Welcome to the second quarter 2008 Build-A-Bear Workshop earnings conference call. (Operator InstructionsI would now like to turn the presentation over to your host for today’s call, Molly Salky, Director of Investor Relations.
Good morning everyone and thank you for joining us for review of our results for the 2008 fiscal second quarter. With me this morning are Maxine Clark, Chairman and Chief Executive Bear, Scott Seay, President and Chief Operating Bear, Tina Klocke, Chief Financial Bear, and also joining the call today is Dory Kruger, Managing Director - Strategic Bear Planning.
In a moment I’ll turn the call over to Maxine to provide her comments on the second quarter. Tina will follow with additional comments on our financial results. At the end of our remarks we’ll open up the call for your questions. Maxine, Scott, Tina and Dory will be available to respond to your questions. Members of the media who may be on our call should 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 question during this one-hour call. Feel free to requeue 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’ll 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 Form 10K filed with the SEC. We undertake no obligation to update or revise any forward-looking statements.
Now I’d like to turn the call over to Maxine Clark for her comments.
Good morning everyone and thank you for joining us to review our second quarter results. During the second quarter we saw pressure from multiple factors placed on the United States consumer. This very difficult consumer spending environment on top of the switch in Easter to the first quarter had a significant impact on our second quarter results.
I’d like to step away from our typical format on these calls to focus my discussion this morning on three important topics. The first is capital allocation and how we think about capital and cash management in the current environment. The second is cost control and the actions we’re taking to eliminate non-essential activities and reduce costs. And third, I’ll discuss some of the ways we’re selectively investing in our brand for long-term growth.
These issues are at the core of our business planning today. We’re actively balancing the near-term uncertainty in the consumer environment with our objective to protect our brand by making prudent investments for long-term growth. The current environment is unprecedented so we are acting carefully and with shareholder value always in mind. Our products are discretionary and we are keenly aware that it’s a discretionary portion of consumers’ budgets being significantly squeezed today. We are also aware that the consumers’ perception of value may change in economic times like this. We are looking closely at the value proposition we offer our guests and for ways to increase our value in the current environment. We strongly believe in our moderated business plan for 2008 and our initial conservative planning for next year and in the strength of our brand and the long-term staying power of our brand experience. The strong cash flow characteristics of our company and our flexible capital structure will continue to serve us well as we manage through this economic slowdown.
Let me start with capital allocation and how we think about allocating capital to new stores in this environment. We take a disciplined and data driven approach to capital allocation. Before committing capital we model the returns expected and demand that our capital earns a high rate of return. Specifically for store capital, we use a multi variable regression analysis that conservatively takes the consumer environment into consideration. In the case of store capital we generally look for project returns to exceed hurdle rates in the mid-30% range. As you know we reduced our new store plans dramatically over the past year from opening 50 stores in 2007 to 25 in 2008 and now looking to open approximately six new stores in 2009. Part of our store profitability discipline also includes opening stores that are built to match the market demand. So rather than having a standard store size and configuration we adjust our store size to the market demographics. Our stores pay for themselves in about the first 12 to 15 months. We believe we have taken a conservative and highly strategic approach to new store openings in the 2009 capital spending plan.
At this time our outlook is to open a total of six stores, four in North America and two in Europe. Each new store location has been evaluated using our capital allocation model with conservative sales assumptions applied. The plan includes adding at least one additional store in Puerto Rico. We opened our first store in San Juan in June 2007. The performance at this first store has exceeded plans. In slightly more than 3,000 square feet the store is highly profitable, produces sales of nearly $2,400 per square foot, and is comping positive in the low-teen range. By strategically expanding this lucrative market with ultimately two to three additional stores on the island we can gain further market share, efficiencies in product distribution and store labor, improve guest satisfaction, and leverage our marketing and brand building efforts along with our investment in language translation.
Store lease renewals begin to ramp up in 2009 and 2010 as we anniversary 10-year lease terms. This renewal process gives us the opportunity to re-evaluate the market where our stores are located and take a fresh look at how the market should be structure. We are deep into this planning with our internal teams and landlords. We are a productive and valued tenant for the sales and quality guests we bring to the mall. It’s important to note that last year on a full-year basis all of our mall-based stores were profitable. Consumers today are very aware of the distance they are traveling to a mall. We will look at the configuration of our markets on existing stores and renewals and maximize our reach within markets where we operate as we evaluate the ongoing operations of each lease. We said that our chain will ultimately be at least 350 stores in North America and about 70 in the UK and this outlook has not changed. We’ll end 2008 with 292 stores in North America and 51 stores in the UK and Ireland giving us room for growth when the economy improves.
