Build-A-Bear Workshop, Inc. (BBW) Q4 2016 Earnings Report, Transcript and Summary

Greetings and welcome to Build-A-Bear Workshop Fourth Quarter 2016 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host, Mr. 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 2016 fourth quarter and fiscal year performance review the key priorities we setup at start of 2017. Voin will review the financials and guidance, and then we will 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 requeue 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. 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. Finally, as previously announced, the company continues its exploration of a range of strategic alternatives. As you are aware, this could take many directions. And there is no assurance that this exploration will result in any strategic alternatives being announced or executed. We continue to be limited as to any additional comments on this topic as the process unfolds, unless and until our Board of Directors determines that further disclosure is appropriate. And now, I would like to turn the call over to Sharon.

Thanks, Allison, and good morning, everyone. After three consecutive years of comparable sales increases and improved profitability, this morning results were announced for fiscal 2016 and fourth quarter that did not meet our goals nor our expectation. These results are disappointing and are not reflective of the progress we've made on key initiatives, the consumer affinity for the brand nor the passion and dedication of this organization to enhance long-term shareholder value. Given the unusual and late impact of the December traffic decline, we felt it was critical and consciously chose to provide a comprehensive summary that includes the financial results, a clear assessment of the causal factors, and an outline of our action steps. Specifically 2016 saw total revenues declined by 3.6% driven by a decrease in consolidated comparable sales of 4.4%, sales at stores in Discovery design increased 4% in North America and 5% in the UK and e-commerce sales increase of 7.2%, a decrease in SG&A of $2.4 million compared to the prior year, and pretax earnings of $5.3 million, including $5.7 million of adjustments and foreign currency impact. As a reminder, in 2013, a strategic plan was initiated to leverage the inherent value of the brand while changing the business model to reflect evolving consumer shopping patterns in order to deliver sustained profitability. This entailed a multiyear approach to implementing foundational changes including updates to an aged and business constraining IT infrastructure, real estate upgrade and repositioning, talent upgrade and organizational restructuring, and an overhaul of internal processes. Throughout 2016, the plan continued to be implemented and the year was intended to be a tale of two halves. The focus of the first half was on making further improvement while the back half was intended to begin to reap some of the benefits of the investment. While there were significant bumps in the road throughout the year such as the unexpected impact of Brexit, our pretax guidance was maintained adjusted for exchange rate through the third quarter. In fact, fourth quarter consolidated comparable sales were positive through the end of November. In December, business took a decidedly different turn leading to a consolidated comparable store sales decrease of 8.3% for the quarter. In addition to the industry reported declines in mall traffic principally in North America, there were other key issues in the quarter likely interrelated that also contributed to the comp decline versus expectation. Given that December is typically the largest and most profitable month for Build-A-Bear, this created an insurmountable challenge particularly coming that late in the year. These other factors included, first, changes in media and marketing as well as impacts from licensed product, a reduction in overall media spend and a move away from historically effective traditional TV and direct mail to digital media in an effort to reach millennial moms more efficiently is believed to have negatively affected planned visits to stores, an impact in the sales of licensed products also affected, results driven by greater than expected decrease in Star Wars, likely driven by positioning of the film to target an older audience versus the prior year. Also in the last weeks of the year unplanned in-store promotional activities were added designed to offset some of the retail traffic decline that did not deliver incremental sales. Second, a decline in gift card redemption. There were significantly fewer gift cards redeemed compared to historical levels likely tangentially related to the overall mall traffic decline. This was in contrast to a double-digit increase in gift card sales driven by a strategic effort to expand the gift card distribution for the quarter. And third, e-commerce challenges. E-commerce traffic saw a double-digit increase in December as a result of changing consumer shopping patterns. However, the e-commerce system and processes were not able to capture the increased sales opportunity in its entirety. At December, e-commerce sales increased just 3%. Based on these assessments, corrections are being made as quickly as possible. Specifically, marketing and media plans have already been rebalanced for the Easter selling period including having both kids and moms’ television advertising and adding direct mail back to the mix. We are aggressively chasing the Pokémon franchise and other license properties to offset the expected continuing impact of Star Wars. We are already seeing higher rates of redemptions of gift cards in fiscal 2017 and expect to encourage the use of gift cards in the future with reminder marketing. And later in the year, we have planned to enhance the website platform and upgrade the e-commerce systems. However, even with the execution of these action steps, the combination of the shift of Valentine's Day in to a weekday, Easter moving into the second quarter, ongoing traffic softness and the continuing impact of unfavorable currency exchange rates, we expect a 2017 first quarter consolidated comparable sales decline at a level that may be consistent with the 2016 fourth quarter. While our recent focus has been on making immediate correction, significant progress has been made over the last few years concerning the much needed fundamental changes that were identified at the onset of the strategic plan in 2013. Given that progress, even with the December challenges, Build-A-Bear is now a stronger, more flexible company than it was. For example, inclusive of this year's decline, the last four years of cumulative consolidated comparable sales has increased over 3% following multiple years of negative comp. And in fact in the face of the unexpected revenue impact late in the year, the overall improved efficiency and increased focus on managing expenses enabled the delivery of a third consecutive year of profitability following five consecutive years of pretax losses. Specific to 2016, we continue to make progress on several key initiatives. Today, we will focus on the progress that has been made relating to the upgrade and diversification of our real estate portfolio. This includes lowering the capital investment needed to open or upgrade locations in part by reducing space requirements, driving down operating expenses and increasing flexibility to respond to consumer shopping