Ulta Beauty Inc (ULTA) 2008 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and thank you for holding.

Welcome to the ULTA Salon Cosmetics & Fragrance, Incorporated, third quarter 2008 results conference call.

(OPERATOR INSTRUCTIONS).

It is now my pleasure to introduce your host, Allison Malkin of ICR.

Thank you, you may begin.

Thank you, good afternoon.

Before we get started, I would like to remind you of the Company's Safe Harbor language, which I'm sure you are all familiar with.

The statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual future results may differ materially from those suggested in such statements due to a number of risks and uncertainties, all of which are described in the Company's filings with the SEC.

With respect to each reference we make on this call to adjusted net income per diluted share as a result of the October 2007 IPO, a reconciliation of net income per share on a GAAP basis to adjusted net income per share has been provided in Exhibit 4 of our earnings release, which is available on our website and has been filed with the SEC on Form 8K.

And now I would like to turn the call over to ULTA's President and CEO, Lyn Kirby.

Thank you, Allison.

Good afternoon, everyone.

Thank you for joining us to discuss our third quarter fiscal 2008 results.

On the call with me today is our Chief Financial Officer, Gregg Bodnar; and following my opening remarks, Gregg will review our financial highlights and outlook, and I will provide closing comments and turn the call over to the operator so that we can answer the questions you have for us today.

Let me start by saying, in these unprecedented times, we remain confident in our strategies and financial position, and we are pleased with our strong third quarter performance, although our performance was impacted by the sudden decline in the macroenvironment that occurred in October.

We are also pleased with the recent start to the Holiday season and the strategies that are driving these results; and if consumers continue to spend on the current trend, we would anticipate delivering fourth quarter comp sales in line with third quarter performance.

However, we recognize that the majority of the season remains in front of us in the most volatile economy we have seen in decades.

So as a result of the change in the macro environment, we have reduced our full year outlook; and further, we believe it is prudent to provide fourth quarter guidance that represents a wider range of potential outcomes due to this volatility.

That said, our EPS guidance represents a solid increase over last year's fourth quarter, and our expectations for sales and earnings remain well ahead of many other retailers.

Quite simply, given the uncertainty of consumer gift spending, we do not want to over-promise.

As I mentioned, we are pleased with our third quarter results, which included double digit growth in net sales and earnings and our 35th consecutive quarter of positive comp growth.

Our comp store sales gain of 2% included double digit growth from many of our prestige brands and was driven by positive customer count as we continue to drive the market share in this difficult economy.

While we are pleased with our overall comp sales gain in this environment, we do want to point out that our total sales comp was negatively impacted by roughly 40 basis points due to store closures in the Houston market as the result of the hurricane.

In addition, like most other retailers, we saw our business drop dramatically in the early October timeframe during the height of the financial crisis.

The good news is that our business bounced back solidly after this period in response to modest incremental spend in advertising and margin.

In addition, as we have discussed previously, we are an established retailer with a 310 store chain, so our comp store comparisons include the impact of transfer sales from new stores opened in existing markets.

As you know, we build our real estate strategy with a balance of comp sales growth in new markets and operating margin improvement in existing markets.

So once again, our third quarter results demonstrate the strength of our business model, even in a weak and turbulent economy.

Specific highlights of the quarter included a net sales of $254.8 million, reflecting an increase of 22.4% from last year.

Our third quarter sales volume was slightly below our total sales guidance range, which reflects the impact of a weak economy on our comp stores and also our new stores.

As has been typical in fourth quarter, we expect stronger performance in our new stores when marketing is allocated heavily towards newspaper inserts that reach a broad audience and drive traffic into new stores.

This strategy is already gaining traction in the early weeks of the fourth quarter, and overall, our 2008 new store program remains on track with our model.

Our operating income growth was 20.4% from last year's levels, and our adjusted income per diluted share of $0.09, meeting the mid-point of our guidance, which of course, was introduced prior to the economic shift that impacted our business in October.

As you're well aware, our third quarter performance compared quite favorably to other retail operators and competitors, such as our big box co-tenants and stores in alternative channels, such as department stores and fashion retailers, the majority of which reported negative comps and negative traffic during third quarter.

This demonstrates that ULTA has become a key shopping destination, and that our business model includes strategies that can be leveraged in a weak and turbulent economy.

Although ULTA and the category are not impervious to the general negative economic conditions, we are more resilient because, firstly, we are convenient to shop.

ULTA is located off mall, closer to neighborhoods, and fits into our consumers' busy lifestyles.

In addition, although we appreciate the traffic from our co-tenants, we are more self reliant, with the ability to drive traffic through our own stores.

We are a category killer, with a choice of 21,000 products which meets all of our customers' beauty needs in one store, and with price points that satisfies all wallets.

Our business model is flexible.

During the quarter, when news of the financial crisis began, we proactively altered our marketing strategies to emphasize even more of our value message and great products in the latter part of the quarter.

As we anticipated, we obtained more of our loyal customers' shopping dollars, as well as attracted new customers, thereby expanding our market share.

And finally, our stores look fresh and exciting each time our customer shops.

