Allison Malkin - IR, Senior Managing Director of ICR Sharon Price John - CEO, Chief President Bear, Director Vojin Todorovic - CFO.

Alex Fuhrman - Craig-Hallum Capital Group Steph Wissink - Piper Jaffray & Co Jeremy Hamblin - Dougherty & Company Greg Pendy - Sidoti & Company Jason Stankowski - Clayton Partners Joey Bond - Delta.

Greetings and welcome to Build-A-Bear Third-Quarter 2016 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the conference over to your host, Allison Malkin. Thank you. You may begin..

Good morning. Thank you for joining us. With me today are Sharon Price John, CEO; and Vojin Todorovic, CFO. For today's call Sharon will begin with a discussion of our third-quarter results and highlight our performance against the key priorities we outline as we scan fiscal 2016.

Vojin will review the financials and guidance, and then we will take your questions. We ask that you limit your questions 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.

Members of the media who may be on our call today should contact us after this conference call with your questions. Please note the call is being recorded and broadcast live via the Internet. The earnings release is available on the Investor Relations portion of our corporate website.

Any replay of both our call and webcast will be available later today on the IR site. Before I turn the call over to management, 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 the annual report on Form 10-K. We undertake no obligation to revise any forward-looking statements.

Finally, as previously announced, the Company continues its exploration of a range of strategic alternatives. As you are aware, this could take many directions. And there is no assurance that this exploration will result in any strategic alternatives being announced or executed.

We continue to be limited as to any additional comments on this topic as the process unfolds, unless and until our Board of Directors determines that further disclosure is appropriate. And now, I would like to turn the call over to Sharon..

Thanks, Allison. Good morning, everyone, and thanks for joining us today. In the third quarter we continued the execution of our stated strategy, which is focused on having more products reach more people in more places more profitably.

Specifically, our results included GAAP pretax income of $2.8 million, more than double last year's third-quarter results, which is in line with our guidance and inclusive of the negative impact of foreign exchange; a consolidated comparable sales decline of 2.2% following last year's 2.2% increase; delivering a flat two-year stack as we anniversaried the height of last year's strong Minion sales, which were driven by the July 2015 movie premiere; and positive comparable sales in our remodeled Discovery format stores, which outpaced the Heritage stores at a double-digit rate on an aggregate basis.

Now I would like to update you on our progress to advance our MORE strategy. First, turning to MORE products, we had a balanced mix of proprietary and licensed offerings to reach each of our key consumer segments. For the boys segment on the licensed product, we continue to build on the success of Paw Patrol and Star Wars.

Those properties have become consistent top sellers, which we keep refueling with updated products. The young girls segment responded well to the relaunch of Twilight Sparkle, a classic my Little Pony character. We continue to take advantage of the Pokemon excitement by expanding our offering beyond Pikachu with the addition of Easy.

We have successfully harnessed social media to connect with our teen-plus consumers to drive the strong sales of these products.

The broad range in our core and traditional plus categories continue to deliver the highest unit and dollars sales, while our proprietary Halloween collection has proven to be a triple threat with appeal to boys, girls and our teen-plus consumers.

Our exciting offering is fresh, proprietary intellectual property is of increasing importance to our strategy and is proving to be a consistent volume and margin driver.

With ongoing updates to lines including our recent Promise Pets refresh such as our Yellow Lab and Tabby Kitty, and the addition of Apple is the Pony to the Horses & Hearts Riding Club; we are driving added consumer engagement for both the boys and girls segments.

Four of our proprietary collections, inclusive of Promise Pets, Honey Girls, Horses & Hearts and the fourth quarter's Merry Mission feature complete product stories and offer play beyond the plush that engages kids with videos, apps and product line extensions and accessories.

These Build-A-Bear-owned properties are elevating to brand status on their own rights as they continue to deliver strong metrics, including dollars per transaction of over $70 and units per transaction of over six. Both of these metrics are more than 50% above our Company average.

Notably, there have been over 50 million cumulative digital engagements with apps and videos that we have created for our own properties since they launched, not to mention the numerous views of user-generated content.

Also during the quarter, through an outbound licensing arrangement, Spin Masters expanded distribution of the new Build-A-Bear Workshop stuffing station toy line to include big-box, specialty toy and online retailers across multiple geographies, including all of our Company-owned territories and select franchise country.

