Build-A-Bear Workshop Inc (BBW) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2006 Build-A-Bear Workshop Incorporated earnings conference call. My name is Cindy and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of today's presentation. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Molly Salky, Director of Investor Relations. Please proceed.

Good morning, everyone, and thank you for joining us for a review of our results for our 2006 fiscal third quarter ended September 30. I am Molly Salky, Director of Investor Relations, and with me this morning are Maxine Clark, Chairman and Chief Executive Bear; Barry Erdos, President and Chief Operating Bear; and Tina Klocke, Chief Financial Bear.

In a moment, I will turn the call over to Maxine, who will provide her perspective on our third-quarter performance and outlook. Barry will update you on our company-owned distribution center operations and international franchising. Tina will follow with additional details on the third-quarter financial results. At the end of our remarks, we will open the call up for your questions. Members of the media who may be on our call today should contact us after this conference with their questions.

We ask that you limit your question to one question and one follow-up. This way we will 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 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 would 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 of 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 would like to turn the call over to Maxine for her comments.

Thank you, Molly. Good morning, everyone, and thank you for joining us to review our third-quarter performance. We are pleased with both our strong earnings performance in the third quarter, as well as the progress we have made on key strategic initiatives integrating our UK acquisition and completing our distribution center, which is now fully operational. New stores have opened on schedule and are performing well. Our brand continues to grow globally, with international franchisees opening five new stores this quarter, including the first stores in Germany and Thailand.

Store operating metrics show strong performance again this quarter. Average transaction value was up compared to a year ago and the number of units per transaction and guest satisfaction scores remained high. Given our year-to-date performance, sales per square foot, which we report at the end of each fiscal year, is trending again towards the $600 range, a level that significantly exceeds the average mall-based retailer and is integral to our highly profitable store model.

Our third-quarter operating performance, successful acquisition integration progress and completed [DC] transition lays the groundwork for achieving our full-year targets.

In our discussion today, I will start with a brief recap of our financial results, update you on our UK integration and review our marketing and brand-building programs along with an update on our new store status. Barry will follow with further information on our new company-owned distribution center and international franchising. Tina will then provide further details on our third-quarter financial results.

Let me turn now to a recap of our third-quarter results. Our consolidated third-quarter total revenue increased 21% to $102 million. Net retail sales increased $17.4 million to $101 million. This growth was fueled by new North America stores opened in the last 12 months, UK store sales totaling $9.4 million, sales from nontraditional store locations and sales over the Internet, which increased 17% to $1.6 million. Higher franchising fee and licensing revenues also contributed to the quarter-over-quarter total revenue growth as well.

Sales over the Internet continued to grow and serve as a meaningful sales channel. While shopping at our stores provides the optimal Build-A-Bear Workshop experience, we find that many guests opt for purchasing via the Internet for additional accessories, gifts -- gift cards and other products that may not be available in all of our stores. These highly efficient sales add to revenue growth and benefit our operating margins as well.

Third-quarter net income was $2.7 million or $0.13 per diluted share on a GAAP basis, in line with our previously announced expectations. The GAAP net income also includes several impacts directly related to the UK acquisition, including an operating loss of $2.1 million, lost interest income and lost franchise revenue. Also included in our GAAP EPS is stock-based compensation expense of $700,000 and onetime costs related to the opening of the distribution center of $1.7 million. This compares to net income of $5.3 million or $0.26 per share in the fiscal 2005 third quarter. Last year's stock-based compensation costs had less than $0.01 impact to EPS.

Helping us achieve these results were our continued strong and steady North American merchandise margins in the third quarter. Looking behind the GAAP results, you'll see that our core North American business operating earnings, excluding stock-based comp and onetime distribution center transition costs, showed modest growth, which speaks to our strong store model and its resiliency in all economic climates.

Furthermore, through leveraging our central office expenses, disciplined expense control and closely monitoring our store payroll expense, we were able to maintain our SG&A margin with only a modest increase. Tina will provide additional financial details later in her discussion.

Let me now update you on our UK store conversions, integration and marketing efforts. We have completed the conversion of 22 Bear Factory stores and have just three left to convert in November. We have been able to convert and reopen all of these stores in about 22 days per store, on budget and on schedule.

This past week, we invited our UK guests to help us celebrate the national grand opening of our stores. Our celebration included in store activities, ribbon-cuttings, a sweepstakes event, national print ads, radio, e-mail and direct-mail. The event was a "barilliant" success, as they say in the UK, providing new guests introduction to our brand experience and demonstrating to returning guests that we are more than just a new name and new merchandise.

