Build-A-Bear Workshop, Inc.
Q1 2019 Earnings Call Transcript

Published: 31 May 2019

[Operator:]

Greetings and welcome to the Build-A-Bear Workshop First Quarter 2019 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.I would now like to turn the conference over to your host, Ms. Allison Malkin with ICR. Thank you. You may begin.

[Allison Malkin:]

Good morning. Thank you for joining us. With me today are Sharon Price John, CEO; and Voin Todorovic, CFO. For today’s call, Sharon will begin with a discussion of our 2019 first quarter performance and review the progress made on our strategy. After, Voin will review the financials share our guidance. We will then open the call to take your 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. Members of the media who maybe on our call today should contact us after this conference call with your questions.Please note the call is being recorded and broadcast live via the Internet. The earnings release is available on the Investor Relations portion of our corporate website. A replay of both our call and webcast will be available later today on the IR site.Before I turn the call over to management, I will remind everyone that forward-looking statements are inherently subject to risks and uncertainties. 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 the Company’s Annual Report on Form 10-K. We undertake no obligation to revise any forward-looking statements.And now, I would like to turn the call over to Sharon.

[Sharon Price John:]

Thank you, Allison, and good morning everyone. We are pleased to announce a solid start to our fiscal year, as total revenues increased $1.2 million to $84.4 million. Retail gross margin expanded over 90 basis points and SG&A as a percent of total revenues improved by 130 basis points, all of which contributed to the first quarter pre-tax income of $2.4 million, which is a $1.8 million increase compared to the same period in the prior fiscal year.We also maintain a strong balance sheet ending the quarter with over $20 million in cash and no debt. As noted in this morning's press release, we are reiterating our previously stated annual guidance for total revenues and pre-tax income. We feel that this quarter's results reflect the impact of a successful execution of our stated objectives for the year, combined with our ongoing efforts to create new ways to leverage the power of the Build-A-Bear brand.I am particularly pleased with the team's focus on delivering these results following a 2018 full of bumps and transition caused by much of what we believe to be unusual impacts, such as Brexit and the Toys "R" Us closure. On today's call, I will discuss the drivers of our revenue growth and highlight the actions we are taking to build upon this promising trend through our efforts to diversify sales and income streams beyond the four walls of traditional mall retail stores as well as other key initiative.From a top-line perspective, the overall growth in total revenues is due to a significant increase in commercial revenue, which includes wholesale and outbound licensing fee, reflecting some of the work that has been done to evolve the business model beyond traditional retail. Our consolidated net retail sales were positive in North America. This momentum was offset by Europe, which posted a double-digit decline. This decrease is largely attributed to continue challenges in the UK associated with Brexit and the implementation as a new privacy laws.Accordingly, the North American region generated a profit for the quarter which was partially offset by the loss in Europe. On a positive note in the UK as a part of our focused effort to mitigate some of the issues in the market, we recently implemented a new technology-based Bonus Club enrollment process that is compliant with the new European privacy regulation. Since then, we have seen significant growth in the option rates of Bonus Club members, which we believe will benefit for business on a go forward basis.We also saw sales from our e-commerce channel continue to gain momentum posting a strong double-digit growth rate continuing our trends to double-digit growth every quarter since the new site launched in October of 2017. Our buildabear.com strategy to expand our consumer base and increase the levels of gift givers and fan-driven affinity purchases is paying off as we leverage our improved digital capabilities. These are large addressable markets that tend to prefer to shop online.We are engaging through unique merchandising efforts and promotional events by primarily highlighting gifting occasions and licensed product. It is important to note that licensed products were one of the key contributors to the overall growth in revenue in the quarter as well. This expected benefit was a result of a slight of family-centric movies that premiered throughout the period, highlights included. An immediate positive response to the -- in the quarter to the products associated with the How to Train Your Dragon movie franchise which significantly contributed to our sales throughout the period.Although, there were moments when we were not in perfect inventory situations, for the most part, we were able to leverage our omni-channel capabilities to support our brick-and-mortar retail store sales with an order in-store shift-to-home option. This was followed by the positive impact of the record setting Avengers

[Voin Todorovic:]

