Build-A-Bear Workshop Inc (BBW) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quarter Two 2006 Build-A-Bear Workshop, Inc. Earnings Conference Call. My name is Lauren, and I will be your coordinator for today. [Operator Instructions.]

I would now like to turn the presentation over to your host for today's call, Molly Salky, Director of Investor Relations.

Good morning, everyone, and thank you for joining us for a review of our results for our 2006 fiscal second quarter, ended July 1.

With me this morning are Maxine Clark, Chairman and Chief Executive Bear, Barry Erdos, President and Chief Operating Officer Bear, and Tina Klocke, Chief Financial Bear. In a moment, I'll turn the call over to Maxine who will provide her perspective on our second quarter performance and outlook. Barry will update you on our Company owned distribution center construction and international franchising. Tina will follow with additional details on our second quarter financial results.

At the end of our remarks, we'll open the call up for your questions. Members of the media, who may be on our call today, should contact us after the conference call 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 re-queue if you have further questions.

Please know that our call is being recorded and broadcast live via the Internet. The earnings release is available on our corporate web site in the Investor Relations section at www.buildabear.com, and a replay of both our call and web cast will be available later today.

I'd like 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 factors section in our 2005 Annual Report on Form 10-K filed with the SEC , and we undertake no obligation to update or revise any forward-looking statements.

Now, I'd like to turn the call over Maxine for her comments.

Thank you, Molly. Good morning, everyone, and thank you for joining us to review our second quarter performance. We are encouraged by our core in North American earnings performance, although our comp store sales in the quarter did not meet our expectations. Excluding the UK acquisition, Amsbra, our 44% core operating income growth illustrates both our profitable store model, and our disciplined expense control. Again this quarter, we delivered strong merchandise margins, delivered strong on-schedule new store openings, and made significant progress on our UK store conversions and our Ohio distribution center.

As I noted in our earnings announcements today, both our UK acquisition and our Company owned distribution center are important building blocks for the long-term growth of our business. We'll provide more details on our progress on these projects in a moment.

First, I'd like to address our second quarter sales performance. As we said on June 23, we believe our comp store sales this quarter reflect changes in consumer spending, resulting from various pressures on the consumer's pocketbook. We know these pressures come from the higher fuel costs, higher interest rates, and a weaker housing market. These non-discretionary cost increases are putting pressure on consumers, particularly on more discretionary purchases. While we continue to analyze our results for further insights into the trends, we can provide some initial take aways.

Our transaction count was down in the second quarter, while the value of our transactions continued to grow. The average transaction value, or honey per guest, as we call it, was up. The number of units per transaction was up, and our guest satisfaction scores are at all time high levels.

These statistics underscore the fact that we continue to improve our productivity per guest, and the accessories we offer are truly value added for the consumer, making the Build-A-Bear Workshop experience unique and special. This is an integral part of the entertainment component of our brand, and one reason our guest satisfaction scores stay high. So while traffic was down, we made the most of the transactions we had, an importantly, our guests continue to be highly satisfied.

I might add that these guest satisfaction results were particularly meaningful to our store operations teams that work diligently to keep payroll expenses at appropriate levels based on store sales levels. Our ability to keep payroll costs in line, and retain high levels of guest satisfaction is a meaningful accomplishment.

Our comp store sales results by age of store and by region show that our strongest comp performance comes from our oldest stores. This, I might add, has been a very consistent result, and points to the higher market awareness, and larger customer database that our older stores enjoy, and that these results show that the northeast region continues to be difficult, although improved from last year.

Also, our database analysis points to several other metrics that remain consistent this quarter. Over 60% of our transactions came from a returning guest. About 30% of our sales are gifts, about 70% of our guests are girls, and about 80% of our guests are 14 years old or younger, therefore, making 20% older than 14 years old. Our broad and diverse demographic profile among our guests has not changed.

Also unchanged is the feedback from our guests that they visit Build-A-Bear Workshop for a stuffed animal, and for the experience. The fun experience is as important as the merchandise they walk out the door with. Also, our approach to growing brand awareness remains consistent. We use marketing to grow our brands, not promotions and markdowns.

As always, we are continuing to dig into our data and further insights, and while macroeconomic conditions are not in our control, we continue to diligently manage our expenses, execute on our marketing and brand building programs, provide the very best guest experience, open new stores on plan, and successfully manage our UK acquisition integration and distribution center operation.

Let me now update you on our UK store conversion system integration and marketing plan. We converted seven Bear Factory stores to Build-A-Bear Workshop stores during the second quarter, and so far in July have converted an additional four stores. On Saturday, we will open the fifth converted store this month in Norwich at Chapelfield Mall. Our conversion process is meeting our plan and hitting all deadlines. Each conversion takes an average of 22 days. We are confident in our plan to convert all 25 stores in time for the holiday season. Additionally, we have identified three new store locations in the UK that we expect to open this year.

