Greetings, and welcome to the Build-A-Bear Workshop Second Quarter 2019 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, [ Jessica Schmitt ] 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 2019 second 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 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 to turn the call over to Sharon.

Thank you, [ Jessica ], and good morning, everyone. In the quarter, even with the anticipated decline in retail revenue given the comparisons to last year's remarkable traffic driving Pay Your Age events, we improved operating results with gross margin expansion and expense management versus the second quarter last year, even with the backdrop of global and economic uncertainties. With the focus of our dedicated teams, the quarter also saw growth in new revenue streams as we continue to execute our business diversification initiatives, which we believe demonstrates the progression of our stated strategy. We also continue to build necessary infrastructure and to solidify relationships with best-in-class partners, which we expect to further leverage the awareness and power of our brand across categories. In short, our long-term goal remains to evolve the company beyond the traditional mall-based retail concept among which it was established over 20 years ago. To that end, we recently completed the execution of the noteworthy agreements in the entertainment space, which I will outline shortly that are expected to build on our brand's strength and contribute to the investment of our overall evolved business model. With U.S. aided brand awareness over 90% and comparative brand metrics that are for parental trust and kid love that rival other family brand [ BMS ]. We understand the potential value that is inherent in our company. It is that same value that allows us to have a list of over 8 million opted in e-mail addresses for direct marketing and communication, 4 million active loyalty card members that represent an estimated 20 million household members and nearly 45 million guests each year that come into a Build-A-Bear workshop, a level that is comparable to attendance at global recognized theme parks. On top of that, on a combined basis, there…

Thanks, Sharon, and good morning, everyone. As Sharon mentioned, the second quarter followed a particularly strong top line performance from last year, driven by the success of our inaugural Pay Your Age Day event. This year's second quarter results were also negatively impacted by unfavorable currency, driven by the volatility in the pound versus dollar during the period. Even with the headwinds faced, we improved profitability versus second quarter last year, driven by significant expansion in gross margin and disciplined expense management. With that in mind, we believe the fiscal second quarter of 2017 represents a more accurate comparison as it removes the anomaly created by 2018's Pay Your Age Day event. Using this comparison, this year's second quarter saw increased sales and improved profitability on a constant currency basis. Importantly, Build-A-Bear achieved solid pretax profitability during the first half of 2019, and we believe these results have us on track to achieve a profitable year. Some highlights of the second quarter include: commercial revenue growth of over 200% to $3.2 million as we continued our progression to grow new revenue streams. Notably, we saw sales growth the first 2 months of the quarter across geographies, inclusive of this year's successful Pay Your Age Day event. This also included our seventh consecutive quarter of double-digit e-commerce growth. Now I'll review the second quarter financials in more detail. Total revenues were $79.2 million, a decrease of 4.8% compared to the second quarter of fiscal 2018. Retail gross margin expanded to 44.1%, increasing by 160 basis points, mainly driven by merchandise margin expansion. We also saw leverage in occupancy expenses as we continue to control cost in number of ways, including managing our real estate portfolio to lower average store occupancy expense and reducing our supply chain costs. SG&A decreased $2.2 million…

[Operator Instructions] Our first question is coming from Eric Beder of SCC Research.

Can you talk a little bit about U.K. operations and what you're seeing there? And how some of the changes you're implementing are affecting that growth?

Sure. We continue to see some challenging environment in U.K. that continues, even though over the last couple of months we have seen some improvements in trends as a result of some of the actions that we have taken earlier this year. As a reminder, last year, we -- due to the impact of GDPR rules, we did have some challenges in opting in our consumers and talking to them. Some of those challenges have been resolved earlier in the year, and we have been seeing some really nice lift from those, especially on our web business. The traffic in our stores, especially in the recent weeks, has been more favorable, but still there is a lot of uncertainty knowing what the geopolitical condition in that country and some of that everyday changes that we are seeing and uncertainty around Brexit. So we are cautiously optimistic. As you know, some of those things are outside of our control, but we continue to be very aggressive in managing our real estate portfolio, managing expenses and things that are directly within our control.

Great. And then just a quick follow-up. On Lion King, so that was a significant push into the stores at 6 new furry friends, backdrops, decals. When you look at -- first of all, you considered what you did there a success in helping driving traffic. And when you're looking at Frozen and Star Wars, are we going to see that kind of push into the stores and online to drive business there?

Yes. In fact, Lion King was very robust for us. It was -- we considered it to be very strong story. And we did have a multidimensional marketing campaign around it, and it was our #1 story for the quarter. So we felt like that there were a lot of things that we did, then levers that we pulled that were very successful to create excitement and drive traffic into the retail locations using Lion King. And indeed, we do intend to use and repeat some of those efforts. We also have a lot of experience with Frozen. As I noted, it was -- it is our historically best-selling license product of all time in Build-A-Bear. So that experience will bode well for us as we create interesting and traffic-driving opportunities for children to come in and get their new Frozen products. Star Wars as well that we will focus most likely in a greater way on Frozen. We do see a lot of opportunity there and have a broad range of products to fulfill what we expect to be a good demand.

[Operator Instructions] Our next question is coming from Steph Wissink of Jefferies.

Our first question, and Sharon, this one may be for you. But as you think about the evolution of the brand and some of the commercial sales that you're doing, I think it mixes up loyalty-based payments with wholesale sales. And I'm wondering if you'd step back and looked at the total brand sales trued up to retail value, if that's giving you any sense of the total size and scope and the potential of the business if we were to look at it from the consumers' lens versus from the way that you report?

