Build-A-Bear Workshop Inc (BBW) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2005 Build-a-Bear Workshop conference call. [OPERATOR INSTRUCTIONS] And now I would like to turn the presentation over to your host for today's call, Miss Molly Salky, Director of Investor Relations. Please proceed, ma'am.

Good morning, everyone, and thank you for joining us for a review of our third-quarter results. With me this morning here at Build-a-Bear Workshop is Maxine Clark, Chairman and Chief Executive Bear; Barry Erdos, President and Chief Operating Officer Bear; and Tina Klocke, Chief Financial Officer Bear. Our call is being broadcast live via the internet.

The earnings release is available on our corporate website in the investor relations section at www.buildabear.com and a replay of both our call and webcast will be available later today. I need to remind everyone that discussions during this conference call may contain forward-looking statements. These forward-looking statements are inherently subject to risks and uncertainties.

Our actual results could differ materially from those currently anticipated due to a number of factors, including those set forth in the risk factor section of our 2004 annual report on Form 10-K filed with the SEC, and we undertake no obligation to update or revise any forward-looking statements. Maxine and Barry have about 25 minutes of prepared remarks, after which we will open the call up for your questions. Members of the media who may be on our call should contact us after this conference with their questions. We ask that you limit your questions to one question and one follow-up. This way we can get to everyone's question during this one-hour call.

Feel free to reque if you have further questions. And now I'd like to turn the call over to Build-a-Bear Workshop's Chairman and Chief Executive Bear, Maxine Clark.

Good morning everyone and thank you for joining us for our earnings conference call. Our strong results this quarter are evidence of both the broad appeal of our entertainment based retail concept and the strength of our model.

The result of the quarter also reflect that we are clicking on all cylinders. Revenue growth came from new stores, comp stores, internet sales, and franchising and licensing. Earnings benefited from our strong four-wall store model and our ability to leverage expenses and drive strong merchandise margins.

All in all, a strong quarter with results in line with our expectations. In our discussion today I'll start with a brief recap of our financial results followed by a review of our marketing and brand-building programs, merchandise programs, and an update on our new-store plans. Then I'll turn the call over to Barry for further details of our financial results and a discussion of our international franchising and licensing businesses and then we'll open the call for your questions.

First, I'll recap our financial results. Third quarter total revenue increased 26% to $84 million compared to last year, with the growth driven by an increase of $17 million or more than 25% in net retail sales. Retail sales growth in the third quarter was fueled by new stores opened during the past 12 months an increase in comparable store sales of 1.3%, and an increase in internet sales of 54%.

We continued to see the strongest comp sales performance coming from our oldest stores, which again points to the staying power of our brand and our unique retail experience. Total revenue benefited from growth of international franchise fees and licensing revenue which increased $485,000 in the third quarter and $934,000 year-to-date.

For the first nine months of fiscal 2005 total sales were up 21% with net retail sales accounting for the bulk of the growth and comp store sales were flat. Third quarter net income was $5.3 million, and included flagship store preopening costs of $300,000 net of tax.

This compares to net income of $3.5 million in the fiscal 2004 third quarter. We are very pleased with the continued improvement in our merchandise margin despite economic challenges such as rising fuel costs and transportation costs. We are able to leverage our larger purchasing power and work with our manufacturers to deliver a higher merchandise margin.

The strong performance of our new stores and leverage on central office and payroll expenses also contributed to the growth in our net income for the quarter. Barry will provide more information regarding these improvements in his detailed comments.

Year-to-date, net income was $16.7 million this year, compared to $13.7 million in 2004 or a growth of 22% on flat comp store sales growth. Embedded in these results are the impacts of Hurricanes Katrina and Rita. As a result of Hurricane Katrina we have one store in Metairie,Louisana that remains closed today the store located in the Lakeside shopping center is currently estimated to reopen no later than mid-November. As a company, we acted quickly to partner with our guests to help those impacted by the hurricane we sponsored mini Stuff-With-Hugs events in all of our gulf shore stores.

Stuff-With-Hugs annual charitable event where we invite guests to make a special bear for free and donate that bear to a child in need. Bears made through these events were taken to shelters throughout the gulf coast to children who had be displaced by the hurricanes. We received hundreds of letters from both guests who made bears, and families who received bears, telling us how much comfort a stuffed animal can bring to a child who's lost so much.

This holiday we'll be selling special Hugs-of-Hope bracelet one for you and one for your bear the proceeds will be donated to the Red Cross to benefit victims of Hurricane Katrina and Rita.

Let me turn now to a review of our marketing and brand-building programs in the quarter. Marketing spending on a year-to-date basis was about 6% of revenue, a rate similar to last year.

We continue to target full-year spending at slightly less than 8% of revenues this year for $28 to $29 million. Our total spending last year was $22.7 million, or 7.6% of retail revenues. As we have said our integrated marketing plan is the cornerstone of our brand building strategy. We use several tools to attract new guests to our stores and bring existing guests back again and again.

