Greetings and welcome to the Build-A-Bear First Quarter 2017 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, Ms. Allison Malkin of ICR. Thank you, ma'am. 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 2017 first quarter performance and review the progress made on the key priorities we shared with you at the start of the year. 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 the 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 and 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. On the last call, we noted that we intend to evolve and accelerate the execution of our retail diversification strategy given the ongoing shift in consumer shopping trends, while continuing to leverage and build on the actions we've taken over the last few years to expand our revenue streams. Thus far, having made significant changes across the entire organization, we have delivered on our first objective of returning to sustained profitability, while simultaneously laying this critical groundwork to achieve the stated long-term goal of sustained profitable growth. Today, I will review first quarter results, discuss some of the business initiatives taken during the period and provide some insights on our plans for the balance of the year. Specifically in the quarter, consolidated comparable sales results were in line with previously stated expectations, declining 8.1%, reflecting the impact of the shift in timing of both Valentine's Day from a weekend to a weekday and Easter from our first quarter into this year's second quarter, which also reflects the impact of school spring break shifts as they generally follow Easter timing. As previously reported, to address some of the challenges that arose in last year's fourth quarter, we made aggressive changes to our overall marketing plan to better connect with both moms and kids, which included a tactical media shift and the return to traditional tools, such as direct mail and in-store events. The impact of the changes were initially apparent in late February and carried into March, when our overall trends began to improve. Accordingly, for the 9-week period from February 19 through April 22, which includes Easter in both years, we saw an increase in consolidated comparable sales in the mid-single-digit range and a positive shift in traffic patterns, with a year-over-year increase of…

Thanks, Sharon, and good morning, everyone. Going into the quarter, we knew that sales performance would be challenged by the significant negative impact of the calendar shifts surrounding both Valentine's Day and the Easter holiday. In addition, we were also impacted by the overhang of changes to our marketing approach from last year's fourth quarter and negative margin pressure from the British pound devaluation caused by the Brexit vote in the prior year. Facing these known challenges, we maintained our disciplined management of expenses, merchandise margin and inventory to deliver solid earnings per share performance in line with expectations. This morning's press release includes details of our first quarter financial performance that I will now review. For the quarter, net retail sales were $88.6 million, representing a 3.8% decrease, excluding the impact of foreign exchange. This performance reflects a consolidated comparable sales decrease of 8.1%, which follows a 2.2% increase in the first quarter last year. Traffic declines and the shift of major holidays were partially offset by increases in dollars per transaction and positive conversion in the quarter. We also remain pleased with our Discovery format store performance. Discovery format stores in their first year of operation continued to achieve a double-digit increase over heritage locations, and stores in their second year are performing in line with the chain average. As Sharon mentioned, comp momentum improved in the latter part of the quarter as we move past the holiday shift and benefited from the return to traditional marketing. In fact, looking specifically at the 9 weeks ended April 22, which includes Easter in both periods, our consolidated comparable sales rose mid-single digits. This improvement reflects increased traffic in North America, increased conversion from improved service model and increased dollars per transaction, all of which gave us nice momentum as…

[Operator Instructions] Our first question comes from Alex Fuhrman with Craig-Hallum. Please proceed with your question.

Thank you very much for taking my question. It seems like things have definitely turned around a little bit the last few months. Curious what's really been driving that increase in traffic. If I'm interpreting your comments correctly, it sounds like traffic in the centers that you're in hasn't necessarily gotten any better, but traffic to your stores has, is it basically just the types of advertising that you're doing, do you feel like getting more into TV and print had essentially fixed that issue or are you still pretty concerned about what mall traffic could bring for the remainder of the year?

Hi, Alex. It is Sharon. How are you?

Good, thank you.

There's a lot of dynamics that are happening, and clearly it's hard to predict exactly what's going on and there is really some external forces we think that may have impacted the traffic as well. I've heard on some other calls about some of the tax returns that may have impacted some of the early turnaround post-Valentine for us, but the things that are in our control, such as our media planning, our marketing, the use of our stores as more of a competitive advantage for us to create experiences for the consumer clearly has shifted some of our traffic versus the norm. As I mentioned in the script that 9-week period, starting post-Valentine through last week, the last full week that was measurable, we've seen traffic up 1.4% versus a real negative trend overall. So we have, historically, as Build-A-Bear, using some of these more traditional tactics, been able to get what we call our unfair share, outperforming traffic norm. So I do believe that returning to some of these more direct mail, in-store experiences, reaching back out to moms in a more traditional way has impacted us, and we've certainly seen it in both sales and traffic numbers.