The Build-A-Bear Workshop stuffing station is already appearing on a number of top toys for the holiday lists, and thus far has exceeded sales expectations. We expect Spin Masters' national TV advertising campaign to fuel further interest for the toy line and to have a halo effect for our retail stores.

On the more people front, we engaged with a broadened consumer base with one of the highlights of the quarter, our integrated events for National Teddy Bear Day on September 9.

With the goal to associate Build-A-Bear Workshop more directly with this holiday, we developed a limited-edition collectible teddy bear and offered it at a promotional price to build both awareness and traffic.

We coupled the offering with an effort to drive broad social interest with a buy one, give one philanthropic component which provided Furry Friends to select charities, including Toys For Tots in the United States. The event was efficiently communicated in public relations, digital marketing and data-based outreach.

The combination of our social media efforts, the strength of our brand, the appeal of Teddy Bear Day and a compelling offer drove excited guests to line up for the opening of our stores from London to Los Angeles.

In fact, the day outpaced our expectations as we delivered a triple-digit comp, effectively selling the equivalent of one Furry Friend per second throughout the event.

Driven by an increase in traffic and overall transactions, the day also delivered additive margin dollars and over 185 million media and consumer impressions, perfectly timed to raise Build-A-Bear's top-of-mind awareness as we approach the fourth quarter.

Also, on the more people front we continue to advance our stated objectives to build our e-commerce business through the expansion of our teen plus and gift giving outreach. With that in mind, we delivered a strong consolidated increase of 25.2%, our ninth consecutive quarter of top line growth and improve profitability for our Fun Line channel.

We intend to remain focused on building our teen plus and gifting business via the Internet with exclusive offerings and customized options, which should also support our enhanced enterprise selling capability.

Moving to more places, we continue to show progress in our strategy to improve and diversify our real estate portfolio as we update an aged fleet to our Discovery format, open new nontraditional and seasonal locations, and provide our successful initiatives to our franchisees to fuel international growth.

Our Discovery branded locations continue to deliver strong results. At quarter's end, we had a total of 43 new or remodeled sides in an updated format with comparable sales in the remodeled locations outpacing our Heritage stores on a double-digit basis.

As you know, we prioritized the vast majority of the Discovery remodels into the first half of this year, so that we would have more time to benefit from the sales list that the stores are generating and to have the downtime associated with the remodels in a lower-volume sales period.

We are also pleased that our international franchisees are following our successful lead in adopting the Discovery format with the first store opening in Australia during the quarter.

The results in the first store have been stronger than planned and we expect our franchisees to open Discovery stores in Germany, Turkey, Thailand and United Arab Emirates by the end of the year.

To more efficiently expedite the growth of international operations, we have leveraged our new presence in China to source fixtures, supplies and stuffing machines, which has been driving down the overall cost for our franchisees.

Separately, we continue to develop nontraditional retail opportunities including expansion of our wholesale relationship with Carnival Cruise Line. Given the current success of this endeavor, Carnival expects to have the Build-A-Bear experience on 10 ships by the end of this year and to expand to 25 ships by the middle of next year.

We remain on track to reopen holiday event sites in three flagship Macy's locations as well as expand to four Gaylord ice events around the country, based on last year's success in Orlando.

Separately, to take further advantage of our best-in-class movie licenses, we are preparing to open our first locations in select AMC theaters in two key markets next month.

Finally, based on our historical success with Toys R Us shop-in-shops, we are planning to execute a shop-in-shop test in select locations later in the quarter at the height of holiday consumer traffic. As I shared with you on the last call, we are now actively leveraging a kit of parts for retail expansion.

Specifically, we have developed an innovative and flexible range of store fixtures and stuffing machines for our retail entertainment concepts in order to have options in size, cost and portability.

This allows us to take advantage of the wide range of places that offer both the right consumer demographic in demand but, heretofore, did not have a viable, cost-effective retail option to meet that demand.

As an example, just this week we opened two locations which we call Concourse Shops, as they are designed to be installed in the open common areas of high-traffic locations.

Because they are standalone concepts, these new shops can be executed with substantially lower capital costs for both fixtures and build outs versus a traditional store and are expected to have a reduced expense structure. We developed this new solution to allow us to profitably expand into viable mid-tier markets and other nontraditional locations.

