Build-A-Bear Workshop Inc. (BBW) Q2 2020 Earnings Call Transcript

Build-A-Bear Workshop Inc. (NYSE: BBW) Q2 2020 earnings call dated Sep. 01, 2020

Corporate Participants:

Allison Malkin — Investor Relations

Sharon Price John — President and Chief Executive Officer

Voin Todorovic — Chief Financial Officer

Analysts:

Eric Beder — SCC Research — Analyst

Presentation:

Operator

Greetings. Welcome to the Build-A-Bear Workshop’s Second Quarter 2020 Earnings Call. [Operator Instructions] Please note this conference is being recorded.

At this time, I’ll now turn the conference over to Allison Malkin of ICR. Allison, you may begin.

Allison Malkin — Investor Relations

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 the discussion of our second quarter 2020 performance and our positioning and actions in response to the COVID-19 pandemic. 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 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.

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 — President and Chief Executive Officer

Thank you, Alison. Good morning, everyone, and thanks for joining us today. As we continue to move forward in a very different and challenging world after initially focusing on responding to and managing the immediate circumstances driven by COVID-19, including the closure of all of our retail locations, we have rapidly shifted our attention to leverage the current situation to accelerate our strategic initiative to successfully operate in both the near and long term.

During this time of accelerated change, we have increasingly relied on our experience, data resources and technological capabilities to drive our strategy forward with a goal to profitably diversify and monetize the power and affinity of our brand. Our belief in the value that the Build-A-Bear brand brings to the world and the opportunity that it presents remains strong even in an ongoing era of uncertainty that demands agility and flexibility from companies everywhere.

As we continue to operate with a reduced corporate workforce that is primarily working from home, we have grounded the organization to remain focused on three key areas that we believe are critical to steer us through the current environment, while also positioning the Company for the future, in line with our stated strategic objective. These initiatives are to accelerate the digital transformation of the Company to not only rapidly grow e-commerce, but to more effectively use technology and digital capabilities throughout our entire organization, inclusive of marketing and leveraging digital content to utilize the strategic positioning and high optionality of our real estate portfolio, to revise the terms of our leases and overall operations to reflect the huge shifts in brick and mortar shopping patterns and evolution of the consumer shopping behaviors; and to maintain a solid financial position with the liquidity needed to support our business, including assertive cash management and meaningful cost reductions. To that end, we made progress in each of these areas in our fiscal second quarter.

Let me highlight you on a select detail. In the digital area, consolidated e-commerce revenue increased by nearly 300% over the prior year’s quarter. We saw strong consumer demand for key licensed products such as the furry friend based on “the child” from the LucasFilm series Star Wars, The Mandalorian on Disney+. Notably, even excluding sales of “the child” product, e-commerce showed a triple-digit increase.

Other key affinity products and gifting options were also popular online, reflective of the merchandise mix, we have seen, increased demand from our team and older consumer segments during this time. We expanded our omnichannel capabilities leveraging store locations to supplement e-commerce fulfillment through buy online, ship from store program and we completed the initial phase of our expanded engagement with Salesforce, which is designed to enhance our CRM capabilities and drive sales by creating meaningful consumer journey, managing multiple touch points with a 360 degree view with the goal of ultimately increasing our guests’ lifetime value.

From a real estate and store perspective, even though our retail locations were closed approximately 60% of the quarter, we were able to modify our bear-building experience to meet COVID safety recommendations with the well-being of our associates and guests foremost in our approach, and initiate a staggered reopening plan as local restrictions were lifted. At this time, we now have reopened approximately 90% of our stores, many however with shortened hours of operations. Notably, much of the California market still remains closed due to governmental restrictions in place in that area.

While traffic levels have been below the prior year, we are seeing higher conversion and spend per transaction. As I’ve mentioned previously, recognized in the trend of declining mall traffic several years ago, we made the strategic decision and took action to infuse a high level of flexibility and optionality into the management of our store leases. We’ve been able to leverage that position and renegotiate contractual terms that include rent reduction, deferral and abatement for approximately 95% of our locations. Importantly, we have maintained much of our optionality with over 70% of locations continuing to have a lease event in the next three years. This allows us to remain responsive to future movement in consumer traffic patterns in brick and mortar stores.

