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Executives

Allison Malkin – Senior Managing Director‎, ICR

Maxine Clark – Founder, Chairman and Chief Executive Bear

John Haugh – President, Chief Marketing and Merchandising Bear

Tina Klocke – Chief Operations and Financial Bear, Treasurer and Secretary

Analysts

Tom Filandro – SIT

Sean McGowan – Needham

Gerrick Johnson – BMO Capital Markets

Tom Filandro – Susquehanna Financial Group

Build-A-Bear Workshop, Inc. (BBW) Q1 2011 Earnings Call May 5, 2011 9:00 AM ET

Operator

Good day ladies and gentlemen, and welcome to the Build-A-Bear Workshop, Inc. first quarter 2011 conference call. (Operator Instructions). As a reminder, today’s conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Allison Malkin of ICR. Please proceed.

Allison Malkin

Thank you. Good morning. Thank you for joining us. With me today are Maxine Clark, Chairman and Chief Executive Bear; John Haugh, our President Bear and Tina Klocke, Chief Operations and Financial Bear.

Before I turn the call over to management, I want to remind members of the media who may be on our call today to contact us after this conference call with their questions. We ask that you limit your questions to one question and one follow-up at a time. This way we can get to everyone’s questions during this one-hour call. Feel free to re-queue if you have further questions.

Please note that our call is being recorded and broadcast live via the internet. The earnings release is available on our Investor Relations portion of our corporate website and a replay of our phone call and our webcast will be available later today on the IR site. Before we get started, I will 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 Factors section in our Annual Report on Form 10-K, and we undertake no obligation to update or revise any forward-looking statements.

And now, I would like to turn the call over to Maxine Clark. Maxine?

Maxine Clark

Thank you, Allison and good morning, everyone. Thank you for joining us to discuss our first quarter fiscal 2011 results. For our call today, I’ll begin with comments from our first quarter performance and update you on our progress in the second quarter. John Haugh, our President, will provide additional insight into our product and marketing strategy and then Tina Klocke, our Chief Operating and Financial Bear, will review our financial results and outlook. Following our prepared remarks, we’ll open the call to take your questions.

In the first quarter, total revenue declined 6.1%, excluding the impact of foreign currency. On a consolidated basis, comparable store sales declined 8.5%, including a decline of 9.3% in North America and a decline of 4.1% in our European operations.

The shift in Easter impacted our first quarter by approximately 5.3 in consolidated comp performance. In the quarter our eCommerce business was solid, increasing 1.5% on a consolidated basis, even with the Easter shift.

We had a net loss of $2.3 million or $0.12 per share in the first quarter, compared to net income of $1.7 million or $0.09 per diluted share in the first quarter of 2010. As previously announced, our 2011 first quarter results included costs of $0.05 per share associated with our consulting project to improve our efficiencies and reduce expenses. I will review our progress on this project in more detail in just a moment.

As indicated in our press release, consolidated comparable store sales are -3.2% year-to-date through April, which includes a 3.3% decline in North America and a 2.7% decline in Europe.

In order to give you the best understanding of our business and because of the sizable impact that the shift in Easter had on our first quarter, I’m going to review our performance in two time buckets, first by combining January and February results and then reviewing March and April together in order to capture the Easter season as a whole.

Note that April falls into our fiscal second quarter, but we feel it is important to update you on March and April combined to fully explain our business. Note that April falls into our fiscal second quarter, again, just for clarity.

For January and February combined, our North American comparable store sales fell 4.8%. For March and April combined, our comp store sales improved, posting a decline of only 1.6%, reflecting very strong April comp performance of +26%. We attribute the January and February decline in North America to two key issues. Lower sales in the overall in the fourth quarter also meant decreases in gift cards. This decrease impacted our first quarter sales since we recognize the revenue from gift cards when the cards are redeemed which primarily occurs in the 90 days following activation.

With the lower distribution of cards on the market, we have fewer cards redeemed in the first quarter. We believe the gift card impact with approximately 1.6% on our comp sales, are about a third of the total decline for this timeframe.

Second, as you may recall, we told you that we put more focus on our core plush animals and the fashion level and units of apparel and accessory categories. We feel we have made strong progress towards our goal, but the first quarter was a period of transition for us. We expect to be in a stronger position, both in terms of quality of assortment and inventory levels by the end of the second quarter.

We attribute the improvement in trend in March and April to three key factors. We added a gift card up sale event for the Easter season and comped the up sale event we had at Valentine’s Day. During these promotions, guests with qualifying purchases could purchase a $10 gift card for half off. The strongest redemptions of the card are in the 90 days following the purchase. Therefore, we expect this promotion to continue to positively impact the current second quarter.