We provide her a choice of 21,000 products, with the right mix of newness and value, which creates an exciting and fun shopping experience each time she comes to our store.

We are able to achieve this without the significant seasonal markdown risk that certain retailers, such as apparel stores, may be facing in this environment due to seasonal obsolescence.

Our store expansion continued to deliver good results.

We opened 21 new stores and completed two remodels during the quarter, and our 2008 class remains on model.

Our openings were also well-balanced.

Six were in major metro markets, nine in medium-sized markets, and six opened in smaller markets.

We opened 12 stores in our existing markets, strengthening our market share and leveraging our operating costs, and entered nine new markets, including first store in St.

Louis, Missouri.

We ended the quarter with 304 stores in 35 states.

During the quarter, we successfully opened ULTA on State Street in Chicago, our first urban location.

The customer and vendor feedback has been terrific, and there has been a lot of buzz.

We are very excited by its potential.

We have opened 62 of our 63 planned new stores for the fiscal year, and will open our final store, located in Miami Beach, Florida, this quarter, which will complete our 2008 expansion plans.

Looking forward, as we continue to experience the strength in our business model, we are maintaining our long-term square footage growth of 20% to 25%.

However, in the short-term, we have made a decision to reduce our 2009 growth plan to 15% to 20%.

We believe this is prudent in a tough economy.

The most recent credit and general economic contraction has delayed some planned retail developments and caused numerous retailers to pull back planned openings in others, diminishing their attractiveness to ULTA.

On the other hand, the large numbers of announced and anticipated store closings have and will open up opportunities in many upstanding centers that have previously been fully leased.

We want to be in a position to take full advantage of this changing landscape.

We ended third quarter in a very strong inventory position, which will allow us to introduce newness and excitement in the fourth quarter in new products and giftables, and across our key categories such as fragrance, Prestige and personal care appliances.

Specifically this holiday, we have 12 new fragrances, including Ed Hardy, Viva La Juicy, Ralph Lauren Notorious and Estee Lauder Sensuous.

We also have exciting holiday giftables from all our major Prestige color brands, including Smash Box, Bare Essentials and Urban Decay.

And of course, our professional category has exciting newness from Chi, T3 and OPI.

As we mentioned during our last quarterly call, we did see some early positive signs in the fragrance category in third quarter in response to our marketing strategy.

We are carrying those marketing strategies into the fourth quarter, when fragrance is a key destination category, and we are very pleased with the early consumer response.

We expect to continue to take market share in this category during what is expected to be a difficult Holiday season.

To summarize, we are pleased with our third quarter performance given the unexpected volatility in the environment.

And because we are nimble, we have been able to better plan for this in fourth quarter.

Our marketing and value propositions are enticing consumers to shop, our stores look great, and our teams are excited.

We have reduced our new store expansion pace in 2009, as we assess the changing real estate landscape.

We also have adjusted our real estate strategy for 2009 to allow us to take advantage of attractive opportunities that we believe will present themselves after the Holidays.

Quite simply, we are controlling those elements of the business where we have direct influence, and are outperforming most other retail operators.

However, we are faced with great uncertainty as we enter into the Holiday gift giving season, both from a general economic and consumer spending perspective, and do not want to over-promise; and therefore, have adjusted guidance accordingly.

With that, I would like to turn the call over to Gregg to review the financials in more detail.

Thank you, Lyn.

As Lyn mentioned, our third quarter results reflect solid double-digit sales growth, positive comp store sales and traffic increases, as well as continued expense leverage, which enabled us to achieve a 20.4% increase in operating income, and a 28.6% increase in adjusted earnings per share.

Beginning with a review of the income statement, net sales increased 22.4% to $254.8 million, from $208.2 million in the third quarter last year.

Sales growth was driven by the addition of 67 new stores in operation versus a year ago, and a 2% increase in comp store sales.

This gain was on top of a 6.7% increase in comp store sales last year, resulting in a two-year comp store sales growth of 8.7%.

During the quarter, we opened 21 new stores and remodeled two locations, ending the third quarter with 304 stores, and expanding square footage by 28% from last year's third quarter.

Our new store program continues to perform on model.

Gross profit dollars in the third quarter increased 16.7% to $79.5 million, from the $68.1 million last year.

Gross profit margin decreased 150 basis points to 31.2%, primarily driven by 100 basis points of deleverage in fixed store costs resulting from our expanded new store program, 30 basis points of expected impact related to the addition of our second distribution center, and 20 basis points of gross margin investment used to successfully drive positive customer traffic and comp store sales increases in this difficult economy.

SG&A expenses were $65.2 million, or 25.6% of net sales compared to $55.6 million, or 26.7% of net sales in the prior year period.

The 110 basis point improvement in SG&A was primarily driven by our ability to leverage our corporate infrastructure on our growing store base and appropriately manage expenses in this environment.

We expect to continue to drive improvement in SG&A as a percentage of sales during the fourth quarter.

Preopening expenses were $4.7 million or 1.8% of net sales, compared to $4.5 million or 2.2% of net sales last year, reflecting the opening of 21 new stores and two remodels during the quarter as compared to 26 new stores and 7 remodels in the third quarter last year.

