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

F4Q09 Earnings Call

February 18, 2010 9:00 am ET

Executives

Jane Thorn-Leeson - ICR

Maxine Clark - Chairman and Chief Executive Officer

John Haugh – President and Chief Marketing and Merchandising Officer

Tina Klocke – Chief Operations and Financial Officer

Analysts

Thomas Filandro - SIG

Paul LeJuez – Credit Suisse

Sean McGowan – Needham & Company

Gerrick Johnson – BMO Capital Market

Michael Smith – Kansas City Capital

Matthew [inaudible] – private investor

Brad Leonard - BML Capital Management

Operator

Good day ladies and gentlemen and welcome to the fourth quarter of 2009 Build-A-Bear Workshop earnings conference call. My name Keisha and I will be your operator today. At this time all participants are in listen-only mode. We will open up the question and answer session towards end of this conference. (Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Ms. Jane Thorn-Leeson with ICR.

Jane Thorn-Leeson

Good morning and thank you for joining us. With me this morning are Maxine Clark, Chairman and Chief Executive Bear, John Haugh, President and Chief Marketing and Merchandising 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 should contact us after this conference call with their questions. We ask that you limit your questions to one question at a time. This way, we will get to everyone’s questions during this one hour call. Do feel free to re-queue if you have further questions.

Please know that our call is being recorded and broadcast live via the internet. The earnings release is available on our Investor Relations portion of our corporate website and the replay of both the call and the 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 risk 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 factor section of our annual report on form 10-K and we undertake no obligations to update or revise any forward looking statements.

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

Maxine Clark

Thank you Jane. Good morning everyone and thank you for joining us to discuss our fourth quarter and fiscal 2009 results. For this morning’s call, I’ll begin with an overview of our fourth quarter and fiscal 2009 performance and outline our priorities for 2010.

John Haugh, President and Chief Marketing and Merchandising Bear will review our product and marketing strategies, then Tina Klocke, Chief Operating and Financial Bear, will review our financial results and outlook. Finally, I’ll make some closing comments and we’ll open the call to take your questions.

Fiscal 2009 represented a year of economic challenge. It was a very tough year, but we showed solid progress. We improved our North American comp store sales trends, we continued our strong and profitable results in Europe, we surpassed our cost reduction goals, and we ended the year with positive cash flow and a strengthened balance sheet.

While the economy continues to impact overall performance given the discretionary nature of our products, we are pleased with the progress we made in 2009 and are well positioned to create greater shareholder value in 2010.

Let me give you more details about our fiscal 2009 results. We had a sequential improvement in our North American comparable store sales with our trends improving every quarter from a low of minus 20.5 in North America in the first quarter, finishing the year at negative 13.3 in the fourth quarter.

More importantly, our comp store trend improvement continues into 2010, reaching negative single digit levels in January and for February, through yesterday, despite the difficult weather in the past few weeks, we are seeing even more significant improvement in trend in both our stores and online. In fact, our sales are flat to last year, but remember, there are still 10 days remaining in the month. This gives us further confidence in our strategy.

Remember, February is a very large month for Build-A-Bear Workshop. We attribute these results to our focus on must-win periods when we know guests will be in the mall, innovation in our core Build-A-Bear Workshop product assortment, fully integrated marketing across all business channels, and [inaudible] operational support improving transaction count trends.

We also made significant advances in our entertainment initiatives with our first ever television special. Holly & Hal Moose: Our Uplifting Christmas Adventure, airing on ABC Family, successfully driving brand awareness and sales of our plush animals.

Turning to Europe, we continue to show strength in our European operations with total revenues up 9% in fiscal 2009, excluding the impact of foreign exchange, and comps increasing by 5% for the year.

We believe we have future growth opportunities in both existing and new stores, particularly in the UK and Ireland, and we are focused on continuing the positive trends that our stores have delivered.

On the cost side, we achieved reductions in cost of $25 million in North America, with $22 million in SG&A including marketing, central office payroll, and outside services, and $3 million in transportation expenses, exceeding our initial goal of $15 million set at the start of the year.

In addition, we achieved significant reductions on store lease expenses which will be realized over the life of the leases. While lowering costs we continued to deliver a great experience in our stores as measured by our guest satisfaction scores which we finished the year with nearly 80% of all guests giving us the top score on overall satisfaction.

We were pleased to be named to the Fortune 100 best places to work for list for a second year running.

Let me give you more detail about our fiscal 2009 results. We also added key talent, naming John Haugh as President and Chief Marketing and Merchandising Bear in April of last year. John is a great partner and has made significant contributions to move our business forward.

Importantly, we ended the year with a strong balance sheet, reported positive cash flow, and have an extended credit agreement in place with US Bank. Looking to 2010, the number one objective is to increase shareholder value by profitably growing our sales and we’re focusing all of our energies in that direction.

Our plans include accelerating our comp store and online sales by continuing to improve products and the impact of our integrated marketing program, as well as aligning the new innovations across our organization.