We continue to be very pleased with our new employees in the UK. These associates have acquired the Build-A-Bear Workshop brand DNA. They understand the importance of guest satisfaction, they are proud to be associated with our brand, and have embraced the training and changes in store operations that will help bring our brand to prominence in the UK.

Our plan is to celebrate our Grand Opening in mid-October when we are substantially complete with our store conversions. This celebration will include a number of exciting in-store events and public relations activities. Our goal is to introduce our brand experience to new guests, to demonstrate to returning guests that we are more than just a new name and new merchandise.

In the meantime, we are leveraging our merchandising and marketing expertise now. For example, during World Cup football, we featured our assortment of football, or soccer, as we call it in America, team wear for stuffed animals in our stores. The merchandise was spot on and quickly became a new favorite in the UK. We also coordinated the launch of Hello Kitty in the UK to coincide with the Hello Kitty launch in the United States and Canada. The launch that was similarly successful in the UK and Hello Kitty is one of our top sellers in both North America and the United Kingdom.

Our systems integration efforts are also moving forward as planned. We continue to receive daily visibility to key business metrics. Our ability to manage our UK operations is facilitated through the use of our existing back office and communications tools, primarily NSBs point of sales, merchandising and sales audit systems, in addition to e-mail, telephone and video conferencing.

Furthermore, our UK operations continue to become more autonomous with less direct involvement by US management and day-to-day operations. I made one trip in April to the UK to introduce Build-A-Bear Workshop to our new Bear Factory associates, and one trip in July to visit stores and work with our marketing and PR teams on our Grand Re-Opening plans. On my most recent visit, I toured several converted stores to ensure that they are on brand. I'm pleased to say that the converted stores I visited are 100% Build-A-Bear Workshop stores in presentation, and in passion.

Our experience in the UK so far reinforces our belief that this acquisition will deliver long-term value for our shareholders. Our ability to position our brand in the very best real estate locations in the UK, combined with driving higher sales through marketing, improved merchandise, and enhanced store experience, plus improving merchandise margin and gaining economies of scale by leveraging our expertise over a larger store base, will lead to earnings accretion in fiscal 2007 and beyond.

Let me now turn to a quick recap of our second quarter results. Our consolidated second quarter total revenue increased 27% to $93.7 million. Net retail sales increased $19.7 million to $93 million. This growth was fueled by North American stores opened in the past 12 months, UK store sales totaling $7.5 million, and sales over the Internet, which increased 32% to $1.7 million. Higher franchise fees and licensing revenues also contributed to the quarter-over-quarter total revenue growth as well.

Second quarter net income was $3 million, or $0.15 per diluted share on a GAAP basis, but includes several impacts directly related to the UK acquisition, including an operating loss of $2.7 million, lost interest income and lost franchise revenue. Also included in our GAAP EPS is stock based compensation expense of $0.02 per share. This compares to net income of $3.5 million, or $0.17 per share in fiscal 2005-second quarter. Last year stock based compensation costs had a $0.01 per share impact.

Importantly, our core North American business merchandise margins remain strong and steady in the second quarter, while overall retail gross margin declined due to the anticipated higher occupancy costs in the UK. The significant growth in our core business operating income again points to the strength of our store model, our strong and consistent merchandise margin, and our disciplined expense control. Tina will provide additional details later in her discussion.

With regard to marketing and brand building programs, we're excited about the potential of our new loyalty program launched this month. On July 12, we launched our Stuff for Stuff, automated frequent shopper program, and thus far we've converted about 18,000 guests per day to our easier and more accessible loyalty program. The program was piloted in the St. Louis, Atlanta, and Pittsburgh markets over the last two years, and we believe this added technology will assist us in driving even more business from our best guests.

Now for a quick store update. During the second quarter, we opened 14 Build-A-Bear Workshop stores in North America. In addition, we opened two new Friends 2B Made stores inside of Build-A-Bear Workshop stores in Riverside, California at the Promenade at Temecula, and in Boston's Historic Stanwell Hall.

Also during the quarter, we opened a successful new ballpark store at the new Busch Stadium here in our hometown. The St. Louis Stadium store was one of the two new ballpark stores opened this year. The other was in San Francisco at AT&T Park. We also reopened ballpark stores in Philadelphia, Cincinnati, and Cleveland, all in time for opening day of the baseball season. Baseball stadium stores are performing well this year. These results point to the continuing entertainment appeal of our concept, and the success of our brand in non-mall venues.

