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Build-A-Bear Workshop, Inc. (BBW)

Q3 2016 Earnings Call· Sun, Oct 30, 2016

$38.04

-1.30%

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Transcript

Operator

Operator

Greetings and welcome to Build-A-Bear Third-Quarter 2016 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the conference over to your host, Allison Malkin. Thank you. You may begin.

Allison Malkin

Analyst

Good morning. Thank you for joining us. With me today are Sharon Price John, CEO; and Vojin Todorovic, CFO. For today's call Sharon will begin with a discussion of our third-quarter results and highlight our performance against the key priorities we outline as we scan fiscal 2016. Vojin will review the financials and guidance, and then we will 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 requeue if you have further questions. Members of the media who may be 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. Any 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. 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. We undertake no obligation to revise any forward-looking statements. Finally, as previously announced, the Company continues its exploration of a range of strategic alternatives. As you are aware, this could take many directions. And there is no assurance that this exploration will result in any strategic alternatives being announced or executed. We continue to be limited as to any additional comments on this topic as the process unfolds, unless and until our Board of Directors determines that further disclosure is appropriate. And now, I would like to turn the call over to Sharon.

Sharon Price John

Analyst

Thanks, Allison. Good morning, everyone, and thanks for joining us today. In the third quarter we continued the execution of our stated strategy, which is focused on having more products reach more people in more places more profitably. Specifically, our results included GAAP pretax income of $2.8 million, more than double last year's third-quarter results, which is in line with our guidance and inclusive of the negative impact of foreign exchange; a consolidated comparable sales decline of 2.2% following last year's 2.2% increase; delivering a flat two-year stack as we anniversaried the height of last year's strong Minion sales, which were driven by the July 2015 movie premiere; and positive comparable sales in our remodeled Discovery format stores, which outpaced the Heritage stores at a double-digit rate on an aggregate basis. Now I would like to update you on our progress to advance our MORE strategy. First, turning to MORE products, we had a balanced mix of proprietary and licensed offerings to reach each of our key consumer segments. For the boys segment on the licensed product, we continue to build on the success of Paw Patrol and Star Wars. Those properties have become consistent top sellers, which we keep refueling with updated products. The young girls segment responded well to the relaunch of Twilight Sparkle, a classic my Little Pony character. We continue to take advantage of the Pokemon excitement by expanding our offering beyond Pikachu with the addition of Easy. We have successfully harnessed social media to connect with our teen-plus consumers to drive the strong sales of these products. The broad range in our core and traditional plus categories continue to deliver the highest unit and dollars sales, while our proprietary Halloween collection has proven to be a triple threat with appeal to boys, girls and our…

Vojin Todorovic

Analyst

Thanks, Sharon, and good morning, everyone. Our third quarter GAAP pretax income was within our guidance range. Our pretax income benefited from lower expenses due to operational efficiencies and disciplined expense management, increase in store counts over the prior year and high flow-through revenue from outbound licensing and wholesale initiatives. These have more than offset headwinds from comparable sales decline and the impact of British pound devaluation. Specifically in the third quarter, consolidated comparable sales decreased 2.2% following last year's 2.2% increase, reflecting a 1.6% decline in North America and a 4.8% decline in Europe. Sales were soft early in the quarter, when we were up against a peak selling time of last year's Minions product, but returned to positive later in the quarter, giving us momentum leading into our critical fourth quarter. In the quarter, we had a 1.8% increase in dollars per transaction, offset by a decrease in overall transactions. Notably, comparable sales in our remodeled Discovery stores in North America increased by 9%, which was a double-digit improvement compared to our Heritage store. Net retail sales decreased by 2.9%. Excluding the impact of foreign exchange, net retail sales increased 0.4%. As a reminder, approximately 20% of our sales are transacted in British pounds. Therefore, the significant decline against the dollar is impacting our results. Excluding currency, the increase in net retail sales was driven by new stores and gift card brackets, partially offset by a consolidated comparable sales decrease in store downtime due to remodel activity. During the quarter, our commercial revenue increased over $500,000 or 66% as we started to recognize benefits of our outbound licensing and wholesale initiatives. On a full-year basis, we now expect commercial revenue to be over $1 million higher than last year, driven by the initiatives with Carnival Cruise Lines and…

Operator

Operator

[Operator Instructions] Our first question comes from Alex Fuhrman with Craig-Hallum Capital. Please proceed with your question.

