Build-A-Bear Workshop - Unstuffed?

It appears that the odds are stacked against the customized stuffed toy retailer Build-A-Bear Workshop Inc. (BBW), once a Wall Street darling. With rivals gnawing on the heels of Build-A-Bear, and the stock losing 9.5% of its value since the beginning of this year, some critics are of the view that this trendy company's concept is turning fad.

Recently, the company announced that it has hired Lehman Brothers to evaluate a range of strategic alternatives for enhancing long-term shareholder value. That said, though Lehman's hiring does not mean a sale is imminent, there's scuttlebutt that Build-A-Bear may put itself on the auction block. According to analysts, Build-A-Bear, which has a debt-free balance sheet and healthy cash flow, is an ideal candidate to be taken private.

Here's the story of Build-A-Bear, a beary special place which provides a unique shopping experience allowing customers to stuff plush animals. The toy industry being fickle, it remains to be seen whether Build-A-Bear Workshop brand will stand the test of time or turn out to be stale and mortal.

Some Bare Facts

Of The Profile

Founded in 1997, Build-A-Bear Workshop, the brainchild of Maxine Clark, is an interactive, entertainment mall-based retailer with an inventive and frolicsome approach that invites guests of all ages to create their own customized stuffed animals.

With profit jumping to $10 million and comparable store sales climbing nearly 14% in the first half of 2004, as a major marketing initiative helped revitalize sales and boost profit, Build-A-Bear primed to go public in August 2004.

Amid a tough IPO market, Build-A-Bear went public on October 28, 2004, taking the wraps off its financial data. The company priced its IPO of 6.8 million shares of common stock at $20 a share. And even in the first day of trading, the company's share price rose a stunning 25% to close the day's trade at $25.05. The company raised more than $25 million in the IPO.

Since opening its first store in 1997, Build -A- Bear has grown to 237 stores in North America and 40 in the United Kingdom at the end of the first quarter of 2007.

Ownership

Insiders own about 24.29% of the 21 million total outstanding shares of Build-A-Bear Workshop. Institutional owners hold about 81.1% of the total outstanding shares. In February, the company announced its decision to repurchase up to $25 million of its outstanding common stock over the next 12 months.

The Pawfect Retail Concept

Build-A-Bear is a combination toy store and workshop that lets kids of any age including anyone feeling young-at-heart create their own teddy bears and other stuffed animals. At Build-A-Bear, customers are referred to as guests and employees as associates while the chief executive Maxine Clark is referred to as chief executive bear.

Guests have an option to choose a furry animal body from a selection of mostly bears and a vast menagerie of other animals. They then stuff the limp body to their preferred squeezability all by themselves with the help of a polyester-fill machine, insert a sound chip, which may contain a pre-recorded sound or one's own message and dress it in high-fashion clothing and accessories available in the on-site boutique.

And what more.... the guests can even name their crafted critters and get a computer-generated birth certificate for the stuffed animals. The prices range from $10 - $25 for the undressed animal and the outfits and accessories like hats or bags may cost an additional $2 - $15 depending upon the choice of attire and accessories.

Build-A-Bear extended the brand by opening its first Friends 2B Made store in November 2004. The Friends 2B Made store allows guests to build their own humanlike doll with contemporary clothing and accessories.

Of The Numbers

Profit & Revenue

Build-A-Bear's fiscal year consists of 52 or 53 weeks and it ends on the Saturday nearest Dec. 31 in each year.

2004 - the year Build-A-Bear debuted on the New York Stock Exchange, was a remarkable one with excellent historical growth and competitive advantages for the company, which had until then seen its comparable-store sales drop as much as 16% due to weak retail climate and low brand awareness.

	2006	2005	2004	2003
Revenue in Mln	$437.1	$361.81	$301.66	$213.67
% change	+21%	+20%	+41%
Net Income in Mln	$29.49	$27.31	$20	$7.62
% change	+8%	+36.5%	+162%
EPS	$1.44	$1.35	$0.43	$0.01

Thanks to the improved expense management and aggressive $24 million TV advertising campaign, which created brand awareness. The company's revenue surged a whooping 41% to $301.6 million and net income nearly tripled to $20 million in 2004, compared to the prior year.

