Build-A-Bear Workshop, Inc. (BBW) Q3 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the Build-A-Bear Workshop Third Quarter 2015 Results Conference Call. At this time, all participants are in a listen-only mode. The question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Allison Malkin of ICR. Thank you. You may begin.

Good morning. Thank you for joining us. With me today are Sharon Price John, CEO, and Voin Todorovic, CFO. For today's call, Sharon will begin with a discussion of our third quarter results and the performance against the key priorities we identified at the start of the year. Voin will review the financials 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 re-queue if you have further questions. Members of the media who maybe 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 and a 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, and we undertake no obligation to revise any forward-looking statements. And now, I would like to turn the call over to Sharon Price John.

Thanks, Allison. Good morning, everyone. Thanks for joining us today. Results for the third quarter of fiscal 2015 include our fifth consecutive quarter of consolidated comparable store sales growth with an increase of 2.1% and 160 basis point expansion in retail gross margin, pretax income of $1.4 million, a decrease of $690,000 compared to last year, net income of $0.06 per diluted share compared to last year's net income $0.10 per diluted share. Importantly, for the first three quarters we've achieved pretax income of $8 million and 134% increase compared to the prior year. This represents the highest level of pretax profit for the first nine months since 2007 but was typically our largest and most profitable quarter still ahead of us. The consolidated comparable store sales growth in the third quarter was achieved with increases in both North America and the United Kingdom. Contributing factors included an increase in units per transaction and traffic, buoyed by a rise in dollar per transaction nearing our all time high. Our year-to-date positive profit position and multiple quarter comp store sales momentum enable us to make a number of investments designed to accelerate our ability to successfully transition the company from our goal of sustained profitability to sustained profitable growth in line with our stated multiyear strategy. Although many of these initiatives are associated with longer-term capital investment, some also require expense investment which is accounted for in the quarter. Key investment included the multimedia marketing launch of our new intellectual property, Honey Girls, the roll out of new stores and remodel plus the temporary opening of pop-up location to preserve a portion of top line sales during the remodel and closure period. The opportunistic expansion of our international footprint, the continuation of necessary upgrades to our IT system and the investment in new skills sets and talents to execute the evolved strategy. On our last call, we shared a framework for integrated approach to marketing and product development which should design to orchestrate a consistent cadence of new introductions with the combination of our intellectual property and license partnership appealing to key consumer segment. We work on a multiyear horizon with consideration to a variety of data including seasonal and summer event. With that as a backdrop, the key collections that drove our positive comp sales result for the quarter by consumer segment were, the top slot for older girls was our own proprietary property Honey Girls. This collection was launched with a multimedia marketing plan that include a TV, print, interactive in-store display and mobile app, music from a Grammy award winning song writer and high quality CGI videos. Pushing into the zeitgeist of today's pop culture, the back story has a girl empowerment theme as Honey Girls who share common level music discover they are better together versus competing against each other in a talent show. Since the brand's introduction, there have been over 2.5 million views of Build-A-Bear and user generated videos about the Honey Girls on YouTube. An important platform for the elder girl. We have already refresh this line for the fourth quarter with new outset and a new music video performed by our Honey Girls based on the brand appropriate heartbeat song made famous by Kelly Clarkson. Our younger girls business was driven by the continuing success as a total frozen collection. For our boy segment the most important story for the quarter was Star Wars. We had collections available during the period starting with classic Star Wars which featured stuff your own Chewbacca and Darth Vader Bear. Separately, we participated in Force Friday in the first week of September with products based on the highly anticipated film the Force Awaken. This was followed by our recently launched Storm Trooper Bear. For the third quarter, Star Wars was our fifth ranking story. This performance was below our expectations impacting our overall results versus plan for the quarter. Although we remain optimistic for the balance of the year. We believe increased movie marketing exposure building up to the December 18 film release combined with our own dedicated Star Wars TV commercial which will begin to air the first week of November will drive the sales of this historically powerful brand for the holiday season. The Minions collection continues to drive overall sales and was a number one story for the over 12 consumer segment. Separately, as a testament to the critical role of our core business, our basic furry friend offering continues to appeal across all consumer groups and once again deliver the highest unit volume as any stuffed animal segment. As I noted during 2015, our intention is to evolve from a stated objective of sustained profitability to sustained profitable growth. We have articulated our more time for business plan that specifies both continues improvement and strategic expansion opportunities in four key areas. Updates to the more times for plan include one, more places. The keystone in our continuous improvement