We will also selectively add new interactive toy products to our stores that we believe will enhance our brand essence and give guests even more reasons to check out what’s new at Build-A-Bear Workshop. The Build-A-Bear Workshop brand has come to represent fun, creative, and imaginative play with high hands on value and family interaction.

We believe that going beyond our traditional merchandise assortment with complimentary toy products will allow us to further drive sales, transaction value, and overall profitability. John will expand upon these efforts in more detail, including the highly successful introduction of the Zhu Zhu Pets product.

Increased membership and engagement in Build-A-BearVille to further engage our guests with the brand and influence additional purchases, and we will be aggressive in making further strategic reductions and operating expenses on top of the cost reductions of $25 million in 2009.

We have also begun a search for a new Board Director to replace Joan Ryan, who announced her decision to retire effective our next Annual Meeting. We intend to have this new Board Member stand for election at our Annual Meeting in May and I’d like to thank Joan for her service, expertise, and commitment during her tenure on our Board.

Now let me spend a few minutes to discuss our views of capital allocation planning for 2010. We look at many opportunities to use our cash, including investing in our business in terms of opening new stores, remodeling existing stores, or improving our infrastructure.

We weighed these choices against our needs for working capital and using cash for other shareholder value enhancing programs. Over the past year, our primary objective was to use our cash prudently and stay both unleveraged and liquid in order to position us strongly for the future.

We believe this strategy, given the downturn in the economy and the pressure on cash flows, served us well. Our approach enabled us to get to what we believe to be the worst of the economic downturn, retaining a strong financial position. We recognize that the consumer is still tentative and spending is still weak, so at this time we have planned a modest number of new store openings and conservative infrastructure improvements in our capital allocations.

Together with our Board of Directors, we will continue to closely monitor the results of our 2010 initiatives and our business cash needs and evaluate additional ways to deploy cash and increase shareholder value on an ongoing basis.

In summary, we made strong progress in 2009, yet we are very focused on delivering significant improvement in 2010. We’re confident that the actions we’re taking by product, marketing, and human and capital allocation, will enable us to further profitably improve sales trends and most importantly, increase value for all Build-A-Bear Workshop stakeholders.

Now I’d like to turn the call over to John to review our merchandising and marketing plans and fiscal 2010 strategies in more detail.

John Haugh

Thank you Maxine and good morning, everyone. As Maxine noted, in 2009 we made great strides to improve our product, merchandising, and marketing and based on guest feedback and the performance of our current launches and events, we expect ongoing improvement in sales and profitability in 2010.

Our brand continues to be very strong and positioned very positively in consumers’ minds. We know we can perform at a higher level and we are focused on five key strategies to deliver our 2010 goals.

Number one, product innovation. We are improving our product offerings by enhancing the size of our launches and the design and value of our animals and related products.

Number two, full integration of product, marketing, and operations, creating a sense of urgency and excitement with each new product launch with strong promotional and marketing support, including powerful store visuals to further drive traffic, increased conversion, and improved sales and profits.

Number three, adding additional products to our assortment. As Maxine mentioned, we have begun to add other categories that our outside of our core plush animals, yet consistent with our interactive toy experience.

Number four, we will continue to grow our virtual world engagement, as well as improve our online and e-commerce business.

Number five, our sales initiatives also include new opportunities for our products to be sold outside of our current store base.

Let me discuss these five strategies with you. First, to have product launches that are bigger in terms of sales volume, in store excitement, and with a presentation that changes the store. While we will introduce a similar total number of new animals in 2010 as we did in 2009, we will group the animal introductions into larger statements that will be more noticeable to our guests, giving us powerful news to feature in our marketing, and having more meaningful visual presence in our stores.

As a result, each launch is expected to have higher impact as we focus our inventory commitments and improved price points to drive margin and average transaction value. Our second strategy is to fully align product, marketing, and operations to maximize store traffic and conversion during the key times consumers are in the mall.

When we deliver each new product story, which in many cases will only be for a limited time, we will create a sense of urgency for purchase. Each story will be told in a dramatic way with strong visual impact and we will focus all of our media and marketing efforts around that story.

We believe we will engage returning guests as well as pull new guests into our stores to check out the news and our merchandise assortments. Ongoing engagement with Build-A-BearVille will allow us to continue the brand relation and play value and continue to influence future visits to our stores.

While we have made significant reductions in our marketing spend to meet our cost savings goals, we are now re-weighting our programs using traditional and new media to stimulate kid demand for our products and to reinforce value with moms, reminding mom how affordable and fund Build-A-Bear Workshop is.

Our launches in 2010 have included the iCarly bear, and for Valentine’s Day, the Be Mine Dalmatian. Both have had terrific response driven by our coordinated approach to product marketing and store events. Using Valentine’s Day as an example, what this means is we focused our efforts on one message, puppy love, and one product statement, the Be Mine Dalmatian and its outfits, and one promotion, sounds.

This resulted in selling out of the seasonal animal and related merchandise, driving up our sound percentage by 6 points and moving our overall business in a positive direction. Our results give us confidence as we move to the key spring season.