We added a free-standing ad insert to our marketing mix at the end of March to maximize early spring break traffic. The redemptions were strong in April. Our core products, particularly our apparel and related accessories, have had strong sales. We are increasing our purchase quantities and pulling in some early receipts to help u maintain our inventory levels in these categories.

Turning now to our European results – For January and February combined, our comparable store sales increased 5.4% and for March and April combined, declined by 10.5%. We attribute the strong January-February performance to benefits from weather which made year-over-year comparisons easier and from pent up demand due to the severe weather that impacted the U.K. in December. In contrast to North America, the U.K. had higher year-over-year gift card sales which positively benefited this timeframe.

We also had television advertising to support Valentine’s Day for the first time in Great Britain. For the Easter season, combining March and April, we believe that the increase in VAT and government spending in the U.K. negatively impacted consumer spending overall.

We realize we can only control what goes on in our own four walls, so we’re focusing on increasing brand awareness and promoting key products through adding marketing initiatives. But we do expect the business in the U.K. to continue to lag North America throughout this year.

We continue to see strength in our eCommerce sales in both the United States and the U.K. Year-to-date through April, consolidated online sales are up 8.5% after strong March-April combined growth of 20%, reflecting web-specific marketing initiatives improvement in conversion, units per transaction and average dollar sales. We’ve seen a significant increase in our add-on sales, driven by enhancements to our technology platform.

For example, now when a guest selects a particular outfit to go with their animal choice, we also show her a wider selection of matching shoes and accessories which has led to additional items in her basket at checkout. This is just one example of how we’re making it easier for our guests to shop our site. We continue to expect a positive impact from our improved technology this year. We have confidence that we’ll be able to meet our annual retail sales goals on a consolidated basis and offset the short fall of the first quarter with several key product launches and other initiatives that John will discuss.

Turning now to our consulting engagement. As you know, we’ve made significant reductions in our expenses over the last two years in response to the economic environment. In order to continue to improve our expense structure, we determined that fresh eyes with broad industry experience would move us to our goals on an aggressive timeline.

We initiated the consulting project with a focus into product sourcing and supply chain because of the global pressure of pricing and other component and transportation costs. We have recently moved into phase 2 of the project, focusing on additional areas of operation, including store productivity, marketing and other expense areas.

We expect to realize savings in the range of $4 to $6 million in 2011, primarily in the second half or $0.13 to $0.19 per diluted share and project annualized savings of $10 million to $15 million. We are aggressively acting on the findings in order to get the most benefit that we can in 2011.

Our 2011 first quarter results included cost of $0.05 per share related to the project. We expect to have a similar expense in our second quarter for a combined impact of $0.10 per share in the year.

We are also aggressively reviewing our existing store portfolio to optimize our overall productivity and profitability. During the quarter we closed 2 stores and for the year we expect to close 5 to 10 stores as we adjust markets to optimally position our stores for future growth.

In the next 18 to 24 months, many of our North American leases have either a kick out option or expiration. In the course of business, we’re reviewing essentially every market of operations to maximize the profitability of our portfolio. We expect to close some stores, downsize to other locations and strategically open new stores throughout this process.

For example, by the end of the second quarter, we will downsize and relocate 4 key stores in North America. We believe we will maintain the sales volume and thereby each store’s overall productivity and profitability.

As part of our long-term planning, we will continue to use pop-up stores to test new locations. For example, in the fourth quarter we opened a pop-up store in Tupelo, Mississippi. This allowed us to test a small market with a modest investment in a temporary location. Tupelo proved to be a huge success for us and we’ve extended our lease on the store. Had it not been for this pop-up strategy, we would not have proven the potential of this market. In short this is a great way for us to use our capital wisely and make better long-term real estate decisions.

We ended the quarter with a strong balance sheet, including $45 million in cash, inventory that was well-controlled, declining from the first quarter last year and we have no debt. During the quarter we invested $2.5 million to repurchase 375,000 shares of our common stock and now have 21.2 million available under our Share Repurchase Program.

We believe in our business model and our ability to achieve our goals. We are in a unique position in that we have great financial flexibility. This allows us to continue to invest in our company and future growth while evaluating all uses of cash for the benefit of our shareholders.

As we look ahead, we feel we are moving in the right direction with our business and will deliver our annual goals. We know that consistency in our sales and operating performance is important and we firmly believe our strategies have us poised to achieve this objective. I will now turn the call over to John to give you more detail on our product and marketing results.

John Haugh

Thank you, Maxine. I’m going to highlight two areas of our first quarter product and marketing and then I will focus on the key initiatives for the second quarter.

