Build-A-Bear Workshop Inc (BBW) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2006 Build Build-A-Bear Workshop Incorporated earnings conference call. My name is Cheryl, and I will be your audio coordinator for today. At this time, all participants are in listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. [OPERATOR INSTRUCTIONS] I would now like to turn our presentation over to your hostess for today's call, Ms. Molly Salky, Director of Investor Relations. Please proceed, ma'am.

Good morning, everyone, and thank you for joining us for a review of our results for our 2006 fiscal fourth quarter, ended December 30. I'm Molly Salky, Director of Investor Relations. Let me start by introducing the speakers on our call today; Maxine Clark, Chairman and Chief Executive Bear; and Tina Klocke, Chief Financial Bear; are both with me here today. In a moment, I'll turn the call over to Maxine to provide her perspective on the fourth quarter and full year performance and outlook for 2007. Tina will follow with additional details on the 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 the call today should contact us after this 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. Do 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 and a replay of both our call and webcast will be available later today. I need to remind everyone that discussions during this conference call may contain forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties. Our actual results could differ materially from those currently anticipated, due to a number of factors, including those set forth in the risk factor section 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. Before I turn the call over to Maxine, I want to give you a heads up regarding some new information we provided in our release today. Included in the selected financial and store data, which is the last page, or page nine of the release, included data on both our sales per square foot and comp store sales by age of store. As we did in 2005, we've broken our stores into age groups of less than three years, three to five years old, and more than five years. Furthermore, we've provided a breakdown of our store square footage between stores located in North America and stores located in the United Kingdom and Ireland. Also included is a breakdown of retail sales over the internet. Now I would like to turn the call over to Maxine for her comments.