trends. This is particularly important given that there are approximately 150 leases expiring over the next three years representing about half of the current North American store base. Specifically key initiatives include making improvements to an aged door fleet, leveraging the new Discovery design, diversifying the portfolio into nontraditional model, including a new concourse format, further developing the international franchise business. First, as it relates to an age door fleet, the Discovery store format was introduced in 2014 and continues to deliver positive results. In North America in 2016 Discovery stores had comparable sales growth of 4%, a double-digit lift compared to heritage stores. Currently, over 80% percent of stores remain in a non-Discovery format, which on average has not been refurbished in almost 10 years. Therefore, we believe that the continued disciplined conversion to the new format in select locations will positively impact their comparative performance. To this point, we have leveraged natural lease events to effective real estate conversion and we finished the year with 57 Discovery format stores versus 11 at the end of 2015. As noted, there is significant opportunity to evolve our real estate footprint with over 80 leases expiring in 2017 alone. Plans are to remodel 20 to 25 of the best locations assuming favorable rent terms and execute short-term lease extensions on the balance of these leases. By the end of 2017, due to ongoing value engineering initiatives, a significant reduction in the capital needed to open a store compared to the original model is expected. In part the reduction is the result of moving sourcing of fixtures to China and excludes the impact of landlord tenant allowances. Our overall store base is healthy delivering a contribution rate of 19% in fiscal 2016 with 95% of North American stores being profitable. This is in stark contrast to the starting point of the strategic plan when the contribution rate was under 10% with 22% of doors unprofitable. Next, as previously reported, Build-A-Bear Workshop has been successful in nontraditional locations where families go for entertainment such as tourist venues. In fact, tourist doors had comparable sales growth of 3% in 2016 and continued to over index on profitability and other key metrics. Plans include expansion into more nontraditional places such as seasonal event settings, resorts or museums, as well as adding shop in shops in other retailers and restaurants. To enable the flexibility needed to operate in these locations fixturing options were expanded by developing a new kind of part that allows retail to be conducted in a wide range of spaces. Specifically in 2016, progress was made on this strategy on a number of front. A new concourse shop was developed and given the early results of test locations, the model is expected to be implemented going forward. Concourse shops require reduced capital, a smaller footprint and provide higher flexibility given their shorter-term leases. We have currently identified a number of mall opportunities for expansion across geographies and we believe the concourse shop can be a solution for a wide variety of retail settings. Other examples of locations where we profitably operated stores in the fourth quarter include these no event locations with Gaylord Hotels, pop-up shops with Macy's and AMC Theatres and the ongoing relationship with Carnival Cruise Line. In summary, for 2017, plans are to open 20 to 25 new stores with 15 being Concourse Shops, remodel 20 to 25 stores into a Discovery format, close five to 10 existing stores, and extend 55 to 65 leases to finish the year with approximately 360 total company-owned stores. Third, on the international front, franchisees ended 2016 with 92 locations in 11 countries adding 15 net locations including the first five Discovery format stores in geographies ranging from Berlin, Germany to Brisbane, Australia. Initial results on the franchisees Discovery stores are positive and consistent with company-operated trend. The new kit of parts and flexible store options that have been created including the Concourse model are expected to be extremely valuable to reach our international development goal. In 2017, existing franchisees intend to add approximately 10 stores net of closures and expansion is expected into additional countries with both existing and new franchise partners. In closing, although December and subsequently the year prove difficult as we enter our twentieth year, we remain confident in both the company and the brand. As a part of our long range plans, Build-A-Bear has made significant improvements ranging from organizational structure to infrastructure. And as a reflection of our updated branding initiative based on external research build at the end of last year, brand affinity and key metrics are stronger with moms now versus the beginning of 2013. In 2017, we plan to continue to make adjustments to elements as the core operations in light of some of the recent business shift while making investments in foundational components designed to enable us to achieve our long-term goals. By the end of the year, we expect to: One, have a more diversified and profitable store portfolio including a higher percent of stores in the Discovery format, additional Concourse shops, expansion of nontraditional locations and increased opportunities to wholesale relationships and franchises. The capital investment required to model and open new store is expected to decline, square footage requirements are reduced and overall retail flexibility increases. Two, have an enhanced website platform and upgraded e-commerce system to expand enterprise selling and better align with the evolution of consumer shopping trends. Three, deliver additional revenue via business channel such as outbound brand licensing and corporate programs. And four, continue to evolve our marketing and media strategies with an integrated plan designed to drive traffic and enhance consumer engagement across a number of such points. Finally, the overall consumer shopping behavior trends we saw in the fourth quarter and to a lesser degree continuing into the first quarter are not new. Many of our choices and actions over the last few years have been in anticipation of these shifts. They have recently just seem to significantly accelerate. Given that acceleration as outlined, we will make some critical and rapid adjustments many of which are already executed. However, as we look to the future, the fundamentals remain the same. First, build a compelling concept. In our case, this is now iconic experiential brand with over 90% awareness that mom's trust and kids love. Second, provide consumers an engaging way to seamlessly interact with the concept or brand whenever wherever and however they desire. For us, this is reflective that the evolution of our physical real estate footprint to create flexible solutions designed to be placed wherever families gather for entertainment combined with the planned overhaul of our digital, mobile and e-commerce platform designed to take our interactive experience online or literally put it in their hands. Third, deliver the consumer interaction or transaction in the most efficient and effective manner possible. This relates to the critical and ongoing infrastructure, talent, organizational and sourcing improvements we've been making that are designed for us to operate more profitably. Now, I would like to turn the call over to Voin.