On March 5, our stores will transform into an Easter theme with guests able to view our merchandise story featuring Easter animals of Blossom Bunny and an Easter chick with light up cheeks. Our marketing including kids television, direct, and moms and kids social and digital media will showcase Build-A-Bear Workshop is the headquarters for Easter. Furthermore, guests will receive a free Easter basket with candy as a gift with purchase with qualifying transactions.

Additionally during this period, based on our sell out of Alvin and the Chipmunks this past holiday, we have also added a special limited edition by of Alvin and Brittany to tie into the worldwide DVD launch in March. In a unique cross promotion with FYE Suncoast, over half a million flyers will be handed out in their US stores promoting this product launch at Build-A-Bear Workshop.

We will drive value to consumers while building our transactions by promoting this pair at regular $22 each or two for $35. Both Alvin and Brittany also have a musical add on which we sell at a very high ratio to the animal itself. We expect to sell through on this famous pair quickly.

We have exciting new merchandise stories launching approximately every 4 weeks throughout 2010 and we believe that the combination of new launches with enticing promotions will deliver the growth we need.

Our third strategy is to give guests more reasons to come to Build-A-Bear Workshop by expanding our leadership in the toy business with products that reinforce our brand values as this broadens our consumer appeal and gives consumers more reasons to come to Build-A-Bear Workshop beyond making their own plush animal.

Our first expansion into other toy products was an initial test of Zhu Zhu Pets, an in demand plush hamster and a perfect example of a toy that complements our brand essence and current offerings. Our product of Zhu Zhu Pets includes product found at other stores but also exclusive products and a tie into Build-A-BearVille.

We have approached the introduction of Zhu Zhu very strategically, closely monitoring guest reaction, sales metrics, and overall results. The test stores have seen an increase in sales driven by an increase in transactions. Overall, the average transaction with the Zhu Zhu Pets product is consistent with our historical average transaction. While the merchandise margin for this product range is below our proprietary levels, we expect to drive higher overall profits and enhance our bottom line.

We initially tested Zhu Zhu in 8 stores in the beginning of February and expanded to the current 50 stores and will expand to all US stores in March and all company owned stores worldwide by summer.

Turning to our fourth strategy which is to drive our online and e-commerce goals, the merchandise and marketing strategies that we are implanting also impact our e-commerce business. Online, our goal is to make it easier for our adults to shop with us and even more engaging for our kids to play with us.

Throughout 2010, we have planned enhancements for our website that will make it simpler to use, provide easier navigation, and allow users to easily find products with a focus on gift items. Already, our online focus is reaping results with positive December sales, our positive web trend continues in 2010, showing strength particularly around Valentine’s Day, which has always been a significant gift giving holiday for us.

In our virtual world, we continue to focus on increasing membership and driving monetization strategies to increase store revenue, sell virtual goods, and further engage our guests with our brand. Our research has shown that 1 out of every 3 guests visits Build-A-BearVille before visiting our store, over 40% of all animals registered in our stores by our core demographic come online in Build-A-BearVille.

In total, the value of the transactions associated with the animals brought to life online exceeded $64 million in 2009. To further build synergy between the real and virtual worlds, this past holiday we began to deliver coupons and other value offers in Build-A-BearVille and we will be adding additional promotions to our virtual world citizens to drive store traffic throughout 2010.

Traffic to Build-A-BearVille rose throughout 2009 and those trends continue in 2010. Site visitors spent an average of 28 minutes per visit, representing over 2.3 million hours of interaction with our brand every month.

Let me now move on to our final strategy of expanding our products and revenues from other sources. Engaging kids in the story of our products has been important to our success but also provides a larger opportunity to grow product and entertainment revenue both in our stores, online, and in other retail stores.

As many of you are aware, we recently announced an agreement with A Squared Entertainment, a global children’s and licensing company. Under this agreement, A Squared Entertainment, led by Andy Heyward and Amy Moynihan, will help us to create a stronger external licensing program.

A Squared Entertainment, in collaboration with Build-A-Bear Workshop, will develop an expanded line of licensed merchandise that will be sold outside of Build-A-Bear Workshop stores, including DVDs, accessories, apparel, and books, to name a few.

In addition, we will develop multimedia entertainment for future distribution online, on air, and on other digital devices. A Squared will also collaborate to produce original programming to expand upon the success of Holly and Hal Moose and will include other Build-A-Bear Workshop properties.

In total, we are providing more innovation, improving our marketing, and adding incremental revenue streams. We are excited about our strategies and encouraged by our early results in 2010. We are confident that our actions will result in improved revenue and profitability this year and now I would like to turn the call over to Tina to review our financial results and outlook in more detail.

Tina Klocke

Thanks, John, and good morning everyone. Our fourth quarter results showed a continued sequential sales improvement from the third quarter and included 180 basis point improvement in merchandise margin, as well as the continuation of disciplined expense and inventory management.

In fact, as Maxine mentioned, we saved an additional $7.1 million in the quarter with SG&A as a percent of sales essentially flat with the fourth quarter last year. For the full year we achieved cost savings of $25 million, $10 million ahead of our original goal.