This double-digit sales growth, combined with solid SG&A leverage, led to a 20.4% increase in operating income to $9.6 million or 3.8% of net sales, from $8 million or 3.8% of net sales in the prior year period.

Interest expense decreased to $1.1 million from $1.3 million last year, reflecting lower interest rates from the same period last year.

The effective tax rate for the quarter was 40.9% compared to 36.9% in the prior year.

The prior year period benefited from a cumulative true-up of our blended state effective tax rate.

Net income for the quarter increased 19.3% to $5 million, from $4.2 million last year.

On a GAAP basis, income per diluted share was $0.09 compared to $0.05 in the third quarter of last year.

On an adjusted basis, income per diluted share for the third quarter was $0.09 compared to $0.07 last year.

Now turning to the balance sheet.

Merchandise inventories at the end of the quarter increased 22.5% to $268.9 million, from $219.5 million at the end of the third quarter of last year.

Average inventory per store decreased 4.5% from the prior year quarter.

This reduction was primarily due to the later flow of receipts this year, better utilizing our supply chain with our second distribution center, and our continued focus on overall inventory management.

Excluding the effect of the supply chain leverage, average per-store inventory would have been flat to the prior year, while delivering a 2% increase in comp store sales.

The $49.5 million increase in inventory was due to the addition of 67 new stores in opened in the last 12 months.

We are pleased with both the level and composition of inventories as we enter the fourth quarter.

As we continue to focus on managing working capital and driving strong financial performance, we delivered $29.5 million of operating cash flow during the first nine months of fiscal 2008.

Capital expenditures for the quarter totaled $28.5 million.

Regarding debt levels and the strength of our balance sheet, as of November 1st, 2008, we had $62 million available in our credit facility and $138 million of borrowings outstanding.

Our credit facility provides borrowing capacity up to $200 million, and is committed through May of 2011 by three of the largest banks in the United States, including J.P.

Morgan, Wachovia and Banc of America.

This credit facility, together with cash flow from our growing store base, provides us with the capital and liquidity to achieve our growth plans well into the future while maintaining a very strong balance sheet that is not highly leveraged.

Now regarding our outlook, given the sudden and unprecedented change in the economic environment in October and its impact on our third quarter results, we believe it is prudent to lower our fourth quarter expectations and provide guidance that represents a wider range of potential outcomes, especially given the uncertainty regarding consumer gift spending in this economy.

Although we are pleased with the recent start to the Holiday season and the strategies that are driving those results, we recognize that the majority of the season remains in front of us in an incredibly volatile macro environment, and as a result is very difficult to predict consumers' ultimate level of gift giving.

Even with this wider range, our guidance represents a solid increase over last year's fourth quarter performance, and our expectations for sales and earnings remain well ahead of many other retailers.

Naturally, during this time period, we will be focused on prudent expense control and inventory management, as we have been all year.

Specifically for the fourth quarter of fiscal 2008, we expect net sales in the range of $354 million to $368 million, compared to the fourth quarter fiscal 2007 of $309.3 million.

Comp store sales are expected to be in the range of minus 2% to plus 2% compared to a 4.5% increase last year.

Income per diluted share on an adjusted basis is estimated in a range of $0.24 to $0.28, compared to fourth quarter adjusted income per diluted share last year of $0.23.

We have opened six of the seven new stores planned for the fourth quarter of fiscal 2008; in the fourth quarter of fiscal 2007, we opened 12 new stores and remodeled three existing locations.

For the full year fiscal 2008, we now estimate net sales in the range of $1.1 billion, to $1.11 billion, as compared to our previous guidance range for net sales of $1.12 billion to $1.13 billion, and versus net sales last year of $912.1 million.

Comp store sales are expected to increase by approximately 1.4% to 2.7%.

Income per diluted share is currently expected in the range of $0.47 to $0.51, which compares to our previous guidance range for income per diluted share in the range of $0.52 to $0.57 and fiscal 2007 income per diluted share of $0.43, after adjusting for the IPO.

Our full year guidance excludes $0.01 per share severance cost for the previously announced management change in March this year.

As Lyn mentioned, we have opened 62 of our 63 planned new stores for this year, with our final store scheduled to open later this quarter.

We have also completed the eight remodels in our 2008 remodel program.

Regarding capital expenditures, we now expect capital expenditures to approximate $110 million, which is below our previous expectations of $115 million to $120 million.

Specifically, we have reduced the construction costs for our 2008 new store program by $7.5 million, which represents a 14% decrease in the capital component of a new store investment.

We have continued to aggressively focus on reducing our total new store investment by leveraging the size of our program, particularly in this economy.

We will continue to emphasize controlling cost, managing inventory and ensuring we leverage our capital investments, particularly in new stores, to deliver strong financial returns.

This focus on cash flow while we continue to increase our market share will leave us in a superior competitive and financial position when the economy stabilizes.

As I have discussed in the past, we have a strong balance sheet position and operating cash flow from our existing store base.

This, combined with our $200 million credit facility, leaves us well-positioned to fund our future store growth.

Our balance sheet is not highly leveraged, with debt to equity at 0.6 times our current seasonal peak debt levels, leaving us presently with $50 million of available borrowing capacity.

