO, I have worked with the executive team, field leadership and store associates in a number of markets. The team has been open to new ways to think about the business and the future opportunities. Although, our sales trend has softened slightly in July, we believe we have the right initiative in place, and are intently focused on executing the balance of the year.

We are also beginning to solidify our strategies for the future, and I believe we have several key strengths from which to build. We have a successful brand. The children of all ages adore and mom's trust, when that resonates with consumers on an emotional level.

We have a seasoned and passionate team and the ongoing key strategic initiatives are showing positive result, including the rebalancing of our marketing to include more brand-building advertising, the store closures initiative, which is showing overall sales transfer rates of 20%, and lastly, the remodeling of stores to the new design to drive improved productivity.

Looking forward, I believe we can enhance brand engagement and increase the lifetime value of our consumers. This includes increasing business with our most loyal guests as well as driving frequency and value with other segments.

One initial action will be to reemphasize our party business, which had both trial and retention benefits. We are effectively using data to positively impact our business and drive key strategic shift, such as repositioning our marketing programs and developing the real estate optimization plans.

However, I believe we can improve our results on a broader basis by expanding the use of more robust data-driven decision making throughout the organization. We are exploring opportunities to increase efficiencies within our product development, sourcing and distribution channels, while balancing the overall value proposition for our guests.

Most importantly, on the longer-term, I see the opportunity to further leverage the power of the Build-A-Bear Workshop brand and take advantage of our core competencies and infrastructure. I am joining this company in a time when the momentum is moving in a positive direction.

The key initiatives that the team are implementing, have improved sales trends and profitability and positioned us for the future. I look forward to updating you on our progress as we move forward.

And now, I would like to turn the call over to the operator, to begin the question-and-answer portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions) We'll move on to our next question from James Fronda of Sidoti.

James Fronda -Sidoti

Can you give us, I guess, any specific into what's driving the strong comp sales? I mean anything in product that you can talk about.

Maxine Clark

We have a strong selection of both proprietary products that are build-a-brand driven as well as a very good array of core licensed products that have driven our sales this year, including for example, My Little Pony line, which was very, very strong for us.

We also have in the January time period, for the first six months, we enjoyed above average gift card redemption, because of the work that the team had done in the December time period of the prior year to sell the gift cards. So that drove a lot of the first quarter results as well.

James Fronda -Sidoti

Is there still, I guess, capacity for those gift cards to be redeemed in the next six moths of this year?

Maxine Clark

Yes. And that will also be a plan, of course, for us to work again for the remainder of the year and driving those gift card sales. Clearly, they are good for us during the quarter, but they also pay-off as we move into the first quarter of 2014.

James Fronda -Sidoti

And I guess, do you think the reduced promotional activity you're seeing, do you think that's sustainable for the rest of the year or at least in the upcoming third quarter?

Maxine Clark

We think that we have some very strong, both proprietary brand marketing plans as well as plans against a number of different initiatives from My Little Pony edition, rather Twilight Sparkle, which will be out in the 31st. We also have Smurfs, that's coming up, so we feel like we have the movie on Friday.

And we've heavied-up our advertising, so we feel really good about some of our brand initiatives going forward. We are prepared, if we need to do some selective promotions, we will. But for the most part, our objective is to continue to build upon the Build-A-Bear brand strength.

Operator

And your next question is coming from the line of Tucker Golden with Solas Capital.

Tucker Golden - Solas Capital

I had a question regarding the franchised segment. In the past, I know that it's fine to disclose an estimated potential for 300 franchised units globally. It seems like we're stuck a little bit in 90 as further some openings, there are also some closings. Wondering if you could provide any color there? And then just your view for the long-term potential and in relation to this how closely you've considered whether or not it makes sense to evaluate converting the European stores to a franchise model and really focusing on the domestic operations?

Sharon Price John

I'm going to let, Tina, answer the first portion about the franchise store count and then I'll speak about the potential for us to change our model.

Tina Klocke

Tucker, we still believe that we have the opportunity for about 300 franchise locations. Again, we are not in China yet, which is a big opportunity for us. But as you are well aware the global economic situation that, our world has been in has also impacted our franchisees, and so while we are sitting at around 90 locations, they are good locations and they are producing favorable results for us.