In the first quarter, we continue to focus on product innovation and the introduction of limited edition products supported by our fully integrated approach to marketing and promotion. We’ve had several successes, including our Valentine’s Day animals, the second release of our proprietary SmallFrys product line and a good overall reaction to Easter products, particularly E.B., the bunny featured in the highly-successful Universal Studios movie, Hop.

Our tie-ins with theatrical releases have been consistently strong and we’re excited about our lineup in this category for the remainder of 2011. While we are happy with these parts of our business, we did have one launch under-performance comp with Wizards of Waverly not matching last year’s iCarly. In addition, the fourth quarter short fall of SpeakerStarz led to a price reduction on these animals, but we moved through the inventory profitably, keeping our assortment quality in place. On the marketing side, we matched closely to last year, but we did reduce our North American television spending in quarter 1 to hold dollars for a later Easter.

We introduced Victoria Justice who stars on the hit show, Victorious on Nickelodeon, as our brand ambassador in our advertising and marketing programs. Build-A-Bear has always been known for our fashion, so partnering with Victoria is a great step. She is all about the latest trends and hot looks, particularly with our core demographic. She is featured in our TV ads, online and coming soon will be Victoria Justice exclusive products in Build-A-Bear Workshop.

The addition of an Easter gift card up sell program put over 200,000 incremental gift cards into the market and will drive business, particularly in the second quarter, if these cards are redeemed.

In the U.K. we supported Valentine’s Day with TV ads. Our brand of tracker shows positive movement in consumer awareness and attitudes. We know that the U.K. will be challenging this year, but we are committed to maximizing our business in this market.

Looking ahead – We feel very good about where we are headed with our product in marketing. It was the second quarter last year that our plans to focus on one product with one promotion and one store emphasis really started to gel. While we feel the strategy has moved our business forward, we are just now really hitting our stride to deliver our results.

The focus on themes or stories of animals has been well-received with all of our collections, selling through very close to their planned out dates. However, we believe we’ve missed some volume opportunities on certain animals by retiring them at the end of the launch period. Therefore, we’re going to be increasing our quantities on select animals in the collections and moving that animal to our core once the theme has ended.

We will be able to build volume on some very strong animals this way.

For example, we will launch our Hot Dogs and Cool Cats collection in May. Dogs are our No. 2 animal category behind bears. So in order to maximize sales from these key items, 2 of the dogs and 1 cat will remain after the theme retires and continue to sell in our core lineup. We feel this collection will exceed last year’s zoo event in both animals sold and coordinating outfits and accessories.

Last fall we added new design talent to our product team to up our fashion quotient and improve our apparel and accessory business. We are very pleased with the results of the initial assortments. We expect to grow our units and average transactions as we continue to improve our apparel and maximize the latest trends.

As you may recall, we had a highly successful Ice Cream Bear collection last year and in 2011 we will introduce the Dairy Queen Blizzard Bears, supported with color coordinated fashion apparel which we believe will have greater appeal versus our ice cream-themed outfits last year. The Dairy Queen tie-in will feature our product in more than double the number of outlets versus last year’s ice cream partner. And we have moved the arrival into this year’s second quarter to kick off the start of summer vacation with a very appealing collection and match the strength of this product to a big power period for our sales. As I mentioned, tie-ins with movies have been great for Build-A-Bear, building buzz and leverage in the energy and advertising that the movie studios create. Looking

Looking into the third quarter, we are excited to have a tie-in with the upcoming Smurfs movie, anticipated to be a summer blockbuster for families, with nostalgic appeal to parents and just plain fun for the kids.

We are happy with the business we are getting from our SmallFrys™ lineup. As a reminder, we launched SmallFrys™ in the third quarter last year and brought out the second collection into our stores this last February. Based on its success, we will have several new collections throughout this year and we are also testing a number of new categories in the next several months to continue to grow our store productivity with expanded product range just like we did with SmallFrys™.

We are intensely focused on delivering all of this at a merchandise margin that works for our business. We continue to work very hard on managing escalating costs and expect to mitigate the increases through supply chain efficiencies as well as by taking selective price increases.

On the digital marketing side, we are keeping our brand alive 24/7 and have several online initiatives driving these goals. As it relates to kids, (inaudible) is the key strategy and we have added new innovative features to this site that have been well received with the brand engagement continuing to grow.

In April visitors were up over last year by 30% and total visits to the site grew 15%. Our Bear Bell iPhone app launched in the fourth quarter of 2010, we now have over 500,000 users and over 4 million sessions played. In addition, we are growing our top of mind brand awareness and spreading our product news through social media.

