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Executives

Allison Malkin - Senior MD, ICR

Maxine Clark - Founder & CEO

Tina Klocke - COO, CFO & Treasurer

Analysts

Gerrick Johnson - BMO Capital Markets

Sean McGowan - Needham & Company

Build-A-Bear Workshop, Inc. (BBW) Q2 2012 Earnings Call July 26, 2012 9:00 AM ET

Operator

Greetings and welcome to the Build-A-Bear Workshop second quarter fiscal 2012 results conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Allison Malkin of ICR. Thank you. Ms. Malkin, you may begin.

Allison Malkin

Good morning. Thank you for joining us. With me today are 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, our call is being recorded and broadcast live via the Internet. The earnings release is available on the Investor Relations section on 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 2012 second quarter and first six months results. On our call today, I will read the progress that we've made on our key strategies as well as update on you store, product and marketing initiatives. Then I’ll turn the call over to Tina Klocke, our Chief Operations and Financial Bear to review our financial results in more detail. After my concluding comments, we will open the call to answer your questions.

At the halfway mark of the fiscal year, we continue to show progress towards our 2012 objectives. We have positive comparable store sales for the first half of the year in North America, showed solid improvement in quarterly trend in Europe and drove significant growth in our e-commerce business. We also have improvement in our operating performance, reducing our pretax loss by nearly $5 million.

As we begin the second half of the year, we fully expect further improvement in sales productivity and profitability. We continue to execute our long-term strategies to optimize our store base, increase shopping frequency and improve cost efficiency.

Let me go into a bit more detail about our quarterly performance. In the second quarter, the Easter Shift had a negative impact on April sales as planned, but we returned to the positive column in May and June in North America. In Europe, where the macroeconomic climate is especially challenging, we saw marked improvement in trend and continue to focus on key initiatives to move this unit back to positive comp and we once again posted growth on the e-commerce side with a 5.5% increase coming on top of a 23% increase in last year’s second quarter. We continue to be in a strong cash position to execute our strategies ending the quarter with $26.5 million and no borrowings on our credit facility.

On the product front, one of the highlights of the second quarter was the strong reaction to our first ever tie in with the Girls Scout as we introduced a special bear in uniform in conjunction with our 100th anniversary. We saw a gain in our core demographic, Twins dress and drove an increase in our party business. We also had a great response to the Avengers costume collection that tied into the movie release, a big hit across the board, but especially with boys.

In marketing, we continue our two-prong approach, speaking to both kids and moms. We’ve had kids know about our new products and fun store experience and make it easy for moms to say yes. We see a renewed opportunity and some early positive results from rebalancing our experiential brand focus advertising and value added marketing events versus featuring only discount and promotional messages that had been needed during the economic downturn.

For example, in June, we brought back one of our most popular gifts for purchase, a summer beach towel and we saw strong guest response to the offer. Our enhanced brand focus has also shown benefit. We continue to engage on the emotional connection that guests have with our brand, with our year-long celebration of our 15th birthday and our Friends Count campaign. We are using this campaign to increase special occasion and celebratory events as reasons to visit a Build-A-Bear Workshop store.

Moms continue to be value focused. So we know it’s important to provide balance. For example, the coupon that was offered in the promotion we ran with McDonald’s continue to drive traffic into our stores throughout the second quarter.

Looking at our third quarter line up, we have an updated to our partnership with Sanrio with the launch of Pink Leopard Hello Kitty. This was followed by our Best Friend’s collection that features strong animals and fashion elements.

We are also bringing back what had become a highly anticipated event, our $29.99 any sale. This very popular bundle promotion offers any animal, any asset and any pair of shoes for one set of price of $29.99 in the United States and core funding value in our other countries of operation.

We’re excited about our fourth quarter product line up and we’ll give you the details on our next call. What I would really like to do today is give you more insights into a few of the strategies that we have in place to achieve our 2012 objectives. These strategies lay the foundation not only for the current year, but for our future as well.

A key component of our plan involves our real estate strategy. We will continue to be very active on this front over the next two to three years. Leading us to this point, we’ve been aggressively and successfully renegotiating rents and executing short-term extensions to line up lease space within market as part of our overall plan to optimize market positioning.