Our third quarter new store line up includes ten new stores, all in new markets, including new stores in Canada, as well as stores in Miami and Naples, Florida. Also opened this week, our first Build-A-Dino store located within the T-Rex Café at the Legends at Village West in Kansas City, Kansas. T-Rex Café, a joint venture between Landry's Restaurant and Schussler Creative, is a unique attraction that features dining and retail in an interactive, prehistoric environment.

Our new store within T-Rex will initially offer eight Dinosaurs. Each Dino comes with its own unique hangtag and facts about its species. Guests stuff their Dino Friendosaur's, add a heart filled with dynamite wishes, and can dress their Dinosaur in prehistoric Stone Age dino denim and fossil feet shoes. We plan to test our Build-a-Dino product in Build-A-Bear Workshop stores later this year to evaluate the possibility of expanding these products elsewhere in our chain.

Let me recap our outlook for 2006. Today we reaffirmed our previous guidance for fiscal 2006 earnings per share to be at the low end of the range of $1.44 to $1.53. This guidance includes the anticipated UK acquisition impact of approximately $0.13 per diluted share, stock-based compensation expense of approximately $0.08 per diluted share and distribution center transition costs of approximately $0.04 per diluted share.

Our full year assumption is for comp store sales to be in the flat, to negative low single-digit range. This guidance also assumes that earnings per diluted share for the third quarter will be between $0.09 and $0.12, which includes UK acquisition dilution of approximately $0.10 to $0.12 per diluted share, stock based compensation expense of approximately $0.02 per diluted share, and distribution center transition costs of $0.04 per diluted share.

As we anticipated, the distribution center transition costs will impact our third quarter as we plan to have the center fully operational in September. This guidance also assume that North American comp store sales in the third quarter decline in the middle single-digit range, while fourth quarter North American comp store sales are expected to be in the flat to negative, low single-digit range.

Our 2006 plan is to open 31 new Build-A-Bear Workshop stores in North America, and to add four Friends 2B Made locations, including one that will be separate from a Build-A-Bear store in Ontario Mills Mall in Ontario, California. In the UK, we look to open three new stores and are prepared to take advantage of additional real estate opportunities that may arise. Our real estate standards are very high, and although we originally thought five new stores would be possible this year, we have now identified three locations that are in negotiation, and we will continue to look for additional opportunities without compromising our standards.

Finally, I'll add that this management team, along with our Board of Directors, remains committed to evaluating alternative uses of cash, including reinvestment in our business, dividends, share repurchase, and strategic opportunities in determining which alternative best enhance long-term shareholder value.

And now, Barry will take you through more detail on our new distribution center and our international franchising business.

Thank you, Maxine, and good morning, everyone. We are pleased with our progress on our new Company owned distribution center in Columbus, Ohio. We expect the center to become fully operational in September. Our construction was completed earlier this month, and we've begun to receive and deliver inventory on a test basis, already. Our full conversion of inventory is scheduled for early August with shipping to commence in late August.

As I mentioned last quarter, we have in place in Columbus both a warehouse manager and a warehouse systems administrator. Since that time, we have added additional key players to the team, as well as our first hourly associates in preparation for our startup. The team all brings a wealth of past experience and expertise to our distribution and logistics function. We continue to hit our project milestones on time and on budget. We look forward to full operation of the DC and the benefits we anticipate through improved centralization of inventory, relative to our store base, improved speed to market, and the potential to reduce, and/or avoid transportation cost increases in the future.

Moving now to our international franchising business. During the second quarter, international franchisees opened three new stores, a store in Australia, in Denmark, and in Taiwan to end the quarter with 21 locations. Also in the second quarter, we added Russia to our franchisee family. Our Russia franchise is headed up by [Natasha Darnell], who is an experienced retailer in Russia, having established the Monsoon Accessorize brand there, and having previous work experience with Mothercare and Timberland.

Our Russian team plans to open their first Build-A-Bear Workshop store in Moscow later this year. Moscow is the largest and most developed city in the country with the highest disposable income per capital. In addition to Moscow, 12 other Russian cities have populations or over one million.

Western development thrives in Russia today. Retail markets continue to develop with the arrival of new brands and new retail operators. Shopping mall space grew by 46% in 2004, and continues to climb. Vacancy rates remain low. So in Russia, as in the case of many of our international locations, finding the right store real estate can be challenging. As always, we are willing to be patient to find the right space.

Last week, I attended the opening of our first Thailand store located inside a central department store in Bangkok. The store looked fantastic, and I was greeted by a large crowd of guests on Opening Day.

