Greetings and welcome to the Build-A-Bear Workshop's Fourth Quarter 2018 Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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. You may begin..

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 a discussion of our 2018 fourth quarter and fiscal year performance, review the progress made on our strategy and the priorities we set at the start of fiscal 2019.

Voin will review the financials and share guidance. 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 maybe 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. 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.

In addition, I want to remind you that given the previously announced fiscal year change, references to the prior year results are based on the un-audited recast results for the fiscal year ended February 3, 2018. Finally, during this call, we will refer to adjusted results which are non-GAAP measures.

The press release we issued earlier this morning includes a reconciliation table presenting GAAP to adjusted total revenues for the 53 weeks ended February 03, 2018 to the 52 weeks ended February 02, 2019 and a reconciliation table presenting GAAP to adjusted pretax loss for the fourth quarter and full fiscal year as well as GAAP net income and EPS to adjusted net income and adjusted EPS.

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

Thank you, Allison and good morning everyone. 2018 was financially disappointing for Build-A-Bear and for me personally, as after delivering four consecutive years of profitability we posted the first full-year loss for the company since I took the helm in mid-2013.

We believe there were a number of major headwinds unique to the year which were reviewed and communicated in January.

Even with the impact of these significant and arguably anomalous disruptions, we had starkly different results geographically as our largest market, North America posted a low single-digit sales decline and a modest profit on an adjusted basis.

However, the negative impact from our largest international market, the United Kingdom more than offset the North American performance as uncertainties surrounding Brexit weighed on consumer confidence, the currency and our business results throughout the year manifesting in a double-digit negative failed, persistent decline in the UK.

The business was further challenged in May with the enactment of new consumer privacy laws commonly known as GDPR which significantly impeded our ability to effectively and directly communicate with our core consumer base for the balance of the year.

In addition to the UK specific issues, other 2018 challenges included, the closure of our single largest and most profitable multimillion dollar retail location, the unforeseen bankruptcy and subsequent liquidation of Toys "R" Us, the impact of new accounting standards and tax policies, and the significant reduction in high-impact family centric license movie properties.

Although we believe any one of these headwinds would have been disruptive to the business, the convergence over the course of a single year could have stressed the company to the point of strategic disruption. However, I'm proud that our team has remained resilient and focused on managing both the short-term and the longer-term strategic objectives.

During the year we systematically attacked each situation by focusing on the things within our control and continues to drive towards the execution of our overall multiyear strategy to diversify our business model and become an intellectual property company leveraging the strength of the Build-A-Bear brand with retail as one of our channels, while simultaneously carrying out one of the most remarkable brand substantiating PR events in recent history.

Given that backdrop, in contrast to the overall financials, we believe the year represented a productive period on the operations side.

We progressed or completed several key milestones that are foundational to advancing our capabilities to deliver long-term sustained profitable growth while leveraging the memorable, emotional and engaging power of the Build-A-Bear brand.

With over 90% brand awareness and affinity numbers that rival some best-in-class kids properties we believe that this brand has the potential to be monetized across a number of revenue streams via retail, geographic, consumer and category diversification.

With this in mind, on today's call, after providing you with some 2018 details, I intend to update you on the forward movement of our key priorities while providing additional insights as to how we expect to continue to execute our strategy to position Build-A-Bear for sustained growth in 2019 and beyond.

First, for fiscal 2018, consolidated revenue decreased by 4.9% on an adjusted basis with a low single-digit decline in North America and a double-digit drop in Europe. As I mentioned, the North American region generated a profit for the year on an adjusted basis which was more than offset by the loss in Europe.

E-commerce sales rose double-digits with consolidated growth of 14% led by an increase of 18% in North America. We have seen our digital sales gain momentum with the recent fourth quarter reaching 10% of net retail sales compared to 7% in the prior year's period.

We expanded our business in commercial revenue which includes outbound licensing and wholesale as well as international franchising by over 15%, and we ended the year with a solid balance sheet $18 million in cash and no debt.

Interestingly, consistent with other retail financial reports, the final weeks leading into the fourth quarter holiday were disappointing. But notably, post Christmas we saw positive momentum buoyed by gift card redemptions and our National Hug Day promotion.

In addition, we saw a strong reaction to an amped up Valentine's gifting effort and we have had promising sales from product tied to the How to Train Your Dragon movie franchise, which we believe is an indication of the potential license property tailwind for 2019.

Both initiatives appealed to a diversified consumer base and helped to end the quarter on a positive note. Before I move on to our growth initiatives, I would like to dimensionalize just one of the headwinds in 2018 to highlight what we believe is a large opportunity in the current year.

