Build-A-Bear Workshop Inc (BBW) 2016 Q4 法說會逐字稿

Greetings and welcome to Build-A-Bear Workshop fourth-quarter 2016 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, 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 and review the key priorities we set at the 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 every one.

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 expectations. These results are disappointing and 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 decline by 3.6% driven by a decrease in consolidated comparable sales of 4.4%. Sales at stores in a Discovery design increased 4% in North America and 5% in UK, an e-commerce 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 mult-year 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 overhaul of internal processes. Throughout 2016, the plan continues 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 investments. 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 expectations. Given that December typically is 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 the median marketing as well as impacts from licensed product, a reduction in overall media spend and move away from historically effective traditional TV and direct mail to digital media in an effort to reach millennial moms more effectively 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 of processes were not able to capture the increased sales opportunity in its entirety as 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 Pokemon franchise and other licensed 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 plans to enhance the website platform and upgrade the e-commerce system.

However, even with the execution of these action steps the combination of the shift of Valentine's Day to a weekday, Easter moving into the second quarter, on going traffic softness, and the continuing impact of unfavorable currency exchange rates, we expect a 2017 first quarter consolidated comparable sales decline and level that may be consistent with the 2016 fourth quarter.

While our recent focus has been on making immediate corrections, 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 comps 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 profitability following five consecutive years of pretax losses.

Specific to 2016, we continue to make progress on several key initiatives. Today we'll 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 requirement, 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 store fleet, leveraging the new Discovery design, diversifying the portfolio into non-traditional models, including the new concourse format, further developing the international franchise business. First, as it relates to an aged store fleet, the Discovery store format was introduced in 2014 and continues to deliver positive results. In North America in 2016 Discovery stores had comparable store growth of 4%.

A double digit lift compared to Heritage stores. Currently over 80% of stores remain in a non-Discovery format, which, on average, has not been refurbished in almost ten years. Therefore we believe that the continued discipline conversion to the new format, in select locations, will positive live impact this imperative performance.

To this point, we have leveraged natural lease events to affect the real estate conversion and 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 on going value engineering initiatives, a significant reduction in the capital needed to open a store compared to all the original model is expected. In part the reduction is a 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 2017 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 at non-traditional locations, where families go for entertainment, such as tourist venues. In fact tourist stores had growth of 3% in 2016 and continue to over index on profitability in other key metrics.

Plans include expansion into more non-traditional places, such as seasonal 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 (inaudible) 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 fronts.

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 geography 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 seasonal event locations with Gaylord Hotels, pop-up shops with Macy's and AMC theatres, and the on going relationship with Carnival Cruise Lines. In summary, for 2017 plans are to be open 20 to 25 new stores with 15 being concourse shops, remodel 20 to 25 doors into a Discovery format, close five to ten 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 trends. 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 ten 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 proved difficult, as we enter our 20th 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 initiatives based on external research field 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 of the core operations in light of some of the recent business shifts, 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 high percentage of stores in the Discovery format, additional concourse shops, expansion of non-traditional locations, and increased opportunities through wholesale relationships and franchises. The capital investment required to model and open new stores is expected to decline as 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 on marketing and media strategies with an integrated plan designed to drive traffic and enhance consumer engagement across a number of touch 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 seemed to significantly accelerate. Given that acceleration, as outlined, we will make some critical and rapid adjustment, 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 a now iconic experiential brand with over 90% awareness that moms trust and kids love. Second, provide consumers an engaging way to seemingly interact with the concept or brand whenever, wherever and however they desire.

This is reflective of the evolution of our physical real estate footprint to create flexibility 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 on going infrastructure, talent, organizational and sourcing improvements we've been making that are designed for us to operate more profitably.

Now I'd like to turn the call over to Voin.

Thanks, Sharon. And good morning every one.

Clearly the fourth quarter performance was disappointing particularly with a significant change in trend in business in the month of December, which negatively impacted both the quarter as well as full year results compared to expectations in the prior year.

Today's discussion will include both GAAP and adjusted results with a reconciliation detailed in 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 American and 0.4% decline in Europe. In the quarter dollars per transactions increased 1% offset by a decreases 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 in 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 results of internal initiatives to build new revenue streams 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 Lines as well as outbound licensing, most significantly, with the sales of Build-A-Bear stuffing station toys 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 direction 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 to higher cost of goods as inventories purchased in US dollars.