Based on our real estate standards and locations currently identified, we anticipate franchisees will open approximately 10 to 12 new stores this year, including our first stores in Norway and Russia, and additional stores in Sweden, Japan and Thailand. We continue to expect revenues from franchising to total approximately $3 million this year, up from $2 million last year. As you know, our franchise revenue includes the combination of an 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 fees on revenue generated by our franchise stores.

Now I'd like to turn this over to Tina for her comments.

Thanks, Barry. I'll add some additional details regarding our second quarter performance. First, I want to address why core business results were better than pre-announced on June 23. The difference relates to the tax rate assumptions related to our UK acquisition, which changed our quarterly effective tax rate.

In addition, our business results were better than previous estimates, primarily in areas of gross margin and expense control. As Maxine indicated, we continue to guide towards the low end of the $1.44 to $1.53 per share range, and recognize that there is still a significant amount of the year to go. Given what we know today, this range remains our outlook for the full year.

Now let me add a few comments on our UK acquisition. We closed the acquisition on April 2, and our financial statement this quarter includes the UK results for the full 13 weeks of the quarter. As expected, the UK acquisition results reflect the fact that we were in the process of converting 25 Bear Factory stores to Build-A-Bear Workshop stores. During the conversion, the stores closed for approximately 22 days. Yet during this time, we continued to pay rent, utilities, and salaries. These conversion costs contributed to the earnings dilution in the quarter.

The full acquisition dilution, which includes the operating loss and the loss of interest income and the loss of franchise revenue, which would have been recognized if the acquisition had not occurred, totaled $0.15 per diluted share. UK stores are not in our comp store base at this time. Stores acquired in the UK will enter the store base in the 13th month after the acquisition, in the case of the Amsbra stores we acquired from our franchisee, or in the 13th month after they have been converted to Build-A-Bear Workshop stores in the case of Bear Factory stores.

Our effective tax rate was also impacted by the UK acquisition. We now anticipate a full year effective tax rate of about 40%. Our previous rate last year was 38.5%. While the statutory rate in the UK is lower than in the US, we're not able to recognize the tax benefit of the operating loss at this time for financial statement purposes. We continue to evaluate strategies and opportunities to reduce our effective rate going forward.

Let me now move to some additional highlights in our financial statements. Starting with net retail sales which increased in the quarter $19.7 million driven by sales from new North American stores opened during the last 12 months, sales from our UK stores, and increase in sales over the Internet, and sales growth in our non-store locations, namely our ballparks. As anticipated, the gross margin rates climbed in the quarter to 43.9% due to a lower gross margin contribution from UK stores, resulting from higher occupancy costs, or establishment cost that exist in the UK.

Our North American core gross margin improved slightly, with improved merchandise margin overcoming the lack of sales volume leverage on fixed costs, and higher fuel costs. This is another factor that illustrates the strength of our core business.

Further to cash flow, our earnings released today does not include a cash flow statement due to the complexities involved in the consolidation of our UK operation this quarter, and this statement will be filed with our 10-Q by August 10.

Capital spending in the second quarter was $21.4 million, up as planned from $10.6 million in the year-ago second quarter and on track with our plan of total CapEx this year of approximately $60 million. Our spending this year includes approximately $24 million for the new distribution center, $10 million to $15 million for UK store conversion with the balance allocated to our new store growth and information system projects. Our balance sheet fully reflects the UK acquisition and the related goodwill.

In early July, we amended our revolving line of credit to include a seasonal over line. This over line increases our credit availability to $30 million from $15 million during the July through December season. This is our seasonal peak use of cash as we build inventory for holiday sales. In the process of establishing this over line, we able to improve the interest rate on the line as well. Finally, as I mentioned, we expect to file the 10-Q this quarter by August 10. Our Q-1 includes some additional disclosures related to the UK acquisition.

This concludes our prepared remarks. Now I will turn the call back to Molly.

Thank you, Tina. We'll open up the call now for your questions. Maxine, Barry and Tina are available to answer your questions.

[OPERATOR INSTRUCTIONS.]

Your first question comes from the line of John Zolidis with Buckingham Research Group.

Hi, guys. Good morning.

Good morning.

Good morning.

Good morning.

I know you talked a little bit about why the second quarter came in better than the pre-announced figure. I was wondering if you could expand on the gross margin, the expense control improvements that you saw relative to the point when you gave the pre-announcement? Then, given the better than expected element of Q2, are you taking down your second half guidance, or is it staying the same? Thank you.

It's staying the same. You could put your definition of the low end of our guidance because it is not to the penny, so you could look into that. But from the standpoint of the difference from June 23 to the close of the month, as Tina said, primarily it was the tax rate on a quarter by quarter by quarter basis for the remainder of the year that changed from an allocation standpoint; did not change how we thought the business from a tax standpoint would be for the year. That was not confirmed from all the people we needed to have it confirmed by until post June 23.

