Build-A-Bear Workshop, Inc. (NYSE:BBW) Q3 2020 Earnings Conference Call December 3, 2020 9:00 AM ET

Company Participants

Sharon Price John - President and CEO
Voin Todorovic - CFO
Allison Malkin - IR, ICR

Conference Call Participants

Eric Beder - SCC Research

Operator

Greetings, and welcome to the Build-A-Bear Workshop Third Quarter 2020 Earnings 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.

It is now my pleasure to introduce your host, Allison Malkin of ICR. Thank you. Allison, 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 third quarter 2020 performance and update you on our priorities as we enter the final quarter of the year. After, Voin will review the financials 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 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 Web site. A replay of both our call and webcast will be available later today on the IR site. The COVID-19 pandemic continues to have a significant impact on our operations, cash flow and financial position. The uncertain and dynamic nature of current conditions and its ongoing impact could materially alter our outlook.

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 review our third quarter fiscal 2020 results. As projected in our earlier preannouncement, we saw an increase in total revenues inclusive of continued triple digit growth in e-commerce, expansion in gross profit margin and a decrease in SG&A expenses compared to the prior year's period. These results were consistent with or better than the expectations that were shared prior to the end of the quarter. These improvements contributed to pre-tax income of $1.7 million, an improvement from the pre-tax loss of $7.7 million in the fiscal 2019 third quarter.

We ended this quarter with over $25 million in cash and cash equivalents with no borrowings on our credit facility, and we’re pleased to have positive momentum at the start of our fourth quarter while remaining appropriately cautious given the ongoing impact of the pandemic. After the initial actions to address the immediate challenges brought by the pandemic, we rapidly shifted our focus in order to leverage the circumstances to accelerate our strategic initiatives for the long-term benefit in three key areas.

As a reminder, these areas are: one, accelerating the digital transformation to drive revenue and meet demand; two, evolving our retail store experience with the goal of safely operating while leveraging our high level of strategically secured lease optionality to reduce risk; and three, securing financial stability with the liquidity needed to support our business with an eye to the long-term positioning, including finalizing a new five-year asset-based credit facility.

During this period of rapid change, we have relied on the experience and discipline of our management team and organization to stay focused and agile. As circumstances continue to evolve, the strength of our brand and our multigenerational consumer connection have provided a critical foundation as we continue to execute our strategy to drive profitable growth by monetizing our brand equity. And while we have made great strides in our digital transformation, we continue to see growth opportunities in this space as well as with our entertainment programming.

Looking further at the details of the quarter, we believe our financial results point to the benefit of the work that we have done to accelerate these key initiatives. We believe our efforts are already driving change and delivering growth and barring any further negative impact from COVID are giving us momentum as we enter the fourth quarter. Highlights of the period include an increase of over 6% in net revenues compared to the prior year, which grew to $74.7 million. As noted, this included another triple digit increase in e-commerce demand.

While we continue to have select COVID driven temporary store closures and reduced operating hours in the quarter, we were able to leverage available store labor and inventory to support the heightened digital demand with buy-online, ship-from-store and buy-online, pick-up-in-store or curbside.

The top line growth was achieved even with a decline in commercial and international franchise revenue which reflects closures and restricted operations due to the pandemic for our third party retailers and international franchisees. We believe these segments of our business will show recovery in the future, although the timing and actual results will be expected to vary by account and geography.

Next, we had an improvement in gross profit margin of 720 basis points compared to the prior year. This is the result of several initiatives, but there are two that are particularly important to call out. First, as previously reported, over the past several years, we have strategically positioned our retail store portfolio to have high lease optionality and flexibility.

When we were required to close our entire corporately managed door fleet due to the pandemic, we seized the opportunity to renegotiate rents to include rent reduction, deferrals and abatement on 99% of North American locations and almost 90% of those in the UK. The change in terms, including a higher level of variable rent deals, will continue to show benefit beyond this quarter and notably our rent payments are all now substantially current. Also, importantly, we maintained the high level of optionality going forward.

And second, following the temporary measures to furloughing associates and reducing salaries for those remaining, we completed a corporate reorganization that was planned prior to the pandemic, with reduced headcount and realigned leadership responsibilities to better support the execution of our current and longer-term strategic initiatives.

With the growth in revenue, the improvement in gross margin and a reduction in expenses, we delivered a profitable quarter with $1.7 million in pre-tax income compared to the loss in the prior year, with a significantly improved cash position and no borrowings on our credit facility. The progress that we showed this quarter is the result of initiatives that are in step with our strategic business model.