We expect to be operating three Concourse Shops in select regional malls in time for the holidays. On the MORE profit front, we delivered GAAP pretax income of $2.8 million in the quarter compared to last year's $1.4 million, an increase of over 100%.

We expect efforts like the development of our new China-sourced retail kit of parts, along with the many other cost savings and process improvement initiatives that we have been implementing over the past two years, to help us to continue to deliver on our MORE profit objective.

As we enter the most important and final months of the year, we feel confident that we will continue to leverage our margin enhancement efforts, and upgraded infrastructures, to deliver improved profitability.

We have the plans in place to improve critical operational store metrics, including dollars per transaction, unit per transaction and conversion. We have an exceptional offering of both proven and new product collections supported with innovative marketing programs to appeal to our broad base of consumer groups, including gift givers.

Specifically, some of the key product offerings for the fourth quarter include a new collection in conjunction with DreamWorks Animation's highly anticipated Trolls film.

As you may recall from last quarter, we elected to launch the Trolls collection in early October rather than at the end of third quarter to better coordinate with DreamWorks' marketing plans and the movie premiere.

The launch campaign included posts on Trolls social media and of product on boxing on comicbooks.com that had nearly 5.5 million media impressions. We kicked off our own integrated Trolls marketing program this week, which includes a TV commercial featuring exclusive animation as well as a digital campaign.

We are very excited with the initial results. In the UK, where the film opened on October 21, Trolls is already our number-one product collection. And Poppy, the lead character in the movie, is our number-one Furry Friend. In North America, where the film opens on November 4, Trolls is already one of our top five stories.

Trolls is slated to be our first property featured in our new AMC theater location, perfectly timed for the US film premiere. For our boys and teen-plus consumer we expect Star Wars to play an important role in the quarter as we introduce our first-ever Kylo Ren Bear as a precursor to the next film.

And yet another new Pokemon character is planning to join Easy and Pikachu this December as we continue to leverage the heightened awareness and interest in the property.

This character was originally planned for 2017, and this is a great example of how our improved planning system and sourcing ability now enable us to take advantage of this type of opportunity to drive incremental sales. For girls we are adding a new my Little Pony character perfect for the holidays, Minty.

We are also planning to have a first-time offering of the beloved Power Puff Girls and we will be launching a new collection for our proprietary property, Honey Girls, during the important school break week between Christmas and New Year's.

We expect the highlight of the season, however, to be the next chapter of our historically successful Merry Mission reindeer assortment, which appeals to a broad consumer base. As you may recall, our goal, when we first introduced the line in 2014, was to create a repeatable story to perfectly lead Build-A-Bear into the holiday shopping tradition.

Given the strong sales from the original launch, we expanded the collection in 2015 with Glisten, a snowy-white reindeer with light up antlers who was impressively our number-one selling item for last year's fourth quarter.

Four 2016, not only will we have the original reindeer and an enhancement of our fan favorite, Glisten; we are planning to introduce two new characters. Of course, we believe our new midnight blue little boy and sparkly teens little girl reindeer named Tinsel and Twinkle will help Glisten and the other reindeer say Christmas once again.

Our Merry Mission collection is scheduled to roll out in stores next week. We expect to drive the business with a fully integrated marketing program that includes a new TV commercial designed to further solidify Build-A-Bear Workshop as a holiday destination.

As a part of the traditional kickoff of the holiday shopping season across America, for the 14th year in a row, Build-A-Bear is planning to have a float in the iconic Macy's Thanksgiving Day Parade. We're also pleased to note that our float is scheduled to be featured in Macy?s heightened marketing program celebrating the parade's 90th anniversary.

To take advantage of the anticipated elevated brand awareness coming from the parade and make the most of the higher traffic patterns associated with the kickoff of the season, we have developed a new, exclusive product and promotional program partially based on our learnings from National Teddy Bear Day to capitalize on both the Black Friday weekend and Cyber Monday sales potential.

Our MORE strategy has included making steady improvement to the overall systems, talent, organizational structure, operations and infrastructure of our Company while moving Build-A-Bear toward our long-term goal of sustained profitable growth.

As we focus on delivering the most important quarter of the year, we continue to feel confident in our products, our marketing and our operational plans.