Our fourth quarter GAAP net loss included the following non-cash charges: $3.9 million or $0.20 per diluted share in store asset impairment, $2.7 million or $0.14 per diluted share related to losses associated with our minority investments in Ride Makerz LLC, a startup company that began in 2007.

Beginning in the second quarter of 2009, we were required to record allocations of Ride Makerz losses. With these current charges, we have written off our entire investment I Ride Makerz who continue to work on their repositioning strategies.

Excluding those charges, 2009 adjusted fourth quarter earnings per diluted share were $0.29 compared to 2008 adjusted earnings of $0.45 per diluted share. Net loss for the fiscal 2009 year included the following costs: $4.1 million or $0.22 per diluted share non-cash charge related to store asset impairment, $5.9 million or $0.31 per diluted share non-cash charge associated with the company’s investment in Ride Makerz LLC, and $600,000 or $0.03 per diluted share related to the Friends 2b Made concept closure.

Excluding these charges, 2009 adjusted loss per diluted share was $0.10 compared to 2008 adjusted earnings of $0.50 per diluted share. For the fourth quarter, total revenue declined 13.5% to $122.9 million from $142.1 million in the fourth quarter last year. This year’s fourth quarter included 13 weeks and compares to a 14 week period last year.

Based on the average revenue per week of $10.1 million in the 2008 fourth quarter, the year-over-year decline is 6.9% versus the prior year. Consolidated net retail sales declined 15.4%, excluding the impact of foreign currency. The decline in sales was primarily driven by the 13.3% decrease in North American comp store sales and the benefit of a 14th week in last year’s fourth quarter.

The comp decline was made up of 9% decrease in transaction and a 4% decline in average transaction volume. While average transaction value was down year-over-year, the trend improved in the quarter. On a consolidated basis, our comp store sales decline in the fourth quarter was 9.9%.

Our European operations delivered another strong performance in the fourth quarter compared to the prior year with total retail sales up 1.4% excluding the impact of foreign currency. The positive performance was attributable to the increase in comparable store sales of 4.5% as our brand and experience continues to gain momentum with consumers.

This was partially offset by having one less week in the fourth quarter of 2009 versus 2008. Based on an average revenue per week of 1.2 million pounds in the 2008 fourth quarter, the total retail sales growth in constant currency is 9.2%.

In the fourth quarter, international franchise revenue increased slightly to $1.2 million. We ended the year with 65 international franchise stores, up from 62 last year. During 2009 we expanded our franchisee business to Mexico where we remain on track to open our first store in Mexico City in mid 2010.

For the full year 2009, fiscal year revenue from franchise operations decreased 19% to $3.4 million, primarily reflecting the global economic slowdown during the past year. For fiscal 2009, we currently expect franchise revenue to be in the range of $3 million to $3.5 million.

We are encouraged by strong new store openings in Australia, Dubai, and Germany. Selecting the right real estate location remains a key objective and as such, our franchisees will continue to pace their store growth. We anticipate international franchisees will open a net of 3 stores in 2010, including our first store in Mexico. As the global economy strengthens, there is significant potential for growth within our franchising operations.

Turning to licensing, revenue in the fourth quarter was $500,000, down from $1.1 million last year. Full year licensing revenue decreased to $2.5 million in line with our expectations. The decline in licensing revenue for the fourth quarter and full year reflects the anniversary of the Nintendo DS and Wii games from December 2008 with new launches for both scheduled for spring of 2010. For 2010 we anticipate licensing revenue to be in the range of $3 million to $3.5 million.

Gross profit margin for the fourth quarter declined 410 basis points to 39.5% from 43.6% in the prior year. While we achieved 160 basis point increase in merchandise margin, asset impairment cost and de-leverage in occupancy negatively impacted gross margin by 280 and 250 basis points respectively.

For the full year gross profit margin declined 460 basis points to 36.7 from 41.3 in fiscal 2008. Of this decline, 430 basis points is related to deleverage and occupancy which includes 90 basis points related to the asset impairment charges.

Total SG&A in the fourth quarter declined 13% to $48 million from $55.1 million in the 2008 fourth quarter reflecting further cost reductions in North America in marketing and store payroll, along with central office expense reductions in salary, outside services, and travel expenses. This resulted in total expense savings of over $7.1 million in the fourth quarter.

SG&A as a percentage of revenue for the quarter was essentially flat with the prior year at 39%. For the full year, we recorded a tax benefit of $11.4 million with an effective tax rate of 47.7% compared to an effective tax rate of 36.8% in fiscal 2008. The increase in fiscal 2009 compared to 2008 is primarily attributable to the impact of releasing valuation allowances that were previously recorded against the deferred tax asset related to net operating losses in the UK.

For fiscal 2010, we currently anticipate an effective tax rate of approximately 36%. Regarding cash flow, we ended the year strong with consolidated cash of $60.4 million, up 29% from fiscal 2008 or up 18% excluding the impact of foreign exchange.