The model is based on optimizing our key skill set of experiential retail operations, both digital and brick and mortar, as well as our core competency in the design, development and sourcing of plush products while leveraging our most valued asset, our brand, to drive new profitable revenue streams.

Over the past few years, we've been systematically building an infrastructure and organization to nurture a continuous cycle of engagement to span lifetime value with the goal of delivering long-term profitable growth, and we believe the third quarter serves as a testament to our ability to achieve this objective.

If we look forward, even with the uncertainty that embodies the external environment and the majority of our corporate staff still working remotely, as noted, we remain focused on three areas critical to positioning our company for the future; accelerating our digital transformation; evolving our retail experience; and maintaining a solid financial position.

Regarding the acceleration of our digital transformation, we remain intent on rapidly growing e-commerce with more effective use of technology and improved and enhanced fulfillment capabilities, while leveraging our expanded digital platform to inform and drive marketing and content efforts.

We delivered our 12th consecutive quarter of double digit or greater e-commerce demand. We continue to see robust demand for key licensed products, including new Harry Potter collection, which launched as an online exclusive before expanding to all store distribution.

We also had good results with this year's Halloween collection and we continue to see upticks in sales of gifting products, as consumers seek out creative ways to stay connected, while many remained more home-based than in the past. Separately, we continue to refine and improve our digital marketing effort, leveraging added CRM capabilities that came with our engagement with Salesforce to create meaningful consumer journeys that have multiple touch points with the goal of driving sales and ultimately increasing lifetime value.

These performance-based digital marketing campaigns, including social media and paid search, tend to be acquisition focused and targeted on individuals based on their areas of interest, shopping intent, and other signals that help us form a profile that is more discrete than the larger demographic segments we’ve reached in the past. And once someone has made a purchase, we then model that data from our loyalty program to identify differences in shopping behaviors and transactional history to encourage repeat buying.

Finally, we see the creation and digital delivery of content as an important part of the expression of our brand and as a tool to drive further consumer connection that tends to generate incremental sales over time. For example, we've created engaging live streaming events with key promotions such as the National Teddy Bear Day and to reveal new product introductions which we plan to expand going forward.

And in order to position our brand staying top of mind with consumers, we have advanced key entertainment platform from Build-A-Bear Radio and iHeart that most recently has grown to nearly 0.5 million monthly unique listeners to the release of our first live action film in conjunction with Hallmark over the holidays that generated over 2 million viewers within the first week of its premiere, to the launch of a new CD which has had over 0.5 million listens to streaming thus far.

Our second initiative is to maintain a profitable real estate portfolio as we continue to evolve our real estate stores in response to macro business and traffic trends. In the quarter, we successfully reopened the vast majority of our store base, although temporary closures continue to fluctuate on a localized level. We implemented safety protocols. We re-imagined our iconic in-store experience, while still offering a memorable and personal experience for both our guests and our associates.

We were pleased with the high level of staff that returned from furlough and the retention levels that were maintained even after we put in a reorganization that eliminated a number of positions. And in addition to the actions taken to lower rent for both the short and longer term, we have been intently focused on reducing operating expenses at the store level.

For the quarter in North America on average, stores recaptured more than 100% of prior year sales following the reopening, inclusive of buy-online and ship-from-store orders while in the UK, e-commerce drove revenue at a higher pace than the brick and mortar stores. Both conversion and transaction value saw a meaningful increase.

While similar to other retails, we saw declines in consumer traffic in both geographies. Looking forward, we remain cautious in regards to our expectations and we continue to prioritize digital initiatives given that uncertainty surrounding physical store operations in various communities and jurisdiction.

As an example of this continued volatility following the end of the quarter in early November, the vast majority of our stores in the UK were once again required to temporarily close due to governmental COVID restriction.

We are pleased to report that most locations were able to reopen yesterday. And finally, we remain keenly focused on maintaining our financial stability with the liquidity needed to support our business, including cash preservation and managing working capital.

In closing, while it is clear that we are continuing to operate in a challenging environment, we believe that the rapid response and actions that we initially took to stabilize our business in the wake of COVID has been effective. And while we are regularly monitoring condition, we have shifted our primary focus to driving our future state.

As previously noted, we've been able to accelerate key initiatives that were once slated for 2021 and beyond, but are now underway in an aggressive manner with the goal to drive sales, both online and in reopened stores and through additional diversified revenue streams.

Importantly, we are seeing the benefits as we implement these innovative solutions and comprehensive programs that are intended to drive transformative change and results through our entire business and organization.