Thanks, Sharon and good morning, everyone. Clearly, the fourth quarter performance was disappointing particularly with a significant change in trend and business in the month of December, which negatively impacted both the quarter as well as full year results compared to expectations and the prior year. Today's discussion will include both GAAP and adjusted results with a reconciliation detailed at the tables provided with this morning's press release. In the fourth quarter, consolidated comparable sales decreased 8.3% reflecting a 10.2% decline in North America and 0.4% decline in Europe. In the quarter, dollars per transactions increased 1% offset by a decrease in overall transactions. As noted, the decrease in net retail sales was driven by a sharp decline in traffic during the month of December, primarily North America compounded by internal tactical missteps. As an example, to address the negative business trend, unplanned promotions were added in an effort to improve store traffic and drive sales. Also, sales were negatively impacted by lower gift card redemptions which is partially attributable to the decline in traffic, timing of holiday breaks and fewer days between Christmas and the fiscal year end. Separately, during the quarter, the result of internal initiatives to build new revenue stream was reflected in a commercial revenue increase of $1.1 million compared to the prior year. This was driven by the wholesale initiatives with the Carnival Cruise Line as well as outbound licensing, most significantly in the sales of Build-A-Bear stuffing station toy through the Spin Master relationship. Turning to fiscal year highlights, total revenues were $364.2 million compared to $377.7 million last year, a decrease of 3.6%. Consolidated comparable sales declined 4.4% including a 7.2% increase in e-commerce sales. This follows a 1% consolidated comp increase in 2015. Currency fluctuations impacted by Brexit reduced consolidated sales by $9.1 million compared to last year. This also negatively impacted pretax income by approximately $3.1 million, which was reflected throughout the entire income statement with most of the impact coming through higher cost of goods as inventories purchased in U.S. dollars. Full year retail gross margin of 45.2% represents a contraction of 190 basis points primarily driven by deleverage of occupancy costs, impact of store asset impairments and foreign currency losses in the UK. As noted, unplanned promotional activity increased in the fourth quarter. Even with the increased activity, merchandise margin on a constant currency basis expanded by approximately 30 basis points versus fiscal 2015. Future merchandise margin expansion is expected through the continuous process improvement initiatives that are underway and through ongoing evolution of sourcing strategies. Full year SG&A declined by $2.4 million compared to the prior year reflecting lower marketing and incentive compensation expenses. This offset additional costs that are detailed in the reconciliation table included in this morning’s press release and most of which I believe to be non-recurring in nature. These costs include charges related to duty disputes in the UK as well as China start-up costs. In addition, other expenses not included on the reconciliation table reflect costs associated with the exploration of strategic alternatives, tax audit and organizational restructuring related to marketing and e-commerce. 2016 GAAP pretax income was $5.3 million and on an adjusted basis was $11 million. Specifically related to taxes, the 2016 effective tax rate was 74%. The tax rate versus expectations was impacted by $1.3 million of discrete adjustments as well as the performance and mix of earnings from lower tax jurisdictions. As it relates to 2017 outlook on taxes, an ongoing tax rate of approximately 36% is expected, excluding discrete items, impact of currency fluctuations and assuming no changes to current tax laws or policies. At year-end, the company had no borrowings under its revolving credit facility, and had cash and cash equivalents of $32.5 million. At the close of the fiscal year, consolidated inventories totaled $51.9 million representing a 3.7% decrease over prior year. Inventory composition was in line with expectations. For fiscal 2016, capital expenditures totaled $28.1 million primarily related to that refresh and opening of stores and IT infrastructure investments. Depreciation and amortization was $16.2 million. The cash flow that continues to be generated from operation is enabling select investments in the future of Build-A-Bear with the objective of delivering long-term shareholder value while maintaining a strong balance sheet and flexibility to execute long-term strategies. Aligned with this approach, for fiscal 2017, capital expenditures are expected to be in the range of $20 million to $25 million and depreciation and amortization between $16 million and $18 million. Approximately, 75% of these capital expenditures are expected to be invested to enable further diversification of the real estate portfolio into non-traditional format by leveraging the discovery model to open new stores and upgrade select existing locations. The remaining 25% of the capital budget is expected to be invested in system upgrades and infrastructure including an enhanced website platform and upgraded e-commerce system. With that in mind, as you model 2017 for the full year, the actions that Sharon detailed to correct the business are also expected to contribute to future growth. In total for fiscal 2017, we expect to report a low-to-mid-single digit increase in total sales and see pretax income growth versus adjusted 2016 pretax results. As it relate to the first quarter, please note that comp sales are expected to decline in the high single-digit range and profit to trail the prior year's first quarter. This is due to several factors including: the timing of holidays as Valentine's Day shifted to a weekday and the Easter shift more peaks sales out of this year's first quarter. The marketing initiatives that are being made are expected to take hold later in the first quarter and there continues to be an impact of sale shifts in key licensed properties and the ongoing negative impact of currency exchange rates that was trigged up by Brexit. Assuming rates remain at current levels, the impact is expected to continue until we lap the initial Brexit vote near the end of the second quarter. The second, third and fourth quarters are currently expected to have positive comparable sales and as noted result in growth for the fiscal year. This concludes our prepared remarks. We will now turn the call back over to the operator to take some questions. Operator?

