Build-A-Bear Workshop Inc. (NYSE:BBW)
Q1 2008 Earnings Call
April 24, 2008 9:00 a.m. EST
Molly Salky - Director of Investor Relations
Maxine Clark - Founder, Chairman and Chief Executive Officer
Scott Seay - President and Chief Operating Officer
Tina Klocke - Chief Financial Officer, Treasurer and Secretary
David Schick - Stifel Nicolaus & Company, Inc
Michael Corelli - Barry Vogel and Associates
Tracy Kogan - Credit Suisse
Sean McGowan- Needham & Company
Mike Smith - Kansas City Capital
Gerrick Johnson - BMO Capital Markets
Brad Leonard - BML Capital
Good day Ladies and Gentlemen, and welcome to the First Quarter 2008 Build-A-Bear Workshop Earnings Conference Call. My name is Michelle, and I will be your coordinator for today. At this time all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of today’s conference. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call Miss Molly Salky, Director of Investor Relations. Please proceed Ma’am.
Thank you Operator, and good morning everyone. And thanks for joining for a review of our results for the 2008 fiscal first quarter. With me this morning are Maxine Clark, Chairman and Chief Executive Bear; Scott Seay, President and Chief Operating Bear; and Tina Klocke, Chief Financial Bear.
In a moment I will turn the call over to Maxine to provide her comments on our first quarter results. Scott will update you on our store operations, including our distribution center logistics initiatives and our international franchising. Tina will follow with additional details on our financial results. And at the end of our remarks we will open the call up for your questions.
Members of the media who may be on our call today should contact us after this call with their questions. We ask that you limit your question to one question and one follow-up. This way we can get to everyone’s question 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 website. And a replay of both our call and webcast will be available later today on the Investor Relations portion of our corporate website.
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 factor section of our 2007 annual report on form10-K filed with the SEC and we undertake no obligation to update or revise any forward-looking statements.
Now I will turn the call over to Maxine Clark for her comments.
Thanks Molly, and good morning everyone. And thank you for joining us to review our fiscal 2008 first quarter results. On balance, we think that given the difficult economic environment in which we are operating our performance in the first quarter was satisfactory. That does not mean we are pleased. But as you can see from our results and from what we will be saying in this call, we are balancing our efforts to invest in building our long-term brand value while managing through the near-term challenges in the retail environment. Maintaining that balance and managing through the environment has never been more difficult.
Our number one challenge remains attracting guest traffic to our great North American stores. We have mulled traffic across the U.S. in a myriad of pressures on the consumer’s discretionary dollar, are strong head winds facing our business and all retailers. We believe that 2008 will be a challenging year industry wide, but especially for companies that offer highly discretionary products like our own.
The strong negative pressures may mask the positive impact of new initiatives, but we remain confident that our long-term brand building initiatives will drive value, and our near-term strategies for managing through the environment are on track and will position us for a strong recovery when the economic conditions improve.
Despite the difficult environment we see several clear positives in our first quarter results. First, our European operations continue to deliver significantly improved results posting a total sales increase of 52%, a comp store sales increase of 14.5%, and an improvement in operating income of 2.1 million. Second, we continue to improve our inventory management. During our first quarter we lowered our inventory per square foot by 9% and our comfortable with our current inventory levels as we move into the second quarter.
Third, we continue to generate strong cash flows and have a debt free balance sheet, thus remain highly liquid and that enviable position allows us to buy back our stock under our increased share repurchase authorization. Specifically, we repurchased $8.6 million or about 19% of the total authorized under the program during March through open market buying and by putting a 10b51 trading plan in place. And we ended the quarter with 41 million in cash. Also I will point out that even in a significantly more difficult retail environment our business model showed its resilience and underlying strength delivering meaningful net income to the bottom line.
A final note regarding the first quarter, remember that Easter fell in the first quarter this year versus the second quarter in 2007. This is an important holiday for our business, along with many of the associated spring break vacations that coincide in timing. We expect the shift to impact our second quarter, historically one of our more challenging business quarters.
As we outlined for you last month, our business plan for the year includes moderating our new store growth plan, slowing growth to about 25 stores this years compared to opening 15 new stores last year. This slow down allows us to focus on our existing markets and stores and to focus on expense saving initiatives.
We know that product newness is key to bringing traffic to our stores, and we have focused on having consistent product newness and collectible products, such as our Gem of a Friend Collect-A-Bear Series, through out the year. And our new online world, BuildABearville.com, is breaking new ground. We are the first company with real world stores to launch an online community, and we are focused on understanding the full business potential of this initiative and integrating it into our overall brand experience.
Despite the cutback and overall store openings, we continue to be offered prime real estate locations demonstrating that a unique, strong consumer franchise married to a strong balance sheet is valued at all times. Our landlords recognize that we bring a valued, family oriented consumer to the mall, increase the time they spend in the mall, and continue to deliver above average store productivity, while families are feeling pressure on current discretionary spending our landlords recognize that we will continue to be an important traffic driver when consumer spending starts to accelerate.
Our selectivity in the stores we opened this year has refocused our negotiations on achieving extremely attractive lease terms. So having a strong brand and cash on hand will serve us and our shareholders well in the future. The strategic alternative process was a tremendous learning experience for me and our management team.
We carefully evaluated all aspects of our business and the opportunities for growth having that process behind us as we move the distraction and allow additional focus on operating our business and managing through the current economic environment.