Great. That's really helpful, Sharon. And then just thinking about gross margin, it looks like that was better than most people would have thought here in the first quarter. Can you talk about what's kind of been driving gross margin in the first quarter and, now that we're through the calendar shift, where we could expect to see that for the remainder of the year?

Absolutely, Alex. Gross margin, especially, merchandise margin improvement has been one of those things that we've been talking for a while. Even last year, on a full year basis, we expanded our merchandise margin. Q4 last year, we had some hiccups related to our promotional activity. As we called out on our fourth quarter call, we added some unplanned promotional events that weren't so successful in driving traffic. We pulled away from some of those things in Q1 and really didn't impact our performance. Actually, our dollars per transactions have gone up, our conversion has improved. So all those things are very beneficial, and we expect to continue with the merchandise margin expansion on a full year basis. In addition to that we continue to find operational efficiencies in our supply chain as we are able to leverage technology more, and we are implementing systems that continue to help us to have more insight and better focus on some of the controllable items that are going to help us to continue to expand margin going forward.

I would just like to add, Alex, on top of that traffic question that you had, that's not our only lever, and we have been focusing on driving the additional levers that improve sales over time. So we have gone through an entire, very robust comprehensive process of retraining our bear builders, our associates on conversion. And so we're really making the most of the traffic. So we're working toward even – whatever traffic is, we're trying to get a higher comp, right, so that we convert more and more the guests that choose to cross our lease line. And in addition, with a lot of this elevated and integrated marketing that coordinate both product and stories together, we are continuing to drive DPTs and UPTs, dollars per transaction and units per transaction, with our dollars per transaction still hovering near the highest they've ever been.

Great. That is really helpful. Thank you both Sharon and Voin.

Thanks Alex.

Our next question comes from Jeremy Hamblin with Dougherty & Company. Please proceed with your question.

Hi, good morning guys. Congratulations on the improved results. I wanted to first just ask about the guidance in the flow of same-store sales in the first quarter, because I'm little surprised by the commentary regarding the Easter period. Obviously, same-store sales came in at your guidance, down high single-digit at minus 8%, but I'm a little surprised that the commentary is from the 9-week period, from February 19 to April 22, that it was up mid-single digits. So I guess my question is, can you provide a little more detail behind the first half of the quarter in Q1 and what the comp was, and what it was in the post-Valentine's just in the first quarter because I'm having a hard time reconciling that you hit your guidance kind of right on the spot, yet it sounds like there was a pretty material improvement in results. I'm just not sure how much of that material improvement was actually in April when Easter period hit versus what you were seeing in March and the very end of February?

Okay. So yes, on the call last time, we certainly talked about the challenges that we've seen already in the first half of the first quarter. And they were fairly substantial, particularly as it relates to Valentines. And we had spoken about that. And even some of the significant double-digit traffic declines, and we had spoken about that as well. And taking that, the 9-week post, there was – as we mentioned, we'd expect it to be able to shift some of our marketing plans, our media tactics, we were having some of the more traditional tools hit the marketplace such as some direct mail, starting to speak with moms again, and we expected to be able to start to impact that toward the end of February, early in March. And we were able to see some shifts in that traffic. And then some of the conversion work that we've been doing just start to kick in, and we started to experience positive comps throughout the remainder of the quarter, except, of course, for the direct comparison to the prior year's Easter week, which would have been nearly impossible to comp. So it's not just isolated to the April time period – direct April time period that would have been Easter this year versus the non-Easter time period last year, although, clearly that was a very positive time frame given the compare – the easy compares on the year. But it was a pretty stark shift in traffic that we were able to capitalize on. Voin, do you want to add any color to that?

I mean, I think Sharon covered well some of those things. Jeremy, clearly this was a tale of two halves within the quarter, and our performance, clearly, definitely improved. Like starting in February – late February, we continued to see some things. There were shifts from the Easter perspective, and it helped to start Q2 on a solid ground. So this was – the month of March was – it came in line maybe slightly above our expectations, and that helped.