For example, we have an avid community on Facebook with over 1 million fans. As a comparison, we stood at 300,000 fans at the end of 2010 and with an all-out push, we have more than tripled our fan base in a very short time. We have specific plans to engage these enthusiastic brand advocates and drive revenue both online and in-store. These digital initiatives will drive our online sales, which are showing double digit increases, as well as drive brand awareness and store traffic.

To summarize, with these product and marketing strategies, we expect to deliver increased, top store sales and operating performance in 2011. Now I’ll turn the call over to Tina to review our financial results and outlook in more detail.

Tina Klocke

Thanks, John and hello everyone. For the first quarter, total revenue was $96 million, compared to $101.4 million last year, a decrease of 5.4%. Consolidated net retail sales were $94.2 million, a decrease of $5.6 million, or 5.6% compared to last year’s first quarter. Excluding the impact of foreign exchange, net retail sales decreased 6.4%. Consolidated comparable store sales for the first quarter declined 8.5%, primarily driven by the decrease in trend actions which were adversely impacted by the Easter shift.

The net retail sales from European operations were $16.1 million in the first quarter which compares to $15.8 million last year. Excluding the impact of foreign exchange, European net retail sales declined 1/1%.

Our eCommerce business was up 1.5% in the quarter, excluding the impact of foreign exchange with solid performance in both North America and the U.K. Commercial revenue was $1.1 million, up 14.4% compared to last year. International franchise revenue was $726,000 in the quarter, up 6.3%. We ended the quarter with 63 international franchise stores. We expect our franchisees to open approximately 5 to 10 stores in 2011 net of closures, including our first store in Brazil.

Our retail gross margin rate in the first quarter was 38.8% compared to 41.1% last year. The decline was primarily due to the deleverage of fixed occupancy costs resulting from lower net retail sales in the quarter. SG&A was $41.3 million or 43% of revenues, Compared to 39% in the first quarter last year. Included in this are $1.5 million in costs associated with our ongoing consulting project.

Excluding the consulting project costs, SG&A, as a percent of sales was 41.4% in the first quarter. The income tax benefit was $1.4 million for the first quarter to compare to the income tax expense of $1.1 million last year. For the full year 2011 we continue to expect our tax rate to be 38%.

Net loss was $2.3 million or $0.12 per share compared to net income of $1.7 million, or $0.09 per diluted share last year. As a reminder, 2011 results include $0.05 per share for consulting fees. Our balance sheet remains strong and we ended the quarter with consolidated cash of $45 million, compared to $53 million at the end of the first quarter last year. We have no debt and not borrowings on our credit facility.

During the quarter, we repurchased 375,000 shares of our common stock and at quarter end we had approximately 21.2 million of availability under the current Stock Repurchase Program.

Capital expenditures in the first quarter were $2.3 million, primarily for software and equipment upgrades, as well as store-related capital compared to $3.3 million in the first quarter last year. For the full year 2011 we expect capital expenditures to be approximately $12-$15 million.

Depreciation and amortization was $6.5 million for the quarter, down from $6.9 million the first quarter of last year. For the full year we expect depreciation and amortization to be approximately $26 million. At the quarter end, consolidated inventories totaled $39.5 million, compared to $47.1 million at the end of first quarter, 2010.

Inventory per sq. ft. decreased approximately 17%. This inventory decline compares to an increase of 11% on a per sq. ft. basis at the end of the first quarter last year. The lower inventory levels give us an opportunity to trace the trends and styles that have been emerging and to keep our assortments fresh.

As a reminder, the second quarter is our smallest quarter of the year, and we typically post a lost, even with Easter shifts in this period. We are pleased with the start to our second quarter with growth in both our comparable store sales and our eCommerce business. Based on our enhanced product and marketing strategies, we expect our positive sales trends to continue for the remainder of the quarter and result in an improvement in our loss for the second quarter. And now I would like to turn the call back over to Maxine for concluding remarks.

Thanks, Tina. I want to take a moment and thank Kathy Savitt for her work on our Board of Directors. And as we recently announced, I’m pleased to welcome Brad Leonard to our Board. We are excited to have Brad, who is not only a significant investor in our company, he is a successful entrepreneur and a father of three daughters who are avid Build-A-Bear fans. We are looking forward to his input on many levels.

In conclusion, while the Easter shift was a tough one, our business is moving in the right direction. We have strengthened our product and marketing strategies and we have identified cost savings which are expected to drive efficiencies across our company.

We are improving the productivity of our stores and we have a strong balance sheet to support our future growth. I’m encouraged as we begin the second quarter and expect our strategies to deliver improvement in sales and operating performance in 2011 and beyond. With that, I’d like to turn the call over to the Operator to begin with the question and answer portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions.) Today’s first question comes from the line of Tom Filandro of SIT. Please proceed.