plan is the evolution of our overall real estate strategy. Our most important effort to date is the rollout of our new specialty store concept we call the Discovery Store. Our September 1 grand reopening of our flagship mall of America store marked the official kick off of our bright friend Discovery Store prototype. We now operate seven of these stores with a combination of in place remodel, remodels within the same mall but within improved location, and completely new stores. Overall, we are seeing strong double digit sales growth driven by substantial increase in traffic combined with above average dollars per transaction. While early these stores exceeding our expectations with a lower initial build out cost and without the benefit of the significant localized marketing spent associated with the previous remodel initiative in 2012 and 2013. As you may recall, in addition to refreshing our aging brand look and increasing guest engagement, the objective of the Discovery Store format is to optimize special planning with a goal of improving both overall sales and sales per square foot. Practically, every aspect of the store has been rethought from a consumer centric and business building perspective including the creation of a focal point for our most unique selling proposition, the stuffing process and heart ceremony. We believe that the placement of our new high impact stuffer at the fun of the store versus the previous low profile stuffer located in the back of the store is creating exciting lease Line Theater to draw in traffic while opening up valuable wall space for merchandize without the need for additional square footage. Based on this positive initial results, we are aggressively value engineering the new format to create standardize build out model for a variety of store type and sizes while accelerating our plans to both systematically remodel and open new Discovery stores in 2016. We believe this will put us in a forefront of redefining our retail business for the future. As a compliment to the evolution of our traditional specialty retail model, our more places continues improvement plan is also focused on expanding in non traditional retail location including opening our first stores in true outlet model and escalating our shop-in-shop strategy with retailers like Macy's. This November will mark the second year in a row we've partnered with this iconic retailer to open shop-in-shop for the holiday season. We expect to be a seven flagship Macy's location such Herald Square versus five last year. Additionally, as a highlight of our long standing partnership, we will unveil our all new Build-A-Bear float this year in Macy's Thanks Giving Day parade. Our presence in this annual event tends to both heighten and broaden brand awareness while further solidifying our brand as a part of this important holiday tradition. On the strategic expansion front, we are pleased to announce that in September we opened an opportunistic location on Li & Fung's Shanghai campus in the exploratory retail environment called, the Explorium. Li & Fung's is a part of the Fung group which is a Hong Kong based multinational with international brands and retail operations across China. This first ever China location allows us to glean critical data regarding this important market and advance an anticipated future expansion. Please note although these exciting and promising real estate activities are clear component of our stated plan and a critical step towards achieving our overall business objective. The temporary churn of opening, closing and remodel can create noise in our comp base top line leverage in other key metrics in any given quarter. With that in mind we look forward to sharing our a comprehensive real estate strategy including an asserting new store opening and systematic remodel plan with you after the first of the year. Two, more people. Our continuous and proven initiatives are focused on expanding our business with our core consumer segment. Key strategies to deliver this goal for the fourth quarter include, first, we will focus on driving our girls' business primarily with our own proprietary property such as Honey Girls and the additional update to Promise Pets in last year's successful Merry Mission App story. Second, we intend to attract a broader array of guest by leveraging our exciting roster of best in class license properties including Star Wars primarily targeted to boys. Third, we believe we can capture a greater share of sales through the entire Black Friday week with our first ever comprehensive promotional program designed specifically to take advantage of this high traffic, gift giving sales period. And fourth, we plan to maximize our holiday promotion opportunity with McDonald's Happy Meal. From November 27 to December 24, Build-A-Bear will be featured in approximately 20 million girl theme Happy Meals in the U.S. supported by McDonald's TV advertising. Each Happy Meal will contain a mini stuffed animal and bounce back coupon that could be redeemed at our store for a free mini t-shirt for the animal and a discount on Build-A-Bear purchase. Based on past promotions, we expect the free t-shirt offer to drive traffic to our stores. And data from the last happy meal event in fourth quarter of 2013 shows that the discount was used in approximately 10% of total transactions for the promotional period. We believe this indicates that this initiative can drive both incremental traffic and incremental sales. On the strategic expansion side, we believe we have the opportunity this holiday season to simultaneously tap into nostalgic appeal for adult while engaging kids with two beloved multigenerational classic family properties. First, we launched our own make your own version of Snoopy and advances a first ever feature film based on the treasured Peanuts character. In support of the November 6 U.S. film launch we are planning a promotion offering a free child's movie ticket to see the Peanuts movie with a purchase of select Peanuts product from our store. We are excited about the potential of its replicable marketing platform for use with the number of our license