Although we have some currency exchange rate headwinds, we believe that we have some key tailwinds as well, including a generally favorable fourth quarter calendar, including an extra week between Thanksgiving and Christmas, approximately 15 additional retail locations compared to last year with an estimated 55 of our stores in the Discovery format, a broad range of compelling products and marketing stories, a soft key for 2015 consolidated comp of negative 5.2% and an opportunity to take advantage of the positive monthly sales trends that we have enjoyed since August.

Finally, as we have regularly shared, supported by a belief in the underlying power of the Build-A-Bear brand, we have been making ongoing strategic investments and overarching operational improvements across a number of fronts to prepare the Company to drive sustained profitable growth.

As you may recall, these systemic investments and operational shifts have occurred simultaneously with the delivery of three consecutive years of positive consolidated comps sales and continued profit expansion.

2016 was planned as a tale of two halves with key investment, particularly in the Discovery store remodel, scheduled for the first half when sales fall aims are historically lower, in order for us to reap the benefits of these investments in the typically larger, more profitable fourth quarter.

Early indicators of the potential success of this strategy are promising, including our quarter-to-date positive consolidated comps, the above-average contribution of the Discovery format locations and the velocity of the new Trolls product line.

We also feel confident about the potential of our proven Merry Mission merchandising and marketing strategy to drive sales all the way to Christmas Day, which is followed by what is historically one of our largest and most profitable weeks of the year, largely driven by the redemption of stocking stuffer gift cards.

In closing, today happens to be the exact date of the grand opening of our first store here in St. Louis 19 years ago.

I'd like to sincerely thank our Founder, Maxine Clark, our Board, and thousands of employees and partners around the world and our millions of guests for this amazing opportunity to be part of the successful turnaround of this truly special Company.

The work that has been done over the last few years to return Build-A-Bear to sustained profitability while building the platform to enable us to expand the brand beyond the original business model has been nothing short of remarkable. It is with great optimism that we look forward to 2017 and the celebration of our next 20 years.

Now I would like to turn the call over to Vojin..

Thanks, Sharon, and good morning, everyone. Our third quarter GAAP pretax income was within our guidance range. Our pretax income benefited from lower expenses due to operational efficiencies and disciplined expense management, increase in store counts over the prior year and high flow-through revenue from outbound licensing and wholesale initiatives.

These have more than offset headwinds from comparable sales decline and the impact of British pound devaluation. Specifically in the third quarter, consolidated comparable sales decreased 2.2% following last year's 2.2% increase, reflecting a 1.6% decline in North America and a 4.8% decline in Europe.

Sales were soft early in the quarter, when we were up against a peak selling time of last year's Minions product, but returned to positive later in the quarter, giving us momentum leading into our critical fourth quarter. In the quarter, we had a 1.8% increase in dollars per transaction, offset by a decrease in overall transactions.

Notably, comparable sales in our remodeled Discovery stores in North America increased by 9%, which was a double-digit improvement compared to our Heritage store. Net retail sales decreased by 2.9%. Excluding the impact of foreign exchange, net retail sales increased 0.4%. As a reminder, approximately 20% of our sales are transacted in British pounds.

Therefore, the significant decline against the dollar is impacting our results. Excluding currency, the increase in net retail sales was driven by new stores and gift card brackets, partially offset by a consolidated comparable sales decrease in store downtime due to remodel activity.

During the quarter, our commercial revenue increased over $500,000 or 66% as we started to recognize benefits of our outbound licensing and wholesale initiatives.

On a full-year basis, we now expect commercial revenue to be over $1 million higher than last year, driven by the initiatives with Carnival Cruise Lines and our outbound licensing program, the Spin Master.

Retail gross margin contracted 200 basis points to 43.3%, reflecting a 120 basis point drop in merchandise margins primarily driven by the unfavorable impact of currency and, to a lesser extent, from the impact of promotional activities and timing of merchandise supplies. We also saw 80 basis points deleverage in occupancy costs.

On a full-year basis we continue to expect both merchandise and retail gross margins to increase versus last year, excluding the impact of foreign exchange. SG&A was $33.4 million or 39.9% of total revenues compared to $36.8 million or 43% of total revenues last year.

The $3.4 million decrease in SG&A versus the prior-year third quarter is primarily due to a planned redistribution of annual marketing spend as we shifted programs in the first half of the year, while improving overall media efficiency.

