Build-A-Bear Workshop Inc (BBW) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 Build-A-Bear Workshop earnings conference call. My name is Latasha, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) 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 the 2007 fiscal third quarter which ended September 29. With me this morning are Maxine Clark, Chairman and Chief Executive Bear; Scott Seay, President and Chief Operating Bear; and Tina Klocke, Chief Financial Bear.

In a moment, I will turn the call over to Maxine to provide her comments on our third quarter results. Scott will update you on our store operations and international franchising, and Tina will follow with additional details on the third quarter financial results. At the end of our remarks, we will open the call for your questions. Members of the media who may be on our call today should contact us after this call with their questions.

We ask that you limit your question to one question and one follow-up. This way we can get to everyone's questions during this one hour call. Feel free to requeue if you have further questions. Please know that our call is being recorded and broadcast live via the Internet. The earnings release is available on our corporate website and a replay of both our call and webcast will be available later today on our website in the Investor Relations section of buildabear.com.

I'll remind everyone that forward-looking statements are inherently subject to risks and uncertainties. Our actual results could differ materially from those currently anticipated due to a number of factors including those set forth in the "Risk Factor" section of our 2006 report on Form 10-K filed with the SEC. We undertake no obligation to update or revise any forward-looking statement.

As announced on June 28, 2007, we are presently conducting a review of strategic alternatives. And while this process is underway, we will not provide earnings guidance, nor will we update or comment further upon the earnings guidance provided prior to the review. There is no assurance that the consideration of strategic alternatives will result in any changes to the Company's current business plans or lead to any specific action or transaction. And as announced on June 28, we do not expect to disclose further developments regarding the process until the Board's review of strategic alternatives is complete.

Now, I would like to turn the call over to Maxine Clark for her comments.

Thank you, Molly. Good morning, everyone, and thank you for joining us to review our third quarter results. The third quarter was a tough quarter. The decline in mall traffic made sales trends very difficult for our Company. The economic environment was and continues to be challenging for many consumers. Higher fuel costs, declines in housing values and adjustments to variable rate mortgages all contribute to a negative climate for consumer spending and mall traffic.

While these factors have a negative impact on overall consumer behavior, they can have a particularly serious impact on discretionary spending. While our business can be more sensitive than other retailers to downturns in the economy, we believe it is also more responsive to upswings. Our strategy during this challenging time is to focus on enhancing our core brand, (inaudible) our execution and new products and experiences while continuing to connect with our guests.

Mall traffic declined again in the third quarter, down in the mid-single-digit range, based on industry reports for enclosed malls. Mall traffic is important for our Company. Walking past a Build-A-Bear Workshop store in the mall is still the number one reason given for why a first-time guest visits our store.

On a positive note, during the key weeks of back-to-school shopping, our sales mirrored the improved trends experienced by many retailers as mall traffic increased during that important shopping period. Our back-to-school marketing and merchandise offerings were strong and supported the increase in traffic we experienced. These trends during the quarter reinforced our view that our business benefits from strong mall traffic and is hindered when traffic declines.

In good times and challenging times, a fundamental strength of our Company remains our very strong economic model. We've said it before and I believe it is worth pointing to again, that our store model has the ability to deliver net income growth in a wide range of economic climates. Our stores are highly productive, generating strong sales per square foot and positive cash flow. Our stores typically pay for themselves in the first year of operation.

We add value to our product and brand by investing in marketing and brand building programs, rather than reducing prices or holding sales in order to drive traffic. This difference helps us maintain our exceptionally high and steady merchandise margins. This store model and our unique store experience puts us in a position to maximize and grow our business when the retail environment does improve.

We have very strong product marketing and guest communication programs in line for the quarter. Before reviewing these in detail I would like to first discuss the third quarter results for our European operations. Our European operations delivered another quarter of improved performance. This segment of our business now includes Company-owned stores in France opened during the third quarter along with our stores in the United Kingdom and Ireland.