Good morning, everyone, and thank you for joining us to review our fourth quarter and full year performance. I want to say thank you for your understanding regarding the delayed timing of our call today, and a special thanks for the good wishes you've sent my family and me over the last week. Also joining us today is Scott Seay, our new President and Chief Operating Bear. I know that some of you already know Scott, and over time I hope that all of you will get an opportunity to meet him. Those of who you have met Scott know that his leadership has been a key part of our growth and that his knowledge of our Company and brand is very strong. It's great to have Scott with us today. Before we turn our discussion to the fourth quarter results, I want to take just a moment to recap our 2006 accomplishments. The UK acquisition, rebranding and integration of the business into the Build-A-Bear Workshop infrastructure was completed in 2006. We are pleased to report today that the acquisition was accretive to earnings in the fourth quarter, as planned. We also completed construction of our Company-owned distribution center and transitioned from a third party to full operation. And we plan to further centralize inventory by relocating our web store operations to the DC this spring. We look to realize initial benefits from the new DC this year. We opened 32 new Build-A-Bear Workshop stores, four friends 2B made stores, two new ballpark locations, our first zoo location, and we launched the Build-A-Dino brand. Additionally, we continue to upgrade and improve our technology infrastructure, with new financial and human resource systems and the installation of a warehouse management system. Investments in brand building continued in North America and we began our initial marketing initiatives in the United Kingdom. These strategic building blocks are an important foundation to support the future growth of our brand, in both the U.S. and internationally. We also believe that organizationally, we are now structured more appropriately for this stage in our development and growth. With all operations now reporting to Scott, we've eliminated redundancy in our organization. I also think it's important to discuss some key differences between an entertainment-based retail concept and a traditional retail company. We are most certainly a retailer and a retailer that is a destination for customers, but we are very different in key ways from conventional specialty retailers. While our end products are stuffed animals, we are not a toy retailer. We sell an experience which results in an emotional connection with our brand. The smaller signature product, the teddy bear, is an icon that has been around for more than 100 years -- what we do is turn that desirable product into a memorable experience and a destination where memories are made. Perhaps this connection is why, unlike conventional retailers, we have very few product returns. Many guests come back frequently to our stores. We strengthen the connection with our guests through ongoing communications, in-store celebrations and new products. We don't de-value our product or brand by reducing prices or holding sales in order to drive traffic, which helps us maintain our exceptionally high merchandise margin. Our profitable store model is the backbone of our business and drives very positive cash flow. Our stores typically pay for themselves in the first year of operation and perform on a sales per square foot basis far above a conventional specialty retailer, an outstanding $573 per square foot in 2006. If you look at our business model over a meaningful period of time, you'll discover that our stores have strong sales in their first year of operation and often comp down from the strong performance in years two and three. Historically as a group, our younger stores have performed at the highest sales per square foot, above the chain-wide average, despite having comp performance pressures. At Build-A-Bear Workshop we can realize significant leverage and drive our profitability with a small comp improvement or even with a slight decline in comps. So am I happy with negative comps? No. Do we see opportunities to improve our performance? Yes. We have several initiatives directed at improving our comps and that will continue to grow our market share as well. Let me turn now to a discussion of our fourth quarter performance. First, and very positive in our view, the UK operations were accretive to earnings for the fourth quarter. Sales in the UK totaled $16 million and drove operating income of $3.3 million. UK stores continue to perform well with a positive post-conversion sales trend. The holiday season was a solid success for us. We opened two new stores in the fourth quarter and plan to open seven to ten new stores in 2007. Our first two new UK stores this year will open in the next couple of weeks on Princes Street in Edinburgh and High Street in Exeter. Our North American store performance was impacted by the strong demand for our special holiday animal, Mumble, demand that was greater than we anticipated. Mumble was our first major, family-oriented, movie-based licensing partnership. While we had the foresight to partner with one of the top-performing box office holiday attractions, a surprise to many in the movie industry, we underestimated the power of leveraging this type of partnership and ultimately, the popularity of penguins and the story of Mumble, a character with appeal beyond a typical seasonal holiday animal. The strength of the character, supported with significant promotional efforts from the studio and our own Build-A-Bear marketing, created a much greater demand for Mumble than we anticipated. In retrospect, we know we could have sold a lot more product. But as I said, it was our first foray into this kind of co-promotion partnership, and it was a product that had no prior history. We took a conservative stance and we learned a lot that will be applied in the future. What we saw in the fourth quarter was that our repeat customers, many of whom have built a sizable collection of Build-A-Bear workshop stuffed animals, have become more product discriminating. Formally, we found that our guests may have come to our stores with a specific product in mind, but they willingly substituted another product that they did not have in their collection. While our guests know that the Build-A-Bear Workshop experience is consistent, fun and fulfilling; we see more than ever before that are your repeat quest is equally motivated into action by the excitement that the new products bring. Also, a significant portion of our fourth quarter marketing and advertising was dedicated to Mumble. And given the inventory limitations, we pulled back and redirected advertising when possible. Looking at our store operations metrics during the quarter; we saw modest improvement in our average transaction value, and despite an overall decline in transactions, we continue to track at 60% repeat guests and 40% new guests. For the year, we received the highest guest satisfaction scores in our Company history, which points to the continued outstanding experience we deliver. These successes were achieved all while managing store payroll percentage lower, an important accomplishment, particularly in a negative comp environment. So what have we learned and how does this change our plans going forward? We will apply this knowledge into future product purchasing, not only for products with entertainment industry tie-ins, but to collectible and limited edition product, in general. It was and is a very instructive lesson that will impact our future product launches. Product newness is very important to the repeat guests, as well as enticing new guests, driving both a sense of urgency and bringing added traffic to our stores. Our product launches are even bigger when supported with advertising that raises product awareness -- both Build-A-Bear Workshop marketing, as well as third party marketing. We are adding incremental new products. Some of our own creations, like our spring seasonal bear, the groundhog and cuddly lamb, and others where we have partnered with a family-oriented entertainment brand. Specifically, Mumble is scheduled to return to our stores in late March at the end of the first quarter. We'll have Mumble and the Happy Feet DVD available for purchase. And we've partnered with DreamWorks Animation to offer Shrek and friends in April, in time for the release of Shrek III. We believe we've planned our inventory appropriately, taking into consideration the impact of outside marketing, combined with our internal marketing, and the significant awareness of Shrek within our target demographic. We plan to maximize the sales