In addition to our disciplined expense management, SG&A reflects a reduction in performance-based compensation and the impact of foreign exchange on our UK based expenses. These savings are partially offset by expenses associated with a review of strategic alternatives.

Total preopening expenses were $571,000 compared to preopening expenses of $817,000 last year in support of the third and fourth quarter openings of new and remodeled stores in both years. Pretax income was $2.8 million, which included $900,000 in preopening and other business expansion cost, and a $500,000 impact from currency losses.

Income tax was $955,000 compared to a tax expense of $300,000 in the third quarter of 2015, which benefited from a tax valuation allowance. Net income was $0.11 per diluted share compared to net income of $0.06 per diluted share last year.

Turning to the balance sheet, at quarter end ,cash and cash equivalents were $11.8 million and we had no borrowings under our revolving credit facility in the quarter. We opened 11 stores and finished the quarter with 330 locations, which is an increase of 13 stores compared to last year. At the end of Q3 we had 43 stores in the Discovery format.

We ended the quarter with $59.4 million of consolidated inventory, representing a 6.8% increase over the prior year. The majority of the increase is the build of inventories to support introductions of new product stories, our wholesale initiative and additional locations.

We are comfortable with the level and composition of our inventories as we enter the fourth quarter, which is historically our largest and most profitable of the year.

Turning to guidance for the year, for fiscal 2016, we are updating our GAAP pretax income expectations while reiterating our adjusted pretax income guidance as a result of the ongoing fluctuations of the British pound exchange rate versus the US dollar.

We now expect total revenue to increase in the low single-digit range compared to the prior year as we benefit from the higher store account and income from new revenue streams; consolidated comparable sales for the year to be in the range of slightly negative to slightly positive.

This reflects our year-to-date performance combined with currently anticipated fourth-quarter consolidated comparable sales growth in the low to mid single-digit range. As a reminder, we are facing an easier comparison, as fourth-quarter 2015 comparable sales declined by 5.6%.

And we believe that we have a strong product lineup in place and product sales momentum to deliver the planned growth. From a profitability perspective, on a GAAP basis including the impact of foreign exchange, we now expect pretax income for fiscal 2016 to grow by 5% to 15% compared to the prior year.

Excluding the impact of currency, we continue to expect pretax income to grow by 15% to 25%. Since the British referendum on exiting the European Union, we have had a negative impact of over $1 million on our pretax income and, using current rates, estimate the impact for the year to be in the range of $2.5 million to $3.5 million.

In regard to the fiscal gear tax breaks, the ongoing decline in the British pound exchange rate is impacting the mix of earnings in different tax jurisdictions, and we now expect the tax rate to be approximately 35% on a full-year basis.

Separately, we expect to finish the year with an estimated 345 stores, of which 55 will be in the new Discovery format. For the fourth quarter we expect to open 15 net new stores.

We also expect to generate additional revenue from up to 15 locations in AMC theaters and Toys R Us shop-in-shops that are not part of our previously mentioned year-end store count. We expect capital expenditures to approximate $30 million, and depreciation and amortization to be $16 million.

Overall, we are pleased with our third-quarter results and believe our momentum and strategic initiatives position us well to achieve our fourth consecutive year of improved profitability, in line with our annual guidance. This concludes our prepared remarks. We will now turn the call back over to the operator to take some questions.

Operator?.

[Operator Instructions] Our first question comes from Alex Fuhrman with Craig-Hallum Capital. Please proceed with your question. .

Great. Thank you very much for taking my question. I wanted to ask a bit about the guidance. It looks like the comp store sales guidance has been tweaked down a little bit for the year. But no change to the full-year revenue guidance, even with the weakening pound.

Is there anything in particular that's driving that? Maybe some of your new stores or the performance of your Discovery stores? Just wondering how we should be thinking about that..

Alex, yes, thanks for the question, nice to hear from you. There's a couple of things that are impacting that. First, I think that it's really important to recognize that we are holding the total top line.

I think that that's a critical piece of the puzzle as well as without the exchange we still believe that we are going to land in guidance on the pretax as well. But there's some changes in the mix in there.

You might recall, in January when we estimated what we felt that our comps would be through the year, we thought that first quarter would be positive, second quarter would be negative, third quarter would be slightly positive. We shifted the Trolls business from the tail end of second -- third-quarter into fourth quarter.