We opened two new stores in the U.K. and our first two stores in France, both in Paris. We ended the quarter with 45 stores in the U.K., Ireland and France. Third quarter sales were $13.7 million, up 46% from $9.4 million in the 2006 third quarter. And our operating performance in the quarter was significantly improved, a loss of $500,000 compared to a loss of $2.1 million last year.

During the third quarter, European results showed a healthy increase in average transaction value, up about 10%, and an increase in party sales. In addition, our average transaction value was up strongly. Party sales, as a percent of revenue, are still at a lower level than our North American stores, but have showed a steady increase this year as we've placed more marketing emphasis on the party opportunity in the U.K..

Parties continue to be an opportunity for us to build on. Guest satisfaction scores are very high in Europe, even higher than our North American average. In the 18 months since we completed the U.K. transaction, our teams have shown they are clearly able to replicate the Build-A-Bear Workshop experience. These improving metrics reflect our continued strong operational execution by our product distribution to our stores, having the proper levels of inventory to support our increased transaction count and transaction value, our initial marketing efforts primarily by direct-mail at this time, and our improved store experience.

We see continued opportunities to grow and improve the European operations. Our strategy includes driving top line growth through raising brand awareness, communications with guests, increasing party business, improve merchandise and inventory management; also improving gross margin through lowering occupancy costs on new stores, which we have made some progress in so far this year in new locations, and improve SG&A by better management of store payroll.

The third quarter performance increases our confidence in the growth and improvement opportunity we see for the long-term success of the European operation. Our strategy during these challenging times is to focus on enhancing our core brand, in-store execution and new products and experiences while continuing to connect with our guests. We have a very strong merchandise lineup for the fourth quarter. Our guests respond to product newness and collectability.

Our holiday floor set previews in early November, and begins a theme of golden shimmer for clothing and accessories that will continue throughout the holiday season. We have strong fashion offerings again this season, metallics, especially gold, continue to be important. These colors complement our ongoing leopard and animal print products that continue to be very successful since launched at back-to-school fashions. Baby Tall Tops and Skinny Jeans and leggings continue also to be key items. And adding to the clothing assortment, our new emerging licensed product favorites, including High School Musical, Hannah Montana T-shirts and pant sets, and Cheetah Girls T-shirts.

The launch this Friday our Winter Bear, the fourth and final bear in our Friend For All Seasons series collection marks the start of our seasonal merchandise. Our seasonal bears have had strong success. We plan to offer a similar series of collectible products again in 2008 under a new theme.

On November 1, we will introduce our new Polar Bear who is playful, cuddly and well priced at $18. A portion of the sales for Polar Bear during the first 10 days of launch will be donated to the World Wildlife Foundation to support efforts to preserve polar bear environments around the world. In celebration of our 10th anniversary we are bringing back one of our most popular holiday animals, Rudolph the Red-Nosed Reindeer, and for the first time he is bringing his special friend, Clarice, for her debut launch.

While Rudolph is a classic, we redesigned him to be even more appealing this year. We have updated his material and design slightly, but his biggest plus is the changeable battery pack which will ensure his nose is forever bright red. Rudolph's special friend, Clarice, is a full-size stuffable girl reindeer who is very cute and comes with a red and white polka dot bow.

In 2004, we ran low on Rudolph very early in the holiday season, so we know many of our guests at that time were not able to purchase Rudolph. Rudolph is a tried and true holiday classic and one that we are highly confident will have success again this holiday season. We know the customer demand for Rudolph was not fully met in 2004 and we have added millions of new and loyal guests since then along with 150 new stores and over 60 new markets.

The addition of Clarice adds more newness and girl appeal to this holiday icon. As in the past our holiday merchandise is supported by our fully integrated marketing programs, including direct mail by our holiday catalog which arrives in homes in early November, national children and women's TV advertising, national print, in-store events, Web and e-mail support. We have increased the distribution of our holiday catalog this year by about 15%.