As I believe you may have already heard from other toy and children's companies, a comparable lack of family focused licensed character movie properties in any given year can have a measurable impact on the business.

Although our proprietary product sales increased in fiscal 2018, we posted a decline in license property sales of over 20% versus the prior year on a segment of business that typically represents about 40% of our total retail sales volume.

Looking below the surface, it is important to understand that kids' movie releases can elevate the business in multiple ways beyond the direct sales of the licensed product themselves. First they tend to drive overall traffic.

Given that over 80% of Build-A-Bear Workshops are located within two miles of a movie theater, our total football can benefit from the millions of dollars spent on the movie marketing, simply because it gives families with children a reason to go to the mall. Second, these popular properties tend to broaden our purchaser profile.

Traffic further benefits as many of these films attract an affinity audience that is older than our core kid consumers. This broadened traffic profile tends to drive our teen plus purchasers to a higher than average rate, both in-store and online.

Third, the movie properties tend to contribute to higher conversion rates because more consumers tend to cross the lease line on a mission to buy a beloved character from the film perhaps having just been to the theater.

And fourth, the movie properties tend to generate more spin per transaction as products generally command a higher retail price and often include incremental add on items such as a sound chip with the music from the film or the voice of the character.

So, solid movie property partnerships tend to benefit the total sales volume at Build-A-Bear Workshop beyond just the license themselves by positively impacting multiple retail levers; traffic, conversion, units per transaction, and dollars per transaction.

Finally, licensed properties have historically over performed in the UK which was yet another drag on that market's results throughout 2018. That's the bad news. The good news is that you may already know 2019 bodes a powerful family license movie property line up with films premiering throughout the year which I will highlight shortly.

But before going there, I would like to first review some of the progress made on our strategic priorities in 2018 while providing insights and expectations for 2019.

Our first priority, in recognition of the ongoing and significant shifts in the retail industry has been to evolve our retail business model to drive sales by diversifying locations, formats, and geographies, while maintaining high levels of optionality as we simultaneously enhance and expand our digital business model.

The shopping patterns and habits of today's families are clearly rapidly changing. Online shopping is on the rise and the mall is no longer the ubiquitous go to place for family fun and entertainment. As such, both the amount of traffic and the composition of traffic going to malls has changed significantly in recent years.

Although not all malls are created equal and we expect to continue to successfully operate in a meaningful number of these locations, overall mall traffic is estimated to have declined nearly 50% in the past five to six years, and data indicates the shoppers are less likely to take children with them to the mall, even in the critical holiday timeframe which was once considered a reliable tradition.

Because we recognized this changing retail dynamics several years ago, we began proactively pivoting our business model to include a broader offering of retail locations that attract families. We also began aggressively developing a variety of new, lower capital, flexible formats like [indiscernible] shops to navigate the market volatility.

Our goal was to provide creative solutions for efficiently entering new nontraditional retail areas, while simultaneously securing significant mall lease optionality with the negotiation of favorable rent deals and short-term extensions which have resulted in now having over 60% of our leases coming up for renewal in the next two to three years.

As such, we currently expect to close up to 30 stores over the next two years with about half of those outside of North America.

We strongly believe that this lease optionality along with the fact that Build-A-Bear's experiential retail offering is widely considered to be more a part of the solution than part of the problem, should provide us with additional favorable opportunities in the future.

While we have been proactively managing the mall portfolio, we have also been diversifying away from traditional mall to broaden consumer accessibility to our brands.

In October, we piloted a half dozen full service standalone Build-A-Bear stores inside select Walmart locations, combining our unique retail experience with the largest retailer in the world at a time when billions of dollars of toy sales are transferring due to the closure of Toys "R" Us.

The early results indicate that new consumers are being introduced to our brand with the majority of Bonus Club enrollees at the Walmart sites identified as First-Time Build-A-Bear Guest.

Based on the pilot stores, we are currently working with Walmart to identify expansion plans for 2019 and beyond with the expectations that this would offset some of the revenue lost from the aforementioned planned closures.

In regard to assuring that we remain in places where families go for fun and entertainment, we have strategically added tour sites with new locations in 2018 such as our very successful shop in shop at FAO Schwarz in New York City and a store near the London Eye in the UK which has been a bright spot for that market further validating the importance of our tourist strategy.

We expect to continue to open select additional tourist locations going forward. As an extension of the tourist strategy, we recently announced a new relationship with Great Wolf Lodge, America's largest operator of family focused indoor water park resorts.