2005 - Build-A-Bear showed impressive financial results in the following year too. The revenue rose 20% over 2004 to $361.8 million, helped by new store openings. During fiscal 2005, the company opened 30 new Build-A-Bear Workshop stores and three new Friends 2B Made stores. The company's net income for fiscal 2005 jumped 36.5% to $27.31 million compared to 2004.

2006 - Driven by new store openings, which included 32 new Build-A-Bear Workshop stores and four new Friends 2B Made' stores opened in North America, and also due to the addition of the U.K.-based Bear Factory stores, the company's revenue grew 21% to $437.1 million while earnings grew a modest 8% to $29.49 million, compared to 2005.

In April 2006, Build-A-Bear Workshop acquired The Bear Factory, a United Kingdom-based stuffed animal retailer, which also follows a concept similar to Build-A-Bear Workshop owned by Hamleys, Ltd., for $41.4 million cash. As part of the deal, Build-A-Bear Workshop also acquired U.K. franchisee Amsbra, Ltd. The acquisition added 28 Bear Factory stores in the U.K. and one in the Irish Republic, which were re-branded into Build-A-Bear Workshop stores. The 2006 earnings were weighed down by costs associated with store conversion and integration of Bear Factory.

Same-store Sales

Same-store sales or sales in stores open at least a year, a key economic indicator, which was treading in the red in 2002 and 2003 rebounded 18% in 2004. Build-A-Bear outlets expanded by 15% in fiscal 2004, with the opening of 20 Build-A-Bear Workshop stores and two "Friends 2B Made" stores.

The increased brand awareness due to online advertising and television advertising coupled with improved economy with higher levels of consumer confidence and a better retail climate helped same-store sales move out of the red into the black in 2004.

	2006	2005	2004	2003	2002
Same-store sales %	6.5%	0.2%	18.1%	15.9%	10%
Number of *BABW stores at year-end	271	200	170	150	108

*BABW stores - Build-A-Bear Workshop stores.

The company's outlets increased by 16% in 2005, while its same-store sales for that year fell 0.2%, as the advertising programs failed to produce the increases that were achieved in fiscal 2004.

The successive year was no better as the same-store sales slumped 6.5% in 2006, in face of Build-A-Bear outlets growing by 36%. The company blamed the changing customer preferences and more difficult macro economic conditions generally impacting customers for the disappointing same-store results.

Other Metrics

Selling General & Administrative Expenses

	2006	2005	2004	2003
*SGA expenses in Mln	$158.71	$133.92	$115.94	$81.09
SGA expenses as % of sales	36.3%	37%	38.4%	38%

*SGA expenses - Selling General & Administrative expenses.

Since going public, Build-A-Bear Workshop has been able to rein in the percentage of sales devoted to selling, general and administrative costs from 38.4% to 36.3%, which has also been one of the drivers leading to bottom line growth year-over-year.

Change in Inventory Vs. Change in Revenue

It is of concern if a company's inventory level outpaces revenue growth. A ballooning inventory suggests either overproduction, low customer demand, or a combination of both.

	2006	2005	2004	2003
Total Inventory in Mln	$50.91	$40.16	$30.79	$22.57
% change in Total Inventory	+26.7%	+30.4%	+36.4%
% change in Revenue	+21%	+20%	+41%

At Build-A-Bear, inventory level is rising faster than revenue and has been the case since 2005. In 2006, while inventory was up nearly 27%, compared to 2005, revenue increased just 21%. This could signal a sales slowdown, if this trend continues and the company will have to discount or mark down in order to sell the stale merchandise.

Declining Margins

Declining gross margins are not a welcome sight for a retailer as it doesn't imply a vibrant business. Gross margin, which is an indicator of how well the management is adept in using labor and materials to support the business, equals gross profit divided by net retail sales.