impact of new products by increasing our focus in inventory and investment on limited edition and collectable animals to drive both new and repeat business. Based on test results, we'll be adding TV advertising aimed at specific new product introductions. We previously focused the bulk of our advertising efforts at raising brand awareness to people who are unfamiliar with the Build-A-Bear Workshop brand. Now we balance that with call-to-action and product-specific messaging that activates our loyal repeat guests with an immediate reason to come back to our stores. We'll also continue to reach out to moms to raise awareness of our brand and to increase store visits and overall business in 2007. We know that parents, moms in particular, are constantly looking for entertaining activities they can have with their children. We plan to advertise to moms by a national TV and print, with advertisements created especially to speak to this target. Our past practice has been to run mom TV in the fourth quarter only. We plan to leverage our loyalty programs to drive sales and repeat visits. Our recently rolled out Stuff-for-Stuff Club enhances our ability to identify and understand our most valuable customers, which we expect to help us meet their demand and excitement on future purchasing visits. So far, nearly 2.8 million members have enrolled. And based on the rewards certificate response rates we've seen so far, we're optimistic about the opportunity we have to leverage this program by tailoring our messages and offerings to those most loyal guests. We have confidence that we'll meet our growth objectives in 2007, in part because we see ongoing opportunity to continue to bring new guest into our brands. Our Name Me Station has given us the ability to build a large database of customers who have visited our stores. We have the advantage of knowing who has been in our stores and registered a stuffed animal, how frequently they purchase animals, and when they last interacted with our brand in our stores. After accumulating the number of households in the markets where we operate stores, we see very clearly that we have significant future opportunity to penetrate new households with our brand. We do not believe we are near maturity. To achieve our full sales growth potential, we are challenging our marketing efforts and renewing our initiatives to communicate our brand, raise awareness and convert new children and their families into guests at our stores. I think it's worth considering St. Louis, our oldest market, but one that continues to grow. We added two new stores to this mature market in 2006, in Busch Stadium and the zoom and expanded our original gallery of stores to include the friends 2B made brand in late fall of 2005. Although the existing stores in the market had a slight negative comp store sales result, the overall market grew nearly 50% in revenues in 2006, to be an $8.5 million market today. We continue to attract a balance of both new and repeat customers. Importantly, St. Louis is not unlike many markets across the country, where we have the opportunity grow our business. Now for a quick store update. During the fourth quarter, we opened six new Build-A-Bear Workshop stores in North America and two new stores in the United Kingdom. We also opened the first stand alone friends 2B made store in Ontario, California, bringing our friends 2B made store count to nine. 2007 will be another busy year for store openings. We plan to add 37 new stores in North America, from as far north as Anchorage, Alaska, to as far south as Puerto Rico. And we'll shore up our already strong Canadian position with the opening of our first stores in Montreal, as well as new stores in Victoria, British Columbia and in Windsor, Ontario, bringing our count at year-end to 18 stores across Canada. We believe there's a potential of 30 to 40 stores in Canada. 22, or about 60% of new stores this year, are in new markets versus markets with an existing Build-A-Bear Workshop store. Seven of these new stores are in smaller markets where we're opening a smaller store, on average, about 2,100 square feet. These smaller market stores, include markets such as Asheville, North Carolina; Bangor, Maine; Charlottesville, Virginia; Bloomington, Indiana; and Spokane, Washington. We expect these stores to perform on a sales per square foot basis similar to larger market stores, although their total volume will be likely smaller than our average, reflecting the size of the market. With regard to our Build-A-Dino product, we'll be adding this new ride to our Myrtle Beach and Fifth Avenue store locations this year. In Myrtle Beach, the Build-A-Dino will have a separate store entrance. You'll recall that we added friends 2B made in Myrtle Beach about a year ago. In the flagship store, we are reconfiguring the lower level of the store to add the Build-A-Dino product line. We selected these tourist locations that reach a large number of guests to help us gauge the potential for the brand on a national basis. Both locations will be complete by June. Also this year, we'll open our first store at the St. Louis Science Center. The Science Center, a very popular attraction for families with children, is ranked as the fourth largest center in the United States, based on attendance and size. Our store will include the full Build-A-Dino product line-up, playing off the center's dinosaur exhibit, as well as Build-A-Bear Workshop product, including products customized for the science center. Working with our partners at Retail Entertainment Concepts, we will also open the first Ride Makerz store -- that's Ride Makerz with a Z. This new concept, focused on boys and cars, will debut in Myrtle Beach, South Carolina at Broadway the Beach in May. Let me turn to our outlook. We see excellent growth opportunities in 2007. Our outlook is for earnings per share to be in the range of $1.65 to 1.75, and is based on several assumptions. First, total revenue growth of approximately 19%, driven by the addition of 37 new Build-A-Bear Workshop stores in the United States and Canada, growth in stores square footage of approximately 14%, and by maintaining our high North American sales per square foot performance. We anticipate North American comparable store sales to be in the flat to negative mid single-digit range. Our international franchisees plan to open 20 to 25 new stores this year. Franchise revenues should increase to $3.7 million. We expect to maintain our gross profit margins through continued strong merchandise margins, minimal markdowns and product returns and from initial benefits from our Company-owned distribution center. Enhanced and more targeted marketing programs are expected to increase brand awareness and store traffic. We plan to invest about 7% of total revenues on marketing programs in North America and the United Kingdom this year, consistent with our spending as a percent of total revenues in 2006. Our capital spending in 2007 is planned to come down to the level of $35 to $40 million. These expenditures support new store growth, store expansions and remodels, and the ongoing investments in information technology. This guidance assumes that earnings for the first quarter will be between $0.35 and $0.41 per share. First quarter 2007 revenue growth is anticipated to be approximately 22% and North American comp store sales are expected to be down in the mid to single, high single-digit range. Our first quarter outlook is impacted by a couple of factors. We have always had a large gift card business, as people want to gift our experience. In fourth quarter 2006, we grew our gift cards as a percentage of our total sales. However, our fourth quarter gift card results still reflect our decline in traffic, which impacts our first quarter sales that are driven, in part, by gift card redemptions. Also, the first quarter will reflect the sales contribution from the UK acquisition for the first time. While we expect the full year to be profitable, due to seasonality, we project an operating loss in the UK in the first quarter. In addition, we will have a strong cash position and remain confident in the future cash flow of the business, including fiscal 2007. As a result, I would like to highlight this morning's announcement that the board has authorized the repurchase of up to $25 million of our common stock over the next 12 months, reflecting our confidence in the prospects of our business, as well as our commitment to driving increased shareholder value. We are pleased that our strong balance sheet and free cash flow allows us the flexibility to return cash to our shareholders, even as we continue to invest in the growth of the business. Now let me turn the call to Tina for her comments.