Tom Filandro – SIT

Hi, thank you. I actually had two quick questions. First is can you guys really give a little more detail on where the $10 to $15 million in savings is coming from? And then my second question is, John, you alluded to testing some new categories, I think you said over the next few months. Can you give us a sense of exactly what that is that you’re talking about? Is that similar to like a SmallFrys™ or is this maybe a toy experience type product? What are you thinking about? Thank you.

Tina Klocke

Tom, on the consulting project, we’re looking at just every phase of our business, from our product sourcing to our distribution to ocean freight to store supplies – it’s really across the board – our IT, just everything that we look at from a perspective of indirect and direct expenses. And, again, we just started phase 2 so we’re really diving into that to see where the potential savings are, so it will be really across the board.

John Haugh

Hi, Tom. With respect to some of the things we’re trying for some new products, talked to you last year about small price. And we spent a lot of energy and thought putting it into market and it’s worked pretty well for us. There’s a little bit of cannibalization, but by and large it’s an incremental purchase, it’s helped us with the tween customer, it’s skewed even a little bit more girl; it’s got a good proprietary Build-A-Bear margin; we feel great about it. So with that as a backdrop, we’ve got several things in tests and I’m going to kind of put them in some groups.

Some are some open-market products. For instance, we’re going to have Angry Birds in our stores next week – 50ish stores and then the rest of the chain about two weeks after that. We’re going to start with some product that we just bought in the open market, but we want it to be out there quickly and if it makes sense, we could turn that into a Build Your Own if we thought that was logical.

We also, though, more importantly believe we’ve got some proprietary opportunities where we take a look at some other pre-stuffed, plush in some cases, again incremental pick-ups, a product that plays off of our heritage, again it’s done with our proprietary margin. We are also going to go in to test with a craft shop product line in some stores. We’re going to take the product that we’ve developed for some of our other licensed partners. We get asked for it on a regular basis so we’re going to put that on a fixture in the store and see if we can drive some business.

We also have something that’s going to come out this summer that we think could expand our demo a little bit. We’ve always talked to you about kind of 3 to 103, but 3 to 12 is really our core. We’re going to put a product in the market this summer that we think can capture some business from 0 to 3. I say this summer, kind of June-July-ish. And a couple more.

And we’re going to put these ideas across the country in some different markets and in one market we’re going to kind of put them all in there and see if we can really drive the business. But we believe the core of what we do is a make your own experience. We’re going to continue to be strong there, but we believe we can drive incremental visits and incremental baskets with some of these new ideas. And so we’re going to stay on it pretty aggressively and you’re going to continue to see us trying new things.

We’re going to miss some; we’re going to make some. But we think if we continue saying this it’ll drive the four-wall productivity of our business.

Tom Filandro – SIT

Thanks very much and best of luck.

Operator

Our next question comes from the line of Sean McGowan with Needham. Please proceed.

Sean McGowan – Needham

Hi, first I just wanted to ask you to repeat something that you die earlier in the call. What was the European January to February increase?

Tina Klocke

It was an increase of 5.4%.

Sean McGowan – Needham

Okay, thanks. And then in terms of a question, I’m following up on something you said earlier, John, regarding keeping some animals after the promotion period. Just wanted to get your thoughts on – is that a SKU management problem or an inventory management problem? How big could that be over time if you plan to keep them in indefinitely or just a little bit longer than the promotional period?

John Haugh

I think more that latter than the former. I’m going to use last year’s Ice Cream Bear as an example. We brought out 4 animals. Obviously there’s a best seller and there’s a No. 4 seller in any of those. That collection literally came in and out of the store in 3, 3½ weeks. We were still getting emails at Christmas saying, “Can I get the Bubble Gum?” “Can I get the Mint Chocolate Chip?”

What we will do is we look at somebody’s collections, we talk to kids ahead of time. We are usually pretty accurate as to what’s going to be the best seller so instead of that line being kind of in-store for 6 weeks, the majority of the line will be in for 5 weeks, we’ll plan to keep around for a few months because we can then still get maximum volume out of it. So we talked about Hot Dogs and Cool Cats this summer.

Our lead guy is this great little wiener dog and he will debut in about 2 Fridays, but we will keep him around longer because we know we can get several months of traction out of that. With respect to SKU management, two things will happen. We will plan for that so we won’t get ourselves kind of over-assorted.

The second thing well do, we mentioned briefly. In 2010, while we’re happy with our launches, a lot of times our apparel would be really specific to the launch. So think of ice cream again, and we had things that were really – our Mint Chocolate Chip Bear had a little dress that was all about mint chocolate chip ice cream.