We are also increasing our holiday new guest mailing to ensure that we are communicating with guests new in our stores in the late August through October time frame who might otherwise miss out on receiving the holiday catalog. TV advertising began this week and includes brand advertising. Later in the quarter we will add product specific and Bear Bucks gift card advertising. National print advertising includes women's and kids media, and you'll see our ads in Family Circle, Good Housekeeping and National Geographic Kids' magazines.

Perhaps the hottest and hardest to get ticket in town these days is to a Hannah Montana concert. We are happy to have tickets for some special guests to concerts in 54 markets across the country. Our Rockin' Hannah Montana concert tickets sweepstakes began October 5 and is running throughout this month. Guests can register in our stores to win tickets to a concert in their local community and they can enter our national sweepstakes for tickets and a trip to the concert in New York City.

When kids come in to register we have our Hannah Montana T-shirt and as the concerts unfold we will also have a Hannah Montana pant set, Hannah Montana screened T-shirts, blond wigs and guitars, all important and relevant to our tween guests. Throughout the concert series our brand advertising will appear in pre-show and intermission entertainment and the concert program will include a coupon offer for use in our stores.

As is our tradition, we will again offer a holiday gift card upsale program. We expect Bear Bucks gift cards to be the choice of many guests and we continue to promote and raise awareness of our gift cards. Our upsale program begins November 23 and runs through Christmas Day. Our gift cards are again available for purchase in our stores, on our website, at Walgreen stores nationwide and in more than 4,000 grocery, drug and office supply stores across the country.

This holiday season our stores will also play an important role in communicating with guests about our new virtual world launch later this quarter. This leads me to a discussion of our strategies aimed at being connected to our guests and specifically the new Virtual World website and our loyalty program communication. Both programs offer new ways to communicate, enhance the store experience, and extend the connection our guests have with with our brand.

Adding the Virtual World experience to our real world store experience is a natural and positive progression for Build-A-Bear Workshop. Previews of our updated buildabearville.com Virtual World to select loyalty program members has been received with resoundingly positive feedback. So we are encouraged that this added aspect will be both brand enhancing and ultimately revenue enhancing.

Let me update you on our new site progress. The new site is scheduled to launch in December. On October 1, we began communicating with guests about the new site and offering them the opportunity to pre-register at buildabearville.com and also providing information at our [naming] kiosk and offering information to parents about the new site.

We will continue to add communications throughout the quarter and we'll reach out to our loyalty program members with a special introduction to the site later this month, always continuing to capitalize on guest traffic in our stores throughout the holiday season. Our new site will be highly complementary to our store experience and will enhance our brand's core values. The site will feature our virtual store, gaming with points that convert to online currency to spend in the virtual world, live chats, and we will introduce new products to guests in advance of their arrival in stores.

Our Virtual World experience is free and guests can bring new and past free friends to life online. Starting November 1, guests can receive a welcome pass in our stores which allow five free friends purchased in the past to come to life online. The Virtual World experience includes an adventure with each stuffed animal purchased after October 1. Adventures include games and earned points that will translate into online currency, or Bear Bills as we like to call them.

We recognize that over the past 12 to 18 months, children's play patterns, particularly girls' play, have shifted to online worlds that offer new formats for traditional play activities. While we have always had an engaging website, our new site will give guests new reasons to interact with our brand and stay connected. That connection, we believe, will increase our opportunities to maximize and grow our business. For a sneak peek at our Virtual World, you can visit buildabearville.com and access our virtual world trailer.

Another initiative aimed at staying connected to our guests is our Stuff Fur Stuff loyalty program. Membership in the program has grown to 4.4 million members with 3 million who have enrolled in the past 12 months. These guests are an important driver of our business.

More than 4 million Stuff Fur Stuff members have made a transaction in the past year and so far this year approximately 65% of our transactions were made by a Stuff Fur Stuff member, evidence of how appealing the program is to our guests and how important our loyalty program members are to our business. In addition to allowing us to improve the timing, personalization and content of our communications to guests, the program gives us insights into member shopping behavior.

