Build-A-Bear Workshop Inc (BBW) 2017 Q4 法說會逐字稿

Greetings, and welcome to the Build-A-Bear Fourth Quarter 2017 Results Conference Call. (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. Ms. Malkin, you may begin.

Good morning, and 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 the discussion of our 2017 fourth quarter and fiscal year performance and review the priorities we've set for the business as we begin fiscal '18. Voin will review the financials and guidance, and then we will take your questions. (Operator Instructions) Members of the media who may be on our call today should contact us after this conference call with your questions. Please note this call is being recorded and a broadcast live via the Internet. The earnings release is available on the Investor Relations portion of our corporate website. A replay of both our call and webcast will be available later today on the IR site.

Before I turn the call over to management, I will remind everyone that forward-looking statements are inherently subject to risks and uncertainties. Actual results could differ materially from those currently anticipated due to a number of factors, including those set forth in the Risk Factors section in the company's annual report on Form 10-K. We undertake no obligation to revise any forward-looking statements.

And now I would like to turn the call over to Sharon.

Thanks, Allison, and good morning, everyone. As we review our results for 2017 through the lens of the multi-year strategic plan that was initiated in the back half of 2013, the year showed progress on key initiatives that advanced us toward our long-term goal, a sustained profitable growth, including delivering pretax profit that exceeded guidance, marking our fourth consecutive year profitability. As we believe that the underlying principles of our strategy reflect the realities of the rapidly changing retail landscape, while focusing on monetizing the value of and the consumer affinity for our powerful brand as we diversify our business model beyond traditional mall retail.

Of course, none of this progress would be profitable without a team of passionate and dedicated associates. And with that in mind, I would like to take the opportunity to congratulate the entire organization for once again being named to the FORTUNE 100 Best Companies to Work For list for the 10th consecutive year, with the announcement coming just this morning.

Now I would like to the recap the year's results and highlight the accomplishments that we expect to move us toward our long-term goals. Specifically, 2017 included total revenues of $358 million as growth in e-commerce sales, commercial and new nontraditional retail as well as income from international franchising almost entirely offset a decline in comparable store sales, which in part shows the positive impact of the strategic shift that we've been making to diversify revenue streams. A 170 basis point expansion in retail gross margin to 46.9%, reflecting the improvements that continue to be made throughout the organization in process and cost savings as well as the efficiencies gained from investments and infrastructure. Notably, retail gross margin for fiscal 2017 was 800 basis points better than the results prior to the initiation of the turnaround plan.

GAAP pretax income of $13.8 million, exceeding our annual guidance and reflecting an ongoing commitment to drive sustained profitability. And finishing the year with over $30 million in cash and no debt. A final note highlighting our confidence in the health of this company, given the strength of our balance sheet and solid underlying fundamentals, is the approval of a $20 million share repurchase program by our board last August. Since that authorization, we have repurchased over 1.1 million shares.

Now let me update you on some key initiatives that we expect to move the business forward in 2018 and beyond. At the top of the list is the upgrade that was completed to our e-commerce platform and the launch of the updated website in advance of the holiday season. The site offers a better overall guest experience with more intuitive navigation and enhanced features, such as the new Bear Builder shopping configurator that more closely aligned with the guided process that consumers know from their interactions in our stores. We believe that this growth of 12% that was achieved in the fourth quarter of fiscal 2017 is the starting point. We expect to gain momentum when further omni-channel options are introduced, and we start to leverage user data, new analytic capabilities and enhanced search features to drive revenues through higher conversion and average per order volume. Historically, we have significantly under indexed in e-commerce sales as a percentage of brick-and-mortar. And when compared to industry norms, we believe we have an opportunity. Accordingly, many of the changes we've been making as a company are designed to allow Build-A-Bear to more fully participate in the internet economy across a number of consumer bases.

In addition, as a part of the e-commerce initiative, we rebranded and modified our loyalty program with the goal of having a fully integrated consumer experience in order to increase lifetime value. Since the program's launch, we have seen higher enrollment and transaction capture (inaudible), which should allow us to expand communication and engagement levels.