As we end 2008, I expect our debt levels to approximate $120 million.

As we head in to 2009 our real estate program will continue to be focused on high quality sites.

While we have the financial capability and are achieving targeted return levels, we believe it is prudent, given the economy, to plan to expand our square footage by 15% to 20% in 2009.

With this planned square footage growth in 2009, our emphasis will be on managing an appropriate balance between operating cash flow and capital expenditures such that we will maintain a significant level of availability in our credit facility, therefore providing us with the ability to take advantage of attractive real estate opportunities that are expected to develop post-Holiday.

As we look further into the future, the fundamentals of our business remain very strong, and we continue to remain confident in our ability to achieve our long-term expansion goals as the economy stabilizes.

And now I would like to turn the call back to Lyn to close.

Thanks, Gregg.

The strength and fundamentals of our business continue favorably in these unprecedented times, and are evident in our solid results this quarter.

Our value proposition, marketing strategies, compelling brands and inviting in-store experience are clear advantages in a tough economy, and we fully expect to maximize these strength this Holiday.

We believe that this economic environment is the time to win market share, and we will continue to pursue this goal through maintaining our investments in our stores, brands, marketing and talent, always with a balanced eye towards return on investment.

We have a strong balance sheet and the financial flexibility to invest in market share strategies, and now is the time to utilize these strengths to position us for greater growth when the economy stabilizes.

While we have cautiously and prudently adjusted our full year expectations to allow for the uncertainty and impacts on consumer gift spending in this unprecedented and volatile economy, we remain confident in our business strategies and ability to deliver to our long-term growth targets as the economy stabilizes.

Operator, we are now ready for some questions.

Thank you.

(OPERATOR INSTRUCTIONS).

Our first question comes from the line of Daniel Hofkin with William Blair.

Please proceed with your question.

Good afternoon, Lyn and Gregg -- and a very nice quarter, I should add, particularly in this environment.

The -- I guess first question on the gross margin, was a little bit of the deleverage from the store program of function of the pace of comp sales relative to, let's say, prior quarters.

And secondly, just I guess with regard to the preopening expense, I just wanted to understand a little bit better why that was up in absolute terms year to year given the lower store openings and remodels.

And then secondly, I guess just recognizing it's quite early at this point, any sense for what 2010 could look like from a store opening perspective?

Thank you very much.

Dan, we will take those one at a time.

In terms of the difference between our 3% to 5% range and the expected impact on store occupancy costs, it's probably about 10 to 15 basis points coming down to the 2 comp.

And then with respect to 2010, are you referring to next year?

Referring to, I guess, the fiscal year ended January 11.

So one year beyond --

But not the year after?

Yes.

If -- I mean, recognizing it's very early I'm just trying to -- I know you've -- I think you guys have said in the past that it's -- even previously -- that the 2010 openings could be impacted by a retail center development.

That's correct, Dan.

So on the negative side is that -- the impact of the economy on real estate development.

On the positive side is what we believe will happen even at the beginning of 2009, as there are retailers who go out of business and there are store closures, and some have, as you know, already been announced.

I think there is a chance that that will continue through 2009, which will continue to give us opportunities in 2010 to balance against the slower real estate development.

So from where we sit right now, it's hard for us to predict exactly the size of the 2010 program.

But I certainly would not expect it to be any smaller growth than what we are currently planning for 2009; and if the economy improves and stabilizes, then we have a chance to go back to the 20 to 25% targets.

Okay.

And then, Dan, on your preopening question, preopening is up a little bit in absolute dollars given the number of stores that we opened.

And if you -- when we talk about Q4 of 2008, as we did the last quarter, you will find that it's a little bit of a shift between the two quarters, just based on the timing of when the stores opened.

So preopening in the fourth quarter will be down from preopening in the prior year.

Okay.

Thank you.

Thank you.

Our next question comes from the line of Neely Tamminga with Piper Jaffray.

Please proceed with your question.

Hey, good afternoon, you guys, and congrats on positive comps.

That's remarkable right now.

A couple of things.

I have some philosophical questions for Lyn, but I want to just cover off some housekeeping here.

Gregg, just D&A at quarter end -- I don't know if we caught that.

I might have missed it in a rundown -- and where you expect D&A to be at the end of the year, as well as any sort of D&A as well as Cap Ex guidance as early as you can for next year, considering you're taking down store growth?

Yes, Neely, for the full year I would still expect D&A to be about $52 million, which is consistent with what we've talked about in the past.

And then for the quarter, it was about $14 million.

Okay, and then Cap Ex for next year now that you're taking down store growth?

You know, let me describe it this way, since we haven't given any specifics on guidance for next year.

If you go from the 25% square footage growth down to the 15% square footage growth, that's a reduction of about 31 stores, which would be about $34 million in Cap Ex.

That's very helpful.

Thank you.

Okay, and then just two philosophical questions here, Lyn.

First, on the stores and the leases and the locations, I mean, I think when you guys were out there on the road and originally thinking you would be potentially kind of 1,000 location-type concept and chain, how many of those 1,000 -- or just sizing it up for us -- a third, a half, et cetera, were you kind of expecting theoretical new center growth?