Yes, that is helpful. I guess, what I'm trying to get at is, there is a – it sounds like a pretty stark turnaround that you got to positive comps outside of the direct Easter comparison. What gave you the confidence to guide to a down high single-digit comp when clearly the first half of the quarter, it must have been at least down low double digits? I'm glad that you hit that, but it makes me wonder what you saw, just because of the timing of when you reported in the middle of February, you had not really seen the benefit at that point of positive turnaround in trends. I guess, what I'm trying to gauge is, how much hope there is in the guidance versus confidence of actually seeing the results transpire, because again, I'm pretty impressed by the turnaround, but it makes – it leaves me wondering why that improved turnaround didn't result in actually doing better than what your guidance was on comps.

Jeremy, I think that we were fairly clear in the prior call about our expectations of shifting marketing plans, marketing strategy, marketing tactics, inclusive of adding dollars to the plan, and that the only reason we were unable to make some of those actions in Valentine's is that we were – did not have complete clarity as to how some of the marketing tactics that had been changed during the fourth quarter were going to impact us in a negative way. And we couldn't really catch the direct mail, some of the other changes, increase to media, shift the media plans to talk to moms again for Valentine's. Now Valentine's was negatively impacted not only by some of the self-inflicted wounds that were – that we've been very crystal about on the marketing front, but it was also that shift from the weekend to the weekday that we knew was going to happen. So we were confident in the ability for those traditional tactics to kick in and work again. We had a lot of history on those tactics working for us. We also had some pretty powerful product launches that we were planning during that time frame, inclusive of Beauty and the Beast film, which was very beneficial to us, and we got back in stock with Pokémon, and we knew we had those things coming.

Okay. That is helpful. And then in terms of just Q2, it sounded like you're running quarter-to-date, mid-single-digit. Did I hear that right, and you're guiding to a low single-digit to mid-single-digit comp this quarter?

We've only said that we're positive through quarter-to-date.

Yes, and we are guiding low to mid-single-digit, correct.

Okay. But you are positive, okay. In terms of just the magnitude, this would just be one other helpful piece of information, on a relative scale, how important is Valentine's Day versus Easter? Is Valentine's Day like a kind of 3-to-1 in terms of magnitude of importance and sales associated with, can you give some relative scale on that?

Well, they're actually a lot closer to the same scale as you – than you might think. Valentine's is often one of – the day itself, when it lands on a weekend, can be one of the biggest days of the year, if not...

It is the biggest.

The biggest day of the year. So when you have it leading up to a Sunday like last year, it can be really high impact. Easter has a lot of the spring break shift involved in it that can drive the month that it's around. But Easter itself often isn't as big of an impact as Valentine's. So they're a little more equal than you might think. They're not that – it's not that much of a dramatic shift.

Okay, great. That's very helpful. And then I just had a couple of questions on the e-commerce, I was a little surprised to see e-commerce down for the quarter given that you didn't really have a good Q1 last year on e-commerce. Is there – and obviously, you're making changes there, we're happy to hear the changes, but anything additional you could call out on e-commerce of why that was actually down year-over-year in Q1?

Some of the overhang of the challenges that we had in fourth quarter were still there in the January time frame. And even, of course, the marketing plans that we had for Valentine's, that also affects how many people come to the website, how many people are interested in the business, how many people are checking out the brand, how well do you convert. So the website also, with the marketing changes, the shifts in our strategy to communicate with our consumers, actually saw a trend shift in the back half of the first quarter as well. In fact, it was slightly positive for the month of March, which is...

Big shift.

Really a big shift, I mean, and that's inclusive of March being – Easter being in March last year.

That's great to hear. And then just again, I'm really pleased. I think the changes to e-commerce, long overdue, can you just give me a sense of the total cost of the investment as well as the timing of it? I think the one thing that I've seen over the last 20 years is e-commerce changes can oftentimes be painful because they never go that smoothly, when do you expect to have the change in the platform done?