Separately, we made ongoing progress to diversify revenue streams beyond mall-based traditional retail, including growth in the international franchise front. Specifically, our franchisees finished the year with 102 stores the (inaudible) in our history across 12 countries. Importantly, this included the first franchise store in China, quickly followed by a second opening in early 2018, which marked entry into the important Beijing market. Currently, plans are in place to add at least 5 more stores in Tier 1 Chinese market in the current fiscal year.

Overall, existing franchisees added 10% more stores throughout last year as they leverage the increased flexibility resulting from the diversification of store format, stemming from our discovery rebranding and fixture update initiatives, including the new concourse model. We expect to continue to expand our global footprint and refine our franchise portfolio as new countries are added in 2018 with advanced discussions already underway with a number of qualified partners. As noted, we also experienced growth in commercial revenue, which contains both experiential wholesale and outbound brand licensing. As a part of the experiential wholesale business, we've developed a successful relationship with Carnival Cruise Line and are now on all of their U.S.-based ships, with discussions underway for further expansion. And as previously discussed, we have been actively working to leverage the equity of our powerful brand to generate incremental, margin-accretive revenue stream through outbound licensing. This includes category expansion beyond plush through a robust program that extends the presence of the Build-A-Bear brand into a significant number of retail products and touch point beyond our stores. Specifically, we expanded the licensing pipeline, ending the year with 15 agreements covering a diverse range of over 10 categories that include toys, crafts, publishing, footwear, beauty and fashion accessories. We expect to gain momentum as royalty income is recognized when new programs that have been in development come to market and further license agreements are added.

And while the year saw almost 30% growth in diversified revenue streams, we remained intently focused on optimizing our retail store portfolio. These retail locations are still the engine that fuels our plans to continue to profitably evolve and grow. As such, we remain intent on making continuous improvements, particularly in areas most in our control. This focus enabled us to increase in store conversion and deliver the highest dollars per transaction in our history in fiscal 2017, while partially offsetting ongoing changes in consumer shopping trends that led to traffic declines, primarily in traditional malls. With that in mind, even with the traffic challenges which intensified for us in December, resulting in soft comps for the quarter and the year, we continued to enjoy a profitable store safe.

In fact, nearly all of our U.S. stores achieved positive 4-wall contribution. Remarkably, because of our ongoing focus on improving efficiency, stores in the top quartile of comp performance had positive sales growth and essentially the same EBIT margin of approximately 18% as the stores in the bottom quartile of our comp performance. This is almost double the 4-wall contribution rate compared to the beginning of the turnaround in 2013. Because of our proven ability to generate profit and cash flow from the broader fleet, despite market headwinds, we intend to continue to operate stores that are delivering positive contribution, even with projected traffic induced sales declines. Simply put, these stores, many of which are fully depreciated, are generating the cash that supports our broader strategic growth initiatives and are helping us to self-fund our company's evolution.

Additionally, with a significant number of leases coming due over the next 3 years, we have amassed a high degree of flexibility to react to the continuing market pressures. We assess these lease events on a case-by-case basis, leveraging the power of our well-known destination-driven retail concept to renegotiate favorable rent deals or selectively close doors in order to achieve our real estate objectives of: optimizing profit, generating cash and lowering occupancy cost, while continuing to diversify formats and reduce capital requirement. As it relates to these real estate diversification initiatives. In 2017, we added 23 of the new innovative concourse shops to the mix. This stand-alone model is approximately 200 square feet, requires significantly less capital, operates on shorter-term leases that are generally percent based and generates much higher sales and profit per square foot than an average traditional in-line mall store. Concourse shop can be easily relocated, giving us higher flexibility to effectively react to the changing mall environments from a real estate management perspective. Notably, guest satisfaction at concourse shops is on par with traditional stores, allowing us to continue to deliver those one-on-one consumer interactions that build the emotional connection that allows us to build and leverage our brand equity.