Full year retail gross margin of 45.2% represents a contraction of 190 basis points, primarily driven by the leverage of occupancy costs, impact of store asset impairments and foreign currency losses in the UK. As noted unplanned professional activity increased in the fourth quarter, even with the increased activity merchandise margin on the constant currency basis expanded by approximately 30 basis points versus fiscal 2015. Future merchandise margin expansion is expected through the continued process improvement initiatives that are underway and through on going 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 tables included in this morning's press release and most of the which are believed 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 reconciliation table reflect costs associated with the exploration of strategic alternatives, tax added and organizational restructuring related to marketing and e-commerce.

2016 GAAP pretax income was $5.3 million and on 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 the discrete adjustments as well as the performance and mix of earnings from lower tax jurisdictions.

As it relates to 2017 outlook on taxes an on going 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 has 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 totalled $59.9 million representing the 3.7% decrease over prior year.

Inventory composition was in line with expectations. For fiscal 2016, capital expenditures totalled $28.1 million primarily related to the 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 operations 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 formats 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 relates 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 moves peak 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 sales shift in key licensed properties.

And the on going negative impact of currency exchange rates that was triggered by Brexit, assuming rates remain at current level the impact is expected to continue until the last 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 comps for December. It looks like you were down somewhere in the 15% to 20% range? Can you just clarify that?

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

Okay. And in terms of the e-commerce problem, can you just -- it looks like there is some serious kind of 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 or e-commerce system is aged. We have had long term plans, from a capital perspective, to upgrade the e-commerce system in 2017, that money has been set aside as has 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 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 -- the new interactive space and be a lot more -- have a lot more interchange with mobile, online, in-store.

You see that through what we did all this year, for example, with IT infrastructure, with the upgrade of our POF and put enterprise selling in and to be able to take advantage by all aspects by the end of next year. So the traffic increase on the e-commerce site at 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 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 and capital, everything has been approved to upgrade that e-commerce site and take us into a new digital age, we've just had this website for so many years now. On the product side, there's always checks and balances 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 we don't call the number exactly right and we've been chasing Pokemon, for example, for a while now. But I think that there's always room for improvement and some of the systems that we 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 ten stores this year and 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, does it make sense when you're seeing what appears to be maybe a potential structural shift in your Q4 patterns, with two really poor Q4 results in a row, does it make sense to be opening up new stores until you have maybe a better assessment of what's happening in Q4? First question again, what percentage of the total company-owned locations are losing money and the second part is, why open new stores right now?

Sure. As I mentioned in the remarks, 95% of our stores are profitable sales so less than 5% that are unprofitable. The opening of stores, you know, there's a lot of dynamics there.

First it's 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 a question of where do you open those stores.

What we have 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 a number of options so that we're not locked in to the old school thinking. So opening stores is one question, opening stores in (inaudible) malls is another. So as we've evolved, in addition to these concourse shops we've created, we have all of these kit of parts 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's -- 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 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 rent prohibitive to us that 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 you. Of those stores, the majority of them are concourse shops.

Okay. And then just another clarification question here. I think, Voin, the guidance on total sales was low single digit to mid-single digit growth which would imply $366 million to $382 million (inaudible) correctly?

You are referring to 2017?

Correct. 2017 guidance.

Yes.

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

We 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 spelled out currency separately in our press release. There are a couple of components how currency impacted us. What's called out on the reconciliation table is that impact of remeasurement of the balance sheet.

The piece that we are calling out, that the on going expense that goes through our cost of goods is that negative impact of currency as we are buying UK goods in US dollars. So that's depressing our margin in UK.

Okay. And what about on S --, 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 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, you know, we expect to be flat year over year. As a reminder in 2016 we did get a benefit of performance based comp and we are going to be offsetting some of that headwind next year with savings initiatives.

Okay, thanks. I'll 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 a little bit more to size up the impact of both the lower gift redemptions in the fourth quarter as well as the impact of e-commerce site. 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 redemptions include in the 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 you 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?

