Build-A-Bear Workshop, Inc.
Q2 2014 Earnings Call Transcript

Published: 24 Jul 2014

[Operator:]

Greetings. And welcome to the Build-A-Bear Workshop Second Quarter 2014 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. I would now like to turn the conference over to your host, Ms. Allison Malkin of ICR. Thank you, Ms. Malkin. You may now begin.

[Allison Malkin:]

Good morning. Thank you for joining us. With me today are Sharon Price John, CEO; and Tina Klocke, Chief Operating Officer and Chief Financial Officer. On today’s call we will begin Ms. Sharon discussion of second quarter results and the progress the company continued to make on its strategic initiative. Tina will follow with the more detailed review of the financials and then we will take your question. 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 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. 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. 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 the annual report on Form 10-K and we undertake no obligation to revise any forward-looking statements. And now, I would like to turn the call over to Sharon John.

[Sharon Price John:]

Thanks, Allison. Good morning, everyone. Thank you for joining us today. I am pleased to report that our disciplined approach to the execution of our stated strategies led to our six consecutive quarter of improved operating performance. And for the first six months our company has delivered pretax income of $1.3 million, an increase of over $7 million versus the prior year, marking the first time since 2008 that we have been profitable at the half way point of the year. As noted in this morning’s release, historically, the second quarters are smallest in terms of revenue, which made it even more important to stay focused on our primary goal of improving profitability. We delivered on our goal of profit improvement. Although, consolidated comparable store sales decreased by 4.9%. Last year’s second quarter was busy by a strong launch of Build-A-Bear’s first MY LITTLE PONY collection and had a 7.3% comp increase. Therefore our strategy for this year was to leverage the benefit of the Easter shift and to anniversary the young girl’s business that have been driven by MY LITTLE PONY. As planned we delivered positive comparable store sales in April, with the solid performance from our proprietary Easter line-up. And for the quarter in total, we improved key operational levers that are more in our control by increases in dollars per transaction, unit per transaction, average unit selling price and consumer convergence. However, traffic was a challenge, in part due to the lingering effects of the first quarter weather pattern, which caused some school vacations to be cancelled and the school year to be extended in many markets throughout the second quarter. This can have a particular impact on experience for children’s retailers, including Build-A-Bear, as our traffic benefits when kids are out of school. Also we made a strategic decision to eliminate a Gift with Promotion that had been repeated for a number of years. This promotion and its supporting marketing had historically driven significant traffic, but did not deliver a profitable return. This decision was consistent with our ongoing strategy to shift from promotion driven marketing to brand building. Our plans to anniversary the MY LITTLE PONY launch and counteract the potential traffic impact of the elimination of the Gift with Purchase Promotion included the addition of the Disney Palace Pets collection, a series of royal pets tied to Disney Princess franchise targeted to the young girl consumer base. And the launch of a series of products tied to highly anticipated movie releases supported by integrated marketing program. Disney’s Palace Pets is a relatively new concept for little girls introduced by their popular app late last year. This product collection is an important part of our assortment for the year. However, the second quarter brand build was slower than planned. As Disney has continued to grow awareness of this brand, we have elevated our partnership marketing with them and the sales have gained momentum. We will continue to drive the collection, which includes the introduction of new palace pets characters in the back half of the year. The movie partnerships were with Marvel’s Amazing Spider-Man 2 and Captain America

[Tina Klocke:]