[Operator Instructions] Our first question comes from the line of Jeremy Hamblin with Dougherty & Company. Please state your question.

Hi, I want to go back to December for a second and just make sure that I have clarity in terms of the implied comp for December. It looks like you are down somewhere in the 15% to 20% range. Can you just clarify that?

We generally don't provide specific monthly comps, but backing into it clearly was a double-digit decline.

Okay. And in terms of the e-commerce problem, it looks like there is some serious tactical blocking and tackling issues here both in terms of having your e-commerce site being ready in December, clearly that’s the most important month of the year and then our checks have revealed that some of your best trending products have been out of stock on a consistent basis in Q1. How do you regain control of these things that seem like more blocking and tackling issues?

Well, first e-commerce, it might be easy to say it’s a blocking and tackling issue but our e-commerce system is aged. We have had long-term plans from a capital perspective and to upgrade the e-commerce system in 2017, that money has been set aside has had all of the research and the choosing of the partner happened all through this year, so that we could pull the trigger early this year which we've already started to be able to upgrade the e-commerce system and as well as evolve the web platform to be much more interactive. So some of that was just - it was planned for 2017 for us to be able to evolve into sort of a new interactive space and be a lot more - you have a lot more interchange with mobile online and store. You see that through what we did all this year for example with the IT infrastructure was to upgrade our POS and put enterprise selling and then be able to take advantage of all aspects by the end of next year. So the traffic increase on the e-commerce side this year what we expected from a traffic increase, we expected to be able to handle that based on our knowledge of what – of the past. But we saw - at the same time of a double-digit decrease, in stores we saw a double-digit increase in traffic, in e-commerce and we just weren't quite ready to handle that. So that’s the bad news. The good news is all the homework and everything, the money, the capital everything has been approved for us to upgrade that e-commerce side and actually take us into a new digital age. We just had this website for some years now. On the product side, there's always some checks and bounces and chases on that front. We've actually gotten a lot better over the past few years but it’s typical that you're going to see some things where don't call the number exactly right and we've been chasing Pokémon for example for a while now, but I think that there's always room for improvement. And some of the systems that we've recently put in help us to plan much, much better and anticipate much, much better. So we have opportunities, there's no doubt, but I think that we're moving in the right direction.