Our integrated marketing programs in the third quarter included our ongoing national TV advertising which ran on national kids and family cable stations for approximately five weeks, the primary cable networks that we use are Nickelodeon, Cartoon Network, Nick at Night and Toon Disney. We also include our ads in some Saturday morning programs such as ABC Kids, NBC Discovery Kids and Fox for Kids.

We continue to evolve and develop both the integration aspects of marketing, focusing on getting all of our marketing components to work together, but also evolving our TV advertising. As you know, we spend a lot of time talking to our guests and involving them in our marketing and product development, to be sure that we're connecting with them on an ongoing basis.

Based on the feedback we received, we developed new TV ads for the fourth quarter that focus on real guests not actors and actresses talking about their store experience and what makes Build-a-Bear Workshop special to them. The campaign started this past Monday October 17th, with the official launch of our fourth-quarter integrated marketing program which we refer to internally as ‘Out of the Mouths of Babes’. You can see our newest ads on our website. Fourth quarter marketing programs are in full swing with our latest TV ads running through December 16.

During the fourth quarter we expand our television advertising to target adult women, as we did last year. In fact, for eight of our markets this will be the third holiday season for TV advertising. Our back-to-school holiday catalog was mailed during the third quarter, direct mail strategies are a major component of our integrated marketing program and include five catalogues per year.

Our holiday catalog will arrive in guest homes the week of October 30. We had a busy summer schedule with in-store events designed to give our loyal guests a special reason to return to our stores we launched four new animals in the third quarter, anniversarying similar launches in 2004. This years World's Wild life fund Giraft was our second largest WWF launch since we started the program in 2000.

The annual Best Friends Run for the Stuffing sweep stakes took place in early August through September of this year. And Bearmy's Birthday Bash was celebrated in late August and is a much anticipated annual event.

NFL kickoff weekend in early September celebrated the official launch of our NFL licensed bear apparel. During the third quarter, our On Tour mobile workshop visited ten events across the United States, including the All Star Baseball game in Detroit, six state fairs and a NASCAR race in Bristol, Tennessee. The mobile workshop will visit three more NASCAR races this year and the famous – Nellis Air Force Base air show in Las Vegas during the fourth quarter.

Along with these marketing programs, we introduced new merchandise in our stores during the quarter. Our stores typically offer 30 to 35 animal skins and approximately 400 SKUs which regularly change to reflect seasonal fashion, holiday special offerings, and introductions of new merchandise.

In a typical year we introduce approximately 20 new animal skins. Some of these become part of our permanent collection and some are available for a limited time. Cuddly Candy Teddy is our limited edition collectibear for Halloween 2005 and this has been a very strong seller. This bear will sell out on schedule, just in time for Trick or Treat.

The human fashion environment continues to drive what our guests want for their bears and we continue to sell skirts, decorated and distressed denim and T shirts, anything with glitter and glitz.

One of the highlights of our third quarter is the arrival of our Halloween costumes. Halloween is a growing retail category in general, and we are no exception. We sell hundreds of thousands of costumes in the second and third quarter. Best sellers this year are Batman and Spiderman, Tinker Bell, Witch, Diva, Pumpkin and our newest addition the Wizard of Oz series.

Typically costumes are the highest ticket clothing items in our collection. One of the best sellers on the web this year was the complete collection of animals dressed in the Wizard of Oz costumes which sold as a set for $200. This collection has a double appeal to guest segments -- Build-a-Bear Workshop fans and Wizard of Oz collectors as well.

In addition, we continue our sports offering which includes the National Football league, MLB, National Basketball Association, the WNBA and NHL team uniforms. Of course the major league baseball playoff generate additional sales and this week we'll deliver American League and National League Division Championship Tees to Chicago and I'm sorry to say to Houston as well. We'll do the same when the world series winner is determined.

And now for what you all have been waiting for, the announcement of our holiday animal. The very cute and cuddly Frosty the Snowman will be revealed today in our in-store calendar and to guests this weekend at our Kooky Spooky Bear Bash in our stores. We are very excited about Frosty and Friends which will arrive in store for Veteran's Day weekend November 11, as part of the official holiday kickoff.

Along with Frosty who has light up cheeks and looks great in his magical hat and accessories come his three co-stars for the holiday classics, Karen, Hocus-Pocus and Professor Hinkel. Of course you could add Frosty the Snowman sound chips and we will sell limited versions of the DVD. Just in case you were wondering, Frosty looks great in all of our apparel, and has his own holiday train as well. We even have a limited edition gift card with Frosty's image that we're sure will be a hit. On November 11, we'll also begin our TV commercials that feature Frosty exclusively at Build-a-Bear Workshop.

As you recall in 2004, we ran short of our holiday animal Rudolph the Red Nose Reindeer, while generating a 23% comp store increase in the fourth quarter. We believe we have planned appropriately to meet the demands of our guests for Frosty in 2005.