Fourth quarter to-date, we have experienced positive consumer demand on a consolidated basis despite the aforementioned closures of the UK. We also had solid results for the Black Friday promotional period, fueled by strong e-commerce demand.

While we are pleased with the early reads and have a number of initiatives in place for the holiday season, as noted, we remain cautious considering the continued uncertainty of the business environment and consumer shopping trends as well as the potential for negative impact on the pandemic through the balance of the fiscal year.

Finally, I would like to once again thank our associates for their resilience and commitment to our company's mission as they know that the comfort of a hug from a furry friend from Build-A-Bear workshop can provide.

We believe our third quarter results demonstrate the passion and affinity that consumers have for our brand, and we intend to continue to drive the ongoing evolution of our company with the execution of our strategic plan with the goal of increasing long-term stakeholder value.

Now, I'd like to turn the call over to Voin.

Voin Todorovic

Thanks, Sharon, and good morning, everyone. I also want to note how proud we are of our entire team working together to deliver a positive third quarter performance across key financial metrics amidst the ongoing pandemic.

After recently sharing our expectations for the quarter, we are pleased to report that we finished the period with results at or above the projected ranges we had provided. As the third quarter has historically been the smallest of the year, we are pleased to report a profitable quarter, ending with a solid balance sheet and strong cash position.

Let me move to discussing our third quarter results in more detail. Total revenues were $74.7 million, a 6.1% increase compared to the prior year. The growth includes an 8.7% increase in net retail sales, primarily driven by 167% increase in e-commerce demand, which reflects online generated orders, including those fulfilled through our stores.

In addition, on average, our stores were closed about 7% of the quarter with brick and mortar locations operating 25% fewer hours. Despite these challenges, our North American stores recaptured over 100% of the prior year sales.

The growth in net retailer sales was partially offset by $1.5 million decrease in commercial and international franchise revenue, mainly driven by COVID restrictions that impacted the opening of our third party retail partners that tend to be hospitality-based businesses as well as international franchisee locations.

Gross profit margin expanded 720 basis points versus the prior year with the majority of the expansion driven by the combination of higher sales and leverage of occupancy costs. This primarily reflects the benefit of the aggressive renegotiation of leases, which resulted in rent reductions, deferrals and abatements in 99% of North American locations and almost 90% of those in Europe.

In addition, merchandise margin also expanded as we prudently managed our promotional activity in the period, which contributed to increasing our dollars per transaction to the highest level ever in the fiscal third quarter.

On the expense side, SG&A was down $2.3 million or 6.6% from the third quarter of 2019, driven mainly by decreased payroll expense due to COVID-19 mitigation efforts. This was a result of combination of lower store payroll, a temporary reduction in corporate salaries, and some permanent corporate payroll savings driven by the planned restructuring that Sharon mentioned.

Notably, late in the quarter, the corporate salaries were restored as business conditions improved. We also reduced our marketing spend in the period while shifting to more efficient digital marketing programs. Overall, SG&A was 44.3% of total revenues, representing a 600-basis point improvement compared to fiscal 2019 third quarter. And finally, pre-tax income was $1.7 million compared to a pre-tax loss of $7.7 million in the fiscal 2019 third quarter.

Turning to the balance sheet. At the end of the quarter, cash and cash equivalents were $25.8 million, an increase of $19.6 million compared to the end of the fiscal 2019 third quarter, driven by improvement in profitability. We had no borrowings on our asset base credit facility at quarter end.

Importantly, we are current on substantially all of our rent payments as the renegotiated terms have been finalized and documented. As part of our discipline approach to working capital and strong management of vendor relationship, inventory was down $14.7 million, a decline of 22.2% year-over-year.

As a reminder, in the prior year, we pulled forward inventory as the mitigation to potential tariffs on goods from China. We are currently comfortable with the receipt flow, level and the composition of our inventory.

Capital expenditures for the quarter were $700,000 compared to $5.1 million in the fiscal 2019 third quarter, reflecting our tight working capital management and reduction in planned capital expenditures amid COVID-19 environment. In closing, we are pleased with our financial performance in the third quarter and the current strength of our balance sheet.

Regarding our outlook for the balance of the year, given the ongoing impact of the pandemic and resulting uncertainty, we do not believe it is prudent to provide guidance at this time. While we have noticed that we have positive consumer demand thus far in our fourth quarter, we plan to continue the disciplined expense management across all areas of the business as we remain cautious given the volatility of the external environment.

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. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first questions come from the line of Eric Beder with SCC Research. Please proceed with your questions.

Eric Beder

Good morning. Congrats on a solid quarter.

