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Executives

Allison Malkin - ICR

Sharon Price John - CEO

Tina Klocke - COO & CFO

Analysts

James Fronda - Sidoti & Company

Jack Ripsteen - Potrero Capital Research

Tucker Golden - Solas Capital

Joey Baum - Delta Incorporated

Build-A-Bear Workshop, Inc. (BBW) Q3 2013 Earnings Call October 24, 2013 9:00 AM ET

Operator

Greetings and welcome to the Build-A-Bear Workshop Third Quarter 2013 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. (Operator Instructions) As a reminder, this conference is being recorded.

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 Sharon Price John, CEO; and Tina Klocke, COO and CFO.

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. This way we can get to everyone's question 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.

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

Sharon Price John

Thanks, Allison. Good morning everyone. On today's call I will begin with an overview of our third quarter results, provide a few fourth quarter highlights, turn the call over to Tina to review financial details, and then we will take your questions.

As outlined in this morning's press release, in the third quarter we delivered consolidated comparable store sales growth of 6.4%. This marks our fourth consecutive period of comparable store sales growth in North America and our third consecutive increase in Europe.

We also expanded gross margin by 360 basis points, and had a $ 3 million improvement in operating performance, reducing our pre-tax loss to $1 million compared to last year's third quarter pre-tax loss of $4 million.

We attribute these results to increased discipline of expense management, improved leverage and occupancy cost, and a balanced merchandized offering integrated with marketing, which allowed us to reduce overall promotional activity compared to last year.

Specifically we saw solid performance in our Build-A-Bear Workshop proprietary core animals and fashions while driving new license introductions. The launch of My Little Pony animals and accessories performed well across geographies and the launch of products featuring the popular singing group One Direction was especially successful in the UK.

This compelling product offering, plus refocused marketing, allowed us to reduce a number of discount driven promotion. As an example we successfully eliminated our all store $29.99 bundle promotion that we had run in the third quarter for the past four years in North America.

Looking ahead, we have a solid plan in place to capitalize on the fourth quarter. This year's holiday scene is towards the fund for Christmas and was strategically developed to encourage kids and families to experience Build-A-Bear Workshop during the holiday season. In support of the concept, our product line features Wishes Santa, which is designed for children to insert their wish list from Christmas, along with a heart as part of our signature ceremony that occurs at the Fluff Me Station.

This positions our stores as an ideal pre-holiday family destination. To round out our holiday lineup we have proven multi-generational holiday favorites, including Rudolf the Red Nosed Reindeer and Frosty the Snowman.

A significant portion of our annual and marketing spend occurs in the fourth quarter. We have an integrated plan to support the "Twas the Fun Before Christmas" theme that features a combination of brand and product messaging, including national television reaching both kids and moms throughout the holiday season.

Driving our gift card program is another important component of delivering the quarter. We intend to expand gift card sales by emphasizing the Build-A-Bear Workshop gift of experience as an ideal NED gifting solution. We are integrating gift card specific messaging in our national marketing, including TV implant, and elevating our suggestive selling into the service model across all channels. We are focused on adding mobile POS to our top gift card stores to deliver speed and convenience to purchase. Not only is growth in gift card sales important for the fourth quarter, it positions us well for the start of 2014.

Additionally, we are pleased that McDonalds for the fifth time will feature Build-A-Bear Workshop Mini Plush in their Happy Meals, starting November 15 and running through December 12. This marketing initiative is expected to reach approximately 20 million consumers in North America. The McDonalds Happy Meals programs have consistently driven traffic and sale to our stores and provided new guest trial.

Our strategy is to rebalance our marketing program, improve our product offering, reduce discounts and promotions, and optimize our real estate, have been driving consistent improvements in our results enabling us to establish a foundation to deliver our stated objective of sustainable profitable growth.

I am pleased that the third quarter and the first nine months of the year we advanced our objectives. Build-A-Bear Workshop is a powerful brand, when the kids love and moms trust.

Going forward, we will leverage the strength of the brand and build on our core competencies and infrastructure to deliver results and increase shareholder value.

And now, I would like to turn the call over to Tina to review our financials in more detail.

Tina Klocke

Thanks, Sharon, and good morning everyone. For the third quarter, net retail sales were $84 million, while operating 31 fewer stores. To put them in perspective the 31 fewer stores resulted in 10% fewer operating weeks in the quarter, while our net retail sales declined less than 1%, excluding the impact of foreign exchange. Consolidated comparable store sales increased 6.4%, driven by a 6.2% increase in transaction value and a two-tenth increase in transactions.

