BUILD-A-BEAR WORKSHOP INC Q3 FY2024 earnings call

Key Points

• Third quarter was the best-ever in Build-A-Bear's history with 11% revenue growth to over $119 million, 26% pre-tax income growth to $13 million, and nearly 38% EPS increase. Returned $7.5 million of capital to shareholders.

Strategic Initiatives

• Experience location footprint expansion: Opened 17 net new units in Q3, expects to open at least 65 net new experience locations in fiscal 2024. Has over 600 locations worldwide, with partner-operated model driving much growth including international expansion.
• Digital transformation: Accelerating multiyear comprehensive digital transformation across the company, optimizing omnichannel tools including AI to unleash combined power of in-store, e-commerce, etc.
• Brand leverage: Expanding product offerings, such as Mini Beans collection; successful license collaboration with Sanrio; added key leadership roles like Chief Revenue Officer and Senior Vice President and Chief Brand Officer.

Total revenues for the quarter were $119.4 million, up 11% year-over-year. Net Retail sales increased 9.1% to $109.5 million, driven primarily by existing stores in the US and UK. Commercial revenue, mainly wholesale sales to partner operators and international franchise revenue, was up 38.8% year-over-year. Gross margin was 54.1%, an increase of 140 basis points. SG&A expenses were $51.6 million or 43.2% of total revenues, a 10-basis-point improvement year-over-year. Pre-tax income grew 26.4% to $13.1 million. Diluted earnings per share was $0.73, an increase of 37.7%.

Revenue and Pre-tax Income

• Revised 2024 guidance: Total revenues expected to be $489 million to $495 million, pre-tax income $65 million to $67 million, both low-single-digit growth at midpoint on a non-GAAP 52-week basis.

Headwinds

• Continued lower-than-expected web demand, plus ongoing wage and inflationary pressures including higher medical insurance costs, increased depreciation, and freight expenses. Updated store guidance to open at least 65 net new experience locations in fiscal 2024.

• Web performance continuing to be below expectations. - Economic headwinds impacting consumer spending. - Complexity of fully integrating omnichannel capabilities. - Supply chain and tariff-related uncertainties. - Uncertainties in lease negotiations for store locations.

Q: Could you help us with the inventory number? If we take out the impact from the tariffs, and I fully understand why you did this and it makes a lot of sense, what would have been the inventory increase or decrease? And going forward, how much is China in terms of your value add here? And how much is the ability to shift that?

A: So, great question, Eric. One of the things as we think about the supply chain and the sourcing organization, where our business is unique in a way that we have a lot of product that we are selling throughout the whole year. So, that gives us flexibility, especially from our core perspective to bring in product earlier and so -- because it's the same product that we are going to be selling throughout next year. We have done a lot of this in anticipation of the potential changes with tariffs. And so, we are just pulling -- so a vast majority of this increase that we are seeing is related to stuff that's in transit. So, our inventory levels will continue to change versus what we have seen in the past as it's two-fold. We continue to grow our Commercial segment. And so, the flow of inventory receipts is going to be a little bit different up and down based on the seasonality of opening stores and replenishment for our partners. In addition to that, we are going to have probably more elevated inventory levels through the end of the year as we have tried to pull as much inventory forward to avoid at least the initial impact.

Q: I want to unpack a little bit on the online weakness. I know that you have historically -- excuse me, I know that the shift has been to move more -- we've seen this kind of less of a lag between online exclusives to the stores. And part of that, I think, is because the stores do, I think, a great job of showing the whole product line. Is that part of this year? When you look at this weakness, especially given how strong everything else appears to be, where should we be thinking about this?

