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

Q2 2011 Earnings Call

July 28, 2011 9:00 am ET

Executives

Allison Malkin – Senior Managing Director‎, ICR

Maxine Clark– Founder, Chairman and Chief Executive Bear

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

Analysts

Sean McGowan – Needham & Company

Janet Kloppenburg – JJK Research

Operator

Good day ladies and gentlemen, and welcome to the Build-A-Bear Workshop, Inc., Second Quarter Fiscal 2011 Results Conference Call. My name is [Kiana], and I’ll be your operator for today. At this time, all participants are in listen-only mode and later we’ll conduct a question-and-answer session (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

Now I’d like to turn the conference over to your host for today, Ms. Allison Malkin with ICR. Please proceed.

Allison Malkin

Thank you. Good morning. Thank you for joining us. With me today are Maxine Clark, Chairman and Chief Executive 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 their questions. We ask that you limit your questions to one question and one follow-up, this way we can get to everyone’s questions during this one-hour call. Feel free to re-queue if you have further questions.

Please note that our 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 our Annual Report on Form 10-K, and we undertake no obligation to update or revise any forward-looking statements.

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

Maxine Clark

Thank you, Allison, and good morning everyone. Thank you for joining us to discuss our second quarter fiscal 2011 results. For our call today, I’ll begin with comments on our second quarter performance and other key initiatives. I’ll also give insight into our product and marketing strategy.

As you know John Haugh, our President recently resigned. I’d like to thank John for his contributions to Build-A-Bear Workshop and we wish him well.

While we evaluate our future organizational structure we have assigned his responsibilities to other senior leaders of our company all with significant retail and Build-A-Bear Workshop experience.

Following my remarks Tina Klocke, the Chief Operations and Financial Bear, will follow our financial results and update you on progress of cost to savings related to our recent consulting project. Then we’ll open the call to take your questions.

In the second quarter we grew our total revenue by 9% excluding the impact of foreign exchange, driven by a 7.1% increase in our consolidated comparable store sales. Comp sales were up in both North America and Europe, positive 8.3% and positive 1.3% respectively.

While the shift in Easter benefited our second quarter comp by approximately 6%, our sales growth continued positively post Easter. Consolidated comp sales in May and June combined are up approximately 1% with strong margins giving its confidence that we are making solid progress towards our annual goal.

Our top line growth also reflects strong e-commerce business up 22.8% in the quarter reflecting the success of web-specific marketing initiatives and our ability to improve conversion and transaction method with an updated technology platform.

Our net loss in the quarter was $6.7 million or $0.37 per share, a significant improvement from last year’s second quarter loss of $8.5 million or $0.45 per share.

As you know, the second quarter is our smallest quarter and typically results in a loss even when Easter shifts into the period.

We remain very focused throughout our organization on increasing shareholder value. We are intensely focused on continuing to grow our comp sales through our merchandize, marketing and operations initiatives and improving our profitability by aggressively implementing the findings of our consulting project to reduce costs.

We see major opportunities to grow our international revenues in an increasingly global economy through existing franchisees and by adding additional country.

We believe Build-a-Bear Workshop is a great investment, so we continue to repurchase our common stock. And we will strategically use our strong balance sheet to take advantage of other growth opportunities they present themselves.

We also see opportunity to update our store design and experience with existing new features that will increase guest engagement and drive traffic to our stores.

During the quarter, we made solid progress towards our product, marketing and expense goal. Our consolidated comp store sales increase was driven by a 5.4% increase in transactions and a 1.7% increase in average transaction value, reflecting the strength of our animal launches and related apparel, marketing support, and operational execution.

Our retail gross margin was up 490 basis points and our merchandise margins were strong as a moderated product cost increases through strong negotiation and selectively increased retail prices, optimizing our merchandize mix in the process.

We are in a full core press implementing projects to improve our efficiencies and reduce expenses identified in our consulting project. As expected, our 2011 second quarter results included cost of $0.05 per share associated with this project and we expect to realize significant annualized savings beginning in the back half of this year.