Alex Fuhrman

Analyst

Great. Thank you very much for taking my question. I wanted to ask a bit about the guidance. It looks like the comp store sales guidance has been tweaked down a little bit for the year. But no change to the full-year revenue guidance, even with the weakening pound. Is there anything in particular that's driving that? Maybe some of your new stores or the performance of your Discovery stores? Just wondering how we should be thinking about that.

Sharon Price John

Analyst

Alex, yes, thanks for the question, nice to hear from you. There's a couple of things that are impacting that. First, I think that it's really important to recognize that we are holding the total top line. I think that that's a critical piece of the puzzle as well as without the exchange we still believe that we are going to land in guidance on the pretax as well. But there's some changes in the mix in there. You might recall, in January when we estimated what we felt that our comps would be through the year, we thought that first quarter would be positive, second quarter would be negative, third quarter would be slightly positive. We shifted the Trolls business from the tail end of second -- third-quarter into fourth quarter. And so we ended up with a negative Q2. So we are just right now pushing that through the rest of the year and being cautious and how we think the comps will turn out in fourth quarter, although we are still confident of a positive fourth-quarter comp. Will it make up for the difference? We certainly have plans in place, the marketing in place and the product to do that. And we feel good about being able to do that. And right now, given that we are positive quarter to date, we have a tremendous momentum going into the fourth quarter. And Trolls looks like it's going to be everything that we hoped it would be. But just a cautionary note -- the reason we didn't move it, though, is because we are getting a greater than expected benefit from some of these initiatives that are starting to take hold from new revenue streams, which Vojin mentioned in his prepared remarks. Plus we added additional doors, given that we were able to work very quickly to create cost-reduced versions of how we execute the stores, so -- and different in nontraditional locations. So we were able to add these new Concourse Shops that I mentioned, these AMC theater opportunities that we mentioned, Carnival is ramping faster than we thought, and do some shop-in-shops and Toys R Us. So we are making up the difference on the total cost line through different mechanisms.

Alex Fuhrman

Analyst

Great. That's really helpful, Sharon. And just to drill a little bit more into the Q4 outlook, now that you have more than a year under your belt with some of the in-house-developed brands that have been very successful, such as the Honey Girls, is your expectation that those brands will continue to comp positively on top of each other for the holiday season as some of these brands get their second shot at holiday season? Or is there some type of a honeymoon effect as you launch a new brand and then that matures over time?

Sharon Price John

Analyst

No, we haven't seen that yet. They are still building and we are still refreshing them. It's not like we put three 1SKUs out on the floor and just expect those to comp on the sales. It's always new stories, always new entertainment that we are putting on YouTube. I encourage all of you guys to go on YouTube and watch some of our Honey Girls videos and look at how many digital interfaces we get. It's pretty amazing. It's even fun to scroll down and look at the comments of how much engagement we are getting on these properties, which I believe ultimately will allow us to generate revenue in some of these properties in new and different ways the on to build a bear's four walls. But no, they are comping. And to use a very specific example, on Merry Mission, we launched Merry Mission, for example, in 2014. We had about 60%-70% lift in 2015, and with the new additions of two additional characters, we're expecting to see a lift again in 2016 on the Merry Mission story.

Operator

Operator

Our next question comes from Steph Wissink with Piper Jaffray. Please proceed with your question.

Steph Wissink

Analyst · Piper Jaffray. Please proceed with your question.

Thank you. Good morning, everyone. Sharon, just a really quick question for you -- as you look out over the next couple of years, what is your comfort level visibility as to the key to content drivers, both your own and your partners? And where do you think we should start to see maybe some stepwise improvement in some of the initiatives around your own brands? I know Alex asked about that as well, but just in terms of thinking of the slotting and the timing overall, the revenue potential for some of your own brands versus partners?