By geography, comparable store sale rose 7.6% in North America, and 2.3% in Europe. Real estate optimization strategies drove approximately 30% of the comparable store sales increase in North America in the quarter with the balance coming from organic growth in our base.

E-commerce business was up 1.1%, excluding the impact of foreign exchange.

Retail gross margin was 40.1%, compared to 36.5% in last year's third quarter. The 360 basis point improvement was primarily driven by decreased promotional activity and leverage and occupancy expense.

SG&A was $36 million, down slightly compared with the third quarter last year. SG&A was 42.2% of revenues compared to 42.5% last year. Included in this year's SG&A was $600,000 in management transition and store closing cost. Excluding these costs, SG&A was 41.6% an 80 basis point improvement versus last year.

Adjusted net loss per share improved to $0.05 from $0.25 per share last year.

For the first nine months net retail sales rose to $257 million while operating 31 fewer stores compared to $259 million in the first nine months last year. Again to put this in perspective the 31 fewer stores led to a 7% decline in total operating weeks in the first nine months of the year, while net retail sales rose 3.4% excluding impact of foreign exchange.

Our consolidated comparable store sales rose 8.2%, driven by 4.5% increase in transaction value, and 3.7% increase in transactions, and included 9.1% increase in North America, and 4.6% increase in Europe.

Real estate optimization strategies drove approximately 20% of the comparable store sales increase in North America in the first nine months, but the balance coming from the organic growth in our base.

E-commerce sales increased 4.7% excluding impact of foreign exchange.

Retail gross margin was 39.6%, compared to 37.3%. The 230 basis point improvement was primarily driven by decreased promotional activity and leverage and occupancy costs.

SG&A was $116 million or 43% of revenues including $4 million of management transition and store closing expenses, compared to $114 million or 43.3% last year. Excluding these costs SG&A was $41.6%, a 140 basis points improvement versus last year.

Adjusted net loss was $4 million or $0.23 per share, a solid improvement from last year's adjusted net loss of $12 million or $0.74 per share.

Turning to the balance sheet at quarter end consolidated cash was $14 million compared to $22 million at the end of the third quarter last year. We had no borrowings on our credit facility at quarter end.

For the first nine months capital expenditures were up slightly from last year at $15 million, primarily for store-related capital and IT infrastructure. Depreciation and amortization was $14 million, down slightly from last year.

For the full year, we continue to expect capital expenditures to be approximately $20 million to support the refresh and repositioning of our stores and investment in infrastructure. Depreciation and amortization is expected to be approximately $20 million.

Consolidated inventory at quarter end totaled $57 million, compared to $55 million at the end of the 2012 third quarter. Inventory per square foot increased 12.1%. The $2 million increase represents a combination of timing of receipts and additional inventory to support our fourth quarter sales plan.

Now, let me update you on our progress to optimize our North American store base. A real estate optimization plans are a key factor in establishing a foundation to deliver sustainable profitable growth. We continue to strategically close stores and transfer a portion of sales to other stores in the same market.

In the first nine months of the year we have closed 34 stores and have retained approximately 20% of their sales on average in other locations. We expect to close an additional 10 to 25 stores in fiscal 2013 and 2014. We also continue to renegotiate leases to improve our rent structure.

As we renew leases, we've updated for less stores in our new design. During the quarter, we remodeled five existing locations and opened three new locations to give us a total of 19 newly remodeled stores.

As we continue to remodel stores, we're working to gain economies of scale and drive down the capital investment needed to build the stores. We have also downsized stores as a part of our initiative to improve overall store productivity.

Organic sales growth combined with our store closure, remodel, and downsizing activity, have driven a 12% increase in sales per square foot in North America for the first nine months compared to last year.

We will opportunistically open stores including four pop-up locations this holiday. This is the cost effective method of validating select market during our highest productivity months of the year. We expect to operate these stores for six months to evaluate their long-term potential.

We expect to achieve approximately $10 million in net cost savings for the year, the high end of our original stated objective. Approximately 60% of savings will be realized gross margin and the balance in SG&A.

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

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from James Fronda with Sidoti & Company. Please proceed with your question.

James Fronda - Sidoti & Company

Could you discuss I guess a little more in detail what's causing the strong comp growth? Do you think it was specifically related to My Little Ponies products or are the products doing well as well?