Our goal is to manage cash carefully and maintain flexibility. Second quarter is seasonally a high cash use time period from an operations perspective. As we managed to the quarter while keeping an eye on our full-year cash flow outlook, we repurchased shares as we determined appropriate and invested in additional capital in the RIDEMAKERZ concept. RIDEMAKERZ is in the test phase. As in any young company they are actively evaluating different real estate options and experimenting with various formats to determine which options will work best for this concept. The first store in Myrtle Beach is now entering its second year and producing very positive comp results. We see enough good things in the start-up that we want to remain involved. We’ve provided RIDEMAKERZ with an additional funding during the second quarter to explore alternative means of maximizing their brand. As a reminder, RIDEMAKERZ is boy-focused. 90% of their customers are male versus 30% at Build-A-Bear Workshop so this concept does not cannibalize the Build-A-Bear Workshop business. RIDEMAKERZ will end this year with 13 stores and during 2009 all stores will begin to comp giving them the chance to evaluate the store performance by real estate type and then determine the rollout strategy.
Next let me discuss actions we’re taking to aggressively control costs and protect our profitability. First is the change in our store management structure which will reduce the fixed cost components of store payroll thereby allowing greater flexibility to control payroll costs, lower overall cost per hour, and scheduling flexibility. The change involves moving a position that was historically a full-time store management position into a part-time position. The new management team structure is made up of one full-time chief workshop manager supported by one full-time assistant and two associate managers which are part-time positions. This structure has been successfully implemented selectively in North American stores as well in our UK operations. It alleviates payroll pressure particularly in our lower volume stores.
We’ve been identifying additional opportunities for cost reduction by challenging our past practices and eliminating non-essential activities. Within our central office cause we’re filling mission-critical positions only. We’ve reduced store travel by localizing training within regions thus reducing travel time and expense, and our total travel spending has also been reduced by more effective travel management.
We’re also taking action on the distribution front as we complete several distribution initiatives. We completed the conversion of all inbound freight to our UPS carrier in May and the benefits include lower pricing, lower container costs, and the ability to maximize container capacity and therefore reduce overall container shipments. UPS technology allows us to track our inventory beginning at the point of purchase and a chief cost savings efficiencies without adding transit time to our shipping cycle. We are using consolidated points at each port so that goods coming from various vendors are consolidated and loaded into containers in the most cost-efficient manner. In addition we are currently testing distribution center bypass shipping taking goods directly to our stores from the port of entry. The near-term opportunity is to reduce distribution costs to stores west of the Rocky Mountains and our merchandise typically sent via an accelerated method.
On the outbound freight side we’ll convert to LTL deliveries, a shared service model whereby our merchandise travels with other companies’ merchandise to a pool point or store location by the end of August. LTL deliveries spread the cost of distribution and fuel charges across all users thus gaining economies of scale for us. We recently renewed our agreement with our transportation company which provides us with additional flexibility to use other trucking services.
These cost-savings measures are in place to help mitigate a portion of the continued rise in fuel surcharges. We have yet to see the signs of fuel charges stabilizing and expect fuel costs to continue to apply pressure to our gross margin.
Investing in our brand for long-term growth remains at the forefront of our business planning. Let me update you first regarding our progress with our new online virtual website BuildABearville.com. As we said our goal with Build-A-Bear is to leverage the brand equity we’ve built in the real world by creating a complementary brand experience in the virtual world. We believe BuildABearville is important for several reasons. First, the online world is where kids play today and will play even more tomorrow. Simply said, this world is important for our brand to stay relevant with our core guests. Second, the online world offers us an opportunity to create synergies between our real world and online world by attracting new and returning guests to our stores. And third, BuildABearville gives our bridge to other entertainment opportunities not in the traditional retail model. We’re pleased with the growth we’ve experienced so far at BuildABearville.com. The site is growing ahead of plan. Over 4.6 million online characters have been created since the site’s launch and there have been nearly 20 million total visits to the site and daily visits have increased over 100% from the beginning of the year. We talk to visitors in the world often and are getting input from Bearville citizens to help guide the development of the world.
We continue to view our unique competitive advantage in this space as being 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 process. While still in the early adoption phase, our goal has been to build both critical mass and engagement in our site. We wanted to see the gross national product of BuildABearville grow, which we have. If kids are making a connection to the world, they spread the word, do something different every day online, and develop an emotional connection with the site and their furry friend. And our world expands. As we plan future enhancements to the online world we consider the first-year anniversary of site as an ideal time to take the world to a new level and to let kids experience the site in a deeper way. The beauty is that enhancements to the virtual world are nearly unlimited so we see a huge opportunity for this platform in the future. Our site is free and will remain that way but we do see ways to monetize some highly desirable options as we offer gift cards for bear builds, our online currency, alongside our store product gift cards. We’ll offer these options in Build-A-Bear stores as well as other outlets that sell our gift cards.
In addition to our efforts in the virtual world we continue to invest in our brand through product development and marketing programs. We’re excited about our back-to-school program and new product introductions that are at the forefront of popular culture today. In the third quarter we’ll introduce the High School Musical bear, in fact we’ll introduce this next Friday, and the Hannah Montana bear. Both are licensed to us by Disney and only available at Build-A-Bear Workshop. Both products are very on brand with unique jewelry gifts that can be worn by the bear or our guests. A dog tag necklace comes with our High School Musical bear and a heart pendant with our Hannah Montana bear. These products offer a great value and are highly relevant to our tween guests.