Thank you, Maxine. I'll add some additional details regarding our fourth quarter and full year financial performance. Our fourth quarter total revenue increase of 21% was fueled by UK sales totaling $16 million, new North American stores opened in the last 12 months, and an adjustment to the loyalty program deferred revenue, and sales from non-traditional store locations. Higher franchise fee and licensing revenues also contributed to the quarter-over-quarter total revenue growth. Our gross margin rate improved slightly to 52.3%, primarily due to the reduction to our loyalty program deferred revenue, effective at the beginning of the fourth quarter. This change in estimate resulted in a $5.2 million reduction in deferred revenue, the corresponding increase in net sales, and $3.1 million increase in net income. I will discuss this changing estimate in more detail in a moment. Also benefiting gross margin was an inventory cost adjustment that reduced cost of goods sold in the UK by $1.2 million. North America merchandise margin also improved. These positives offset higher occupancy costs in the UK, the lack of leverage on fixed costs -- fixed occupancy costs in the North American operations and higher distribution costs. SG&A expense margin improved to 35.2% compared to 38.1% last year. The margin benefit from the UK operation accretion -- and we continue to leverage our central office expenses and manage our store payroll at a slightly lower percentage of sales. Severance costs associated with the management change made in the fourth quarter were offset by a reduction in stock-based comp expense, as options and restricted stock were forfeited. These impacts, combined to deliver an operating margin in the quarter of 17.4%, compared to 14.2% last year. Moving down the income statement; the effective tax rate was slightly lower than last year at 38.4%. We look for a tax rate of about 38% in 2007. Let me now spend a minute discussing the adjustment to the loyalty program deferred revenue. In July 2006, the Company implemented an automated system for tracking the frequent shopper loyalty program, the Stuff For Stuff Club. Prior to July, the Company used a manual punch card system and a portion of every transaction was deferred. With this new automated system, we did not change the program benefit. The program benefit has been and remains that for every dollar spent, the guest earns one point and receives a $10 gift certificate upon reaching 100 points. What did change is that our guests now actively join our loyalty club. They take the time to enroll in the club and share their personal info with us, which points to the motivation and in the connection these guests have with our brand. Also importantly, we now have improved visibility and financial accuracy to the redemption rates, coupon redemptions and usage via the automated card. As a component of our significant accounting policies, we review the redemption rates and assess the adequacy of deferred revenue at the end of each quarter. We've periodically adjusted the deferred revenue based on our review. We lowered the redemption rates, and importantly, reduced our deferred revenue in fiscal 2003. And in fiscal 2004, we adjusted the percentage of revenue being deferred on a prospective basis. Based on the most recent assessment of historical redemption rates, and with the enhanced visibility to these rates through our new automated system, we reduced our estimated loyalty program redemption rates. This change in estimate, effective at the beginning of the fourth quarter, resulted in a $5.2 million reduction in deferred revenue. This fourth quarter reduction includes $3.6 million related to estimated deferred revenue from periods prior to fiscal 2006, and $1.6 million related to estimated deferred revenue from the first three quarters of 2006. Looking at the adjustment on a full-year basis; the change in estimate is effective at the beginning of the 2006 fiscal year, and results in a $3.6 million reduction in deferred revenue, a corresponding increase in net sales, and a $2.2 million increase in net income, or $0.11 per diluted share. Additionally, the amount of revenue being deferred beginning in the fourth quarter was decreased by 0.6%. This change in redemption experience does not reflect on the rate of returning versus new guests. Reduction has more to do with a transition from paper cards to an automated system and the full visibility we now have to the future liability. Importantly, the new cards are easier for customers to use and are fully integrated with our POS system. As Maxine discussed earlier, we now have visibility to non-stuffed animal purchases and communicate directly with these high-quality customers, track the lifetime value of our guests, and understand more fully how they respond to our marketing efforts. Looking now at our full year results, I think it's helpful to talk through the items impacting the GAAP results. Full year 2006 GAAP operating income was $46.9 million versus $42.7 million last year. This GAAP operating income includes the UK acquisition loss of $1.5 million, the third quarter distribution center transition costs of $1.7 million, higher stock-based comp expense of $1.3 million, and the adjustment to the loyalty program redemption rate and deferred revenue of $3.6 million. Looking behind the GAAP results shows that excluding these items, our core business operating income showed growth, even in a negative comp store sales environment. These results continue to point to our strong store economic model. Now for a couple comments on the balance sheet. Capital spending in the fourth quarter was $ million, down from $8.5 million in the 2005 fourth quarter. The year-ago spending included the purchase of our DC real estate in Ohio, which was approximately $2 million. For the full year, our spending totaled $53.5 million. We ended the year with a cash balance of $53.1 million. During the year, we did not utilize our line of credit. Our outlook for 2007 is for cash to increase by approximately $30 million. Our 2007 outlook for EPS in the range of $1.65 to $1.75, delivers operating income growth when you make the comparison to 2006 operating income, excluding the UK dilutions, distribution center transition costs, higher stock-based comp and the adjustment to the loyalty program deferred revenue. I'll add a couple of comments on our quarterly outlook. The UK acquisition closed in the second quarter of 2006, so first quarter 2007 will reflect the contribution from the UK acquisition for the first time. However, due to the seasonality of the UK business, we anticipate that the business will report an operating loss in the first three quarters of 2007, an operating profit in the fourth quarter, and a full year operating profit. We look for the UK revenues to total approximately $12 million in the first quarter. Also, the tax rate across the 2007 quarters will be lumpy, as a result of the UK operating loss in the first three quarters. Moving now to some final comments on international franchising. During the fourth quarter, international franchises opened seven new stores, including the first stores in Norway, Moscow and Singapore. During 2006, we opened a total of 15 stores and ended the year with 34 international franchise stores. We recently awarded the franchise for South Africa to Intensity Entertainment. Intensity operates the Crafters Market chain of retail stores in South Africa, which was started in 1996. The Crafters Market sells quality craft merchandise produced in South Africa and around the world. Our franchisee expects to open their first Build-A-Bear Workshop store in Johannesburg this summer. Also opening this year are the first stores in India. As we mentioned earlier, and based on our real estate standards and locations currently identified, we anticipate franchisees will open 20 to 25 new stores in 2007, with the majority opening in the third and fourth quarters. This concludes my remarks. Now I'll turn the call back to Maxine for her final comments.