Yes. So a couple of questions in there, right? One is the cost. We usually don't share specific costs associated with individual IT or systems upgrades, but you can get a sense of all the multiple things that are going on, it's listed in our capital separated from the real estate to other things, and Voin can give you some color on that. The second is, we're clearly shooting for and have been planning this e-commerce upgrade for a long time, like over a year, about 1.5 years at this point when we first started to investigate what type of partners we wanted to work with, who's best-in-class in certain areas because it's not just the facing portion of the e-commerce that needs to changes, it's not just the e-commerce side, it's that entire system and platform upgrade, because part of our challenge in the fourth quarter, for example, is we could not manage the traffic to the site, we couldn't turn the traffic on the site. So we have – this is a full range, as I said, comprehensive reboot in the script of the way we do business on the Internet, inclusive of making it a lot more intuitive and pushing it all the way to what is the fastest-growing commerce platform right now across the United States and the globe is the mobile side. So we are looking at – we have a whole cadence of betas and testing, but we do not want to miss the holiday time frame, Jeremy. And you're right, it is painful, but it is worth it. And it is absolutely necessary for us to participate in this type of commerce, and we believe that we can create something that's worthy of Build-A-Bear in terms of this experiential side. All I can say is that we're on track right now, but being cautiously optimistic, you're absolutely right, there can be hiccups, but so far, so good.

Well, yes, I have to be more specific and push on that a little bit because I guess, in terms of the timing, I think the worst time to turn that on would be November, because there's inevitable hiccups, and oftentimes they can't be fixed quite that quickly. So I guess, what I'm just trying to assess risk in doing this and thinking from the perspective of when you guys do business, if that's something that could be done in August or September, it probably is pretty good timing, I'm just wanting to be comfortable that your timing is not too close to the holiday period.

Jeremy, we've been doing this – we've been planning this year and a half. We understand that there are hiccups. And when I say we expect to be up and running before the holiday time period, that's inclusive of having testing and processes in place to do betas and have break fix completed before the holiday time period.

Got it. All right. Thank you for your patience. Good luck.

Thanks.

[Operator Instructions] Our next question comes from Gerrick Johnson with BMO.

Hi, good morning. So you plan to increase pretax earnings over adjusted 2016 results, but I noticed that, in the first quarter last year, you're readjusting some numbers, and wondering if there'll be additional readjustments in the second, third and fourth quarter? And because of that, what is the exact pretax – adjusted pretax earnings number we're trying to shoot for here?

Good morning Gerrick. Thanks for the question. We are – we provided some guidance regarding the fiscal '17 on the last call, and we are staying on that guidance that we are expecting to exceed our adjusted pretax results from 2016. As a reminder, in Q4, we had some adjustments to the tune of about $5.7 million, close to $6 million. And so when we – some of those – that was the only time when we made adjustments last year. So from the consistency perspective, we are going to be sharing some of those over every quarter, but the biggest impact is going to be in Q4. Does that answer your question?

Well, we know about that one. What we didn't know about was that add-backs that changed EPS from 1Q '16 to $0.19 from $0.22 cents. So I'm just curious as to whether or not there are going to be additional adjustments in 2Q and 3Q that would change the target that we're shooting for. I understand our guidance for this year, but we have a moving target versus last year?

Yes. Some of those adjustments, when you look at Q4 last year versus the full year, most of the adjustments that we had earlier in the year are going to be related to our China start-up costs, and we are going to be providing those on the subsequent calls.

Okay. So should we assume that those start-up costs would be similar to the first quarter '16 or declining over time?

I mean, they will fluctuate. We opened a store, a China store in Q2 last year. So like a lot of those costs are going to be in Q2, and they are going taper off in Q3 and later. And I think if I can just look it up versus last – in Q4 what we shared on the total, I can get you some of that information, it's in the numbers that we shared.

Okay, okay.

So I've been trying to look them up, but I'll try to get that back to you. So it's in the information that we have shared in the table in the back.

Okay, okay.

I think China start-up cost, yes, it's on a full year basis, it was close to – it is $1.1 million, and so like about $800,000 was first three quarters.

Okay, great. Thanks, and then one more, first quarter comps down 8%, and I think you said year-to-date up mid-single digits, meaning the first three weeks of April were up nicely, but your guidance for the quarter is up low to mid-single. So is it correct to assume that you're expecting declines in the balance of the quarter in May and June?

Gerrick, hi, the first quarter comps were down 8.1%, and the mid-single-digit increases for the 9-week period from February 19 through April 22. And then we shared that, quarter-to-date, we are positive.

Okay. So the difference is that's not a year-to-date number, that's a mid-February through mid-April number.

That's a given when our call is, that's our best capability to kind of capture this Marpril idea, the March/April, with the 9-week period, because we don't have a full week in the last week of April to put Easter in both years and kind of give you a good comparison.

It is good information. Thank you.

Thank you. At this time, I would like to turn the call back over to Sharon John for closing comments.

Thanks again for joining us today. And we look forward to speaking with you when we report second quarter results.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and have a great day.