And while the formal strategic process is complete, you should know that our management and board continue to evaluate all aspects of our business, prioritize initiatives, and take steps that are geared toward enhancing shareholder value. The board’s decision to increase the share repurchase program reflects the confidence and optimism we share in the strength of our business model and our commitment to increase shareholder value.
With that said, we have some updates to our strategies and initiatives to discuss with you today, but I will first provide some additional details on the performance of our European operations in the first quarter. We are very pleased with the performance from Europe in the first quarter. Our brand building and store operations strategies are taking hold and delivered significantly improved results compared to the 2007 first quarter.
We began reporting comparable store sales for the European operations this quarter. Thirty-nine of our total 51 stores are included in the comp calculation. Each of these stores has been under our ownership and/or converted to our brand for more than 13 months. In the future, new stores will enter the comp calculation beginning in their 13th full month of operation.
We opened two new stores in Europe during the quarter, our first store in Northern Ireland in Belfast and a store in High Wycombe, England. Both stores had very strong openings. The opening in Belfast coincides with the strong growth and renewal that is happening in the City. And the store High Wycombe is a new shopping center that is revitalizing an existing downtown shopping area.
I visited stores in the U.K. this past weekend and continue to be very happy with what our teams have accomplished and the high standards they set. They have truly embraced the Build-A-Bear Workshop brand and are redefining entertainment retail in the United Kingdom just as we have done in North America.
We ended the quarter with 51 stores in Europe. First quarter sales from the European operations grew 52% to 16.4 million, and our operating loss in the quarter was about $100,000 compared to a loss of 2.2 million in the 2007 first quarter. This improved performance comes as we continue to fully integrate and put our best practices in place in our European operations.
When we acquired the Bear Factor business in April 2006, we described the long-term growth opportunity as positioning our brand in strong real estate locations in the U.K., leveraging our North American infrastructure by our purchasing, marketing, merchandising, logistics, and store operations functions over a growing store base, and establish a single national brand with significant expansion potential in the U.K. market. We are seeing progress on all fronts, as evidence by the financial results. Underlining these positive trends are improving average transaction value, growth and in store party business, and world class guest satisfaction scores and feedback.
We are pleased with how this business is performing and expect that growth to continue this year and beyond as we build out the market. This year we will continue to put our most successful U.S. strategies into place in Europe. We still have opportunities to raise brand awareness and introduce new guests to our stores for the very first time. We also see a real opportunity to build value through our retention program and having existing guests return for more frequent visits.
We expect to benefit from targeted communication programs, including the introduction of our Stuff Fur Stuff Loyalty Club in the second half of the year. Operationally, we continue to focus on store payroll expense and store occupancy costs to improve overall profitability in our European operations.
A cornerstone of our long-term growth strategy is the investment we are making in our new online virtual world website, BuildABearville.com. Our goal with Build-A-Bearville is to leverage the grand equity we have built in the real world by creating a complimentary brand experience in the virtual world.
We know that kids are using the Internet for play in increasing numbers and at younger ages. The concept of virtual world online communities that immerse children in a brand centric environment is still very early in the adoption curve. As we create synergies between our real world stores and our new website we believe we will be able to attract new and returning guests to our stores. We also believe that Build-A-Bearville gives us a strong platform for growth in other entertainment oriented areas for our brand.
We launched Build-A-Bearville this past December, and we are pleased with the initial guest response. There have been over 3 million avatars, online characters as you call me, created in the new world in just 4 months, a strong endorsement for our brand franchise. Build-A-Bearville has no fees and imposes no expiration. The site offers many special features including the ability to create a unique online character or avatar by choosing hair and skin color, all with personalizing the style, and coloring, and clothing options.
Guests can earn Bear Bills, the online currency, by playing online games and quests. They can purchase from a vast array of clothes, furniture for their cub condo homes, and other items to have a completely customized in world experience. Citizens can also trade items they have purchased with others in the world and even send mail and leave messages for other citizens.
Several measures are in place to help protect the privacy and safety of our guests that visit Build-A-Bearville, including a safe chat system that allows parents to control the chat options for their children. In addition, the site is continuously monitored for safe socialization.
Our unique competitive advantage in this space is that we are the only company with both real world stores and an online world. Having both allows us to control the in store experience and incorporate traffic driving and ultimately revenue driving features into the overall process. We are still in the test and learn mode with regard to what programs and features work best to create synergies between the online world and our real world stores.
While we believe that the ultimate measure of Build-A-Bearville success will be in our in store sales, we are focused on three very important metrics; achieving critical mass on the site by raising brand awareness and converting our store guests to Build-A-Bearville citizens, maximizing the online engagement by increasing the frequency of visit and time spent per visit, and growing the economy in the world measured in the Bear Bills earned and spent online indicating the emotional investment that citizens have made in customizing their characters and adding furry friends to their homes.
Let ma outline a few of the programs we have in place so far in Build-A-Bearville. First, our brand experience that happens in our stores is still the heart of who we are and what we do. But now it is also the starting point for the in home play experience that will include registering on BuildABearville.com. We have significant touch points in our stores to help our associates communicate the added value to our guest.
In February, we began offering our Stuff Fur Stuff club members a special benefit in the online world. For every dollar spend in the store our Stuff Fur Stuff member gets 100 Bear Bills, making this club membership a benefit for both mom and kid, keeping our best guest engaged in the brand, and encouraging a visit to Build-A-Bearville. Additionally, every animal made in our store comes with an initial Bear Bill gift of 2,000 Bear Bills. And newly introduced animals comes with an extra 1,000 Bear Bills bonus, as well as other animal specific quests and condo décor items.