In ‘11 we’re going to have fashions that match back to the look and to the color of the animal but that fashion will be able to go against more animals and we’ll be able to live with it a little bit longer as well. So we think we can get more mileage out of some of this great fashion emphasis that we mentioned earlier. So we are acutely aware of managing the inventory but we think this is actually a win-win because we’ll have the strength of the launches and those good animals will stay around even longer. And if you remember one of the things we learned last year, we talked about it in our last call was our core was not quite- Our launches were good but our core was not as strong as we wanted it to be and we think this kind of hits both sides.

Maxine Clark

And one thing about the SJ you mentioned, we only have 36 bins in every store in the United States and about 30 in the UK, so that’s all the animals you could have at any one time. So last year the core animals and outfits that John just referred to weren’t changing out as much because we didn’t let these launch animals become part of the core which they did in prior years. So even though we may not have had four animals in a launch in 2009, we might have had one, that animal after it launched stayed in our line unless it was a seasonal animal like St. Patrick’s Day or something like that, and that allowed our core to be fresher.

So this is I think the perfect balance between where we might have been prior to 2010 and where we’ll be going in the future. So the customer doesn’t visit us every single month, so the customer who comes to visit and wants the ice cream, sees the ice cream bear- So they go to Bearville and they visit our website all the time, but they’re a child and mom’s not going to bring them to the store until they come to town or until they go to grandma’s house and they miss some of those things. And we really listen to those comments and I think that many of these items can become stronger parts of our assortment, and while they’re planned to be shorter if the sales are warranted we’ll keep them longer. Like we had Peace Bear, our Peace Bear continues to be a really, really strong seller no matter which way we bring it in and it was meant to be part of a trend in 2009 that was playing off peace symbols that were a lot in fashion.

But we have a Peace Bear that we’ve had since then and we just launched one as part of our Rainbow collection, the Rainbow Peace Bear which is very strong and we’re reevaluating whether we want to keep that longer than just a few months because it’s such a good bear. So I think those are the kinds of things that we like to be flexible about but we have already done it in some way, shape, or form. But the 36-bin contain us and make us very SKU aware.

Operator

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

Gerrick Johnson – BMO Capital Markets

Hi, good morning. I was wondering how was your merchandise margin compared to last year excluding the fixed occupancy.

John Haugh

Yeah, Gerrick it’s John. Our retail margin which is what we talk about to kind of keep wholesale and some things isolated, our retail margin for Q1 was actually down 0.2%, so 20 basis points, and it was a mix issue – that was not an escalating price issue. So we feel pretty good about that. As we’ve talked about and as you’re well aware, the whole world is seeing price pressure but we have spent a lot of energy trying to really manage our margins.

We have looked at our product and how we build it and have seen where there might be opportunities to reengineer it a little bit. We have looked at our supplier base – this is again, all part of this larger consulting project that Tina and Maxine have mentioned. So we’ve also looked at our supplier base and said “Is there probably a day out of supplier or two in some of our different categories to continue to keep our pricing in line and keep everybody kind of honest?” We have made good progress on our logistics expense so we’ve taken some money out of what it costs us to get product out of Asia over to the West Coast and then from the West Coast out to our stores.

And then finally as mentioned we have looked at some pricing opportunities where we think it makes sense where we think we can deliver value to the consumer and charge just a little bit more. So when we put all that together, while we were off a little bit in Q1 we believe we will keep our retail margins in line with our plan for 2011.

Gerrick Johnson – BMO Capital Markets

Okay, there’s been a lot of discussion about rising cotton costs but how does that impact polyester and what are you seeing in those other inputs that you use?

John Haugh

Well I think what happened, the guys who do polyester – remember it’s an oil-based product so and oil’s up kind of 2X. I think in the past when one commodity went up the other guys would say “Hey, I’m going to capture a bunch of market share.” What we saw with polyester and acrylic and some of the things right now is when cotton went up they said “Why don’t we get in on it too?” and they just started raising the prices right along with it, not quite to the 2X level that cotton saw but all of those raw materials have gone up. And labor has gone up in Asia as you’re probably aware, so I don’t think it’s gone up quite to the same level as cotton but it has gone up. Rubber has gone up – obviously rubber goes into our shoes. So we’ve got material cost pressure across the board no different than probably anybody else you cover or anybody else in our industry.

Gerrick Johnson – BMO Capital Markets

Okay. And then on the stores, you talked about leases coming up for renewal or subject to kick out. What percentage or portion of your US store base would be coming up for renewal or kick out in the next 12 to 18 months? And then kind of related, any plans on reformatting stores, the existing store base and when was the last time these stores were kind of refreshed?