Now, let me go through some of the main highlights driving our sales growth in the quarter, which gave us growth across all geographies. Our key merchandize initiatives moved us forward including our new animal introductions, updated core animals, improved coordination of apparel and accessory and the addition of new product categories.

For example, our on core to last years’ Ice Cream Bears, Blizzard Bears in North America and Ice Cream Bears in Europe had updated features such as the scented ice cream cup and fashionable related apparel.

We launched this collection earlier than last year in order to leverage a high traffic June and give us a strong kick off to summer. We brought two great brands together this year in North America with the time of Dairy Queen. This gave us brand exposure in over 6,000 DQ store and high visibility in digital media resulting in many more brand impression than last year.

In the UK we partnered with Baskin-Robbins in a similar way to expand the reach for our brand beyond our stores.

In our previous calls, we said we would be making more frequent update to our core animals, which in this quarter included a great launch of Pink Hello Kitty. Hello Kitty has been a powerful property for us for several years, but this is the first time we offered a pink version.

Pink Hello Kitty has a higher than average retail and her coordinated apparel and accessories results in a high average transaction value. This was such a successful core update that we’re going to leverage other colors seasonally as we move forward.

Our most recent launch starting July was the introduction of Smurfs in conjunction with the movies release. Theatrical tie-ins generate and help bring traffic to our stores as we leverage the energy in advertising that the movie studios generate. The Smurfs launch has been such a strong traffic in sales generator that we are bringing in another round of product timed with the release of the movie’s DVD coming this holiday.

We continue to capitalize on opportunities to sell other brand consistent toward products just for impulse purchases and add on sales. After a successful test, we added Angry Birds product, flash versions of the Birds and Pigs that are featured in the highly popular mobile game to all stores in late June.

And we also added a new collection of our proprietary SmallFrys on July 1, and we’ll introduce another collection in September. We are building a key business category by offering relevant pick up items that are easily added on to core product sales, but also appeal to in all of the demographic and bring new customers into our stores.

Our integrated marketing and promotional support was also very effective. Our Easter gift card up sell promotion were guests could purchase a gift card for half off with the qualifying transaction resulted in 200,000 incremental cards going into the market taking advantage of strong Easter traffic to feed business into the summer months as redemptions peak.

We engage with kids and moms and we’re using digital media to reach both of these targets through online initiatives that put our brand where our customers are spending more and more time.

For kids, Bear Bell continues to grow and our new features have resulted in improved key metrics. Unique business to the sites were up over 48% over last years second quarter and we now have over 20 million avatars created. The amount of time children spend on the site per visit has increased, which means engagement with our brand continues to grow.

Camp Happy Heart, a highly anticipated annual event is once again in session and is on track to set new records this summer. Moms are showing their royalty to our brand as well. We know have over 1 million Facebook fans making us one of less than 300 companies worldwide have over 1 million fans.

And we have new initiatives in work that will engage our guests with video content and creation and give us a stronger presence on YouTube, a site that is very popular with kids and adults.

Victoria Justice, our brand ambassador is star of the hit show; Victorious on Nickelodeon continues to be featured in our advertising and marketing program.

Build-a-Bear Workshop is known for our fashion, so partnering with Victoria is a great fit. She is all about the latest trends and hot looks. In August, we will be launching Victoria Justice fashion for bears to lever this relationship even further.

We are confident that our strategies will continue to grow our sales in the second half and we expect to achieve our profitability goals for the year.

On August 5, we’ll start the third annual $29.99 bundle promotion that gives our guest the opportunity to purchase any animal, any outfit and any pair of shoes for $29.99. This event makes it easy for mom to say yes to their kids when they’re outdoing their back-to-school shopping.

In September, we are really excited to introduce the world famous Peanuts characters, Snoopy for the first time ever. Our version of Snoopy has a fun movement and musical feature.