Yes on the e-commerce side, Alex, the e-commerce did grow. It grew -- what was the total in the quarter? 3% in was in December. 2% for the quarter. And 3% in -- that's right. 3% in December. And that was on a double digit traffic increase.

The reason that's impactful is, one, clearly we weren't able to translate some of the traffic into sales. But when you look at what happened on the macro level I believe that the brick and mortar retailers that also had e-commerce, even though on the 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 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 or comp in the quarter but it is a significant opportunity for us in the future, which is why we wanted to call it out as well. Because we still having e-commerce 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's 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's -- 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 their consolidated comp.

Okay. And, Alex, on 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 we really expanded our gift card distribution and we did actually sell double digit more gift cards in the 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 redemption and sales coming from gift cards in the fourth quarter represent even up to 25% of our December sales.

What's really interesting about our business, not as a typical retailer week after Christmas, we do get additional traffic as people come to redeem the 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 receipts you've seen, is there any one particular kind of area? I know you mentioned the licensed business more broadly. But just given the very significant change in trend so suddenly, is there any particular product area that really lead that weakness?

The Trolls did perform well and the end of third quarter we shared with you the initial reads on Trolls was positive. I will say we left some money on the table with Trolls, although because it was more of a mixed issue than anything, Poppy, even though, of course, we bought more Poppy than we bought of the other characters, it was significantly skewed toward Poppy. And so we had to chase Poppy a little bit through the quarter.

Which I actually 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 still didn't deliver against what we had as the planned numbers.

We expected that the residual interest in Star Wars as well as the fact that an in you film was coming out would buoy the business back-up to the level that we planned it to, clearly, that did not happen. And given our spottiness in Pokemon we were unable to meet the needs of the non-traditional consumer that often walks in our door mainly almost direct little because of some license that piques their interest.

So those were the two things that happened. As it relates to was something other than the Star Wars that sort of surprised us specifically in December, it was a -- 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 21%. So it sort of contracted over all as the traffic contracted. The interesting thing is that at same time, and if we had even 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 had asked me at the end of November guidance at the low end I would have said it looks as if we can if these traffic trends continue.

And with the 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 effected our planned store visits, which is something that we can change and already in the process of changing.

Okay. That's very helpful. Thank you.

Yes.

Thank you. Our next question comes from the line of Greg Pendy of 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 further out would you pursue paying early lease determination costs and removing stores that are headed in the wrong direction?

Well, clearly if there are stores 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% of our doors in unprofitable. So if you think of the macro strategy of what we can do first we're in a -- we're in a unique situation here in that we do have 80% of our or 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, the types of malls we're in, whether we're in a mall or not and that's kind of a good thing in this environment that we're not stuck in a vast majority of ten year leases with automatic rent 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.

The strategy is to take the portfolio and look at it, try to get out ahead of what's happening, look at it in the way of where are family's 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 comps Discovery did comp positive and if you breakdown the malls, in the A, B and C malls you're going to see certain malls worked for us.

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 the -- kick the can on some of these leases and leave them in the Heritage store just to squeeze the four wall out, just to squeeze the profitability out as the mall environment evolves. So, we're being very selective on the doors that wear touching. And with the concourse shop it gives us leverage in the negotiation of whether we want to go back into a mall or shift to a concourse shop.

Because we don't have to resign the lease. And the malls really like these concourse shops that we have created. They're out in the center area of the 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 a fixed box so it's additional revenue. They are significantly less expensively than a remodel.

They have much shorter leases generally more in the three year versus the ten year range, they're moveable 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 to be more aligned of what is going to be the future state of how consumers shop.

Okay. Thank you. That's helpful.

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

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

Yes, good morning, Brett.

Hi, Voin, I just wanted to make sure that we understood what you said about, kind of, the pretax number. You said as we take the pretax number from the just finished 2016 and move out $5.3 million and add back the $6.6 million or so of charges under your income to adjusted income reconciliation towards the back of the press release, that you expect to surpass that in 2017, is that what you said?

Pretty close to that. So we have 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 is about $11 million and we believe we are going to be surpassing that number in 2017.