An early learning from the program is that communications with new guests during the first three months results in a higher likelihood that the new guest becomes a best guest. Our best guests visit our stores four-plus times per year. Moving more members into this best guest category is a key growth strategy.

We launched the Stuff Fur Stuff Club in Puerto Rico in October and will expand throughout Canada, including Montreal in November. Our plan is to launch the program in the United Kingdom during 2008. Through expanding the program and further analysis of guest shopping patterns, we expect the program to have strong future benefits.

And just one comment on another way we connect with our guests. For those of you who have children who are Build-A-Bear Workshop fanatics, we have teamed up with Game Factory to develop a Build-A-Bear Workshop game for Nintendo DS. The game will be available in typical game retailers through a special program with GameStop,our games sold through GameStop will include a $5 off, $25 bounce back coupon to our stores. GameStop has over 4,000 locations and 80% of our stores are located in a mall with a GameStop store.

Now for a quick update on Ridemakerz, a new retail concept that allows children and families to build and customize their own personalized cars. Our partnership with Ridemakerz includes a capital investment of approximately $3 million along with operational and advisory services in exchange for additional equity ownership. Two Ridemakerz stores opened this summer in Myrtle Beach, South Carolina and Mall of America in Minneapolis. Two more stores will open in November in Indianapolis and Fredericksburg, Virginia.

The current outlook for next year is to open another eight to 10 stores pending compatibility with our tight real estate standards and to test the concept in some new non-mall venues such as town centers or strip centers. Finding the right real estate location and the right size is always the number one priority. The stores are highly interactive and early results show the concept has a broad demographic appeal, particularly for boys of all ages.

Guest survey data is also very positive. Over 91% of respondents indicated they are likely or highly likely to return to the store, and over 95% of respondents rated their level of satisfaction as highly satisfied. We continue to be excited with our partnership and look forward to our first holiday season. Now, I will turn the call over to Scott for his comments on the quarter.

Thanks, Maxine, and good morning, everyone. I will start with an update on our new store openings in the third quarter. We opened 16 new Build-A-Bear Workshops stores, 12 in North America, two stores in England, and two stores in France, both in Paris. Eleven of the 16 stores are in new markets.

We're on track to open eight new stores in North America during the fourth quarter including three stores in Montreal opening later this month and early in November, another new market for Build-A-Bear Workshop. Four additional stores within our European operations will open in the fourth quarter, three are new stores in the U.K. and one additional store in France. We are nearing completion of the remodel work at our downtown Disney store in California which has gone very smoothly. With about 6,000 square feet on two levels, the store is one of our busiest and most productive.

The bulk of the remodel work will take place in September and October to avoid the summer season crowds. We also staged the work as to minimize guest disruption and flow. The store did not close at any time during the remodeling process. Our grand opening event is scheduled for early November.

During the third quarter, our North American stores made the most of store traffic. While transactions were down, we maintained our average transaction value compared to last year and guess satisfaction scores continued to trend higher. Our results benefited from our strong, stable and improving merchandise margin and continued modest efficiencies in store payroll.

As Maxine said earlier, our business model has demonstrated the ability to deliver net income growth and positive cash flows in a variety of economic climates. In the current climate, we are more focused than ever on delivering a highly satisfying guest experience, making the most of every transaction, evaluating returns on all investments and controlling our costs. We continued in the third quarter to leverage our store payroll costs. We have achieved leverage on store payroll throughout 2007 and have further fine tuned both our store labor planning system and our store staffing models.

Our Company-owned distribution center provides for centralized inventory and enhanced supply chain visibility giving us the ability to analyze and optimize inventory distribution and logistic options. We continue to test and evaluate a combination of distribution methods including FedEx Ground, LTL deliveries and direct truck deliveries for store inventory. Our systems give us the ability to alternate distribution methods depending on our store needs and seasonal inventory demands, and the flexibility to move stores from one system to another as sales dictate.