Consistent with our expectations, on average, we continue to see our updated discovery store format outperform Heritage stores on a comp sales basis, and tourist locations exceed traditional mall stores on multiple key metrics, including sales and profit. At the end of 2017, we had over 100 locations in a discovery format, including the October addition of a new store in New York City located next to The Empire State Building, reflecting our ongoing emphasis on tourist sites. Other nontraditional tourist locations, such as seasonal-shopping Gaylord Hotels, also continue to perform well with sales exceeding the prior year. These insights will continue to inform our real estate evolution and priorities as we move forward.

As it relates to merchandise and marketing, we once again have solid sales on our proprietary Merry Mission collection, which maintained its position as the #1 story for the holiday season. Now in its fourth year, we continue to build the equity of this property and drive its relevance with the introduction of new characters and storylines. The development of our own intellectual properties, which includes Promise Pets and Honey Girls, remains a priority as we shift from a mall-based experience to retailer to become a common diversified global branding company. Separately, we are anticipating entering into agreement for Build-A-Bear to be featured in a traveling exhibition for children's museums throughout the U.S. The exhibit will tour various children's museums over the next 3 years, following the projected early 2019 grand opening at the Betty Brinn Children's Museum in Milwaukee, Wisconsin. We believe this is not only a testament to the strength of our brand but wonderful exposure in a family-centric entertainment venue.

Looking ahead, this morning's press release included guidance indicating that we expect revenues to be slightly positive for the year. It's important to understand some key factors that underlie this expectation, including the recent closure of a multimillion dollar store in Downtown Disney in the Southern California area. Notably, the store's lease had a radius restriction. And with this limitation removed, we can now reposition the market to better serve this highly populated tourist region. However, this will occur over time, so we expect a short-term negative revenue impact from the closure until the market is fully restructured. And a change in the revenue recognition from gift card breakage due to new accounting standards will negatively impact total revenues in 2018 by almost $4 million. Voin will go into more details in his remarks.

As a reminder, we expect to see continued choppiness in comparable store sales as our real estate portfolio evolve, which is one of the reasons we are most focused on total revenue and profitability as key measurements to the overall health of our business.

In short, we believe that this business has evolved and is now supported with an improved infrastructure in organization that can deliver total revenue and profit growth. As we begin to scale the programs that have been established through our diversification efforts. We fully believe in our long-term prospects of the company with the beloved brand that is stretchable and monetizeable, a unique in-store experience that has a multiple generation appeal and an enhanced infrastructure designed to drive efficiencies as we begin to implement plans to scale our diversified business model with informed, data-driven consumer insights.

I believe this will continue to advance our strategy and make the transformation from a retail company that happened to build a strong brand into a global- branded, intellectual property company that just happens to have vertical retail as one of its channels.

Now we'll turn the call over to Voin to discuss the financial results in more detail.

Thanks, Sharon, and good morning, everyone. We are pleased to report a pretax income in the final quarter and, for the full fiscal year, surpassed our guidance driven by gross margin expansion and the disciplined management of expenses. For the fiscal year, we delivered $13.8 million in GAAP pretax income compared to $5.3 million last year. While traditional mall traffic decline significantly contributed to lower comparable store sales, we ended 2017 with a healthy store base. Lower markdowns, improved margins from continued sourcing efficiencies and ongoing reductions in our occupancy costs help to maintain solid profitability across the store base. In addition, we saw improvements in key operational metrics, led by higher conversion and dollars per transaction. With these improvements in mind and plans in place to deliver increased revenue in 2018, for clarity, we believe the evolution we have made in our business model to address the ongoing changes in the retail environment enabled us to continue to grow pretax earnings in a negative comps scenario as we demonstrated in 2017.

