Build-A-Bear Workshop, Inc. (NYSE:BBW) Q1 2021 Earnings Conference Call May 26, 2021 9:00 AM ET

Company Participants

Allison Malkin - IR, ICR
Sharon Price John - President & Chief Executive Officer
Voin Todorovic - Chief Financial Officer

Conference Call Participants

Eric Beder - SCC Research
Dave Kanen - Kanen Wealth Management

Operator

Greetings, and welcome to Build-A-Bear Workshop First Quarter 2021 Earnings 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 today, Ms. Allison Malkin of ICR. Please proceed.

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 first quarter 2021 performance, our strategic initiatives, and our outlook for the year. After, Voin will review our financials and guidance in more detail. 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 question 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. A replay of both our call and webcast will be available later today on the IR site. 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

Good morning, everyone, and thank you for joining us today to discuss our results for the first quarter of fiscal 2021. We delivered a record-breaking quarter on many levels. We attribute this in part to the investment and actions that we put in motion prior to the pandemic and in many cases accelerated during the pandemic. These include leveraging the increased fulfillment capacity due to our warehouse reconfiguration and systems upgrades, driving innovation with intense efforts on merchandise and marketing, including aggressive positioning of our Gift Giving program, as well as transforming our omni-channel capabilities supported by our Salesforce partnership.

Overall, we believe that the discipline and relentless focus we've had on executing our strategic plan put us in a position to take advantage of the improving consumer demand that we saw in the quarter. The quarter's results were outstanding on both top and bottom line, including total revenues of $92 million, up 97% from 2020 and up 9% from the fiscal 2019 first quarter. This includes increases in both our physical stores and digital channels. We believe the improvement was driven by the strength of the emotional connection that has kept our Build-A-Bear brand a desired and relevant brand, strong merchandise mix, and improved digital marketing program.

While our company benefited from better traffic trends coincided with the timing of the stimulus package and pent-up demand as consumers sought to reengage in personal experiences, we delivered a material improvement in conversion rates and our highest level of dollars per transaction in our history, which drove our sales growth. Notably, we had an 87% increase in e-commerce demand compared to the fiscal 2020 first quarter and a 194% increase versus the 2019 period. This was fueled by a triple-digit increase in transactions from new guests, highlighting the effectiveness of our digital marketing campaigns.

First quarter gross profit margin improved by 52.8% of total revenues, reflecting the benefit of ongoing lease negotiations, leverage of fixed occupancy expense and expansion of merchandise margin, which we have been consistently expanding for multiple years. We've returned to profitability in the quarter with $13 million in pre-tax income, which represents the highest profit for our first quarter in our nearly 25-year history. And looking at the balance sheet, we ended the quarter with total cash and equivalents of $46 million. We are pleased with our first quarter results and while we expect to see continued evolution of consumer shopping patterns and preferences in the balance of the year, we believe we have evolved as an organization and built the infrastructure to respond with greater agility to deal with potential uncertainty as we expect to deliver growth in 2021.

As we have previously shared, we remain focused on our strategic priorities for the year, which are centered primarily on three key areas. One, further acceleration of our digital transformation, including content and entertainment initiatives. Two, rapidly evolving our retail capabilities and experiences including omni-channel and significantly expanding e-commerce capacity. And, three, maintaining a solid financial position, including a strong balance sheet to support our business and make strategic investments designed to drive further growth.

Regarding the acceleration of our digital transformation, we are intent on building our business with more effective use of technology and improved and enhanced fulfillment capabilities, while leveraging our expanded digital platforms to inform and drive marketing and content efforts. We believe that our multi-year sustained strong trend in e-commerce demand, including this quarter's 87% increase over the prior year, highlighted by another quarter of triple-digit growth in North America, demonstrates the progress we continue to make in this area.

In the first quarter, we saw significant gains in our business around gifting moments and occasions, including Valentine's Day, Easter, and most recently Mother's Day, as well as graduation. We leveraged our enhanced digital marketing to target consumers that were searching for gift solutions for these events. With many of the key occasions centered on adult to adult guests, we are leveraging our status as a multigenerational brand to diversify and expand consumer segments to drive incremental sales. We also continue to develop our innovation pipeline and expanded our digital merchandise offerings for gift giving and other older teen plus affinity guests with a launch of The Bear Cave, a new section of our website that offers carefully curated products designed specifically with these demographic segments in mind, which prefer to shop online. We expect to add products that are slightly edgier, but still on brand as the year progresses.