A: Yeah, well, as I mentioned in the remarks, Eric, this is a multiyear process. And you can kind of look at what happens out in the world with a lot of other omnichannel retailers. We're in a little bit of a different situation in that most of the omnichannel retailers, the consumer that they're servicing in their stores and the consumer that they're servicing online are often the exact same consumer. If you think about it on a Venn diagram basis, you're going to have a really big overlap. We service a little bit of a different consumer in both of these channels. One is the traditional family kid end user is the larger proportion of our sales in our stores, and it is an adult often sometimes a teen online buying a collectible, a trend product and often gifting. So, there is going to be some bifurcation of the types of products that we offer, but it is also important that we are using that website because the other reason people come to that when we talked about the 50 million people coming to our website, they 're often checking to see what store is near them, planning a party. So, there's still this fundamental integration between the consumers, our stores, the products and now that we have 'buy online, ship from store', where these are all very strategic steps to become a much more integrated organization where we can have a golden record of the consumers, send out personalized e-mail, send meaningful discounts that are exclusive and specific to the shopping patterns of that individual. Well, it's a hallmark of best-in-class in this area. And that takes a lot of steps to do that as well as highly skilled individuals and the integration of all of these systems that we've been putting in. That's a long answer, but that's not half as long as it takes to make it happen. But you're right, we are truncating some of those launches, which is only marginally associated with this situation. That's really listening到 our consumer base. Some of these exclusives that we were offering online for our collectors, there was a push and a request from them that they wanted to make these in store. We're also often shipping them to store because that's an efficient way for us to then service online. Again, it's a very integrated process, and we've not mastered it yet, but we're getting closer every day.

Q: How should we be thinking about the Sanrio collaboration from a strategic sense? Is that something that makes sense to do on a more permanent basis or in certain locations? Are there other collections like I don't know, Pokemon that would make sense for that?

A: Yeah, so we've been in business with Sanrio for a long, long time, and they're great partners and Hello Kitty and Friends, very, very popular and the mashup of the brand for both of our fan bases clearly resonates. So, this was incredibly opportunistic moment for both brands, particularly to go into Westfield in L.A. And as we noted in the remarks, it's been very successful. Yes, by putting a successful stake in the ground like that, certainly, it opens up conversations and opportunities. None of these decisions are unilateral. They're partnership based, and that's how we build great relationships. So, we will be working with Sanrio to determine if that does make sense to open another location. And that success also bodes well for potential other discussions, which, of course, we wouldn't be able to share, but that -- it does open your mind to different types of possibilities.

Q: Could you provide more color on the four key metrics - traffic, conversion, units per transaction and size, and which stood out more?

A: Yeah, so thank you for the question. As I mentioned, yes, all of our four levers have been up. We did call out that -- in total, we were up like 9.1%. We shared the traffic was up 3% against the national traffic that was down 3%. The other three metrics we saw increases across all of them. So again, healthy growth in all these aspects. So -- and this is great when we are seeing higher average unit retail, when we are seeing higher conversion in our stores and also when the guests come into our stores, they are buying more units per transaction, which talks about overall marketing that we are doing in our stores and the customer engagement that's happening. Our customers are resonating with that really well, and we are pleased how our Halloween collection really helped drive some of these numbers in the quarter. Again, as I mentioned last year, what we have done, we ran out of product basically before the end of the holiday season. So, we made some strategic investments from the Halloween inventory buys, and that's really helped fuel the growth in Q3 this year.

Q: What's driving the increase in store count growth to at least 65 net new locations?

A: I'll just give you a little bit of color in the start of that is that we talk about the three different models of corporately-operated, partner-operated and franchise. And interestingly, as we -- highlighted in my comments, as we started to open the international partner-operated locations, in many cases, like in Italy, where we specifically noted, they've been very successful. And so, our partner in Italy, and it's more -- it's a combination, but it's largely up to them on how fast they want to accelerate and open stores or open shop-in-shops often, sometimes they're stand-alone, sometimes they're inside other locations. They've been incredibly bullish on Build-A-Bear. So, they're opening at a faster rate. And we're also now I noted a number of countries where we have created partners, new partnerships. So, a lot of those are international and a lot of those are partner-operated driven by the partner themselves.

Q: What are the holiday trends and what's behind the web softness?