As it relates to our financial health and liquidity, I believe our disciplined approach to expense management and willingness to take decisive action is evident with over $14 million in reductions in SG&A for the period compared to the prior year, a solid cash balance and no borrowing under our credit agreement.

Recognizing the need to operate as a leaner simpler organization, we recently completed a long-planned corporate reorganization that aligned key functions and leadership roles with our stated strategy, inclusive of our intended future digital positioning versus our past traditional specialty store structure. Accordingly, the decrease in expenses reflects the reduction in workforce from both furlough activity and position elimination as well as reduced marketing costs combined with tight overall expense control.

In addition, we saw continued expansion in merchandise margin with less promotional activity and intensified supply chain oversight. Assertive cash management allowed us to end the quarter with a higher cash balance and lower inventory compared to the same period in the prior year. And importantly, as we previously reported, we have finalized a five-year asset-based credit facility for up to $25 million, increasing our financial flexibility.

As we look to the back half of the year, let me highlight some opportunities that we expect to realize, particularly in the area of accelerating our digital transformation. Consumers have demonstrated that they are willing to order almost anything online as well as engage in entertainment and family activities virtually. Our teams are embracing these trends and working to capitalize on them and leverage our investments to be more digitally-focused organization.

For example, we recently announced that we had canceled our highly popular annual in-store Pay Your Age promotion due to COVID-19 and replaced it with our first NO LINE, ON-LINE Bear-Building Sale event. This event resulted in online order volume in the top five days of our e-commerce history. We were able to make use of new capabilities, such as our virtual waiting room to manage the high demand, and over 70% of the orders were fulfilled from a store location versus our central warehouse. This paves the way to plan for other traditionally high traffic store events such as National Teddy Bear Day, which we are moving to a primarily digital format featuring a live streaming virtual store event later this month.

Another example is our new Party in a Box offering that is available online for families that want to celebrate special occasions from birthdays to thanking the hero in a live with a curated product collection that stimulates the party activity that we had previously had in store.

As I noted, we have completed the initial planning phase of the Salesforce engagement and are actively implementing key initiatives. The technology and capabilities that we have added from Salesforce combined with the data that we have collected through various consumer touch points, including our Bonus Club program are being used to expand guest profile in segmentation, improve the consumer experience and drive current and future demand. This includes developing and deploying sophisticated multichannel buyer journey.

New guest journeys are being designed and activated that engage consumers at different touch points and their relationship with Build-A-Bear with the goal to drive additional incremental future purchases. In addition, the tools and data are being used to develop lead generation and efficiently reach look-alike consumers with increased accuracy. Closer related, our marketing program has significantly shifted media mix and embraced a digital first approach.

We have restructured our key campaign and post campaign tracking around journey-based outcome with algorithms to optimize key metrics and reach target audiences. We are actively working to increase brand consideration and conversion, while focusing on driving a higher return on ad spend with lower overall investment. This digitally-focused approach will be evident as we launch key affinity products such as the new Harry Potter collection that is planned for release tomorrow. This is one of the most successful over-arching licensed properties on record and one of the most-requested from our own guests as we anticipate a high level of excitement when it comes to market. With the expectation that it will have strong appeal to the team plus each [Phonetic] segment, reflecting interest from the fans that grew up with this property, the offering will be exclusively online for a limited time before expanding distribution to our stores.

With the anticipation of strong online demand during the holiday season as well, we have been reimagining and reconfiguring our warehouse operations in order to increase order fulfillment capacity and efficiency. This has resulted in several key changes, including accelerating our omnichannel competencies of buy online, ship from store and buy online, pickup in store.

Effectively, this allows us to use over 200 of our currently operating stores as many distribution centers, an efficient shift, particularly given the ongoing challenges in traditional retail traffic. This allows us to leverage the geographic proximity of stores as well as available labor to help fulfill strong e-commerce demand both seasonally and associated with popular product releases such as Harry Potter.