Thanks, Sharon, and good morning everyone. As previously mentioned, we believe first quarter performance has us on track to achieve the annual guidance we provided on our year-end call in March.We generated top line growth and progress on the initiatives that are assisting us to capitalize on the part of Build-A-Bear brand. While the UK economy remained a headwind to our performance, other revenue inclusive of commercial licensing and franchising income grew 88% for $3.3 million.Notably, we improved our net retail sales trend versus fourth quarter in both North America and Europe with North America being positive. This included our sixth consecutive quarter of double-digits e-commerce growth. We maintain a solid balance sheet and remain focused on achieving our objective of long-term profitable growth.Now, I will review the first quarter financials in more detail. Total revenues were $84.4 million and increase of 1.4% compared to the first quarter of fiscal 2018. Retail gross margin expanded to 45.2%, increasing more than 90 basis points mainly driven by merchandise margin expansion and lower occupancy costs.We continue to control costs in number of ways to improve our retail gross margin, including managing our real estate portfolio to lower average store occupancy expense and reducing our supply chain costs.SG&A decreased $500,000 to $35.8 million or 42.4% of total revenues, as we continue to maintain disciplined expense management and remained focused on our controllable spend. GAAP pre-tax income was $2.4 million compared to GAAP pre-tax income of $600,000 in the prior year.Income tax expense was $1.2 million with an effective tax rate of 50.3% compared to an effective tax rate of 45.2% in the fiscal 2018 first quarter. The income tax expense in the first quarter of fiscal 2019 was higher than the statutory rate primarily because no tax benefit was recorded on the losses in certain foreign jurisdictions. Net income was $1.2 million or $0.08 per diluted share, compared to $0.02 per diluted share in the fiscal 2018 first quarter.Turning to the balance sheet, at quarter end, cash and cash equivalents were $20.2 million, up $1.4 million compared to the end of the first quarter last year, and there were no borrowings under our revolving credit facility. We ended the quarter with approximately $56 million of consolidated inventories, representing a $6.6 million increase compared to the prior year. The inventory increase is driven by timing of product launches supporting our second quarter.Opportunistically, we are increasing investment in our key license movie product inventory and frontloading our buys to take advantage of the typical spike around movie release dates. This strategy also increases our flexibility to meet ongoing demand, as many of these properties are expected to have prolonged selling windows consistent with historical trends.Capital expenditures totaled $2.7 million for the first quarter of fiscal 2019. And for the full year, capital expenditures are now estimated to be in the range of $13 million to $15 million, reflecting us to 25 additional Walmart locations. We expect the capital investment for these stores to approximate $150,000 per location.With regards to revenue and pre-tax income on a GAAP basis, we are reiterating the previously shared guidance. We continue to expect total revenues for the year to increase in the range of mid-to-high single digits and pre-tax income to be slightly positive, reflecting increase sales as well as improved gross profit margins.As noted in this morning's press release, this guidance assumes that there are no material changes to current tariff rates or policies. If the potential four tranche of tariffs is put in place covering all products of China shipped to the U.S., we would likely see an impact later in the year. We are continuing to analyze the situation and have taken some actions to mitigate the anticipated increase in tariffs, which unfortunately includes retail price increases.Finally, our full year guidance includes an improvement in second quarter results versus last year's $2.5 million pretax loss.This concludes our prepared remarks and we will now turn the call back over to the operator for questions. Operator.

[Operator:]

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from a line of Steph Wissink with Jefferies. Please proceed with your question.

[Steph Wissink:]

Thanks. Good morning, everyone. Thank you, Sharon and Voin for all the information. Just have a few maybe more housekeeping oriented questions first. The first is, Voin, if you can just update us on the sites by format. I want to make sure we're managing the model correctly. So, the mall-based concourse space and then if you're willing to give us the percentage that you consider tourists given that was one of the initiatives you talked about?

[Voin Todorovic:]

Sure. So from the store count perspective, we have, we ended the quarter with 366 location. We have about 37% of our locations in the discovery format. We have about 30 -- 34 concourse locations open at the end of the quarter. We still continue to work on modifying and creating flexibility with our real estate portfolio. And concourses represent a big part of that plan, as they give us flexibility in our negotiations with landlords either to change this format or stay in line.As we talked about the tourist locations, we do have probably from the store count, like maybe it's a smaller percentage, but from the volume, it's a bigger, so probably some place 10% to 20% of our sales are coming from the tourist locations that are coming in variety of different formats, from traditional stores to shopping shops or concourse locations.

[Steph Wissink:]

And then just on the concourse locations, I want to make sure we have the arithmetic correctly. So even though it's considered a site or location of store, it does do lower volume. So if you convert a four wall workshop into a concourse, you do have a revenue headwind. Are we thinking about that correctly even though the margins actually can improve?

