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

Q4 2011 Earnings Call

February 16, 2012 09:00 am ET

Executives

Maxine Clark – Founder, Chairman and Chief Executive Bear

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

Allison Malkin – ICR

Analysts

Sean McGowan – Needham & Co.

Operator

Greetings and welcome to the Build-A-Bear Workshop’s fourth quarter and fiscal 2011 results conference call. (Operator instructions) A brief question and answer session will follow the formal presentation. 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 and 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 2011 fourth quarter fiscal year results. On our call today I will discuss our full year results including our fourth quarter, then I’ll turn the call over to Tina Klocke, our Chief Operations and Financial Bear, to review the financial details. After that, I’ll conclude the call with an overview of our growth plans for 2012 and beyond.

For the full year of 2011 we had essentially flat net retail sales and our comp store sales declined about 2% on a consolidated basis. I am extremely disappointed to report a sales decrease in the fourth quarter, particularly on the heels of two periods of positive comps in our second and third quarters.

We do understand the reasons for the decline and we are already putting changes into effect in 2012 to improve our results. In fact, through Valentine’s Day, our comp store sales are essentially flat in North America, and the UK and e-commerce is up almost 9%. Coming off of a solid third quarter in which we grew our total retail sales, comparable store sales and e-commerce, we believe that we had a line up to the fourth quarter that would continue to improve our sales.

Not only do we have a solid core assortment of Build-A-Bear Workshop proprietary products, but we also had tie-ins with highly anticipated feature film releases, particularly Happy Feet Two and Shipwrecked featuring Alvin and the Chipmunks. We were excited that the movie industry was placing such a high emphasis on family-oriented films, and given our strong sales history of products that tied into these movies, we felt that our holiday would benefit from these partnerships.

Unfortunately for the movie industry and for Build-A-Bear Workshop, the holiday season at the theater was one of the most disappointing in years. Both Happy Feet Two and Shipwrecked were sequels with strong historical box office performance and very strong sales on the feature characters at Build-A-Bear Workshop, but neither film performed as projected or in accordance with their box office.

In fact, box office revenues were down over 60% and 40%, respectively, to their last releases. This contributed to a sales shortfall to our plans for our movie-related product. Had either of the films performed to expectations, our fourth quarter would have had positive sales on a consolidated basis.

As many of you know, the holiday season was also very discount-driven. We anticipated this trend and offered promotions throughout the holiday to entice shoppers, including our popular bundle promotion, which we’ve used successfully in the past to increase average transaction value and guest conversion. However, when the characters from the movies came up short of plan, we had to step up our promotions to move the inventory and drive traffic. These promotions impacted our merchandise margin for the fourth quarter, which declined by 150 basis points from the prior year. It was the right thing to do given the season and our product challenges.

The final note on the fourth quarter is that our gift card sales increased on a consolidated basis indicating that the Build-A-Bear Workshop’s gift of the experience is still very much in demand. To add to that, our guest experiences for us for the fourth quarter were at record levels.

As we begin 2012, we recognize the global economy remains uncertain and consumers are still focused on value and promotions, and yet we have demonstrated that when we have the right product, make it easy for moms to say yes, and deliver our signature guest experience, we’ve been able to grow our sales both in our stores and online.

We are intensely focused on improving our product offerings and refining our promotional strategies, putting our learning from the holiday season into practice right away. On the product side, our goal this year is to continue to leverage our proprietary product collections, which arrive about once a month, to encourage increased shopping visits, and offer new products when guests come into our stores.

In early March, we begin our buildup to the Easter season with the arrival of the Watercolor Bunny and Sunny Chick. We will also launch a purple Hello Kitty, and in conjunction with the Girl Scouts’ 150th anniversary, we’ll introduce a limited edition Girl Scouts Bear and official uniform for the first time ever.

I do want to note that while we had a rough season at the box office this past holiday, we continue to have success with licensed product and we will evaluate each opportunity as it develops and maintain a greater balance in our offerings.

On the marketing front, our goal is to let kids know about our exciting new products as well as our front store experience and make it easy for moms to say yes. To highlight three key marketing events – our currently running promotion with McDonald’s Happy Meals, the kickoff to our 15th birthday year, and a refresh of our loyalty program.

Starting with McDonald’s, beginning February 10th and running through March 8th, McDonald’s Happy Meals feature a collectible mini Build-A-Bear Workshop animal. There’s a coupon for a free mini-T for the Happy Meal animal that is bringing guests into our stores, and while they’re there, they can use a $10 off coupon that also comes in the meal to purchase our latest merchandise.