High School Musical bear represents the first time we’ve created a bear for a licensed musical property and will be featured in a dedicated TV commercial. This unique red-and-cream colored bear has the High School Musical emblem on one paw and the Wildcats logo on the other. We’ve expanded our line of clothing and accessories themed around High School Musical. A sound chip is also available with familiar phrases from the musical. The new High School Musical movie is scheduled for national release in North America and the United Kingdom in October. The High School Musical product coordinates and complements our back-to-school theme and store design, Catch the Build-A-Bear Spirit, which will be fully in place in our stores beginning July 31. Our third quarter programs feature popular High School Musical star Corbin Bleu. Corbin will appear in TV commercials and support a sweepstakes promotion with a grand prize opportunity for Corbin to visit the winner’s school.
In September we will launch our Hannah Montana bear, a sparkly white bear with purple trim that combines the cool factor and the cuddle factor all in one. We will increase our commitment to the successful line of Hannah Montana licensed clothing and accessories, outfit tees and handbags, as well as Build-A-Bear Workshop branded wigs and plush microphones to make the bear even more diva like. A sound chip from the hit song Best of Both Worlds will complete the package. As part of our Disney channel sponsorship we’ll participate in a Hannah Montana sweepstakes promotion with the grand prize winner receiving a trip to the set of the Hannah Montana show, a meeting with cast members, and several photo opportunities.
We expect to carry High School Musical and Hannah Montana bears through the holiday season to drive traffic to our stores and capture mall traffic throughout the month. Our School Days Giveaways promotion from July 31 to September 1 will offer a free gift for anyone visiting our stores. There’ll be a new item each week and fun free stuff to stir up excitement with our guests. School Days Giveaways will also be supported by TV featuring Corbin Blue.
While we are not repeating the McDonalds promotion that took place in August 2007 due to the timing of McDonalds’ promotional calendar, we expect the School Days Giveaways programs to offer our guests an even more compelling reason to visit our stores and we expect to partner with McDonalds again on a unique promotion in 2009. We feel good about back-to-school programs, new products and School Days Giveaways offer. We think that our dynamic assortment of highly relevant product, marketing support and free offers will be exciting to our guests during the high traffic back-to-school season.
I’ll conclude my portion of the call with a few final comments. We’re keenly focused on balancing near-term challenges with long-term opportunities to grow our brand and as I’ve described we’re focused on what is within our control to change and impact. We have a difficult time explaining how our shares are valued by the market but we believe the market perspective is too narrowly focused on the current consumer environment and the impact that the environment is having on our current business trends. We take a long-term perspective and we value our company. We are confident in the long-term value of our brand and in our ability to successfully navigate the current environment without sacrificing our brand prospects. To brand survey responses the millions of visitors to BuildABearville and through our store guests we know that our guests are more engaged in the brand than ever before. However the reality is that in today’s economic climate guests are simply not visiting the malls or stores as frequently as they have in the past.
Because this is not business as usual we have stepped up our efforts to expand our partnerships with relevant teen entertainment properties and gone over and above what we have done in the past to attract new and returning guests to our stores. And as we finalize our plans for the fourth quarter, including our holiday animal buying plans and marketing programs, we are including even more business drivers and several strategies that are a further departure from what we’ve done in the past.
And now I’ll turn the call over to Tina for her comments.
I’ll provide additional details related to our second quarter financial performance. The decline in second quarter total revenue of $5.7 million was driven by the decrease in North American comp store sales. This decline was partially offset by new stores opened in the last 12 months and an increase in comp store sales in Europe. Just a couple of reminders first. Easter shifted into the first quarter this year compared to falling in the second quarter in 2007. Easter gift giving, school breaks, and increase in mall traffic associated with the season have historically benefitted our business trends. Therefore the holiday switch had a negative impact our 2008 second quarter. Total revenues included international franchise fees which increased 22% to $824,000 compared to a year ago. During the quarter franchisees opened six stores and ended the quarter with 58 stores. There were no store closings in the quarter. We expect franchisees to open a total of 14 new stores this year net of store closings.
Our focus in the franchise area this year is to work hard to improve the performance of our existing base of franchisees. Through additional oversight from our North American operations we’re helping franchisees benchmark their business models to our North American best practices. Our oversight extends to inventory planning and art of flow, planning and analysis of marketing programs, merchandise and assortment planning, and includes a visit from the North American team in support of store operations and associate training about once a year. Full-year revenues from franchise fees are targeted at approximately $4.6 million up from $3.6 million in 2007.
Our licensing revenues declined in the second quarter due to timing of shipments. Our full-year outlook for licensing revenues is $2.5 million roughly flat with last year. Our European operations continued to show improvement in the second quarter even as the consumer environment in the UK became more difficult. We added one new store and ended the second quarter with 52 stores in Europe. Second quarter sales from European operations increased 39% to $15.3 million and our loss in the quarter totaled $1 million compared to a loss of $1.7 million in the 2007 second quarter.
Our gross margin rate was 36.4% compared to a rate of 41.8% last year. The decline in gross margin was primarily attributable to a lack of leverage on fixed occupancy costs in North American operations and partially offset by improved occupancy cost leverage in Europe. Within the gross margin rate the consolidated merchandise margin was slightly improved. Also the consolidated distribution and warehousing costs as a percent of revenue increased modestly as an increase in North American distribution costs driven by higher fuel costs was only partially offset by positive cost trends in Europe.
