Greetings, and welcome to the Build-A-Bear Workshop First Quarter 2019 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Allison Malkin with 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 2019 first quarter performance and review the progress made on our strategy. After, Voin will review the financials and share our guidance. We will then open the call to take your questions. [Operator Instructions] 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. And now I would like turn the call over to Sharon.

Thank you, Allison, and good morning, everyone. We are pleased to announce a solid start to our fiscal year as total revenues increased $1.2 million to $84.4 million. Retail gross margin expanded over 90 basis points and SG&A as a percent of total revenues improved by 130 basis points, all of which contributed to a first quarter pretax income of $2.4 million, which is a $1.8 million increase compared to the same period in the prior fiscal year. We also maintain a strong balance sheet, ending the quarter with over $20 million in cash and no debt. As noted in this morning's press release, we are reiterating our previously stated annual guidance for total revenues and pretax income. We feel that this quarter's results reflect the impact of the successful execution of our stated objectives for the year combined with our ongoing efforts to create new ways to leverage the power of the Build-A-Bear brand. I am particularly pleased with the team's focus on delivering these results following a 2018 full of bumps and transitions caused by much of what we believe to be unusual impacts such as Brexit and the Toys"R"Us closure. On today's call, I will discuss the drivers of our revenue growth and highlight the actions we are taking to build upon this promising trend through our efforts to diversify sales and income streams beyond the 4 walls of traditional mall retail stores as well as other key initiatives. From a top line perspective, the overall growth in total revenues is due to a significant increase in commercial revenue, which includes wholesale and outbound licensing fees, reflecting some of the work that has been done to evolve the business model beyond traditional retail. Our consolidated net retail sales were positive in North America. This momentum was offset…

Thanks, Sharon, and good morning, everyone. As previously mentioned, we believe first quarter performance has us on track to achieve the annual guidance we provided on our year-end call in March. We generated top line growth and progressed on the initiatives that are assisting us to capitalize on the power of Build-A-Bear brand. While the U.K. economy remained a headwind to our performance, other revenue inclusive of commercial, licensing and franchising income grew 88% to $3.3 million. Notably, we improved our net retail sales trend versus fourth quarter in both North America and Europe with North America being positive. This included our sixth consecutive quarter of double-digit e-commerce growth. We maintained a solid balance sheet and remained focused on achieving our objective of long-term profitable growth. Now I will review the first quarter financials in more detail. Total revenues were $84.4 million, an increase of 1.4% compared to the first quarter of fiscal 2018. Retail gross margin expanded to 45.2% increasing more than 90 basis points mainly driven by merchandise margin expansion and lower occupancy cost. We continue to control costs in number of ways to improve our retail gross margin including managing our real estate portfolio to lower average store occupancy expense and reducing our supply chain costs. SG&A decreased $500,000 to $35.8 million or 42.4% of total revenue as we continued to maintain disciplined expense management and remained focused on our controllable spend. GAAP pretax income was $2.4 million compared to GAAP pretax income of $600,000 in the prior year. Income tax expense was $1.2 million with an effective tax rate of 50.3% compared to an effective tax rate of 45.2% in the fiscal 2018 first quarter. The income tax expense in the first quarter of fiscal 2019 was higher than the statutory rate primarily because no net…

[Operator Instructions] Our first question comes from the line of Steph Wissink with Jefferies.

Just have a few maybe more housekeeping-oriented questions first. The first is, Voin, if you can just update us on the site-wise format. I want to make sure we're managing the model correctly, so the mall-based, concourse-based. And then if you're willing to give us the percentage that you consider tourist given that was one of the initiatives you talk about.

Sure. So from the store count perspective, we have -- we ended the quarter with 366 locations. We have about 37% of our locations in the Discovery format. We have about 30 -- 34 concourse locations opened at the end of the quarter. We still continue to work on modifying and creating flexibility with our real estate portfolio. And concourses represent a big part of that plan as they give us flexibility in our negotiations with landlords either to change to this format or stay in line. As we talked about the tourist locations, we do have probably from the store count like maybe it's a smaller percentage, but from the volume, it's bigger. So probably some place 10% to 20% of our sales are coming from the tourist locations that are coming in variety of different formats from traditional stores to shop-in-shops or concourse locations.