Sharon Price John

Analyst · Piper Jaffray. Please proceed with your question.

Thanks, Steph. Well, as I just mentioned to Alex, we are really excited about the kind of engagement that we see with our brands from the new Horses & Hearts, the continuation of Promise Pets to the Honey Girls. And they are very sticky properties. As I've mentioned in previous calls and I just said to Alex, we believe that there's opportunity beyond just the four walls of Build-A-Bear to build these brands. And it's not -- when we look out on the horizon, with a lot of our best-in-class license partners, we still have the great honor, in many ways, to have all of these relationships. And we will be able to take advantage of the best films for kids that are coming down the pipeline. It's how we plot these content opportunities in around them to help not only buoy the total revenue but, in many ways, to help us balance out the quarters. You see some of the bumpiness in our quarters because we still are reliant on, in many ways, and enjoy -- I won't say reliant; I will say that we enjoy the opportunity to be engaged with some of these big film properties because it raises the awareness level of Build-A-Bear to a consumer base that do not necessarily automatically think of Build-A-Bear. So a great example of that is Minions, of how many people in the teen-plus consumer base came to Build-A-Bear just to buy Minions and have been reengaged and reminded of their childhood and now have been coming back to Build-A-Bear. So it's a great partnership for us. So I think, at the end of the day, it's having both of these levers, if you will, puts us in a much stronger position of being able to partner with people where they are investing marketing and awareness in products that are beyond what we normally would think of our core consumer base and then slotting in things that are beyond traditional bears in -- against key consumer segments and launching new opportunities in and around what would be other people's marketing money. So it's a great tool for us, and I'm excited about the potential. And when I look out on the horizon I see a lot of increased opportunity for us to do this type of thing.

Steph Wissink

Analyst · Piper Jaffray. Please proceed with your question.

That's great. And then one for Vojin just with respect to currency -- it doesn't impact on the margins in the quarter, but could you talk a little bit about your hedging strategies or any opportunities you might have to help cushion some of the impacts? I know that British pound change was fairly abrupt, so maybe hard to hedge into that. But maybe you could talk a little bit about your currency hedging strategies and maybe we should be thinking about going forward.

Vojin Todorovic

Analyst · Piper Jaffray. Please proceed with your question.

Yes, sure, thanks. The continued weakening of the British pound against the dollar affects our results in several different ways. As I mentioned before, 20% of our revenue is coming from US-based operations. And when we translate some of those local currency results to US dollars, there is an impact on our results. What we have been seeing a bigger impact this year is really the remeasurement of the balance sheet and some of the local currency-denominated assets and liabilities remeasured in US dollars have been having a big impact on our results. And there is really not much from that aspect that we can do. We are really focused on figuring out the ways to mitigate the impacts. One of the things is like looking to lock into some of the spot rates as we are buying our inventory for UK separations in US dollars. So we are trying to mitigate some of the cause here. But then we are doing things on the operational side really to mitigate either through select price increases or through other operational efficiencies, to mitigate the impact on the exchange rates. And again, we believe that eventually it's going to normalize. And still it's a very viable business for us.

Operator

Operator

Our next question comes from Jeremy Hamblin with Dougherty & Company. Please proceed with your question.

Jeremy Hamblin

Analyst · Dougherty & Company. Please proceed with your question.

Good morning. And thanks for taking the question. Just wanted to ask about the remodels and the status of -- I think that you have 12 remodels scheduled for Q4. Where do those stand today? I know that you want to have those really complete before we get into the true thrust of the holiday season.

Vojin Todorovic

Analyst · Dougherty & Company. Please proceed with your question.

Jeremy, just to help you clarify some of that stuff. We finished the quarter with 43 stores in the Discovery format. We expect to have 55 stores by the end of the year. Some of those stores are not necessarily remodels; some of those are stores that we are opening the new stores. What Sharon mentioned, some of the Concourse Shops that we just started to open in Q4 as well as some of the temp-to-perm stores that we are opening as well as some of the seasonal stuff with Gaylord's and Macy's. So we still believe we are going to have approximately 55 stores in the Discovery format by year-end.