And finally with regard to friends 2B made merchandise last weekend we introduced a new collection of Sweetheart Dolls in our five friends 2B made stores.

The Sweethearts are larger, plumper and cuddlier and have a higher price point. $16 versus $12 for the friends dolls. We think they will appeal to a slightly younger guest and offer our doll guests even more choices. We continue to learn what our guests want and to be excited about our friends 2B made concept.

Let me give you a quick update on our store locations in the United States and Canada. During the third quarter, we opened seven new Build-a-Bear Workshop stores, the same number of stores opened last year in the third quarter. Through the nine months we've opened 23 stores compared to 15 in the first nine months of 2004. We do not anticipate any store closing in 2005.

As mentioned earlier, our new store openings have been exceptional, stores in both new markets and in markets with existing stores, have had very successful openings with strong continuing sales trends. Third quarter openings included our store in Mall of America and Minneapolis which opened on July 15 and includes the friends 2B made store adjacent to and connected to the Build-a-Bear Workshop.

We opened one additional friends 2B made store in the St. Louis galleria, adjacent to our Build-a-Bear location in early September. The Galleria store brings our friends 2B made store count to five at the end of its second year of operation, very comparable to Build-a-Bear Workshop, which had four stores opened at the end of its second year of operation. Also during the third quarter we opened the ‘Eat with your Bear Hands café' in our New York City store. The restaurant is being managed for us by [Levy ] restaurant company.

With the cafe open the flagship store is in full swing with three private party rooms and local marketing and in store events. We will host special events in December like breakfast with Santa and breakfast with Frosty exclusively at our New York City store. The Flagship store is meeting expectations and we look forward to a great holiday season on Fifth Avenue.

We will open an additional seven Build-a-Bear Workshop stores in the fourth quarter, bringing our full-year total new stores to 30. The seven openings include two stores in Canada, one in Dartmouth, Nova Scotia and Oshawan, Ontario, bringing our year-end Canada store count to nine.

Now let me turn to a few comments regarding our outlook. Based on our performance to date we are comfortable with the mid-to high end of our earnings guidance for fiscal 2005. Our previously announced guidance includes net income in the range of $25.1 million, to $26.3 million, which represents net income growth of 26% to 32% or diluted earnings per share of $1.24 to $1.30. This guidance assumes total revenue growth of 15% to 20% and flat comparable store sales for the year.

In closing, I'll repeat that our strong merchandise margins continue to get stronger, our integrated marketing programs reinforce each other so that one plus one can equal ten. Our innovative product appeals to a broad customer base and as always, our associates deliver an exceptional experience. We look forward to delivering on our plans in the fourth quarter, we have confidence in the broad appeal of our unique entertainment-based concept and in our business strategies and we believe that the economy's staying on track we can deliver a solid 2005 performance.

Now Barry will take you through more detail on our results and growth plans.

Thank you, Maxine. And good morning, everyone. I'll provide some additional comments on our financial results, update you on our performance in the northeast region, our international franchising, and on our licensing programs. And provide a few additional comments on our outlook specific to the fourth quarter.

I'd like to first expand for just a moment on Maxine's analogy of our business clicking on all cylinders. What is powerful about our business model is the significant net income growth our business can drive to the bottom line. Importantly, we have several cylinders driving out growth. And unlike other retailers, we protect our merchandise margins and don't use markdowns or promotions to drive our sales. Finally, our high-store sales productivity drives the superior store economic model that we enjoy.

Now for an update on our northeast region performance in the third quarter. While the region continued to post comp store sales below the chain-wide average, we saw improvement as the gap in performance began to narrow. Changes we've made and the management focus we placed on the region's performance have made a difference and we expect continued improvement going forward.

Moving now to some additional details regarding our third-quarter performance. As we said, our net retail sales increase in the quarter was driven by sales from new stores opened during the last 12 months, comp store sales growth and our internet sales. Growth of internet sales, which are included as part of net retail sales and not in our comp store base accelerated in the third quarter increasing 54% to $1.4 million. Internet sales are up 35% for the first nine months of the year.

In 2004 internet sales for the year accounted for about 2% of total retail sales. We recently moved our internet sales fulfillment operation into a new 12,000 square-foot facility here at our World Bear quarters in St. Louis . The operation is highly efficient and we are prepared for higher sales as we enter the fourth quarter gift-giving season.

Predictors of consumer trends point to internet sales and gift card sales as being big winners this holiday season. We are well prepared for both. Our gift card program this year includes several new card styles that will allow the giver to customize and personalize their card. Our popular upsale program will be in place again this year to provide an incentive to add on a gift card to any purchase. And gift cards will again be available as Walgreen’s nation-wide.

We have all of our marketing tactics in place to support this growing business. From in- store signage, to direct mail, to internet marketing. As an experience-based retailer, it's a natural to give the gift of Build-a-Bear Workshop through a gift card. And remember that our gift card sales will benefit our first-quarter results when they are redeemed in January, which for Build-a-Bear Workshop is in the first quarter.