And so we ended up with a negative Q2. So we are just right now pushing that through the rest of the year and being cautious and how we think the comps will turn out in fourth quarter, although we are still confident of a positive fourth-quarter comp.

Will it make up for the difference? We certainly have plans in place, the marketing in place and the product to do that. And we feel good about being able to do that. And right now, given that we are positive quarter to date, we have a tremendous momentum going into the fourth quarter.

And Trolls looks like it's going to be everything that we hoped it would be. But just a cautionary note -- the reason we didn't move it, though, is because we are getting a greater than expected benefit from some of these initiatives that are starting to take hold from new revenue streams, which Vojin mentioned in his prepared remarks.

Plus we added additional doors, given that we were able to work very quickly to create cost-reduced versions of how we execute the stores, so -- and different in nontraditional locations.

So we were able to add these new Concourse Shops that I mentioned, these AMC theater opportunities that we mentioned, Carnival is ramping faster than we thought, and do some shop-in-shops and Toys R Us. So we are making up the difference on the total cost line through different mechanisms..

Great. That's really helpful, Sharon.

And just to drill a little bit more into the Q4 outlook, now that you have more than a year under your belt with some of the in-house-developed brands that have been very successful, such as the Honey Girls, is your expectation that those brands will continue to comp positively on top of each other for the holiday season as some of these brands get their second shot at holiday season? Or is there some type of a honeymoon effect as you launch a new brand and then that matures over time?.

No, we haven't seen that yet. They are still building and we are still refreshing them. It's not like we put three 1SKUs out on the floor and just expect those to comp on the sales. It's always new stories, always new entertainment that we are putting on YouTube.

I encourage all of you guys to go on YouTube and watch some of our Honey Girls videos and look at how many digital interfaces we get. It's pretty amazing.

It's even fun to scroll down and look at the comments of how much engagement we are getting on these properties, which I believe ultimately will allow us to generate revenue in some of these properties in new and different ways the on to build a bear's four walls. But no, they are comping.

And to use a very specific example, on Merry Mission, we launched Merry Mission, for example, in 2014. We had about 60%-70% lift in 2015, and with the new additions of two additional characters, we're expecting to see a lift again in 2016 on the Merry Mission story..

Our next question comes from Steph Wissink with Piper Jaffray. Please proceed with your question. .

Thank you. Good morning, everyone.

Sharon, just a really quick question for you -- as you look out over the next couple of years, what is your comfort level visibility as to the key to content drivers, both your own and your partners? And where do you think we should start to see maybe some stepwise improvement in some of the initiatives around your own brands? I know Alex asked about that as well, but just in terms of thinking of the slotting and the timing overall, the revenue potential for some of your own brands versus partners?.

Thanks, Steph. Well, as I just mentioned to Alex, we are really excited about the kind of engagement that we see with our brands from the new Horses & Hearts, the continuation of Promise Pets to the Honey Girls. And they are very sticky properties.

As I've mentioned in previous calls and I just said to Alex, we believe that there's opportunity beyond just the four walls of Build-A-Bear to build these brands. And it's not -- when we look out on the horizon, with a lot of our best-in-class license partners, we still have the great honor, in many ways, to have all of these relationships.

And we will be able to take advantage of the best films for kids that are coming down the pipeline. It's how we plot these content opportunities in around them to help not only buoy the total revenue but, in many ways, to help us balance out the quarters.

You see some of the bumpiness in our quarters because we still are reliant on, in many ways, and enjoy -- I won't say reliant; I will say that we enjoy the opportunity to be engaged with some of these big film properties because it raises the awareness level of Build-A-Bear to a consumer base that do not necessarily automatically think of Build-A-Bear.

So a great example of that is Minions, of how many people in the teen-plus consumer base came to Build-A-Bear just to buy Minions and have been reengaged and reminded of their childhood and now have been coming back to Build-A-Bear. So it's a great partnership for us.

So I think, at the end of the day, it's having both of these levers, if you will, puts us in a much stronger position of being able to partner with people where they are investing marketing and awareness in products that are beyond what we normally would think of our core consumer base and then slotting in things that are beyond traditional bears in -- against key consumer segments and launching new opportunities in and around what would be other people's marketing money.

So it's a great tool for us, and I'm excited about the potential. And when I look out on the horizon I see a lot of increased opportunity for us to do this type of thing..