While we typically review our Q4 product introductions on our next call, I do want to mention some highlight. We are very excited to partner with Microsoft on the fall launch of Kinectimals now with Bears. Introduced last year, Kinectimal has become one of Microsoft’s most popular titles for their animal friendly Kinect to the Xbox 360 platform.

As you may know, the Kinect system launched in the fourth quarter of 2010 with record-setting demand over 10 million systems sold. In Kinectimals, kids, families and animal lovers of all ages interact virtually with animals featured in the game. The play experience is adorable and has brought a whole new customer to Xbox including (inaudible).

Thanks for the leadership of our Digital Marketing Chief, Teresa Kroll and our CIO Dave Finnegan; we are once again bringing two great brands together. This year’s extended release of the Kinectimals game has a bear theme and Build-A-Bear Workshop will offer several exclusive bears that will unlock branded Build-A-Bear Workshop bears inside the game.

It is a natural fit for the leading gaming system and the authority [unflash] to come together in this unique way. Both companies will use full marketing assets to drive revenues and cross promote each other’s product.

In addition to this merged DVD, we will also tie in with two major holiday theatrical releases, which will bring a lot of attention to our product and bring guest to our stores to bring the movie characters to life without flash version.

To summarize, we are optimistic about the back half of 2011. Our product assortment looks great. We’re supporting this with strong marketing, integrating these initiatives into our signature store experience. And while the quarter has just begun, July is off to a good start.

Now, I’ll turn the call over to Tina to review our financial results and outlook in more detail.

Tina Klocke

Thanks, Maxine and good morning, everyone. Let me start by giving additional details about our second quarter results. For the second quarter, total revenues increased 10.4% to $81.8 million from $74.1 million in the second quarter last year. Excluding the impact of foreign currencies, total revenues increased 9%.

Consolidated comparable store sales increased 7.1% with increases in both North America and Europe of 8.3% and 1.3% respectively. International franchise revenue increased to 714,000 from 661,000 last year. We ended the quarter with 70 international franchise stores versus 60 last year.

During the quarter, we expanded our international business with a successful opening of our first franchise location in Brazil. We believe that international growth is a key opportunity and are working closely with our franchisees to aggressively move the business forward.

Retail gross margin increased 490 basis points in the second quarter to 35.8% from 30.9% last year. This increase was primarily driven by a 130 basis point improvement in merchandize margin and 320 basis points in leverage of fixed occupancy cost.

We will continue to refine our sales mix and expect the benefits of our consulting project to allow us to maintain strong merchandised margins in the second half of the year.

Total SG&A in the second quarter was $40.5 million or 49.5% of total revenues, compared to $36.4 million or 49.1% of total revenues in 2010. Excluding the consulting project costs, SG&A, as a percent of total revenue was 47.7% in the second quarter.

For the quarter, we recorded a tax benefit of $4 million, which compares to a tax benefit of $4.1 million in the second quarter of 2010. For the full year of 2011, we continue to expect our tax rate to be approximately 38%.

Net loss in the second quarter was $6.7 million or $0.37 per share compared to a net loss of $8.5 million, or $0.45 per share in the second quarter last year.

As Maxine mentioned, the net loss for the second quarter of fiscal 2011 included a consulting fee that impacted our earnings by $0.05 per share. As a reminder, net loss for the second quarter of fiscal 2010 included a non-cash charge of approximately $300,000 or $0.02 per share related to the impairment of ceratin long-term deposits.

Now turning to our first half results, total revenues increased 1.3% to $177.8 million form a $175.6 million in the first six months of the year. Excluding the impact of foreign currency, total revenues increased eight-tenth of a percent.

On a consolidated basis, our comp store sales declined by 2%. This includes a 2% decrease in North America and a 1% decrease in the European operation.

Net loss for the first six months of 2011 was $8.9 million or $0.15 per share compared to a net loss of $6.8 million or $0.36 per share in the first six month of last year. Net loss this year included $0.10 per share in consulting fees. Net loss in 2010 included $0.02 per share at non-cash impairment charge related to certain long-term deposits.