The SG&A expense margin increased to 44.5% compared to 39.1% last year. The margin reflects higher North American store payroll as a percent of revenue, higher marketing as a percent of revenue in part due to higher marketing spend in Europe this quarter versus last quarter, and the ongoing cost of maintaining our multiple websites which now include BuildABearville.com. High stock-based comp expense also impacted SG&A. With regard to store pre-opening, these expenses are lower in the current quarter versus last year. For the full year pre-opening expenses are estimated at about $2.6 million, a decrease versus 2007 full-year pre-opening expenses of $4.4 million reflecting the lower store openings planned this year in North America and Europe.
Interest income declined as we were carrying lower cash balances and are experiencing lower interest rates compared to last year. Moving down the income statement the effective tax rate in the second quarter was 34.8% compared to an effective rate of 34.7% last year. For the full year we expect the effective tax rate to be in the range of 37% to 38%. Quarterly tax rates are based on our full-year expected results. To cover the quarterly effective rate we’ll fluctuate as foreign losses fluctuate in relationship to our North American results. Our effective tax rate for the first six months was 42.7% compared to 37.4% for the first six months. The higher rate results from losses in foreign operations where no tax benefits can be recognized as these anticipated losses are excluded from our full-year tax rate calculation. The lower diluted share count in the second quarter reflects the impact of our share repurchase program. During the second quarter we repurchased over 520,000 shares for $4.8 million. Year-to-date we’ve repurchased and retired approximately 1.6 million shares using $13.4 million.
Finally on the income statement, a reminder that in 2007 second quarter the adjustment to the frequent shopper program resulted in a reduction of deferred revenue of $300,000. So far this year we’ve made no adjustments to the frequent shopper program.
Now for a couple of comments on the balance sheet. Cash spending on capital items in the second quarter was $9 million down from $11.8 million in the 2007 second quarter primarily due to fewer new store openings this year. At mid-year our capital spending totaled $14.7 million and we expect full-year spending to come in at the lower end of the $25 million to $30 million range. Depreciation and amortization remain on track for approximately $30 million for the full year. We ended the second quarter with a consolidated cash balance of $16 million and did not utilize our line of credit during the quarter. Just a reminder that our $15 million bank line of credit increases to $30 million during the third and fourth quarter as the seasonal overline goes into place.
The borrowing facility carries a rate of prime -1 or LIBOR plus 1.5% whichever is lower. Our consolidated inventory at the end of the quarter stood at $46 million compared to $55.7 million at the end of the 2007 second quarter. On a per-square-foot basis excluding inventory in our web store and non-traditional locations, inventory per square foot decreased 25% to $51.00 per square foot down from $68.00 per square foot. We continue to manage our inventories aggressively as we monitor our sales trends, new product introductions, and marketing programs in order to maintain our lean and clean inventory levels. With regard to the quarterly flow of our earnings in 2008 it is important to note that 2008 is a 53rd week year and the 53rd week falls into the fourth quarter. Also of note is the growth we’ve experienced this year in our European operations, which is a business that generates over 40% of its annual sales in the fourth quarter.
Finally, as we noted in our earnings announcement our initial planning for 2009 includes opening approximately six stores. Our capital spending plan at this time is approximately $15 million and depreciation and amortization is targeted at approximately $35 million.
This concludes our prepared remarks. Now I’ll turn the call back over to Molly.
Now we’ll open the call up to your questions. Maxine, Scott, Tina and Dory are available to answer your questions.
(Operator Instructions) Our first question comes from Paul Lejuez - Credit Suisse.
Paul Lejuez - Credit Suisse
On the comp can you maybe break down for us the transactions per ticket and the impact on the comp and also wondering if you’re seeing any big regional differences in the comp performance? And second, what is the timeline for when you start to try and monetize some of that traffic at BuildABearville?
I’ll answer the last part and then Tina can answer the first part. On BuildABearville I think that we could say that we are already monetizing. It’s just not easy to point to what it is. I mean when we launch an animal for instance like Hello Kitty, she appears in BuildABearville about a week or 10 days before she actually launches in our stores and starts being noticed and people start seeing it and they know that she’s coming and they know that she’s going to have a gift with her new buyer in the store. And we’ve seen since BuildABearville that our product launches have been even more successful and we think that part of that is that ability to promote directly to guests that are playing online and who are very interested in acquiring more products. So we think that certainly we are doing that.
And last week for instance we launched our new rooms, you can add on rooms, and we saw a 43% increase in new avatars made at buildabear.com from the week before, same time period Friday, Saturday, Sunday, Monday, a big phase, and because the rooms are so expensive, they’re the most points to buy, the best way to get the most points is to buy animals. So we’ve structured those things. And we think those things over time begin to build a huge reason why you go to a store and you buy an animal just like they’ve done for other companies who had no business and started from zero. So I think those are already monetizing. Can you say that X millions of dollars were absolutely totally associated to BuildABearville? No but I think you could say that because of the increased engagement the best customers are staying engaged and the buzz is building and new customers are coming.