We opened our first post-acquisition new store in the UK as well in Plymouth earlier this month and will open one additional new store in Basildon in December. In addition to a smooth integration, our accomplishments in the UK include an improvement in store sales trends after conversion to the Build-A-Bear Workshop brand with minimal marketing support. Our UK teams have embraced the Build-A-Bear Workshop culture. They are strong business-minded store managers with both the sales and service orientation and they recognize the opportunity to turn around and improve their business performance and be part of a successful and growing brand. They have wowed me from day one.

Our UK teams continually provide as with feedback on merchandise and store operations, and we listen, providing us with an abundance of opportunities to further leverage our merchandising and marketing expertise in that market. We continue to believe 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, improve merchandise and enhanced store experience, plus improving merchandise margins and gain in economies of scale by leveraging our expertise over a large store base, will lead to earnings accretion in fiscal 2007 and beyond.

We'll host our annual managers meeting here in St. Louis this weekend. Store managers, district and regional store leadership from across North America and the UK will participate. Preparing our store teams for the holiday season, team building, and sharing best practices will be our leading focus. It is a fun and energizing event every year, and this year will be bigger and better than ever with the addition of our UK staff.

We continue our brand building strategy of investing in marketing to build brand awareness and drive sales. Our newest tool in our marketing tool kit has already begun to show encouraging results. In mid July, we launched our Stuff Fur Stuff Club, automated frequent shopper program, throughout the United States. This loyalty program was initially piloted in the St. Louis, Atlanta and Pittsburgh markets over the last two years. Supported with state-of-the-art CRM software, this program gives us the ability to refine our frequent shopper program used in the past.

The programming rewards one point for every dollar or partial dollar spent by the guests. When a household has 100 points, it is sent a $10 Stuff Fur Stuff Club certificate to use on their next purchase. The program gives us added visibility into guests' purchases, particularly nonstuffed animal purchases, including the products, the frequency, the response to certain offers and increases our ability to communicate by mail and e-mail directly to our best guests.

Since launched in July, over 1.4 million households have joined the program. We still have much to learn and more data to accumulate, but our early view is that is a program that could significantly benefit our direct to guests marketing events.

Our fourth-quarter holiday marketing programs are getting started. National children's TV advertising began this week and will run through mid-December. And as we have done in the past, our fourth-quarter TV advertising includes national women's programming. Great brands attract other great brands and we are very excited about our fourth-quarter partnership which allows us to feature Mumbles, the Emperor Penguin, and star of "Happy Feet", the animated comedy adventure from Warner Bros.

Mumble and his little friends will be available in stores beginning November 9. The movie release is scheduled for November 17. Our product offering will include the movie soundtrack CD, a special sound, and many festive holiday accessories.

Another important part of our holiday merchandising is our first designer dog, the Maltipoo. Maltipoo joins our Bearemy Kennel Pals collection beginning November 1. This white curly puppy can be accessorized with designer style carrying bags and outfits.

This year will also be our first holiday season with Hello Kitty. So our merchandise sales and excitement comes from several different product directions. As in the past, our holiday merchandise is supported by our fully integrated marketing program, including direct-mail by our holiday catalog, which arrives in homes in early November, national children's and women's TV advertising, national print, in-store events and web and e-mail support.

Unlike other retailers that use markdowns and promotions to drive traffic into their stores, we use marketing and product assortment to add value to our brand and enhance our highly profitable store and business model.

We expect Bear Buck$ gift cards to be a choice of many guests and we continue to promote and raise awareness of our gift cards. In addition to being offered in Build-A-Bear Workshop stores and on our website, our gift cards are again available for purchase at Walgreens stores nationwide. New this year is a partnership we have entered into to distribute gift cards through grocery stores, drugstores and some office supply stores across the country.

Finally this year, our integrated marketing program will include TV commercials that feature brand advertising, Mumble, gift cards cards and Maltipoo adds. Product-specific TV advertising has been successful on a test basis at raising product awareness and traffic in our stores.

Now for a quick store update. During the third quarter, we opened ten new Build-A-Bear Workshop stores in North America. In addition, the first Build-A-Dino store opened within the T-Rex Cafe at the Legends at Village West in Kansas City, Kansas. Based on the early success of the Build-A-Dino brand, we plan to open a temporary holiday store in St. Louis in early November. The store will be located in Chesterfield Mall, a mall location with no other Build-A-Bear Workshop brands currently located there and close to our home office, which allows us to monitor the store's progress. The store's about 850 square feet of selling space and like our Ballpark and Zoo stores will be unique to the brand while also highly identifiable as a Build-A-Bear Workshop brand extension.