On the capital side, you discussed closing five to 10 stores as you are opening 20 to 25. First part of the question is, what percent of your stores are losing money on a four wall basis today? And then the second part is, doesn't make sense when you are seeing what appears to be maybe a potential structural shift in your Q4 pattern with two really poor Q4 results in a row? Doesn't make sense to be opening up new stores until you have maybe a better assessment of what's happening in Q4? But first question again, what percentage of the total company-owned locations are losing money? And then the second part is, why open new stores right now?

Sure. As I mentioned in the remarks, 95% of our stores are profitable so over 95%, so it’s less than 5% that are unprofitable. The opening of stores, there is lot of dynamics there. First, what is your macro strategy, right? We believe that Build-A-Bear is built on an experiential platform. It’s not the fact that people don't want to enjoy the experience, it’s where do they want to enjoy the experience. So it's not a question of the stores, it’s a question of where do you open those stores. And what we've been talking about is, as you see in the remarks and over the course of the evolution of this strategy is trying to create a really flexible retail footprint and with number of option so that we're not locked into the old school thing. So opening stores is one question, opening doors in VNC [ph] malls is another. So as we’ve evolved in addition to these Concourse Shops we've created, we have all of these kit apart so that we can go where we believe families are going to go for entertainment. And that flexibility is a part of the strategy for the future. There has to be ultimately this virtuous circle between the digital and the physical space when you have a brand that’s interactive. We intend to evolve the store platform to put stores where people are going, not just repeat the history while assuring that that sends people to the digital space which then makes people want to go back to the physical space. So you'll start to see that with things like Gaylord hotels or Carnival Cruise Lines or shop-in-shops or even these Concourse Shops they allow us to go into new malls that have been basically prohibitive us aren’t seeing these kinds of traffic decreases. So it's about flexibility and being able to get in front of consumers where they want to interface with you and that's the strategy behind that. Of those stores, the majority of them are Concourse Shops.

Okay. And then just another clarification question here, I think that the guidance on total sales was low-single digit to mid-single digit growth in total sales which should imply like $366 million to $382 million, is that correct?

You are referring to 2017 or?

Correct, 2017 guidance.

Yes.

And then, what was on the profitability side? What was the guidance?

We just provided guidance that we expect our pretax in 2017 on a full year basis to grow compared to our adjusted pretax in 2016.

Okay. And the hold back on that you're saying is currency, that's inclusive of currency?

No. Well, actually when you think about it like we spelled out currency separately in our press release, there are couple of components how currency impact us. What's called out on the reconciliation table is the impact of re-measurement of the balance sheet. The piece that we are calling out that the ongoing expense that goes through our cost of goods is the negative impact of currency as we are buying UK goods in U.S. dollars. So that's depressing our margin in UK.

Okay. And what about - last question here and I'll get out of the queue, SG&A, how should we be thinking or modeling that for 2017?

So, SG&A is going to be one of our focuses to continue to leverage SG&A as a percentage of sales. We expect with some of the planned increases related to the store count, the store SG&A dollars to go up but from the overall overhead perspective and some of the support functions, we expect to be flat year-over-year. As a reminder, in 2016, we did get a benefit of performance-based comp and we’re going to be offsetting some of that headwind next year with savings initiatives.

Okay, thanks. I will hop back in the queue.

[Operator Instructions] Our next question comes from the line of Alex Fuhrman with Craig-Hallum Capital Group. Please state your question.

Great, thanks for taking the question here. I was wondering if you could do little bit to more size up the impact of the lower gift card redemptions in the fourth quarter as well as the impact to the e-commerce side. If I heard your comments correctly, it sounds like e-commerce sales still grew in the fourth quarter so that really wouldn't explain the weakness in December. Just want to make sure I heard that correctly. And then on the gift card side, what percentage of sales in a normal environment here would gift card redemption include in a fourth quarter and when does that typically become a bigger part of redemptions? Are you seeing those redemptions so far in Q1 and the Q1 comps are just being negatively hurt by the calendar shift or is that more of an expectation that gift card redemptions will happen in the future.

