Street Knocks the Stuffing Out of Build-A-Bear

Shares of the plush animals retailer were pounded Friday after the company drastically cut its second quarter forecast

Build-A-Bear Workshop (BBW) halved its earnings forecast for the second quarter after the close of trading on June 14, citing feeble North American sales. The following day, the company got a less than warm and cuddly response from investors, who pounded the shares 20% lower to $23.70.

The specialty retailer of customized stuffed animals sheared its earnings outlook for the June quarter to between seven and 10 cents a share from an earlier forecast of 15-19 cents a share. Driving the revised earnings forecast are weaker-than-expected comparable store sales in North America for the 10 weeks ended June 9, now expected to drop 7% to 9%, vs. a previous projection of flat to 5% lower.

Build-A-Bear also trimmed its guidance for the full year to between $1.55 and $1.65 a share from a previous projection of $1.65 to $1.75 a share. Last year, the St. Louis children's retailer earned $1.44 a share.

Same-store sales took a hit from disappointing demand for newly introduced licensed products, which turned out to be more popular with boys than girls, who Build-a-Bear considers its core customers. Build-A-Bear licenses characters from Sesame Street, Disney Studios, and from current popular kids' films such as Shrek 3 and Happy Feet.

The company "has made a major inventory bet on Shrek 'skins' and outfits, and despite the movie's success we wonder if in some aspect it isn't more of a boys' picture than a girls' picture," A.G. Edwards (AGE) mused in a research note June 15.

In a news release, Chairman and Chief Executive Maxine Clark said she believes the company can manage the inventory and that she still expects revenue and earnings to grow this year.

"In this particular case, given that I don't think they can put the inventory back to the vendor, which I think was Dreamworks, they'll have to deal with it on their own, so I think there could be some margin pressure," analyst Robert Buchanan at A. G. Edwards & Sons said in an interview with BusinessWeek.

Clearly, the company's experience with under-ordering inventory of the Mumble character from the movie Happy Feet last year hasn't made management any savvier in calculating demand for further licensed skin inventory purchases, Susquehanna Financial Group said in its note on June 15.

Also likely to weigh on anticipated second-quarter results are higher advertising costs as a percentage of sales compared with a year ago, performance-based bonus expenses and language translation costs tied to store openings in Montreal and Puerto Rico in the second half of 2007, Build-A-Bear said.

Having known CEO Clark for 17 years, Buchanan at A.G. Edwards said, "Sometimes she has too many good ideas."

A major acquisition in the U.K. about a year and a half ago has been a big distraction and has used up a lot of top management's time, he said. He also sees the company's recent decision to open stores in France as a mistake. "I'd rather see them focus on the core business in the United States."

While he likes the company's ability to generate free cash and says its average sales of $552 per square foot of retail space is comparatively strong, Buchanan says he's wary of its assurances about earnings after watching Build-A-Bear miss forecasts quite a few times. He lowered his earnings estimates to nine cents a share for the second quarter, $1.41 a share for 2007 and $1.61 for 2008.

Although the stock may trade on fundamentals over the near term, Susquehanna said it still thinks the company will eventually be bought out by a private equity firm. The difficulty in predicting licensed skin demand and of generating consistent positive same-store sales is likely at some point to convince management to go private, Susquehanna said. Its forecast for 2007 earnings is $1.61 a share.

Buchanan doesn't own the stock, but A.G. Edwards played a part in the company's initial public offering, and also expects to be compensated for investment banking it has done with the company in the next three months. Susquehanna does and seeks to do banking with the companies it covers.

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