Build-A-Dino, where Best Friendosaurs are made, has its own language, color scheme and unique merchandise, while staying to true to the interactive theme park in a mall process that we consider our core competency. The store will also offer ten dinos is to choose from and less than clothing and accessory SKUs. After holiday, we will also do parties in the store.

In addition to this temporary store, we plan to test Build-A-Dino products in a few Build-A-Bear Workshop stores via an in-store fixture. Through the temporary store and in-store fixtures, we believe we will gather valuable learning regarding how this brand can conform and be in a position to evaluate the future plans for Build-A-Dino. We have had great success this year with our nontraditional store locations. Our St. Louis Zoo store, which opened in March, and our five baseball stadium stores have performed well so far this year demonstrating the continuing entertainment appeal of our concepts and the success of our brand and store model in non-mall venues.

I should add that having the Cardinals playing in the post-season before thousands of passionate Redbird fans of all ages has been an added plus for us. The five baseball stadium stores, which average less than 800 square feet in size and are open for typically five hours on 81 game days, delivered sales per square foot this year of over $700 a foot. Guests have purchased over 75,000 baseball team mascots so far this year exclusively at this team store location, adding a unique stuffed animal to their collection and adding to the fun and enjoyment of attending a baseball game and being a fan.

Ours Zoo store, which operates at about 1000 square feet, surpassed the $1 million sales mark this month, another highly productive contributor. These non-mall venues offer our guests yet another reason to experience our brand and often translate into a transaction value that is higher than our mall store average. We are evaluating and developing other non-traditional locations for future store openings.

Our fourth-quarter new store lineup includes six new stores, four of the six opening in new markets. By mid-November, when the holiday shopping season moves into high gear, we will have over 230 stores opening in North America - including our first stand-alone Friends 2B Made store and temporary Build-A-Dino store.

Let me now turn to our full year outlook. We remain cautious regarding the impact of the macroeconomic environment on consumer discretionary spending. However, our third-quarter earnings performance was in line with our expectations and, based on this performance, our guidance for the full year remains unchanged.

As previously disclosed, our guidance is 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 dilution of approximately $0.16 per diluted share, stock-based compensation expense of approximately $0.08 per diluted share, and distribution center transition costs of about $0.05 per diluted share. This full-year guidance is predicated upon North American comp store sales being in the flat to negative low single digit range. It also assumes flat to negative low single digit fourth-quarter North American comparable store sales.

For the year, we will open 32 new Build-A-Bear Workshop stores in North America and four new Friends 2B Made locations. Our four Friends 2B Made store will open in November in Ontario Mills in Ontario, California, and will be separate from our Build A Bear store. This store will provide us with an understanding of how this brand can perform on its own, away from a Build-A-Bear Workshop store.

In the UK, we will open two new stores and are well on our way toward identifying five to seven new store locations in the UK for 2007.

Finally, I will add that this management team, along with our Board of Directors, remains committed to the valuating alternative uses of our cash and is determining which alternatives 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. I am pleased to report that our new distribution center located in Groveport, Ohio, became fully operational in September. The growth of our business was the driving force behind this new facility. We are confident that this new DC will serve us well as a building block for our future growth. The new distribution center is now our primary distribution center for our North American store operations. The center is 350,000 square feet and is ideally located from both a store-based perspective and from the perspective of the unique capabilities and distribution center resources available in the Groveport and greater Columbus, Ohio, area.

The new center includes state-of-the-art equipment and technology, including a warehouse management system from Manhattan Associates. This system now interfaces with our product planning and allocation process, allowing us greater inventory visibility and control. Enhanced capabilities we did not have with the third-party distributions center service provider.

The DC will improve inventory control and management, allow us to realize greater efficiencies and reduce operating costs, and has been designed to accommodate our projected growth well into the future. This was a very successful project from construction, start-up and transition from third-party provider to full operation all as planned.

Moving now to our international franchising business, during the third quarter, international franchisees opened five new stores -- our first store in Bangkok, two stores in Japan and Tokyo and Narita, and an additional store in Taiwan, and our first store in Hamburg, Germany. We ended the quarter with 27 international franchise stores. So far in October, a second store in Hamburg, our second store in Sweden, and a second store in The Netherlands have also opened.