Again, June 23 gave us another approximately week and a half of business to go, and from that time until we closed the book, we picked up some additional margin improvement as well as SG&A improvement through many, many accounts. That's how you get from a reconciliation standpoint from the $0.07 to the $0.15.

Your next question comes from line of Brian Tunick with J.P. Morgan.

Good morning. It's [Evron] for Brian. I have a question; there is a difference you are seeing by age of store, in terms of the comp performance. Is it declining more in older stores or newer stores? Can you expand a little upon - you said it's consumer discretionary spending and macro drivers for weaker comps. If you can expand a little bit if you are seeing any differences by, like I said, the age of store, or anything else that we can understand a little?

The biggest difference in the age of stores is the number of people in the database and the people that we can market to. The older the store, the more customers we have in that marketplace, and those stores have annualize themselves, probably have also passed - as many factors that go into this as we've explained over the time, but they also have come against their own new store openings in their market, so there is not cannibalization, the impact of cannibalization. They are more than three years old, and they have reached a steadier state of business.

But, depending on the market, they could also be more or less impacted by the economic time. Some markets are faster growing than others, and could be younger; and some are faster growing than others, and are older, or even slower growth, but still doing well because they are in a mature and good base of customers for us. So, it really depends on a by store basis, but this is one factor that's been consistent. Our oldest stores continue to do better than stores that are newer, that have not yet reached their steady state of business. Or it's a new market we're developing and we continue to open new stores in that market, which affects the cannibalization of the first store that opened there.

Okay, and a quick follow up. Are you seeing any changes in the new store productivity on the store wall returns? In the first year, are the volumes lower or similar to what you have seen in over the last year or two?

No, it's similar.

Thanks.

Your next question comes from the line of Bill Sims with Citigroup.

Thank you, and good morning.

Good morning.

Good morning.

Good morning.

I have two questions. First, can you give us a little more color on your SG&A discipline? It seems like you produced good leverage, either flat, slightly down SG&A year-over-year despite a number of one-time costs. What can you tell us? What's going on behind there? How are you more disciplined this quarter than the previous year's quarter, with the understanding that you had a little bit of a calendar-shift benefit, etc.?

Well, I think we always are diligent about our expenses. As we get to be an older more mature Company, we have better systems in place to help monitor this, and our labor planning system continues, which we had to invent ourselves, because there wasn't a labor-planning tool for an experienced retailer. We continue to tweak it, and manage it better based on knowledge of the kinds of transactions that you have. How many transactions that you have that has bears in them? How many that have just clothes? How many that have gift certificates? And all that is fairly predictable, and helps us to guide the business, and as the business comes in every single week, every single day, a store manager can really manage that.

We've also, at Bearquarters, managed our expenses very, very closely, which is a lot easier to do than when you have it out there in 230 stores. I have to applaud the stores for the amazing work that they've done, and again, point to the fact that our guest satisfaction is at an all time high. We've managed to tweak that, but still keep the customer experience very strong, and the value of our transactions that the customers that are coming in the door, growing. That is a very big positive.

It's really always just been there, Bill. As all companies do, you do what you have to do, but we're really just getting better at it, and our new back office system, all of the things that have come into the technology that we've invested in over the last several years really does work hard. We're a team, and we work together and we do what's necessary to support the business, and also increase shareholder value.

Okay, and the same question is, presumably after a month of Happy Meals promotion with McDonald's, you have millions of little bears advertising statements running around out there. You have a distinct absence of mention of the Happy Meals promotion. We're you not pleased with the promotion? Can you share with us; did it have any benefit that you could quantify? Any traffic levels, etc., and would you consider doing a deal again with McDonalds' if it that was offered?

We really are just in the process of, we've done some survey work post that event. We're really evaluating it. Obviously, people I'm sure came into Build-A-Bear Workshop because they heard of that and they knew it was existing and we think that definitely did help us in building long-term brand awareness. We would certainly consider working with McDonald's again, but right now we don't really have anyspecifics, other than a few test markets, a bounce back to the store. It's really hard to tell exactly how many people came in. We don't believe it hurt our business at all, so we really feel that in that respect, it's just a long-term business opportunity for us.

You mentioned in a few test markets you had these coupons that were paid out. Is there anyway to quantify the redemption rate of those coupons, and the expectation you were expecting in your guidance for its drive further traffic in the next couple of quarters for the coupon? Do you think it's dried up at the end of this quarter?