Just said another way, I mean, if what has happened in our economy has been so unprecedented -- and it has been -- how much of this might potentially affect the longer term growth opportunity for ULTA?

You know, I -- if -- you know, this is a -- sort of just a reflection on what we have been doing the last couple of years -- I would say in the 1,000 or the 700 or so to go, about 30% would be new centers.

And the key comment, does it slow us down, it really goes back a little bit to the response to Dan.

You know, on the one hand, we'll have slowed down in new centers; but for us, on the positive, we really do believe that there will be some very attractive sites that we would not otherwise have been able to get into in existing centers that are going to come our way.

So where -- we see a tremendous silver lining in what is going to go on here in the economy.

And so you take those two factors together, and I'd go back to my response to Dan, it's really very early for us to predict the size of the 2010 and out program.

But at some point, when this economy does stabilize, we do anticipate that we will move back to our original growth targets and certainly don't see any need to diminish our original program of 1,000 doors.

That still remains very relevant; and in some ways, as I say, great opportunity for us to get back into centers that we have not been able to get into.

And I think, you know, given that I'm an analyst for 12 years and I'm asking a leading question -- I'll just be open and honest about that -- I think you're making exactly the point, right?

That the brand -- because we are unprecedented and because you have this opportunity, would you expect that you have unprecedented conversations with future brand growth, particularly on the Prestige side to continue to further open up those opportunities for market share gains?

We continue to have the conversations.

I do have a smile on my face -- thank you for being transparent.

We continue to have conversations with the brands that we would love to attract.

And as we have always said, that the more we continue with our store openings, the more important we are as an alternative channel of distribution for the brand.

And like you, we remain hopeful that that could be a silver lining in this economy.

But there is no change from where -- what we have always disclosed on that, which is that we are still just in conversations.

All right.

Good luck.

Thanks very much, Neely.

Thank you.

Our next question is from the line of Liz Dunn with Thomas Weisel Partners.

Please proceed with your question.

Hi, good afternoon.

Hi, Liz.

I guess my first question relates to your comment about the comp expectations for fourth quarter.

When you say its spending trends remain as they are currently, does that suggest you're running -- your November results were sort of in line with what you saw in the third quarter?

My answer to you is that the first few weeks of this quarter are exactly where we had anticipated Thanksgiving -- a little better than we had anticipated.

But the trends that we're running are in line with the guidance -- or actually, let me not say the guidance -- in line with the performance that we delivered in third quarter.

So with the current trends that we have, we would expect to deliver the same performance in third quarter -- so a 2 to 2.5 was unknown -- and I do want to make sure I stress this -- we really cannot predict the impact of this -- the macro environment on the consumer headset going in to fourth quarter.

And particularly around gift giving, we think it's very volatile, and we -- just like everybody else, we don't have clear enough eyes in here to say that our comps would stay 0 to 2, for example.

We really felt the need to broaden the range, because we just do not have eyes into it.

Okay.

Are you doing some specific things to be more giftable and more compelling from a value proposition?

As we have in third quarter, we continue with those strategies.

We do continue to invest some of our own margin into our private label business.

We continue to partner with our vendors to invest surgically in pricing that can drive traffic into the stores, and we certainly do that.

You heard me touch on an exciting new product program that we have in that fourth quarter, so we do have some really good newness coming in.

And we continue -- although we have not spent more on advertising rates in this quarter than last year -- we have certainly started from scratch, as we always do with every quarter, to learn from last year.

And we believe that we have a more exciting marketing program than fourth quarter last year, and believe that we are very solidly positioned for this Holiday season as long as the consumer is spending at a normal and expected rate.

Okay.

Now did I understand, Gregg, you correctly when you said you would have $120 million in availability on your bank line at the end of 2008?

And is there any help you can provide on what you might need to draw on that line in 2009?

The debt levels at the end of this year we're expecting to be $120 million.

Okay.

Okay?

Debt levels at the end of this year.

And then as we look into next year, part of our approach in planning in this environment and being cash flow-focused, and also leaving some dry powder available for real estate opportunities, is to try and balance the capital investment with our cash flow needs so that we maintain a significant level of availability in our credit line.

I wouldn't say exactly levels that they were this year.

Probably slightly below that.

Okay.

And then just my final question relates to, I think since the IPO you have been able to ratchet down your preopening costs, and it sounds like your construction costs now, with today's reduction in Cap Ex.

Can you just update us on what you see as the four wall cash contribution and the cash payback terms?

Or if not, just give us -- update us on construction costs per store and preopening costs per store?

Yes.

Let me take those -- all three of those -- each individually, Liz.

I will take the last one first -- or the second to the last one first.

If you look at our store model, right now there is a 3.5 year cash on cash return.

Based on some of the improvements that we've made in lowering construction costs that are meaningful coming out of this particular year -- it's about $120,000 a store -- which is about 7% of our total store investment of $1.6 million, and it has the impact of reducing that payback period from about 3.5 years to just over 3 years -- so about 3.25 years.

So a first nice step is we have been focused on lowering that payback and improving our financial returns.

And then as it relates to preopening costs, the impact of what we have done this year is pretty modest relative to the impact of the construction costs.