Earlier in the third quarter, we awarded the franchise for Germany to Choose Holding, a Denmark company, which also holds our franchise rights in Denmark, Sweden and Norway. Choose Holding now operates five stores in Denmark, two stores in Sweden, one story Norway opening later this month, and the two stores in Hamburg.

The Choose Holding team has been one of our most successful franchisees. They have been highly effective in replacing -- replicating all of the various elements of our business model. We believe they will bring a high level of experience and excellence to the German market. They expect to leverage certain elements of their Danish business infrastructure and have hired a team of German-based real estate in operations experts.

Based on our real estate standards and locations currently identified, we anticipate franchisees will open approximately 10 to 12 new stores this year, bringing our total international franchise stores to 29 to 31. We continue to expect revenues from franchisees to total approximately $3 million this year, up from $2 million last year. As you know, our franchise revenue includes a combination of an additional onetime developmental country fee, paid when the franchise agreement is signed, and recognized over the life of the agreement, and a 7.5% royalty fee on revenues generated by the franchise stores.

Now I would like to turn it over to Tina for some comments.

Thanks, Barry. I have some additional details regarding our fourth quarter performance and update you on our information technology initiative. Let me first start with gross margin.

As anticipated, consolidated gross margin rate decline in the quarter to 42.2%, primarily due to a lower gross margin contribution from UK stores resulting from their higher occupancy costs or establishment costs that exist in the UK and our distribution center transition costs.

As Barry described earlier, during the quarter we transitioned from a third-party provider to our company-ended distribution center. We incurred $1.7 million in duplicative costs as we made this transition. Transition included moving from both our St. Louis and Los Angeles third-party providers. These transition costs are now completed and will not occur in the future.

While our North American merchandise margin increased in the third quarter, the overall North American gross margin declined as higher distribution costs and lack of leverage on occupancy costs increased. SG&A expense margin increased slightly to 37.5% compared to 37.3% last year. We continue to leverage our central office expenses during the third quarter and managed our store payroll to slightly lower percentage of sales, partially offsetting higher stock-based compensation costs. Importantly, our guest satisfaction scores remain very high.

The operating margin in the quarter of 4.1% compared to 9.7% last year primarily reflects the impact of our UK dilution. As a reminder, the full acquisition deletion includes the operating loss, primarily reflecting the cost of temporarily closing the stores for conversion and re branding, and the loss of interest income and the loss of franchise revenue which would have been recognized if the acquisition had not occur.

The effective tax rate in the quarter was 38.1% versus 38.5% last year, reflecting a lower rate resulting from tax benefits related to our new DC becoming operational. We continue to expect the fourth quarter tax rate to be approximately 40%.

Now to cash flow and balance sheet. Capital spending in the third quarter was $12.6 million, up as planned from $6.5 million in the year-ago third quarter. Year-to-date, our spending stands at $47.5 million on track with a plan of total CapEx this year of approximately $60 million. As we have highlighted in the past, our spending this year includes approximately $24 million for the new distribution center, approximately $10 million for UK store conversion, with the balance allocated to our new store growth and information system projects.

We ended the quarter with a cash balance of $9.8 million. During the third quarter, we did not utilize our line of credit. In early July, we amended our revolving line of credit to include a seasonal overline. This overline 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 overline, we were able to improve the interest rate on the line as well.

Let me move now to a free status report on our key information technology projects. First, our UK integration from an IT perspective has been smooth and is nearly complete. In addition to moving stores onto our systems, we have also successfully integrated our party scheduling and business scorecard systems in the UK. Also, we have recently gone live with our UK website, now under the U.S. technology umbrella. We will continue to provide IT support to our UK stores from our St. Louis Technology Center.

A key component of our successful DC operation was the transition to our Warehouse Management System. Our WMS is fully operational and integrated with our product planning and allocation processes. Two other key projects this year include our new human resources and general ledger system. The core components of the systems are now fully operational. We have completed our financial closing cycle and our processing all accounts payable transactions using the new (indiscernible) system. On the HR side, we have begun to roll out the self-service aspects of the system to store personnel and anticipate significant benefits through the highly integrated capabilities the system provides. These IT initiatives help support our highly flexible and dynamic technology infrastructure.

This concludes my remarks. Now I'll turn the call back to Maxine for her final thoughts.

Thank you, Tina. I would like to end our prepared remarks with final comments on our business. For the majority of our UK acquisition store conversion's complete and our DC fully operational, we have accomplished the key strategic initiatives we set out for our Company this year. Our store economic model continues to be the backbone of our business.