As you know, we are an international company and as a result, about half of our cash on the balance sheet is domiciled outside of the US. Again this year, we had no borrowings under our revolving credit facility.

Because our cash fluctuates seasonally, we evaluate our use of cash on a continued basis. Our cash usage peaks ahead of holiday and key business periods as we build our inventories. At year end, our cash balance is high due to significant gift card sales and seasonal sales volumes.

For example, while our year end cash balance was $60 million, the seasonal fluctuation at the end of January resulted in a reduction of $20 million below year end levels. Accordingly, we constantly monitor our cash against seasonal needs and other possible uses.

We will continue to evaluate all opportunities to enhance shareholder value, including opportunistically resuming open market purchases of our company’s stock subject to market conditions, and we will also allocate our resources to opportunities that are expected to increase the sales productivity and profitability of our stores.

Depreciation and amortization for the quarter was $7.4 million, up from $7.1 million in the fourth quarter 2008. For the full year, depreciation and amortization was $28.5 million, down from $28.9 million last year. Depreciation and amortization for 2010 is expected to be approximately $28 million.

At the end of the quarter, consolidated inventories totaled $44.4 million compared to $49.7 million at the end of 2008. Inventory per square feet decreased approximately 11% and on a two year basis our inventory per square foot is down about 14%. We feel comfortable at the composition and level of our inventory as we begin fiscal 2010.

Capital expenditures in the fourth quarter were $1.5 million, down $2.7 million compared to the fourth quarter 2008, primarily due to no new store openings. Capital expenditures for the full year totaled $8. 1 million compared to $23.2 million in fiscal 2008.

Looking ahead to fiscal 2010, our top priority is to support the strategies we have developed to reignite profitable growth for our company, particularly in the marketing and merchandising areas as John just outlined.

We expect to increase our capital spending in 2010 to approximately $12 million, which will primarily be driven by upgrades in our infrastructure as well as the opening of 3 new stores, two stores in the UK in the fall and one new format store in the US by early summer. In addition, we will relocate one store in early fall, also in our new format.

With that, I’d like to turn the call back over to Maxine for her concluding remarks.

Maxine Clark

In conclusion, we began 2010 in a strengthened financial position. Our merchandising and marketing strategies have led to steady improvements in our North American comp and online sales results throughout 2009 and we are pleased with the ongoing improvements we’re having in 2010.

We also continue to improve operating efficiencies with further reductions in cost. Build-A-Bear Workshop possesses a highly passionate and dedicated team and I’m confident in our ability to generate improved performance in 2010. We are off to a good start. We look forward to updating you on our progress in the months ahead.

Now I’d 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) Your first question comes from Thomas Filandro – SIG.

Thomas Filandro - SIG

My question is around that low single digit comp comment as well as the flat in February to date. That’s a pretty dramatic turnaround from what you’ve experienced thus far. Are there any anomalies in terms of comparisons and can you explain exactly what’s going on, what’s working, is it transactional based, is it AUR or a combination of that, and could you give us an insight on what you’re thinking in terms of your marketing dollar spend and specifically how are you targeting dollars this year versus last year, what variances shall we see?

John Haugh

I think what you want to look at it is we feel like we’re making great progress and again, we’ve got product people really want, our marketing has been spent effectively, and our store operations team is really performing at a high level. We’re not going against easy numbers last year. In fact, we had some weather going against us. If weather were better, we’d be in even better shape. Everybody says that so we’re not blaming the weather for anything.

We are driving transactions, we are driving our average transaction, and we’re driving our units by really trying to bundle things together, so we feel like we’ve got a really good strong integrated program.

With respect to marketing, it’s a new frontier out there. We need to, as we’ve always had the challenge, we’ve got to get moms to say yes, we’ve got to get kids to want the products. New product is what we call shin kicking, it gets the kids to say to mom “I have to get into Build-A-Bear” and then we need something for mom, whether that’s a strong promotion, whether that’s a bundling opportunity, whether it’s some kind of limited edition.

So we’re trying to really drive both kid demand and give mom the ability to say yes and again, we’ve got to do it, first and foremost through product and Tina’s really done a nice job, the product assortment not only for the first two months of the year looks great but for the whole year. It’s laid out and we feel fabulous about it.

Then effective marketing and effective store operations. With respect to our marketing spend, we took a bunch of money out last year. As an A to S ratio, we’re going to come down a little bit more in 2010 but it’s not about just taking money out, it’s about trying to be more strategic with how we talk to both moms and kids, drive our CPM down, and ultimately get more people into our stores.

Operator

Your next question comes from Paul LeJuez – Credit Suisse.

Paul LeJuez – Credit Suisse

Just wondering what the margin looks like on the Zhu Zhu product compared to your regular assortment. Also how many stores are operating at a four wall loss and how many leases expire over the next two years? I guess I’m just also wondering if you can provide any details on rent reduction conversations that you’ve had.