In addition to store payroll and distribution costs, we have achieved some year-over-year savings in the area of travel expenses and our corporate office overhead. Another savings initiative is the work we have done to reduce store square footage and reduce the cost to build a store. An important learning has been that our stores could be smaller in size and still deliver the same outstanding guest experience and sales productivity.

In fact, our U.K. stores showed us how the full Build-A-Bear Workshop experience can be delivered in about 1,500 square feet. Through improved equipment, such as our stuffing machine which today is smaller and has two nozzles rather can one, improved inventory control, and improved technology we found ways to operate our stores more efficiently. Smaller store square footage also provides a more intimate setting for our guests and a store footprint that makes managing the store and staff multi-tasking more doable.

The result is we are building stores that average a little more than 2,500 square feet this year compared to stores that averaged nearly 2,800 square feet in 2005, and close to 3,000 square feet in earlier years. We have achieved store buildout savings this year on a per store basis and continue to look for more. Another savings tool is the new credit/debit machines we have installed in all U.S. stores this month which will reduce the fees we pay on this payment method.

Moving now to inventory. Our consolidated inventory at the end of the quarter stood at $54.5 million compared to $48.1 million at the end of the third quarter last year. On a per square foot basis, excluding inventory in our web store, inventory declined about 2% to $61.82 per square foot from $63.06 per square foot a year ago. We are comfortable with our inventory levels.

As I mentioned earlier, with our enhanced system and increased visibility to our full supply chain, via our warehouse management system and Company-owned distribution center, we are in a better position to manage and adjust our inventories to sales trends on a real-time basis. We continue to monitor and adjust inventory throughout the supply chain, working with our suppliers and managing processes to ensure that our inventory levels are appropriate.

Specific store growth plans for 2008 are currently under review. Importantly, at Build-A-Bear Workshop it has never been about growth for growth's sake, but always about earning a high return on our investment and growing our brand in the right location and in the right size store and in the right market. As a point of reference, in recent years our new store openings have ranged from 21 stores to 43 stores in a given year. Again, the primary drivers of our store growth plans are the right real estate location, in the right market, mall and store size.

On the International franchise front, our franchisees opened six new stores, including our first stores in South Africa, and additional stores in India, Germany and Thailand during the third quarter. Our franchisee in Taiwan closed one store in Taipei, with plans to reopen the store when a suitable location is identified. These openings bring the franchise store count to 46 at the end the quarter. During the fourth quarter, franchisees plan to open seven new stores located in Thailand, Norway, Russia, Japan, and South Africa. With these openings, franchisees will open a total of 19 new stores this year.

The pace of growth and store expansion in international locations continues to be highly dependent on the availability of the right real estate location for our stores, which in many countries can take time to identify and negotiate. We continue to be highly involved with our franchisees in real estate decisions, and work closely with them on global marketing and store training programs to ensure the quality of our brand and store experience is highly consistent.

Now I will turn the call over to Tina for her comments.

Thanks, Scott. I'll add some additional details regarding our third quarter performance. Total revenue growth of $8.2 million in the third quarter was driven by sales from new stores, a $4.3 million increase sales from the European operations, and a $470,000 increase from franchise fees and licensing revenues.

As mentioned earlier, this quarter we began reporting the financial impacts of our stores located in the U.K., Ireland and France on a combined basis as our European operations. Consolidated net income in the quarter of $3 million, including an operating loss of $500,000 from European operations, compared to a loss of $2.1 million in the year-ago quarter. As we've noted in the past, we expected the seasonality of the European business to result in losses in the first, second and third quarters. Within the third quarter results was continued strong and improved merchandise margin driven primarily by the stronger merchandise margin we received on European sales.

Warehouse and distribution costs as a percent of revenues was lower compared to the third quarter last year as we incurred duplicative D.C. costs last year during our transition from a third party D.C. to our Company-owned facility. Those transition costs last year totaled $1.7 million. Partially offsetting these factors was a reduction in sales leverage on occupancy costs in our North American operations. The consolidated retail gross margin increased to 43.3% from 42.2%.