North American stores continue to generate significant sales per square foot and significant store contribution. Although not all comp positive this year, our older stores consistently performed the best on a comp store sales basis, and our youngest stores consistently generated the highest sales per square foot, even higher than the $615 per comp stores.

Our new stores typically pay for themselves in their first year of business. Our brand and interactive retail experience has proven itself to be successful in both malls and non-traditional, non-mall locations beyond what may be possible for the traditional specialty retailers. This in turn provides us with further growth opportunities for store growth and brand extensions.

Finally, we see much growth ahead as we build our U.S. and Canada market opportunity of about 350 stores; our United Kingdom and Ireland potential of about 70 to 75 stores; and our international franchising potential of about 300 stores.

And now we will open up the call to your questions. Operator, please queue the first question.

(Operator Instructions). John Zolidis, Buckingham Research.

A couple of questions regarding the UK deal and how that affected some of the items in the income statement and the balance sheet. I was just wondering if you could quantify the total impact of occupancy deleverage in the quarter? And second, how much is the UK deal adding to the inventory position at quarter end and any comments you can make on the freshness or appropriateness of inventory and whether that was impacted by the DC transition as well, I guess? Thank you.

When you look at our overall inventory, we are up about 11% from a year ago. And it is mainly resulting as we are building inventory for holiday sales. So it is majority related in transit. But again, remember, we are not fashion-sensitive. So if we have more inventory at the end of one quarter it is not a big deal.

We will end on plan. The only thing as mentioned by Tina is a larger in-transit and that is just a timing issue.

On the freshness of our inventory, everything--- the warehouse has been -- the DC, John, has been running very, very well, and everything is in our stores on time, and we are in the Halloween mode right now, which all delivered to our stores on time, and has actually sold through incredibly well. And then new holiday merchandise arise this weekend, begins on plan, on schedule, as it has been planned. So there is no changes in the topicality of our inventory whatsoever.

On the UK question, Tina will -- .

John, on the occupancy costs, I think as we have previously told you that the occupancy costs or establishment costs, as they are called in the UK, are generally a lot higher than they are in the United States. However, their merchandise margins are higher, so it offsets a little bit, but not the total occupancy increase.

Tom Filandro, SIG.

I guess the question for Maxine -- Maxine, regarding the holiday season, Mumble and the designer dog -- it seems like the strategy this year is somewhat different than in prior years were you had a single big item that was very holiday-related, Christmas-related. This Mumble is interesting.

I kind of just want to get a view of how you determine a team that this was the right approach. It is somewhat different than you have had in the past. Maybe you can give us a little insight on that. Thank you, and then I have a follow-up.

Actually, Tom, it is not that different. We really always have on November 1 almost every year, we have always had a dog launch. Last year was the Husky, and this year it is the Maltipoo. And Hello Kitty is new this year. We launched it in the summertime and it is very, very successful.

But we always have a very multi-product approach to our holiday season, and that is why if we run short on any of our -- the absolutely specific Christmas or seasonal merchandise, the customer has so many other choices. But this year, we made probably because of the customer demand for the product, the Hello Kitty been so successful and our dog business being so positive, and also the fashion trend, if you will, of these -- for lack of a better word -- girly dogs or froufrou dogs or designer dogs, it is part of the fashion merchandising message. And so we have always had dogs in our assortment.

We just decided this season based on the success of things that we have been selling all year long to make it a slightly more prominent. But it really is not a significantly different and our merchandise mix that we have had in any of the Christmases prior.

Mumble is -- Penguins have always been hot for us. We have always -- the past two times that we have had a penguin in our assortment, it was very, very popular. Last year, with the "March of the Penguins" movie that was so popular, penguins are very strong. We have a penguin in our assortment in the Zoo that has been phenomenally successful.

So this with the fun that is getting behind it, that Warner Bros. is getting behind, we thought it was an appropriate opportunity to tie to the current movie. But we always -- we look at the times, what is going on in the times, what is going on in the proposed promotional and the media marketplace, and try to benefit wherever we can from what is going on the marketplace.

So in 2007 in 2008, there will be lots of other exciting things going, just like there are this year with this movie, and there will be lots of opportunities, and that is the flexibility we like to maintain in our merchandise assortment.

Brian Tunick, JPMorgan.

It's (indiscernible) for Brian. A couple of questions. First of all, can you give us a sense of the potential for the UK business, maybe where the sales productivity and operating margins are today and where they can go? And the second question is maybe if you can quantify -- what kind of savings do you expect from the new Distribution Center, the dollar savings? And finally, my final question is do you have any jeans for the Bears? Thank you.