Before I review our fourth quarter and full year results, I would like to provide some perspective on the impact of the recently enacted U.S. tax reform. One of the key changes in the tax law was the reduction of the federal corporate tax rate to 21%. Given this rate change and our deferred tax asset position at year-end, we incurred a one-time noncash expense of $1.4 million in the fourth quarter. We have excluded this expense from the adjusted result that I will now discuss.

Turning to our fourth quarter results. Total revenues were $107.6 million, a decrease of 2.5% compared to the fourth quarter of fiscal 2016. Retail gross margin expanded 510 basis points to 51.1%, reflecting a 260 basis point expansion in merchandise margin and a 230 basis point improvement in occupancy cost, which was positively impacted by the absence of noncash store impairment taken last year. SG&A declined $2.1 million to $44.9 million or 41.7% of total revenues. Fourth quarter GAAP pretax income was $9.7 million compared to GAAP pretax income of $3.5 million.

Adjusted net income was $6.8 million or $0.43 per diluted share compared to adjusted net income of $5 million or $0.31 per diluted share in the fourth quarter last year. For the 2017 fiscal year, total revenues were $357.9 million compared to $364.2 million in fiscal 2016. Retail gross margin expanded 170 basis points to 46.9%, driven by gift card breakage, cost efficiencies and the absence of the negative adjustment of $2.3 million related to noncash store asset impairment taken in fiscal '16.

For the year, SG&A was $4.5 million less than prior year, even with over 4% growth in store count. As noted, GAAP pretax income was $13.8 million. And net income on an adjusted basis was $8.4 million or $0.53 per diluted share compared to adjusted net income of $6.6 million or $0.41 per diluted share in fiscal 2016.

Turning to the balance sheet. At year-end, cash and cash equivalents were $30.4 million, and there were no borrowings under our revolving credit facility. We ended the year with $53.1 million of consolidated inventories, representing a 2.4% increase over the prior year, mainly driven by an increase in store count. Capital expenditures totaled $18.1 million in fiscal '17 and depreciation and amortization was $16.2 million. Following the August 2017 authorization by our Board of Directors of a $20 million share buyback program, we repurchased over 500,000 shares of our common stock for $4.7 million in fiscal 2017. Since the end of the fiscal year, we have repurchased more than 600,000 additional shares for approximately $5.3 million. Under the program, we have bought back over 1.1 million shares to date and have approximately $10 million remaining.

Separately, as we previously shared, our board approved a change in our fiscal year-end to the Saturday closest to January 31, from the previous end date of the Saturday closest to December 31. This change was effective immediately following the end of fiscal 2017. There will be a 1 month -- 1 fiscal month transition period, which will be reported on our Form 10-Q along with results for the quarter ending May 5, 2018.

For your reference, we provided a recast of our unaudited historical financial information for the fourth quarterly periods of fiscal 2016 and the first 3 quarterly periods of fiscal 2017 in this morning's press release.

Before turning to guidance for fiscal 2018, I want to note the impact of revenue recognition, accounting standard changes related to the timing of breakage for certain gift cards. Previously, we recognized gift card breakage after 60 months. Now the new standard required -- requires gift card breakage be recognized based on our actual redemption experience. As such, we will not recognize $12.3 million in revenues from gift card breakage for gift cards sold from 2013 to November of 2015. This change will negatively impact fiscal 2018 revenue and pretax profit by $3.9 million. The remaining balance will have an ongoing impact through fiscal 2020. As a result of these changes, effective December 31, 2017, we made the beginning balance adjustment to retain earnings to record this impact. This will be captured during the transition period given the change in our fiscal year.