Okay. That's helpful. And then just on the concourse locations, I want to make sure we have the arithmetic correctly. So even though it's considered a site or a location, a store, it does do lower volume. So if you convert a 4-wall workshop into a concourse, you do have a revenue headwind. Are we thinking about that correctly even though the margins actually can improve?

Yes. Absolutely. So what we have shared in the past, Stephanie, was that typically we expect our concourse locations to do about half of the volume of our traditional mall locations. We expect from the 4-wall contribution percentage to be a higher percentage because the economics are different. But absolutely from the overall total revenue and total EBIT dollars, those numbers are going to be smaller. So roughly you would need 2 concourse locations to make up each 1 traditional location.

Yes. And when you think about it, though, we're -- typically when we're in the same mall from 2,500 square feet to 3,000 square feet to a 200 square feet concourse shop. So even though it's -- there's a decrease in the total revenue, the dollars per square foot is a -- makes it more of a positive story.

That's helpful. The reason I was asking is that you do naturally have an inherent headwind built into your revenue model currently as you...

Yes.

Yes.

That's correct.

But to still report revenue growth would imply that your existing -- we think about kind of organic like-for-like stores are performing better, particularly in North America. So can we maybe just deconstruct that a little bit? What are you seeing on the site level basis that is generating such a nice step-up? Is it a combination of properties? Improvements in the marketing? Or do you feel like you're starting to get a better cadence or rhythm to the business that some of these things might be sustainable as we move into the next few years?

So definitely, we are seeing improvements in our North America performance compared to what we have seen in prior few quarters. Especially as we have seen some of the movie releases that came out earlier in the quarter and that helped elevate traffic trends that we have seen in our stores, we believe based on some of the data that we have internally in tracking our stores that are in the malls where we have theaters, we tend to see stronger traffic than in stores that don't have these adjacent to them. So further away the theater locations are, the traffic impact is more challenging. Overall still, we are experiencing -- or the national traffic, it still continues to be very challenging. We are beating some of those trends. So that's helping some of the results that we are seeing. But overall, there is a lot more focus spend on our controllables in form of managing the promotions and driving dollar per transactions really to help us offset some of the traffic headwinds.

I'd -- also just to add a little bit of additional color there. Yes. We are certainly benefiting from the film releases and our adjacency to theaters as we addressed in the last -- the year-end remarks actually that we expected to see that. But the longer-term real estate objectives of diversification and the different types of formats, locations, leaning into tourist whether if that's direct revenue to -- for us that -- from a retail perspective like FAO or indirect through the wholesale relationships with something like Great Wolf, where we're opening additional 17 locations, all of that is about preparing us for a longer-term success rate. And then you add in this Walmart situation where we're discussing upwards of 20-odd stores inclusive of the 6 pilot stores that we really had. What we've been looking for is a feasible, financially beneficial way to scale the business on the retail side that is not completely a hold into a traditional mall format. And I think between those 3 different types of approaches that we outlined in the prepared remarks, having some options for traditional malls like a concourse shop, having some options like a kit of parts or something like a Walmart and creating options that are more specific to a tourist type of location likely created in a whole new branding approach. For example, FAO are boding well for us as we look out to the future. So even though we've got this tailwind this year from the traffic situation with licensed properties that is helping our overall business to some degree, I want to be cautionary to note that we're not just relying on that. We're building a longer-term solution on how to make retail a sustainable engine for us as we pivot the company to create revenue streams in these other areas, which we saw growth in, as we noted in the commercial revenue on a number of other different fronts. So it's been a bumpy road as we noted. But we feel like we're moving in the right direction.

Okay. That's helpful. And then on sourcing, just as we think about the cost side of the business, I know you're not embedding any incremental tariffs into the plan for the year. But can you just remind us what percentage of your business comes from China? And how we should think about tariff exposure within your COGS, the landed cost versus your total cost?

So -- sure. I can start with that. As we mentioned, guidance assumes there is no material changes to the current tariff rates or policies. We do import a lot of our product from Asia with most of that coming from China. Currently, we are looking at ways and we've been looking for a period of time to diversify our sourcing base more. It is not an easy task. And it's not one that's going to happen overnight. But we continue to make some progress there. Some of those potential tariffs could have, again, assuming it's across-the-board 25% in this 4 tranche, that would definitely have a meaningful impact on our overall cost. We are working and exploring different options how to mitigate some of that stuff. Short term, the -- one of the few ways that's unfortunate as we shared in our prepared remarks was, it's by raising prices. But over the long haul, we would be looking to further diversify our sourcing base as well as work with our factories and partners to find some additional synergies in supply chain to offset some of those increases.