John Haugh

From a margin perspective, as we said, we’re not going to make the same gross margin on a product like Zhu Zhu that you can find in other locations. You can find it at ToysRUs, you can find it at Wal-Mart, you can find it at Hallmark, you can find it at Justice.

That said, as we look at the lineup, as we mentioned, we’ve got both product that’s available elsewhere as well as exclusive product. We will price strategically. Delivering value to our customers is very, very important. So we’re not going to chase a Wal-Mart price point but we’re also not going to gauge our customers.

We’re going to have a fair price and we’re going to have product in stock when they’re looking for it, so we actually believe while we won’t get to as we said earlier our proprietary product gross margin, we do feel like we can have a good strong gross margin here in net net. It’s incremental business versus substitute business. It delivers more gross margin dollars to the bottom line.

Tina Klocke

In answer to your next question, we had a few stores in North America operating at a loss. We looked at them from an accounting perspective, from an impairment analysis, and impaired those this year as well as a few in the UK. Again, we’re not closing those stores, we’re looking at every way that we can, whether it be a rent concession or any other operating expenses that we can do to reduce costs associated with those stores so that they can become profitable again.

In answer to how many leases we have coming up for renewal this year, over the next two years, it’s about 30 stores that will be up for renewal but we continue to make progress with our landlords in negotiating rent concessions for anywhere from a period of one year to several years and just as a reminder those savings are amortized over the rest of the life of the lease which is on average about 5 years.

Operator

Your next question comes from Sean McGowan – Needham & Company.

Sean McGowan – Needham & Company

First just a follow up on Zhu Zhu, is this more of a unique opportunity because they’re neighbors in St. Louis or is it an indication of a different direction that you’re going in with some of the other sort of licensed products? Specifically what I’m looking for, are you going to allow consumers to actually make a moveable electronic of Zhu Zhu [inaudible].

John Haugh

It’s coincidence that they happen to be neighbors in St. Louis. For us what’s important is that the product is what our consumers said they are looking for. We did not jump into this lightly. We have spent time talking to our consumers. This started last summer and said, “What might a consumer expect to see” and we are about an experience, and Zhu Zhu happens to be a product that’s very experiential. It’s a big play value.

So it made sense for us to bring that into our assortment, but again it’s a complement. It’s not going to be the majority of our business, it’s something that our customers said it would be nice to have so we brought it in strategically but it’s not a big percentage of our business.

The second part of the question is do we fundamentally change it and make it stuffable? Probably not really. Right now that team has done a nice job with their product. They’ve got a great new product pipeline and that’s what we will capitalize on, and again, I mentioned we’ve got exclusive opportunities with them, as I’m sure some of their other partners do.

So that’s how we will talk to our consumer, that we’ve got an in demand product that compliments, doesn’t substitute, Build-A-Bear Workshop and we’re going to continue to offer you what you’re looking for as a Build-A-Bear customer, both as a kid and a mom.

Operator

Your next question comes from Gerrick Johnson – BMO Capital Market.

Gerrick Johnson – BMO Capital Market

I was hoping you could discuss a little more the new format store you’re talking about and then perhaps some commentary on the ToysRUs holiday express stores and how they may have impacted your business this past holiday season.

John Haugh

Here’s where we are on new format. We have one of the most iconic brands in retail. Kids love us. Moms love us. If kids could, they’d go to our store every single day of the year. But retail is about refresh, it’s about innovation, so what’s really critical to us is that we refresh and we innovate but we don’t lose our iconic status, so we do have a new format that will keep the core of what people really expect at Build-A-Bear, the experience, the ability to create this personalized experience.

But we’re going to update it a little bit. We’re going to make it a little more contemporary, we’re going to give it a chance to tell more stories, more vignettes. As we really push for big product ideas, we want to make sure when a customer comes in they see that product holistically and they really get a chance to see the Be Mine Dalmatian with all of its outfits and with its sound and we really get to have that kind of front and center and we’re really about that for a Valentine’s Day or Easter or whatever it happens to be.

So that’s where we’re going to go. We’re shooting for Memorial Day and we’re confident in it based on success it would be where we would try to go with a renewal as we talked about earlier as we start in some cases repositioning. With respect to ToysRUs, we don’t know what they did for the holidays. We’ve heard they had a good holiday season.

The key is when more interest comes to kids and kids toys, all ships go with the rising tide, so we feel good about that, if they drive more people to the mall, fantastic news for us because we know we’re going to capture them.

Operator

Your next question comes from Michael Smith – Kansas City Capital.

Michael Smith – Kansas City Capital

The Zhu Zhu Pet thing, will you carry the whole line of Zhu Zhu Pets like the new Ninja that’s coming out shortly?

John Haugh

Zhu Zhu, a complement in our business to our core. Right now it’s on a two way so it’s got about four linear feet of exposure in a store that’s 2500 or 2600 square feet. So that gives you some sense of kind of where it is.

What we will do, as our customer would expect, newness and freshness and innovation, so when Zhu Zhu, Cepia, the parent company, says we’ve got a new line for summer and fall or holiday, whatever it happens to be, and we’ll take a look at that line and figure out what makes sense to go into our store in terms of what the whole market has available to them, what we want to customize for our customer, and then we’ll make the right choice but again, from a limited inventory perspective.