In addition, kids receive a code to use in Bearville for a virtual prize. McDonald’s is supporting the program with national television, online and in-store marketing. While this is our fourth Happy Meal promotion in total, this one is a plus over last year. There will be between 25 million and 30 million meals with Build-A-Bear Workshop cobranding distributed during this time, and historically, we’ve seen a lift in our business in conjunction with the program.

Second, we will be adjusting the balance between product-specific advertising, those that feature our store experience and brand marketing. We will leverage the occasion of our 15th birthday and highlight Build-A-Bear Workshop as the place to celebrate to increase visit occasions and grow our party business.

In December we sold our 100 millionth Furry Friend and we will use this platform to reemphasize the connective and emotional elements of our brand and store experience. Our guests are our best brand advocates and they can tell their own personal stories across a wide variety of channels, including our Facebook community, which has now grown to 2 million fans.

This month we are refreshing our Stuff Fur Stuff loyalty program with the objective to increase program awareness and increase guest retention metrics such as shopping frequency and spend per household. Members can earn rewards sooner and more often. For example, guests will get an award at every 50 points versus the previous 100 point threshold. While early, we are pleased by the initial response and expect to see benefits in the second half of the year.

We continue to be in a strong cash position, ending the year with $46.4 million in cash and no borrowings on our credit facility, even as we invested $15 million to repurchase $2.5 million shares of our common stock during the year.

In summary, we had a good second and third quarter in 2011 and a tough fourth quarter with our dependence on movies. We are aggressively acting to move our business in the right direction in 2012. Our product and marketing strategies are key to our success for the year and we have initiatives to expand our customer base and to connect more closely with our loyalty members to drive incremental sales in our stores and online channels.

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. Before I review our results this morning, I would like to discuss the non-comparable cost and benefit that impacted our fourth quarter and fiscal 2000 year results, which are also detailed in a reconciliation table in the press release we issued earlier this morning.

For the fourth quarter, these costs include a $15.6 million, or $0.93 per diluted share non-cash cost related to the establishment of a tax valuation allowance; a $285,000 after-tax, or $0.02 per diluted share non-cash store asset impairment cost; and a $915,000 after-tax, or $0.05 per diluted share benefit to deferred revenue related to our loyalty program. Excluding these non-comparable cost and benefits, our adjusted net income for the fourth quarter of 2011 was $5.9 million, or $0.34 per diluted share.

For the 2011 year, in addition to the cost and benefit included in the fourth quarter, we also incurred a $1.7 million after-tax, or $0.10 per share in non-comparable costs related to our consulting project. Excluding the cost and benefit just mentioned, adjusted net loss for fiscal 2011 was $435,000, or $0.03 per share.

As many of you are aware, GAAP requires companies with a three-year cumulative book loss to record a valuation allowance to reduce net deferred tax assets. The recording of the valuation allowance is a non-cash book charge and does not have any impact on our consolidated operating income or cash flow. In addition, recording the tax valuation allowance does not impact our ability to utilize our deferred tax assets when we generate taxable income in future periods. As such, we will be able to recognize a benefit in future profitable periods.

Now, on to our review about the fourth quarter. For the fourth quarter, total revenues were $119.1 million compared to $125.8 million in the fiscal 2010 fourth quarter. Total revenues include $1.5 million in net retail sales due to an adjustment to deferred revenue related to the royalty program.

In the fourth quarter of 2010, this adjustment added $4.3 million to net retail sales. Excluding the impact of foreign exchange, total revenues declined 6%. Consolidated net retail sales decreased 5.8% excluding the impact of foreign currencies. Comp stores sales decreased 4.9% on a consolidated basis, which included a 6% decline in North America and a six-tenths decline in Europe. This was driven by a 6.1% decline in transactions partially offset by higher transaction values.

Consolidated e-commerce sales rose 3.5% in the fourth quarter excluding the impact of foreign exchange. Retail gross margin was $50.7 million, a decrease of $5.6 million, or 9.9%. Our retail gross margin percent was 43.3%, a 240 basis point decrease from last year. The decrease was primarily driven by a 150 basis point decline in merchandise margin due to higher promotions and discounts and 100% basis points of deleverage on fixed occupancy costs.