Third-quarter net income reflected higher store preopening costs offset by the leverage of comp store sales growth on costs and expenses, higher new store sales, lower stock-based compensation expense, and higher interest income. Gross margin rate improved 30 basis points to 47.7% as a result of leverage on fixed costs primarily occupancy expense and as Maxine mentioned, continued strong and improving merchandise margins driven by our increased buying volumes.

Our third quarter SG&A expense, as a percent of total revenues, improved 80 basis points to 37%. In part, due to lower stock-based compensation expense in the current quarter versus a year ago and also improvement in store payroll and central office expenses.

And finally on the income statement. Interest income increased as we earned interest -- earned interest on a higher cash balance this year versus last year. Cash balance at the end of the quarter stood at $51.6 million compared to $15.7 million a year ago.

Further to the balance sheet. Capital spending in the third quarter was $6.6 million, up as planned from $5.1 million in the year-ago third quarter. Through the nine months of the year, capital spending totaled $22.7 million, on track with our full-year spending estimate of approximately $30 million.

Higher capital spending in 2005 reflects the higher than typical costs associated with the flagship store in New York, more new-store openings this year versus last year, and several key systems development projects underway or near completion. We expect continued strong operating cash flows throughout 2005 and with our board remain committed to evaluating alternative uses of our cash -- including, reinvestment in our business, dividends, share repurchase, and strategic opportunities -- and determining which alternatives best enhance long-term shareholder value. Let me turn now to an update on our international franchise business.

So far this year we've added eight new international stores for a total of 20 stores. New stores in the third quarter were open in the United Kingdom, Japan and our first store in Taipei, Taiwan. We've also added this year four additional countries to our international franchise program, we added the Benelux countries, which include Belgium, The Netherlands and Luxembourg and most recently we added Norway. These country agreements bring the total number of international countries with franchise agreements to 12.

Our fourth-quarter plans call for opening about 12 new stores for a full-year total of approximately 20 new stores, down slightly from our original estimates due to the timing of identifying acceptable store locations from both a location and a size perspective. Although many of the stores not opening that we thought will open in spring of 2006.

So far in the fourth quarter we've opened in Wimbledon and Covent Garden in England and in Amstelveen, which is a suburb of Amsterdam, Holland, which is our first store there. International franchising revenues totaled $846,000 in fiscal 2004, our full-year outlook for 2005 remains for this level of revenue to more than double to approximately $2 million.

As you know, the franchise fee revenues include the combination of initial one-time development or country fee, paid when the franchise agreement is signed, and recognized into income over the life of the agreement. And a 7.5% royalty fee on revenues generated by the international locations.

Another component of our total revenues are licensing revenues. We continue to actively work with about 40 licensing arrangements with third-party manufacturers to develop a collection of lifestyle Build-A-Bear Workshop-branded products. Products today include mini Build-A-Bear stuffed animal kits, greeting cards and calendars, scrapbook supplies, Christmas ornaments, children's shoes, slippers, sleepwear, books, and other categories as well.

Licensed products arriving in department stores this month include girl's sportswear, activewear, T shirts, sleepwear, and lounge wear. Licensing revenues in the third quarter were as planned. Our full-year outlook for 2005 remains for this level of revenue to approximate $1 million as the bulk of licensing revenues are received in the fourth quarter.

Importantly, we are very selective in our license arrangements and are looking at these initiatives as potential to enhance our brand, raise brand awareness, and drive increased revenues and earnings.

In closing, I'll make a few additional observations concerning our earnings outlook specific to our fourth quarter. As we discussed last quarter, we have allocated a higher percentage of our marketing and advertising spending in the fourth quarter of this year compared to last year.

We've targeted our full-year marketing and advertising spend at $28 to $29 million compared to $23 million last year. A higher percentage of that spending, approximately 51%, is targeted for the fourth quarter of this year.

In 2004 approximately 48% of the marketing investment was spent in the fourth quarter. Also, our 2004 fourth-quarter results included some unusual charges that will not recur this year. Stock-based compensation or cheap stock charges were recognized in the third quarter and fourth quarter last year. These costs, which were embedded in SG&A expense, totaled $500,000 in the third quarter and $1.4 million in the fourth quarter.

Also recognized in the fourth quarter last year was an unusually high level of bonus expense associated with our outstanding performance in 2004. A large amount of this bonus expense was recognized in the fourth quarter due to the uncertainty of achieving the bonus targets. The level of bonus expense is not expected to be as large this year, particularly in the fourth quarter. This concludes our prepared remarks and now we'd like to open the call up for your questions.

[OPERATOR INSTRUCTIONS] And our first question will come from the line of Tom Filandro with Susquehanna Financial Group. Please proceed, Tom.

Maxine, question for you. friends 2B made You've had some time now to sort of evaluate that business. You've expanded the assortment there. Can you give us a little more color on -- or maybe just a clearer view on what your expansion plans are for that business? Thank you.