Maxine Clark

Hi Gerrick, it’s Maxine. We have in the next 18 to 24 months about 45% of our stores will come under review for a kick out, either a first or second kick out – we often put two in there – or lease renewal. So that gives us a great opportunity to really look at market-by-market, store-by-store in that market. And then the refresh of the stores- We constantly refresh our stores. As we put something new in the stores, a new fixture or a new category then all the stores get it – like last year when we launched Small Fries and we put in a new fixture for Small Fries, every single store got that fixture.

And last year we also did a couple of experiments in a new kind of format that we have several stores that are in that look, and it’s still the Build-A-Bear process and procedure but a slightly fresher look if you will, not necessarily seeing any more sales from those stores that have that look but we are working on a much more engaged, maybe back a little bit more to our roots magical experience that pulls back some of the things we put in the store originally that we took out actually for space, and first just to make room for customers; and then actually taking out as part of value engineering that we’re going to be looking to add back into our stores, especially some of our larger volume stores like Disney, New York, Myrtle Beach, where they truly are tourist and vacation and long experiences, longer than the average which is 45 minutes in a store longer when they come to a tourist attraction like Disneyland or Myrtle Beach, or New York City for that matter.

Gerrick Johnson – BMO Capital Markets

Okay, I’ll just throw one more in there. You touched on sort of the tourist attractions – how about the Orlando Airport store and your Children’s Hospital store, the status of those and you know, your initial reads on how those are performing?

Maxine Clark

The Orlando Airport store opens next Friday, or Thursday, so it isn’t open yet; we don’t have any sales to report but we’re excited about that because obviously lots of kids come through Orlando Airport. And while May is not the biggest month in Disney’s schedule we’ll have a good start to just see how the traffic goes and then obviously it heats up pretty dramatically for the summer and beyond. In the Children’s Hospital, that opened up last month and is doing well so far. It was a quiet opening and they’re going through their experience because not only did they open up, expand and open up a Build-A-Bear store but they opened up a Starbucks, in a sense almost like a mini-mall in a hospital. So they’re managing that and all reports are that it’s going as planned and very, very smoothly.

Gerrick Johnson – BMO Capital Markets

Alright, thank you very much.

Operator

(Operator instructions). And our next question is a follow-up from the line of Tom Filandro. Please proceed.

Tom Filandro – Susquehanna Financial Group

Okay, thank you. I want to go back to the comment, originally you talked about the gift card trend in Q4. Tina, can you maybe tell us precisely what happened to the gift card trend in Q4, like how much was it down? I hear you stated I think you had a negative impact of 1.6% so I have two questions related to that: one is any initiatives in place to reverse that trend during the holiday season as we approach it this year? And then the second one is what impact are you anticipating the Easter gift card redemption to have on the Q2 results? Thank you.

Tina Klocke

Sure. Tom, I think that again some of the decline was the decline in the overall Q4 sales in North America, and I think that one way to stem some of that offset was to put in the upsell gift card program we had in Easter in the US which we had not done in the past year; and continue our upsell gift card program at Valentine’s Day which we had last year. So that put about 200,000 more cards in the marketplace. And I think on a go-forward basis in holiday again this year we’ll continue to work, we’ll continue to have our upsell gift card program.

At Easter time and Valentine’s Day we actually lowered our limit from a perspective of it used to be a $30 purchase you could get the $10 card and we lowered that to $20 to help stem and put more cards in the marketplace. And again, I think we’ll probably do that at holiday time to help put more cards in the marketplace. But again, our gift card program is very successful and we are going to continue to look at outside places to sell our gift cards, whether it’s Walgreen’s stores or Cosco’s or what have you. As you walk into the grocery stores most everywhere carries gift cards now so we’ll continue to enhance that program as we go forward.

Maxine Clark

Tom, one of the other things, this is Maxine. One of the other things that we are doing and one of the things that Build-A-Bear’s known for is our packaging, and as we go into the holiday season we’re going to put back some really fun packaging for our gift card that we had actually- It was available but people had to ask for it more so than we just sort of went to this fast mode of “Let’s just sell a lot of cards and put them in an envelope and sell them out the door.” And we’re going to put back some fun packaging for them to make them as giftable.

But we do have a lot of outlets now in the United States. It’s a pretty mature market, the United States, selling gift cards in grocery and drug stores, but the UK, one of the reasons why the UK had a positive year is that we just opened up secondary outlets for them last year, not as many as we would have even liked but that opportunity is still out there strongly for the UK to have expanded places to buy a Build-A-Bear card. And as our awareness grows, too, that’s just perfect timing.