So preopening costs in our store model was about $205,000, and that's come down about $5,000 on average.

All right.

Thanks, and let me add my congratulations on the positive comp, and just say you guys are doing a great job on being very cautious and prudent in this environment.

Thanks very much.

Thanks, Liz.

Thank you.

Our next question comes from the line of Joe Altobello with Oppenheimer.

Please proceed with your question.

Thanks.

Good afternoon, guys.

First question, in terms of the comp in the quarter, could you give us a sense of how sales progressed throughout the quarter?

Particularly, did they get materially worse in October?

Joe, we have not commented on individual monthly performance at all, and so we are not going to respond to that question specifically.

However, the -- you did hear me say that we were able to be very nimble as we watched, even from the beginning of third quarter, before that the major crisis that hit in October, we could see some softening coming out of the second quarter, so we were nimble enough to be able put in some advertising and some very modest margin investment at the very back end.

And we were very pleased with the response to that strategy, and that is a strategy that we have continued into the first weeks of this quarter; and again, very pleased with what we are seeing at the beginning of the quarter.

So not a specific answer, but hopefully it gives you a flavor.

Okay, were comps positive in all three months?

Can I ask that?

You can ask, but we are not going to answer.

We actually -- we don't want to slide into the territory of being a monthly reporter, so we're just not going to do it.

And also, keep in mind, the other strategic reason why is, as Lyn has said in the past, we look -- we take a fresh look at the marketing strategy and its comparability to the prior year every quarter as they approach the quarter, and then adjust during the quarter as necessary.

So therefore, the comparability may not make as much sense on a monthly basis.

Okay, fair enough.

And then, in terms of slowing down the door growth, or the square footage growth, you guys did talk about this a lot.

But I was just curious, in terms of the mindset or the thought process behind that, I mean, you've obviously got two competing goals here -- one is to be prudent in this environment; the other is to gain market share and go after market share when there is share to be gained.

And so how much internal debate was there in terms of slowing down the square footage growth for '09?

Let me take the first part, and then Gregg can add.

It was -- there was actually no internal debate.

As we started to see some co-tenants -- and it really -- it did become fairly precipitous in October.

We began to see more co-tenants drop out of our centers and some -- as a consequence, more slowdown of new centers, so we certainly do not want to be in centers where the quality of the co-tenant had changed.

So they were very, very easy decisions for us.

We obviously were also very cognizant of some of the slower states around the United States in terms of their economies, so we took a very close look at those as well.

So the desire to pare the program back is consistent with what we have always said, which is we are never chasing a magical number of 20% to 25%.

We were always focused on delivering quality real estate, and if that started to change we would appropriately change.

So that was -- the first half was as we began to see the change, it was quite easy decisions; and it is not that we couldn't have made money in many of these centers over time, but we would not have optimized the short-term return on the cash.

In conjunction with that, we certainly began to see news breaking on closures that we can expect after the Holiday season, and we think that that may actually accelerate as well.

And we wanted to -- as Gregg just mentioned, we just wanted to keep our powder dry so that we can be very opportunistic with those sites as they become available to us.

So the two things that were actually separate decisions, one was only quality, and the changes caused us to want to pull back; but it gives us the simultaneous advantage of being able to be very flexible as these opportunities break; and we think they will certainly break post-Holiday, but will probably continue through the year as well.

And Joe, we believe this is the right balance.

I mean, we are continuing to gain market share in our comp doors as well as our square footage growth, and that opportunity, particularly in this environment, is going to continue to exist whether we're growing at 15% to 20%, or 20% to 25%.

We have a very rigorous evaluation process on our real estate -- takes all the emotion out of the decision make process.

And when that criteria tells us that the centers that were focused on the quality and the returns are not there, then we change the targets.

Got it.

Okay.

An then, lastly, if I could -- and I apologize if I missed this -- it sounded like you said earlier that store traffic was up.

Was average ticket up in the quarter as well?

No, the average ticket was our customer count growth outpaced the average comp, so we saw a slight downtick in average ticket.

But the traffic was very solid and so those two things balanced out.

And that was very much in response to the question you asked at the very beginning, where we didn't give you a specific monthly response but I said to you we invested some margin and advertising at the back part of the quarter; it was done deliberately to drive traffic.

We had anticipated that to be a very difficult time period -- not just because of the economic trends, but it was pre-election, and anticipated quite a bit of concern and caution on the consumer's part.

So we specifically drove traffic during that period of time, and we are delighted with the response that we got.

We drove traffic, both in terms of our existing loyalty members, who we got additional shopping from, as well as really good response to our investments in our newspaper inserts, which attracted new customers to the brand.

Okay, great.

Thanks a lot.

Thank you.

Our next question is from the line of Brian Tunick with J.P.

Morgan Chase.

Please proceed with your question.

Thanks.

Hi Lynn, hi Gregg.

Hi, Brian.

Hi, Brian.

So I guess I've got one for you, Lyn, and then two for Gregg.

I guess, so -- when you talk about market share and a lot of your co-tenants potentially closing their doors, but what do you see happening in your own drugstore/salon area?