There are some coupons that show up at Build-A-Bear, but for the most part usually in every business, you get them pretty early on. It was respectable. It didn't knock the doors down, but it was certainly respectable performance. We get a very good performance from our best guests, so we have a high standard when we give a coupon out, or a frequent shopper coupon, we know those are going to our best guests, so they are very responsive. So, our standards are high, but quite frankly, we haven't' really looked at as yet, or had a chance to get into it store-by-store, and how close the McDonald's was to that store.

A couple of other things that we are looking at also, are how many of them were used on parties versus regular transactions, so we're really looking at that. There was nothing that was overwhelming, like you said, "My gosh, let's do this again in 60 million coupons in 60 million Happy Meals next year." But I think that we do believe that it was a positive for our brand.

All right. Thanks very much, and good luck.

Thank you.

Thank you, Bill.

Thank you.

Your next question comes from line of Paul Lejuez with Credit Suisse.

Hey, guys.

Hi, Paul

Hi, Paul.

Hi, Paul.

You gave a few metrics earlier about percentage of customers under 12 per piece. Do you have what those numbers were a year ago? Anything to compare that to?

It's the same; it hasn't changed. Other than the repeat business, which obviously has grown over the years, because we have more customers in our database, that's fairly close to what it was six months into the St. Louis Galleria when we first looked at and really analyzed our business really closely. The Boyd part of our business has grown about 5% over the last several years, so now it's 70/30 versus 75/25, but that's been the same for the last couple of years. When we started adding the sports outfits into our business, that really moved the Boyd target.

Have you considered, or maybe just remind us on your thinking about where you stand as far as raising prices on either the Bear Skins or the Accessory products just to combat some of the higher prices you are seeing.

What do you mean the higher prices we are seeing?

Energy and freight.

Oh. Our merchandise margins have, we've continued to be able to negotiate and work very closely with our vendors to negotiate outstanding costs, and reduce costs in many cases, and also maintaining costs, not getting cost increases, which have helped us enormously.

We don't' really raise priced, per se. It's not like we take an animal, the same animal we had last year, Bearemy, and we raised its price from $18.00 to $20.00. We don't do that. We look at our business overall of the products that we sell, and we look at what the customer prefers. What size bear they prefer? What kind of materials they prefer? And we develop animals out of those materials, and out of those sizes, and those kinds of novelties, and fortunately, those are in our higher priced animals, animals over $15.00. Our business in our animal category over the years, and not just this year, but over the years has really improved. We sold more animals over $15.00. Hello Kitty, which is a very successful product for us, is $20.00. That really does help.

Our clothing, depending on what it is and how many details, if we've added details to it, like if we've added a handbag, or we've added a hat to the outfit, or something like that, we might add on $1.00, or $0.50 or something, depending when we think that it is worth it, but we really look at it from a customer's perspective of value.

The other thing that has changed over the years though, not just this year, Paul, is that the licensed clothing that we sell, the sports apparel particularly, the Disney costumes, the Superman costumes, those all have sold at higher prices over the years. That's why we've watched them and monitored them, and continue to expand that. It is a higher price and it is a good margin, not necessarily on a percentage basis, higher than the markup or the margin that we get on an item at a lower price. Certainly, because it is higher price, there is more gross margin dollars. But still, it helps us trade the customer up.

It isn't any significantly different this year in mix than it was a year ago, but the customer is preferring the higher priced animal, whether it is Hello Kitty, or our own Sassy Kitty. The novelty materials, the taller length, the more details on the animal, the Soft, Soft, Soft Fur, the specialty furs, those are all very popular and allow us to develop animals at the mid to higher range of our assortment.

All right. You did say gross margin increased in North America operations?

Yes.

What was the comment behind that?

It's markup. Our markup has really - initial purchase markup has increased, and that has helped us offset the raise in fuel that has affected us. All of our products, particularly stuffing, is petroleum based, it's a polyester material, so these things have cost increases in the material base, but also have it in the shipping. Packaging, that also has been impacted by fuel and freight costs. We've been able to work very, very closely with our vendor partners to manage the merchandise margins in the right direction.

Also, we are negotiating with a bigger base of business, and into all of our vendors when we made the acquisition of UK. We're able to project a different kind of business then we could project opening a store at a time, a few a season. This really gives us a lot of leverage. We actually use all of our international franchising projections to help do that. Our vendors are growing substantially with us, and helping us really find economies of scale in terms of production.

Not to get into too much detail about this, but we've talked before, we've really managed materials, like our dark denim is a fashion item this Fall. We buy it, we plan out these needs of the yardage, and then we cut skirts, short pants, jackets, depending on that. We cut narrow leg jeans, flare leg jeans, or decorated jeans from that. So we are able to really use our materials and time to market very effectively, which also helps us protect our inventories and not have old merchandise.

