Ulta Beauty Inc (ULTA) 2009 Q3 法說會逐字稿

Greetings and welcome to the ULTA Salon, Cosmetics & Fragrance third quarter fiscal 2009 results conference call.

At this time, all participants are in a listen-only mode.

A brief question-and-answer session will follow the formal presentation.

(Operator Instructions).

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

Thank you, Ms.

Malkin.

You may begin.

Thank you.

Good afternoon.

Before we get started, I would like to remind you of the '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 projected in such statements due to a number of risk and uncertainties, all of which are described in the Company's filings with the SEC.

We will make references during this call to the metric -free cash flow, a non-GAAP financial measure.

Free cash flow is defined as net cash provided by operating activity, plus purchases of property and equipment.

A reconciliation of free-cash flow, to its U.S.

GAAP equivalent, has been provided in Exhibit 5 of our earnings release, which is available on our website and has also been filed with the SEC on form 8-K.

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

Thanks, Allison.

Good afternoon, everyone.

Thank you for joining us to discuss our third quarter fiscal 2009 results.

On the call with me today is our Chief Financial Officer, Gregg Bodnar.

Following my opening remarks, Gregg will review our third quarter financial results and fourth quarter outlook.

And I will provide some closing comments and turn the call over to the operator, so that we can answer the questions that you have for us today.

We are pleased to deliver better than expected third quarter sales, earnings, and free-cash flow, building upon our positive momentum from the first half of the year.

We attribute our strong third quarter performance to the continued successful execution of our core marketing and merchandising strategies and better than expected performance of our expense management and working capital reduction initiatives.

For the third quarter, net sales increased 11.5% to $284 million.

Comp store sales increased 1.5%, exceeding our guidance and following a 2% increase last year.

So on a two-year basis, comp store sales are up 3.5%.

Gross profit margin increased 70 basis points to 31.9%, which included a 40 basis point increase in merchandise and marketing margins.

And we also exceeded our guidance with earnings per diluted share, increasing to $0.14 as compared to $0.09 last year.

As we have previously communicated, we take a fresh look at each quarter and create a marketing strategy that is right for the environment.

The rapid deterioration of the economic and consumer environment in third and fourth quarter last year caused us to react with additional marketing strategies with very little lead time.

As this year has progressed, we have become more experienced operating in, and have been able to increasingly plan for, this challenging economic environment, which is demonstrated in our comp performance.

The marketing and merchandising calendar created for third quarter 2009 delivered a 1.3% increase in comp store traffic, which follows a 6% increase in comp traffic in third quarter of 2008, and a 0.2% increase in average ticket, which is the first positive growth in average ticket we have reported since third quarter last year.

Importantly, this performance was delivered while increasing merchandising margins by 40 basis points, and decreasing our marketing spend by 50 basis points versus last year.

The improved third quarter marketing rate was achieved through efficiencies, not through a reduction in marketing events.

The merchandising and marketing programs in third quarter included a very successful fragrance event early in the quarter, that continued to drive momentum in the category.

The strength of the fragrance event helped deliver a positive fragrance category comp for the quarter, which is a great result when compared to the rest of the industry.

Our positive performance in the fragrance is encouraging, as fragrance is a key driver of holiday gift purchases.

We experienced a significant improvement in our styling tools category.

As , styling tools are a somewhat discretionary purchase, and have been more affected by the tough economy.

While comp trends continue to trail the prior year, the improvement we experienced during the quarter is encouraging for holiday, as styling tools are another example of a key gift-giving category.

We optimized major new brand and new product introductions.

We continue to be pleased with the early performance of Benefit Cosmetics and Philosophy Bath and Fragrance brands.

The quarter also included a launch of Bare Escentuals new matte foundation, and our first ever Bare gift-with-purchase offer, developed exclusively with ULTA.

Both of these new Bare Escentuals offers performed very well for us.

The improved performance in fragrance and styling tools and the continued growth of Prestige color and skin were key drivers of our average ticket growth during the quarter.

We continue to utilize private label to drive consumer count at affordable margin by offering compelling value propositions to our customers, such as our private label blockbuster, a $200 value for $19.99 and our ULTA cosmetics 15-piece free gift with purchase, a $72 value.

In addition, during the quarter we expanded our private label offering across bath, skin and cosmetics, more than doubling the new line extensions versus third quarter last year.

The quarter included the successful launch of our first-ever social marketing campaign.