Four shops were open in the fourth quarter and we expect them to expand to 17 locations in 2019. Of note, this is a wholesale relationship whereby Great Wolf furnishes and operates the space and purchases goods from us similar to our arrangement with Carnival Cruise Lines.

While we have been actively involving our physical retail footprint, we have also been making critical investments in our e-commerce business model to take advantage of the expanding digital economy.

As such, our e-commerce sales have risen at a double-digit pace for five consecutive quarters with our online business continuing to benefit from an upgraded web platform and enhanced capabilities that support our key initiatives.

We continue to make strategic investments to expand key functionality including refined predictive and suggestive selling, upgrading our CRM capabilities, and optimizing our mobile first consumer experience.

During the holiday season, with the momentum rolling into Valentine's Day, we were pleased with the performance of our expanded gifting offering designed to appeal to an older consumer.

As we have seen stronger site traffic improves conversion and transaction metrics, as well as Bonus Club enrollment, and we expect to further evolve our digital strategy to drive double-digit growth in online sales in 2019.

Regarding our ongoing efforts to expand our geographic presence, 2018 saw the addition of a new franchise agreement in India, a country with the world's second largest population and one of the fastest growing global economies.

Our multibillion-dollar partner, Lulu Group recently opened the first Build-A-Bear location in Bangalore to much fanfare followed by two additional stores within the week. Separately, we saw growth from our franchisee in China which ended the year with 8 locations.

Between India and China we expect to expand to 40 stores in these regions in fiscal 2019. Finally I am happy to announce we recently finalized a new franchise for Chile, allowing us to establish a presence on the continent of South America.

Our second priority has been to diversify and expand our consumer base with a focus on acquisition, engagement, and increased lifetime value. The year saw growth in new guest acquisition and consumer engagement in North America which is key to growing lifetime value.

We accomplished this in part by re-launching and invigorating our birthday program, beginning with the Pay Your Age Day promotion in July.

This highly successful event was the kickoff to our ongoing Count Your Candles program which was designed to build on the fact that birthdays and birthday parties are the number one occasion for a visit to Build-A-Bear, generating up to a third of our store revenues throughout the year.

Pay Your Age Day coverage generated over 3 billion impressions exceeding our expectations on a number of fronts including consumer turnout with estimates of over a half million people visiting our largely mall-based brick-and-mortar retail locations to have the experience of creating their own furry friend on a single day in July, which is traditionally one of the slowest retail months of the year.

We also had strong sales and although we were unable to service all the guests that day, which was disappointing, we believe we achieved multiple objectives including broadening our consumer base, giving more economic accessibility with the hook of [ph] Paying a Child’s Age for a furry friend.

We enrolled over 1 million members into our Bonus Club loyalty program, drove trial and successfully launched the Count Your Candles campaign with the featured Birthday Treat Bear remaining our number one unit selling furry friend since its launch.

We have continued to communicate and engage with the significant expansion of the new first time Bonus Club members to increase future visitations and lifetime value, and given the average age of the children participating in the birthday offering is around five years old, we believe that ongoing engagement with families through milestone periods of their lives gives us an opportunity for growth for years to come.

Priority number three has been to leverage the power of the Build-A-Bear brand beyond retail through diversification and through new consumer categories, primarily through outbound brand licensing and by entering the entertainment arena.

In 2018, we grew our outbound licensing revenue with partners in a wide array of categories including footwear and slippers, kids apparel and accessories, media and cosmetics, stationery and craft kits, sleepwear and gifts, as well as select toy categories through an agreement with Just Play.

We expect to expand into additional categories, such as publishing, party supplies, betting games and eyewear this year.

Finally as a part of our overall entertainment strategy, we have developed proprietary intellectual properties under the umbrella of Build-A-Bear, which have become recognized brands in their own right, such as Merry Mission, Honey Girls, Promise Pets, and most recently Cubbit [ph], that are often launched and promoted using content such as apps, games and music, that have generated millions of digital interfaces increasing our brand engagement and affinity.

In summary, I am confident in our ability to leverage the investments and operational progress made in 2018 as we now have several of these headwinds behind us. As we start the new fiscal year, consolidated retail sales are positive.

Our North American business is up and e-commerce is growing at a double-digit rate in both of our key markets, which is offsetting the softness in the UK brick-and-mortar locations. We are confident that the company will continue to benefit from one of the most promising movie slates for families in recent years.

And as noted, I also believe this has the potential to improve the UK business trends based on historical sales data for movie properties in that country.

In addition, the How to Train Your Dragon movie from DreamWorks' success and this year's strong multi-movie line-up includes three highly anticipated Disney offerings, with updated versions of Aladdin and The Lion King, as well as the second installment of Frozen.