That's great. And then one for Vojin just with respect to currency -- it doesn't impact on the margins in the quarter, but could you talk a little bit about your hedging strategies or any opportunities you might have to help cushion some of the impacts? I know that British pound change was fairly abrupt, so maybe hard to hedge into that.

But maybe you could talk a little bit about your currency hedging strategies and maybe we should be thinking about going forward..

Yes, sure, thanks. The continued weakening of the British pound against the dollar affects our results in several different ways. As I mentioned before, 20% of our revenue is coming from US-based operations. And when we translate some of those local currency results to US dollars, there is an impact on our results.

What we have been seeing a bigger impact this year is really the remeasurement of the balance sheet and some of the local currency-denominated assets and liabilities remeasured in US dollars have been having a big impact on our results. And there is really not much from that aspect that we can do.

We are really focused on figuring out the ways to mitigate the impacts. One of the things is like looking to lock into some of the spot rates as we are buying our inventory for UK separations in US dollars. So we are trying to mitigate some of the cause here.

But then we are doing things on the operational side really to mitigate either through select price increases or through other operational efficiencies, to mitigate the impact on the exchange rates. And again, we believe that eventually it's going to normalize. And still it's a very viable business for us..

Our next question comes from Jeremy Hamblin with Dougherty & Company. Please proceed with your question. .

Good morning. And thanks for taking the question. Just wanted to ask about the remodels and the status of -- I think that you have 12 remodels scheduled for Q4. Where do those stand today? I know that you want to have those really complete before we get into the true thrust of the holiday season..

Jeremy, just to help you clarify some of that stuff. We finished the quarter with 43 stores in the Discovery format. We expect to have 55 stores by the end of the year. Some of those stores are not necessarily remodels; some of those are stores that we are opening the new stores.

What Sharon mentioned, some of the Concourse Shops that we just started to open in Q4 as well as some of the temp-to-perm stores that we are opening as well as some of the seasonal stuff with Gaylord's and Macy's. So we still believe we are going to have approximately 55 stores in the Discovery format by year-end..

Yes. So Jeremy, our focus is not to close down stores in the fourth quarter. So the vast majority of those stores that are being touched and will ultimately be Discovery stores are new locations. And some of them are temporary new locations like seasonal shop-in-shops, but we are not shutting down stores..

Understood, thanks for clarifying.

On the gross margin front related to the British pound impact, 120 basis points in Q3, can you just give a little bit more of a range for us, Vojin, on how we should be thinking about that impact on gross margins for Q4?.

So what we said, we expect our merchandise margins to continue to improve as well, but merchandise and the retail gross margins on a full-your bases. So clearly we expect to see some of those improvements in Q4. There is still going to be an impact of exchange rates, especially in UK.

But we believe, with some of the initiatives, pricing initiatives that we put in place, we are going to mitigate some of that.

But as well as the continuous improvement initiatives that we have been working on all along to really continue to drive margin expansions, we believe we are going to start reaping additional benefits in Q4 as well as the mix of earnings that we are getting is going to help us deliver the objective of continued expansion in merchandise margins for fourth consecutive year.

.

No, I understand that. I was just hoping to get may be a more precise view on how I should be thinking about mix and British pound impact, that you expect that to be a 150-basis-point impact or drag on gross margins as opposed to 120.

Any way to clarify that?.

That's what is really hard to estimate. We're just assuming the same exchange rate to be flat basically on a full year basis. But we would still expect our overall margin to expand inclusive of the impact of exchange rates on a full-year basis, retail gross margins..

That's assuming, and we can't -- and that's very difficult as Vojin said. So just a cautionary note -- of course, we can't predict further fluctuations..

Understood, understood. Okay. And then I just wanted to -- you mentioned that you've seen some success here with Pokemon and a nice testament to how quickly you can manage the team and product development.

Did you actually indicate which character was going to launch as the third character in your lineup and the approximate timing on that?.

I did mention the timing. It will be December. And I did not mention the character because my S2 PR team would not allow me to. The reason we are doing that is because clearly it creates a lot of buzz for us when we keep that on the down low and then partner with some of the great social media groups that we have tremendous relationships with.

And that's partially what is driving this interest in business. So stay tuned..

From checks that we have done, it sounded like you guys were selling out pretty fast on that product, including the Easy launch.