Yes. Thank you, Stephanie. Appreciate the question. We definitely do look at grossed up approach to try to value the brand at retail so that everything is equal. You're right that a lot of these things that we're doing, and we mentioned it all the time, that many of these license opportunities are -- they're margin accretive to us because basically where we're getting royalty dollars, which are very rich with little overhead associated with them. We have done some rough numbers on that, $400 million to $450 million. I think, Voin, if you like to add some color to that. But that's also inclusive of the grossing up of our franchise business. Is that right?

Yes. If you think from the enterprise, probably some place between $400 million, $450 million. As you know, a lot of these revenues are coming in variety of different streams. We do have, as Sharon talked about, some of the royalty income we are getting in our commercial channel through outbound licensing. We are getting franchise income from our international stores as well as we have these experiences that we refer to as third-party wholesale with Carnival Cruise Lines and Great Wolf Lodges that also will be grossed up on the retail level as we sell to them on a wholesale basis. So when you add up some of those things, you are in that range, $400 million to $450 million, depending on the exchange rates and some of the things that we have and seasonality of those businesses.

I think you're right. Yes, I think you're really right to question it, because sometimes those are undervalued inside of the comparisons that -- when you're looking at the majority of our sales being at retail value, and it's hard sometimes to you sort of lose the plot on that these dollars are valued at a different level in some way.

That's right. I think that's very helpful because I know what the total scope is as well. I mean second question is just to unpack the sales guidance. So couple of angles, I'd appreciate you taking. The first is, you've been in a net closure cycle for the peak sales and total dollars being down. It's not necessarily a huge surprise. But I'm wondering if you can just give us a scope of what factored the closures of the net retail footage declines has had as an impact on sales versus the underlying performance of the business? And then how that factored into the way that you're guiding and the takedown from mid- to high single to kind of a low single-digit range, which seems like a more extreme revision? So if it's more than just the footage changes, if it's something in addition that you could just provide some additional context that would be helpful.

Sure. So I can start with some of that stuff. So yes, we did lower our full year revenue guidance. There are a few things that go in there, like, first, as we talked about, we did have some misses in first half of the year, especially in the second quarter, as we did have some of this challenging comparisons with Pay Your Age Day events. Now we did have -- as you talked about, we did close 6 stores this year in second quarter, and the timing of Walmart stores has shifted a little bit impacting our seasonality and timing between quarters. As we said on one of our previous calls, we expect over the next 18 months or so or next 2 years to close up to 30 stores. We are in constant negotiations with our landlord community. And as we have a lot of optionality with our leases, we are going to be taking advantage of those. And if we are not getting the terms and achieving profitability that's expected for us, we may be walking from some of those locations, and that could impact the top line. In addition, as we think about the second half of the year, there are more positive things coming up as we believe Frozen should be our biggest license of the year, and that should be floor set, I think, early October for us. We also are going to be getting a benefit from opening of additional 17 stores, Walmart locations. We did -- our initial guidance included few more stores, but some of those shifted the timing into beginning of next year. We expect still to have double-digit increase in our e-com business, as we continue as well to drive our non-retail revenue streams in form of our commercial revenue. So we feel good about some of those things. Another piece that's worth noting, Stephanie, it's the exchange rate risk in U.K., with the pound devaluation and especially at the current rates, it's going to be at least 1%, probably a little bit more of sales decline on a full year basis due to the weakening of the pound.

Yes. And Stephanie, I also think it's important to understand that the retail changes that we're making when you -- talking on a more macro level are really fundamental, when you start to think about it. It's -- we're shifting not only away from and managing down the traditional mall-based business as a percentage of our total retail offering. And in that percentage of total retail offering, it's inclusive of, when we think about it in its broadest terms, with the third-party retail and seasonal shops and shop-in-shops with a variety of different models. But at the end of the day, what you're going to end up -- what we believe we're going to end up with is something that's very different from what was kind of a cookie-cutter 2,500, 3,000 square-foot store that rolls out in what would have been considered traditional or is now considered traditional mall retail to something that has a decrease in square footage per store yet the number of stores would increase for us to have a broader accessibility to consumers to be able to experience Build-A-Bear that we believe will buoy these other revenue streams. So you end up with our goal of having more yet smaller more profitable locations. So your average store volume goes down, but your average -- but your total store count goes up. Does that make sense?

It does. Yes. So I think looking at kind of footage basis versus a unit basis, it seems to be a shift that we need to make in the modeling. If you agree with that?

We have looked at that, and Voin can add some more color. Again, we have -- there is that challenge that what you brought up in the first question of how do you normalize on the third-party retail versus our owned and operated retail. But there are ways to do that, I think, that will help people understand this fundamental shift that we're making.

And also with some of the things that have been done over the last couple of years and diversification of our real estate format, our concourse shops are about 200 square feet. Our Walmart locations are about 1,000 or in that vicinity. Our traditional stores are 2,000 to 2,500. So the mix of real estate format definitely impacts that square-foot calculation, and it is challenging for you guys to model, but we can try to work to provide some additional color so that people can have better understanding on some of those things and help you model the revenue a little bit better.

Voin, could I ask you one more? And just related to the tariff situation, I know you quantified -- provided the qualification that you're shifting some of your production outside of China. But can you just remind us what percentage of your U.S.-bound goods come from China today and what your goal would be?

So today, we probably have -- over 90% of our goods are coming from China, and we are going to be working to diversify and shift our sourcing base. And maybe over next 12 to 18 months to have like maybe 1/3 or roughly so of production coming from outside of China. And we'll continue to look and review that number as we go forward and understand what kind of challenges and changes are going to take place with the new tariff structure.

Yes. It's important to note, though, for the vast majority of that shift, we are working with long-term partners and existing production facilities and companies.

Thank you. At this time, I'd like to turn the floor back over to management for any additional or closing comments.

Thank you for joining us today, and we look forward to updating you on our business on the third quarter call.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or log off the webcast at this time. Thank you, and have a wonderful day.