Yeah. On the e-commerce side Alex, I think the e-commerce did grow, it grew but with a total in the quarter, 3% was in December, 2% for the quarter and 3% - that's right, 3% in December and that was on a double-digit traffic increase. The reason that is impactful is, one, clearly we weren't able to translate some of the traffic into sales. But when you look at what happened on a macro level, I believe that the brick and mortar retailers that also had e-commerce even though they consolidate in the retail area when they saw the traffic decreasing which isn't a unique issue to Build-A-Bear. That seems like that was a trend going on at least from some of the reports that I've read. They were able to translate and capture some of the sales that naturally migrated to their e-commerce site. We clearly missed on that opportunity. So it's not in the whole range of things, it's more like a point or so of comp in the quarter but it is a significant opportunity for us in the future which is why we want to call it out as well. Because we still being having e-commerce is less than 5% of our total sales is below the norm on a brick and mortar e-commerce multi-transactional type of company. The norm is more up in a 10% range, so we have a tremendous opportunity in the future to evolve that e-commerce mobile, the entire format of digital to take advantage of where the shoppers are going. So that was the reason why we just did not capture as much of the shift in the traffic that I think a lot of other retailers were able to capture in the consolidated comp.

Okay. And Alex with your question related to gift card sales and redemptions, just to start first with, in Q4 of last year, we made a strategic change and like we really expanded our gift card distribution and we did actually sell double-digit more gift cards in a marketplace in the fourth quarter. However, our redemptions in the month of December were actually over 20% down compared to the prior year. Typically, gift card redemptions and sales coming from gift cards in the fourth quarter represent even up to like 25% of our December sales. What's really interesting about our business is not as a typical retailer week after Christmas. We do get additional traffic as people come to redeem this gift card. What impacted us this year in addition to lower traffic as I mentioned in my remarks was we had fewer days between Christmas and our fiscal year end. So we do expect some of these gift cards to be redeemed throughout 2017.

Okay, that's helpful. And then just thinking about some of the different product items that you had, I mean it certainly seems like from your merchandising in the windows, there was a big focus on Trolls and some other major media properties in Q4. Just from the receipt you’ve seen, is there any one particular kind of area, I know you mentioned the license business more broadly but was there – given the very significant change in trend so suddenly, is there any particular product area that that really led that that weakness?

The Trolls did perform well and at the end of third quarter we shared with you that the initial rates on Trolls were positive. I will say we left some money on the table with Trolls although because it was more of a mix issue than anything, even though of course we bought more Poppy than we bought at the other characters. It was significantly skewed towards Poppy and so we had to chase Poppy a little bit through the quarter, which I think I actually mentioned that we anticipated that even in those early days based on the mix. Star Wars did not hit our planned numbers. We did plan it down of course you would. We actually planned it down fairly significantly, but it still didn't deliver against what we had as planned numbers. We expected that the residual interest in Star Wars as well as the fact that a new film was coming out with [indiscernible] the business back up to the level that we had planned it too clearly, that did not happen. And given our spottiness in Pokémon, we were sort of unable to kind of meet the needs of this universal consumer than non-traditional consumer that often walks in our door mainly almost directly because of some license that peaks their interest. So those were the two things that happened. As it relates to was there something other than the Star Wars that sort of surprised us specifically in December, it was more of a level contraction. Our top four stories are still our top four stories, the top four stories that we planned. Our number one story was Merry Mission. Our Merry Mission story was up 20%. So it sort of contracted overall, it’s the traffic contracted. The interesting thing is at the same time – and if we’ve had flat to slightly down traffic, if the traffic had continued as it had through November, which was soft, but not this soft, the numbers would have worked out. If you’d ask me, even at the end of November we hold guidance at the low, I sort of said it looks as if we can if the traffic – if these traffic trends continue. And with the traffic, significant traffic decline and the fact that we had shifted our media plans and that was a tactical mistake, it was an informed tactical mistake, but ultimately a tactical mistake in what was an unforeseen headwind, and that media shift likely significantly affected our planned store visits, which is something that we can change and we’re already in the process of changing.

Okay, that’s very helpful. Thank you.

Thank you. Our next question comes from the line of Greg Pendy with Sidoti & Company. Please state your question.

Hi, guys. Thanks for taking my call. I guess my main question is and correct me if I'm wrong, but you mentioned 80 leases will expire in 2017 and I guess roughly 150 stores expire within three years. Would you pursue, I guess, if you see some stores deteriorating that are further out, would you pursue paying early lease termination costs and maybe removing some stores that you think are just headed in the wrong direction? Thanks.