As we move the strategy forward, we will close underperforming stores in conjunction with natural lease expirations and kick out clauses primarily in multi-store markets. For example, last year we closed 14 stores including temporary and seasonal locations and this year we will close 10 more. We expect to maintain a percentage of sales from the closing stores by transferring customers to other locations that remain open in the market. While it’s early, based on the closures that we have made so far we believe that on average about 20% to 30% of sales from closed stores will move to our remaining store.

We will also improve productivity by relocating and right sizing select stores and remodeling other stores in a new design that will update our experience. Our excitement is building as the first newly imagine store will soon be opening. In just over a month we will introduce this highly interactive store in St. Louis. Following the St. Louis debut we will open stores in Detroit, Indianapolis, Washington DC, Annapolis and the San Francisco East Bay area.

I am very excited about this store. When Build-A-Bear workshop started our concepts redefined retail and this new design will change it again. The new store merges Build-A-Bear workshop hands-on-bear making experience with the power of technology to provide a magical new experience to our guests. The new interactivity is an evolution that recognizes that technology is a part of play for kids today and a way to enhance our signature process.

We have been working with a group of kids, our sub-advisors and their moms on the interactive feature. This co-creation has been extremely valuable to perfecting the working model of the design and really get a feel for how our guests will engage with the store and our product. The store will be great fun and continue to provide memorable innovative experiences for families for many years to come.

A new look and enhanced experience combined with closing secondary locations would give our newly imagined stores flagship status and destination appeal. We have designed modular components that will allow us to update and remodel future stores with select features, once we have identified the stations with the largest return on investment.

Our competitive advantage is our interactive retail environment; no one does it like Build-A-Bear Workshop and we will continue to lead in this space. We have lot of the year to still deliver but I believe we have the right strategies to allow us to continue our progress on our long term objectives.

And now I will turn the discussion over to Tina.

Tina Klocke

Thanks Maxine and good morning everyone. Our results for the first six months of the year show solid progress toward our annual and long-term objectives. The shift in Easter and associated school holidays impacted the timing of our sales on a monthly basis, but we have delivered improvement in our pretax loss both the first and second quarters.

Our first half results which removed the Easter shift show stability in our North American comparable store and consolidated e-commerce sales and put us in a good position as we move into the back half of the year.

I would like to highlight the key components of our second quarter, the full details can be found in our press release. In the second quarter, revenue was $80 million. Our net retail sales decreased 1.8% excluding the impact of foreign exchange. Consolidated comparable store sales decreased 1.7% driven primarily by a 6.1% decline in transaction as a result of the Easter shift partially offset by an increase of 4.7% in transaction value.

Our e-commerce business rose 5.5% in the quarter excluding the impact of foreign exchange with a solid performance in both North America and UK. This was our eight consecutive quarter growth in our e-commerce business.

Our retail gross margin declined 80 basis points to 35%. On the positive side, we had benefits from reduced warehousing, distribution and packaging cost. However, this was offset by product margin pressure primarily due to promotions and mark downs needed to accelerate the clearance of carryover on seasonal holiday products.

While impacting our margin rate, this allowed us to end the quarter with appropriate inventory levels. SG&A was $37 million or 46.1% of revenues compared to 49.7% in the second quarter last year. The change is a result of improved payroll management and savings and other operational expenses, included in last year’s SG&A were $1.5 million and expenses associated with our consulting project.

Excluding the consulting fees, SG&A as a percent of sales improved 180 basis points. Pre-tax loss was $8 million compared to a pre-tax loss of $11 million last year. Our effective tax rate was 9% in the second quarter compared to 37% last year. The wide variance is due to the valuation allowance established on all of our US deferred tax assets at the end of 2011.

Net loss was $8 million or $0.46 per share. This compared to net loss of $7 million or $0.37 per share last year. Our second quarter net loss was negatively impacted by $0.14 per share related to the change in our effective tax rate, and $0.04 per share resulting from a change in share count due to repurchases that were made in the second half of 2011.

Last year’s net loss was negatively impacted by $0.05 per share related to our consulting project. For the first six months, total revenues were $177 million, a decrease of four times excluding the impact the foreign exchange. On a consolidated basis, comp store sales were essentially flat and included a 1.1% increase in North America and a 6% decrease in European operations, our retail gross margin improved by 30 basis points to 37.7%.