The specific things that we mentioned in here in terms of the gift cards will start in the fourth quarter some time probably around the beginning of November. Hopefully the cards will be available and they’ll be distributed. And then we’re working on a couple of other product ideas that will be similar that you’ll be able to buy in our store as well as online at buildabear.com but use on BuildABearville.com.
And Paul, on the answer to your first question, the decline in comp was basically transaction-driven. Our HPG, which is our Honey Per Guest or average transaction, remained relatively flat during the quarter. And we really didn’t see any regional differences. It was all transaction-driven.
Paul Lejuez - Credit Suisse
On the High School Musical bear and the Hannah Montana bear, what was lined up against that last year? And I’m wondering if you could talk about the size of the buys in to those products versus what you had last year?
I actually don’t remember exactly. Molly will check it out on the calendar what we were up against exactly, but this we believe is a much stronger animal. I think Hannah Montana is actually a plus to last year so we didn’t have anything in that specific slot. We have bought substantially to this but we think this is an ongoing product, not something that’s necessarily going to be here today and gone tomorrow. But we’re planning August and September particularly large and then in October when the movie breaks we’re also beefing up towards that movie. Hannah Montana comes out in September and it should have some impact against this. We think they’re the same customer so it’s really you’re going to buy one or the other when you come into the store. Hopefully you’ll come back and will be able to - You may buy both but pretty much of the time somebody buys one or the other and then they’ll come back again a few months later and get something else.
We also have a big increase. Last year we had High School Musical last year, just T shirts and I think a couple of accessories by the time we got to Christmas, but now in our back-to-school mailer we have a line of High School Musical apparel as well as we think it will help sell more cheerleaders, more basketball uniforms, more other things that tie along to the movie and you’ll see those things that we always carry on display in our stores. So we count all of that as part of the merchandise prep. So it’s really offsets our own private label product versus not, and this thing is much more well known and it’s something that we haven’t done before. It’s so cute. Our store people like it. It’s been in the display window in the stores and getting a lot of great response. And we actually even before we’ve had some sales just based on the customer response, we’ve actually pulled some of our orders for the October period up into September and November into October because we want to make sure we don’t miss the business.
Our next question comes from Sean McGowan - Needham & Company.
Sean McGowan - Needham & Company
I just wanted to clarify something. You said right at the very end of your comments Tina the cap ex projection of $15 million and D&A of $35 million, was that for 2009?
Yes. That’s for 2009.
Sean McGowan - Needham & Company
The other question I had was regarding the McDonalds promotion of a year ago, would you expect that will be something that can be sort of anniversaried and overcome by High School Musical and Hannah?
Also we have our School Days Giveaways which is our own version of Happy Meals. When you come to our store you get something for free and each week there’s something different. So hopefully that will bring I think a lot of traffic. And also we’ll be doing a lot of exposure of that in the malls that we’re in so if you’re coming to the malls for back-to-school apparel and you can stop by Build-A-Bear and get something for free, you’re going to come in and do it and I think that especially if you’re a loyal customer. We’ll be promoting it heavily on television, we’ll be promoting it in BuildABearville, and already, and you’ll see some other places where it’ll pop up as well but already we’re getting a lot of interest from that. And I think people are seeing it on our calendars that are being distributed and our store people are talking it up, so I think it’s going to be an exciting opportunity for us. The McDonalds was good and it brings in a certain level of customer. We felt it was a positive and we got positive feedback from our customers, but when you work with them on their schedule, it always moves. The first year we had it was in I believe May and then they wait for a couple of months, they evaluate the results, then they schedule it again and then they wait for another month. And we were working on something with them quite different but it moved out of 08 and into 09 because of the way their promotional calendar works.
Sean McGowan - Needham & Company
Did you actually sell product to McDonalds for that promotion or was it just - ?
No, they make their own products.
Sean McGowan - Needham & Company
So it was under a license. Was there a significant amount of direct revenue associated with that promotion?
No, they make everything themselves and they don’t buy anything from us and they just make it. It is under a license with agreement to make the products with your brand and then they distribute it in their restaurants, but it doesn’t - No revenue for us.
Sean McGowan - Needham & Company
So there’s no licensing revenue even then? It’s just a traffic builder for you.
Well, yes, you work out the marketing and how much you want to spend on marketing and all that kind of stuff. So it’s a very good thing. I mean it’s a 1+1 = 10 kind of relationship and it advertises our brand to their customers and their customers we get exposed to their brand in our store so it works out quite well.
Our next question comes from Michael Corelli - Barry Vogel & Associates.
Michael Corelli - Barry Vogel & Associates
I know you didn’t give guidance per se but you did kind of confirm that you expect you can meet the analyst estimate that’s out there. I just had a question about that. Obviously earnings were down pretty dramatically in the first half, about 83% versus a year ago, and in order for you to achieve the $0.68 you need $0.60 in the back half and if you exclude the strategic review and the inventory write-down costs, about $0.74 last year so that would only be down about 19%. I know you’ll benefit from the 53rd week and a lower share count and hopefully improve results in Europe, but it still seems like a pretty high bar to have such a dramatic improvement. Could you give me a little more color on if there’s anything I’m missing or if I’m just not seeing what might be as powerful in the back half?