Well, clearly, if there are stores that are headed in the wrong direction and significantly unprofitable to the point that the buyout of the lease makes financial sense. Right now, there actually aren’t that many. We have less than 5% doors of in unprofitable. So if you think about the macro strategy of what we can do, first, we are in a – we're kind of in a unique situation here and that we do have 80% of our lease – excuse me, 80 of our leases expiring in 2017 and 150 of our leases expiring. That gives us a really natural lease event driven, so a low cost situation to completely evolve and overhaul our real estate portfolio. Where we are, what footprint it is, how we – the types of malls we’re, whether we're in a mall or not and that’s a kind of a good thing in this environment. They were not stuck in a vast majority of 10-year leases with automatic rate increases. We have a unique situation that's coming down the pipeline in the next three years to look very different, three years from now. So the strategy is to take the portfolio and look at it, trying to get out ahead of what's happening, look at it in a way of where families going, what's going to happen, what's happening with the malls, what types of malls are winning, what types of malls are losing and we've been doing that for a long time by calling out these C-level malls and B minus malls and getting in the malls that work better for us. In fact when you look even at our comp, Discovery did comp positive and if you break down the malls in the A, B and C malls, you're going to see certain malls worked for. Then it comes to a fact of – in some of these places where we're still making money, don't you just squeeze it out and that’s all of those leases that we spoke about that we’re just going to kick down – just kick the can on some of these leases and even leave them in the heritage store just to squeeze the four wall out – just to squeeze the profitability out as the mall environment evolve. So we're being very selective on the doors that we’re touching. And with the concourse shop, it gives us leverage and the negotiation of whether we want to go back into a mall or ship to a concourse shop because we don't have to re-sign the lease and the malls really like these concourse shops that we’ve created, they're out in the center area of a mall for example or they can be in a number of other locations where families gather, but that is a solution for a center area. It creates money for them out of – that’s not in fixed box and so it’s additional revenue. They're significantly less expensive than a remodel. They have much shorter leases, generally more in the three-year versus a 10-year range and they are movable and their operating costs are a lot lower. So we're trying to create as much flexibility as possible and are looking at these – this vast number of leases that are coming down the pipeline as a tremendous opportunity for us to change the retail footprint entirely of what Build-A-Bear is and be more aligned with what's going to be the future state of how consumers shop.

Thank you. That's helpful.

Thank you. Our next question comes from the line of Brett Hendrickson with Nokomis Capital. Please state the question.

Hi, good morning. It’s Brett with Nokomis. Can you hear me okay?

Yeah, good morning, Brett.

Voin, I just want to make sure that we understood what you said about kind of the pretax number, so you said as we take the pretax number from the just finished 2016 and we have about $5.3 million and we add back the $6.6 million or so charges onto your income to adjusted income reconciliation towards the back of the press release that that you are going to – you expect to surpass that in 2017, is that what you said?

Pretty close to that. So we have like our GAAP pretax income in 2016 was $5.3 million. You can see on the table in our press release that we have about $5.7 million in adjustments. So, when you add those two numbers, the adjusted pretax it's about $11 million and we believe we are going to be surpassing that number in 2017.

Okay. I had a little higher number of adjustments, but I guess since the time of pretax, we shouldn’t look at the income tax adjustment.

Correct.

So 5.3, 5.7, got it. So about – you are saying surpassing $11 million, given where the stock is, I think, people may have missed that. It’s not good, but it’s not that bad either considering where comps are running. That implies obviously SG&A rationalization. And you touched on it Sharon, but I would think as renewals come up now, we’ve had a significant change in what the landlords are with other – of their tenants and we are hearing it in the last few weeks from some of our contacts.

Yeah.

I would say if we are going to have rent reductions on most of these stores as they come up for lease comparing to what your last year’s lease was on the next [indiscernible]?

One, we’re certainly hoping so. Two, we certainly are using our concourse shops and the environment as a negotiation tool without a doubt. And I think a lot of us have talked about this, sort of this – in its most acute form, the unsustainable of 10-year leases with automatic rent increases when traffic continues to decline.

And Brett just to add a little bit more color to that, we do expect to get some cash savings. As you know, we are going against the last year cash trends and – but when you are looking from the P&L perspective, as you know these rent streams get amortized over the – straight line over the life of the lease. The P&L impact may be lacking some of that.

Okay. I want to talk more offline. And then just – I’m glad you are saving cost on new stores because I think that also means you are saving cost on the cost of remodel to [indiscernible].

Absolutely.