Okay. And then last one is just on the U.K. I want to understand a little bit more about what you think might be happening there in the context of the Brexit overhang? Are you seeing any signs of hope or improvement? It sounds like you are, maybe in some of your prepared remarks. So maybe just give us a sense of how long can that drag persist at this degree, a double-digit decline? Or are you anticipating that, that drag lessens as the year progresses?

Yes. So we -- when we first talked about where we thought we would head for the year, we were -- had a lot of great hope that on March -- excuse me, yes, March 29 that there would be some solution for Brexit on -- and that we could start to plan accordingly with the facts on the table. And as I -- as everyone recognizes now, that's been delayed to October 31 on making a decision about the approach that the U.K. intends to take in regard to the EU. So that delays some of our direct and specific ways to mitigate because we don't know which way everything is going to go. But in the meantime, we did see in the first quarter, although still negative, some improvement versus the fourth quarter. And then quarter to date, we're actually seeing a much greater improvement in the U.K. Some of that has to do with they're in half term and they have some bank holidays piled into this, but most of that being anniversaried. So there is that separate element where the U.K. Kingsdale were indexed on movie properties. And we've seen that over the course of time over the years and that is holding true right now. Additionally, they are building their e-commerce business at a very rapid pace and are not that far off par what's happening on the -- in the U.S. when we talk about this double-digit growth. That's actually across-the-board. We believe that the improvement in our ability to capture name now post the GDPR implementation and we're capturing them in our stores and immediately getting the second opt-in, which is the critical part of being able to communicate directly with the Bonus Club members is helping us both in-stores and online. So…

Okay. That's helpful. And just to tie that up with, Voin, your comments on Q2. I think you mentioned or the phrasing was improvement from the $2.5 million pretax loss last year. Are you expecting to be profitable in Q2? Yes.

Sorry. Yes. Our goal is always to be profitable. Some of the stuff that we are talking about Q2, just want to remind everyone like last year we did have a lot of shift. And like first couple of months of the quarter were very challenging, then we had the Pay Your Age Day event that really drove significant number of transactions at a lower margin. So really as we go into this year and trying to understand what kind of impact the prolonged use of vouchers that we had after Pay Your Age Day event is going to have on our business, we currently believe that our margin's going to improve. But there is still some unknown related to the impact on the overall transactions. What we have going into our favor some of the things that Sharon talked about from the overall e-comm perspective, there are some positive trends. But we also have launch of The Lion King property in July that should help offset some of the headwinds that we are having from these prolonged voucher uses. So we expect to be better. Definitely, the goal would be profitable. But we just don't have enough information because it's the first time we are anniversarying some of these big shifts from last year.

[Operator Instructions] Our next question comes from the line of Eric Beder with SCC Research.

I'd like to talk a little bit about online. I know you gave in Q4 that online was about 10% of sales. What was it like in Q1 in terms of that? And when you look at it, what are the economics of that customer? How are they different? And how can you maximize that going forward?

So yes. I can help you maybe with some of the stuff. Definitely, in Q4, our e-comm business is a bigger percentage of sales. But like it continues to grow as a percentage of sales every quarter. Some of that is driven by a really strong double-digit performance that we are seeing in that particular channel. It hasn't been like to double-digit in a quarter, but we are seeing meaningful improvements versus the prior year. In addition to that, one of the things that's important when we talk about our e-comm channel, it's different than for a lot of other retailers because we don't necessarily have very many returns, which is -- so our profitability in a channel, it is profitable. And from the economic perspective, the transaction value that we see on the web, it's very comparable to what we see in stores of and we do have special bundles that are available for sale online only that tend to be in a much higher price point $60, $70 for those bundles. So that helps overall elevate the dollar per transaction in that particular channel.