Regarding cash flow, we ended the first half with a strong consolidated cash balance of $34.7 million. We have no debt and we did not make any borrowings against our credit facility.

During the quarter, we repurchased 389,000 shares and now have $18.6 million available under our share repurchase program.

Depreciation and amortization for the quarter was $6.2 million compared to $6.8 million in 2010. We expect depreciation and amortization for the full year 2011 to be approximately $25 million.

Capital expenditures in the second quarter were $3.8 million, primarily for store related capital and software and equipment upgrade. This compares to $3.2 million in the second quarter of 2010.

We continue to aggressively review our visiting store portfolio to optimize our overall productivity and profitability. During the second quarter, we completed the downsizing and relocation of four stores in North America. Initial results from these relocated stores are in line with our expectations.

For the year, we are on track to open five permanent new stores across geographies. In addition, we expect to open three pop-up stores which allows us to reuse fixtures and equipment and testing markets prior to making long-term based commitment.

We expect to close five to 10 permanent stores this year. To date, we’ve closed three stores in North America and one in the U.K. We’ve also closed three pop-up stores that were opened last fall.

We expect capital expenditures for the full year to be between $12 million and $15 million.

At the end of the quarter, consolidated inventories totaled $46.2 million compared to $57.1 million at the end of the second quarter of 2010. Inventory per square foot decreased approximately 20% inline with our plans, and puts us in good position to respond to product and pop culture trend in the back half of the year.

Turning now to our consulting engagement, we initiated the consulting project with a focus into product sourcing and supply chain, because we anticipated the global pressure on pricing and other component and transportation costs that the industry is now experiencing.

Towards the end of the first quarter, we moved into Phase II of the project focusing on additional areas of operations including store productivity, marketing and other expense areas.

We continue to expect to realize savings in the range of $4 million to $6 million in 2011, primarily in the second half, which would equate to $0.14 to $0.21 per diluted share. We expect annualized savings to be $10 million to $15 million. We are aggressively acting on the findings in order to get the most benefit we can in 2011.

As we move into our fiscal third quarter, we are pleased with our current sales trend. We’re focused on implementing the findings of the consulting project to improve our cost structure and we’re committed to our goal of increasing shareholder value by profitably growing our sales.

For those of you that build models in our business, we would like to remind you that last year second half included $6.4 million in non-reoccurring commercial revenue at no gross margin, $5.8 million coming in the third quarter. We do not anticipate a similar transaction this year.

This concludes my remarks. Now, I’ll turn the call back to Maxine.

Maxine Clark

In conclusion, we feel good about the start to the second half of the year. We are growing our business in our company-owned stores and e-commerce by building synergies between our core product, our partnerships with other world-class brands and through added engagement in and out of our iconic stores.

Build-A-Bear Workshop is a powerful global brand, kid’s lover and moms trust us worldwide. We are in a strong financial position to drive growth both domestic and international.

Along with our Board of Directors who will continue to evaluate all potential users of our capital, including the repurchase of shares and invest as opportunities arrive in strategic initiatives for the benefit of Build-A-Bear Workshop’s stake holders.

With that, 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) And our first question comes from Sean McGowan with Needham and Company. Please proceed.

Sean McGowan – Needham & Company

Good morning. Thank you. My questions are regarding gross margin. Typically over the years the second quarter is generally the lowest of the four quarters in terms of gross margin as a percentage of sales, do you expect that to be the case this year and how much higher than this level you think they can get?

Tina Klocke

Hey, Sean it’s, Tina.

Sean McGowan – Needham & Company

Hi, Tina.

Tina Klocke

Last year we ended the year with a gross margin of 40%, and so we believe that we can get to that and hopefully improve a bit upon that with our cost savings initiatives through out our consulting projects. But again in the second quarter, we were able to leverage our fixed overhead expenses, because we had comp growth in that quarter.