Our new Bear Boutique opens for business today and gives our stores guests who make a clothing or accessory purchase exclusive access to the Bear Boutique virtual store online. The Bear Boutque offers exclusive clothing for your online furry friend, and you can only get these items if you have shopped in a store.
We also have programs in place to drive return visits to our stores. In March with a purchase in our stores guests could get exclusive access to an online beach party with Lucas Grabelle from High School Musical in Build-A-Bearville. This month we are featuring exclusive access to behind the scenes footage of the Hannah Montana Best of Both Worlds Concert and a virtual guitar.
This virtual guitar and video footage is only available to our online visitors with a purchase of $15 or more at a store. Partnering with Hannah Montana hits the bull’s-eye of what is cool and relevant to our core guests. Hannah Montana is still the hottest ticket in town, and we believe this exclusive concert video footage is a highly attractive offer.
Again, we are still learning and evaluating programs and tactics to create synergy between the real world and the online world, and have many future plans in the works. We view the online world as a long-term strategy for enhancing our brand, expanding the entertainment value of our brand, and growing revenues.
Our 2008 marketing programs will leverage Build-A-Bearville as a new platform for communicating with guests. The virtual world is real news and a highly relevant new offering to tell our guests about. In fact, our new T.V. advertising campaign, which began airing this week on National Kids T.V., incorporates both the real world store experience and the online world experience.
This commercial takes you into our store and in a very clever way also introduces you to the virtual world. The message packages our dual brand experience into one, coherent brand message. This ad will run until early June and is available on our website at BuildABear.com for viewing.
Top rated kids and tween shows like Hannah Montana and The Secret Life of Zack and Cody, to name a few, are targeted for our T.V. ads. New this month, we have added the Disney Channel to our T.V. mix and have developed a customized spot to highlight our year long sponsorship. You can view this spot on our corporate website as well.
As you know, we have engaged our guests in the development of BuildABearville.com. From the early development stages they helped choose the name, and give us ideas to develop, to expanding offerings and events, they provide feedback on the new developments they want to see in the world, vote on online polls, and help us improve the usability and navigation in the world. Our goal is for our guests to own the world and provide user generated content as the product expands and the emotional connection deepen.
As I mentioned earlier, a fundamental strength of our business model is our strong merchandising expertise. While there are many pressures on price and margins due to changes in the Chinese manufacturing system, the weak U.S. dollar, and much more expensive petroleum products, and fuel charges. We are working closely with our manufacturers to maintain the value that we have always offered our guests.
We know that the consistent introduction of new seasonal and collectible products drives newness and excitement with our guests. We started this year with a product assortment that continues to emphasize newness and collectiblity.
Our spring product assortment included several successful new product launches beginning with the Hearts Fur you Puppy in late December and the Gem of a Friend Precious Pink Teddy in January, the first of our Gem of a Friend series of four collectible teddy bears. In February Happy Chick and Possum Pink Bunny with rainbow striped ears all enjoyed strong sales.
Moving into April we are launching our Black Lab II as part of our Bear Meets Kennel Pals collection. Our original Black Lab was introduced in November 2001 when we had just 72 stores and was our first Bear Meets Kennel Pals dog. The lab was retired in March 2004 when we had 151 stores. And since then we have opened about 175 stores in many new markets, and our guests have been clambering for a new black lab.
Our new lab, which has been updated with new material and a new facial expression, he is actually smiling, also comes with a virtual gift to access in the online world. Importantly, the purchase of a Black Lab provides a donation to Canine Companions for Independence to help kids who need extra assistance from a guide dog.
Our partnership with Canine Companions came to us from one of guests, Shae Megale, a special guest who has a rare disease, Spinal Muscular Atrophy. Shae, who is now 12-years old, has worked hard to raise awareness about her disease and work towards a cure. And she wanted to work with Build-A-Bear Workshop to make a difference for kids with her disability and for working dogs like her dog Mercer.
Shae is an author of a recently published series of books about Mercer, who she was matched with by an organization called Canine Companions for Independence. Her books highlight the friendship between Shae and Mercer as he tucks her into bed and heads off for exciting adventures. We are pleased to support Shae in her efforts and to help this cause. Our new Black Lab is available in stores beginning tomorrow. And we will also be selling an assistance dog backpack that can be worn by any furry friend.
On the fashion front, our Hannah Montana skirt set and top sets and High School Musical products continue to be best sellers. We will build on this assortment throughout the year with other celebrity tie-ins. Equally strong has been the skinny leg work; Skinny Jeans, Skinny leggings, and Skinny Capris, combined with baby doll tops, dresses, anything with jems and sparkle, paired with ballet flats, of course. We are optimistic that our product and merchandise assortment can help us attract new guests as well as offering something new for our returning guests.
Now just a quick update on Ridemakerz, during the first quarter Ridemakerz opened our one new store in Baltimore at the Avenue at White Marsh, an outdoor, lifestyle center. This year they plan to add seven additional stores. Locations include two stores in Detroit; Chicago; Houston; Appleton, Wisconsin; Branson, Missouri, and Hagerstown, Maryland where the store will be located in a power center.
As you know Ridemakerz in an interactive retail concept that allows children, especially boys, and families to build and customize their own personalized cars. Our partnership with Ridemakerz includes an initial capital investment of about 3 million. Along with operational and advisory services in exchange for additional equity ownership. Our operational partnership with Ridemakerz has given them the ability to focus on resigning their product offering and store operations rather than building an infrastructure, a distinct advantage for their brand.