movie partnership particularly given the high rate of co location of theaters with our mall stores site. Second, we have updated our historically successful make your own Grinch from the perennial favorite Dr. Seuss book and film, How the Grinch Stole Christmas. This year for the first time we will also offer a make your own version of Max the Dog. Because the Grinch's heart grew three sizes that day we will have an extra large heart for the guest to place into the Grinch at our iconic stuffing station. This is just another example of how Build-A-Bear can create unique and memorable experiences for our guest. Three, more products. As we have noted one of our key efforts for continuous improvement of product is the development of intellectual property concept enhanced with extended play such app, game and music videos. The concept of play beyond the plush is designed to elevate brand engagement while appealing to the tech mind mindset of our core kid consumer. We believe this effort has contributed to increases in both our units and dollars per transaction as demonstrated by the above average performance of our recent launches of Promise Pets and Honey Girls. You may recall that our initial execution of this strategy with last holiday Santa's Merry Mission ranger toy which generated strong sales delivered over 1.5 million game session on the app and was a key contributor to our positive comp for the 2014 first quarter. Building on that success, we plan to expand story this holiday with the addition of a new snowy white reindeer, Glisten, whose magically illuminated antlers help to save Christmas. We will offer new signature closing for the original eight reindeer as well as Glisten, and the property will enhanced within updated mobile app. Once again the Merry Mission theme of service our umbrella holiday marketing campaign and we will incorporate our multiyear clause marketing partnership with Toys for Tots in to the story line. Under the strategic expansion category we are pleased to announce two developments in both wholesale and outbound licensing designed to contribute to our product beyond the plush strategy. First we have extended our presence in Costco beyond historical successful gift card program with a wholesale offering of a branded gift set. Each packaged gift set features an exclusive pre stuffed bear with a heartbeat you can really feel. A unique outfit for the bear and a matching three hat for the child. The products were recently placed in top tier Costco location and as with our gift cards we expect to get set to appeal to Costco's higher than average income base. Second, in addition to the outbound licensing programs we have launched in categories ranging from cookies to costume, we've recently signed an agreement with Spin Master to make market and distribute a line of Build-A-Bear branded toys. We believe the line up of complimentary toy products which we expect to launch in fall of 2016 will be both top line and margin accretive while significantly increasing our brand reach. Four, more profitability. The delivery of continuous improvement in areas such as value engineering and supply chain management a contributing factor to the 134% increase in pretax income for the first three quarters. As well as the 11th consecutive quarter of enhanced retail gross margin. On the strategic expansion front, we continue to upgrade our IT systems in the quarter with the launch of a new product planning platform which we expect to enable us to improve our store planning capabilities which should produce incremental profitability. Separately, we believe the investments we are making in process, infrastructure and skill set to support the creation of end marketing of intellectual property are accelerated real estate efforts, and international expansion and outbound licensing will provide additional opportunity for profit enhancement via potential royalty income and increase overhead leverage. Thus far in the fourth quarter our comparable store sales in October which is historically the smallest month of the year are down versus year ago. Like many companies that focus on toy or children's products we are anniversarying strong increases from fourth quarter 2014 driven by the holiday launch of Frozen. We are also comping the long- awaited delivery of Toothless stock to meet the high pent up demand that have been created by the rapid second quarter sell out of last year's product. Even with this we believe we have crafted a comprehensive plan for the remainder of the quarter including, the introduction of Frozen Fever which just launched and showing good momentum. The upcoming release of a new character from How to Train Your Dragon designed to engage the broad consumer base of Toothless. The continuation of successful licenses including My Little Pony and The Avengers as well as the new Build-A-Bear Workshop sports central concept which leverages our relationship with most major sports league and many popular universities. As noted we also have new collections of classic characters from Peanuts and the Grinch, updates to proven success including Merry Mission and Honey Girls to new sales driving tool that we did not have last year including an extended Black Friday promotion and proven McDonald's Happy Meal program. Separately, last week Star Wars move to our number one overall story likely due to the recent release of the trailer for the Force Awaken which has already had more than 50 million views on YouTube. Overall, I believe we are in the midst of game changing time at Build-A-Bear. We have defined a strategy that's working. We have invested in talent to deliver the strategy and we have created positive momentum. Everyday, we are focused on those driving the current business while building the infrastructure to leverage our valuable brand due to expansion of our business model. We felt confident that the ongoing execution of our stated multiyear plan will bring us closer to achieving our objective of sustained profitable growth while increasing long-term shareholder value. Now I'd like to turn the call over to Voin review our third quarter financial in more detail.