In addition, we are featuring select merchandise offerings that have a limited number of pre-defined bundles that are more quickly assembled and reconfiguring the layout of certain areas of our warehouse to improve speed and efficiency to support our expanding e-commerce business. We also have continued to emphasize and focus on liquidity, cash management and expense reductions as the year progresses. And finally, a key tenet of our strategy has been to develop entertaining content to build further brand equity and consumer engagement.

As I previously noted, we believe that our business model will benefit on multiple fronts, including the synergy of leveraging the branded entertainment content, which effectively acts as a marketing tool to drive our own retail as well as outbound licensed product sales. We expect the interaction with our iconic retail experience to in turn drive additional interest across multiple entertainment platforms in an ongoing circle of engagement and value creation, reflective of a model that is proven to be successful for other branded company.

We recently saw the release of our first music offering through our agreement with Warner Music Group’s Arts division with an album entitled Workshop Jams. This soundtrack delivers a Build-A-Bear spin on classic songs that are expected to appeal to kids of all generation. The music is available on iTunes, Spotify, Amazon or your favorite streaming service. The songs have been added to the mix on Build-A-Bear Radio on the iHeart media platform. Notably, we recently saw the largest monthly increase in listenership for Build-A-Bear Radio since the beginning of the iHeart relationship as we added new programming design to appeal the families looking for engaging entertainment.

Separately, we are also excited to share that our first movie through our relationship with the Hallmark Channel is slated to release this holiday season as a part of the ever-popular Hallmark Channel Countdown to Christmas. Build-A-Bear Entertainment is a production partner on the film, which features a heartwarming story line and is called Deliver by Christmas.

In closing, I think it is important to reiterate that many of the moves we are making in response to COVID also play into our long-term strategy. In fact, we’ve been able to accelerate key initiatives during this time taking on activities that were once slated for 2021 and beyond that are now underway in an aggressive manner with the goal to drive sales, both online and in our reopened stores.

As you may recall, before the pandemic, when we announced our 2019 year-end results, we also noted that our fiscal first quarter 2020 year-to-date sales were positive versus the prior year. Turning to the present, as we noted in this morning’s press release, we have seen sequential improvement in sales trends compared to the prior year with our operating stores recapturing over 80% of sales in August, an improvement from the 70% level that we saw in July. I am pleased to add that the improvement has continued, and we’ve recently seen positive year-over-year consolidated daily sales for the first time since the mid-March COVID-driven closures.

Finally, I want to thank our associates for their continued dedication to our mission and long-term goal. During this time, we have been reminded of the importance of the core values and purpose that we have as a company. These include collaborating and learning as a team in totally new technologically advanced ways and embracing the value of each diverse individual that is touched by our brand, particularly with the backdrop and heightened dialog around social justice.

We have been reminded of both the need for and responsibility that we have to achieve our mission of adding a little more heart to life as a generational brand that truly in our opinion, makes a difference in the world. I believe that we are in the process of strengthening our company by developing additional core competencies while enhancing others. That will be critical to evolve and ultimately achieve our strategy. We are committed to remaining flexible, agile and innovative in order to succeed and return to position of sustained profitable growth with the goal of creating long-term value for our stakeholders.

Now let me turn the call over to Voin.

Voin Todorovic — Chief Financial Officer

Thanks, Sharon, and good morning, everyone. I want to add that I’m also proud of how our team has executed through this unprecedented crisis. In the second quarter, we once again managed the controllables while driving digital sales and moving our strategy forward. We have taken steps to more closely align our cost structure with the anticipated lower revenues, while preserving cash and securing a new bank credit facility to improve our overall liquidity. We have actively impacted every functional area of our company to achieve a meaningful SG&A reduction, combined with ongoing negotiations with landlords and partnering with suppliers and vendors to reduce operating costs and revised payment terms.