Thank you, Tina. I would like to end today with final comments on our business. We've learned some important lessons about our business and our guests. We are not content with our performance, and are taking quick and effective actions to make improvements, as I outlined earlier. We plan to maximize the sales impact of new products with both new and repeat guests. We will further differentiate product with product-specific call-to-action TV advertising. We plan to further brand awareness with moms. We expect to leverage our loyalty program to maximize the value of our best guests. And we've made significant steps towards enhancing our store experience and our connection with our guests. And bringing new kids and their families to their brand remains a big opportunity. This fact, combined with the actions and tools we have in place, gives us confidence in our outlook.

Thank you, Maxine. Now, Operator, we would like to open the call up for questions. Maxine and Tina are now available for your questions.

[OPERATOR INSTRUCTIONS] Our first question is from the line of Thomas Filandro of SIG.

Thank you. And Maxine, again, my condolences for your loss.

Thank you, Tom.

Quick question, really this relates to the whole Shrek -- the concept of Shrek and Mumble, the opportunity maximize the selling of those key items with those partnerships. This question is directed sort of at Tina -- can you give us a sense of what the inventory levels on a per square foot basis look like heading into the first quarter? And how we should view inventories as we roll out into the spring season? Obviously, I think, Maxine, I heard you say you underestimated Mumble, the power of that. Clearly, you would position yourself more aggressively to maximize the selling of these type of skins. So I want to get a better handle on how we should view inventories going forward. Thank you.

Well, Tom, it's Tina. Thank you. We ended the fourth quarter slightly lower than what we had in the fourth quarter of 2005, at about $63 a square foot compared to about $65 a square foot; so a slight reduction. We ended up coming right in on plan of where we had anticipated. And as we build inventories, as we normally do in the first quarter of this year, we'll include the appropriate amounts that we believe for the Shrek. Shrek will not be out until April of this year.

Next question, please?

Our next question is from the line of David Schick of Stifel Nicolaus. Please proceed.

Hi, good morning.

Good morning.

When you guys talk about the franchise fee expectations or guidance for this coming year of $3.7 versus the $3.5 you did with -- with the stores opening and maturation of stores, is that conservative guidance? Or how should we think about that?

David, it's Tina. I think-- as I said, based upon the real estate constraints in our franchise markets, most of the stores, as they have historically, will open in the back half of the year -- in the third and the fourth quarter. And so that -- our estimate is based upon that happening, with the $3.7 million and 20 to 25 new stores.

Okay. If you look at the marketing spend guidance, how does that compare -- or how consistent is that with the past, 7%?

It is consistent, on a consolidated basis, with 2006 as a percent. Dollars are higher, but percent is the same.

Next question, please?

Our next question is from the line of Brian Tunick of JPMorgan.

Thank you. Also want to offer my condolences.

Thank you, Brian.

I guess I'm only allowed two. So first one, Maxine, you didn't talk about any licensing revenues. Is that still such a big opportunity that you've talked about before? And then the second question, I guess would obviously be on the boys concept -- what do you guys know about that business? Do you have an internal team? How many number of stores, possibly, could we see next year in that [slot car] business?

The licensing is still a viable part of our business and we haven't emphasized it in a while, but it still is a part of our business. And as you probably remember, we have a big launch this spring in the furniture area, a line of furniture from Pulaski, and we're very excited about that. And we had a launch in the fourth quarter of last year from Scholastic Books and that's doing quite well. So we're really comfortable with that. We just don't see it as big a growth as we see some of the other things we're talking about. Regarding Ride Makerz, we will open up more than the one store, but we are reserving our information processing on this particular project for a number of reasons that we want to keep as much of it close to the belt as we can. But we're very excited about it. We did have a separate product development team, outside consultants helping us. Just a reminder this, is in partnership with Retail Entertainment Concepts. So while a lot of the business operations will be managed here at Build-A-Bear and leveraging our systems and our great teams and our distribution center, the product and -- up until now, almost everything's been developed 100% separately from our team here at Build-A-Bear Workshop.

Next question, please?

Our next question is from the line of Bill Sims of Citigroup.

Good morning. I want to extend condolences as well for your loss, Maxine.

Thank you, Bill.

Two questions. First, can you comment on the newly opened DC and how should we look -- should it dilutive or accretive to earnings in the first half of '07, as well as full year '07?

Scott, why don't you answer that.

Yes, this is Scott Seay. Welcome, everyone. The DC continues as we stated last year. We're looking for the increased centralization of our inventory, and that gives us a better visibility so we can gain some efficiencies and some operational effectiveness. We're also looking to improve our inventory management with our new systems out there. This allows for greater turns in our store and better productivity of our systems. We're also, because of the geographic centralization, our speed to market, as well as what it gives us on a reduced fuel cost based on the recent fuel increases -- we see some leverage with that. We're also just -- announced this week that we will be moving our web fulfillment operation to the DC, which will take place the end of April, first of May. So with all these things, we think we can gain better leverage in our DC and use that much better in 2007.

Next question, please.

And we have a question from the line of Sean McGowan of Wedbush Morgan. Please proceed.