Thanks, guys. Good luck.

Your next question comes from the line [Hal Godes] with the Boston Company.

Can you discuss in traffic trends or mix, what bears are selling best? At what price plan do you have entry level bears? If a birthday bear is at $10.00, and they go well above $20.00? Are there parts of the country that are doing better than others? Tell me about how brand new markets are performing relative to how a brand new market performed a year ago, or two years ago.

The average sales price of an animal is in the $16.00 to $17.00 range. Our $10.00 animals, we only have two $10.00, and we have a few $12.00. Really the core of our line goes from $14.00 to $25.00 and only one animal or two animals at the most at any one time is $25.00. Most of our assortment is $14.00 to $22.00. It always lands in the middle of the range, and we continue to move that range up with more core animals in the middle there, as I said.

Hello Kitty is a very popular animal. We knew it would be, and it has done quite well. There are other animals all along that price point. That $20.00 price point has continued to be good for us. It doesn't vary too much around the country by animal type. What does vary is the growth of the marketplace. The southwest and west, the southeast, Florida, have continued to be strong growth areas for the country, I'm sure for other retailers as well as Build-A-Bear Workshop, and we've focused our store growth in those areas, and those stores continue to do quite well. Store openings continue to be very, very strong. Last year, we opened up two big, big stores for us in New York City and Mall of America, which were very strong openings. This year we don't have any stores on our agenda that are that scope, but all of our store openings, new stores continue to do very well.

There is a strong pent up demand of these markets for our stores based on customers visiting us in other markets, so we have names in our database that we market to when we open a new store, as well as the national television marketing, the integrating marketing plan we have. They see TV about Build-A-Bear Workshop, in this case, the market that we opened up this year, three years we've been on television in some of those markets, building awareness. That really helps us open up the stores strong, and most of our stores open up significantly higher on a productivity basis then the average $615.00 a foot. I think that should answer the question for the most part.

As I said, the regions, vintage is important, the age of our store and the maturity of the market. Again, St. Louis is our oldest market and a very strong market for us. While we don't count it in our comp store base, we have the ballpark here and the zoo stores here. They have not negatively impacted the growth of Build-A-Bear Workshop in this market. In fact, they've enhanced, and I think the fact that they are different products, and another reason for people to go and have a fun, family experience not far away; they don't have to get in their car and go very far away, really is a plus to this particular market, especially with such a large number of people in our database that have been shopping with us for nearly nine years now.

To St. Louis, we are a local, entertainment enterprise for sure. Again, the northeast, as we said, continues to be more difficult for us, though less seems to be improving over a year ago, and we are continuing to work on that. The west and southwest and south Florida, Florida in particular, seem to be the stronger areas for us.

Say all the last regions again, please.

The southwest, the west, and Florida. Southeast and Florida.

Thank you very much.

Your next question comes from the line [Janet Kloppenburg] with [JJK] Research.

Hi, everybody.

Good morning, Janet.

Good morning.

Good morning.

I was just interested if you could give us an idea of where you thought the tax rate would be, Tina. I think you said that was one of the effects of the better than expected results from the domestic operation. I was also wondering if you could give us an idea if you think the better than expected gross margin rate in the US and the payroll effect, etc., could continue, if these benefits could continue as we move into the second half of the year.

Lastly, for Maxine, I was wondering, you talked a lot about product and how you are working on it, but I was wondering if you've taken any consideration to product assortment on marketing given this consumer hesitation that you addressed? Thank you.

Janet, we're not going to discuss our actual quarterly effective tax rate, but overall the annual rate will come in at about 40%, and so it's more of a smoothing throughout the quarters. In addition, as Maxine said in her comments, we remain diligent in looking at all of our expense initiatives, and maintaining and controlling expenses in all areas of our business.

Janet, on the pricing of the merchandise, honestly, what's good in St. Louis is good Maine, is good in Los Angeles at Disneyland, so really the product assortment, the price line, there is no variation really between stores. If it's in a store that's not performing as well as we would want it to be, it's still the same proportion to that store's business.

The stores that do a lot of parties have a tendency to sell more of the lower priced animals, because the mom comes in and says, "I want to spend $15.00 a child, or $20.00 a child including the animal." Still that is only about less than 10% of our business across the country. It doesn't really vary very much. That's one of the good things. The customer, it's just traffic levels. It's just managing the inventory appropriately between store locations.

In our ballpark stores, there is nothing that is at $10.00 in terms of an animal. Everything starts at above $15.00 level. Those customers are responding very positively. It's not about price. It's about having a fun experience and a new stuffed animal that they didn't have before. At our zoo store, which again is only one store, it's a free zoo. It's a different economic level of the customer that probably does visit there, but our transaction is very, very close to our normal transaction at a Build-A-Bear Workshop store. We're very excited about that. I think that really points to a lot of opportunities for us in that sector, in that line of merchandise.