[Voin Todorovic:]

Yes, absolutely. So what we have shared in the past Stephanie was that typically, we expect our concourse locations to do about half of the volume of our traditional mall locations. We expect from the four wall contribution percentage to be a higher percentage because the economics are different. But absolutely from the overall total revenue and total EBIT dollars, those numbers are going to be smaller. So roughly, you will need two concourse locations to make up each one traditional location.

[Sharon Price John:]

Yes, when you think about it though, we're going typically when we're in the same mall from 2,500 square feet to 3,000 square feet to a 200 square feet concourse shop. So even though, there's a decrease in the total revenues the dollar per square foot, it makes more of a positive story.

[Steph Wissink:]

The reason I was asking is that, you do naturally have an inherent headwind built into your revenue model currently as you.

[Sharon Price John:]

Yes. You're correct.

[Steph Wissink:]

But you still report revenue growth would imply that your existing -- you think about kind of organic like-for-like stores or performing better particularly in North America. So can you maybe just deconstruct that a little bit? What are you seeing on the site level basis? That is generating such a nice step-up. Is it a combination of properties, improvements in the marketing? Or do you feel like you're starting to get a better cadence or rhythm to the business that some of these things might be sustainable as we move into the next few years?

[Voin Todorovic:]

So, definitely, we are seeing improvements in our North America performance compared to what we have seen in prior few quarters. Especially, as we have seen some of the movie releases that came out earlier in the quarter and that helped elevate traffic trends that we have seen in our stores, we believe based on some of the data that we have internally interacting our stores that are in the malls, where we have theaters we tend to see stronger traffic than in stores that don't have these adjacent to them.So further away the theater locations are the traffic impacts more challenging. Overall still, we are experiencing or the national traffic still continues to be very challenging. We are beating some of those brands, so that's helping some of the results that we are seeing. But overall, there is a lot more focus spent on our controllable in form of managing the promotions and driving dollar for transactions, really to help us offset some of the traffic headwinds.

[Sharon Price John:]

I also, just to add a little bit of additional color there. Yes, we are certainly benefiting from the film releases and our adjacency to theatre as we addressed in the last the year-end remarks actually, that we expected to see that. But the longer term real estate objectives, the diversification and the different types of format, locations, leaning into stores whether of that direct revenue for us that from a retail perspective, like FAO or indirect to the wholesale relationships with something like Great Wolf, we're opening additional 17 locations. All of that is about preparing us for a longer term success rate.When you add in this Walmart situation where we're discussing upwards of 25 stores, inclusive of the six pilot stores that we already had, what we've been looking for is a feasible, financially beneficial way to scale the business on the retail side that is not completely beholden to a traditional mall format. And I think between those three different types of approaches that we outlined in the prepared remarks of having some options for traditional malls, like a concourse shop, having some options like a kid apart for something like a Walmart, and creating options that are more specific to a tourist type of location likely created an old new branding approach, for an example in FAO are voting well for us as we look out to the future.So even though we've got this tailwind this year, from the traffic situation with license properties, that it's helping our overall business to some degree, I want to be cautionary to note that that's that we're not just relying on that we're building a longer term solution on how to make retail, a sustainable engine for us as we pivot the Company to create revenue streams in these other areas, which we saw growth in, as we noted, in the commercial revenue on a number of other different funds. So, it's been a bumpy road as we noted, but we feel like we're moving in the right direction.

[Steph Wissink:]

Okay, that's helpful. And then on sourcing just as we think about the cost side of the business, I know you're not embedding any incremental tariff into the plan for the year. But can you just remind us what percentage of your business comes from China? And how we should think about tariff exposure within your cogs to the landed cost versus your total cost?

[Voin Todorovic:]

So, sure, I can start with that, as we mentioned guidance assume, there is no material changes to the correct tariff rates or policies. We do import a lot of our product from Asia which most of that coming from China. Currently, we are looking at ways and we've been looking for a period of time to diversify our sourcing base more. It is not an easy task and, it's not one that's going to happen overnight, but we can we continue to make some progress there. Some of those potential tariffs could have.Again, assuming it's across the board 25% in this four tranche you know that will definitely have a meaningful impact on our overall cost. We are working and exploring different options, how to mitigate some of that stuff. Short term one of the few ways it's unfortunate as the shared inopportune remarks was, is by raising prices. But over the long haul, we would be looking to further diversify our sourcing base as well as work with our factories and partners to find some additional synergies in supply chain to offset some of those increases.