Do you have what?

Any jeans.

I will answer question one and three. We have -- I think we have said that we thought there was a potential for 70 to 75 stores in the United Kingdom, and while there are -- we have always said the store volumes in these markets were less than the store volume in the United States. The average (indiscernible) of the Build-A-Bear store.

We believe that the potential is certainly what we do in the United States. That does not mean that they are going to get there in year one or year two, so there is lots of building opportunity. And similar to stores that we opened in the United States that do not open up unnecessarily at the $2 million rate but we continue to have comp store positive sales, we feel that these stores have a tremendous potential to grow each and every year.

The operating margins are lower than in the United States, and our goal is to raise those significantly. And again, the potential is as good as we have and within the United States, although I do not think that is going to happen over the short-term. It will be a building process. This will be very respectable improvements in operating margins.

We also have a marketing opportunity which we are just starting to benefit from now that we have this national brand in the UK and last week was really our first week of doing that. We also have our regional office located in Windsor, just outside of London, which manages the store operations in the UK; and there are some financial accounting offices there as well as human resources. And that has brought us tremendous leverage and operating efficiencies.

And then we handle all of the technology from here in the United States, and other accounting services are also provided, real estate services, merchandising is all done here in the United States; allocation in products is done from here.

But the actual physical distribution of the product, meaning the warehouse for it is in -- just outside of our Windsor area regional offices.

On the skinny jeans, yes, we have skinny jeans for Bears. But as you have noticed, probably, on our Bears legs vary in skinniness. And so they are adjustable skinniness, so you can make them as skinny as you want. We also have those for our dolls as well, and they are quite popular.

On the distribution center, relative to an expense savings, we clearly feel on a cost per unit basis to move a unit in and out to our stores will be less than we are now paying on a -- or have paid to a third party, which sort of goes up every year using third party. So first we will stem that tide and as more units past through the facility we will begin to see a per unit reduction. Remembering we are talking about this year almost 50 million units passing through the various facilities. So there's opportunities galore there.

Also, a little harder to measure is the efficiency of the inventory. As we marry systems that Tina alluded to earlier, we will get units and product to our stores on a faster and a more qualitative basis, faster. So we should see a slight improvement, relative to the sellthrough in the stores, which would equate to a little stronger merchandise margin as well.

Janet Kloppenburg, JJK Research.

I had a couple of questions. Tina, if you could review your comments on the profitability in North America and if the gross margin in the North American business improved over the last year. I was a little unclear on that delineation.

And also, Maxine, if you could talk a little bit about the Mumbles introduction -- I know the Hello Kitty was successful. I was wondering if this will be a more frequent merchandising strategy where you would be introducing newer characters on a more frequent basis. I think it is a very interesting idea to help traffic.

And lastly, I was wondering if you could discuss your comp trends in North America by month. As you know, September happens to be a very strong traffic month in the malls, and I was wondering what effect or benefit you may have incurred from that. Thank you.

Janet, on the gross margin in North America, what I said was the merchandise margins increased in the third quarter, but the overall North America gross margin declined slightly as higher distribution costs and lack of leverage on occupancy costs increased.

On the Mumble introduction, I think to referring really licensing outside brands being introduced into the Build-A-Bear Workshop assortment. Is that what you mean, Janet?

Okay. Yes. As they relate to -- as they are part of the customer interest level and are fashionable, that has always been part of our plan. We have had Frosty the Snowman and Rudolph the Rednosed Reindeer, two Christmases in a row. We have had the Sesame Street characters as part of our assortment for several years. And those have been really successful. We have also brought in the character costumes, whether it is Batman or Spiderman or this holiday Tigger, Eeyore, and Piglet added to our assortment in the costume category. Those have always been successful.

Our introduction of Mumble is very similar to our introduction in the past holiday seasons of our holiday character, starting with the way we did Rudolph the Rednosed Reindeer and improved on it for Frosty the Snowman. We feel like we have improved on it this year. But it launches to the consumer marketplace in our holiday catalog with a double truck ad, which the others did as well in the two prior years.

And we do not comment on the comp trends by month, but the result for the quarter were right about where we expected; and our guidance for the year, as we said, remains unchanged. Our business model has shown resiliency in all economic climates by delivering earnings growth even when the comp store sales have been negative. We're focused on continuing to grow revenues and market share and benefiting from all the traffic and changes and the upbeat economy, where that is. When combined with our high-end stable merchandise margins give us the ability to deliver significant earnings growth.