Sharon Price John

Analyst · Dougherty & Company. Please proceed with your question.

Yes. So Jeremy, our focus is not to close down stores in the fourth quarter. So the vast majority of those stores that are being touched and will ultimately be Discovery stores are new locations. And some of them are temporary new locations like seasonal shop-in-shops, but we are not shutting down stores.

Jeremy Hamblin

Analyst · Dougherty & Company. Please proceed with your question.

Understood, thanks for clarifying. On the gross margin front related to the British pound impact, 120 basis points in Q3, can you just give a little bit more of a range for us, Vojin, on how we should be thinking about that impact on gross margins for Q4?

Vojin Todorovic

Analyst · Dougherty & Company. Please proceed with your question.

So what we said, we expect our merchandise margins to continue to improve as well, but merchandise and the retail gross margins on a full-your bases. So clearly we expect to see some of those improvements in Q4. There is still going to be an impact of exchange rates, especially in UK. But we believe, with some of the initiatives, pricing initiatives that we put in place, we are going to mitigate some of that. But as well as the continuous improvement initiatives that we have been working on all along to really continue to drive margin expansions, we believe we are going to start reaping additional benefits in Q4 as well as the mix of earnings that we are getting is going to help us deliver the objective of continued expansion in merchandise margins for fourth consecutive year.

Jeremy Hamblin

Analyst · Dougherty & Company. Please proceed with your question.

No, I understand that. I was just hoping to get may be a more precise view on how I should be thinking about mix and British pound impact, that you expect that to be a 150-basis-point impact or drag on gross margins as opposed to 120. Any way to clarify that?

Vojin Todorovic

Analyst · Dougherty & Company. Please proceed with your question.

That's what is really hard to estimate. We're just assuming the same exchange rate to be flat basically on a full year basis. But we would still expect our overall margin to expand inclusive of the impact of exchange rates on a full-year basis, retail gross margins.

Sharon Price John

Analyst · Dougherty & Company. Please proceed with your question.

That's assuming, and we can't -- and that's very difficult as Vojin said. So just a cautionary note -- of course, we can't predict further fluctuations.

Jeremy Hamblin

Analyst · Dougherty & Company. Please proceed with your question.

Understood, understood. Okay. And then I just wanted to -- you mentioned that you've seen some success here with Pokemon and a nice testament to how quickly you can manage the team and product development. Did you actually indicate which character was going to launch as the third character in your lineup and the approximate timing on that?

Sharon Price John

Analyst · Dougherty & Company. Please proceed with your question.

I did mention the timing. It will be December. And I did not mention the character because my S2 PR team would not allow me to. The reason we are doing that is because clearly it creates a lot of buzz for us when we keep that on the down low and then partner with some of the great social media groups that we have tremendous relationships with. And that's partially what is driving this interest in business. So stay tuned.

Jeremy Hamblin

Analyst · Dougherty & Company. Please proceed with your question.

From checks that we have done, it sounded like you guys were selling out pretty fast on that product, including the Easy launch. Do you feel like you are prepared? Have you had time now to adjust for the magnitude of potential impact on that? Was there any lost sales, I guess is a better way to ask this question, in Q3 because you didn't have enough product?

Sharon Price John

Analyst · Dougherty & Company. Please proceed with your question.

Well, first we -- in each case we feel like we are better prepared because we have more knowledge and more learning and more understanding of the demand. Clearly, whatever we sell out there's some lost opportunity. In many cases for a product though just to be clear we are a lot -- since 60% of our sales of Build-A-Bear are planned, we don't lose off purchase sales. When people come to Build-A-Bear, sometimes they choose something else. But when we sell out of a hot property, there was probably some lost opportunity. Is it lost in the year? Maybe not. We're certainly preparing to take advantage of both, the continued interest in Pokemon, the launch of new characters and the knowledge that we have of the velocity of these products as we roll into the fourth quarter. So we feel like, just like with any other situation, the more information you have, the better you can do it.

Jeremy Hamblin

Analyst · Dougherty & Company. Please proceed with your question.