During the third quarter, the SG&A margin increased to 38.8% compared to 37.5% last year. The impacts to SG&A included higher advertising spending directed at an increase in TV advertising on national women's programming during the third quarter. SG&A expenses also include costs related to our review of strategic alternatives. In the third quarter, these costs totaled approximately $460,000 pretax, or about a $0.01 a share. These higher costs more than offset the continuation of modest efficiencies in store payroll expenses.

On a year-to-date basis, SG&A expenses reflect higher cost of approximately $660,000 pretax, or about $0.03 per share related to review of strategic alternatives. With regard to store pre-opening, these expenses were slightly higher in the current quarter versus last year. For the full year, pre-opening expenses are estimated at about $4.5 million, an increase versus 2006 reflecting the increase in store openings this year in both North America and Europe. Importantly, on a per store basis our pre-opening costs are slightly lower than last year.

Interest income increased slightly versus last year as we are carrying higher cash balance this year. Last year our cash balances were drawn down by the U.K. acquisition and the distribution center construction. Our effective tax rate in the quarter of 37.8% was slightly lower than the rate last year reflecting benefits associated with our Company-owned distribution center. Our outlook remains for a tax rate of approximately 37.5% to 38% for the full year.

Diluted share count decreased slightly from the second quarter as our share repurchases in the first quarter more than offset additional share grants and option exercises in the second and third quarters. Our cash position at the end of quarter was $17 million compared to $9.8 million in cash at September 30, 2006.

During the third quarter, we used $10.9 million for capital expenditures compared to $12.6 million in the third quarter last year. Our capital spending last year included costs associated with our Company-owned distribution center and, therefore, was higher than this year even though we are opening more new stores this year than last year. On a year-to-date basis, capital spending totaled approximately $26 million. We remain on track with our full year spending plan of $35 million to $40 million for the full year.

Depreciation and amortization for the quarter was $6.6 million, and $19.2 million on a year-to-date basis. Our full year depreciation and amortization should come in at approximately $25 million. As we indicated last quarter, we continue to evaluate the most appropriate timing for including the European operations comp stores sales in our business metrics. We expect that these metrics will be provided no later than our first quarter 2008 which is reported in May of 2008. This concludes our prepared remarks. Now I will turn the call back over to Molly.

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

(OPERATOR INSTRUCTIONS) And your first question comes from the line of Paul Lejuez with Credit Suisse. Please proceed.

Hey, it is actually Tracy filling in for Paul. A question first on the advertising. You said it was higher. Can you quantify that at all? And was that because of additional women's TV? Is that something you expect to do in the future, and then can you also talk about the McDonald's campaign and whether you think that was a success? Thanks.

Hi, Tracy. We spent in the quarter, about half a million dollars on additional promotion around our 10th birthday, which has been going on throughout the year and about $1 million in incremental used for women's national television.

We did spend money on women's TV last year ,but this was, we spend about $400,000 last year. So the incremental was about $1 million.

We have not officially reported on the McDonald's promotion, but we did feel it was successful and contributed very positively to our August and back-to-school business.

Your next question is from the line of -- I am sorry. Your next question comes from the line of Sean McGowan. Please proceed.

This is Sean McGowan for Shawn McGillan. (laughter) Can you give us an idea of the performance of the older stores, and then I have a quick follow-up question relative to the newer stores, that metric you sometimes talk about?

Sean, it's Tina. The performance of the newer stores continue to be the best of -- I'm sorry, the older stores continue to perform as they have in the past, the better of the entire chain.

Okay. You may have said this and I missed it writing down something else. Do you have a forecast for CapEx for the year?

$35 million to $40 million.

$35 million to $40 million?

Yes.

Thank you.

(OPERATOR INSTRUCTIONS) Please stand by for your next question. Your next question comes from the line of Brian Tunick with JPMorgan. Please proceed.

Hi, it's Evren Kopelman for Brian. We were looking at your sales per foot numbers and, I believe, historically, we have a low of $502 in 2003, and currently looking at trailing 12 months it looks like it is trending around $530. Can you talk about what you believe is maybe a sustainable level and where you think the declines can stabilize?