Thank you. Two areas. First, could you talk about these licenses, like Tom was asking about earlier, upcoming? Are there any other properties with any visibility that you could talk about you would be going for? And how important, generally speaking, will that business be -- that kind of business be, going forward? And then the second question is, with an outlook that seems to be skewed more towards maybe flat to down slightly, rather than flattish, does that change your spending plans for store operations? Thank you.

Well, the first question is, we've always been in the -- we've always partnered with different entertainment brands like Disney. We've had Winnie the Pooh in our assortment and we've had Mickey and Minnie in Disneyland in Orlando. We've also had Hello Kitty, and from time to time -- for holiday in the prior two seasons, we had Rudolph the Red-Nosed Reindeer and Frosty the Snowman, which weren't about movies now, but were about entertainment brands. We've always done quite well with those. While we do have a few more of those things planned, we want to reserve the right to announce those as they come up closer for the time of our customers. But there are a couple of other things in the works. As well as you may not count this as -- it's not tied to a movie, at least not a current movie, but we will be launching, and it's out in our stores, Cat in the Hat on March 2nd as part of Dr. Seuss' anniversary celebration this year. So we're very excited about that, although in our minds, that's not the same magnitude as something like Shrek.

And, Sean, our outlook for capital spending is $35 to $40 million, which we still believe this at the end of the year will give us a $30 million increase to cash. So while it is less than last year, remember, we did build the DC that we won't have in this year's numbers.

Next question, please?

Our next question is from the line of Paul Lejuez of Credit Suisse. Please proceed.

Thanks, guys. Price points in '07; how are you thinking about your average price point? And as you think about the comp guidance that you're giving, how much of that do you assume is from declining traffic?

Well, we don't exactly plan it out specifically like that, but we do expect that our average transaction, our HPG, as we refer to it, will go up slightly. Obviously, some of these licensed products, as the customer buys more of those, those are higher retail. And so they do impact our transaction dollar value. But overall, we expect it to be about the same in 2007 as it was in 2006.

Next question?

Our next question is from the line of Rob Wilson of Tiburon Research Group.

Yes, thank you. Was the deferred revenue adjustment, was that included in your previous guidance? And also, the UK profits in Q4, the $3.3 million, is that net income, or is that operating income? And what should we think about that as a -- on a pennies or cents per share?

The deferred revenue adjustment was not included in our previous guidance. And as you look at the operating income of the UK for the fourth quarter, that was net of operating -- net of lost interest income and lost franchise royalties in the fourth quarter. On a go-forward basis in 2007, we were just going look at operations -- income from operations. And we expect that to be accretive for the full year.

Next question?

Our next question is from the line of Rick Lodewick of SeaRock Capital.

Thank you for taking the question. Can you just briefly discuss what benefits you see in being a public company at this point? I think you pointed in your remarks your strong cash flow characteristics of your year one stores. You have a strong balance sheet, certainly. So do you need capital? Or what are the benefits of being public at this point?

Well, obviously, we have a strong cash flow business and we like the idea of being in the public marketplace. It's a great place for our associates to be able to have the value of their investment and see their Company grow and prosper, and we're very satisfied with that at the present time.

Next question, please?

And we have a question from the line of Janet Kloppenburg of JJK research.

Good morning, everyone.

Good morning, Janet.

Hi. Maxine, I hope you're doing okay.

Yes, thank you.

Couple questions. Tina, how do you want me to look at the fourth quarter operations on a normalized basis? Do I just ex out $0.11 of the deferred revenue adjustment?

When you look at it -- when you look at the deferred revenue as a -- starting in the fourth quarter, you have to look at $0.15 cents.

It's $0.15 --

We also had increased stock-based comp of $0.01 and the UK acquisition accretion of $0.13.

Next question, please?

We have a follow-up question from the line of David Schick of Stifel Nicolaus. Please proceed.

Hi. Thanks. And the question is, as you're working with these partners like DreamWorks, what kind of marketing support is coming from your partners in these roles, as it seems to be growing?

Well, you can see what their -- I think, David, you've probably already notice the marketing that they are doing. They don't necessarily commit to any big specific dollars, but you can see they are already marketing the countdown to Shrek 3. They are marketing the Shrek with the past Shrek movies in retail stores. They are marketing on their website pretty aggressively. This is a very large franchise for DreamWorks and something that they have been working with us on. So they are doing quite a bit of marketing. It's already started. And we will be also be starting our marketing quite soon and getting our our customers excited about that as well.

Next question?

We have a new question from the line of John Zolidis of Buckingham Research.

Hi, good morning.

Good morning, John.

We look at the fourth quarter, obviously, the big story of the fourth quarter was the success of the Mumble product, and then at the same time, not having enough of it. You made these comments about your repeat customer getting more sensitive to new product introductions. Do you think that going forward, you need to churn your existing product offering more frequently? Or can you drive better comps and sales with more appropriate ordering of product? What are you focusing on, going forward, to try to reverse the trend that we saw at 4Q? Thank you.