Just to reinforce both your question as well as others, Build-A-BearVille is critical to us. We mentioned earlier about continuing to engage our kids. When they come to us via Zhu Zhu as an example, we’re also going to get them into Build-A-BearVille and that strengthens our brand and our franchise and our virtual citizen.

So we kind of win both ways here. We feel really good about it.

Operator

Your next question comes from Thomas Filandro – SIG.

Thomas Filandro - SIG

Can you tell us what comp you need to leverage occupancy and then can you give us some understanding of what you’re seeing in terms of the product costing side of the business? How should we think about [INUs] in 2010. Maybe you can sort of regroup us on the concept of value. We moved this strategy to more $10 and $12 skins and how that plays out in 2010 and a view of [AUR].

Tina Klocke

I think from a perspective of what we need to comp, I think once we can leverage expenses, I think if we did just a positive comp we’ll be able to have a good flow through that will actually leverage expenses.

As far as initial merchandise margin, we saw an improvement in the fourth quarter and we hope to continue to see an improvement into the first and second quarter of this year.

John Haugh

Let me build on Tina’s point and then we’ll hit the last point about value. We have a great product development team. We have great partners and like all retailers, when we sit down together and plan 2010, we said to them, we want to grow our business together and we want you to charge us less for the product but we want to deliver more value to the customer.

So we have initiatives in place to continue to work on our gross margin. Our initial markup as well as our maintained margins, so while we have a promotional strategy during key times, we talked about Alvin and Brittany so Alvin and Brittany are coming out at $22 per or 2 for $35. We have gone ahead and already planned the 2 for $35 into our gross margin so we’re going to be able to deliver to the consumer a value but also not just take $7 out of our gross margin.

So that’s how we’re trying to think about it and we feel good about that. With respect to where we land our business, $10 and $12 is important to the business. It serves our party business well. Often times it’s an introduction to a new customer. Our core is $15 or $16 animal with an outfit, with sound, with shoes, and with an accessory. That’s what Build-A-Bear was built on and that’s what we continue to focus on, and that’s where we put our energies.

So $10 and $12 will continue to have x% of our inventory, x% of our sales, because we want to be there, it’s what we stood for early, it’s what we still stand for, but our core business is in the $15 to $16, kind of what we call the heart, the middle of our [inaudible] wall, and that’s where we’re really going to continue to drive our innovation and our product developments.

Operator

Your next question comes from Sean McGowan – Needham & Company.

Sean McGowan – Needham & Company

I was wondering if you could go over again some of the metrics on Build-A-BearVille, if you could repeat what you said already on what kind of incremental benefit you’re getting and then just give a little bit more color on where you see that going.

Tina Klocke

Build-A-BearVille has been very, very strong for us. We have over 14 million registered avatars and growing every single day over the prior year. So its engagement with our customers is increasing. As John mentioned, about a third of our customers go to Build-A-BearVille before they even come to our store to see what’s new, to see whether there’s a promotion, to see what’s happening in our stores.

Then they come to Build-A-Bear and then buy. Then when they leave our store, about 40% of them in our target demographic which is girls over 8 years old come back online and register that animal for its prizes and its rewards and its accoutrements that go with it online and play with it online and just those transactions of that group altogether were $64 million in revenue last year so while we know that some people might have come to Build-A-Bear Workshop anyway, we can see their play and engagement online and that is very impressive.

Then they spend almost 30 minutes online playing every time that they come on so we have a very loyal customer. It may not be the highest number of unique visitors of some of these sites that come online, but it’s a very loyal customer and they come frequently, we see points, they play games, and now we’ve started to promote back to them, giving them a reason to come to the store with a free Build-A-Bear Outfitter’s credit card, something that they can bring back again to Build-A-BearVille and become engaged with our brand.

That’s the most important thing. Even in the days of a couple weeks ago when schools all over the country were closed for snow, we could see those were very, very large days of engagement with our kids. They were online playing in record numbers and if we didn’t have that, we wouldn’t have had any engagement with our kids that day, it would have just been a total white out.

So we feel very encouraged by how this is growing on a month by month basis, on a week by week basis, and we can see it exactly, we can see into it, we can turn it on at any given time of the day and notice children’s engagement with our brand and parents as well.

Operator

Your next question comes from Matthew [inaudible] – private investor.

Matthew [inaudible] – private investor

I understand it’s a weak environment but in 2010 you guys generated $13 million of cash and announced today on [$50] million in cash on your balance sheet. In a zero interest rate environment, isn’t that destroying shareholder value?

Tina Klocke

As we said in our conference call script, it continues to fluctuate. At the end of January, that balance was already $20 million less because of the seasonal nature of our cash flow and also as a reminder, that half of our cash is domiciled outside of the US so as you know, there are tax implications of bringing the cash back and we’re going to utilize some of our cash in foreign operations to build some new stores.