With that in mind, as it relates to fiscal 2018 guidance, we currently expect total revenue growth to be slightly positive compared to the prior year, including the aforementioned loss of $3.9 million in sales related to gift card breakage, and the closure of flagship Disney store that Sharon mentioned. Drivers of the revenue growth include: double-digit increase in e-commerce, as we are able to better leverage our upgraded web platform; growth in revenue generated from our diversification initiatives, including international franchising and commercial sales inclusive of outbound brand licensing and experiential wholesale; and on the retail store front, we expect to benefit from the analyzation of the 23 concourse shops open last year in our New York City tourist location as well as from partial year sales from tourist locations we will open during fiscal 2018 in San Francisco and Baltimore. Pretax income to grow in the range of 10% to 15% after adjusting 2017 GAAP pretax income for $3.9 million related to revenue recognition standard changes. Capital expenditures to be in the range of $15 million to $18 million and depreciation and amortization in the range of $16 million to $17 million. And diluted earnings per share in the range of $0.53 to $0.57 using an effective tax rate range of 25% to 27%, assuming no discrete items.

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

(Operator Instructions) Our first question comes from the line of Alex Fuhrman with Craig-Hallum.

I wanted to ask about a couple of your growth initiatives for 2018. Firstly, on e-commerce plans to grow that double-digit. Do you feel that in 2017, you could have done double-digit e-commerce growth if you'd had the upgraded platform? And that's what was really holding you back as it certainly seems like the e-commerce results have been pretty volatile and not necessarily coinciding with your own same-store sales in your retail stores. So if you could give us some color on how that might progress throughout the year? And what the drivers of that would be? That would be helpful.

Alex, the results that we have enjoyed post the launch of the website would certainly indicate that we could have done double-digit growth throughout the course of the year. We had a plus 12% growth in the fourth quarter, and we saw that -- the impact of that. And that we ultimately started to approach at least the low end of what would be the norm of e-commerce sales as a percent of brick-and-mortar in the fourth quarter with 9% of our sales coming from e-commerce, which usually 5% or less. Now the norm in brick-and-mortar is in the 10% to 20% range now. And we certainly believe we should be on -- yes, in the midpoint of that. So yes, we do believe that. And that's without the analytics turned on. I don't want to overamp on it but clearly, the market place is moving in the direction of e-commerce, and we have as we've noted multiple times really been unable to fully participate in that market place due to our platform -- in the struggles that we've had with that platform that has caused us some challenges in the past. So we're really looking forward to a fully consumer centric e-commerce and omni-channel approach to this. It also gives us opportunities to be much more efficient and effective. And our media choices is digital -- is all kind of one big approach to that. You have really have to have a robust e-commerce sale to -- e-commerce site to optimize your digital marketing as well. So we're looking forward to optimizing this.

That's definitely helpful. I also wanted to ask about the outbound licensing. I know that's something that you guys have talked about for a couple of years now. It sounds like that's really starting to come to fruition now for the first time with some viable deals here in the pipeline and some action. We would love to get a sense of how much resources you have devoted to this in terms of fixed cost or headcount? And at what level you would expect outbound licensing to be break even and become accretive for the company?

Yes, so outbound licensing certainly takes a while to build a meaningful business because you're working with a lot of different companies and a lot of different categories. And it takes -- once you sign the deal, clearly it takes them a while to develop programs and products that didn't get launched into other retailers, but the benefit is great. For one, it's almost -- well, it's royalty based, so it's almost immediately accretive to your question. But of course, we're not getting the enterprise value of that, we're just getting the royalty value of those products. The additional value that we get is exposure, being present in a number of different retail venues outside of our own venue. So there's marketing value to it, if you think about it that way. It's really just extracting brand equity that already exists in our brand. The other thing, though, is that we are currently -- and this is not atypical to get started. We're using an agent to help us build those relationships with some of the outbound licensing programs, some of them we hold inside, but we have a partner that helps us do that, where they do take a percentage of the royalty do that. So our additive headcount is minimal -- very minimal, in fact, most of it we've absorbed into -- the things that we need to do, we've absorbed it into our headcount as it sits. When the outbound licensing becomes a big enough piece of our total business, of course, we will look at, perhaps, a different structure.

Our next question comes from the line of Jeremy Hamblin with Dougherty & Company.