Voin Todorovic

Good morning. Thanks, Eric.

Sharon Price John

Good morning, Eric.

Eric Beder

You guys have done a lot of internal change on the pieces. How should we be thinking looking forward in terms of the potential when things somewhat normalize in terms of hours and flow, the potential SG&A savings and in terms of what should be the inventories? I know now that you're doing by getting buy-online, pick-up-in-store and ship-from-store, the need for inventories is a little bit changed. How should we be thinking about that as we go forward?

Voin Todorovic

Okay. So, let me start first, maybe we can talk about inventories first, and then we'll tie back into the SG&A. Definitely from the inventory perspective, we continue to stay focused on what we can control. We are pleased with the product that we have, the composition of our inventory, how we are managing our promotional activity that's reflected in strong margin results that we have shared.

We continue to stay focused and work with our vendors to deliver product timely as well as we are looking at the opportunities to drive increase in our inventory turn, as we are trying to deliver benefits or achieve benefits from investments in all the infrastructure and technology that we've been making over last several years. Our investments in new warehouse management systems are going to enable us to do some of those things.

In addition, Eric, earlier this year, we started on initiatives like buy-online, ship-from-store; pick-up-in-store. We are also working on initiatives to deliver from stores, which really is going to help us to be even more efficient with our inventories, and really manage that working capital even better.

So, again, what I mentioned in my prepared remarks, some of the inventory fluctuation versus last year is driven by the potential mitigation of tariffs that we were expecting to happen last year that never materialized. So last year is probably not a good comparable data point, but at the same time we are pleased how we are managing inventory and we believe there is some opportunity to further improve our turn with some of the things that I just mentioned.

Then on the other side, as we talked about SG&A, again, we are living in some uncertain times. There are closures of stores happening. We just reopened our stores in UK couple of days ago.

Sharon Price John

Yesterday.

Voin Todorovic

It was yesterday. So, definitely, we were making some adjustments. We unfortunately had to furlough majority of the people that are in those particular locations. These things are going to be happening. We are going to do what we can to mitigate everything that's within our control. We've proven, I believe, that we can manage SG&A, but at the same time we need to continue to make the right investments in business and continue to invest in places that still support our strategies and to continue to deliver long-term shareholder value.

Sharon Price John

I think the key here, Eric, is – and we to point I think that we've shown the ability to do this is to find that balance between maintaining tremendous flexibility, managing our cash situation in the midst of uncertainty, while still making strategic investments in the future.

Eric Beder

Yes, it's definitely come through that way. One other question here. You have – you did it with Child and you did it with little Harry Potter buy online first and then shifting it into stores? How do you see that flowing out? Is that something we're going to see more of? And how did the store personnel or the people kind of – how did the different stakeholders respond to that?

Sharon Price John

Right. So the initial effort that we made on a big launch that was online first was associated with the Child, the Disney Mandalorian, Baby Yoda as it's known. And that was simply because all of our stores were closed during the launch period. So we had to – speaking of flexibility and the ability to shift focus and react to the marketplace and the pandemic, we quickly shifted our entire effort to be an online effort and repositioned the launch to – and it was quite successful as we've shared in previous quarters and continues to be so with the new Mandalorian 2 having just launched and created a continued demand for that particular product and some of the add-ons that we've now included in the offering.

But we learned a lot during that. We learned that we can reach a different type of consumer, a broader consumer base, a consumer base that might be not Build-A-Bear first, but be affinity products first. So that combined with our new capabilities in digital marketing enabled through Salesforce relationship that we signed in January of this year really drove a lot of these sales and also has expanded our consumer base that we're now bringing into the Build-A-Bear fold, modeling and driving, as I mentioned in some of my remarks, opportunities for additional add-on sales and pulling them into our loyalty program over time.

So, there's a number of things going on and we actually learned through that process that it’s ideal given the particular profile of that product to actually launch online first, and then bring it into the store, different types of consumer that wants a different type of experience. And so that is why even though our stores were reopened when we launched Harry Potter, we chose to replicate that approach, because it drove value and stretched out the tail of these particular high affinity products.

Eric Beder

Great. Good luck for the holiday season.

Sharon Price John

Thanks.

Voin Todorovic

Thanks, Eric.

Operator

Thank you. [Operator Instructions]. There are no further questions at this time. I would like to turn the call back over to Sharon Price for any closing remarks.

Sharon Price John

Thank you. Thank you all for joining us today. And we appreciate you tuning in and we wish you all a safe and happy holiday season. Be safe, be happy and enjoy.

Operator

On behalf of the Build-A-Bear team, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time.