Thanks, Sharon, and good morning, everyone. Our second quarter pre-tax results were in line with both internal and external expectations. As noted, for the first six months of the year, we generated pre-tax income of $1.3 million, an increase of over $7 million from last year. This is the first time in six years that we have had a pre-tax profit to the first half of the year. Net retail sales were $75 million, with 10 fewer stores in operation at quarter’s end compared to $80 million in the prior year. On average, approximately 16% of sales from closed stores transferred to other remaining stores consistent with past closures. Consolidated comparable store sales declined 4.9%. A decline in store traffic contributed to an 8.3% decrease in transactions, partially offset by an increase in average transaction value. We improved the key operational metrics that are more in our control including dollars per transaction, units per transaction, average unit selling price and consumer conversion. By geography, comparable store sales declined 4% in North America and 8.1% in Europe. Excluding the impact of foreign exchange, e-commerce sales decreased by 4.3%, with a continued improvement in profitability. Retail gross margin increased by 220 basis points to 39%. This was a result of a 360 basis point improvement from expansion in merchandise margin and reduction in distribution costs, partially offset by deleverage of fixed occupancy expenses. SG&A was $34 million or 44.6% of total revenues, compared to $37 million or 45.1% of net revenues. Management transition and store closing expenses were $900,000 in the second quarter last year. Excluding these costs in 2013, SG&A as a percent of sales was 44%. While sales declined, expansion in gross margin and lower expenses drove a $2 million improvement in pre-tax loss compared to the same period a year ago. Net loss was $4 million or $0.25 per share, compared to a net loss of $6 million or $0.38 per share in the second quarter last year. Adjusted net loss was $0.25 per share, an improvement from $0.33 loss per share in the second quarter last year. For the first six months, total revenues were $174 million, a decrease of 8.6%, excluding the impact of foreign exchange. Consolidated comparable store sales declined 3.4%, and included a decrease of 2.8% in North America and 5.5% decrease in Europe. E-commerce sales declined 7.2%, excluding the impact of foreign exchange with continued improvement in profitability. Retail gross margin was 41.6%, an improvement of 220 basis points compared to last year. This increase was driven by 300 basis point improvement in merchandised margin, partially offset by deleverage of fixed occupancy expenses. SG&A was $72 million or 41.2% of total revenues, including $400,000 in management transition and store-closing expenses. This compares to $81 million or 43.3% of total revenues, including $3 million in management transition and store closing expenses in the first half of fiscal 2013. Excluding these cost in both periods, SG&A improved 60 basis points to 41% of total revenues in the first half of fiscal 2014. Pretax income was $1.3 million compared to pretax loss of $6 million in the first six months of fiscal 2013. Adjusted net income improved to $0.06 per diluted share from an adjusted net loss of $0.19 per share last year. Turning to the balance sheet at quarter end, consolidated cash was $42 million, up $14 million from last year. This is primarily attributable to our improved profit performance in the first half of 2014, decreased capital spend and the timing of payments for inventory and rent. We had no borrowings on our credit facility. Consolidated inventories totaled $43 million, compared to $48 million last year. Inventory per square foot decreased 6.7% reflecting the timing of transit inventory. Capital Expenditures were $3 million primarily for store-related capital and IT infrastructure. Depreciation and amortization was $9 million. For fiscal 2014, we continue to expect capital expenditures to be in the range of $12 million to $15 million to support selected store updates and opportunistic openings, as well as the ongoing investment in IT infrastructure. This includes the opening of six to eight popup stores in advance of the holiday season. We continue to expect depreciation and amortization to be approximately $18 million. As a reminder of fiscal 2014 and January 3, 2015 and includes the 53rd week versus last year’s 52-week year. In summary, by staying true to our strategy and focusing on brand-building programs, we delivered solid improvement in gross margin, operating performance and our bottom line, leading to our sixth consecutive quarter of improved results. We believe our initiative position us to continue our progress towards the same profitability in the second half of the year and longer term. And now, I would like to turn the call over to the operator to begin the question-and-answer portion of the call.

[Operator:]

Thank you. (Operator Instructions) Our first question comes from Steph Wissink with Piper Jaffray. Please proceed with your question.

[Steph Wissink:]

Thank you. Good morning everyone. Tina, I wonder if I could just draw out a couple housekeeping questions and then, Sharon, a question for you. Curious on the comp for leverage point in the model now that you've extracted some of the cost and lowered the overall store base? And then if you could help us to navigate the tax rate for the year that seem like below the line items for where we were off of it on the loss per share estimate that you could help us just reconcile as we think about the back half, how we should be modeling the tax. And then Sharon for you, really intrigued by this notion around kind of social media and leveraging your follower relationship base as well as some of the affiliate marketing and partnerships. Could you talk a little bit about the margin potential as you see building into some of those leverage points as well as some of the anticipated traffic improvements from some of the licensed partnerships into the back half? How we should be thinking about the next couple of quarters? Thank you.