Total SG&A in the fourth quarter was $42.7 million, or 35.9% of total revenues, a 290 basis point improvement primarily due to a reduction in salaries and bonus compensation as well as decreases in marketing costs. In 2010, SG&A included $800,000 related to the closure of the remaining stores in France as well as higher payroll costs associated with the bonus.

Turning now to our full-year results, for the full year 2011, total revenues were $394.4 million compared to $401.5 million in the fiscal 2010 full year, a 1.8% decrease. Excluding the impact of foreign exchange and a $6.4 million from non-recurring commercial transactions in fiscal 2010, total revenues declined 1.2%. Consolidated net retail sales were $387 million, essentially flat compared to $387.2 million in fiscal 2010.

Fiscal year 2011 included $1.5 million in net retail sales due to an adjustment to deferred revenue related to the loyalty program, which compares to a $4.3 million adjustment in 2010. On a consolidated basis, comparable store sales declined 2.1% and included a 2.5% decline in North America and a two-tenths decline in Europe.

Consolidated e-commerce sales rose 8.5%, excluding the impact of foreign exchange, and included growth in both North America and the UK. For the full year, retail gross margin was $154.5 million, a modest decrease of $660,000, or four-tenths, from 2010. Our retail gross margin percent was 39.9% and represented a 20 basis point decrease from the prior year. Total SG&A for the full year was $162.3 million, or 41.2% of total revenues, a 40 basis point decline from the prior year.

Regarding cash flow, we once again ended the year with a strong consolidated cash balance of $46.4 million. We have no debt and we did not make any borrowings against our credit facility. During the year we invested $15 million to repurchased 2.5 million shares of our common stock. Depreciation and amortization for 2011 was $24 million compared to $27 million in 2010.

Year-end fiscal 2011 inventory was 51.9 million, representing a 12.5% increase on a per-square foot basis as compared to year end fiscal 2010. Over half of the increase in inventory was driven by an earlier Chinese New Year, which caused in-transit inventory to be higher in the fourth quarter this year.

Also, at year end, we renewed our two-year credit facility with US Bank. This extension lengthens the maturity of the facility through December 31, 2013, increases our financial flexibility, and includes the same or less restrictive covenants. Available credit has been maintained and includes $40 million for the first half of each calendar year with a seasonal overline of $50 million from July to December each year.

While Maxine will go into more detail about our future plans in just a moment, in 2012 we will be very active on the real estate front. For the past two to three years we have been aggressively renegotiating rents and executing short-term extensions to line up lease states within markets as part of an overall strategic plan to optimize our store locations and market positioning.

As the next phase of that plan moves forward, we will close 15 to 20 stores this year in accordance with natural lease expirations and kick-out clauses primarily in multi-store markets. We expect to maintain a percentage of sales from the store closings by transferring customers to other stores that remain open in the market.

We will also open four to six new stores, relocate ten to 15 stores and remodel approximately five stores in a new store design and enhanced experience. In support of those plans, capital expenditures for 2012 will be between $20 million and $25 million. This compares to $12 million in 2011.

Turning now to our progress on our expense-saving initiatives, for the full year, we generated $3 million in savings, of which $1.6 million was in SG&A areas as we reduced store payroll and other store expenses and overhead costs. The remaining $1.4 million represented a reduction of cost of goods sold, primarily through freight and product-related costs. Looking ahead, we expect cost savings to be approximately $9 million in 2012.

Now I’ll turn the call back to Maxine.

Maxine Clark

In conclusion, I want to restate my disappointment with our fourth quarter results, but I also want to be very clear that I’m excited about our future. 2012 is moving in the right direction. We think very strategically about our business and are on track to meet our long-term goals.

We are executing, again, several key strategic growth platforms that I will review with you. First I’ll talk about our stores and then I’ll review our key marketing plans. As it relates to our stores, Build-A-Bear Workshop was built on our experience and going to one of our stores is a special occasion. We have a two-pronged strategy to reenergize and build the destination appeal of our stores and to maximize our productivity and profitability.

As Tina mentioned, we’ll close between 15 and 20 stores in 2012 as an initial phase to right-size our store portfolio, primarily in multi-store markets where we’ve become over-stored. These are strategic closures that will benefit the comp sales of the remaining stores in the market. We will also relocate select stores in existing malls, reduce their square footage and increase productivity.