	2006	2005	2004	2003
Net Retail Sales in Mln	$432.6	$358.9	$300.4	$213.4
Gross Profit in Mln	$205.5	$178.5	$149.56	$97.58
Gross Margin in %	47.4%	49.7%	49.8%	45.7%

Build-A-Bear's gross margin has been declining year-over-year. In 2006, the company's gross margin declined to 47.4% from 49.7% in 2005. The decrease resulted from higher store occupancy costs and higher shipping and transportation costs.

The Future - Rocky Times Ahead?

Build-A-Bear Workshop is slated to release its second-quarter financial results on July 26.

In mid-June, the company revised down its earnings outlook for the second quarter to a range of 7 cents to 10 cents per share, from prior guidance of 15 cents to 19 cents per share, to account for the higher costs associated with increased advertising expenses, performance-based bonus compensation, and language translation costs surrounding store openings in Montreal and Puerto Rico. Wall Street analysts expect the company to earn 8 cents a share.

Build-A-Bear's quarterly performance has been erratic. In the recent first quarter ended March 31, 2007 the company posted a net income of $8.1 million or $0.39 per share, down from $8.3 million or $0.41 per share in the prior year quarter. Quarterly revenues increased 18% to $116.8 million from $98.6 million in the preceding year quarter. Wall Street analysts expected the company to earn $0.38 per share, on revenues of $118.82 million for the first quarter.

Build-A-Bear has slashed it's per share earnings outlook for the full year as well. The company now expects its full-year earnings to range between $1.55 per share and $1.65 per share, which is down from its prior view of $1.65 - $1.75 per share. Analysts are looking for per share earnings of $1.53 for the year.

The company's comparable same store sales, a metric to gauge sales growth at stores that have been open for more than a year, continue to trend in the red. In the recent first quarter ended March 31, Build-A-Bear's same store sales declined 6.9% and the company has projected a 7% to 9% drop in same-store sales for the second quarter too.

However, Maxine Clark, the founder of Build-A-Bear Workshop, who remains pridefully optimistic, plans to expand the company's North American store base to at least 350 stores and European store base to approximately 120 stores. As of March 31, the company had over $42 million in cash on its balance sheet. Clark believes that through the highly profitable business model and unique retail-entertainment concept, Build-A-Bear will continue to grow total revenues, increase net income, and generate excess cash flow.

According to reports, insiders have sold off a net 792.2 thousand Build-A-Bear shares over the last three months - indicating the big swing towards bearish sentiment. Contrary to critics' views, some proponents believe that Build-A-Bear's stock is due to join the bull market. They believe that the company's significant investment in a new retail concept store called Ridemakerz could act as a catalyst to galvanise the stock price of Build-A-Bear.

Ridemakerz stores, which lets kids of all ages create and customize toy cars made its national debut June 1, in Myrtle Beach, South Carolina. Build-A-Bear, which has a 25% stake in Ridemakerz, plans to boost its holding to 34% by next year. Build-A- Bear has made an equity investment of $2.96 million in Ridemakerz and is also offering over $15 million in back-office support.

Conclusion

It has been quite a roller-coaster ride for Build-A-Bear's stock since going public in October 2004. The irony is that even after nearly 3 years of going public, Build-A-Bear's stock, which has had wild swings reaching as high as $35.7 in 2005, has gained a mere 2.6%, compared to over 30% gained by Dow Jones industrial average in the same period. Build-A-Bear's stock closed Wednesday's regular trade down 1.68% or $0.43 at $25.13 on a volume of 358,900 shares. In extended trading, the stock gained $0.05 and was at $25.18.

With shrinking gross margins and declining same-store sales, analysts believe that taking itself private appears to be the smartest play for Build-A-Bear, a move, which will allow the retailer to carry out the business without having to worry about the stock prices. Recently in a research note to investors, Susquehanna Financial Group analyst Thomas Filandro wrote, "We continue to view this company as a prime private equity buyout candidate." The analyst sees a potential buyout valuation range of $34 - $36 per share for Build-A-Bear.

Will Build-A-Bear continue as a stand-alone public company or hoist the For Sale' sign over its head? Stay tuned!

For comments and feedback contact: editorial@rttnews.com