Yes. The -- and what's interesting about it too is that we -- when we first redefined our strategy for e-commerce and relaunched the e-commerce platform in October of 2017, we recognized that, yes, we do have some overlap with consumers in our store. But perhaps one of the bigger opportunities for us is to shift our approach to appeal to this as we noted in the remarks, gift giver and affinity consumer. And what they're often doing is buying either for themselves and in many cases, another adult, not just a gift giver like a grandma giving it to a kid. These are collectors in some ways. And that is a much larger addressable market than the child consumer market. Plus they tend to want to shop online. The experience of Build-A-Bear is not why necessarily they are engaging with Build-A-Bear where our in-store transactions are all about the experience. So we have identified, we believe, this potential consumer base that acts very differently and also tends to have a larger dollar per transaction as well much to the -- to what Voin was referring to on being able to pull these bigger bundles together that are most of them associated with desirable licensed goods and licensed products. Pokémon, as we mentioned in the remarks, is a good example of that. It has averaged $70 retail, which is 50% higher than our normal transaction dollars per transaction. So it's serving an additive opportunity for us where, in a lot of cases, I think from brick-and-mortar to e-commerce, there's an overlapping type of strategy where we have some of that. But we see this as a way to build an entirely different type of business model. And in these early stages, we feel pretty good about it between Valentine's and some of this licensed effort that we have done. So that's -- and as Voin said, which is -- really just does a great benefit to us. We do operate profitably there. It's not that dissimilar to the rest of our business model on the retail side. And we feel like that we are in the early stages from mastering a lot of these technological advances that I shared from the augmented -- or actually the AI and our SEO efforts as well as our CRM database and being able to drive that lifetime value. So we're coming at it from 2 ways, driving it through the Bonus Club with our core consumer base, trying to drive transactions -- average transactions and also a whole new consumer base that we feel like we're getting a little bit of traction with some of the strategies that we've implemented in the last few months.

Great. A follow-up on international franchising. So the number of units went down. I assume that's because of Australia. And when you look at the new Chile, India and China, how should we be thinking of those rolling on? And are there opportunities to add even more countries to the mix?

Yes. The decrease for the last quarter was Australia's restructuring. So we are, of course, pleased that they are out of the reorganization and it was certainly helpful that they're much more stable and healthy entity post that. And we are working very closely with them to assure that we maintain and grow our second large -- or actually, our largest franchise relationship. They have been with us for many years and we expect us to continue to move forward there. On the second front, in India and China, we are still in the early stages. Those are obviously massive countries with tremendous opportunity both with emerging strong middle classes and they're -- with very stable and, in many cases, particularly -- or in one case, particularly, in India, a multibillion-dollar company that's well-capitalized to drive the business. So we expect to see stores continue to open. I think that we've mentioned this in the past, but the LuLu Group, who we are partners with in India, is -- also has the Toys"R"Us franchise there, which is actually a separate instinct -- entity versus the portion set that had the trouble last year here in North America. And there's a strategy of shop -- side by sides, which, out of the gate, have been doing very well and they're incredibly pleased and have actually pulled forward some of their expansion plans. Chile, we're in the early stages, but expect to see some stores opened before the end of the year.

Okay. And last question on the Walmart surge. Obviously, this is a learning experience on this mix. When you look at the potential for returns there, can it be as high, as strong as your regular stores? Are you -- do you staff them with your own people? How does that work in terms of the [indiscernible] expenses there?

So I'll start answering that for you, Eric. We are excited about the opportunity with Walmart. Those are the stores that we own and operate, stores where we -- basically, the deals are structured on -- as a percentage of sales deal. We do have control of our labor. We do have flexibility as it relates to operating hours because, again, a lot of these supercenters are open 24 hours a day. And clearly, we wouldn't be open all day long. But we do have flexibility. So that's going to help with our payroll model. From the overall top line perspective, these stores are going to be smaller because, again, the square foot is going to be smaller. We expect them to be roughly 800, 900, 1,000 -- let's say, 1,000 square feet. $150,000 in CapEx investment for those. We are still trying to understand the full year sales. We only have about 6, 7 months under our belt. We are pleased with the performance that we are seeing. I would probably think that they're going to be more around performance of our concourse from the top line perspective than our traditional stores. But then again, as we continue to expand and be in different locations, we'll learn more about the overall program.

Congrats on the quarter.

Thank you.

Thanks, Eric.

Ladies and gentlemen, that concludes our question-and-answer session. I will turn the floor back to Ms. John for any final comments.

Yes. Thank you for joining us today, and we look forward to speaking you -- to you when we report our second quarter results.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.