So again, just as a reminder, we have a seasonal nature of cash and that again as we talked about in 2009, that we wanted to protect our balance sheet. We also made mention that we would also continue to look for opportunistically to repurchase our shares and we will continue to do that in line with our Board of Directors.

Operator

Your next question comes from Brad Leonard - BML Capital Management.

Brad Leonard - BML Capital Management

The only thing that stumped me was the North American comps. I thought they’d be a little bit better and when you look at the breakdown between traffic and ticket, I’m also a little surprised that ticket was down 4% I believe Tina said and so how did the flow through the quarter on a month to month, because on the last call Maxine said that they got better each month of the third quarter and into October.

You said also that they’re kind of a lot less negative, you said while not yet positive they’re a lot less negative and I don’t know where a lot less negative falls but it make same believe that maybe through the quarter the comps weakened a little bit. I know we’ve seen a change so far year-to-date which I’m happy to hear, but any help on the comps and kind of also I really thought with the price points being higher this quarter that the ticket would have maybe flatlined or been stronger. So any help on that would be appreciated.

Tina Klocke

On the ticket price, we actually did have an improvement in our animal sale price. Our animal prices did go up but we lost a little bit in our units per transaction so the number of units that people bought, which I think is reflective of the economy. They did buy the stuffed animals and we’re seeing that growth in our animal ratios to total sales and they like the animals but the prior year remember we had a huge amount of animals sold at $10 and $12 and there were a lot of transactions of that.

It may have looked like it was an easy, even we were surprised, we thought we could definitely maintain more of that traffic than we did. In the third quarter, there’s always a month up or a month down but in the end what we did in the fourth quarter better than the third quarter, even though October was better and November was slightly worse and then December was back on track towards the improvement.

What we’re most encouraged about and we’ve seen that consistently since December, is that each week is getting sequentially better and then so far in February, normally we wouldn’t even talk about it because we don’t want to do anything to jinx it, encouraged by it because of the weather that impacted and the number of closed stores we had and to be at the level that we’re at even through yesterday is I think a very good sign that the customer is coming back to Build-A-Bear Workshop.

Also, as John mentioned, we had very strong product introductions in January. While they were singular and not yet on the strategy that we have of multiple animal promotions or introductions, they were very strong. We had an iCarly sneak peek event over a weekend, tremendous response, and we had the Valentine’s animal which actually we launched later this year than we did prior. We usually launched it right after Christmas but this year.

That might have impacted it a little bit in our December sales but we had very strong Hello Kitty launch at the end for the kids. As we launched the heart spotted Dalmatian, Be Mine Dalmatian, and it has been strong since the day it launched and we actually are very, very clean on it

We had what I consider to be the best news of all, an incredible Valentine’s weekend, our biggest weekend since last Valentine’s Day and our biggest Saturday ever, and also a very, very big strong Sunday and Monday, showing that when the customer has got some interest in buying, Build-A-Bear is a place they come, and that’s continuing.

So I don’t want to be overly confident but I think these are very, very positive signs that point to maybe even us getting, we have a plan that takes us month by month by month back up to positive, and I think that we may be slightly ahead of that track based on January and February performance so far.

Anything can happen. March is a very big month, we’re excited about March with or very big focus on Easter as a holiday and as an event in our store, and I think we’re going to have a good first quarter. Then we’ll be able to be a little bit better down the road is how this is moving, but we are very excited about our product introduction.

The Build-A-Bear product line is incredible and we really feel very strongly about how big that will be for our customers and how strong it’s been in the last several launches that we’ve had, even into the end of 2009.

Operator

Your next question comes from Thomas Filandro – SIG.

Thomas Filandro - SIG

Just a broad long term kind of question, is there anything structurally different in our business that would not allow you to achieve the high single digit, low double digit operating margins you’ve experienced in the past?

Maxine Clark

Structurally, obviously the climb back up in comp store sales and sales productivity for any retailer would be sequential and hopefully smooth and steady but I think that there’s nothing in the way of getting there that I know of. I think it’s incumbent upon us to continue to find a product, whether it’s Build-A-Bear product or a new product outside of Build-A-Bear now that we believe we can sell profitably in our stores to help us drive that.

John Haugh

Further to Maxine’s point, we feel positive about where we’re going with sales and we talked about taking $25 million of expense out last year. We didn’t put that back in in 2010 and in fact we think there’s a little bit more so if we get sales where we’re all looking for them to be, we as well as you all, we’ve already got that going for us so that I think is a big positive and I think despite crummy times last year, taking that money out and keeping that money out for 2010 is important to us and make a little more progress and that’s going to help us overall.

Operator

We have no further questions in queue at this time. I will now turn the call back to Ms. Maxine Clark for any closing remarks.

Maxine Clark

I’d like to thank everybody for joining us today and we look forward to speaking with you when we report our first quarter results in late April.

Operator

Thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect your lines. Good day.

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Source: Build-A-Bear Workshop, Inc. F4Q09 (Qtr End 1/2/10) Earnings Call Transcript
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