Thanks, Sharon. And good morning to everyone. In the third quarter, our consolidated comparable store sales rose 2.1% driven by a 7.3% increase in dollars per transaction partially offset by a decrease in the number of transactions. By geography, comparable store sales rose 0.2% in North America and 8.9% in Europe. Net retail sales were $84.3 million compared to $85.6 million in the prior year. Our increase in comparable store sales and sales from the addition of new stores were more than offset by the negative impact of currency, Q1 week calendar shift related to the 53rd week last year. The strategic closure of our multimillion dollar store on Fifth Avenue, New York City and low sales from temporary store closure due to remodel activities. Excluding currency, net retail sales increase 0.8% for the quarter. Consolidated e-commerce sales rose 4.1% excluding the impact of foreign exchange. Retail gross margin increased by 160 basis points to 45.3%. 100 basis points of which were due to merchandise margin expansion with the remainder attributed to lower distribution and occupancy expenses. SG&A was $37.6 million or 44% of total revenues compared to $36.2 million or 41.8% of total revenues last year. SG&A in the third quarter this year included $1 million in management transition cost and currency loss compared to $1.6 million last year. Adjusting for these items in both period, SG&A as a percent of total revenues was 42.9% compared to 39.9% last year. The majority of the $1.4 million increase in SG&A reflects investment in support of our long-term strategy that positions our company to accelerate sales and earnings growth. As Sharon noted we invested in key areas to support our long-term strategic growth plans specifically in the quarter we invested in incremental marketing to launch our new intellectual property the Honey Girls which came in as the top story for the older girl segment. We opened temporary occasion to minimize low sales from store that are being remodel in our design. We incurred cost to support the opportunistic opening of our first China location in the Fung group Explorium in Shanghai. And as we implement new systems, upgrade our stores and develop new business trends with wholesale and licensing, we are adding new talent and transitioning select roles to support our future plan. As a result, our expansion in gross margin was more than offset by the increase in SG&A bringing our net income to $1.1 million, or $0.06 per diluted share compared to net income of $1.8 million, or $0.10 per diluted share in the third quarter last year. Adjusted net income came in at $1.7 million or $0.10 per diluted share for the third quarter. From an adjusted net income of $0.19 per diluted share in the same period prior year. For the first nine months, consolidated comparable store sales increased 4% and included increases of 1.9% in North America and 13.1%. Net retail sales were $256.2 million compared to $257.8 million in the prior year as an increase in comparable store sales was offset by the negative impact of the one week calendar shift due to the 53rd week in fiscal 2014, the negative impact of currency and store closure and remodel activity as previously mentioned. Excluding the impact of foreign exchange, net retail sales increased 1.5% compared to the first nine months of 2014. Consolidated e-commerce sales rose 7.9% excluding the impact of foreign exchange. Retail gross margin was 45.3%, an improvement of 300 basis points compared to last year. SG&A was $110.8 million or 42.6% of total revenues including $2.4 million in management transition cost and foreign exchange losses, this compares to $108.1 million or 41.4% of total revenues including $1.9 million of management transition cost and foreign exchange losses. Adjusting for these items in both period, SG&A as a percent of total revenues was 41.7% compared to 40.7% last year. Year-to-date income tax expense of $721,000 with an effective tax rate of 9% primarily comprised of foreign and state taxes given the valuation allowance on our domestic deferred tax assets. We continue to expect to reverse the remaining U.S. valuation allowance in fiscal 2015. However, for modeling purposes we suggest that you continue to use no tax expense or benefit this year. Adjusted net income increased to $0.51 per diluted share from $0.25 per diluted share last year. Turning to the balance sheet. At quarter end, consolidated cash was $37.1 million compared to $40.5 million at quarter end last year. The change was driven by increased capital spending and share repurchase activity offset by improvement in profitability. In the third quarter, we utilized $1.9 million to repurchase 106,000 shares and at the end of the third quarter we had $8.9 million of availability under the current share repurchase program. In the third quarter, we have no borrowings on our credit facility. Consolidated inventories totaled $55.6 million compared to $45.7 million in the fiscal 2014 third quarter. This $10 million increase was driven our stronger inventory position on key stores and the timing of purchases to support fourth quarter product launches as well as additional store opening during the holiday season. This follows an $11 million decrease at quarter end last year with inventory declining 2% on the two year basis. We feel good about the quality and quantity of our inventory and believe it positions us well as we go into what is typically our highest sales period of the year. Capital expenditures were $12.9 million primarily for store related capital and IT infrastructure. Depreciation and amortization was $12.3 million. For fiscal 2015, we continue to expect capital expenditures to be in the range of $20 million to $25 million to support store updates and openings as well as the ongoing investment in IT infrastructure. We continue to expect depreciation and amortization to be approximately $16 million to $17 million. We currently expect to end the year with 10 more stores than last year finishing 2015 with 334stores, which includes 11 stores operating in the new Discovery format. As we model the remainder of the year, keep in mind this last year's fourth quarter was comprised of 14 weeks compared to 13 week this year. We also benefited from an adjustment to deferred revenue related to our loyalty program which was approximately 1% of net retail sales for the last year's fourth quarter. The additional week of sales and the loyalty program adjustments I just mentioned had a higher float through rate to gross margin given minimal fix occupancy cost associated with this week. So while we expect our initiative to continue to result in increase merchandized margin, we anticipate that one less week of sales with similar fixed occupancy cost compared to the fourth quarter of last year will result in the lower retail gross margin percentage. Also SG&A expense in the fourth quarter is expected to be lower than last year as we have one less week of variable costs. In summary, we remain committed to our stated strategies to deliver sustained profitable growth and increase shareholder value. We believe our strategic initiative continue to gain traction and position us well for improved financial performance. Through the first nine months of 2015, our pretax profit of $ 8 million is an improvement of $4.6 million from last year. We remain confident in our ability to successfully transition from our goal of sustained profitability to sustained profitable growth. And now I'd like to turn the call over to the operator to begin the question-and-answer portion of the call.