I will include my portion of the call with a final few comments. As I said earlier, with the moderation of our store growth this year we are focusing on expense savings, on driving product newness and collectiblity, and on raising awareness of BuildABearville.com, and merging this new component of our brand experience into everything we do.
The fundamental strengths of our company remain in tact and area as relevant in today’s challenging retail environment as ever. Our superior store economic model, strong cash flow, and flexible capital structure position us for long-term growth. We remain optimistic, yet realistic, that the strategic initiatives we are putting in place this year for the long-term will increase the value of our brand franchise.
And now I will turn the call over to Scott for his comments.
Thanks Maxine, and good morning everyone. Let me start with the store update. During the first quarter we opened two new Build-A-Bear Workshop stores in North America, both in Canada, in Saskatoon Saskatchewan, which is a mall location, and Niagara Falls Ontario.
Our Niagara Falls store is a free standing store in Clifton Hill, which is the main venue for Niagara Falls. These are two of three Canadian stores we have planned for this year. The third store in Canada will be open in August in Sudbury Ontario. As Maxine mentioned, we also opened two new stores in the United Kingdom.
The end of March also bring baseball. We opened our ballpark stores in Philadelphia, ST. Louis, Cincinnati, and San Francisco and added a new store in the Washington Nationals new stadium. These five baseball towns not only have great teams, they also have family-friendly stadiums, amazing fans, and have become great partners and locations for our brand. We are looking forward to anther great baseball season.
Maxine mentioned the importance of slowing our new store growth, focusing on existing stores, and driving expense savings. I would like to review our initiatives in these areas. With the decline in sales that we have experienced, operationally we are working hard to manage our store payroll. This has required us to streamline everything we do in order to maintain the level of customer service that Build-A-Bear Workshop is known for.
We have reviewed all aspects of our organizations, our communications, and our processes to remove any obstacles that get in the way of our primary focus, guest service and selling. We call our approach Simple Excellence. In essence, we have stepped back and eliminated organizational barriers, non essential communications, and processes that do not add value in the current environment.
This effort has extended to our store staff where we have simplified our store associate communications. We focus on introducing our guests to BuildABearville.com and to the Stuff Fur Stuff Club. We consider these two messages to be our core strategies for building our brand over the long-term. We are trying to keep it simple for our associates and for our guests.
In March we announced the formation of a new operations position, Managing Director Workshop Experience. Primarily the position is focused on the guest experience, including the experience itself and looking at ways to keep the experience fresh. The store design and environment including the addition of Build-A-Bearville and our merchandise and pricing opportunities. Essentially nothing is sacred as we focus on short-term expense savings and log-term brand positioning.
From the Simple Excellence approach we expect expense savings from reduced travel expense and elimination all non essential expenses throughout our Operations and Bear Quarter Organizations. These reductions will help us mitigate cost pressures such as increasing products costs and rising fuel costs that are being felt by all retailers.
Let me add a few comments on our logistics and distribution efforts. We have now ad our company owned distribution center fully operational since September 2006. We have realized initial benefits of having our inventory centralized with systems in place that help us manage our supply chain and provide us greater visibility to inventory movement.
One of the early benefits has been our ability to test and alternate our distribution methods. We now use a variety of methods for moving product from the warehouse to our stores and alternate the method depending on store and seasonal inventory demand.
In a logistics area, the external pressures we have faced relative to realizing cost savings have been rising fuel costs. In 2007 fuel surcharges made it difficult to gain overall cost savings from our distribution process. Even further increases in fuel surcharges continue to impact us this year, nearly doubling so far this year.
However, during the first quarter we managed to keep our North American distribution and warehouse expenses essentially flat on a percent of revenue basis, a big accomplishment in the current fuel cost environment.
During the fourth quarter and into the first we converted all 18 Canadian stores from direct truck deliveries to LTL or less than truckload service. LTL essentially allows us to share distribution costs versus utilizing a dedicated direct truck delivery. A test of 25 U.S. stores was implemented in the first quarter converting from direct truck to LTL service.
These changes help drive down our outbound freight cost and helped us partially offset the high fuel charges. Last quarter we discussed a cost savings opportunity related to our inbound distribution systems, the majority of our merchandise is produced in China and comes to the United States and the UK via over the water container transport and then is trucked or railed to our distribution centers. Our company owned distribution center in Ohio and our third party distribution centers located in Toronto and in Middlesex England.
We have begun the conversion of all inbound freight to one carrier, UPS. This conversion will not only provide us with lower negotiated rates per container but will also give us the opportunity to better maximize container usage, through utilization of their consolidation facilities. We will be leveraging more full containers and reducing our usage of smaller containers.
In summary we look to these distribution system changes related to both our inbound inventory shipments and out outbound distribution to our stores to partially mitigate the over cost increases we are experiencing from fuel. Unfortunately in the current environment we don’t expect to achieve lower overall distribution costs.
Moving now to inventory, our consolidated inventory at the end of the first quarter stood at 50 million, compared to 48 million at the end of the 2007 first quarter. However on a per square foot basis excluding inventory in our web store and non-traditional locations inventory declined about nine percent to $55.80 per square foot, down from the $61.30 per square foot year ago.
We bettered the first quarter with a clean and lean inventory and are very comfortable with these levels. We will continue to monitor and adjust inventory on a real time basis to insure that our inventory levels remain appropriate.
In closing I will add that we continue to closely monitor all expenses, as Maxine mentioned we are very realistic about the challenging environment and are aggressively working to scale back and eliminate non-essential processes and expenses. IN order to successfully manage our way in these times it is essential that we focus all resources in our organization on the initiatives that will bring us the biggest return. Either driving top line sales or improving the bottom line profits. WE have Identified the areas of focus so that all teams within our organization are utilizing the simple excellence process that has delivered the results we have seen in the operations area.