We report, as you know, Evren, we report those numbers once a year. Again, our fourth quarter is the largest quarter. On a trailing basis, as you noted, our low has been $502, our high has been $615.

Also, we have a different mix of stores so the smaller stores, as they -- actually we plan those to even at a lower sales level based on their size meaning smaller market stores to be as productive as the Build-A-Bear Workshop stores historically have been in the high of $500s, low $600s.

Can we take the next question, please, operator?

Your next question comes from the line of John Zolidis with Buckingham Research. Please proceed.

Hi. Good morning. Just looking over the quarter's results, it does appear there were a couple of points of light in here. You had very strong gross margin performance. Clearly in the U.K. the EU businesses are showing very nice momentum versus the prior year.

But I guess the biggest issue here for Investors is the same store sales trend which has now been negative in a pretty serious way for seven quarters. You did mention that you were considering, it sounded like, a slower rate of square footage growth in 2008.

So i guess my question is when you look at your business and you look at that same store sales trend and take into account the negative mall traffic and so on, is there a point at which you have to say, hey, let's take a pause here and really reevaluate the business model and make some tougher decisions about investing in the future in terms of CapEx until we can try to figure out how to stabilize the sales trends and what the true levels of profitability for this business are? Is any discussion like that going on at the firm?

What is the likelihood that we will see a significant reduction in CapEx spending next year as the Company goes through and reevaluates what Build-A-Bear wants to be when it gets to be a bigger company from here? Thanks.

Yes. We always evaluate that and have made changes in that throughout the course of our 10-year history as business warrants, as well as market conditions, meaning available real estate expansion, market expansion, whatever, as we look at the whole brand and its impact and saturation, market by market basis.

We are evaluating that as we speak. We will look at that. I would say that it is probably reasonably safe to say that we certainly won't have the same level of store growth next year that we had this year.

This year was an issue of available stores that were in the A locations in the markets that we had part of our plan, and as we look at next year there are less of those available anyway. We are looking at that very closely.

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

Hey, it's Tracy again. A question on your merchandise margin. You mentioned that it was up, I guess, primarily because of the U.K. business. Can you talk about the merchandise margin just in the U.S. business?

And then, secondly, can you talk at all about trends by month? I know you mentioned trend improvement with back-to-school, is that more of an August thing and then things fell off in September like it seems the rest of retail did? Thanks.

Our traffic did follow the patterns of what was very consistently reported by other retailers. We don't promote our business. We don't go to sales, we don't use that to drive customers into our stores. Typically, we are dependent on how good or otherwise the mall itself is doing. Tina, you want to comment on that?

Tracy, merchandise margin in North America was basically flat. We did have, as you know, improvement in warehouse and distribution primarily related to the D.C. duplicative costs last quarter, a year ago last quarter.

Your next question comes from the line of Brad Leonard with BML Capital Management. Please proceed.

Hi. A couple things. On that earlier question about the older versus newer stores, I believe you may have said that backwards. I want to get that straight. Are the newer stores still opening at a higher sales per square foot?

The newer stores open at a higher sales per square foot, but the older stores have a lesser comp store decline than the newer stores. That continues. That is consistent.

Your next question comes from the line of John Zolidis with Buckingham Research. Please proceed.

Hi, it's Zolidis. Question on the U.K. business, it looks like the loss on an operating basis through the first three quarters of the year, I believe, was about $4.4 million. So it suggests that you need to have an operating profit of $4.4 million in the fourth quarter versus $3.3 million in the prior year in order to break even on the U.K. business for the full year. Is that something you think is possible? Thanks.

Yes, John, it's Scott. As we pointed out in the past, the U.K. is much more reliant on the fourth quarter right now. As we build the party business and some of the other marketing, we think that will spread a little more evenly. But still last year, and what we are seeing this year is we're expecting 40% of our sales in this fourth quarter. And certainly with the leverage we've got on our payroll and our other expenses there we feel very comfortable that we will make that in the fourth quarter. That is our plan.