Sean McGowan – Needham & Company

Okay. So that would imply, then at the margins in some subsequent quarters could be higher than 40, right?

Tina Klocke

Right.

Sean McGowan – Needham & Company

Okay. Thank you.

Operator

(Operator Instructions) And our next question comes from the line of Janet Kloppenburg with JJK Research. Please proceed.

Janet Kloppenburg - JJK Research

Hi everybody.

Tina Klocke

Hi, Janet.

Janet Kloppenburg - JJK Research

Hi. I just wanted to ask about Smurfs. It sounds like it’s doing very well and I’m wondering about the inventory availability there and if you think you’ll have enough to meet demand as we go through this period. and then, I think the DVD releases the fourth quarter. Will you be able to meet demand there?

Tina Klocke

Well, we actually have been to [south] for a couple of weeks, so we’ve been selling it like hot cakes. And while we will have some through the weekend, I’m sure and we have some alternatives to little pickup items add-ons, we’ll have those longer than we’ll have to make here. So it depends on the store, but obviously there is always opportunities somewhere and we have gone into it for the fourth quarter to make a bigger deal of it and we are also bringing in pop-ups for the fourth quarter. So that will be a really nice addition to our assortment.

Janet Kloppenburg - JJK Research

Okay. And I just wanted to ask about the comp store sales trends in the post Easter period. They were positive. Is that right?

Tina Klocke

Yes

Janet Kloppenburg - JJK Research

And were they up to your expectations or did you think that you might have done better if you would had different inventory or different promotions perhaps you could talk a little bit about the post Easter period?

Tina Klocke

No, I think that we have some inventory challenges in early, coming out of Easter and we had a very strong Easter, and we’re repositioning our inventory, but I think that considering how much better our Easter was than our plan then, it will take some customers out of the market earlier than later.

And then in May and June, which we were positive we ended up there was some changes in school holidays and things like that, but June ended on a very strong note and then July is very strong, especially with, since most of it has come out. So July is good and this continues, it seems to continue to build, so we are building back our inventory position and we are feeling good about our business as we go into this part of the year as I said.

It’s just getting all the inventories back in line, and also making sure that we the inventory behind the key products that we are featuring for our gap, I mean, the Smurfs has just been fantastic and we’re very excited about how that’s added to our business in the last few weeks.

Janet Kloppenburg - JJK Research

Great. Thank you so much.

Maxine Clark

Thanks, Janet.

Tina Klocke

Thank you.

Operator

And we have a follow-up question from the line of Sean McGowan with Needham and Company. Please proceed.

Sean McGowan – Needham & Company

It’s actually sort of a multi faceted question about the consulting project and the subsequent cost savings. If you can touch on a couple of things; was there any benefit of the cost savings seen in the second quarter. Similarly where will we see the impact, will it all be in SG&A with some of it being in cost of sales, and is the savings goal that you’re articulating, is that net of the cost of the consultants or is that before taking out that cost?

Tina Klocke

Okay. So there was just, really just slight benefits not even worthy to call out in Q2 as we started at the latter part of Q2 with the transportation savings that we have gotten and that will be in third and fourth quarter. And what we look at where it will be I would say right now, we’re looking at probably about 40% of the, between the $4 million and $6 million will be related to gross margin and the other portion will be in SG&A expenses, and the $4 million to $6 million are after consulting services. So it’s the net, because we’ve already taken $0.10 or the $3 million in consulting expenses in the first and second quarter.

Sean McGowan – Needham & Company

Okay. So of the annuals or annualized as well as the after I mean (inaudible) are similar pay $5 million to save $5 million. Okay, thank you.

Operator

(Operator Instructions) As there are no further questions, I’ll turn the call back over to Maxine Clark for closing remarks.

Maxine Clark

Well, thank you again for joining us, and we look forward to speaking to you again when we report our third quarter results in October. Have a great day.

Operator

Ladies and gentlemen that conclude today’s conference. Thank you for your participation, you may now disconnect. Have a great day.

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