In addition, we finished the quarter with lower inventory and reduced capital expenditures, all of which improved our cash position at the end of the quarter. During the second quarter, as Sharon noted, our sales were negatively impacted by forced temporary store closures due to COVID, resulting in 60% fewer operating days compared to the prior year. As it relates to our current store operations, we have approximately 90% of our corporately managed stores reopened and are encouraged by the progress made on two fronts.

First, we are seeing improving sales trend since the start of the reopenings. In July, we recaptured approximately 70% of last year sales volume in operating locations with this percentage improving to over 80% in August, with some of our most recent daily sales performance positive over the last year.

Second, because we had secured a significant number of short-term leases and kick-out dates over the past few years, in the wake of COVID, we have been able to successfully renegotiate approximately 95% of our leases and are continuing to work with our remaining partners and expect a favorable outcome. This has been a comprehensive effort and is resulting in the rent reductions, deferrals and abatements, while continuing to maintain high lease optionality with approximately 70% of our leases still coming up for renewal in the next three years.

While nearly all these locations have historically been profitable, we believe it is critical to continue to have the flexibility to exit locations as part of overall strategic evolution of our real estate portfolio.

Regarding rent abatements, in the second quarter, we expensed 13 weeks of ramp with the benefit of negotiated rent abatements to be recognized over the remaining lease term in the income statement. The cash benefit is reflected in our cash balance at quarter end. In regard to rent payment deferrals and short-term lease extensions, with more favorable rent terms, these will be primarily reflected in subsequent quarterly results as many of the negotiations were also fully executed after the period end balance sheet date.

Our cash balance was positively impacted by rent deferrals that will mostly be recognized in fiscal 2021. Most of this cash deferral is expected to be offset by savings generated through the renegotiated rent reductions for 2021. We are making rent payments based upon new terms as the revised deals are executed. Importantly, these negotiations have increased the percentage of our leases with variable rent structures to one-third of our North American fleet. This structure is intended to increase flexibility in an environment with high sales volatility and provides a natural hedge against potential sales decline.

Even with a significant decrease in revenue and profitability, our cash balance improved over $10 million at quarter end from the second quarter last year, driven by expense in the working capital savings initiatives and previously mentioned impact of rent negotiations. Also, as a part of our disciplined approach to working capital and strong management of vendor relationships, inventory was down $6.6 million, a decline of 11% year-over-year. Separately, we had no borrowings on our credit facility in place at the end of second quarter.

Finally, as noted in this morning’s press release and yesterday’s aftermarket 8-K filing, we improved our financial flexibility entering into a new five-year asset-based credit facility with availability of up to $25 million. We are pleased to enter into this agreement with PNC Bank, a strong reputable partner particularly in these unprecedented times.

Moving now to a further review of the second quarter results. Total revenues were $40.4 million compared to $79.2 million in the second quarter of fiscal 2019. This includes a 48% decline in net retail sales, which reflects a 60% reduction in store operating days in the quarter due to temporary store closures driven by COVID-19.

As noted, during the quarter, in the reopened brick and mortar stores, we recaptured 70% of last year sales volume, partially offset by an increase in e-commerce revenue of almost 300%. Commercial and franchise revenue was slightly over $1 million, down 75% from the prior year, mainly driven by temporary store closures of our third-party and international franchise locations due to COVID-19. Retail gross margin was significantly lower compared to prior year as it reflects full occupancy cost for 13 weeks, while as noted, we only had sales for about 60% of the period. Notably, during the quarter, merchandise margin was 210 basis points higher than the prior year, fueled by lower e-commerce promotional activity. Our retail gross margin excluded $2.1 million in non-cash store asset impairment charges that were recorded in the quarter.

SG&A was down $14.2 million or 40% from the second quarter of 2019, driven by lower store and corporate payroll due to our COVID-19 mitigation efforts. Due to store closures in the quarter, marketing spend was reduced and redirected to drive e-commerce sales. Pre-tax loss was $14 million compared to a pre-tax loss of 700,000 in the fiscal 2019 second quarter. This year’s second quarter pre-tax loss includes $2.1 million related to estimated non-cash asset impairment charges.