While you might think there would be some differences, actually there is no difference even to the UK, or to Canada, our stores in Canada. I should have mentioned this earlier, but Canada is also one of our very strong regions of North America. In business, as well.

We sell the same products. The customer has a worldwide market. The Internet certainly has made that. Hello Kitty is strong in every single country that we offer it in, at the top of this list.

Your next question comes from line of [Tom Whitepat] with [Value Holding].

Hi, good morning. I just want to get some clarification. You said that you are opening three new stores in the UK. Are you still on plan to close four of the stores you acquired?

Yes.

Yes.

Okay. So we are looking a net of negative one from the 40 that you got?

Yes.

Okay. Internally, have you discussed at all what you plan on doing next year for new Friends 2B Made in Build-A-Bear Workshop stores?

Our Build-A-Bear Workshop stores as we have stated strongly, that we plan to open 25 to 30 stores a year on a continuing basis. The Friends 2B Made stores we have not yet announced, but we are evaluating that. I think we really wanted to get into our warehouse and distribution centers where we finally can handle the growth of the Company. Also, the evaluation of having Friends 2B Made in separate stores, even in malls possibly where Build-A-Bear Workshop wasn't in, as well the Build-A-Dino concept. Also, the new markets that will be opening up, possibly the zoo stores as well as baseball park stores. All those are part of our store planning, but we really have only stated officially the Build-A-Bear Workshop store growth.

As far as franchises for next year, that's a little too hard to tell as well?

Right.

Again, as persnickety as we are in getting the right space in North America, we hold sway to that in the rest of the world. We'll announce further as the year progresses what the anticipated franchisee location opening will be in '07.

Okay, then regarding the franchisees for this year, in the earnings release this morning you said that you expect $0.10 to $0.12 for the year, but I think I remember at the end of last year that you were calling for about $0.20 to $0.25. Is that just due a lack of real estate opportunities now?

It's a real estate issue. We certainly could open those numbers, but they wouldn't be qualitatively in the locations that we want, so clearly we're waiting for the best locations. As you can see, as well from the press release, that our revenues generated, income generated from the business that have been already been opened, and the new stores opened this year, that we are right in line.

So you still feel strong about international demand for the brand. It's just a simple matter of the real estate being too expensive or not high quality enough?

It's all of the above. Yes, we continue to look favorably internationally. I just came back from Thailand and some other countries in Asia, and yes, this is in the future plans of our business.

Okay, and just one more if I could. You said in the opening comments that the number of transactions was down this quarter, but dollars per transaction was up. In applying that, the number of transactions against traffic would be below the negative 4% for the comp. Are you willing to quantify exactly how low, year-over-year, guest traffic was?

No.

Okay. All right, thanks very much.

You're welcome.

Thank you.

[OPERATOR INSTRUCTIONS]

Your next question is a follow up from Brian Tunick with J.P. Morgan.

Well, thank you. It's Evron, again. When you pre-announced on June 23, you guided for about $0.07 for the quarter, and now you deliver $0.15. So the $0.08, what percent of the [delta] was driven by the difference in tax rate and what percent from the difference in expenses?

The biggest component clearly, was the tax that we alluded to, and then there was a fair distribution relative to margin and expense improvement for the balance of the $0.08 swing.

Okay, so this quarter's tax rate reported with 44%, right? So you expected a tax rate higher than 44%?

Yes, we did.

Okay. If I can have one more follow up about your second half guidance. There is a question about lowering your second half guidance when you said that it was low end, but it sounds like its $0.08. I just wanted to see if you expect more marketing spend or difference in expenses, because I am assuming you are keeping your comp guidance for the year, that's not where the change is. Or do you think it's just tax rate and different things; it's not really a lowering of guidance?

[Evron], the key to that response is that why we continue to say low end of the range, and Tina mentioned the word smoothing, so some of the pickup from an EPS standpoint relative to tax, some of that gets added back into the fourth quarter. Clearly, the tax rate for the year and performance as indicated from margin and expenses in the second quarter, which we think should be similar in the back half, they are all reflected in the guidance at the low end of the range.

Great. Thank you.

There are no further questions in the queue.

Thank you operator, and thank you everyone for participating today. In closing, let me mention that we will be visiting with investors in New York City in August, and early September. If you have any interest in meeting with us, or have any follow up questions, please give us a call.

Thanks, and have a great day.

Thank you for your participation in today's conference. This concludes the presentation.