[Steph Wissink:]

Okay, and the last one is just on the UK, I want to understand a little bit more about what you think might be happening there in the context of the Brexit overhang. Are you seeing any signs of hope or improvement? It sounds like you are maybe in some of your prepared remarks, so maybe just give us a sense of how long can that direct persist at this degree, a double digit decline? Or are you anticipating that drag lessens as the year progresses?

[Sharon Price John:]

Yes. So, when we first talked about that, where we thought we would head for the year, we were had a lot of great hope that on March -- excuse me, yes, March 29th, that there would be some solution for Brexit on and that we could start to plan accordingly with the facts on the table. And as I, -- as everyone recognizes, now, that's been delayed to October the 31st, on making a decision about the approach that the UK intends to take in regard to the EU. So that delayed some of our direct and specific way to mitigate, because we don't know which way everything's going to go.But in the meantime, we did see in first quarter, although still negative, some improvement versus the fourth quarter, and then quarter to-date, we're actually seeing much greater improvement in the UK. Now some of that has to do with their in half term and they had some bank holidays piled into this, but most of that being anniversary. So there is that, that separate element where the UK tends to over index on under the properties. And we've seen that over the course of time over the years, and that is holding true right now.Additionally, they are building their e commerce business at a very rapid pace, and are not that far off part of what's happening on the in the U.S. when we talk about this double digit growth that's actually across the board. We believe that the improvement in our ability to capture names, now post the GDPR implementation, and we're capturing them in our stores and immediately getting the second opt in, which is the critical part of being able to communicate directly with the Bonus Club members is helping us both in stores and online. So that's been a very, very material shift for us on being able to capture those names, and use those names to market specifically to that to that consumer base.And finally, one of the things that we just find so interesting in the UK, and it's not that just similar to the yet U.S. is, is it about who we are as a brand and what we're doing or is it about where we are. In many of the same things from a traffic perspective in traditional mall locations that are happening in the United States and North America also happening in the UK. So when we pick up a Build-A-Bear and put it in a tourist location, like within steps of the London Eye, we are seeing very positive results.We're actually outperforming our pro forma there which was we're that's very pleased to announce that that there is a, there is some positive new coming out of the UK from again, the e-commerce some improved trends and our current performance at the London Eye. All that being said, it is very hard to predict what's happening. And we also have the FX fluctuation as well, that impacts us and runs through our balance sheet, so.

[Steph Wissink:]

And just to tie that up with Voin your comments on Q2, I think you mentioned the phrasing was improvement from the $2.5 million project last year. Are you expecting to be profitable?

[Voin Todorovic:]

Sorry, yes, our role is always to be profitable. Some of the stuff that we are talking about to just want to remind everyone like last year, we did have a lot of shifts and like first couple of months of the quarter were very challenging, then we had the Pay Your Age Day event that really drove significant number of transactions at the lower margin. So really, as we go into this year, and try to understand what kind of impact to the prolonged use of vouchers that we have, after Pay Your Age Day event is going to have on our business.We currently believe that our margins are going to improve, but there is still some unknown related to the impact on the overall transactions. What we have going into our favor some of the things that Sharon talked about from the e-com perspective, there are some positive things. But we also have launch of The Lion King property in July that should help offset some of the headwinds that we are having from these prolonged larger uses. So we expect to be better. Definitely, the goal would be profitable, but we just don't have enough information, because it's a first time we are in diverse during some of these big shifts from last year.

[Operator:]

[Operator Instructions] Our next question comes from the line of Eric Beder with SCC Research. Please proceed with your question.

[Eric Beder:]

I'd like to talk a little bit about online. I know you gave in Q4 that online was about 10% of sales. What was it like in Q1 in terms of that? And when you look at it, what are the economics of that customer? How are they different? And how can you maximize that going forward?

[Voin Todorovic:]

So, yes, so I can help you maybe that some of the steps. Definitely in Q4, our e-com business is a bigger percentage sales, but like it continues to grow as a percentage of sales, every quarter. Some of that is driven by a really strong double-digit performance that we are seeing in that particular channel. It hasn't been like to double-digits in the quarter, but we are seeing meaningful improvements versus the prior year.In addition to that, one of the things that's important when we talk about our e-com channel, it's different than for a lot of other retailers, because we don't necessarily have very many, many returns, which is also our profitability in a channel. It is profitable. And from the economic perspective, the transaction value that we see on the web is very comparable to what we see in stores. And we do have special bundles that are available for sale online only, that tends to be in a much higher price point $60, $70 for those bundles, so that helps overall elevate the dollar per transaction in that particular channel.