Our Windows of Love event supported a great cause, raising $600,000 to support the Breast Cancer Research Foundation founded by Evelyn Lauder, while assisting us to create a powerful and long-lasting emotional connection with our customers.

This is demonstrated through dialogue with our customers, both online through social websites, as well as in our own stores.

Looking ahead, we plan to hold this event next year as an effective way to connect emotionally with our customers and to support an important cause.

As we saw in second quarter, the improvement in our comp store performance was driven entirely by our retail business.

In salon, the new Keratin treatment service and Runway Your Way strategy that we introduced in the third quarter are bringing new customers into our salons, which is good news.

However, it is not been enough to offset the impact of the decrease we are continuing to experience in overall salon customer visits due to the challenging economy.

As a result, the salon business remained a negative comp for the quarter.

As a reminder, the salon is a service business, and we have the ability to flex the expense structure with the business trend.

On the web, we continue to post significant double-digit increases in the third quarter, and we expect this trend to continue for holiday.

We continue to expand our assortment at Ulta.com and improve the site shopping experience with increased functionality, including customer reviews and ratings online and an improved checkout process, which were introduced third quarter.

Finally, in third quarter, we were pleased with the performance of new stores, which continued to perform to our new store model.

During the quarter we opened twelve new stores, ending the period with 345 locations.

In November we completed our store program.

For the fiscal 2009 year, we opened 37 new stores and expanded square footage by 11% over fiscal 2008.

With our experience this year navigating this economy and having had more time to plan for challenging economic environment, we have developed an exciting merchandising and marketing program to drive our performance for the fourth quarter.

We have planned for a very competitive and highly promotional environment, but believe we have impactful events and several new and exciting (inaudible) strategies for ULTA in the key weeks leading up to holiday.

For marketing, we plan to utilize TV for the first time.

Our television advertising will cover 150 stores, representing more than 40% of our overall store base during the key days leading up to Christmas, with ads that focus on products and value to drive store traffic and transactions from both new and existing customers.

We also plan to air commercials on Hispanic radio in our top Hispanic trade areas.

And we have planned a new online marketing event with a countdown to Christmas theme that we're excited about and believe will create some nice buzz in the marketplace.

Most importantly, we will continue to execute the successful marketing and merchandising strategies that have been delivering results for us through the third quarter.

We have planned high impact events and compelling value propositions throughout the season on some of our best brands, including Bare Escentuals, OPI, Chi and Sebastian.

For example, through strategic buys, we were able to offer an exclusive for ULTA Chi flatiron at our lowest price ever of $79.95.

This was offered on the front cover of this week's "Marketing." And our early consumer response has been great.

In addition, we will be offering exciting exclusives to ULTA, such as the launch of a new line of Ed Hardy styling tools and accessories, Bare Escentuals Jewel Collection, a Smashbox blockbuster and OPI holiday colors.

We will also be advertising the new brands we introduced in 2009 including Benefit Cosmetics, Philosophy Bath and Fragrance, Cosmedicine, CARGO, Phyto and Caress Skincare.

And of course, we have new fragrances, such as Couture Couture by Juicy and Hearts and Daggers by Ed Hardy.

We expect to continue the positive momentum in fragrance that we saw in the third quarter, which is important as fragrance is a key gift-giving category during holiday.

As we have done historically, we have planned two major fragrance gift-with-purchase events in the fourth quarter, including our very successful annual bathrobe program.

As we did in third quarter, we expect to maintain comparable marketing (inaudible) with cost efficiencies allowing us to reduce marketing spend as a percent of sales, as compared to prior years.

Finally, as in third quarter, we also expect to improve our merchandising margin.

Last year, as you may recall, compared to the marketplace, we made a modest 90 basis point margin investment in response to the economic environment.

With more time to plan this year, we expect to recover a meaningful portion of that margin investment.

In summary, we expect to be able to compete effectively in what we believe will be an aggressive promotional environment, and we expect our efforts to lead to a solid fourth quarter performance at ULTA, which is reflected in our guidance.

While we have some flexibility with our marketing programs, if the environment becomes as deeply promotional in the key weeks leading up to Christmas as it did last year, we will judiciously balance the growth on the top and bottom line of the business.

As importantly, if there is more positive consumer spending than expected, we have developed strategies with our suppliers to allow us to adjust our inventory on key gift-giving items as well as on basic stock.