And so I think as the economy gets better globally, we'll see that pick up. We'll as we hopefully enter China. That has lots of opportunity. We're not in India. There is several big countries that we still haven't sourced in. And as we continue to look for the right franchisees, we believe that we'll be able to be in those countries in the near future and reach our potential of the 300 locations.

Sharon Price John

And in terms of the model, for me I've been here since June 3, clearly I'm going to be looking across the organization at different opportunities based on some of the basic outlines of strategy that I provided, which is inclusive of insuring that we're building on and leveraging the strength of the brand and managing and leveraging our infrastructure in core competencies. Right now, the franchise model does seem to be working for us, in terms of, it is providing positive results from a revenue perspective, and that's so in the short-term we'll remain with the current model. And the U.K. we will maintain the ownership position, at least, in the foreseeable future.

Tucker Golden - Solas Capital

Is there anything structural there that would prevent a potential to consider franchising the stores?

Sharon Price John

Well, clearly there is opportunity and we continue to revaluate what's the most beneficial business model for the corporation. As of this moment, again having, I've only been since June 3, and getting to know the U.K. organization and how it works with our team overall.

We're in the early days of exploration on what would be the right business model for us. But in the foreseeable future, we would expect to keep the U.K. in an ownership position. And also continue to expand the franchise model, selectively throughout the rest of the world where it's beneficial to us. Additionally, as I'm sure you know it helps us cover our costs to have that organization.

Tina Klocke

Just one more thing, we have 60 stores there. And our policy at least has been in franchise is to not divide up a country, to have one franchise dealer. So you'd have to find somebody, who'd have substantial wherewithal, and to really experience in running a retail business or sell the business, something like that.

And I think that we have found that it just gives us, as Sharon just said, leverage in our company. We don't have to duplicate our staff over there. We have a tremendous leverage. And I think that with Sharon's initiative, we will have that business clicking really strongly and be a good stronghold for us in Europe, for expanding our franchisees in those countries that we're not in yet.

Tucker Golden - Solas Capital

And then, if we could just get a little more detail on the new franchise, in which did you grow and in which market did you get back some stores? I think there were 10 added and 10 closed or something like that.

Sharon Price John

We've continued to expand in Germany and then I think in few select countries they've reduced where there non-performing locations have been. So it's not any one country, it's many different.

Operator

Our next question comes from Jon Evans with JWest.

Jon Evans - JWest

Can you just a talk a little bit about kind of the cadence that you saw in the quarter from a comp store basis or a comp stores sales? And then you said July was a little bit softer, if you could give us any more insight? And then the other question, the $5 million to $10 million that you said in the cost saves, can you split that up between COGS and SG&A? Those are my first two questions.

Tina Klocke

I'll take the cost savings first. We're looking at and again primarily in the back half of the year that about 60% of that will be in cost of good sold and the remaining portion will be in SG&A. And again, as you probably know Easter switched from second quarter of last year to the first quarter of this year. So we did have some strengthening in the first quarter because of that, but remained fairly consistent through the rest of the quarter from the May and June perspective.

Sharon Price John

And the comps in the quarter as we mentioned in the call, the comp store sales in consolidated with 7.3%, and that's 8.6% in North America and 1.7% Europe. And the July softness that I mentioned is we are looking at opportunities, of course to move that forward overall. It's kind of across the entire retail organization, but one of the things that we've done to build up that July opportunity is as of July 22, we actually heavied up our media. We have Smurfs coming as I mentioned and we've actually seen some positive early results of the Smurfs movie expectations on Friday as well as the heavy up of TV, which is a balance between both Smurfs specific advertising and our brand-driven advertising. Does that answer your question?

Jon Evans - JWest

But I mean, I guess, so if you think about July so far, I mean are you still positive or are you negative? Or can you give us any kind of insight, you just said it's come-off from the pace that you have?

Tina Klocke

At this point, Jon, we really don't give monthly comps.

Jon Evans - JWest

So if you take the $5 million to $7 million, the midpoint $7.5 million and if you take 40% of that, that's $3 million. So if we look at SG&A in absolute dollars, are you basically saying that you would expect SG&A dollars for the year to be down $3 million year-over-year, is that a fair assumption?