In addition to our proprietary products offerings, we will include relevant license options which continue to contribute to increased digital demand. Sales from evergreen licenses such as Pokemon, Harry Potter, and the most recent successful introduction of a new product line inspired by Nintendo's highly popular Animal Crossing: New Horizons, digital game, are driving robust interest and demand. Some of the upcoming additions planned for The Bear Cave licenses include Space Jam, Lord of the Rings, and Cruella, the new Disney movie. As noted, we are able to effectively target high potential consumers that are likely to have an affinity for Bear Cave products through our advanced digital marketing programs, including CRM, online campaigns, and improved communications across touch points.

With the enhanced technology from the Salesforce platform that were added in early 2020, combined with robust consumer data, we continue to fine-tune our tactics to efficiently acquire new consumers and drive lifetime value of existing guests, which we believe contributed to our first quarter results. In addition, we continue to use digital media, content, and entertainment as marketing and brand building tool to engage consumers and drive sales both online and in our stores as COVID restrictions began to ease. Our second initiative is to rapidly evolve our retail capabilities as we extend ways to connect with and meet the changing needs of consumers by driving omni-channel engagement and expanding delivery options.

Our North American stores were largely opened and operating throughout the quarter. We began the period with all of our European stores closed due to governmental restrictions. However, the majority reopened in April. Not only did we see improving traffic patterns in stores as consumers re-engaged with our interactive retail experience, our workshop also helped fulfill the increase in digital demand through buy online, ship from store, or pickup in store option. Locations effectively acted as mini distribution centers, leveraging labor and optimizing inventory. So the reopening of our brick and mortar locations provided advantages in multiple ways. The enhanced capabilities that we put in place in 2020 to diversify our omni-channel options, including adding an allocation algorithm to optimize geographic positioning have continued to provide critical building blocks to support our sustained strong e-commerce demand. This allowed approximately one in every five digital orders to be made and shipped from a traditional store in this year's first quarter.

As our third priority, regarding financial positioning, given our improved results and strong balance sheet as well as our positive business trends, we are actively evaluating initiatives that would enable a more rapid acceleration of key programs in investment opportunities to aggressively grow our company. As such, we plan to provide more details on investment priorities, including use of capital on our second quarter call.

In closing, as I noted at the beginning of this call, we believe the initiatives and investments that were put in place prior to the pandemic and, in many cases, accelerated during the pandemic are driving improved results, which we continue to -- expect to continue. We have developed a meaningful business segment through gift products on occasions that we plan to aggressively expand. License products continue to be important and we remain strongly positioned with best-in-class partners and we have reopened the vast majority of brick and mortar stores in the US and UK. Thus far, sales in the current second quarter have remained strong, giving us the confidence to increase our profit guidance for the fiscal year, as highlighted in this morning's press release.

As Build-A-Bear, like the rest of the world, continues to navigate the pandemic, our associates have remained focused on fulfilling our mission to add a little more heart to life. I'm very appreciative of the care they show to deliver personal experiences, both in-store and through digital interactions. I'm proud of our organization's ability to remain agile and successfully pivot to drive our strategic plans forward in this uncertain environment. This includes aggressively evolving our digital capabilities, increasing omni-channel integration, maintaining a flexible real estate portfolio with high lease optionality and diversifying revenue streams to leverage our powerful brand.

Finally, I'm excited to share that we recently sold our 200 million furry friend since the company was established in 1997 and that is a lot of heart. Ultimately, it's the consumer connections associated with these experiences that have kept this Bear -- brand strong and gives us a great opportunity to grow and expand our business with the goal to deliver a long-term sustained profitable growth.

Now, let me turn the call over to Voin for further discussions on our performance and outlook.

Voin Todorovic

Thanks, Sharon; and good morning, everyone. We are pleased with a strong start to our year and the robust momentum we have in our business. These results reflect the affinity consumers have with the Build-A-Bear brand and the progress we have made towards our strategic goals, including leveraging our elevated digital platform and competency to transform our omni-channel capabilities. We believe that pent-up demand and stimulus programs in the US positively benefited our business. Throughout the period, we saw improving traffic and sales trends in our brick and mortar locations across the US as the quarter progressed. Our stores in the United Kingdom and Ireland were closed for the majority of the quarter with reopening starting on April 12. Sales in those locations have been meeting our expectations. As Sharon noted, thus far in the second quarter, we have maintained strong momentum.