And we think remodeling, based on our work here at Nokomis, we think Discovery store format is still a necessary component of this business, but we kind of look at the commercial revenue and the franchisee revenue, we kind of call it mailbox money because you get these other peoples capital and other peoples effort and you are largely giving – send checks in the mail and wires. And so we think that’s an interesting component of what we have here. But with the – the market maybe telling us something that – and of course I think maybe they are overreacting, but right now you are trading at around $100 million enterprise value, we think the franchise is worth a lot more than that. We think the ability to return cash to shareholders is worth a lot more than that, but I’m not sure that opening as many new stores in the future makes sense, maybe it’s more international franchisee and license agreements and return capital to shareholders because right now the market is telling you are not a growth company and this is possibly $1 billion brand, internationally walking around at a $100 million enterprise value right now. So we think – I’m not sure opening more stores in malls of North America even if they are B plus malls is really what the market is going to reward you for and it really makes sense from a capital allocation standpoint at this point. So I want to talk more offline about that, but I just wanted to give you a response for that.

Yeah, it’s – of course it’s something we talk about a lot. And the interesting piece of that is just to get down in the details of it. The concourse shops for example and I’m talking a lot about them, they cost me $100,000 to put in, right, and we expect to get about half the volume of an average store, so rough and tumble, they cost me 20% of what it takes me to remodel a store, yet I get half of the volume and expected half of the volume that I would get for the remodel. I can get out in three years, they have a lower operational cost, and I have no leasehold, so I just backup a truck and move them out, move them to the next mall, move them to a museum, move them to a zoo, they just create tremendous flexibility. So when you are thinking about “all of these stores” yes, Discovery is a component, but also discovery stores in the format of concourse shops, they are a component. And all of these stores, it’s – don’t think, oh, it’s another 25 square foot box sits in – stuck in a 10-year lease with 3% increases every year, a lot of these stores are nontraditional execution like a concourse shop, like a shop in shop, like a Gaylord store. So when you are counting – when you look at our store count year-on-year, it has a lot of different types of stores in there. So at the end of the day, yes, we have to be completely scrutinizing and we are looking at this situation as one lease at a time, one negotiation at a time, one mall at a time, where are we in the mall, what are the anchors, does this makes sense, just a high level of scrutiny. But at the end of the day, we do believe that we fundamentally need some physical retail environment to continue to evolve and build the brand. And if that means we ultimately send them back to engaging the brand in a digital way, that's fine, but there's got to be this place to where you go and actually build a bear.

Yeah, I agree. But in terms of opening kind of brand new stores whether or not a remodel, [indiscernible] might not be the best in terms of 5-year return on capital especially when I look at what your cost of capital is now [indiscernible] Wall Street and on that…

I can’t argue – I can’t argue with that. You got a right point.

And the good thing is that you transitioned from traditional stores to concourse stores, it’s kind of one-timey, but you have a reduction in inventory too, so your free cash flow actually get to pump from that. And so, just on that point, just given out some of the pretax and add back most of the D&A, I mean the stock would have a 7% or 8% yield, if you did that. I don’t think the stock was sticker and we are not – or for building the long-term value of the franchise, but it’s just – it’s something to think about when you can pay shareholders while you continue to build out the international value of the franchise, is this something shouldn’t you think about, so we will follow up offline, but…

Yeah, thank you. We completely agree with the thinking. And ultimately what you are saying was mailbox money and is that – how do you extract the value of the brand that’s been built over the last 20 years and we completely believe in that.

Okay. Thanks a lot.

Thank you. Our last question comes from the line of Joey Bond, Private Investor. Please state your question

You’ve been doing phenomenally with the digital content, YouTube shows have been doing really good, there’s been a lot of demand. Are you planning on expanding that?

As I mentioned, we are going to overhaul our entire digital platform by the end of this year, from e-commerce to website to the way kids interface with Build-A-Bear even from a mobile perspective as well. And a big part of that solution is an aggressive and comprehensive content strategy. We have had a lot of success in that. I’m glad that you are watching our Honey Girls videos. It’s 1 million plus video viewership, even in the last ones, couple of ones that we posted at the first of the year. So we do believe that that is a part of this digital solution that will bring Build-A-Bear into really the new retail environment and the new engage environment and we are excited about that. We are also of course feel like that there is more legs behind that from a distribution perspective and we are engaged in looking at and partnering with people find ways to expand that distribution. Ultimately, the goal is to build the brands and create revenue from them, not just the videos, but the characters behind the videos.

And going into a cartoon for TV?

We are certainly open to that if that makes sense for a partner or a distribution arm. We feel like that we are building equity in these properties. In fact, this year on our licensed front, we will actually have a little girl’s makeup brand that’s Honey Girls branded.

That does conclude our question-and-answer session. And at this time, I will turn it back to Sharon John for closing comments. Sharon Price John So, thanks so much for joining us today. We really look forward to speaking to you when we report of first quarter results.