We also are looking at very specific goals around these initiatives so we are driving towards measurable results and holding our teams accountable for achieving those results. Now I will turn the call over to Tina.
Thanks Scott, I will add some additional details regarding our first quarter and financial performance. Our first quarter total revenue increase to seven million was fueled by new North American stores opened in the last twelve months. An increase in European sales of 5.6 million and higher combined revenues from franchise fees and licensing. These increases were partially offset by a decline in North American comp store sales.
Consolidated net income in the quarter of $6.4 million included an operating loss from European operations of $100,000, compared to 2.2 million operating loss in the year ago quarter. Our gross margin rate in the first quarter was 43.6%, the decline in gross margin was contributable to a lack of leverage on six occupancy costs in the North American operations. And partially offset by improved occupancy cost leverage in Europe.
Also within the gross margin rate our consolidated merchandise margin was slightly down. A decline in the North American merchandise margin reflecting supplier cost pressures was partially offset by a stronger margin we received on our European sales. And finally as Scott mentioned earlier we managed to hold distribution and warehousing costs as a percent of revenue flat as a slight increase in North America was offset by positive cost trends in Europe.
During the first quarter the SG&A expense margin increased to 36.2% compared to 35.5% last year. The margin reflects higher stock based comp expenses and costs associated with the review of strategic alternatives which were not included in the year ago quarter. The SG&A margin increase also reflects slightly higher North American store payroll as a percent of revenue and the ongoing cost of maintaining our multiple website’s, which now include BuildaBearville.com.
Moving down the income statement the effective tax rate was lower than last year at 37% in the first quarter versus 37.9% last year. For the full we expect a tax rate of about 37%, but as always we will continue to refine the rate as we move through the year.
Now for a couple of comments on the balance sheet. Cash spending on capital items in the first quarter was 5.7 million up from 4.9 million in the 2007 first quarter. Primarily due to the timing of invoices and cash payment associated with capital items.
For the full year capital expenditures will decline reflecting our slower new store growth, we expect CapEx to be in the range of 25 to 30 million and depreciation and amortization to total approximately 30 million. During the quarter we repurchased over 1 million shares for $8.6 million, we ended the quarter with a cash balance of 41 million and did not utilize our line of credit during the quarter.
With regard to providing earnings guidance aside from what Maxine has already discussed in about how we see the year developing from a calendar shift point of view we have considered that for the near term, we will now provide comp store sales or EPS guidance. Our business is being affected like most retailers by macro economic issues in a declining consumer spending. The environment lacks predictability and visibility and makes providing earnings guidance very difficult.
I might also add that this is a year where we believe our results may not be representative of the value we are adding to our company, which is aimed at growing our brand over the long-term.
With that said I can provide you with some insight as to how we see our 2008 business plan developing.
In line with our store growth plan, we expect our square footage growth to be about 6%. We have moderated our marketing spend to reflect the current pace of business; we expect to maintain our marketing spending in the range of 7 to 7.5% of revenues. Our margins will be affected by the rising prices from product coming in from China and of course shipping is affected by increases in surcharges on fuel.
With regard to the quarterly flow of our earnings in 2008 there are a couple of things to note, first 2008 is a 53 week year and the 53rd week falls in the fourth quarter. As Maxine mentioned earlier Easter shipped into the first quarter this year, thus our second quarter will be negatively impacted by the shift. Our business in the UK has improved significantly and our outlook for 2008 is for the seasonality of the business to remain fourth quarter heavy.
You will recall that in 2007 the European operations generated losses in the first, second and third quarters and delivered profit in the fourth quarter and for the full year. We expect that pattern to be similar in 2008. This concludes our prepared remarks I will now turn the call back to Molly.
Thank you Tina, now the operator will open the call up for your questions. Maxine, Scott and Tina are available to answer any questions.
Thank you ladies and gentlemen (operator instructions). Our first question comes from the line of David Schick of Stifel Nicolaus, please proceed.
David Schick, Stifel Nicolaus & Company, Inc
Hi, good morning. Two questions, first the comps are still obviously negative and we all read about others and mall traffic in general. But, relative to others in the mall the deceleration has slowed, if that is fair to say so business overall is worsening faster than perhaps you over the last six or nine months. All be it under the negative umbrella, can you point us to things, Build-A-Bearville is obviously there but, are email openings in general an open rate or something you are doing more targeted.
Talk to us about why that might be happening, in that a natural level of the business from poor customers, just your thoughts on that metric, your numbers relative to the other or the mall in aggregate? The second piece is for both Tina and Scott you talked about brining your warehousing and transportation costs flat as a percentage of sales and not driving leverage there, if the comp were to get better. Obviously comps are quite negative still, if the comp were to get better should we see leverage off of that line, or is it simply going to just flex up and down?
I will take the first question on what we think is happening on maybe why ours is a little bit different, I think mostly the number one thing is we don’t really play with our prices and we have a pretty steady business. We are focused on getting new guests; we have that, our retention plan in our separate stuff, a program which is very strong.
As of yesterday we have 6.2 million members in that program and they come back to our stores at a pretty significant rate. And we can motivate them pretty easily, you know meaning communicate with them because we have all their data on what they buy and we can keep the communications with them pretty focused, and we are using Build-A-Bearville to drive higher engagement. And we think that, that is starting to click in now with us having the 3 million active characters online. That is a significant, significant number.