Moving now to review our first quarter results. Total revenues were $91.7 million, a 96.7% increase compared to $46.6 million in the first quarter of fiscal 2020. For added perspective, compared to the first quarter of 2019, which wasn't impacted by the pandemic, total revenues increased 8.7%. We delivered growth in total revenues even as our European and Canadian stores were temporarily closed for the majority of the quarter due to COVID restrictions. Separately, our net store count decreased by 14 stores at the end of the period compared to the prior year, due to lease events.

Gross margin profit was significantly higher compared to prior year, a strong sales growth, leveraged fixed occupancy expense. In fact, the margin rate was the highest percentage in Build-A-Bear's history for first quarter results. Rent expense was lower year-over-year as we benefited from more favorable lease terms that were negotiated starting in 2020 with the onset of the pandemic. We also saw expansion in merchandise margin, also the highest ever, during the first quarter, driven by strong initial markup and lower promotional activity. As a reminder, the fiscal 2020 first quarter included full occupancy cost for 13 weeks, while we only had sales for six weeks. On a full year basis, retail gross margin expanded 750 basis points versus the first quarter of 2019.

SG&A was $35.2 million, up $8.5 million from the first quarter of fiscal 2020, driven by increased salary expenses given the reopening of our store base. As a reminder, at the end of the first quarter in 2020, the majority of our workforce was on furlough and corporate salaries for the remaining associates have been temporarily reduced. On a two year basis, SG&A as a percent of sales improved by 400 basis points. We delivered the highest level of pre-tax income for the first quarter in Build-A-Bear's nearly 25-year history with $13.2 million. On an adjusted basis, pre-tax income was $12.3 million. This compares to pre-tax loss of $18.7 million in the prior year's quarter and to pre-tax income of $2.4 million in the first quarter of 2019.

Turning to the balance sheet. We ended the first quarter with cash and cash equivalents of $45.9 million with no borrowings on our credit facility. Strong business performance and profitability improvement helped drive the $24 million increase in cash. Our cash balances partially benefiting from timing of inventory receipts and deferred the rent payments for 2020 obligations that were pushed out to this year to preserve cash during the pandemic. Also, the cash balance is benefiting from timing of capital expenditures. During the quarter, we spent about $500,000 versus $2.8 million in last year's quarter. Our current plan includes capital expenditures in the range of $5 million to $10 million for the fiscal 2021. The surge in demand across channels in the first quarter caused us to end the period with inventory down $9.5 million, a reduction of 17.8% from the 2020 first quarter. We have accelerated inventory receipts in order to support the anticipated strong demand. While we have experienced some challenges with our global supply chain, our goal is to minimize the impact of product and transportation cost increases, logistic disruptions, and delays in product shipments.

Based on the strong first quarter performance and positive trends and outlook, we are raising our profit expectations for fiscal 2021 EBITDA in introducing total revenue guidance. For fiscal 2021, we currently expect EBITDA to be in the range of $28 million to $32 million. This is an increase from our previous guidance, which was to exceed fiscal 2019 EBITDA of $15.3 million. Our updated expectations include depreciation and amortization in the range of $13 million to $14 million.

We are also adding insight that we expect total revenues for fiscal 2021 to be above fiscal 2019 total revenues of $338.5 million. Specifically related to our second quarter, as noted in our press release, sales trends have remained strong and we expect total revenues to exceed both 2020 and 2019 levels. As a reminder, in fiscal 2020, e-commerce was our only channel of revenue for the majority of the period due to temporary store closures. Combined with the launch of several highly anticipated license products, we had online growth of 299% compared to fiscal 2019 quarter. With that in mind, although we believe e-commerce demand will be strong for the full year, in the second quarter we expect the demand to be essentially flat to 2020, maintaining a triple-digit increase over 2019. This outlook assumes no additional significant negative impact from the pandemic, such as prolonged store closures due to government mandates.

Please keep in mind, that while we expect to see annualized savings from expense reduction initiatives implemented in fiscal 2020, our plans reflect higher payroll and marketing expenses as salary levels have been reinstated to pre-pandemic levels. Furloughed employees have returned and marketing activity has expanded to drive sales growth.

In closing, we are pleased with our financial and operational performance in the first quarter and believe the momentum of our business and progress against our initiatives positioned us well for the remainder of the year.

This concludes our prepared remarks, and we will now turn the call back over to the operator for questions. Operator?

Question-and-Answer Session

Operator

Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] Our first question comes from Eric Beder with SCC Research. Please proceed.

Eric Beder

Good morning. Congratulations.

Voin Todorovic

Good morning, Eric. Thank you.