At the same time, we’re investing in our company as we build our first newly designed stores that feature a bold new look and enhanced experience. I’m very excited with the design, the culmination of nearly two years of intense work. While many other retailers are trying to create an experience to draw shoppers to their brands, we have always offered that and we will continue to lead in the interactive experiential retail space.

While our store base in North America will be leaner with fewer stores that have higher volumes and profitability, we will continue to grow internationally in our company-owned operations in the UK and through franchisees, those already existing and by adding more countries. In 2011 our franchisees grew their store base by 25% net of closures and they plan to add another ten to 12 stores in 2012. Build-A-Bear has been on the forefront of international growth and we are putting the support and infrastructure in place to continue this expansion.

On the brand building and marketing front we plan to leverage our database and more finely segment our customers as we update and develop new products and experiences that will increase the lifetime value of our guests.

In order to grow our business, we need to continually have new guests come in to our brand and retain them once they have experienced our store. To attract new guests, we will enhance our marketing initiatives that focus on our experience and our brand. For the past two and a half years, our marketing has focused primarily on specific products and promotions and we’re rebalancing our messaging.

We are also intensifying our guest retention strategies. Our guests—kids and moms, both—are passionate about our brand, as evidenced by our 2 million Facebook fans, our Bearville community, and our in-store database and loyalty program members. We have specific plans to maximize engagement in and across each of these channels, including our loyalty program refresh that I discussed earlier.

We recognize the changing demographics in the United States and we’ve dedicated team members to improve our business in our most diverse markets, particularly in highly Hispanic areas. We are seeing positive results and will continue to develop this platform.

Finally, we sell a lot of gifts, not only in the fourth quarter, but all year long. The number one gift occasion for Build-A-Bear Workshop is someone’s birthday. Guests have made coming to our store for their birthdays an annual event and we are using our own 15th birthday occasion to take this initiative to an entirely new level.

Build-A-Bear Workshop is a powerful global brand, one that kids love and moms trust. We’re in a strong financial position to drive our growth and long-term strategies. On a final note, I’m proud that Build-A-Bear Workshop was recently honored where we were named to the Fortune 100 Best Companies to Work For list for the fourth year in a row.

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

Thank you. We will now be conducting a question and answer session. (Operator instructions) Our first question is from Sean McGowan of Needham & Co.

Sean McGowan – Needham & Co.

Good morning. First, a clarification and then a question. On the clarification, Maxine, did you say that if either of those movie promotions had met their targets that consolidated sales would have been up?

Maxine Clark

Yes.

Sean McGowan – Needham & Co.

Okay, thank you, and Tina, could you review what some of the other influences are on gross margin? Maybe give us a little bit more color on what the markdowns on these movie promotions cost, just generally talk about puts and takes on gross margin?

Tina Klocke

Sure. On a quarterly basis, Sean?

Sean McGowan – Needham & Co.

Yes, please.

Tina Klocke

Basically, our retail merchandise margin was down about 150 basis points, and then the other 100 basis points was due to deleverage of occupancy costs.

Maxine Clark

So, Sean, we had to take some markdowns during the holiday season on Happy Feet -- or we promoted him pretty aggressively. Not the Chipmunks, not quite as aggressively. They did better and they’re still selling, and all of this is still selling in our stores, by the way, but we’ve had to, at least particularly on the Happy Feet movie, bring those down pretty aggressively and have since the middle of December.

Sean McGowan – Needham & Co.

Can you give us some sense of what the impact would have been if you had sold those products at the expected margin? Were there other factors that impacted the merchandise margin?

Maxine Clark

No, honestly, those were really -- the lack of business on those two products, which are key products for the holiday season, we put a lot behind them and we had had -- The Happy Feet movie was six or seven years ago, a long time between them. We’ve never had a bad penguin, and the Chipmunks movie had been very successful for us all the times we had run it before, so there was nothing to really indicate that that wouldn’t have been good, and actually, up until the beginning of November when we launched them, everything was in great shape for a wonderful quarter.

So, as we said, we’ve looked at it a million ways until Sunday. I think if either one of them had gone and made their plan -- obviously Happy Feet missed its plan by the most. Our other products did well. Our core and proprietary products lived up to expectations as best they could because there was -- the traffic just wasn’t wanting the movie products.

Sean McGowan – Needham & Co.

Okay, thank you.

Operator

(Operator instructions)

Maxine Clark

Thanks again for joining us. We look forward to speaking with you when we report our first quarter results in May.

Operator

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

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