Michael, I would just say a couple things. Again the 53rd week and the timing of the 53rd week because kids are out of school and redeeming their bear bucks, so that’s a positive to last year. And the other thing would be as I noted in my comments was that our European operations have historically performed at 40% of their total revenue in the fourth quarter. They’re a much more driven fourth quarter business than the US is.
Michael Corelli - Barry Vogel & Associates
And obviously based on what you’ve been seeing year-to-date there you feel very confident that you could have a strong fourth quarter?
At this point we believe that we can meet the analyst expectation.
Our next question comes from Brad Leonard - BML Capital Markets.
Brad Leonard - BLM Capital Markets
I’ve got a laundry list of questions here but I’ll limit them to two for now. As far as the SG&A goes, by my estimates it looks like the store level would have grown faster in square footage this quarter and in the middle of May you came out with a Q detailing how you’re going to maintain or try to maintain store payroll as a percentage of sales and all these other expense initiatives and now you come out and delever 500 basis points on SG&A. I guess I’d just like a little bit more explanation on that and when are the cost savings going to try to kick in?
I think we go back to again part of my comments when I talked about the second quarter SG&A expense. Again the North American store payroll as Maxine noted in her comments is we’ve got it implemented in several stores but not all of them at this point in time. Again we’re trying to do it through attrition. And the other thing is it reflects higher marketing spend as a percent of revenue as we increased our marketing spend in Europe plus again we maintained six or so websites including BuildABearville.com and we had higher stock comp expense in SG&A.
Brad Leonard - BLM Capital Markets
The stock comp is marginally higher. That’s not going to explain it. I mean if we’re on a cost control program here, if you’re comping down this negatively, I would expect that there’d be a little bit more maybe the pace of cost-cutting needs to be stepped up a little bit.
I think your comment is a valid one. We didn’t have a plan to drop the revenue that much. You cannot in that short a period of time. As it happens to you, you can’t that quickly impact that particular quarter especially with something that was a significantly larger decrease in business than we anticipated. It just wasn’t. So I think we’re putting those things in place and you have to open up your store, you have to have people in your store, and that’s where the business is done. And we’re making as many changes to that overhead as we possibly can in a reasonable amount of time without totally disrupting the business in total.
Brad Leonard - BLM Capital Markets
I understand that but you also come out five or six weeks into the quarter with the Q describing these expense initiatives and you’re not even close on maintaining store payroll and you’ve got a long way to go. I mean why imply it in the Q when you’re just going to blow it up on the next quarter? I guess I’m just dumbfounded at the SG&A expenses for this quarter.
Scott S. Seay
Well Brad, from the store payroll perspective four to six weeks into the quarter we didn’t anticipate having the type of negative store comp that we did have and we implemented our new management structure in there to take out some of the fixed costs. That has taken time to do that and we’re still not completed with that process and should be in the third quarter. In the third quarter we’ve taken a much more aggressive stance on that. We have certainly over the period of that quarter we’ve had substantial drop in our fixed costs and we will continue to maintain that. Again we didn’t anticipate the amount of store negative comp that we had in the second quarter and we’ve made those adjustments and we’re working very diligently to make sure we get it back in the third and fourth quarters.
Brad Leonard - BLM Capital Markets
On the follow up then, so the comps are worse than expected but yet we’ve cited that the Easter shift negatively hurt the comps. I would have assumed that the Easter shift would have been relevant or apparent on the last call because the last call was -
It was, and the Easter shift, we’re not saying the Easter shift is the reason. I mean we’re really suffering from the change in the consumer demand for discretionary products. It’s really impacting us. June is one of our largest months of the year. It’s when kids are out of school and vacations and a lot depends on it. June is a big part of the quarter. May and June, the end of May and June. Those are big parts of the quarter, so in this particular situation it certainly is a fact that it moved and we had that sort of built in to our plan but we did not have the negative impact to the consumer hitting us so dramatically in this quarter and particularly in key times when the kids are out of school and we benefit from that. I mean vacations, people traveling, much more postponed if it’s going to happen. Much more postponed and causing havoc on our business more so than it is on other people’s business but everybody’s feeling it.
Our next question comes from David Schick - Stifel Nicolaus & Company, Inc.
David Schick - Stifel Nicolaus & Company, Inc.
My question is sort of about the malls and the relationship there. We’ve heard about some mall players closing down and you guys are very important to bringing valued family traffic into the malls. As that’s happening externally and mall traffic’s bad everywhere, how is the discussion going with the mall operators? Is there any room to make progress on your rent in order to keep you happy in there and bringing people into the malls?