As you might expect, we are preparing a wide variety of innovative marketing and experiential retail events to take advantage of this opportunity.

As Voin will share shortly, we expect revenue to expand in 2019 driven by the improvement of the line-up, increases in other revenue as we diversify our income streams and the consistent double-digit e-commerce growth.

And while the UK will likely continue to face challenges due to the uncertainties related to Brexit, we believe trends will benefit from the inroads that we have made to rebuild our contact database with the parameters of the new privacy law and the fact that the UK tends to over index in movie properties as I noted.

Additionally, although we have already taken meaningful actions, we intend to continue to aggressively manage expenses in the UK while exploring a number of options to restructure the business.

In closing, 2018 will be remembered as a challenging year, but it will also be remembered as a year in which we rose above some of those challenges to achieve key operational milestones supporting our long-term strategy of monetizing the power of the Build-A-Bear brand.

We believe the continued execution of this strategy will allow us to capitalize on our strong brand as we evolve the business model to diversify revenue and profit streams.

Our goal is to maintain a financial discipline while targeting strategic investments focused on pivoting the business model in our ongoing effort to deliver long-term value for stakeholders. I look forward to sharing our progress with you as we move through the year.

And now, I would like to turn the call over to Voin to review our financials in more detail..

Thanks Sharon and good morning everyone. From a financial perspective, we had a challenging year in fiscal 2018.

As Sharon mentioned, we believe we made operational advancements to move our strategy forward despite several challenging events throughout the year, particularly those impacting the business in the United Kingdom, our largest international market.

For the full year we incurred about $10.8 million in nonrecurring charges of which $9.1 million represented non-cash asset impairment costs. These charges, along with the losses in the UK business, ultimately led to us establishing a $3.7 million non-cash valuation allowance on our foreign net deferred taxed assets.

My comments will reflect results for full 2018 fiscal year followed by sharing 2019 guidance. Total revenues were $336.6 million compared to $364 million in fiscal 2017.

On an adjusted basis, excluding almost $10 million dollars from changes associated with revenue recognition and the impact of the 53rd week in fiscal 2017, total revenues declined 4.9%.

This reflects a 17.6% decline in Europe and Asia, primarily related to the United Kingdom while revenue in North America declined 2% impacted by the significant reduction in family-centric movie properties.

And as a reminder, 2018 saw a $7 million revenue reduction in North America due to the closure of our largest store located in Anaheim, California. Retail gross margin was 42.7% compared to 47.2% for the 53-week period ended February 3, 2019.

The decline in retail gross margin was impacted by promotional activity related to extended voucher redemption period following Pay Your Age Day events and the deliveries of our occupancy cost. The company was successful in maintaining flat rent expense for the year even with the additional 19 new stores.

SG&A was $1.6 million, less than the prior year even with over 5% growth in store count. During the year, we made changes to reduce the corporate portion of SG&A while reinvesting some of the savings to expedite growth initiatives in revenue streams beyond traditional retail.

We expect to realize additional corporate SG&A savings in 2019 with a full year run rate target of $2 million reflected in 2020. Adjusted pretax loss was $7.7 million and net loss on an adjusted basis was $5.9 million.

The decline in profitability is mainly driven by our performance outside of North America and while we continue to be cautious of the economy in the UK, due to the uncertainty surrounding Brexit, we have plans that are intended to stabilize the business.

Turning to the balance sheet, at year-end cash and cash equivalents were $17.9 million and there were no borrowings under our revolving credit facility. We ended the year with $58.4 million of consolidated inventories, essentially unchanged from the prior year.

On hand inventory was down 5% offset by an increase of in-transit inventory due to a change in the timing of Chinese New Year. Capital expenditures totaled $11.3 million in fiscal 2018 and depreciation and amortization was $16 million.

As it relates to fiscal 2019 guidance, we currently expect total revenue to increase in the range of mid to high single digits driven by a more favorable movie license year compared to prior year.

Growth in revenue generated from our diversification initiatives including in-store shop openings, in particular through the potential new Walmart locations, double-digit growth in our commercial and franchise revenues, and a double-digit increase in consolidated e-commerce as we continue to leverage our upgraded web platform.

We expect full year EBIT to be slightly positive reflecting increased sales and improved gross margins driven by a lower discount rate associated with non-recurring Pay Your Age Day event voucher usage, strong movie licenses, and the resulting sales growth leverage. We are planning improvement in SG&A as a percentage of total revenue.