Bill Sims, Citigroup.

Just a follow up on the comment. Maxine, you said you remain still very cautious on the macroeconomic environment. Can you point to anyone or two or what particular macro indicators your business is most sensitive to? And how with the improving gasoline prices and some other improvement what still is the biggest drag on your business?

We really can't -- don't identify that publicly. We do not always know exactly one thing or the other. There are many economic attributes that are in our store model when we evaluate a new store we believe those same things impact the consumer environment. But we are optimistic as we always are about the business trends; and we feel that we will deliver the performance that we have guided, and we are looking forward to a fourth quarter that is exactly where we said it will be.

Paul Lejuez, Credit Suisse.

It is Tracy Kogan, filling in for Paul. To questions. First, can you give us an update on Friends 2B Made, and now that you have more D.C. capacity, any thoughts to a more extensive roll out there? And then secondly, some follow-up on the UK stores that you converted. It seems like you are coming into the low end of your guidance in terms of accretion for the fourth quarter.

Is that really a timing issue or is there something else going on there? Thank you.

There is no timing issue there. That is exactly what we said for the last two quarters, and we are going to still hold true to that guidance. So there's nothing changed about that. Obviously, there is always potential for that to change as we say in our disclosures, but I believe that we are going to be, as we said on the guidance, that those numbers are very realistic.

Friends 2B Made, as we said, we are still very much in a test mode; and we are doing the right thing for our business at all times. The stores have shown much greater sales success this year as we have opened up more stores, and we have a couple of more tests that we're doing. One is a separate store away from out Build-A-Bear store, which would give us some added insight into the business and the business potential and understand better the cannibalization or lack of cannibalization - and also the opportunity in 2007 to test some stores that may not be in Build-A-Bear Workshop malls, and we have obviously Build-A-Dino that we have talked about and some of these other -- the baseball, the Zoo, that are trending very well.

So we make those decisions about expansion, including the Build-A-Bear Workshop brand, and our capital uses based on what the customer tells us and what we see the greatest potential for. So it is an evolving process, and we are not in any great hurry to grow any one of those.

We use our real estate, the locations that are available to us and our capital to do what our customers say is the right thing to do, as well as where we can see the greatest financial benefit for the Build-A-Bear Workshop Inc. in all of our brands.

We did refine our fourth-quarter estimates slightly for the UK. We previously said the UK deletion would be about $0.13. We think we are coming in right now at around $0.16 dilution, and that is primarily as we refine our estimates; and also we had anticipated being able to add a few more new stores than we are going to be able to add in this year, which will be added in 2007.

Hal [Goche], Boston Company.

My question is on the international development side. You mentioned that you have upwards of over 300 stores out there. Could you tell us the level of development commitment you received from franchise developers in a given region? Like for example there's 27 open now, but you have commitments from franchisees to develop X amount over the next couple of years? Can you give us that detail?

Sure. When we sign a franchise agreement, inherent in that agreement is the number of stores we feel we have agreed that can be opened based on the demographics of that country. So what we don't tell you upfront how many stores we think are in our development programs for Germany or Russia, etc.. Okay, there is a schedule, and that is supported by the capital on the franchising store to make sure those things happen.

Morton Cohen, Clarion Partners.

I'm sort of puzzled by your low end of the guidance, given that your store base is larger given that you are going to get some accretion from the UK, bearing in mind your comments on the macro side, but I would have expected the guidance to be a little bit higher.

Well, I think we have been pretty -- as we have reported the results of each quarter and then gave outlook for the balance of the year, for then now the second quarter in a row, we are right where we said we would be.

Rob Wilson. Tiburon Research.

Can you speak to directionally where you expect gross profit margin in SG&A will fall in Q4? And also are there any changes in marketing with maybe TV advertising or catalog circulation that are planned in Q4? Thank you.

I will first address the marketing question, Rob. There is no major plan in circulation. We continue to spend our catalog to our existing database and those customers who shop within the framework of time and our best guess; and we continue to get strong response rates to those -- that mailing.

The TV is not substantially different. However, as I said my comments, we have made -- we are adding a commercial that is going to focus on the Maltipoo. We have had a -- we've tested some TV on specific products over the course of the year; and we have only really done that before on Christmas time on our Frosty the Snowman or Rudolph the Rednosed Reindeer and then, in some sporadic test throughout the year.