Regarding our outlook, as previously highlighted, given the rapidly evolving nature of the pandemic and the resulting uncertainty, we do not believe it is prudent to provide guidance at this time. As you would expect, we will continue a disciplined management of expenses across all areas of the business. In closing, we believe we have the financial flexibility and strategy to navigate during this challenging time while continuing to make progress on our initiative that evolve our business model to maximize the power of our brand and drive value for our stakeholders.

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

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Eric Beder with SCC Research. Please proceed with your questions.

Eric Beder — SCC Research — Analyst

Good morning.

Voin Todorovic — Chief Financial Officer

Good morning, Eric.

Eric Beder — SCC Research — Analyst

Congrats on navigating through these crazy times. Could you give us an update on how it’s going with Walmart and how the U.K. stores are doing?

Sharon Price John — President and Chief Executive Officer

Hi, Eric. It’s Sharon. Well, the Walmart, we closed those stores as well when we talk about the stores that had been in forced closures that we felt was inclusive of Walmart for us, partially because that’s — even though some of the Walmarts remained open, we did not continue to operate those until much later in the process. We have started to reopen some of those stores and they are performing really no different than some of the more regular stores that we have or more traditional stores that we have.

Although we do have, just to be clear, some interesting dynamics going on in different locations, then I’ll just kind of riff on that for one moment, if I can, because it will make sense when I speak about the U.K. Some of the big urban areas are struggling, for example, like some of our New York areas and so, some of like London as well. But that same kind of what we might have been previously defined at the tourist location, we have tourist locations in more rural areas, let’s say, like the Smoky Mountains that are outperforming even last year. So it’s a really interesting dynamic but that — overall, the resulting in the data that we shared with you on the prepared remarks has an improving trend, and in some cases, starting to see some days that are now performing better than prior year.

The U.K. is not performing as well as the North America right now, but it’s starting to ramp up as well and we’re seeing that same acute kind of difference between the London and the rest of the world. So it’s pretty dynamic. Do you want to add anything, Voin?

Voin Todorovic — Chief Financial Officer

Yeah. So, also in U.K., Eric — the stores in U.K. were mostly opened mid late June across the country and after the reopening, we started to see sequential improvement as the stores are opened little bit longer, but again, we are seeing same similarities with U.S. as Sharon mentioned regarding the urban locations in Central London versus the rest of the fleet in U.K.

Eric Beder — SCC Research — Analyst

Last question. And if you look at some of the corporate relationships and other pieces, how are those ramping up and how do you expect them to go going forward? Thank you.

Sharon Price John — President and Chief Executive Officer

Are you referring to our third-party relationship?

Eric Beder — SCC Research — Analyst

Yeah, correct.

Sharon Price John — President and Chief Executive Officer

Yeah. So some of the third-party relationships such as Carnival Cruise Lines or Great Wolf Lodge or Landry’s Restaurants, of course, were significantly impacted by COVID and closed down entirely. Carnival, for example, that you may know is — continues to be closed down and all — none of those businesses, just like ours even inside of Walmart even though Walmart is considered essential, were not considered essential. So we are unable to open those stores and they’ve been unable to open back up. We are open during that time period.

We are now seeing some of those locations start to open, Great Wolf Lodge is opening, and we’re starting to ship product back to them. They’re very — most of our partners are very encouraged about their future, and we’re here to support them in their — in the future state, but it’s still — the word is dynamic and things are changing, information — new information comes out on a regular basis and we have to maintain our flexibility to manage through that. But we’re very helpful and still believe in our overall strategy on the other side of this pandemic is strong and right that Build-A-Bear should be where people go for fun and entertainment, that’s just changed a little bit right now. And — but eventually when the new normal arise, that will still be a driver for consumers who want to make memories as family.

Eric Beder — SCC Research — Analyst

Great. Thank you.

Operator

[Operator Instructions] Thank you. At this time, I will turn the floor back to Sharon Price John for closing remarks.

Sharon Price John — President and Chief Executive Officer

Thank you for joining us today, and we look forward to providing further updates following our third quarter.

Operator

[Operator Closing Remarks]