As we look to the back half of the year, we expect cost pressure and our promotional environment to negatively impact gross margin in the third quarter. However, we expect a slight expansion in gross margin in the fourth quarter. SG&A was $77 million or 43.7% of revenues compared to 46.1% in 2011.

Included in last year’s SG&A were $3 million in expenses associated with our consulting project. Excluding the consulting fees, SG&A as a percent of revenues improved 70 basis points. We expect deleverage in SG&A as a percentage of revenue in the back half of the year driven by a shift in the timing of marketing and other expenses to coincide with new openings and accrual for incentive compensation this year versus no accrual last year.

Pre-tax loss for the first six months was $9 million, an improvement from pre-tax loss of $14 million last year. Net loss for the first half of the year was $8.6 million or $0.53 per share. This compared to a net loss of $8.9 million or $0.50 per share last year.

2012 was negatively impacted by $0.17 per share related to the change in our effective tax rate and $0.05 per share resulting from a change in share count due to repurchases that were made in the second half of 2011.

Last year’s net loss was negatively impacted by $0.10 per share related to our consulting project. As it relates to the balance sheet, we have a strong position with consolidated cash of $26.5 million. We have no debt and no borrowings on our credit facility. At the quarter end, consolidated inventory was $47 million, an increase of 3.3% on a per square foot basis.

Depreciation and amortization was $5 million in the quarter and we continue to expect approximately $22 million for the year. Capital expenditures in the second quarter were $5 million, primarily for store related and IT upgrades.

For the full year, we expect capital expenditures to be $20 million to $23 million; about half of our anticipated capitals spend for the year will be for stores. We’re building six stores and are in new design and three in a current design, two of these in the UK.

We’re also relocating select stores in existing malls in conjunction with least explorations to right size their square footage and improve productivity. All of this activity is part of the multi-year real estate strategy that Maxine spoke to earlier.

The balance of our capital expenditures are primarily being invested in IT. We’re making updates to systems that will support our stores, improve overall back office efficiency, power the experiences of our new store design and continue to upgrade our e-commerce.

The updates will support key initiatives to our organization and position us to continue to execute our long-term strategies. Build-A-Bear workshop has a disciplined approach to capital expenditures with a focus on delivering a solid return on our investments.

One of our other key objectives is to grow our business globally. I want to give you an update on our progress and plans for this business segment, particularly our franchise operations.

When you combine our company-owned international stores and stores operated by franchises, nearly 40% of our store base is outside the United States, other than our stores in Canada and UK we currently use our franchise model. This is a highly effective model that requires a minimal capital and brings the localized expertise of our franchises to our business. We’re also able to leverage key resources and deliver profits that can be reinvested back into the segment.

In the past year, we have been focused on helping our existing franchises deliver their business plans and growth commitments. We’re also developing the infrastructure and talent that is needed to grow both with existing franchises and new countries. This is a multi-year strategy that will increase shareholder value as we grow the segment.

At the end of the first half, our franchisees operated 84 stores in 14 countries and our revenue from international operations was $1.5 million. Build-A-Bear workshop has been on the forefront of international expansion and we will continue to grow this business.

Now I would like to turn the call back over to Maxine for concluding remarks.

Maxine Clark

Thanks Tina. Let me wrap up by saying that I am confident that we will post further improvement in sales productivity and profitability when 2012 is complete. Our brands are in favorite of kids and moms and we are investing in key areas that will keep it a favorite for future generations.

Our new store design will bring renewed energy to our experience. We will rebalance our marketing to include a stronger brand message while still recognizing the challenging economy that families face. This strategy will be a key to increase shopper frequency.

It is important to keep our prices affordable given the discretionary nature of our product and while we have cost pressures, we are very committed to disciplined expense control and delivering profitable results.

We are executing a strategic real estate plan that includes closing select locations and increasing productivity and profitability of remaining stores. And as Tina discussed, we are positioned to continue to grow internationally with the existing franchisees and new countries of operation.

Let me reiterate, I am very excited about our new store design, it will reenergize the interactive retail experience that we bring to the mall and once again put Build-A-Bear workshop on the cutting edge.

We are on the right track and we have the long-term strategies in place to change the dynamics of Build-A-Bear workshop, continue to grow our comp store sales and maximize shareholder value.