[Operator Instructions] Our first question is from Stephanie Wissink from Piper Jaffray. Please proceed with your question.

Thank you. Good morning, everyone. Two questions if we can. Sharon if you could just help us appreciate a bit more of the timing and sequencing of some of the products flow releases in this year's fourth quarter into first quarter versus last year, just with respect to some of those I think property tie-ins or media-related tie-ins? And then Voin, if you could also just give us a bit more color on the SG&A run-rate in the quarter and how we should think about that progressing over the course of the next few quarters and where your opportunities are to drive incremental leverage? Thank you.

Okay. Last year Frozen was a big launch for us as you might recall. That launched late in October and earlier in the UK and little bit later in the United States. It hit with immediate traction. A loss was juggernaut for us. The difference this year as I noted was when you have like sort of a four quadrant hit like we did first with Honey Girls again -excuse me with Frozen against that younger girl then we also had the continuation Teenage Mutant Ninja Turtle which was doing quite well for us, at that time we launched Merry Mission into first week of November which will be the same timing that we are doing at this year. And then we also had Toothless which was against universal consumer. So we were hitting on all four cylinders against all our four consumer groups. We have created a cadence this year to hit on all four those cylinders again. You might recall we had a 9.8% almost 10% in the fourth quarter of last year so we knew that we needed to build a very robust plan versus this year to combat the 2014 comp. So the cadence of this year as we launched Honey Girls actually in the third quarter because we wanted to make sure that it had some time to build. And the media and marketing against that was the dynamics sure that we will be going into the fourth quarter with a lot of visibility, a lot of awareness and a lot of opportunity. The next launch for us against that girl consumer which is little bit of younger girl consumer was the Frozen launch which we just recently launched; it had already some traction and moved to the number one position for the younger girl consumer almost immediately. So we are seeing some positive momentum there. We launched Star Wars earlier as well but that's going to be our hit against the boy business combating what would be to Teenage Ninja Turtle from last year. We expect that to see the rise on that, the curve to give get steeper as the year goes on and marketing particularly from Lucas starts to kick in. We actually expected to see a little bit higher in the third quarter but that's a big part of what our differences are for third quarter versus plan. And then we also have the Merry Mission that's coming back with the nice girl spin on it which is the Glisten product. So we feel like we are sort of one for one and then we have a lot more support concept to buoy up the business because it's going to take us few more story to hit the same, as we planned to be able to get to the combination of Frozen and Teenage Mutant Ninja Turtle from last year. So we are hitting it with more properties that we think we have things that are lined up to give us a really good shot at doing that. Does that make sense Stephanie?