We're focusing on both of those things. But I think that, yes, the answer that we are adding more new animal products than we've ever had before. We are changing them out more frequently. That is somewhat of a risk because they are going to be available for a limited time and you may not be able to supply all of the demand that the customer has there. So we've targeted a few things to be larger than other things, like you would do in any line in assortment planning. Shrek is one of those things. It also is occurring earlier in the year, so we can in fact, as successful as it is, continue to buy and continue to carry it as long as we want to carry it. So that's not limited by a particular season. And like we just had -- December was a month we couldn't possibly have -- from November to December gotten that much more product in our stores. Our vendors couldn't have produced that much more. So we have planned these out based on a certain valuation that we give them from what's publicly known as Q Scores, the popularity that customers give some of these things, and how we weight them in our inventory. Based on also the marketing that we believe the people are going to spend on it, the relevance -- the cultural relevance of the product; all kinds of things that go into the adjustment. The price, the market that its targeted to; is it a product for all genders, is it a product for younger children, is it a product for tweens -- like Hello Kitty is clearly targeted to a tween audience, and something like Winnie the Pooh was targeted towards a younger audience. All of those things have to be taken into account as part of our planning. Larger quantities fulfill the demand of existing guests and they increase -- but they also increase missed opportunities, people left out. And so we want to continue to keep that demand going, keep the popularity of the item going. But not -- not overdo it either, not oversaturate the market. But we totally underplayed the Mumble. We just didn't have any idea, nor did they. I don't think that's one you could predict as clearly, in terms of popularity, as Shrek. Shrek is already an existing franchise.

Next question?

Our next question is a follow-up from the line of Paul Lejuez of Credit Suisse.

Hi, thanks, guys. Could you just talk maybe qualitatively about the UK business in the first three quarters? I think you said it was going to lose money. Why is that --- that they cannot make money now that the stores are all converted? And is that a -- just something about the business model where that business won't make money ever in the first three quarters of the year?

This is Scott again. The UK business is much stronger in the fourth quarter, about 40% of their business is in the fourth quarter, and they have less seasonality in the first three quarters. Where we have several, what I'll call Hallmark opportunities in the first three quarters, they are not as big in the UK right now. Although, they are growing significantly. Also as we -- our brand is just not as strong there as it is here as of yet. But our marketing efforts, which kicked in in the fourth quarter and will continue through the -- this year, will also help with us our brand image there. So I think through this first year, it will still be a little bit of a struggle as we get our brand out there. But it will continue to get stronger as the year goes on.

One of the things -- just to add so that you are aware of this -- in some of these licensing partnerships are done differently in different countries, they have different licensing agents, and in the case of Shrek, we will not have that in the UK. So, just so you know that and aren't counting on that. But we expect the majority of the business, anyway, would be driven by North America. But most of our other licensing relationships are across the UK as well. The other thing is that United States and North America in particular, are well known for our Hallmark kind of holidays; the strength of Valentine's Day, Saint Patrick's Day, Halloween, Mother's Day, all these things. While they are growing in importance in the UK, they aren't quite as strong as they are in the United States, which balances out the holiday business for us. But we are working really hard to make them a much stronger part of the business. And we also have a huge party opportunity in the UK that will also help us leverage business across more quarters and we're working on all of that. Our brand awareness in the United Kingdom, just another point to add -- we've already measured it when we went into the marketplace, and it is low. Like it was for Build-A-Bear Workshop back in 2003 before we started our television advertising. And we do realize that we have a lot of opportunity and we're working on brand building -- significant brand building. We do believe we can change this over time, but we're going about it in a much more planful way and not trying to -- we're not putting in TV yet, we're not doing some of those things. So we are really working on a lot of our in-store events, parties, marketing, public relations, and certainly making the things that are really good in the United States that we can put in the UK. Another strong point that we have that we didn't have -- Bear Factory didn't have and our own Build-A-Bear Workshop franchisee didn't really develop, was our database management. And we have a very, very strong building every day information base of customers that we are marketing to and we're seeing the results of those labors quite strongly.

Next question?

Our next question from the line of Rob Wilson of Tiburon Research Group.

I'm sorry, Tina. I'm still a little confused on the UK. In your SEC filings, you actually give us the net income for the UK. I was wondering if you could give us that number for Q4? And also, Scott didn't necessarily answer the accretion/dilution question related to the distribution center in 2007, earlier. I was wondering if he could expand upon that? Thank you.

Well, for the fourth quarter, on our operating income in the UK will be $3.3 million. And that was accretive, as we've already said. And as we go forward into 2007, as both Maxine and Scott just alluded to a minute ago, is that we will be -- there will be a loss in the first three quarters and accretive in the fourth quarter, for the full year being totally accretive.

From the DC perspective, we really haven't looked at it as being accretive. We're really basing our assumptions on the benefits that we from it and what we'll see through this year. It's only had one quarter of full operation and so we're looking at everything every quarter. We do see the benefits in it and we will see that strengthen over the year.

One of the things, Rob, when we looked at evaluating going into a distribution center, it was clear to us that no matter what we did, our costs were going to go up. Our third party provider was going to have to build a larger distribution center and charge us more money to operate and run our business. And so we took all of that into account when we worked with our consultants to decide how do we keep costs at current levels, as well as reduce them over time. And I expect that over time, because of the sheer millions and millions of units that we're bringing in, we'll be able to leverage that cost across a much bigger base of business. The Ride Makerz business will also be coming through our distribution center in Columbus, Ohio, and that will also further leverage that infrastructure. So we expect that we will see improvements. However, we aren't yet projecting what those will be. Our goal is to keep our costs at where we are and also maintain our very high merchandise margin.

Next question?