Are you seeing salons closing?

Have you seen this part of the cycle before?

Are you seeing drugstores closing?

Maybe just talk a little about -- you know, maybe about capacity coming out of your own sector for a second.

And then I'll ask Greg the other two.

Okay.

Well, first let me just make the statement that although they are partial in our segment, we certainly see ourselves as much more than just a drugstore or salon.

So I do want to just make that comment to you.

But relative to salon, we are not seeing any significant closing in chain salon.

Certainly small independents -- I think that we are not specifically tracking them, Brian; but I am sure post Holiday season that we may see some business close -- businesses close down there, and that may give us some positive traction.

We are -- just on the salon business in general -- we are seeing some slowdown in our salon business.

We remained positive comps in third quarter, but certainly some slowing down there -- not to -- not a complete surprise, given some of the shifts in this economy that happened, particularly in the middle of October.

As it relates to the drugstore business and our drugstore -- our mass businesses.

Our mass businesses continue to do very well.

They are -- we are not seeing a shift -- it's not just that it's been a slight downtick in average ticket, as you heard me say to Joe -- we are not seeing any significant mix shift in the business.

The customers who buy Prestige continue to buy Prestige.

The customers who buy mass continue to buy mass from us.

And we are not seeing any significant shift there, just an overall slight downward tick on purchasing.

And as it relates to the competition in the mass sector, what we primarily see is not significant price changes from our competition there, but there was certainly continued increase frequency promotion, and we have our eye very closely on that and continue to compete in the manner that we always do with our own advertising -- ad pages if we feel that's appropriate so that we can compete with greater frequency with what we are seeing in the drugstores.

So Brian, did that give you enough flavor?

Was I --

Yes, yes.

I was just curious if you were seeing store closings in anywhere else -- and obviously, there will be some department store closings, which obviously could help you as well.

We remain ever hopeful on that point, Brian.

Not so much to wish our department store competitors ill so much as we continue to hope that the economy will provide us some opportunities with some of those department store brands.

Okay, terrific.

And so, Gregg, I guess for you the two questions.

Number one, now that you have brought down new store growth, can we also expect your SG&A leverage point to come down?

So in other words, if comps are flat somehow next year, can SG&A actually grow slower than sales?

And then my second question, Gregg, is that I guess 50 some-odd stores are going to enter the comp base, I think, here in the fourth quarter; and how are you thinking about those stores relative to your comp guidance?

Do you now expect those stores to come into the comp base maybe closer to the chain average versus several points above?

Two things, Brian.

As we look into next year -- and you kind of look and see what kind of SG&A leverage we get coming out of this year -- but as we look into next year, I would expect somewhere around a 2% comp before we give specific guidance for next year; that we're going to require probably somewhere around a 2% comp to start to leverage SG&A going into next year.

Okay, okay.

And how about -- the new stores entering the comp basis quarter?

Yes, if you look at the change from third quarter this year to last year and then fourth quarter this year to last year, you actually have an increase of about 13 stores growing into the comp base from third quarter to fourth quarter.

And that will provide a modest benefit to comps in the fourth quarter.

Okay, and just if I can, are you guys going to announce the Holiday comps like you did last year?

Yes, that's our intention.

(SPEAKERS OVERLAPPING).

Okay.

Thanks very much, and good luck.

Thanks, Brian.

Our next question comes from the line of Jason Gere with Wachovia Securities.

Please proceed with your questions.

Thanks.

Good afternoon.

Just one housekeeping-type question.

So with the 15% to 20% square footage growth for next year, can you kind of talk about how many will affect the new Phoenix facility versus the east -- the Chicago facility?

And then on the same note, maybe new markets versus existing markets?

Let me take those one at a time, Jason.

In terms of what is going to affect Phoenix, I think it's going to be fairly balanced between Phoenix and Romeoville, based on what we see in the program so far this year headed into next year.

And then, as it relates to -- I'm sorry, Jason, what was your second question?

New markets versus existing markets.

Jason, our current -- the current approved sites are about a 50/50, pretty much in line with what we had done last year.

But obviously, we are going to wait and see what happens with store closings.

And they could go both new or existing, although if you ask me to give you a best guess perspective, my guess is they'll probably lean a little more towards existing markets.

Because much of our new markets -- as you know, we have opened up some great opportunities in smaller metro -- smaller markets, not necessarily metro -- and we think that the closures will happen more in the larger metro markets, which would be our existing markets.

Okay, great.

Next question, I guess just going back on the SG&A, and I guess you're saying that you need a 2% comp to leverage SG&A, one of the things you have been talking about is just cost control.

And I was just wondering, you know, with the slowdown in the economy, is it fair to assume that -- you know, has there been any change inside the store with a lot of your full time personnel you have?

It seems to be -- I mean, there is a good mix of part time and full time.

But you do have a lot of layers of management in the stores, so I was just wondering if there was any type of thought there, and if you were able to kind of manage those schedules a little better because of the slower traffic you're seeing?

Jason ,what we have done -- well, first of all, again, our traffic isn't slower.

We had positive customer count in third quarter, and continue with third quarter trends at this point in time in fourth quarter.