Absolutely. Thank you.

All right, thanks.

Okay, Stephanie, and regarding the SG&A question, Q3 was an investment quarter for us as we talked about in the past. Like we are really focused on the value creation, and a lot of our SG&A activity is really focused on driving the value to the organization in the upcoming quarters and years. So really you know when we talk about some of these investments that I mentioned in our prepared remarks and we talk about investment in marketing, when we talked about the store remodel activity, some of these things are going to depend -- there is going to be some timing in future quarters. We are going to be providing little bit more color to you guys at the beginning of the year when we discuss our real estate strategy. There are going to be some additional cost as we talk about stores pre opening and closing expenses due to downtime then we remodel the stores into the new Discovery format. At the same time, we have the continuous effort to leverage our SG&A, and as we have been discussing in the past, our goal is still to continue to drive operating margin expansion in the future. And some of these investments that we are making in SG&A are really reflecting the benefit in the overall margin that you are seeing even today. Does that help?

It does. That's really helpful. So we'll look forward to that conversation on real estate. If I could just one more on the Discovery format? I think Sharon you mentioned early indications, you've been pretty pleased. If you could just give us a sense of some of the metrics that are showing some nice steady improvement, whether it's mixed related or just traffic overall?

Yes we are seeing strong double-digit growth. One of the things that we are really pleased about is I also mentioned in the script that we have a number of different formats of where we are putting these Discovery Stores. So whether that's a brand-new location, a location that we've remodeled in place or a location that we've moved inside of a mall, we are still seeing similar double-digit growth metrics. When we dig deeper because we are putting traffic counters in all of these and as you know we are expanding traffic counters slowly into all of our other stores so we can have a much better metrics to manage our business, it's a significant increase in traffic and then buoyed by a better than average dollars per transaction. So it is really interesting dynamic. I am pleased to see it increase in traffic because clearly that's going against what's happening generally in the mall business today and is one of the bigger battles for retailers overall. We believe that in store lease line theater is drawing in consumers in a way that has perhaps not in the past. We are certainly catching people's eye, people are just coming in and to explore in a way that they might not even noticed before, we have a lot of incidental data about while I didn't even know you are here and these are in the remodel and place stores. So it is pretty interesting how eye catching the new color palette the new branding seems to be. And then you marry that with increased dollars per transaction, it seems like a really nice story for us. The stuffer that we have created also has increased productivity with three novels and a number of other things that we've done to improve that. So for a store like our mall of America location where our biggest challenge in many ways during our peak period with throughput, we've already increased that significantly our ability to manage the throughput on the weekend and on important holiday season. So just that alone is doing our mall of America business.

Our next question is from Alex Fuhrman of Craig Hallum Capital Group. Please proceed with your question

Hey, thanks guys. I wanted to ask a couple questions about gross margin. It sounds like your occupancy cost leverage a little bit here in the third quarter on a 2% comp. Wondering to what extent that was driven by the Fifth Avenue closure in New York City, and then kind of looking out at the next few quarters, can you leverage occupancy cost on a flat comp? Wondering where we should be thinking about that for Q4. And then just more broadly as it relates to the fourth quarter gross margin, just trying to understand thee fixed components that might be in there and the extra week comparison. I mean I would be thinking that your rent is the largest item there. Were there not 14 weeks of occupancy costs in last week's fourth quarter? I am just trying to understand where is the disconnect here and why Q4 retail margins are going to be down?