Your next question comes from the line of Gerrick Johnson with BMO Capital Markets. Please proceed.

Hi, good morning. I was just wondering how the new smaller store size affects the store economic model. I assume it carries the same amount of inventory, but perhaps you can update us on the capital investment pre-opening and things like that? Thank you.

Yes, this is Scott. Part of what we do when we shrink the square footage of the store, obviously, is we have some build out costs that reduce. We've been able to see that in a range of $80,000 to $100,000 less than our typical store build out, which helps us on the economic model.

We do have a full range of products. It also helps us with where our staffing model there. If you have been to some of our larger stores when you are spread out, you can have two or three people there, you can really get spread out and the guests can't have the same intimacy that you can have in a smaller store.

So in the smaller square footage with our payroll model, those two or three people can be more efficient and see more. Obviously, also with a smaller store our lease terms are significantly better as far as what we are getting on our rent and that percentage of our sales. We see a good, strong store model on that.

And the inventory is less, although the same assortment is carried. The inventory behind it -- we definitely have a smaller back room because we don't need to be managing that much inventory, and we flow with our new distribution center, our new techniques that we are using, we flow the goods more frequently so they are, in fact, just get the inventory they need. We do not have A, B, C store assortments. Everybody gets the assortment that is appropriate. The total assortment we have and then any additional items, whether it is licensed sports that's appropriate for wherever their location is.

(OPERATOR INSTRUCTIONS) Your next question is a follow-up from Brad Leonard from BML Capital Markets. Please proceed.

Hi. I actually have two questions. With the mall traffic being down, and you are not the first retailer to say this, is there any thought about going to a lower cost, off-mall power center with Bed, Bath & Beyond and people like that where it is an attractive mall, and also do you see the new buildabearville.com being a powerful comp driver in the Q4 or possible in Q1? Thanks.

Yes. Thanks, Brad. We are not in any of the strip centers, or what you would call power centers like where there is a Target. We are in malls where there is a Target and we are in lifestyle centers. That was the next phase we went to, some open air lifestyle centers in certain areas. But so far we've found, although I think that may change as those areas grow, those kinds of venues are not as strong for us as an enclosed mall.

Certainly, it depends on where they're located. But whether, when a mom is bringing a group of 10 kids to a birthday party, she wants that to be in certainly a safe place, and an easy place to access. And we find that a lot of the strip centers that we've actually started to look at, or power centers, if you will, that are more aligned probably closer to a lifestyle center. We need the critical mass, we need the fashion consumer when they are actually going to go out and walk around.

As we said in our earlier comments, and throughout our surveys every single year we have been doing them, the customer finds us through shopping at the mall. Typically at a strip center they don't find you. They are not really shopping every single store. They are going there as a destination.

And I think we have to be wary of that because a lot of our customers, our new customers especially come from the mall traffic. That is one of the challenges really. Our best guests are actually our returning guests. Once they come to us we are able to keep them. It is attracting new guests in this declining mall traffic situation.

Bearville, we are excited about it and we feel really strongly that we will be able to use it unlike anybody else who has a interactive virtual world website, we have stores and we can really use both the real world and the virtual world to drive cross traffic and cross promotions.

And while we haven't been able to test anything yet, we feel positive about that and the ability to do that over time and to tie in to the same things that are going on in our store and a reason for you to go to the store, to have something that when you go to the Virtual World, you have it again. We lots of programs designed that will roll out over time to drive business and support what we're doing in the stores and hopefully enhance our sales.

We feel that this is a big play, and hopefully the way we are going to do it, although it has never been done by anybody before, meaning with a store and using it that way, that we will be able to learn how lot and drive positive business trends.

(OPERATOR INSTRUCTIONS) I show no further questions in the queue.

Thank you, operator, and thanks to everyone, for your participation today. Feel free to give me a call if you have any follow-up questions. Thanks and have a great day.

This concludes the presentation. You may all now disconnect. Good day.