Yes, we are continuing to expand. We are negotiating for leases as we speak. We have several done already. And we're looking, you know, probably next year like we did for Build-a-Bear in our third year, somewhere in the neighborhood of five to ten expanded stores, some will be next to Build-A-Bear stores, some might not be.

And we're moving along and the business is developing and we are learning and we'll comp our first stores at the end of -- middle to the end of November. And it's -- like it is for Build-A-Bear Workshop II. We're always learning and growing and changing our which is to evolve it and make it as good as it can be. You learn about new categories that are selling better than others and that's just part of our job on an ongoing basis.

Thank you.

And your next question will come from the line of Brian Tunick with J.P. Morgan. Please proceed, sir.

Hi. It's Evren for Brian Tunick. I have two questions. The first one -- we've heard that mall traffic hasn't been that spectacular over the last quarter, especially in September, and your performance has been pretty strong. Can you talk a little bit to that reconciling those two things?

Yes. I think as Maxine said earlier in her remarks, we sort have not traditional retailer, that we're -- the events that have taken place, both regionally and on a macro level tends to affect mall traffic, which we see, okay, really has a lesser affect on us because we're an experience and, remember, our experience of 45 minutes or so with an average price sale of $32 really sort of -- you get a lot for the time spent in our stores.

Also, everybody celebrates birthdays and there's always a reason to go to the mall. So I think based on what we've seen and what we've seen historically with our business, we have a lesser affect from a negative standpoint with some of the macro issues hurt other retailers.

Thanks. If I can have a follow-up. This is about your merchandise margins. Can you tell us how much merchandise margins improved year-over-year in the quarter and kind of what the future opportunity may be specifically for 2006 in terms of growth maybe on a basis point basis? Thank you.

Yes. We don't talk about merchandise margins. I mean I -- could you -- I apologize. Could you sort of restate the question as I didn't hear all of it.

Right. So your merchandise margins improved and you said you don't talk about what the merchandise margin is but I was wondering if you can give us a sense of how much they improved year-over-year because we know how much your growth margins improved to 40 basis points, trying to figure out how much of that comes from the merchandise margin improvement and what we can expect going forward for 2006 in the longer term?

Much of the improvement was a leverage on -- on the occupancy. So you can see that comp store sales really are a great motivator when -- when it's up we obviously show a better external reporting of our margins, but we continue to have great relationships with our vendors, our volumes that we order are getting higher and higher so we are able to get equal to or better pricing even -- even in spite of some of the conditions relative to natural resources.

So -- and again we have that ability of not being a volatile margin business because we really have no markdowns to speak of. So all the positive aspects of the quality -- and I think that's the key. The quality of our margin are in place and again with very little volatility attached to it. So we look forward to either -- to remain at or slightly improving our merchandise margins. But again you need to tie that to how well we perform on a comp basis.

Thank you.

Your next question will come from the line of Paul Lejuez with Credit Suisse. Please proceed.

Hi, guys. One clarification if I can and then a question. When you guys talk about the best results coming from your mature stores, are you talking about the highest comps coming from mature stores, or are you talking about productivity on the sales per square foot basis?

And then the question, wondering if you can talk a little bit about what drove your comps? Was it transactions or transaction size? Maybe you can talk a little bit about month-to-month performance. Thanks.

We're not going to talk about month-to-month performance, we report on a quarterly basis. But let me say that the -- you have to look at all of our stores. In the oldest stores the comps were very strong. In some of those stores are also the highest productivity stores but also we have highly productive stores in places that are still well over $600 a foot but that may not have comps. So the model itself is very, very strong.

We've talked to you about the pressure in the past in the northeast. Those are some of our highest productive stores. They may not be our highest comp stores. But it really -- it really is -- look on a store by Store basis where that store's located, you know, is it in a tourist location, is it in a -- is it the only store in the city? Is it -- all those kinds of things, Paul, go into account.

So you can't look at it on a -- just one of those factors. The other is that traffic is really what drives our business. We've said this since the beginning of our time. There's no correlation really to stores that have the highest -- what we call honey per guest or average transaction to the highest productivity or the highest comp store sales. It really is about traffic.

And some of our best stores may have a transaction value of $32 and some may have one of $28 or $29. It really depends on the traffic of those malls and the community. And we have many, many stores having much improved traffic this quarter even over last quarter, which was -- last year's third quarter which was also very strong.

And, again, as Maxine said, the comp of 1.3% for the quarter, the most part was a derivative of transactions and not the average sale.

Were transactions way up and average sales down or --

Talking about 1.3%, so without giving information we normally don't, it's -- it's in line with the comp growth relative to the transaction.

Okay. Thanks, guys. Good luck.

Thank you.

Your next question comes from the line of Sean McGowan with Harris Nesbitt. Please proceed.