[Sharon Price John:]

Okay. Thanks. I’ll take the question first and then hand it over to Tina. Okay, Steph, thanks for the question. Yeah, affiliate marketing partnerships and social media, one of the things that we feel that we have an opportunity with, is that social media impact. I believe that we’ve noted a few times that we have a very robust loyalty program that includes 4.4 million active loyal team members. And consumers given our high emotional brand are very involved and engaged in our brand on a number of different front from Facebook, Pinterest et cetera. So being able to activate against that as a part of a more integrated marketing program can be a key for us particularly as our consumer base shifts to more than Millennial mom and move who as you know and have heard from many marketers, I’m sure, at this point, are really native to that entire environment. So it is that piece of the puzzle, it’s actually much more efficient wide market. It is cost effective. It’s very clean. It’s in the moment. It keeps your marketing dollars pretty liquid up until you need to spin them versus other types of media from direct mail to television where often you have to make commitments far out and you might be uncertain of your actual need to push the media given the sales of the product. And so we can really activate that in a very efficient manner that can actually be [aid in our 8F] (ph). I think on the affiliate marketing partnership, it’s really -- it's kind of this concept of when a number of different entities are saying the same thing you get more leverage. It is a classic one plus one equals 10 kind of approach. And when you elevate the partnership that -- really what it means is there is a give and take. Our partner see us a value as well as we see them as a value. That value lies not only in but certainly partly in. The fact that we do have this very loyal consumer that we can reach directly and speak to them in a very unique way, particularly given that the products that we offer that represent their brand that we offer them in a way that it’s the only place that you can experience it. You could come in and make a very special Spider-Man Bear and it’s the only place that you can do that. He has the Spider webs all over him and he is very high affinity to that young boy and an experience that they look forward to having. So we feel like that that approach that we just now started to activate against as you saw and as I sort of explained in the second quarter against Spider-Man, Captain America (indiscernible) gives us a lot more latitude in a much more efficient way to drive consumer demand. And frankly in this quarter, it drove consumer demand beyond what our supply was. And I am -- what we have to do is learn where those levers are and what the opportunity, the untapped opportunity still is when we hit all of those levers at the same time. Does that make sense?

[Steph Wissink:]

Yes. It is very helpful. Thank you.

[Sharon Price John:]

Okay. Tina.

[Tina Klocke:]

Good morning. Traditionally, we’ve just needed a slightly positive comp to leverage our SG&A and leverage our fixed occupancy expenses. So as -- and you can see that in past quarters that we have enabled the leverage when we do have that slightly positive comp. Related to the tax, just a reminder that we are in a full valuation allowance on our U.S. taxes, and so any tax expense during the quarter is related to taxes that are paid in jurisdictions other than the U.S. when we don’t have an offsetting benefit. And we at this point expect our full year tax rate to be somewhere in the range of 15% to 20%.

[Steph Wissink:]

Okay. Thank you. I will jump back in queue.

[Tina Klocke:]

Thanks.

[Operator:]

Our next question comes from James Fronda with Sidoti & Company. Please proceed with your questions.

[James Fronda:]

Hi, guys, how are you?

[Sharon Price John:]

Hi, James.

[James Fronda:]

Just on the I guess the Disney and the Nickelodeon products, are there any significant license fees, licensing fees associated with those without her margins at all?

[Sharon Price John:]

There is a royalty associated with the license products.

[James Fronda:]

And what is that that comes out of sales or is that part of cost of goods?

[Sharon Price John:]

Yes. It’s a part of cost of goods and what we tend to do, because in traditional terms the payment of a royalty should be expressing added value in a brand awareness of the property that you’re paying the royalty for. So comparatively, it’s built into our margin and we are able to generally charge a slightly higher price for licensed properties.