Okay. Yes, I had a little higher number of adjustments but I guess since we're at a talking pretax I shouldn't look at the income tax adjustment. So about $5.3 million (inaudible), got it. You're saying surpassing $11 million. Yes, 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. So 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 where the landlords are with other tenants and we're hearing that in the last few weeks from some of our contacts, I would think we're going to have reductions on most of these stores as they come up for -- at least compared to what your last year's lease was (inaudible).

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 that a lot of us have talked about this in its most acute form, the unsustainability of ten 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 you're looking from the P&L perspective as these rent streams get amortized over the life and straight-lined over the life of the lease, you know, the P&L impact may be lagging some of that.

Okay. Yes, I want to talk more offline. And then, I'm glad you're saving costs on new stores because I think that also means you're saving cost on the costs of remodel too. (Inaudible).

Absolutely.

When we think remodelling based on our work here at Nokomis, we thing the Discovery store format still are a necessary component of this business. But we kind of look at the commercial revenue and the franchisee revenue and call it mail box money because you get, it's other people's capital and other people's effort and you're largely getting, you know, sent checks in the mail and wire. And so we think that's an interesting component of what we have here. But the market may be telling us, and I personally think maybe they're over reacting.

Right now you're 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 franchisees and license agreements and return capital to shareholders because right now the market is telling you you're not a growth company and this is possibly a $1 billion brand internationally walking around in a $100 million enterprise value right now. So we think -- I'm not sure opening more stores in malls in North America, even if they're B plus malls is really what the market is going to reward you for and really makes sense from a capital allocation.

So we'll have talk more offline about that. But I just wanted to hear your response to that.

Yes, you know, of course it a he something we talk about a lot and the interesting piece about this, 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 costs me 20% of what it takes me to remodel a store, yet I get half the volume -- and expected half of the volume I would get for the remodel.

I can get out in three years. They have a lower operational cost and I have no lease hold. So I just back up a truck and move them out, move them to the next mall or move them to museum, move them to a zoo.

They just create tremendous flexibility. So when you're think about quote, unquote, all these stores, yes Discovery is a component but also Discovery stores in the format of concourse shops are a component and all these stores, don't think oh, it's another 25 square foot box that's stuck in a ten year lease with 3% increases every year. A lot of these stores are non-traditional executions like the concourse shops, like stop-in-shop, like a Gaylord store.

So when you're counting -- when you look at the store count year on year it has a lot of different types of stores in there. So, you know, 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 model at a time. Where are we in the mall, what are the anchors, does this make 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 engage in the brand in a digital way that's fine. But there's got to be this place where you go and actually Build-A-Bear.

No, I agree. In terms of opening the kind of brand new stores, whether or not or remodel and traditional mall stores, it might not be the best in a five year return on capital, especially when I look at your cost of capital is now, you know, that's afforded you by Wall Street. And on that note, by the way (inaudible -- multiple speakers).

No, Yes. Listen, I can't arguing with that. You've got a great point.

And the good thing is you transitioned from traditional stores to concourse stores, concourse stores you are -- it's kind of one timey, but you have a reduction in inventory so your free cash flow gets a bump from that. On that point is, (inaudible) some of the pretax and back most of the (inaudible) I mean the stock would have 7% or 8% yield if you did that. I don't the stock would stay here and we're not -- we're for building the long-term value of the franchise but it's something to think about when you can pay shareholders to wait while you continue to build out the international value of the franchise. But just something interesting to think about. So we'll follow-up offline (inaudible)

Yes. Thank you. We completely agree with the thinking and ultimately what you're saying with mailbox money 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 [Bowm] Private Investor. Please state your question.

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

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 and I'm glad you're watching our Honey Girls videos.

Million plus videos -- viewership, even in the last ones, couple ones that we posted at the first of the year. We do believe that that is a part of this digital solution that will bring Build-A-Bear into the new retail environment and the new engagement environment. We're excited about that.

We're also, of course, still like that there's more legs behind that from a distribution perspective and we're engaged in looking at and partnering with people to 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're certainly open to that. If that makes sense for a partner or a distribution arm. We feel like we're building equity in these properties. In fact, this year on our licensed front we will actually have a little girl's make-up brand that's Honey Girls branded.

Thank you. That does conclude our question-and-answer session. At this time I will turn it back to Ms. Sharon John for closing comments.

So, thanks so much for joining us. We look forward to speaking to you when we report our first quarter results.

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