Tina Klocke

Yes. And I think that's a fair assumption.

Jon Evans - JWest

And then the rest is in COGS, so can you help us understand that cost saving COGS, is that because you got cheaper rents or what's that because I think you also have an initiative to buy better to increase gross margins also. So can you maybe help us understand the difference between the two? Because one, to me it seems like it's a cost saving efforts where you're doing better on real estate or redoing stores. And the other one seems like it's you're buying better and those seem like they're different. So could you help us articulate that strategy?

Tina Klocke

It is a combination of both of those. And the $5 million to $10 million is net year-over-year. So you're going to get some impact of the store closures. And as we said earlier in our first quarter call that we were going to increase our marketing spend, so that's in office. So closing stores impacts the COGS, it does impacts SG&A, offset by some increases in marketing and our transition costs as we've called out as well as store closing. So I would say probably from the perspective of cost of goods sold, the relationship between closing stores and improvement in true retail margin, it's probably fifty-fifty.

Jon Evans - JWest

And then could you maybe help us to think about if you're successful in your strategy of buying better and putting this team together of improving gross margins over time. Can you help us understand the opportunity you think to improve your retail margin?

Sharon Price John

Yes. We haven't really given that guidance per se from our margin perspective. But we do believe that we have the opportunity long-term to get into double-digit operating profits, returned to double-digit operating profits as we have been in the past. But again, as you know, this year and next year transition years, from us from a perspective of our store closing and remodels that we haven't worked on for the last 18 months. And when we get a slightly positive comp, we do leverage our occupancy costs, which are primarily fixed, those of the warehouse and rents and things like that. So as we continue to have the positive comps, we will get some of that leverage back too.

Jon Evans - JWest

And then the last question I would for you, is can you give us a roadmap of kind of where you expect to be from a store base of the new concept stores. So in another words, if we're at the next year in 2014, can you give us a sense of where you or what percentage do you hope that the store base would be of the new stores?

And then the other question I would have is, when will you give us kind of the productivity difference in the new stores on a four-wall basis? You have said that they're producing 20% better kind of sales, but I'm curious what kind of return that they're producing better, so can you help us understand?

Tina Klocke

The first store has just been open, not even a full year. It's about 10 months at this point in time. So again, so that's one store. So as we continue progress and give more information, we'll update you on that. We just don't have information. And we believe that our goal from a store comp basis that in North America that will be 225 to 250 stores once we're through all of the transition of closing stores.

We also believe at this point that we remodeled six stores last year. We're going to remodel 25 stores this year. And we believe the opportunity for next year is 20 to 25. And that's about where we have left off from that perspective as far as going out. So the opportunity to be 50 plus stores in this remodeled formats. However, we believe we also have the ability for modular moving some of these specific items that we put in the new stores like Hear-Me station that we can move in other stores and not have to do a complete remodel.

And I guess we are working on engineering and driving our costs down in the new stores. So far we are pleased with their performance and we're on target to hit our pro forma payback, which is two years and less, which is back to historic as we were opening stores in the early 2000, we were paying back our stores in less than two years.

Operator

Our next question is a follow-up from the line Tucker Golden with Solas Capital.

Tucker Golden - Solas Capital

You touched on operating leverage and warehousing costs. Just curious, what utilization rate and what capacity rate do you see currently running?

Tina Klocke

The DC is running at probably about 75% capacity. And again, that's going to fluctuate during peak inventory times, it's going to be more productive in the back half of the year as we're building inventories for the higher sales volumes.

Tucker Golden - Solas Capital

Do you get close to full capacity there during the year?

Tina Klocke

Not at this point.

Tucker Golden - Solas Capital

Is it under consideration that you might, with the owned store base being reduced, is it under consideration that you might want to explore options there, whether it's brining in another partner to share the facility or somehow becoming more efficient on that area?

Tina Klocke

Of course, and we continued to look at all opportunities to leverage the warehouse, whether it be another business partner expanding the web business, because our web fulfillment center is in the warehouse also. So we continue to look at all of that.

Operator

Thank you. There are no further questions at this time. I would now like to turn the floor back over to Sharon John for closings remarks.

Sharon Price John

Thank you for joining us today and we look forward to speaking with you when we report our third quarter results in October.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.

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