And now we will open the call to your questions.

Question-And-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Gerrick Johnson of BMO Capital Markets. Please proceed with your question.

Gerrick Johnson - BMO Capital Markets

In locations where you had multiple stores and you did close in under performing store what kind of comp list do you see in the remaining store there?

Maxine Clark

It depends on the store location, I don’t have any quite off the top of my head but we said we have about 20% to 30% transfer rate until that definitely does give us a plus, most of the stores all we do is tell the customers that the store is closing and the new store, the closest store to them is that.

We haven’t done any marketing like we will do around our total remodels and stores of the future. So those are really getting some higher than other transfer sales some in the mid-teens, others in the low single digits but it just depends on where the store is, and how many other stores may be in the market because some stores may split up to, customers may split up and go to multiple store locations. So, everybody could pick up 5% with overall you are picking up a good percentage of that business.

Gerrick Johnson - BMO Capital Markets

And may be just for clarity, can you or Tina run through the store openings, closings and with locations that you had in the second quarter and you expect for the full year? Thank you.

Maxine Clark

For the full year we expect to open or remodel or relocate 20 stores. We expect to close 10 and this quarter we closed three.

Gerrick Johnson - BMO Capital Markets

So, in net of 10 new stores at the end of the year?

Maxine Clark

Well, relocated here we are going to relocate and remodel.

Gerrick Johnson - BMO Capital Markets

Well that's what I am trying to get to, I am trying to see if you could breakdown what's being open brand new, what's being relocated and what's being closed rather than comping it all together?

Maxine Clark

So we will have, we will open five new stores and we will relocate or remodel 15. And then of that 20, six will be in the new store design.

Gerrick Johnson - BMO Capital Markets

Okay, and closing 10.

Maxine Clark

Correct. And the 10 include seasonal and temporary locations also.

Gerrick Johnson - BMO Capital Markets

And lastly you mentioned clearance and promos affecting gross margins, so what kind of same-store sales result would you have had if you excluded those sort of promo sales and just looked at current if you will current product sales.

Maxine Clark

Yeah, Garret there's always going to be a portion of clearance and promotional activity and so we really, we don't look at it that way, it's part of the overall base of our business and what we do at this point in time.

Operator

Our next question comes from the line of Sean McGowan of Needham & Company.

Sean McGowan - Needham & Company

I also have a couple of questions. If you can review the promotions and programs that are planed for the third quarter, could you review for us what are you are comping against last year and/or get a sense of what might be incremental this year. And say could you do a Hello Kitty last year.

Maxine Clark

We did Maxine Clark last year but in a different timeframe, so that might not necessarily be comparable, but our promotional schedule for the third quarter is pretty much the same. The biggest promotion that we have is our any sale, the $29.99 event which is a national event. It's an annual event and that comes in August and it’s the same time this year as it was last year and then the rest of the events are really kind of are really launches of Animal, a little repositioning sometimes, one may reopen in one week and then it was another week last year but there is not any major shift and certainly not really any big plusses in the third quarter. We really are focusing our efforts on correcting the things that we thought were are shortfalls last year in the third quarter, which just might be a just a better product in the same week that we launched something last year and then also on our fourth quarter transition.

Sean McGowan - Needham & Company

So then the comp growth, whether it’s in May and June period and your forecast is really coming from traffic, I mean transaction values, you are just doing a better job of getting people to splurge on shoes and stuff.

Maxine Clark

Yes. While the transactions themselves might be down slightly. The customers who are coming in to the stores is being spending a little bit more and we’re improving our ratio of accessory shoes and clothes to the Bear transaction. We’re working very hard on that and getting that back up to the levels that it has been in the past because it is part of our experience and the customer at least up until the present time has been positively responding to that. Again economy does come into effect, but I wouldn’t say that the mall traffic is significantly a positive factor. I don’t think that’s up to pre-2008 level yet but has been improving slightly.

Sean McGowan - Needham & Company

Tina, regarding some of the leases coming up. If we look at over the next several years, is it sort of an even flow of how leases are expiring or is their concentration in any particular year when you have leases coming up?