Hi Dave, this is Scott on the second part of your question, the comps relative to our leverage on our distribution costs there are certainly some leverage, if our comps were to turn positive. But the main items that we really have to deal with on are distribution costs and certainly our margin is the cost in China and what we are facing with our manufacturers there, but more so the fuel.
The fuel is really what is driving, we have seen it almost double from first quarter this year to first quarter last year, and if we could just get that under control and see some of that decline we would certainly see a much better leverage on that.
And our next question comes from the line of Michael Corelli from Barry Vogel and Associates, please proceed.
Michael Corelli- Barry Vogel and Associates
Hi, good morning.
Michael Corelli- Barry Vogel and Associates
Just a question regarding your stores in North America, if I do the analysis of operating profit which is basically the retail sales minus the cost of merchandise sold, SG&A and store pre-opening and I add back the loses and your domestic business is probably down some where north of 40%.
Operating profit wise, even including the benefit of the spring break and the Easter shift. So I was wondering if one, you could give us a little bit of color on you stores domestically, how many of them might be cash flow negative and how many might be losing money on a four wall basis.
And how come the company isn’t choosing at this time to exercise the option that they have in the majority of their leases, where if they get to the third or fourth year and the sales don’t meet a certain level that they could terminate the lease and get out of the location. Because you must have locations that the performance at this point is really dragging down the returns and margins of the company, so if you could answer those couple of questions I would appreciate it.
First of all we don’t have any mall stores that are not making a profit, so I am not sure where you would assume that and because of our lease terms and our rent negotiation and our significant volume in the margins on our business and our control of payroll we are able to make a profit in our stores, and we evaluate that on a on-going basis.
A lot of times because we are so on top of this if you see it that you have a kick opportunity and your business would be declining or you see an opportunity for a rent reduction that is what we would negotiate for. And we are so desired by our landlords that we almost get, whenever we need something we get it, and we have had a lot of cooperation from our landlords over the years.
This isn’t something that we just started to do, we watch it on a by store basis every year, every single year, every single quarter and when an opportunity arises we take it. So, we are very focused on that, and if a store deserves to be closed and we look at this all the time than we will close it. But so far we have not had that reason to react to it.
And our next question comes from the line of Paul Lejuez of Credit Suisse, please proceed.
Tracy Kogan - Credit Suisse
Thanks it is actually Tracy Kogan filling in for Paul, I was hoping you guys could talk a little but about your franchise and licensing revenue. It was higher than expected this quarter and maybe you could tell us what is driving that? Specifically on the license side and then also how you think about both of those businesses in terms of a long term revenue potential there, thanks a lot.
Well from the licensing revenue Tracy we have more stores than in the mix, than we did last year. So it is increasing from that perspective and Scott can tell you more about our strategy in the international.
On the international side we really spent a lot of time this year bringing them into the full of our domestics stores, so we have helped them a lot with their operations side, we have reviewed their P&L’s, we have helped them with some distribution costs, we have looked at their product mix. So the more successful we make them the more we will see it on our side of the revenue.
So we spent a lot more time in the last year bringing them to more of what we do domestically in the U.S. We just had a meeting with all of them last week again on product mix and on operational excellence to help them drive their profitability, which adds to their sales model.
So we have really spent a lot of time this year, we have really slowed down adding countries and have really focused on our existing countries, and making their stores as profitable as we can, so that is really going to be our goal to really drive our portion of that franchise business back to us.
Tracy Kogan- Credit Suisse
And any forecasts on how big those businesses can be and then on the licensing side can you just tell us, describe some of the new license agreement that you have out there?
You mean licensing like product licensing or do you mean like franchise licensing?
Tracy Kogan- Credit Suisse
No, licensing as in product licensing? Like you had the deal with Target, with the Build-A-Bear kits?
Right, okay there really are not that many new ones. The most significant new one clicked in last fourth quarter which is from Game Factory with the Nintendo DS game, and that has been incredibly successful. We also have a furniture line that was launched last year, which is a high ticket line of furniture that also has been very, very successful but wasn’t in our numbers this time last year.
So that has been very strong and then all of the other ones that are in place are growing, because they are very targeted and very focused, and we also have coming forward in a place high ends to BuildaBearville.com,. So products that you buy in somebody else’s store, in a bookstore, in a Nintendo DS game and soon the WI game will also have a Build-A-Bear tie in so, we are really totally integrating all of these things.
And we have some new things that will hopefully be able to talk about more in the second quarter as they unfold that are also tied to engaging our guests in Build-A-Bearville as well as in products available in the regular marketplace.
And our next question comes from the line of Sean McGowan of Needham & Company, please proceed.
Sean McGowan - Needham & Company
Hi, two questions one this might be for Scott, can you give us a sense of the timing of store openings this year. How that will flow throughout the year, I know that there is slippage from one quarter to another all the time but just an idea of how it will compare to last years?
Yes for the most part the second and third quarter will be our biggest number of store openings we generally every year try to have our store openings completed before the Christmas season kicks in. So we should have most all new stores open by the end of October, first of November, but a vast majority will be in the second and third quarter.
Sean McGowan - Needham & Company
Okay that is helpful, and then secondly in terms of the economic model for Build-A-Bearville is this something that the company is looking for to be a direct source of revenue and if not how tolerant would you be of losses. At some point would you consider changing the economic model?
We absolutely do see this as an opportunity for revenue on its own, through several programs that we are developing as we speak and also in some of the product offerings that you will see coming out hopefully over by Christmas. Where they are directly tied to Build-A-Bearville, and they connect a product to even further which will have a revenue based to it. So I really think there are opportunities that are unfolding as we speak and I think there’s lots of possibilities here.