Okay, great. And then just one last one to slip in here -- in terms of potential color on Q4 SG&A, is that also expected to be down modestly, then, year-over-year?

Vojin Todorovic

Analyst · Dougherty & Company. Please proceed with your question.

Yes. We continue to stay focused on SG&A, as we said in our previous calls. We expect overall SG&A to be down year-over-year in Q4 as well as, as we said, back half of the year. So yes.

Operator

Operator

Our next question comes from Greg Pendy with Sidoti. Please proceed with your question.

Greg Pendy

Analyst · Sidoti. Please proceed with your question.

Hey, guys. Thanks for taking my call. Just real quick on the CapEx, it looks like it's coming in. You are guiding it within the range but at the high end. Is that something we should read into -- are the Discovery stores running a little bit ahead? Or is it just the fact that you are doing a lot more with, I guess, a faster -- faster Carnival cruise and some other things?

Vojin Todorovic

Analyst · Sidoti. Please proceed with your question.

Hi, Greg. Yes. We tightened that guidance. We said before $25 million to $30 million. We think it's going to be coming closer to that higher end of the range. We are testing more stores as well as we have been able to achieve more with the same amount what we were thinking. So basically efficiencies that we are gaining through our sourcing and reducing the overall cost of our store build out, we are able to invest some of those monies and accelerate some of the remodels and test out some of these new concepts such as Concourse Shops that we talked about, as we believe they are going to be a really strong, viable option for us going forward.

Greg Pendy

Analyst · Sidoti. Please proceed with your question.

Okay, thanks. That's helpful. And then just one more, now that you seen at least Trolls in the UK, it looks to be off to a strong start, I got the impression -- and I could be wrong, on the last call that you thought Trolls would be heavily skewed toward girls. Are you possibly seeing some of the strength in that it's appealing to younger boys and girls, as we think about the November launch in the US?

Sharon Price John

Analyst · Sidoti. Please proceed with your question.

That's an interesting question. Thank you, Greg. In the UK and in the US right now, Poppy is by far the number-one Furry Friend in the offering. We have Poppy, we have Branch and we have Guy Diamond, the three characters that we are offering. We also have Branch and Heat. We have two versions of Branch. But Poppy being the number one SKU leads us to believe that it is definitely girls business because she's just very appealing to young girls. We do expect, just like we've seen in the UK, that the mix will start balancing out as people see the film. Poppy is just appealing because of her color and her hair, even before you really know what the film is about. Once you seen the film, which I have, it just puts a smile on your face. It's a great feel good film with tremendous music. And we couldn't be more excited about it. It does lead you to have a much greater affinity toward some of the secondary characters. So I think it's possible that not only will we balance out the mix with a few boys, but this could transcend to the teen-plus consumer base as well. Right now our velocities are very high and we are pulling forward copy inventory from first quarter.

Operator

Operator

Our next question comes from Jason Stankowski with Clayton Partners. Please proceed with your question.

Jason Stankowski

Analyst · Clayton Partners. Please proceed with your question.

Hey, guys, congratulations on the profitability in the quarter. It was great to see. I was curious. Last quarter you had mentioned a little bit about the cost of the strategic project. Just curious if we wouldn't be more profitable, and if you can give a sense of what you are actually spending on a pretax basis per quarter pursuing the strategic alternative.

Sharon Price John

Analyst · Clayton Partners. Please proceed with your question.

Hi. We are just really unable to speak to those things specifically, anything about strategic alternatives, as you know. There are some costs associated with that, as you might imagine. And to the degree that they are impacting our SG&A, the answer would be yes, we would have been a little more profitable.

Operator

Operator

[Operator Instructions] Our next question comes from Joey Bond with Delta. Please proceed with your question.

Joey Bond

Analyst · Delta. Please proceed with your question.

Hi. I have a quick question about FinMaster. What is the margin that Build-A-Bear makes on the toys that are sold?

Sharon Price John

Analyst · Delta. Please proceed with your question.

We generally don't discuss the exact deals with our partners on the specific royalty rates.

Operator

Operator

There are no further questions at this time. At this point I would like to turn the call back to Sharon John for closing remarks.