[James Fronda:]

Okay. All right. So it wouldn’t affect the margins either way, I guess, if you are able -- still at the higher price, correct?

[Sharon Price John:]

We have -- it’s into our overall objective of what our margin strategy is.

[James Fronda:]

Okay. And the continuation of…

[Sharon Price John:]

Degrading is that, it’s not margin degrading.

[James Fronda:]

All right, okay. And I guess just in terms of the franchise closures, I mean the previous strategy I thought was to expand those, but are those going to continue to close I guess for 2014 into 2015?

[Sharon Price John:]

Yes, the margin -- the franchise expansion strategy which we spoken about is not only the right -- part of that is the rightsizing first of our franchises that we currently have but also the expansion of franchise partnership into new countries and territories.

[James Fronda:]

Okay.

[Sharon Price John:]

So for example the announcement of Turkey would be a franchise expansion that we announced last quarter. But in the meantime, some of our franchises are going through not at a similar situation that we in North America went through in the last two years of a need to do similar state optimization.

[James Fronda:]

Okay.

[Sharon Price John:]

So you are going to see some puts and takes in our longer-term franchises, but at the same time as we write it, started to write the ship in the North American side, we are getting a lot of interested parties on potential expansion into new international countries and territories.

[James Fronda:]

Okay. All right. Thank you, guys.

[Sharon Price John:]

Thank you.

[Operator:]

Our next question comes from Gerrick Johnson with BMO Capital. Please proceed with your question.

[Gerrick Johnson:]

Hey, good morning. I understood the impact on store traffic from the vacation schedules being shifted, but e-commerce is down a little bit, does that impact by vacation schedules as well and what explains that decline?

[Sharon Price John:]

No, Gerrick, that would not be impacted by vacation schedules. The comps on our e-com specifically are compared to period from first half of last year where we were still in a highly promotive mode on e-com. So that midyear last year somewhere in the back half, around the back half so shortly after arrived, we looked at our e-commerce business and put a strategy around it, that was inclusive of it not just being a clearinghouse but being more of a brand building consumer facing entity. So we are taking out a lot of the promotions on the e-com front that has negatively affected the comps, but we now have been significantly increasing profitability over the past few quarters.

[Gerrick Johnson:]

Good. And then third quarter looks like that’s a pretty tough comp, what are we comping against there, marketing campaign, changes, more Pony what else is in there?

[Sharon Price John:]

We had some good proprietary products through that time period as well as My Little Pony continue to do quite well through that period. You are correct.

[Gerrick Johnson:]

Okay. Thank you.

[Operator:]

Our next question comes from Alex Fuhrman with Craig-Hallum. Please proceed with your questions.

[Alex Fuhrman:]

Great. Thanks, guys. I really amazed to see the phenomenal gross margin here and in spite of the continued traffic weakness. And I am wondering as you think about the merchandise assortment and specifically the licensing goods here, I mean it seems like a lot of retailers, and including some of the vertically integrated retailers are having a lot of success with top brand licensing partners. And the hard part of that’s obviously getting the partnerships and you’ve got partnerships with all of the top brands, I mean Spider-Man, Teenage Mutant Ninja Turtles, these are top brand and the demand for a lot of these products seems like it’s been more than you would have anticipated. I mean, is this a big kind of focus that changes some of the merchandising direction? I mean, is this the catalyst that can get comps actually back into growth mode? And then I’m wondering maybe more broadly if you think about distribution, I mean, ecommerce, obviously, that’s not a huge channel for you and like you said that they’ve been very promotional in the past. I mean, just having the inherent brand awareness and tapping into the brand awareness of the Spiderman fan and the Teenage Mutant Ninja Turtles fan. I mean, is that change the thought of ecommerce. Does that get more people coming into that channel? And then similarly, internationally, I would think having partnerships with a lot of those top brands would also cause you to have more awareness right off the bat as you think about international market. So with all that cash on the balance sheet provided that held out of the country, I mean, is there any thought and maybe taking an approach out of the country, especially now with a more broad licensed assortment of top brands. I mean, is there any thoughts maybe going with more of an in-house capital approach there?