Sharon Price John

James, I think that it's a combination. This is a Sharon. It's a combination of things. As we said, we have a balanced product offering, proprietary Build-A-Bear products that are driving sales as well as some Vikings products including My Little Pony, and as we mentioned One Direction. We're very pleased that it's a balanced approach.

James Fronda - Sidoti & Company

Okay. And did you record any decent I guess gift card sales during the quarter or that's primarily during the fourth quarter?

Sharon Price John

We have actually improved our gift card sales over the first nine months as well.

Operator

Our next question comes from Jack Ripsteen with Potrero Capital Research. Please proceed with your question.

Jack Ripsteen - Potrero Capital Research

For next year if you look at, what kind of expenses do you think you could drive out of the middle of the P&L as you shrink the store-base?

Tina Klocke

Thanks Jack. It's Tina. And I would say, on a go forward basis, we'll continue to look at our supply chain from the point where we manufacture the product and try to all the way to where we take it into the store. And so, we're embarking on that. So we believe that there is some leverage that we can find there whether it be the product makeup, whether it be transportation, how we do things. And so we think that there will be some expansion in that area. But also as we continue to close stores and have the benefit of a full year of those store closures we should see improvement in not only that piece of the gross margin but also in SG&A.

Jack Ripsteen - Potrero Capital Research

And in terms of SG&A, I mean, last year it was on about 165. I mean, can that come down to like 150 with this new store base? Just generally speaking, how much is left to come out of that?

Tina Klocke

Well, I think from that perspective it's the cost to operate the store from a salary perspective, payroll perspective, and other supplies and that type of stuff. So I think there is some room there. And as we get deeper into the store closings we will come and come back to you all with a target number that we think we can hit.

Sharon Price John

Okay. And Jack --

Jack Ripsteen - Potrero Capital Research

Yes.

Sharon Price John

This is Sharon. On that front, we are doing a complete supply chain effort right now. We're looking at taking cost out on every link of the value chain and we will be driving some value engineering, as well into the product lines. But just as you know that takes a while for it to flow. So we might be able to see some improvement in SG&A before we are able to see some improvement on the cost.

Jack Ripsteen - Potrero Capital Research

Okay. But I was just kind of curious because obviously you're shrinking the store base but you want to transfer the sales and -- but you stop to spend a certain amount of SG&A dollar towards marketing?

Sharon Price John - CEO

Yes.

Jack Ripsteen - Potrero Capital Research

So can we see some improvements, is there a way to grab some efficiencies there as well, even though you're still trying to achieve the overall branding and marketing campaign?

Sharon Price John

Yes, there will be efficiencies overtime. We are transferring as we said on average about 20%. And there is some marketing expenses associated with that on a one-time basis to communicate to the consumers that we are more familiar with the store that's closing, to ensure that they understand that there is some times a newly imagined store open -- being opened near them or to tell them to go to in a different store in their location, near their location generally within 5 or 10 miles. So that expenses in there that won't be an ongoing expense. But we also see that we might have some opportunities with more elevated and integrated marketing that have a little better ideas over the course of time.

Jack Ripsteen - Potrero Capital Research

Yes. I'm just trying to -- if I look back like a Q4-to-Q4 comparison that's coming up, at one point in -- like say a '11, I think the SG&A was $42 million, and you had roughly the same sales and in the next year it jumped to $51 million and I'm just trying to discern what's the right number because clearly the sales were about the same of the SG&A, almost $10 million higher?

Sharon Price John

Yes that was a process I think which was a good process for the company to go through rebalancing the marketing communication, which included, brand marketing and product marketing. And some of that brand marketing was inclusive of advertising to moms in a more robust manner and mom's TV is a little more expensive to kid's TV. But I think over the course of time now we are really learning what that right balance is. And as I say, I'm hopeful that we will have a better ideas as we go forward.

One other things that we're doing was the "Twas the Fun Before Christmas" campaign for example, is ensuring that the communication points are the same from moms to kids and were saying, were pulling everything together throughout all touch point to the consumer, so that again elevated and integrated approach really drives generally some efficiencies in the process.

Jack Ripsteen - Potrero Capital Research

So what you say if it's into that $50-ish million is kind of the high watermark and we wouldn't expect to see that going forward?

Sharon Price John

I would certainly hope so.

Jack Ripsteen - Potrero Capital Research

Okay. Great.

Sharon Price John

I mean, it would be relative of course if we continue to drive sales, right --

Jack Ripsteen - Potrero Capital Research

Right. But just closing store sales.