Tina Klocke

I think 2012 and 2013, back when we, in 2002 and 2003, I think we had about 80 stores that we opened. So those will be coming through natural lease expirations, but then again as we've talked before, over the last several years, we’ve been aligning some other leases in the market, so that we can look at the overall market. So, about 80 leases will come due in between now and the end of 2013.

Or we already have as part of our real-estate negotiating repositioned, extended, we’re really working on those on an ongoing basis, market by market. So many of those stores are some of the most profitable stores in the Build-A-Bear family. And we want to make sure that those are the stores that are targeted for remodel. The good news is that most of them, we did position them to be in 2013 and 2014 because we wanted to have the benefit of what we learned from the new store, the future and what elements might, if not all of them be transferred into the new store. Any stores that we opened up this year prior to September are updated, but not a new format.

And maybe have a feature or two of the new features that we just reopened in Hamleys. In the UK we re-did our store there as part of their remodel and we put in a couple of new elements from the store, the feature that has been very, very positive to their sales. So we feel really encouraged about the ability to remodel stores, not necessarily start all over and call it a new store, but move elements of the new store, the feature that we're working on into next year's remodel from the ones that we’re doing the remainder of this year.

Sean McGowan - Needham & Company

On relocations and any new locations, are there still 10-year leases or are they shorter?

Tina Klocke

It’s going to vary by location. Few of them are shorter in terms and the average would still be about 10.

Sean McGowan - Needham & Company

Tina also for you, what are the tax rate in the quarter, I know it is weird when you have negatives and tax allowances, but what does it mean for what you effect and what you expect to see assuming some return to profitability? Or just say a permanent reduction in the effective tax rate or is it just a quart of that quarter?

Tina Klocke

It’s going to be a quart of the next few quarters Sean because of the valuation allowance and so until we are able to reverse that valuation allowance it’s going to fluctuate and I think that and it’s hard to -- it’s really hard to say what it will be. I mean it could be about a 14% rate this year.

Sean McGowan - Needham & Company

Okay, thanks. Then last question, when does (inaudible) open a new store, a new model I mean?

Maxine Clark

The 21st of September, we will send you a formal notification. We hope you will join us.

Sean McGowan - Needham & Company

The cardinal is town.

Maxine Clark

It will be because of the world series, the final, to get and go in there. That's what may do the best, September.

Operator

Thank you. (Operator Instructions) Thank you. We do have a follow up question from the line of Gerrick Johnson of BMO Capital Markets. Please proceed with your question.

Gerrick Johnson - BMO Capital Markets

Great, thanks. Just one more question on the components of the same-store sales, you said 6% decline in transactions, 4.7% increase in transaction value, how about unit ,the third component or if you could break out transaction value between units and price perhaps?

Maxine Clark

I think Gerry, it’s probably about flat on units and the majority of it is from a price perspective, increase in price.

Gerrick Johnson - BMO Capital Markets

The increase in price or perhaps an increase or change in the mix?

Maxine Clark

It could be that too, it could be a little bit of change in mix but I think units are essentially flat. Like Gerrick just FYI, I think this might be helpful. So in the past years, the girl scout party. If the girl scout came in and brought a Bear for a party they would have probably brought a $10 or $12 Bear as part of their party, but the Girl Scout bear that we made this year was $15 and it was special and so I would say a huge percentage may be 90% of the Girl Scout parties that came in brought a Girl Scout bear plus all the other Girl Scout.

So it was definitely an upgrade and we have the uniforms that are $15, so they all got pretty delved in those uniforms as special part of the Girl Scout anniversary celebration. So that is the plus for this year as well as the fact that on a couple of our promotions particularly on the Beach Towel promotion, we raised a threshold on the product. So that you had to spend $30 in order to qualify and that also raised our – you know those kind of things when you have a really good value promotion like the Beach Towel that tied under the Sea Collection and you encourage the customer to spend $30, they will.

You can't do that all the time but I think that that really helped us as well as. And so those are the kinds of techniques that you can use, it doesn’t work sometimes just on a regular launch when you just -- it is just a new animal and it does have its cute clothes and everything. But there is not much of a marketing effort put behind it. But the Girl Scouts put their own marketing behind their anniversary. That helped us, and as well as our own marketing and then the promotion of the Towel promotion was one that we added back in this year.

Okay with no other questions thank you again for joining us and we look forward to speaking with you on our Q3 call in October. Have a great day.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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