Our next question is from the line of Janet Kloppenburg of JJK research.

Hi. I didn't get all of my questions answered the first go-round. Tina, if you could just give us an outlook on the operating income normalized for the fourth quarter, and exclusive of items that weren't previously in guidance, I would appreciate that. And also, Maxine, if you could discuss the marketing program. I think, as you said, the percentage rates are flat to last year, which I understand and appreciate. But I think you also said that your increase in TV advertising during the non-holiday or non-Christmas period --

I'm sorry, Janet, I didn't hear the first part of your question directed to me, to Maxine. I couldn't hear what you asked about.

The marketing program, the flat percentage to sales.

Right.

But I also think it includes increased advertising in the non-holiday period. Which means that to me, marketing expenditures must be coming out of some other areas to bringing you in at a flat level. Thank you.

Okay, great. Let me answer that question first. Marketing, as a percentage of sales, will be at the same level of last year. Because our sales are going up it, it does give us more dollars and we're merchandising those dollars, for lack of a better word, across all of the media that we use, whether it's radio, magazines, direct mail, television. And so we have a -- obviously, our television goes across the country, whether we have a store in a market or not. So adding these 22 stores to new markets to our Company this year also leverages our already national spend towards more markets. So we aren't planning to spend any more percent, but we will be spending more dollars, as a virtue of the percentage of sales. And we will be remerchandising those dollars across all of the media that we use.

And Janet, in looking at Q4 over Q5 fourth quarter, there is, when you take out the UK operating profit, the stock-based comp increase year-over-year and the adjustment to the loyalty program, you come up with a slight decrease in operating income year over -- quarter-over-quarter. But when you look at it year-over-year and make the same adjustments, including the DC one-time transition costs, we do have a total full year operating increase of about 12% in total operating income.

Our next question is from the line of Brian Tunick of JPMorgan. Please proceed.

Yes. I was hoping maybe you could give us some more color on how the quarter played out between the three months? Sort of when -- this big shortfall of earnings relative to your guidance, is that all deleveraged? Just trying to understand that for Q4. And then finally, how you would characterize your guidance for the remainder of the year? Do you consider it to be pretty much realistic given down earnings in Q1?

Well, as you know, we don't give inner monthly guidance by month on a -- either on a lookback or a go-forward basis. And basically, when we look at the full year, this is where we believe we're going to end based upon all the items that we have highlighted, and not only are released in our conference call. Whether it be the increases to the capital spending budget or any of the other information that we highlighted in the call. At this point in time, we believe our guidance is $1.65 to $1.75 for the year to date.

Next question?

We have a question from the line of [Lily John] of [Canicus]. Please proceed.

Good morning. I was wondering if you could just explain the gross margin adjustment that was made in the UK?

Sure. As we -- as you know, when you purchase an entity, you have approximately a year to finalize the purchase accounting. And as we look through and analyzed our inventory, it was a result of the final -- the adjustment to gross margin, based upon our merchandise that was left in -- left over from the Bear Factory.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to return the floor to management for any further closing remarks.

Thank you, operator. And in closing, let me just mention that we'll be presenting at the Stifel Nicolaus Consumer Conference on Tuesday, March 13 in New York City. And meeting with investors in Boston on Wednesday, March 14. If you have any interest in meeting with us or have any follow-up questions, please feel free to contact me. Thank you, and have a good day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes our presentation. You may now disconnect. Good day.

Editor: [Unspoken forward-looking statement]

This conference call contains "forward-looking statements" (within the meaning of the federal securities laws) which represent the Build-A-Bear Workshop's expectations or beliefs with respect to future events. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated. Those factors include, without limitation: we may be unable to generate comparable store sales growth and may continue to have negative comparable store performance; our marketing initiatives may not generate sufficient brand awareness and sales or demand for our retail experience; we may be unable to respond to changing consumer preferences; customer mall traffic may decrease as a result of various factors, including a reduction of consumer confidence because of terrorism or war; general economic conditions may worsen; our market share could be adversely affected by competitors; the availability and costs of our products could be impacted by international manufacturing and trade issues; our warehousing and distribution vendors may perform poorly, and we may be unable to realize the anticipated benefits from our distribution center; we may fail to protect our intellectual property and may have infringement, misappropriation or other disputes or litigation with third parties, which could be costly, distract our management and personnel and which could result in the diminution in value of our trademarks and other important intellectual property; we may be unable to open new stores, renew or replace our store leases, enter into leases for new stores on favorable terms, or continue to comply with our current leases; we may lose key personnel or be unable to hire qualified additional personnel, including store associates; vendor deliveries may be disrupted; we may not realize some of the expected benefits of the acquisition of Amsbra and The Bear Factory; we may be unable to effectively manage our international franchises or comply with changing laws relating thereto; we may experience communications or information systems failures; we may suffer negative publicity or be sued due to alleged violations of labor laws, employee regulations or unethical practices, either by us or our merchandise manufacturers; and we may violate or be accused of violating privacy or security laws by reason of improperly obtaining or failing to adequately protect Guest information. These and other applicable risks, cautionary statements and factors that could cause actual results to differ from the Company's forward-looking statements are included in the Company's filings with the SEC, including as described in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2005. The Company undertakes no obligation to update or revise any forward- looking statements to reflect subsequent events or circumstances even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.