[Sharon Price John:]

Yes. And what's interesting about it too, is that we -- when we first redefined our strategy for e-commerce and re-launched the e-commerce platform in October of 2017, we recognize that, yes, we do have some overlap with the consumers in our store. But perhaps one of the bigger opportunities for us is to shift our approach to appeal to this as we noted in the remarks, gift giver, and affinity consumer, and what they're often doing is buying either for themselves and in many cases, another adult, not just a gift giver like a grandma giving it to a kid, things are collectors in some ways.And that is a much larger addressable market than the child consumer market. Plus they tend to want to shop online, the experience the Build-A-Bear is not why necessarily they are engaging with the Build-A-Bear where our in-store transactions are all about the experience. So we've identified, we believe this potential consumer base that acts very differently, and also tends to have a larger dollar per transaction as well, much to the, to what Voin was referring to and being able to prove these figure bundled together that are most of them associated with desirable license goods and license products.Pokemon as we mentioned in the remarks is a good example of that it is average $70 retail, which is 50% higher than our normal transaction, dollars per transaction. So it's serving an additive opportunity for us. Where in a lot of cases, I think, from brick and mortar to e-commerce, there's an overlapping type of strategy where we have some of that, but we see this as a way to build an entirely different type of business model. And these early stages, we feel pretty good about it between Valentines and some of this license effort that we've done.So that's and as Voin said, which is really just a great benefit to that we do operate profitably there, it's not that dissimilar to the rest of our business model on the retail side. And we feel like that we are in the early stages from mastering a lot of these technological advances that I shared from the augmented or actually the AI and our SEO efforts as well as our CRM database, and being able to drive that lifetime value.So, we're coming at it from two ways, driving it through the Bonus Club with our core consumer base, trying to drive transactions, average transaction, and also a whole new consumer base that we feel like we're getting a little bit attraction with some of the strategies that we've implemented in the last few months.

[Eric Beder:]

Right. A follow-up on international franchising, so the number of units went down, I assume it's because of Australia. And when you look at the new Chile, India and China, how should we thinking of those rolling on? And are there opportunities to add even more countries to the mix?

[Sharon Price John:]

Yes, the decrease for the last quarter was Australia's restructuring. So we are, of course, please, that they are out of the reorganization and certainly hopeful that was much more stable and healthy entity posts that and we're working very closely with them to ensure that we maintain and grow our second large are actually our largest franchise relationship. They've been with us for many years. And we expect us to continue to move forward there.On the second front, in India and China, we're still in the early stages. Those are obviously massive countries with tremendous opportunity, both with emerging strong middle classes. And there were with very stable and in many cases particularly or one case particularly in India, a multibillion dollar company that well capitalized to drive this business.So we expect to see stores continue to open I think that we've mentioned this in the past, but the Lulu group who we are partners with in India is also has the Toys "R" Us franchise there, which is actually a separate entity versus the portion that has the trouble last year here in North America. And there's a strategy of shop side by side, which at the gate has been doing very well. And they're incredibly pleased and eventually pull forward some of their expansion plans. Chile, we're in the early stages, but expect to see some stores open before the end of the year.

[Eric Beder:]

Okay, and last question on the Walmart search, obviously, it's a learning experience on this six. When you look at the potential for returns there, can it be as high as a strong as your regular stores? Are you -- do you staff them with your own people? How does that work in terms of specific expenses there?

[Voin Todorovic:]

So I'll start answering that for you, Eric. We are excited about open between Walmart those are the stores that we own and operate stores where we are basically the deals are structured on -- as a percentage of sales deal. We do have control of our labor. We do have flexibility as it relates to operating hours. Because again, these super centers are open 24 hours a day and clearly we wouldn't be open all day along but we do have flexibility so that's going to help with our payroll model.From the overall top line perspective, these stores are going to be smaller because again they are square foot is going to be smaller. We expect them to be a roughly 800,000 to 900,000 square feet. 150,000 in CapEx investment for those, we are still trying to understand the full year sales, we only have about six, seven months under our belt. We are pleased with the performance that we are seeing. I would probably think that are going to be more around the performance of our concourse from the top line perspective than our traditional stores.But then again, as we continue to expand and be in different locations, we'll learn more about the overall program.

[Operator:]

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Ms. John for any final comments.

[Sharon Price John:]

Yes, and thank you for joining us today, and we look forward to speaking to you when we report our second quarter results.

[Operator:]

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