So now we are adding the Maltipoo to our TV commercial opportunity and we think because of the popularity of our dog line; the popularity of this particular dog with our -- in our pretest with our customers that that is a good thing to do. So it's not necessarily more advertising dollars behind or significantly more advertising dollars behind television but the way we allocate the television by seam, branding, Maltipoo, gift card and also Mumble.

We also have our Stuff Fur Stuff Club, which is really the first time we will have had this nationwide for our Company in the fourth quarter, and those customers get special offerings in their mailer that they'll get -- they will get a special coupon and they will get something directed especially to them, very similar to the way Chico's uses their Passport program and the way they use coupons in their mailers.

And so that was one of the plans for this program and we think that that will provide us again with rewards for our best customers and bringing our best customers back even more frequently, incentives to come back even more frequently than they would have come before as this program unfolds.

Relative to the fourth-quarter, you have heard our outlook for guidance. Suffice to say that those results will be based on, and I will not give you the specifics, but it will continue to be strong merchandise margins and well-controlled SG&A, similar to our previous results.

(Operator Instructions). Hal Goche. Boston Company.

Maxine, you mentioned that your older stores are comping the best, and I was wondering if you had any detail on any data you could share with us on the age of the stores and kind of what level that they are at? And any qualitative comments on cannibalization of stores that are opening second and third stores in the same market and what you are seeing there. Thank you.

We do not, except on an annual basis, give out the sales performance by age of stores; but as we continue to see our stores that are in our oldest group, which we say are over five years, perform the best of the group of stores that we have.

And the stores that are the youngest have the this challenge because they open up so strong in their first few years and it takes them a while to build back their sales. But remember, they are highly productive. Some of those stores range well over $1000 a foot in their first year of business, and they pay for themselves in the first year. So we feel that has been a fairly consistent trend.

It depends on the market where we open up secondary stores -- how much that can impact the market, have close it is to the existing stores in the market. We're opening -- we have, this year most of our stores have been opened up in the markets, which has been very good for us.

But the -- we will be opening up in a couple of weeks or this week, I think it is common coming up in San Diego in a new store we've always had for the last several years, just one store in a market. This is on the other side of time. It will give us advanced market share, which is really what we are after. One store does not serve the San Diego market. And we are looking to expand our market share, but we do know to customers accounted this fashion valley store for years from all over the San Diego market place.

So we expect that store to be impacted when every single year out until now has had a positive comp store sale.

One thing that we point to often is our success in the St. Louis marketplace, where - while we have not opened up any more Build-A-Bear Workshop stores in the last few years, that market continues to be positive market. But we did this year open up our Zoo store. And we have also opened up a store at the St. Louis Cardinals stadium which has not negatively impacted the St. Louis area stores.

Again, we're focused on continuing to grow our revenues, which combined with our high margins give us the ability to deliver significant earnings growth. We are looking to -- we still have a lot of potential to add stores here and to grow our market share in markets that we do not exist and in large markets where we already do exist. And that will always guide our expansion decisions, reaching our customers as profitably as and with as much sales and as much profit as we can, and not necessarily whether that will negatively impact the comp store sales of another store in the trade area.

Mick [Byrne]. Huntley, Byrne Investment.

There was that big article in our St. Louis paper this week about your furniture partnership with Pulaski. That was new to me and I have not heard you say anything about that. I am not sure everyone knows about that.

Thank you for that question. It is not a -- it is a licensed partnership. Just like our license with Target or a license with [Elan Polo] on shoes, and while furniture is high ticket -- a little higher ticket and can deliver some significant royalties on a licensee basis, it is one of those great brand building activities for us.

We are very excited about it. The customer's very excited about it. The vendor, Pulaski, is very excited about it because it allows them to be in very strongly in the children's furniture market with a great brand that has high recognition. They did a lot of market research on it and they are getting a great response to it at High Point market this week. But I think we did -- it was -- it has been announced over time.

Again, our licensing revenues are relatively small, but growing part of our revenue stream and a part of our brand building -- overall brand building in market awareness program.

At this time, ladies and gentlemen, I would like to the call back to Molly Salky.

Thank you, Operator. And in closing, let me mention that we will be presenting at the Susquehanna Consumer Focus Forum on Thursday, October 26 in New York City. As always, if you have any interest in meeting with us or have any follow-up questions, please feel free to give me a call. Thank you again for your participation and have a great day.

Thank you for your participation in today's conference. This does conclude the presentation. You may now disconnect your lines and everybody have a wonderful day.