Well I do believe that absolutely the further engagement of our customer in Build-A-Bearville.com will enhance our store business. I believe that this is a revenue building model and that we can in fact drive revenue. Just like we drive licensing revenue, I don’t know if we would put it on a different line or what we would call it at that point but we are now focused on growing it on every level that we possibly can.
And we see a tremendous potential based on the early success and also the research that we are doing, and talking to our guests and getting feedback and the outside resources that we use that our helping putting us well into the 21st century of this kind of concept.
And our next question comes from the line of Mike Smith of Kansas City Capital, please proceed.
Mike Smith - Kansas City Capital
Well good morning, I wonder if you could go into a little bit more your affiliation with Ridemakerz and how much of that you own and what kind of options you might have for increasing your ownership?
Well as we said on the call we have an initial investment of about $3 million, plus we have added equity over the last year, based on our services agreement. So, as we have said publicly before we own about, or will own about 30% and we have the option to increase that as new capital is required in that investment.
Mike Smith - Kansas City Capital
Do you have any long term plans with that?
Well, like everything we are looking at it with an ongoing basis and it still is in its infancy, but we are absolutely encouraged by the opportunist that it presents. And the strong customer following that it has. It is very segmented to boys and men and so the biggest opportunity is really in evaluating the right shopping locations for that. And the distribution model and ultimately I think you will see the potential for the online virtual world aspects of a brand like Ridemakerz as well to have a financial opportunity.
Then we have our licensing propositions of product licensing that is actually called, we refer to it as in-licensing versus out-licensing. But, as you know we carry brand name cars that aren’t incredibly successful part of our mix and how that produces revenue is a little bit different than you might expect. So there really are some great opportunist here its just really in looking at that brand is it made for the 21st century, not just as you might think about it in the past.
There are just a few stores that in May will hit our first store that has been open a year, so we have along way to go and we are very encouraged by the opportunity and I would say the strong customer connection to the brand, so far.
Mike Smith - Kansas City Capital
And our next question comes from the line of Gerrick Johnson of BMO Capital Markets, please proceed.
Gerrick Johnson - BMO Capital Markets
Hi good morning, I was hoping you could talk a little bit about your birthday party business, and how that comp is doing, whether it be number of parties or revenue from them? Thank you.
Our party businesses, some people believe is much larger than it has always been less than 10% of our business and as we open up new stores and markets we don’t look so much at the comp at the store that is there, we look at the market comp. And so our party business has been reasonably consistent as it performs across our stores, and it is growing quite rapidly in the United Kingdom, because the base was much lower.
So we do see that this has been a good business. I think that one of the things that we also noticing is that as the consumer spending, they might have brought 10 kids a year ago or 18 months ago to a party, they might now be bringing eight kids, so the party count might be similar, you might be hosting as many parities as you always did, but they might be brining less customers, less guests to their party, but it has always been less than 10% of our overall business in the United States.
Gerrick Johnson of BMO Capital Markets
Okay, so the number of parties though is pretty consistent year over year in the U.S., its just the number of kids coming to the parties is a little bit lower.
Well it varies by store and by market but, you have a big mix of both, you have some markets that it’s down and you have more mature markets and you have other markets where it is up. We haven’t really focused as much on our marketing parties, we just sort of let it be a constant because we also don’t want too many parties can negatively affect our guests’ experience.
And we also build our stores smaller today, there is only so many parties that you can host at a given time, where the bigger stores you might have been able to host more parties right now in a store that is 2,200 to 2,500 you can’t have more than one party going on at any given time.
So, we have consciously done that. So I would say that it' just varies. We have not been making it a major focus because we want to make sure that we attract a broad range of customers and all ages of customers. So the average, the bull’s-eye target for a party for a Build-A-Bear customer is about a 10.5 year old girl we also have 20% of our customers that are over 14 year old.
So that is not a non-party customer, and we have some smaller children too where we don’t encourage parties before three years old at the earliest, maybe even five. So it just depends, but I would say that like all traffic and all business it’s not up, but it would be certainly – it’s consistent.
(Operator instructions) And our next question comes from the line of Brad Leonard of BML Capital, please proceed.
Brad Leonard - BML Capital
Hi, you know the gross margin deteriorated a little bit more than it had I guess the last few quarters and I guess the SG&A was only about 7% year over year. Are those trends we should expect to continue throughout the year?
Well I think as you look at from a gross margin perspective the amount of fixed cost in the rent and that, as long as the comps are in a declining mode we cannot get leverage on that. If the business turns and we start to get leverage, you will see an improvement in the gross margin, and the same way with SG&A, there is a good portion of that, that is fixed.
Brad Leonard - BML Capital
Well I guess the question would be more as the gross margin deteriorated this quarter year over year than it did on Q4 on a similar comp trend and what is the cause of that primarily? The extra 70 basis points or whatever it was.
Some of it is product mix, from a perspective of how many bears people might be buying, which goes back to the cost of our initial products that are coming out of China, we are trying to maintain the cost with the pressures in the China manufacturing environment. I think also it is a balance, because the UK has come out strong that has helped the overall margin from, I think Scott talked about the distribution being able to be basically flat because of the benefit that we received in the UK.
I think we just have to be careful the fuel surcharges are, that everybody is facing today and our products are petroleum based products so, we have to see some turn in the fuel environment. And also I think our merchandise markup, if you are just looking at merchandise markup has been reasonable considering all of the changes that are going on in the UK.