Do you feel like you are prepared? Have you had time now to adjust for the magnitude of potential impact on that? Was there any lost sales, I guess is a better way to ask this question, in Q3 because you didn't have enough product?.

Well, first we -- in each case we feel like we are better prepared because we have more knowledge and more learning and more understanding of the demand. Clearly, whatever we sell out there's some lost opportunity.

In many cases for a product though just to be clear we are a lot -- since 60% of our sales of Build-A-Bear are planned, we don't lose off purchase sales. When people come to Build-A-Bear, sometimes they choose something else. But when we sell out of a hot property, there was probably some lost opportunity. Is it lost in the year? Maybe not.

We're certainly preparing to take advantage of both, the continued interest in Pokemon, the launch of new characters and the knowledge that we have of the velocity of these products as we roll into the fourth quarter. So we feel like, just like with any other situation, the more information you have, the better you can do it. .

Okay, great.

And then just one last one to slip in here -- in terms of potential color on Q4 SG&A, is that also expected to be down modestly, then, year-over-year?.

Yes. We continue to stay focused on SG&A, as we said in our previous calls. We expect overall SG&A to be down year-over-year in Q4 as well as, as we said, back half of the year. So yes..

Our next question comes from Greg Pendy with Sidoti. Please proceed with your question. .

Hey, guys. Thanks for taking my call. Just real quick on the CapEx, it looks like it's coming in. You are guiding it within the range but at the high end.

Is that something we should read into -- are the Discovery stores running a little bit ahead? Or is it just the fact that you are doing a lot more with, I guess, a faster -- faster Carnival cruise and some other things?.

Hi, Greg. Yes. We tightened that guidance. We said before $25 million to $30 million. We think it's going to be coming closer to that higher end of the range. We are testing more stores as well as we have been able to achieve more with the same amount what we were thinking.

So basically efficiencies that we are gaining through our sourcing and reducing the overall cost of our store build out, we are able to invest some of those monies and accelerate some of the remodels and test out some of these new concepts such as Concourse Shops that we talked about, as we believe they are going to be a really strong, viable option for us going forward..

Okay, thanks. That's helpful. And then just one more, now that you seen at least Trolls in the UK, it looks to be off to a strong start, I got the impression -- and I could be wrong, on the last call that you thought Trolls would be heavily skewed toward girls.

Are you possibly seeing some of the strength in that it's appealing to younger boys and girls, as we think about the November launch in the US?.

That's an interesting question. Thank you, Greg. In the UK and in the US right now, Poppy is by far the number-one Furry Friend in the offering. We have Poppy, we have Branch and we have Guy Diamond, the three characters that we are offering. We also have Branch and Heat. We have two versions of Branch.

But Poppy being the number one SKU leads us to believe that it is definitely girls business because she's just very appealing to young girls. We do expect, just like we've seen in the UK, that the mix will start balancing out as people see the film.

Poppy is just appealing because of her color and her hair, even before you really know what the film is about. Once you seen the film, which I have, it just puts a smile on your face. It's a great feel good film with tremendous music. And we couldn't be more excited about it.

It does lead you to have a much greater affinity toward some of the secondary characters. So I think it's possible that not only will we balance out the mix with a few boys, but this could transcend to the teen-plus consumer base as well. Right now our velocities are very high and we are pulling forward copy inventory from first quarter. .

Our next question comes from Jason Stankowski with Clayton Partners. Please proceed with your question..

Hey, guys, congratulations on the profitability in the quarter. It was great to see. I was curious. Last quarter you had mentioned a little bit about the cost of the strategic project.

Just curious if we wouldn't be more profitable, and if you can give a sense of what you are actually spending on a pretax basis per quarter pursuing the strategic alternative..

Hi. We are just really unable to speak to those things specifically, anything about strategic alternatives, as you know. There are some costs associated with that, as you might imagine. And to the degree that they are impacting our SG&A, the answer would be yes, we would have been a little more profitable..

[Operator Instructions] Our next question comes from Joey Bond with Delta. Please proceed with your question. .

Hi. I have a quick question about FinMaster.

What is the margin that Build-A-Bear makes on the toys that are sold?.

We generally don't discuss the exact deals with our partners on the specific royalty rates..

There are no further questions at this time. At this point I would like to turn the call back to Sharon John for closing remarks..

Thank you for your time today. And we wish everyone a happy, happy holiday season..