I wanted to first start with -- just looking forward here at the potential licensing opportunities in 2018 and get a sense for some of the potential movie launches that you see as key for this year. I know, last year, you had some nice success with Beauty and the Beast in the springtime. There is a little bit of an Easter shift. But in terms of the near term and what you have visibility on at this point, what do you see is maybe key opportunities? Whether it's, again, something like the Incredibles 2 or Christopher Robin, any commentary on that front?

Sure. Yes, we are comping in (inaudible) Beauty, which was a bit of a surprise hit for us last year because more of the Beast sales were outperformed by our expectations, but -- and we're comping against that right now. But when you look out on our licensing front, there's news and there's the -- there's a lot of licenses that we have that are really bread and butter for us, things like Pokémon and PAW Patrol continue to deliver. Those are -- those have been really great partnerships for us. But when you look out beyond that of what's like the spiky good -- new news, we have Peter Rabbit right now, which hopefully will do quite well for us as Easter starts to approach. We have Black Panther, which will be -- it's a really big PR movie right now, it's getting a lot of tremendous buzz. We'll have the -- back in the Marvel's business, which we usually are with the Avengers movie release. We are back in business again with Girl Scouts, which we took a respite for a while, so we're excited to do that. That's a -- sometimes has been in the past a very big party business for us. So there's a lot of excitement going on as we look out into the future on some licenses. They're not any of the big chunky breakthrough films that you might have seen in the past, perhaps maybe holding out Marvel -- some of the Marvel properties. But still, that's an important part of our overall portfolio.

Okay, great. And then just in terms of, with the change in the fiscal year, can I assume that the timing of Easter moving forward to the end of March is kind of a nonevent this year?

Yes, it's April 1 this year. And that's one of the key reasons why we wanted to shift our fiscal year to be -- to get that Easter noise out of the shift from first to second quarter, which it does many times. So I think that, ultimately, this shift will make things a lot more comparable for you guys and for us as well.

Okay, great. And then on the SG&A front, wanted to just get underneath kind of the outlook in '18. And get an understanding of -- this year kind of ended up delivering pretty strong Q4 despite the softness on comps so nice profitability. What impact in terms of comparing '17 versus '18 on the incentive compensation front? How close are you to achieving kind of standard incentive compensation? Do we need to account for any of that in our modeling in 2018?

Thanks for the question, Jeremy. We continue to manage our SG&A and overall controllable that we have to the best of our abilities and that's showing in our results. We will continue in 2018 to manage our SG&A. I'm not going to talk specifically about the performance-based comp. But like over next year, we continue to expect to leverage our SG&A. And we continue to expect to make investment in business, but we will expect our dollars to be much in line with what we have this year.

Okay, got it. Last one, the gross margin performance really, really impressive in Q4. As we look forward, not just in '18, but beyond that, how much more can you kind of squeeze out on the gross margin side if we don't see kind of a little bit higher lift on the sales front? Is there multiple hundreds of basis points from here or something maybe a little less than that if we don't get more acceleration on sales?

There are several things that impact our retail gross margins. We continue to believe there is room to expand our merchandise margins. And we will continue to do that through sourcing efficiencies, through cost reductions, through selective price increases, things that we can control. We also going to see a headwind as it relates to gift card breakage -- accounting changes that we talked about going forward, especially over next 3 years. But we believe our occupancy management and reduction in our overall occupancy cost will help us continue to leverage and improve gross margin, even though if we deliver flat or slightly below prior year total revenue. The idea is to drive the top line revenue and to continue to expand the gross margins. Historically, our high was close to 49.5%. So we still believe that's a nice growth to have over next several years.

Okay. And then just one point of clarification. In the release you indicate that there's a little over 600,000 shares, I think, purchased since the beginning of -- since the end of 2017.

That's correct.

Okay. So did that leave about $10 million left on the buyback authorization overall?

Yes, exactly.

Yes.

(Operator Instructions) There are no further questions at this time. I'd like to turn the floor back over to Sharon John for closing remarks.

Thank you. Thanks for joining us today on the call. We really look forward to reporting first quarter on the next call, and have a great day.

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