In terms of the store base, we've actually taken a deliberate position over the last nine months to move our store base from full time to more part time; and the reason we did it was so that we could leverage our workforce deployment IT program.

What we found is that with the extent of full time personnel that we had, we could not get as much flexibility as we needed, and so we shifted more to part time.

We do not anticipate at this point in time any significant change in our full time personnel or the structure of our stores.

We believe we are well resourced in our stores, with that point in time, with this one change that I've described to you that we put into play earlier in the year.

Okay.

No, that's fair.

And then I guess the last question, you talked about the 20 basis points of investment of our own margin to sharpen your value during this quarter.

I mean, can you talk maybe a little bit about the conversations you're having with some of your vendors right now?

I mean, I think in the past you guys have received some dollars from them in order to kind of support some of the marketing initiatives you've done.

And I was just wondering if you could talk maybe a little bit more about some of those initiatives and how receptive they have been to supporting their own brands in your store at this point?

They have -- they continue to be very responsive, Jason, simply because they get a good return on the investment.

We are very disciplined in tracking the responsiveness to the investments we make, so they do continue to want to partner with us for the short-term.

But at least as important as that is the long-term partnership that they know they have with us.

They have few partners who will still grow with the square footage growth that we will continue to do in this sort of climate.

We do talk to them, not just about the individual tactical program with them, but we do talk to them about the investment -- the margin investment on our own part that we make in our programs, particularly in some of our marketing strategies, and our different purchase strategies that drive traffic into the total brand that they, of course, benefit from as well.

So we talk tactically, we talk strategically with them.

And although I am certainly not going to say they have an open checkbook, that -- we would neither expect that, nor would they have that -- but we continue to have very good partnerships and support where we can prove that this makes sense to the brand.

Okay, great.

Thank you.

Thank you.

Our next question comes from the line of David Cumberland with Robert W.

Baird.

Please proceed with your question.

Please proceed with your question.

Thanks, hi.

Can you give some examples of what you're doing to manage the expense structure in response to the environment?

Yes, sure.

And just with regard to -- you know, as we head in to next year, even in advance of -- you know, we certainly haven't given specific guidance for next year.

If you look at the guidance that we've given for the fourth quarter, you know, we are going to continue to show SG&A leverage even below that 2% level.

And as we head into the 2009 time period and continue to evaluate the strength of the economy -- the weakness of the economy -- we will continue, David, to manage expenses so that we get the maximum mall leverage, and also focus on continuing the long-term growth of the business as well.

We have continued to do a couple of things.

One, making sure that we are leveraging the technology investments internally in the business.

We have continued to focus on making sure that we have -- and Lyn was referring to this on the last question -- we continue to make sure that we leverage all of our four wall store operating costs to make sure that we utilize the tools that we have today to make sure that we are lining up hours with guest count and moving very quickly when we see any fluctuations in that, and planning for those ebbs and flows in guest count as well.

And then just various other means that we are taking to leverage our growth, which is similar to what we did on reducing construction costs for our new store program.

We are working with all of our vendor partners -- not just our merchandising vendor partners, but all of our supply partners as well to make sure that we are getting maximum leverage on the growth that we are experiencing here -- as we should as a high growth retailer.

Thanks, and my other question is on the 15% to 20% store growth planned for next year.

Would real estate opportunities that you've talked about related to closings by others potentially add to that range, or would those opportunities mainly translate to some of your 2010 openings?

The -- there's two parts to that.

The reason for a 15% to 20% range -- and that range allows for some of what you just asked potentially happening in 2009 -- but the reality is as those sites do become available post Christmas, very few will probably be able to fit into the 2009 timelines.

There is a possibility some could get into a late third quarter, perhaps into January; but by and large, we expect the majority of those opportunities flowing probably more into 2010.

Great, thank you.

Thank you.

Our final question comes from the line of Neely Tamminga.

Please proceed with your question.

I just have one follow-up question.

Gregg, how should we think about the store openings next year?

I think logically analysts usually approach that as going more in the first half versus the second half.

But I just wanted to double check, is that how you guys are thinking about it?

You know, we've actually done -- and it's been sort of part and parcel, Neely, the theme that we've talked about this year, too, as well.

You know, as part of trying to leverage the infrastructure, we will shift more store openings into the back half of the year next year, unlike what we did this year.

So this year about 55% of our openings were in the first half of the year, and about 45% in the second half of the year.

Next year I would expect the relationship close -- to be closer to 40% in the first half of the year and 60% in the second half of the year.

Great, thanks.

Thank you.

Ladies and gentlemen, at this time there are no further questions.

I would like to turn the floor back to management for closing remarks.

Yes, a couple of things.

Again, as we sign off here, let me again just say that we remain very confident about our long-term -- sorry -- our long-term prospects.

We, of course -- as we have described to you for the reasons we gave you -- we remain cautious about our -- the gift giving period that we are confronted with in the very immediate short-term, but remain confident in the long-term growth opportunities.

So let me thank everyone for joining us today.

We hope you have a happy and healthy Holiday and New Year, and we certainly look forward to speaking to you in 2009.

Thank you very much, everyone.

Thank you.

Ladies and gentlemen, this concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.