Eric Beder

So you are returning back to normal here in the space, how do you look at the potential to eventually add parties to the mix and the potential to see gains from movies coming out as being part of the mix again?

Sharon Price John

Thank you, Eric. Well, as we have carefully done throughout the pandemic, we follow the CDC guidelines and balance that with our own needs from a business perspective and the oversight of the safety of our guests and our associates. So we are carefully, as we would and as we have, assessing the party business, because clearly that gathers groups of children together and adults and we just have to be mindful of that. I think that we're looking out into the future, we would expect to see parties. Assuming everything stays the same and there is no resurgence of the pandemic, I think we'll start to see parties trickle back into the system later this year. We have not specified date yet. It may depend on the size of the store, so we'll be rolling them out based on, again, the CDC guidelines of distancing and assuring that we can meet the needs as well as disappoint point other guests that are there to participate in Build-A-Bear given our higher demand for natural traffic that we can service them appropriately at the same time. So there's a lot of levers. It seems so simple. Just flip the switch and start having parties, but there's a lot of complexity involved in. We thus far have been, I think, diligent and prudent and it has served us well.

On your question about the movies, we're certainly looking forward to a lot of these films that we've already had -- as we mentioned, we have these best-in-class license relationship. Some of these films that were planned, were planned for 2020 and 2021. They've been pushed out. We've been in relationships with these guys for a long time. We already have all the products developed. In some cases, some of the products may still -- we're looking forward to it. And I think we're just -- we're going to have to be again mindful. I'm not sure anyone is willing to take the big bet on how many people are going to go out to see -- goes straight to the theaters, particularly with children. But I think that either way, our partners will find an approach, a marketing approach that makes the characters appealing and exciting, and this is right in our wheelhouse of knowing how to optimize. So, we're looking forward to that.

Eric Beder

Great. And one more. So, last year, Baby Yoda was a huge success. It went from online to stores and it's still doing well over a year plus into it.

Sharon Price John

Yes.

Eric Beder

When you look at Animal Crossing, does that -- you've started to sell still online, you can order in stores, is that kind of aggression that we saw in Yoda and where it moved kind of how kind of how successful, then do you believe that as kind of what we'll be seeing with Animal Crossing, and do you believe that franchise has the ability to be something like a Pokemon or Yoda that has a tremendous life to it as opposed to kind of a movie, which is a little bit shorter? Thanks.

Sharon Price John

Well, sometimes the films are what we call spiky and sometimes they have longtail. It really depends on the franchise. And so I can't categorize that all movies act this way or that way when the -- because sometimes the movie itself becomes a franchise. Star Wars is a great example of that. For Yoda, which is adjunct product, actually a Baby Yoda, a Grogu, to the Star Wars franchise, that has maintained some of excitement because of The Mandalorian continues to -- had continued to have new episodes. So as long as the Lucasfilm believes that there is potential opportunity with The Mandalorian series, I think we could expect to see some business associated with Grogu. In fact, it's one of our top selling graduation gifts this year was a Grogu with a congratulations 2020 grad sash. So he's very searchable.

The second -- your second question about Animal Crossing, very different, right. It's not that you are sitting, waiting to see some piece of entertainment, that's an always-on type of "entertainment gaming side" that people have tremendous affinity for. They relate to these characters and play with them in their own world, and out of the gate we were very pleased with Animal Crossing and certainly expect that that will have a long tail as well. So, we're pleased for about both of these types of properties, and it's the balance of management of these of the spiky kinds of movies, their relationships with these franchise types of entertainment properties, as well as now the great what has turned into be long-term relationships with the gaming side, like the Pokemon that gives us balance across the licensing side that has aided us in being able to create a smoother curve and plan-out years in a better and more effective way.

Now will Animal Crossing become a Pokemon? Pokemon has got multiple decades behind it, that certainly hard to say. But thus far, we're very pleased with it. Thank you for the question.

Eric Beder

Thank you and good luck for the rest of the year.

Operator

[Operator Instructions] Our next question comes from Dave Kanen with Kanen Wealth Management. Please proceed.

Dave Kanen

Good morning, guys, congratulations.

Sharon Price John

Thanks, Dave.

Voin Todorovic

Good morning.

Dave Kanen

Also let me add, congratulations to some of your team members that I'm not meeting anyone on purpose. But I know Jenn and Chris are a big part of helping execute and I would just like to express my gratitude and acknowledgment of their efforts in doing a great job. All of you guys. So, first question, could you -- do you guys at this point have a specific initiative to go after the pet gifting market? Do you have dedicated product for that with a ruggedized or durable, shell so to speak?