We have a great relationship with our landlords as you know and we work really closely with them. We’ve been spending our time in our normal portfolio reviews as well as in working with them on marketing efforts that can help drive traffic to the mall, and I feel that we are definitely benefitting from our very strong relationship over time. And the unique position that we have is one of a kind in a mall and because of the kind of marketing that we do and draw traffic to the stores so the landlords are always glad to work with us because we are driving traffic in. I would say that we’ve been very successful in doing the kinds of things we want to do and we’re continuing to work on it. I think our landlords have been incredibly cooperative with us.
David Schick - Stifel Nicolaus & Company, Inc.
So would we see any progress or any material benefit from you working with the landlords?
Well I think it depends on what you’re looking at. We have very profitable stores and we’re not going in and just unilaterally asking for rent reduction. We’re really working very aggressively, I was applying that very aggressively to our rent renewals and our lease renewals and some of the things that we want to do in the stores. But where there are some stores that are maybe not as profitable as we would like them to be, we work with our landlords. I should say we want every store to be more profitable but with the ones that are below our normal occupancy costs, that are significantly below, we work on those and I don’t know that those will necessarily be added up for you to see any significant decrease.
I think what we’re working on really is we have so many leases coming up for renewal and making sure that those are not at sky high rents that we have to close them or move them because they’re raising the rent so high on us, which they’re not doing, but that could happen and then you have to go and build a new store in the same town which costs you money from scratch. We’ve got great stores. Though they’re not busy enough by our standards, so many landlords tell me, “You’re the busiest store in our mall. You look so busy. You’re always busy. It’s hard to believe that your sales are not as good.” But they’re not and we see that and I’m sure you see it when you go in a store, too. It’s just not enough. So they’ve been very helpful and we’re really focused on, because we have so many leases starting to come up, on really the future and renegotiating some of the leases that are very important to our company going forward to good rates, and that’s been going well.
The same thing happens to landlords. The landlords haven’t planned for this kind of economy either and it’s really important that we all work together so that we still have malls that are exciting and marketed and have the things in them that they need to attract the customer. So it behooves all of us to work together and I think that we are. And some of these big things that are happening to them, they impact all of us. Traffic to those malls is impacted by any big or even small closing, but I think we are in a good position and I think we’re making some significant progress as it relates especially to lease renewals.
Our next question comes from [Mike Smith - Kansas City Capital].
[Mike Smith - Kansas City Capital]
You did affirm that you probably have earnings in the neighborhood of $0.68 a share which is a consensus estimate. I’m wondering when you go to do that, what are you looking to happen to your gross margins and your same-store sales trends and so forth?
We’re not going to detail that out for you at this point in time.
Our next question comes from [Jason Pandilosky - Capital T].
[Jason Pandilosky - Capital T]
I was just curious if you’re seeing any kind of relationship between ad spend and traffic. With comps at these type of levels, how are you looking at the ad spend, kind of your marketing as a percentage of revenue and is that a driver that you feel that you’re pushing on kind of a wet noodle and it’s just a waste of money? Or, is there a percentage of revenue that we could get to where maybe in this environment the store model needs to take a little bit of a hit on kind of the IOR there and we can keep traffic up and keep the doors open? Any comments on that?
I think that our goal is that our marketing spend would be – our goal as a percent of sales is that it would always have maintained at a 7% to 7.5% rate of revenue. But, we recently have done some testing that has been very interesting. We wanted to see the same thing that you’re talking about and also test some different kinds of strategies and we did the test in weeks we didn’t have marketing going and so some of the test markets had zero and some had a little bit more, and some had a little bit more, and some had a little bit more and the ones that had I would say near the top spend, we didn’t go to the full enhanced expenditure but pretty close, they had the most improvement in their transactions significantly to a comp store positive. What it says to me is that the customer is so down in the dumps and in order to get them to move on a discretionary product you have to move them, you have to spend more money.
I’m not saying that we intend to spend more money but it tells me if I didn’t spend them money I’m spending we probably would have had a much more steep decrease in our business. You’ve got to stay top of mind and I think that we moderate our spend, we keep changing it. The dollar level that we intended to spend at the beginning of the year, we are not spending. In our expense cutting we’ve cut in our marketing particularly and we continue to cut. We’re thinking very strong about the fourth quarter, especially in the children’s business the [inaudible] are flying and we do a heavy gift and gift card business and you don’t want to be top of mind when you have the most opportunities to gain. So, that one is really a challenge.
I think that we are really looking at how we use BuildABearville. You have to be careful but it’s right in front of the customer, many hundreds of thousands of customers are looking at your website every single day and BuildABearville.com and how can you use that as a more significant marketing tool over time. But, I think moms, the way you’re going to reach moms to determine whether they’re going to get in the car, put gas in the car and go to the mall is really by television and public relations and some other things that we do. With moms TV, especially TV that matters which is primetime is very, very expensive. We don’t spend very much of that but when we do we see a difference in our business. But, we’re moderating that.
We’re looking and I’m telling you quite frankly we’ll go through Christmas and we have some things we think are very exciting. In fact, every quarter we tweak everything that we do based on what happened whether it’s last year or last quarter. We’re very nimble and very flexible and we test it and change it and see what we can do to spice it up and we’ll be testing some other things pretty significantly here coming up and I think that we’ll see. I think that this school days giveaway is a really different departure for us. But, if you don’t tell anybody you’ve got it you’re only going to be giving it to people who are already in the mall, we’re trying to get some people in the mall.