Sure, Alex. So you know gross margin as we talked about there are two pieces of that question. In Q3, really we were able to expand our merchandise margin, which has been a continuous story throughout the whole year, and we expect to continue to drive the expansion of merchandise margin in the future quarters as well as I mentioned earlier. As we talk about our occupancy expenses in Q3, we had some favorability in other occupancy costs and distribution expenses that are going to our gross margin. When we talk about Q4, we were trying to explain in our prepared remarks the impact of the 53rd week. So last year in fourth quarter, it comprised of 14 weeks versus 13 weeks this year. So when you talk about the leverage from the dollar perspective, our occupancy, our rent was comparable year-over-year. But last year I had one extra week of sales, so I was able to get additional leverage of our occupancy costs. This year that one week is gone, so like it's tougher for us to leverage the same occupancy base. But at the same time, we continue to expect to see the merchandise margin expansion in Q4.

Our next question is from Gerrick Johnson of BMO Capital Markets. Please proceed with your question.

Hi, good morning. I was hoping you could talk about inventory; it looked like that was up sharply on a year-over-year basis. And then also if you could discuss historic economics on the outlet stores, how do they differ from traditional stores and also how might they impact on traditional stores be nearby? Thank you.

Okay, Gerrick. Thanks for the question. Our inventory was up $10 million compared to the same period last year. As we mentioned, we have a stronger position on some of our key product stories, but there is also timing of purchases to support our fourth quarter product launches and additional store openings in for the holiday season. As we mentioned, on a two year basis, our inventory is actually down 2%. So really there is a lot of timing and shift in calendar. This quarter end of this year, it's one week closer to Christmas than the week same comparable week last year. So really we still feel very confident about the quantity and quality of the inventory that we have, and we believe it positions us well to deliver our Q4 plans.

Hi, Gerrick. It is Sharon on the other question. We now have six outlets that we opened five in the U.S. and one in the UK. As you might recall one of the strategies that we had with outlets was to overlap this concept of outlet malls which are one of the better metrics of overall mall business with this construct of tourist locations and tourist destinations that we tend to over index on, and we really did that in the United States in locations like Hilton Head for example and Rehoboth Beach, Delaware. And what we are seeing and what we have planned on saying was there going to have opposite seasonality, I remember about our other stores because we are in very beach location. So our objective with those outlet openings and that particular location is to run them out through a calendar year so that we can see the ups and downs and the puts and takes on that. There were two objectives that was one to be able to take advantage of this tourist location combined with this concept of the type of mall that seems to be over indexing, so putting those two things together and seeing a new opportunity for us, is non cannibalistic from a real estate perspective. The second is a way for us to manage our inventory better and flush our inventory better. So we are learning on two fronts, but thus far pretty excited about the opportunity to be able to master this new sort of store format for us. And we are seeing differences between the places where we had more closely related to beach type of location and the places that are more in like our UK store. It is over performing versus those types of stores but that was the way we thought it would work because we are going to see opposite seasonality. And that's where we are so we are kind of learning and not only from a consumer, the way the consumer interacts with that outlet space but also learning and not only from the way we manage our inventory and flush it too and manage this pricing process and promotional cadence in those outlet. So it's going to be a great tool for us.

Okay. Great and one last one. Hey, Voin, what kind of tax rate would you anticipate next year?

So we expect to be a taxpayer next year, so we will be providing a little bit more guidance at the beginning of the year.

[Operator Instructions] Our next question is from Greg McKinley from Dougherty. Please proceed with your question.

Yes. Thank you. Could you talk a little bit about more about your promotional calendar for the quarter? You talked about some special Black Friday promotions, and then maybe just recap for us, if you could, what you're doing with McDonald's and the potential impact there?