Hi. Thank you. A couple questions on -- one quickie. Is the -- the comp include only the -- the Build-A-Bear Workshop stores and not the friends 2B made stores and will that be the case in the future?

It includes -- well, friends 2B made stores are part of Build-a-Bear Workshop stores so when we made a friends 2B made store next to Easton -- first of all they haven't comped yet, those two stores haven't comped yet, they won't comp until November. But they're part of a store so those stores come out of our comp base. So Easton and Robinson, which opened last year, are not in our comp base, they'll come back into the comp base in December.

Okay. And on internet sales, could -- I think you mentioned that they were up 35%.

No.

Year-to-date.

Year-to-date.

54%.

Consistent rate of improvement throughout the year?

It was higher in the -- in this particular quarter and we think some of that has to do with the time period of people not, you know, traveling due to the, you know, hurricanes and whatever but still needing to buy birthday gifts and gift cards and things like that, so -- also we had -- we came out with a very strong line of our holiday -- Halloween costumes and whenever we have a new launch and a new catalog that comes out our web sales do spike but this was a much stronger spike than usual and it's consistent with what other people are reporting about their web businesses based on the economy, travel, gasoline prices, etc.

Will you be providing that internet sales figure on a go-forward basis for each quarter?

Yes.

Yes.

Thank you.

Thank you.

Our next question comes from the line of Janet Kloppenburg with JJK Research. Please proceed, ma'am.

Good morning. And congratulations on a great quarter.

Thank you Janet.

I know your last name, Janet.

She actually got it right. My question is when you look at the growth of the internet sales and your discussion about looking for a big gift card business. Could you think that that -- those -- the rate of growth of those two vehicles could maybe be hindering the comps and did you think about that a little bit when you planned your fourth-quarter comps? I mean could it be that the gift card business is stronger and the comps might be a little lighter but you get it all back in the end?

Well, we are planning our web business up substantially but we have funded up every single holiday season since it's been in existence and we have sold -- we have a history of this, almost to the day we can predict our business by a day-by-day business. It's far more predictable than mall traffic, I can promise you that. At least as a percent to that day is to the month. I think we have taken into account the good news is that the day -- between Christmas and New Years are -- is one more day this year than last year and it's in our December which allows for a lot of redemption of gift cards that still impact us positive in our stores. They're not that they're not redeemed on the web but they're more -- the vast majority is redeemed in our stores and therefore -- and gift cards burn a hole in the kids' pocket usual the day after Christmas there's a line waiting outside our stores just like there is the day after Thanksgiving waiting to buy gift cards, waiting to come back in and have the experience of making their own stuffed animal with Grandma or their Aunt or whoever gave them their gift card.

Okay. So you think the gift card business can be strong and the comps can still sort of be flat? What did you say --

Yes.. I mean a sale is a sale.

Right.

And -- you know, if it's comp, fine, if it's internet, it's fine. We don't -- we don't think about that. We just think about the top line in general.

Right.

We're very happy about the internet sales. We don't report internet sales, as many retailers do in the comp base because, you know, we try to be as pure as we can on a comp store base. But again, a sale is a sale is a sale.

Okay. And then my other question is I know the stores in the oldest markets are comping -- I think you said at the highest degree -- highest level in the company. Could you maybe talk about stores that have been open a year now and two years and how their comps look and what you're learning from that? I mean is there a backup in the first year and then in the second and third year you start to see acceleration again?

Janet, it depends again, you know, on so many things. You can't just look at it like that. And I don't mean to avoid your question.

No -- To deal with sort of filling in the market with stores. So if you could just --

The store -- if a store is annualize itself and it's in a market where there's not new stores opening up on top of it then more than likely it is moving into what we call a steady-state business and it ramps up to a certain level and then it -- it solidifies and then it starts to have comp store increases. Sometimes very strong ones. It is -- it really depends on the market, depends on the part of the country it's in, the growth in that particular economy and that area.

There are a lot of things that go into that. But generally speaking, the -- what you can count on is the stores that have been opened just -- when they comp themselves after their first opening, they do have a -- have a time where they're down pretty substantially because our openings are so strong and this year they've been even stronger. And then they come back up. And sometimes they come up faster than others, it just depends.

The earlier in the year they open up they kind of seem to get to a steady state and we are -- but it really, really depends on the market, the economy of that market, the other Build-A-Bear stores in the market, what other kind of -- events might be going on in the market -- visiting in the market. There are really lots of things that can drive the transactions and the sales in that particular area.

Okay. Great. And then my last question, Maxine, is when you think about friend 2B made and the successes you're seeing in that business, do you think that at some point in the future you'll talk to us about maybe accelerating the rollout of that business?

I'm sorry, I didn't hear your last sentence.

Rollout of that business.

Rollout.

Right now, you know, it's an important part of our growing strategy but it's not the mothership and we really are focused on making sure that the mothership is -- still has so much growth going for it and we do plan to grow the friend 2B made business but we will talk about it probably more as it gets to be a more substantial part of our -- our infrastructure as well as our sales base.