The other thing that we saw from the test of the television that we just did, the different marketing levels of spend was the amount of new customers that came in. So, it’s just getting through to the customer in a way that makes them think about doing something fun and that just doesn’t come cheap. And, there’s a certain level of marketing that you’re at and you try and make sure that you’re raising the level, not the dollar level but the impact level and you’re tweaking it and making sure that its giving you everything that it can give you. But, mom is the driver. She’s literally and figuratively the driver. Kids may want to go but if mom doesn’t want to spend the money and kids are very aware of it.
The number of letters we get today, recently, emails, suggestions about coming to my mall, why aren’t you in my mall, it’s too far to drive my mom won’t take me have increased dramatically over the last couple of months. We have so many stores now we hadn’t been getting as many letters but now we’re starting to get them because mom is saying that. It may be her excuse, “Gas is too expensive so we’re not going to go to the mall today. Stay home and play on BuildABearville.” Well, thank goodness we have BuildABearville to keep them engaged. But, I would say that it’s a challenge but we’ve seen some really good results from our marketing which lead me to believe on the one hand how to spend it different buy also if we weren’t doing it how much more difficult our business would be.
Our next question comes from the line of Michael Flaherty – FDS Capital.
Michael Flaherty – FDS Capital
I have a question related to the advertising spend, you make it sound like it’s a binary type of result, spend or not spend. But, in terms of a down economy, why not cut our spending considerably, cut it in half, reduce opening stores while you try to get your comp store sales up and dedicate your excess cash flow to more aggressively buying back your stock and even putting some debt on your company to buy back some stock?
First of all, we are cutting our store openings. You plan your store openings significantly head of time, you don’t just plan those in the year they’re happening, you negotiate those leases and you start building those stores early in the year so we did reduce our stores from the year prior from 50 down to 25, a pretty significant decrease and then we’re cutting it down even more significantly this year so we did do that.
Michael Flaherty – FDS Capital
When you saw that comp store sales were going down and we were moving into a challenging economy, you guys had such forward commitments that you couldn’t have adjusted 25 store openings to zero or to considerably less than that this year?
No, you have leases that you’ve signed fully. You sign your leases, you have a commitment to open. We also target those stores in terms of new markets where Build-A-Bear doesn’t exist. But, we certainly brought them down from our plan. At the beginning of the year, the economy had certainly taken a more serious turn for the worse as we read in all of the newspapers from bankers to retailers and I think that what we saw coming we responded too. We didn’t open up 35 or 40 store as was our original plan in our mind, we opened up 25 and some of those stores are in the UK where our business is quite strong. Then, as we’ve responded this year’s learnings to next year. That may be a mistake, maybe it will turn around and we’ll start to ramp up for 2010. But, always we’ve been opportunistic but when a lease is signed and you have deal to open up in that store, you open up in that mall and we wanted to open up those stores, they’re in important locations and part of our building our company over time.
Marketing spend, if you don’t spend it, if you don’t reach out to your existing customers, if you don’t try to get new customers, you’re just going to sit there and be a victim of everyone else’s lack of sales. As it is, it’s tough when they come in to the mall and they just pull up to the store for the sale and they leave. It’s a tough thing if they don’t come down the mall and go shopping so you get them in your store. You get them in to your store, you pay mall rents and pay to be at top malls in the country as we do because you benefit from the traffic. It’s our number one reason of how people have found out about Build-A-Bear over the years is they see you in a mall. But, we are doing those things and we are looking at cutting our marketing spend and moving our marketing dollars. We have cut it from our original plan and we’ll continue to trim it where we see the reason.
You can even send out less, it just cost more. I mean, television costs more, postage costs more, there are a lot of things that cost more and spending less gives you a lot less. But, it is something that we’re monitoring. We’ve always said it should be in the 7% to 7.5% range and that’s what we’re trying for. Unfortunately, the sales are decreasing and making it a higher percent to total but the dollars have been going down. Not cutting by 50% or 20% but we’ve been monitoring it over the years that we’re operating and we’re working on our plans for next year now. We don’t have anything that shows us that if we don’t advertise we do more business. We do less business, less business than we are doing today when we don’t advertise.
Our next question comes from the line of Sean McGowan – Needham & Company.
Sean McGowan – Needham & Company
I was just wondering if you would offer some commentary on how all these changes your basic underlying economic model, what are you looking at now when you’re opening these stores as an expected payback? What percentage of your investment do you expect to get back in that first year?
We saw the same payback. We look at our stores and we say that we negotiate harder on the rent and we negotiate on allowances and we’ve got our store costs down, the stores are smaller, much smaller in terms of the way they were several years ago and some of the stores are opening up in smaller markets where the construction costs are less. We’re managing that quite well and we’re still getting our 12 to 15 month return payback.
We have no further questions. I would like to turn the call back over to management for closing remarks.
Thank you operator and thanks to everyone for your participation on our call today. Feel free to give me a call if you have any follow up questions. Thanks. Have a great day.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!