However, SG&A dollars are expected to be slightly up. We currently anticipate to have losses outside of North America driven by the ongoing macroeconomic challenges primarily in the United Kingdom.

Moving to tax, because our rate will be impacted by the mix of earnings by jurisdiction, we are not able to provide a specific full-year tax rate at this time. However, during fiscal 2019, we don't expect to pay any material cash taxes.

In addition, we are planning capital expenditures to be in the range of $10 million to $15 million and depreciation and amortization in the range of $15 million to $17 million.

The largest portion of the capital spend is related to strategic diversification initiatives and the upgrade of key system platforms to enable future growth in previously mentioned expected Walmart store count expansion. Notably, our goal is to partially offset that expansion as we continue to aggressively manage our real estate portfolio.

We believe that we may close up to 30 stores primarily in traditional malls within our existing store base over the next 24 months as natural lease events come due with approximately half of these stores coming from our operations outside of North America.

We believe that the actions of strategies placed will benefit our long term objective to drive sustained profitable growth. This concludes our prepared remarks and we will now turn the call back over to the operator to take some questions.

Operator?.

Thank you. [Operator Instructions] Our first question comes from the line of Sebastian Barbero with Jefferies. Please proceed with your question..

Hi. This is Seb on for Steph Wissink. Thanks for taking our questions.

We wanted to unpack [ph] your key growth drivers for 2019 and then also if you can give us a breakdown of your gross margin decline in the fourth quarter?.

Sure. Hi. I'll start with the growth drivers and then turn it over to Voin for the second part of the question. We feel like, one just as a reminder, the few years that I've been here, we've had consistent profitability. This is - the last year was a bit of an anomaly.

So we feel like some of the potential or big portion of the potential to return to growth in order to grow in 2019 has to do is just all of the novelistic challenges that occurred in 2018 as a contrast to the positive tailwinds if you will for 2019.

And we believe we've got most of those behind us, all but Brexit and the uncertainties around that really being arguably one time event. So, as you look forward to 2019 we then have almost an opposite impact from the slate of movie properties as a great example.

This coming slate inclusive of what we've already launched, How to Train Your Dragon which is hopefully a bellwether to the expectations of what we're going to see going forward has been very positive for us followed by as we mentioned on the call, Aladdin and Lion King, and Frozen 2, and some other films also embedded in there hit throughout the year and really in an opportunistic pattern that we believe could benefit us quite well.

We also believe that we will expect to continue to see this ongoing double-digit rate of e-commerce growth as I noted in the comments, we are positive right now year-to-date and that is driven by being positive in North America and that's the combination and as I noted, How to Train Your Dragon and some of our really great gifting business coming out of Valentine's and our e-commerce business.

That e-commerce growth now that we are really learning how to pull those levers and use that data and pushing into a broader consumer base including this adult-to-adult kind of gifting space which was very insightful and promising for us moving forward, we believe is the second pillar. So we are confident on that front.

And then third is the continued revenue increase, although still small, we're getting a solid base on revenue outside of traditional retail. So, and we have our license business is growing. Our commercial revenue business is growing.

So I think that gives us the ability and then finally it's the relationship with Walmart and some of these new store locations that are opening our accessibility to new consumer bases.

So even if we do end up closing some of these stores next year which could arguably would decrease some of our revenue, we feel like we have a lot of plans to offset that.

And note, even though we have a tremendous amount of optionality, each one of those natural lease events still remains a single negotiation event and one at a time because if we can stay as we've always been sort of pushing, if we're able to stay profitable or able to negotiate an agreement that allows us to maintain in these areas where we don't feel like we're cannibalizing any other store in the geographic location, we would prefer to stay there, but you know at some juncture you do have to make some choices to close those stores.

But we really feel good about the fact that we now have an option to continue to service the Build-A-Bear guests in almost any market with the partnership with Walmart as we look at where we want to go forward with them.

Voin?.

Okay. Regarding the gross margin question in Q4 just Sebastian as we talked even in the past, we did have a significant impact of deleverage in Q4 with our decline in sales as well as, you know we did take some one-time charges that impacted us in the quarter, as well as we think about the overall promotional activity in the Q4.

We did run some additional promotions especially in times prior to the key holiday season period right before Christmas.

So our promotional activity is a little bit more elevated, but most of the decline in gross margin was related to deleverage of our occupancy cost as we saw sharp declines in total revenue in particular in those few weeks leading into Christmas and the overall softness that we have seen in our UK business..

Cool, thank you for that..

Thank you. We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments..

Thanks so much again everyone for joining us this morning and we look forward to speaking to you when we report our first quarter results. Have a great day..

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day..