The same -- you know, we had -- last -- the second year of Build-a-Bear Workshop we had four stores, we have five friend 2B made stores and again, compared to the 200 Build-A-Bear stores that's small in relative terms.

Your next question will come from the line of Jaison Blair with Rochdale. Please proceed, sir.

Good morning, how are you?

Morning.

Congratulations on the third quarter.

Thank you.

Thank you.

Maxine, with Build-a-Bear you've kind of proven that you're a great merchant and --

Thank you.

You clearly have really kind of put yourself on the map, not that you weren't there before. Now, what -- what we've often times found with some of the great merchants is that when their winning concept begins to mature they tend to say well we can do it again. Home Depot tried to do it with expo and Villager and it didn't work. Wal-Mart's trying to do it internationally and there's some debate whether that's doing. TGX is trying to do with AJ Right and Home Goods.

Those stores have really poor economics. So you have Build-a-Bear which has excellent economics and now friend 2B made made from store walks I've done, friend 2B made just doesn't seem to be a Build-A-Bear. And in '06 it looks like you're going to do five, ten stores you've said -- kind of said -- excuse me.

Excuse me.

In -- in -- you've said you're going to roll out five to ten stores in '06 as part of your growth strategy. It appears to me that you're ramping this thing up and I guess I am wondering, is it premature? 24 to 36 months down the road are you going to end up with a friends 2B made store base that's not generating returns or not generating the sales per square footage and is that going to be a drag on the total company's valuation?

I guess -- you've said that in the second year of Build-A-Bear you had four stores in the second year of friends 2B made you have five stores. What are your sales per square footage in your kind of -- your economics of your stores early on for Build-a-Bear and how do those compare with the economics --

Our first store opened up at the St. Louis -- Galleria it was 2200 square feet and it did $1.7 million in the first -- you can do the math itself. But friends 2B made is a subset of the customers that shop at Build-A-Bear Workshop. We've never said anything else.

Obviously Build-a-Bear Workshop has a broad customer appeal from three to 103, boys and girls, teenagers, Teddy bears are a universal product where dolls are appealing to girls and a certain age set of girls. So we've always understood that from the beginning. We've built the model and the margins to support that level of business and that subset of customers. And we are I think doing exactly what you're suggesting, going about this in a very modest way. Building the business, adding -- it is adding revenue to our business and it is not added substantial infrastructure to our business. It is not adding -- a lot of things yet until we see how much more business it can get.

The other thing is you kind of sometimes have to let go and say okay, what are we going to do to make it into a giant concept? If it was started by somebody else who didn't -- wasn't attached to it having this mother brand build a bear's workshop how big could it be? Could it be bigger then we are -- could grow faster even than what we are growing right now like a lot of good companies who have big businesses to still grow and protect and also have other ideas they want to develop we're monitoring it and doing it on a very -- what I would consider to be a very sensible and strategic way.

Our merchant -- we have great selling staff in these stores, products are doing very, very well, but again it is not the same customer base as Build-a-Bear Workshop and when I started Build-A-Bear Workshop people told me it would never be successful, it was for 3-year-olds, no adults would ever shop there, you know, all kinds of things and -- not that I don't -- I'm not cautious of those kinds of things but I think we have a much clearer understanding when we develop friends 2B made of who our customer base is and how to market to that customer base than we ever did when we started Build-A-Bear Workshop. So we have all that sort of planned into the model, Jasion.

We'll take the next question, please.

And your next question comes from the line of John Zolidis with Buckingham Research. Please proceed, sir.

Hi, guys. Nice results.

Thank you, John.

A couple of questions. I wanted to I guess first just one housekeeping question. Can you give me the period end square footage and just tell me whether that's a gross or selling number, please.

It's 599,000 square feet.

Your next question comes from the line of Arnold Brief with Gold Smith and Harris. Please proceed, sir.

Arnold but not -- not to be picky. Could you give us -- you have been doing what I would call aggressive spending I'm not sure that it is but you have franchise activities and license activities and your friends 2B made activities, all of which are growing rapidly from a small base. You have to have some infrastructure involved in each one of those activities. As you look at them, are they now losing money, and when -- if so, when do you see them swinging over to profitability?

Without giving you the P&L analysis of each one of those components, there is an infrastructure in place for all of those, business channels, not large, but clearly we understand the growth opportunities and we are geared to improve and increase the infrastructure as the business grows.

This has always been a lean kind of organization but make no mistake, there are people supporting our franchises all over the world from Bearquarters in St. Louis, the same goes with our relationship both internal here with our licensing partners out there.

And clearly, although we're leveraging some of the Build-A-Bear merchandising and product side people in friends 2B made, those people, though, are clearly tuned in to friends 2B made. And as that grows, so will the infrastructure. So we're not heavily loaded. I would tell you the spending relative to the revenue that we're deriving clearly is in line for where we are today.