A: Sure. Black Friday is an important part for us. It's not actually as important as it is for a lot of retailers because we're not a big discount destination. But given we have a significant portion of our stores still in malls, which, by the way, the traffic reports were pretty positive this year and positive for us as well, we do participate in it. It's important for us, but not as big a predictor of our future as it is for the quarter or the holiday season as it is for a lot of companies. We tend to see a much steeper -- a pretty steep curve, particularly in a year like this. And what I mean by that is a year when Thanksgiving falls almost as late, if not as late as it possibly can. So that first week of December, which is usually the last week of November falls in the previous quarter. And we're -- so it's a harder, more contracted time period for us to make predictions. So, just a little color on that. Net-net, we were pleased with it. And we offered a number of online and in-store specials, and we -- we felt like it was good for us. I can't say it was gangbusters, but it was strong.

Q: What's the reason for the sequential decline in commercial revenue in Q4?

A: Well, when you think about a lot of these -- we recognize our revenue at the time of shipments to our partners. So, depending on the timing of openings of these locations and when they are replenishing for the holiday season, just with the calendar, some of those times may fluctuate a little bit, especially now that we have some more international business. So, we still feel good about that business, about the growth, about the excitement in that, but there it's going to be a little bit of choppiness as we start anniversarying some of those initial shipments and timing of replenishment orders.

Q: How does store traffic leverage help in lease negotiations?

A: Yeah, that's a great question, and I appreciate the comment, and I might go as far as compliment on traffic. We think that, one, Build-A-Bear is an experience. So -- and that's been a very strong point of difference for us through some of the shifting consumer buying and shopping habits. We do see, we believe, a return to wanting to have moments and memories together. And that usually is a very positive thing for us during the holidays. And we use that as a strong marketing tool for us. But yes, we did see plus 3% on our traffic where the national retail traffic reported was at a negative 3%. So that's a strong delta. And indeed, when we're negotiating with our landlords and our retail partners, we do note that we're often driving our own traffic. If we're outpacing the mall traffic, that's -- we're not only driving traffic and bringing families and highly desired consumers to the mall, to us, we're bringing them to the mall. And that often is related to other spending that they would do while they're there having a family experience. And our partners tend to recognize and acknowledge that. We have been very careful over the past few years, as I think we've noted with many of you on these calls on certain shorter-term leases as the market has been volatile. So yes, we have different lease optionality and natural lease rates coming up, and we have constant communication -- we're in constant communication, constant updates on those. But I will note, as we also do well, that's pressure on Build-A-Bear, because they know that we're doing well. So, it is a back and forth just because我们 are a strong brand and a noted brand and that we're driving our own traffic, that's not a [cart] (ph) launch by any means. It's still -- these are still tough negotiations, and we always try to land in the right place with our partners and have enough lease latitude and negotiation latitude. I'm really proud of the team on what we've been able to do over the years, particularly in the post-COVID environment, where we renegotiated practically every single lease. And I think that utilizing the power of the brand has leverage, and I believe we've done a very good job at that. And when you look at our metrics, it would support that position.

Q: How is the international expansion strategy balancing more markets entered versus saturating them?

A: So, I'll start. We are definitely pleased with the markets that we are opening and some of the successes that we are initially seeing. As you think about this process, it does take a long time to really go through the contract negotiation, find the right locations, find the right partners. We are protective of our brand. And really, in a lot of different markets, our partners may be managing multiple businesses, tie back to toys or similar categories. And so, we believe finding the right partners in these countries, it will create a lot more opportunities. And absolutely, over time, some of those things and some of these key markets you want to be in the best real estate, some of our early stores in Milan, Italy, where we families in some of the best mall. So, we are seeing some good results. And that's kind of like part of that strategy to grow and be in a lot of best places in those respective markets. But again, this is the other side of the equation being partner-operated. They are making those choices. They are negotiating these leases with respective counterparts in those countries. So, it does take -- it's more give and take on those, and we have a little bit less control where they can be opening locations.