[Sharon Price John:]

That’s interesting. First, I want to just make some comments on some of the early pieces of what you said. Yes, we are excited about some of these partnerships. And what we’ve done and the partnerships that we’re creating and the value-add that’s being created on both side of that relationship. The interesting piece is that you are correct. Ecom does have a broader and more significant role when you think about some of these licenses, particularly, as it relates to a consumer segment that I mentioned a lot in the script, which is the adult affinity consumer, who often time bids and as excited about the making of the product. They just want the product. And we are seeing some interesting off take, I mentioned one particularly, which was exclusive, a web excusive My Little Pony where we’ve been actually been able to break what has been a historical animal price point of $35. And there seems to be absolutely no pushback on that. So, we had opened up an entirely new space for us. On that front so I just want to be a little cautionary that we’re not in the business of just becoming a licensed staff, placed for only licenses. But I did -- because we had just incredible opportunity for not only the creation of our own proprietary concepts and lines that we need to learn how to market and drive ourselves, but also just our classic bears are still a big driver. And most of our top three -- top five products are still just a classic and in some cases entry-level price point core product line. So I don’t want to misconstrue that the licenses are just everything about what we’re doing, but it has been what we’ve been able to create some of the early successes, if you can think about driving business to the point of driving -- selling out a success, but driving successes with this integrated approach. On the international side, you have a terrific point that it gives us a foray into new market that may not be as aware of Build-A-Bear out of the gate to put some of these license property that do have high awareness, in our windows, in the upfront area, use it in our advertising to drive trial. And on the capital side, we’re still going to stick with our franchise approach for now. But that’s interesting to think about the insight that you have there.

[Alex Fuhrman:]

Great. Well, thanks for the answers there and looking forward to seeing the new products as it rolls out in the stores.

[Sharon Price John:]

Thank you, Alex.

[Operator:]

(Operator Instructions) Our next question comes from Clay Kirkland with Intrepid Capital. Please proceed with your question.

[Clay Kirkland:]

Good morning. Actually, you just answered a couple of my questions. But while I have you here, can you give any more color on what's driving the deposit comps so for in July, whether it’s traffic or pricing, some of the new launches you have out? Just any color on that would be great.

[Sharon Price John:]

Absolutely. So we mentioned in the script that the key new product launches are creating a lot of buzz for us and a lot of opportunity with My Little Pony and Teenage Mutant Ninja Turtles. But interestingly, we believe that some of the positive comps out is starting and almost kick started, almost on the first day of July, is the fact that kids finally got out of school. So what’s interesting is well as when we look at our four level model right now, traffic, conversion, UPTs and DPTs, we’re positive on all fronts through July. So we've been able to not only maintain those improvements in key metrics that I mentioned that we've increased through the first half of UPTs, DPTs and conversion in AUR But now with that ability of traffic, it’s really starting to show up in our comp.

[Clay Kirkland:]

Okay. Make sense. All right. That’s all I have. Thank you very much.

[Operator:]

We have a follow-up question from Steph Wissink from Piper Jaffray. Please proceed with your question.

[Steph Wissink:]

Thank you. Just a quick follow-up Tina, on the transference of sales when you do close some of your stores. Can you talk a little bit about, I think you said 16% that has been tracking pretty consistently. Any efforts around building awareness in those markets where you’re online only or where you maybe exiting a lease and still trying to retain some business in your ecom channel?

[Tina Klocke:]

Yes. I think that’s just part of the overall integrated marketing plan and as we identify where the consumers are shopping, their shopping patterns are. Also keeping in touch with them and leveraging our database to communicate with them to make sure that they're still aware of all the promotions in the products that are coming out. That 16% has been fairly consistent throughout since we started closing stores.

[Steph Wissink:]

Okay. Thank you.

[Operator:]

(Operator Instructions) There are no further questions in queue at this time. I would like to turn the call back over to management for closings comments.

[Sharon Price John:]

Thank you for joining us today and we look forward to updating you again on third quarter.

[Operator:]

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a great day.