Your next question will come from the line of a follow-up with Tom Filandro with Susquehanna Group.

Barry, can you give us color on the inventory levels and expectations as we head into the holiday because you did comment you'd be in a better position.

Sure. Good question. Our inventories on a per square foot basis are $56.60 this year versus $57.70 last year. So on -- a nice sales gain our inventories on sort of an apples-to-apples basis is down 2%. So where we were at the beginning of the year, which we said was more of a timing issue, the last two quarters now we were below last-year levels and we look for a continuation of that in the fourth quarter. We are very happy with where we are from an inventory standpoint.

Thank you.

Your next question comes from the line of Bill Sims with Citigroup. Please proceed, sir.

Hi it’s Tracy for Bill Sims. You stated in your release that you're going to begin expensing stock options in 2006. Would you be able to give us any color on the impact we could see?

Not really until -- until we get to that period because we -- we need to gather the information and see where we are relative to the pricing and numbers of shares. We will give more color and more detail as we -- as we get to the first quarter.

Okay. Thank you.

You're welcome.

Next question, please, Operator.

Ma'am, your next question is a follow-up from the line of John Zolidis with Buckingham Research. Please proceed, sir.

Hi. Just a follow-up question on the gross margin. Looking at the 1% comp, it seems to me that you probably can't get much leverage on occupancy and distribution costs as a result of that, especially if you assume that occupancy costs are increasing at some kind of underlying rate. So I was wondering, is there something else that caused the gross margins to go up? And how -- how much merchandise margins were up?

We gain them in both aspects of it. Clearly if one had to weigh -- weigh those components, it would be more on some of the quantity pricing that we take advantage of and some of the other efficiencies on the distribution side in spite of some of the higher energy costs, as well as slight leverage on our occupancy and other fixed costs.

Did IMUs increase as well.

Yes.

Yes.

Okay. Thank you.

You're welcome.

Next question, please, Operator.

Your next question will come from the line of Pauline Reader. One moment. Miss Reader has removed herself from the queue. The next question will come from the line of Sean McGowan. Please proceed.

Hi. A couple quick balance sheet cash flow kind of questions. Can you please give us the gross PP & E accumulated depreciation and what the D & A was in the quarter?

Sean, it's Molly. There's a full balance sheet in the press release and I'm happy to help you with any -- anything offline that you're not finding on the balance sheet in the press release.

Okay. Then can I ask if there were any regional differences that -- not regional differences but regional trends and, you know, anything that came out of different sales trends in different parts of the country that is noteworthy?

I don't think -- The base is still a lag -- but less than a lag, but, uh, we -- we have seen geographically nice performance across the nation.

Your next question will come from the line of Pauline Reader with Thomas Weisel Partners. Please proceed.

Hello. I was wondering, looking at your comps in the first half of the year and looking at it on a two-year basis, you guys jumped a lot in the third quarter. There was pretty big acceleration. And I'm just wondering kind of what you attribute that to? I know you spent a little bit more on marketing but that probably doesn't account for all of it.

And I mean maybe fewer second-year stores. I'm just trying to understand why -- why you saw such an acceleration or maybe your business is just inherently volatile? Can you help me out with that?

It's what we've said after the second quarter when I guess there was some modicum of doubt out there relative to what we said for the back half of the year based on the second-quarter results. But we felt all along that having compounded the advertising from a national TV point of view going into the back half of the year with six quarters, as Maxine said, we've had eight -- eight parts of the country markets that were even longer with the higher spend marketing, especially in the fourth quarter, that those were for the most part the reasons we felt good about the flattish comp guidance we gave, also we thought our inventories were in a little better shape from the standpoint of last year with 18% for the year, 23.5% for the fourth quarter, we were chasing a lot of business and ran out, which won't be the case this year.

So for those reasons is why we felt in spite of going up against spectacular numbers last year that we had an excellent chance of positively comping moves from a positive standpoint.

Your next question will come from the line of Rob Wilson with Tiburon Research. Please proceed.

Yes. I was wondering if you could give us some guidance next year on the number of stores you may plan to open and also could you give us some sense of this 8% marketing spend, will that change going forward, or will that be a constant 8% going forward.

We have a plan to open up 25 to 30 stores a year and that's been -- that we're on that program for next year as well. And our plan is to spend about that amount of money against marketing. But over time I expect that that will change. Some markets will be overall the market might be the same but some markets it costs more to advertise than others and on a market-by-market basis there are fluctuations but overall that it would probably stay around that amount.

At this time, I'd like to turn the call back over to Miss Molly Salky for the closing remarks.

Thank you, Operator. And thank you, everyone, for your participation today. Just alert you, the one -- one upcoming event we'll be speaking at the Harris Nesbitt playtime toy conference in New York City next week on Wednesday, October 26th. We look forward to seeing you there or speaking to you soon. Thanks again. Good-bye.

Thank you for your participation in today's conference. This concludes your presentation. And you may now disconnect. Everyone have a wonderful day.