Yes, sure. Stephanie asked a question earlier about it how we are lining up product launches to product launches, and on top of that we have two really important promotions that will buoy or we expect to buoy the total business to Build-A-Bear. One of those is a much more robust Black Friday week promotional cadence. In the past what we've done is really a one day product offering at a discount on the actual Black Friday that's usually specifically procured product maybe like buy one get one half and we be in and we be out for that one day. Given the increase in the total interest in Black Friday and the Black Friday week and how retailers and malls are reacting to that we build the whole cadence this year inclusive of the use of and partnership with some of our key licenses for the first time ever. So it's not a more of a generic product. It is actually a highly desired assortment of that some of our license properties that will be offered during this Black Friday timeframe. And there is a whole week of what we call deal that are consumers and our loyalty consumers will get involved in and engaged in so we think that there is a lot of opportunity there and we once again will be also participating in Cyber Monday with special offerings for consumers and this is such a high traffic high gift purchasing time period and we believe that we should participate in that given that we are a real such gift option for consumers. The second is McDonald's. We did not have McDonald's last year. The last time that we did, have McDonald's was in 2013 and we are very excited about it this year. We think the timing is absolutely perfect for us. And we will be in over 20 million Happy Meals from November 27 through December 24, what happens with this Happy Meal is they get a small stuffed animals. I mean they are Christmas themed, they have a lot of look and feel of our Merry Mission campaign which will be used as our overarching Build-A-Bear sort of holiday theme, and you get the coupon to come back in to our stores and you get a tiny little t-shirt that fits on this little animal. Our history shows that this is a big driver for little girls to come in to Build-A-Bear and get that t-shirt. Additionally, as you may know, there are lot of McDonald's that are co located with Build-A-Bear and mall so it is really easy to just once they get the coupon to still want to go over Build-A-Bear while they are in the mall and it drive that traffic. What we then have also found particularly when we dig into the metrics of 2013 is it does not only just drive traffic through in consumers coming in, we actually also drive conversion. Once they are inside Build-A-Bear and they see the excitement of everything that's going on, we have a big tendency to convert the consumer and so it is a net positive for us based on our past.

Thank you. And then how did those promotions impact how we should think about margins or operating expenses, or are those being more funded by your license partners at McDonald's?

Well, no, they're not funded by our license partners or McDonald's, but they are built into our expectations.

And Greg, as I mentioned in my remarks, we expect merchandise margins still to be up in Q4 compared to the Q4 last year.

Then also recall that McDonald's, the exposure that McDonald's provides to us through the Happy Meal and sales, the in-store displays in the tens of thousands of McDonald's -- I am not sure how many there are, I know thousands of McDonald's in the United States as well as the TV advertising that they bring is tremendous exposure for us during an absolutely critical time period.

Okay, all right, thank you. Getting back to merchandise margins, Voin, in the past, you've occasionally quantified the breakdown how much of retail gross margin improvement came from merchandise margin. Could you provide that to us?

Yes, in Q3 100 basis points or 160 basis point improvement came from merchandise margin.

Okay, thank you. And then regarding within same store sales and I know you sometimes also given us a sense of value per transaction versus number of transactions. Are you able to give us some color there?

Yes. So we share that our dollar per transaction has been up 7.3% that was offset by the number of transactions we haven't specified like but as we talked about unit per transactions are driving that as well as our average unit retail continues to be very strong but it is offset with the number of transactions.

[Operator Instructions] We do have a follow up question from Greg McKinley. Please proceed.

Okay, sorry about that. So maybe just one more thing if I could ask a little bit about on the investments in your various media programs and getting talent at corporate to steer some of your initiatives. I'm wondering if you can just revisit how you and we should think about your operating margin expectations for 2016 in relation to 2015, and then can you narrow in at all on October same-store sales trends? I know you said they are down, but if you could be more specific than that I'd appreciate it. Thank you.

So to answer your question about SG&A in the context of operating margin expansion, as we previously mentioned we continue to expect on a full year basis this year and in the future that our operating margin is going to continue to expand. There are going to be some fluctuations in our quarterly results as we continue to make investments in the business but still we expect to deliver continued improvement in our operating profits. Each one of these situation that we called out incremental marketing, it is really tied to the timing of the new launches in the promotions that we have and really the timing of the calendar year-over-year is going to be driving some of that. As we are going to be trying to provide little bit more color beginning of next year as we talk about the higher story model activity next year because as we've some downtown in the stores that are being remodel that does have an impact. As a reminder, Greg, Mall of America store when it was down we had a temp location, so we are really trying to protect the top line but at the same time we are incurring some duplicative expenses. And as we talked about China we are making some investments on the China front we are making investments as we talk about whole selling outbound licensing, really so these SG&A investments we believe are going to be accretive to earnings in a future and we are going to be seen both the benefit in overall top line revenue as well as the margin expansion. And your second question was related to the comps in Q3, so we really provided some color as where are right now. I don't know that we will provide any more color than that.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I'd like to turn the floor back to management for closing remarks.

Thanks again for joining us this morning. We want to wish you all are happy and healthy holiday season and really look forward to speaking with you at ICR Conference in January and our Fourth Quarter call in February.