Sharon Price John

We certainly haven't announced anything like that or shared anything like that David. There is nothing in the public forum concerning that.

Dave Kanen

Okay. So my question is this some -- is this an initiative that you're eyeballing and is in the works, rephrase it?

Sharon Price John

We haven't announced anything specific about any sort of strategic initiatives concerning pet products in the public forum.

Dave Kanen

Okay. And then, if I can -- I guess similar category would be non-fungible tokens NFTs right now a lot of buzz halo effect there. It seems like this is an opportunity for you guys, are you evaluating it. Is this something potentially that you will look to monetize.

Sharon Price John

Although we have not shared anything like that in the public forum as well I’m happy to tell you that we've spoken with some experts in the arena to assess the value of NFTs the way they operate and whether that makes sense for Build-A-Bear and Build-A-Bear type of assets.

Dave Kanen

Okay. And then, can you give us an update on your 3D e-commerce initiatives?

Sharon Price John

As we shared in the January ICR deck, we have expectations to launch what we call the Bear builder 3D in 2021.

Dave Kanen

Okay. And then, this is quick [ph] questions here. So the next one is third party retail obviously with force closures and so forth, it could not have contributed much. Can you tell me what's your expectation in terms of the cadence of that ramping back up throughout the year? And I believe third party was like $2.5 million for the quarter, where do you see it ultimately settling when things go back to normal?

Sharon Price John

We normally provide specific projections on individual revenue generating areas but the third party retail is depending on the partner itself it's in different places and its evolution post-COVID. Great Wolf Lodge is already open and doing quite well, and of course as the complete opposite Carnival Cruise lines, they are still in the process of preparing their ships and I know that they have started to announce some expectations of when they will start going on cruises again and we would anticipate -- participating in those cruises when they do start to embark, so we're excited about that. And Voin if you'd like to add any color on that [ph].

Voin Todorovic

David, this is one of those asset light initiatives that you know we are definitely very well aware of, and like we continue to work and try to find additional partners. But you know again with COVID delays and impact, some of these things have slowed down, but definitely, this is one of our high priorities for the organization.

Dave Kanen

Okay. I guess the way I'm looking at it is, even though the quarter was phenomenal, it was really with very little contribution from third party retail with $2.5 million. What was your peak -- what I'm driving at is it -- this is going to be incremental as we work through the year and into next year as things go back to normal. And also, what were your peak quarterly revenues in third party retail prior to the pandemic?

Voin Todorovic

I mean, it's little a bit hard to answer your [ph] question because you know, like really when you initiate some of those relationships and you have some of the initial orders and shipments and you're rolling things out, there are some spikes that we are seeing definitely on a full year basis in the past we have seen like that. That business was pretty big [indiscernible] information available publicly. We believe with some of those things as things return back to normal and -- Like Carnival Cruise, that is a big portion of our lineup of third party retail locations reopens and assuming they have the same number of ships sailing that we are going to be able to get back to some of those numbers that we had shared historically. But, and again it just going to depend on some of these partners and how well their business is, as a lot of them are in tourist locations. And so this is where unfortunately the COVID is impacting not as directly but indirectly to some of these partners. And as I mentioned, we are going to continue to look at ways to grow this channel through different partners but again there is nothing more that I can share at this point in time.

Dave Kanen

Okay. I'll go back and I'll research it what your peak was. The final item on my list here, it's more of a comment for the board, even though our stock has gone up quite a bit when I assume in $11 stock price and then back out the cash and using 31 million of EBITDA, we're trading it like 4.25 times EV-to-EBITDA CapEx [ph] is coming down, we're positioned to generate very substantial free cash flow. To me, it makes sense to actually buy back our stock here and I know psychologically seeing it go from 3 to 11, one would have a knee-jerk reaction, and say, oh no, it's up a lot, but the valuation is so low and it would be so value accretive, so just a commentary for the board being that I think at this point we're somewhat overcapitalized and well-positioned. And frankly, I think your EBITDA guidance is very low, I think you're going to easily exceed it so. Anyway, again congratulations and thank you for your hard work, and look forward to next quarter.

Sharon Price John

Thank you, David.

Voin Todorovic

Thank you.

Operator

Thank you. At this time, I would like to turn the call back over to management for closing comments.

Sharon Price John

Thanks to everyone for joining us today. And we look forward to seeing some of you on Zoom during our meeting at the Cowen Conference later today and tomorrow during the fireside chat with D.A. Davidson. Have a great day.

Operator

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