Sharon Price John

Dollars will go up and (inaudible) will go down, yeah.

Jack Ripsteen - Potrero Capital Research

Right. But just closing. I mean, so even if you improve sales you still are sort of flat right on revenues, sort of taking the levels that will have come down, right?

Sharon Price John

Right. Well, there should be some leverage there, sure.

Operator

(Operator Instructions) Our next question comes from Tucker Golden with Solas Capital. Please proceed with your question.

Tucker Golden - Solas Capital

I had a question about the balance sheet. So if we look at the cash position versus about a year ago it's declined to $8 million or $9 million and it seems to me that you're basically spending all your EBITDA no more, no less on various capital initiatives and store remodels systems and it looks like working capital really accounts for the vast majority if not all of that reduction in cash. So wondering if you could just go through the items there, looks like receivables are over $10 million, like it's never been that high in my memory, inventory and payables, smaller moves and I think you explained in the release that you're making a small incremental that on the fourth quarter and so maybe that's why inventories are a little higher per foot. But really receivables is the thing one that's big shock to me, which is we just like to understand why that kind of sucked up $6 million of cash over the last year and whether we can expect that to come back and see that kind of year ending cash balance back at that sort of $45 million level what was last year or hopefully better?

Tina Klocke

Sure Tucker, its Tina. To answer your question about cash and the receivables pieces as you highlighted a portion of it is the increase in inventory. The other portion is this we build these stores we get tenant allowance, construction allowance from our landlords and so that's the portion that we need to collect as these stores are completed. Since we only built only six stores last year and we're on the road path to do 25 that's going to increase that. But that will go down by the end of this year beginning in the first quarter of next year.

And the other pieces is ad we've highlighted in our 10-Q we have a dispute going with the customs authority in the UK and that in order to continue to go through the process we had to make a deposit or we put it on the books as a receivable and that totals about $2.5 million and as we proceed through that late hearings in that we should -- we will either have to pay that or will get it back. It's just as part of the overall.

Tucker Golden - Solas Capital

So may be $2.5 million from this customs dispute and the other kind of $4 million -- $3 million, $4 million from tenant allowances correct?

Tina Klocke

Correct.

Tucker Golden - Solas Capital

Just being kind of higher than last year?

Tina Klocke

Right. And then a couple million in inventory and then the capital is slightly higher and so that balance is with really the change in cash.

Sharon Price John

Right, again remember this is our low point. Q3 is always our low point as we build inventory and as we head into the holiday season and that we will have -- we'll be pretty close to our setting cashes last year, at the end of this year as we, as the sales come in, gift cards come in and the like.

Tucker Golden - Solas Capital

Yeah, I just wanted to confirm that the change versus the disappoint last year was not permanent. Thank you.

Sharon Price John

Okay, great. Thanks.

Operator

(Operator Instructions) Our next question comes from Joey Baum with Delta Incorporated. Please proceed with your question.

Joey Baum - Delta Incorporated

Hi, you guys are doing a great job helping Build-A-Bear realize its real value as a business. But closing on profitable stores will only get you still far. Can you give some more details on how you're planning to help Build-A-Bear realize its growth prospects?

Sharon Price John

Okay Joey, yeah. The -- if this is a multifaceted approach to return into sustainable profitable growth. So the real estate optimization program was a necessary part of this and we realized that the closure of the unprofitable doors is only a portion of the solution and that is why it's not the only part of what we're doing. As we mentioned we are rebuilding the marketing program by rebalancing the communication and ensuring that we're branding as much as we are, driving products, and we're at the same time reducing our promotional activity and discount activity because we know the strengths of the brand.

When you really back away from it though and recognize what's going on with the store closures, we still are having growth, the whole water level is rising because we're having organic growth from the stores on the comp, where our comp base is 70% from the organic doors versus the newly remodeled doors. So it's not just a closure of the doors that's helping us. It's everything that we're doing to drive the brand overall. It is the combination of driving the top-line and as well as improving our bottom-line by closing all possible doors.

Operator

There are no further questions in queue at this time. I would like to turn the call back over the management for closing comments.

Sharon Price John

Thank you again for joining us today and I remain confident in our business prospects as we enter the final quarter of the year. The strategies we've implemented have led to improvements in our comparable store sales and margins and profitability and we expect to build upon our progress during the holiday season and into 2014. We would look forward to speaking with you when we report fourth quarter results in February.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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