So we think that with all those things- We look at every single piece of marketing. It wasn’t so much that gift cards were less a (inaudible) set of our business, it’s just that overall the business was less. So and we did have the strong upsell program so it could have been some tradeoff of customers, instead of buying a $35 or a $50 card were buying the upsell card. But it’s such a successful program and has over time put a lot more cards in the hands of our customers that we thought it was a valuable and worthwhile tradeoff.

Tom Filandro – Susquehanna Financial Group

Thank you.

Operator

Our next question is a follow-up from the line of Gerrick Johnson with BMO Capital Markets. Please proceed.

Gerrick Johnson – BMO Capital Markets

Hey, you had Hop for Easter this year. Was there a comparable sort of licensing event last year? I can’t really recall.

John Haugh

Yeah, if you remember Gerrick, we brought out Alvin and his friends for Q4 ‘09, and it was so successful we scrambled and brought Alvin back and Brittany in full size, make your own. We had them for about three weeks kind of right in the middle of March, so Hop was really kind of a comp to Alvin and Brittany last year – both $22 price points. Hop was supported by kind of the first introduction of the movie, or excuse me, EB was the first introduction of the movie and Alvin and Brittany were riding on the DVD release in Q1 ‘10. But yeah, those were pretty much a comp.

Gerrick Johnson – BMO Capital Markets

Okay, and ever since the Shrek debacle several years ago your licensing initiatives, at least on the skin side, have seemed to perform pretty well – things like Hello Kitty and Hop and Alvin. What percent of your skins these days are licensed and how does that compare, and how do you think that’ll look through 2011 with the addition of Smurfs and whatever other licensed skins you’re going to bring on?

John Haugh

Yeah, I think you have to kind of put it in a couple categories. You’re right – Hello Kitty is licensed and she has done very, very well for us since- She came in in ‘04 in apparel and into full size in ‘06 and she’s been a star for us ever since. We have on 6/10 or June 10th we’re breaking a pink Hello Kitty, first time ever, and we are really, really excited about it. We’ve got Smurfs and then we do have some things with the holidays which we’re not going to get into here today but we will next time we talk to you guys.

When we look at our licensed skins, and then you’ve also got to think about licensed products throughout the store, right? So whether that is sports uniforms, whether that is tie-ins with iCarly or with Wizards of Waverly, when we look at all the license business overall kind of 20%-ish, a little bit more, somewhere in that range though – some skins, some apparel. We want to be there, we want to be contemporary. We want to certainly trade on these large (inaudible) releases and the budgets they bring and the energy they put in the market, but we don’t want to get over licensed so we’re always trying to find that balance.

So you do have some evergreen properties like in HK and then you have some of the movies that we kind of have for the period of time, and then we’ll do something like a Victoria Justice who will be our brand ambassador this year and into next year, and we’ll do some product with her, both apparel and animal. So that’s how we look at that business overall and again, kind of 20%-ish, a little bit more.

Gerrick Johnson – BMO Capital Markets

Okay. And on your existing stores I guess 2800 sq. ft. was kind of the average and then you talked about shrinking down to 2200 with some new stores and new formats and new locations. Is that still kind of the goal – 2200 sq. ft. or maybe are we shooting for something lower? What kind of square footage are you looking at for relocations or new stores?

Tina Klocke

No, they’re in the 2200 to 2600 range so it just depends on the shape of the store. We’re not lower than 2000 sq. ft. anywhere. I mean the selling square feet might be below 2000 but the store itself, the gross square footage is usually 2200 to 2600.

Gerrick Johnson – BMO Capital Markets

Right, but stores that you relocate.

Tina Klocke

What we’re relocating are stores that are 3000 sq. ft. We’re relocating them to the current, what we believe is the current optimum size of 2200 to 2600, somewhere in that range. So they were bigger, much bigger stores and in some cases they were even over 3000 sq. ft. One of the stores that’ll open this week, I believe it’s this Friday is International Plaza, which when it opened in 2001 in Tampa, right after 9/11 actually, it had a party room in it. So it was over 4000 sq. ft. and now it’s being downsized to a 2500-ish sq. ft. store. So a significant reduction but in the same mall and in the same general location, and so it’ll be a good store for us and much more cost effective.

Gerrick Johnson – BMO Capital Markets

And is the birthday party concept, is that a significant part of your business anymore or has that kind of gone by the wayside? How’s the party business?

Maxine Clark

The part business is not insignificant. It’s never been as big as a lot of people think it is, it’s under 10% of our business but it still is a healthy business and a very important part of our business.

Gerrick Johnson – BMO Capital Markets

Okay, thank you.

Operator

That concludes our question-and-answer session. I would like to turn the call back to Maxine Clark for closing comments.

Maxine Clark

Thank you again for joining us. We look forward to speaking to you when we report our Q2 results. Have a great day.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you so much for your participation, you may now disconnect.

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