We just don’t find it in China, it is not an appropriate time to be significantly raising prices. There are some things that we have just decided that we are going to, we would rather just sell it than mark it up and maybe not sell it as the customer, the pressure has been there, but, so there is a little bit of that in there.
So we are monitoring that as we go and taking appropriate new products where we see that the value can be, the product can be raised and be a higher markup, than we would go there, but I think that right now we are a discretionary product and we want to make sure that the value for the consumer is evident and clearly apparent every time they walk into our store.
Brad Leonard - BML Capital
Sure and then just on the SG&A, do you think that is something this year over year level of increase around 7% is something that we are going to be able to ball-parkish for the year?
You know I think one of the things when you look at it year over years, as I stated before we did have increase cost of stock option expense for SG&A, so I think that’s going to continue to increase year over year. We also talked about costs of maintaining all of our websites that is in SG&A also. So there will be some increase, but again you get leverage from that if you get a better comp store return.
And our next question is a follow up question from the line of Michael Corelli, please proceed.
Michael Corelli- Barry Vogel and Associates
Hi, just a comment on my last question and then I had another question. It is good to see that the company continues to produce profits at all its stores considering, the obviously recent deterioration in the mall traffic and comps. My comment was just basically that sometimes if stores are earning a very low return versus others it might make sense to close them to be able to focus the resources on the other stores that had better potential that is all.
And as far as the share repurchase program, I just had a question. You were pretty aggressive in the first week or so buying about 954,000 shares and then you slowed down a lot, just wanted to know what the thought process was behind that?
Let me just comment first Michael in your comment, we do look at that. And actually that’s all part of one of the things is looking at by a market basis and so saying if we close this store – if we have an opportunity to close it and we closed it could we do more business in another store. And we do look at that, that is a very, very important part of our real estate.
But also we are at a time period right now where customers are not wanting to travel very far to go to a store. That is one of the challenges I think, you know they want you to be closer because of the gasoline and so not that we wouldn’t close a store that was a significant challenge, but as we look at it and we look at the math and we look at each market and this week we examined quite a few markets very, very closely, based on the profitability of those stores, the contribution of those stores and the closeness that they have, the party business that they have, the frequency of customers that they have, we look at all of these factors and we don’t want to force a customer to have to drive further, would that make it even more discretionary of our product they just wont go.
So we are looking at it and there are maybe a few places that, that maybe come down the road there will be some opportunities. We only have – we are still a young company and we have some stores that are in their third and fourth year, coming into their fourth year that we will still evaluate.
We also have to kicks built into many, many of our leases. So that more so, not so much for our business situation but as the market changes, but also a lot of our stores have cast their first kick because very, very profitable and now we are looking towards the next one which might come up in the future.
So we are evaluating it, I don’t want you to think that is why we built them in there to give us some flexibility. But we also are a very unique concept in a mall and you can bet pretty surely that the landlords are going to work really hard to keep us and make it attractive for us to be there, wspecially with our sales per square foot, so it works to our advantage whichever way you want to look at it.
And from a perspective of the shares repurchase, our share repurchase was inline with our agreement that we set out that we would purchase under the open market and then when we went into a closed period, we purchased under our 10-B-51 plan.
And our next question is a follow up question from the line of Sean McGowan, please proceed.
Sean McGowan - Needham & Company
Maybe you have answered this in other forums recently but I was just wondering if you had a sense now for what you think the ultimate opportunity is in North America in terms of number of stores, has that evolved recently?
We haven’t changed from our original, I think we’ve been saying all along 350-ish stores to 400 probably at the max but I think that is the number that we have always been talking about. And again some of those stores would be in smaller markets some would be multiple markets in existing stores. We have been focusing the last few years of opening up new markets, trying to make sure that we are entering a place that there isn’t a Build-A-Bear store.
And our next question, I apologize ma’am?
I was just going to say that this year I believe 17 of the 20 stores are in brand new markets that Build-A-Bear, in North America that wouldn’t have been - had Build-A-Bear stores there before.
And our next question is a follow up question from the line of Brad Leonard, please proceed.
Brad Leonard - BML Capital
I have two questions for you. On the European stores seem to have been doing really well as, you know, on a year over year comparison, one is it possible that those guys could, I mean you’re almost profitable this quarter and I don’t know what the charge was for closing the store that you mentioned, that you could get to profitability in Q2 or Q3 if the trends continue.
And two, any comment on comp trends here through April in either UK or North America? I mean are they similar or would you like to even comment at all about that, thanks?
We’re not going to comment on inner-quarter comp trends. But, as I had said on the conference call that while our business has improved significantly, our outlook for 2008 is still in the European operations to have a loss in first, second and third quarter and deliver a profit in the fourth quarter and for the full year.
And our next question is a follow up question from the line of Paul Lejuez, please proceed.
Tracy Kogan - Credit Suisse
Hey, it’s Tracy. Tina, I was hoping you could just tell us what the cash flow from ops was this quarter? Thanks.
We haven’t disclosed that yet. We haven’t finished our Q and that will be – it’s part of our disclosure in the Q.
Tracy Kogan - Credit Suisse
Ladies and gentlemen this does conclude the question and answer portion of today’s conference call. I would like to turn the presentation back over to Ms. Molly Salky for any closing remarks.
Thank you operator and just thanks to everyone for your participation today, feel free to give me a call if you have any follow up questions. Thanks and have a great day.
Ladies and gentlemen, this does conclude the question and answer portion of today’s conference call –
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