Since our last call, we have continued to build our 2010 new store pipeline, and expect to increase our square footage growth next year.

We remain confident in our 1,000-store opportunity long-term.

And now I would like to turn the call over to Gregg to review our financials in more

Thanks Lyn.

Our third quarter results were driven by better-than-expected sales and margin performance due to the continued it innovation and successful execution of our marketing and merchandising strategies combined with our focus on expense management and cash flow initiatives.

Despite the ongoing challenging economic environment, we delivered another quarter of sequential improvement in retail sales performance.

This, combined with our prudent expense management, has enabled us to exceed our third quarter targets, resulting in sales and earnings above our guidance range.

Now beginning with the review of the income statement, net sales increased 11.5% to $284 million from $254.8 million in the third quarter last year.

Sales growth was driven by the addition of 41 new stores, since the third quarter last year, and a 1.5% increase in comp store sales.

This follows an increase of 2% last year, resulting in a two-year comp store sales gain of 3.5%.

Comp store sales growth was driven by a 1.3% increase in traffic, and 0.2% increase in average ticket.

During the quarter, we opened 12 new stores, ending the third quarter with 345 stores and expanding square footage by 14% from last year's third quarter.

We continue to be pleased with the performance of of our 2009 class of new stores.

Gross profit dollars in the third quarter increased 13.9% to $90.5 million from $79.5 million last year.

Gross profit margin was 31.9%, an increase of 70 basis points over last year.

Gross margin expansion was driven by 40 basis point improvement in merchandise margins, primarily driven by our ability to plan the third quarter, marketing and merchandising strategy for this challenging economic environment, rather than being in more of a reactive mode, as the economy significantly deteriorated in the third quarter last year.

Supply chain operational efficiencies provided a 60 basis point improvement for the quarter.

These increases in gross margin were offset by a 20 basis point of deleverage in fixed store cost.

The deleverage from fixed store costs has decreased versus previous quarters due to the stronger sales in comparatively lower square footage growth.

SG&A expenses were $73.7 million, or 25.9 percent of net sales, compared to $65.2 million last year.

The 30 basis point deleverage in SG&A, compared to the prior year, was due to 170 basis point increase in incentive compensation expense, which was largely, but not completely, offset by 50 basis points of leverage in marketing, 40 basis points in store operating expenses and 50 basis points in G&A, before the impact of incentive compensation expense.

We remain on track to achieve annual, permanent cost savings of approximately $18 million this year.

Pre-opening expenses totaled $2.2 million in the third quarter, which compares to $4.7 million in the third quarter of fiscal 2008.

The decrease in pre-opening expense was due to the planned reduction in our 2009 new store program.

The reduced pre-opening expense was also slightly better than our expectations, driven by better leverage in our new store advertising costs and lower labor costs.

Better-than-expected sales growth and margin expansion, along with our planned lower store opening program, led to a 52.9% increase in operating income to $14.7 million, or 5.2% of net sales, from $9.6 million last year.

Interest expense decreased to $ 0.4 million from $1.1 million last year, driven by the lower (inaudible).

The effective tax rate for the quarter was 40.6%, compared to 40.9% in the prior year period.

Net income for the quarter increased 68.6% to $8.5 million, or $0.14 per diluted share, from $5 million, or $0.09 per diluted share, last year.

Now turning to the balance sheet and cash flow results.

Merchandise inventories at the end of the quarter, were $274 million, compared to $268.9 million at the end of the third quarter last year, reflecting an increase of $5.1 million, due to the addition of 41 new stores, versus a year ago and the benefit from our inventory management initiatives.

As a result of these initiatives, we have achieved an average inventory per store reduction of 10.2% from the prior year quarter.

Just as a reminder, these initiatives are primarily leveraging our supply chain inventory and have no impact on our store in-stock position or consumer experience.

We remain comfortable with both the level and composition of our inventories headed into the fourth quarter and believe we are well-positioned for the holiday shopping season.

Regarding debt, during the quarter, we were able to pay down $26.3 million on our credit facility balance.

This was driven by our focus on aggressively managing working capital levels, specifically in inventory and receivables and lower capital expenditures on planned fewer new stores.

Outstanding borrowings as of October 31, 2009, were $39.2 million, and our debt-to-equity ratio was a very modest 14%.

As of quarter-end, we had $160.8 million of availability on our credit facility, which provides a borrowing capacity of up to $200 million.

We achieved free cash flow of $25.4 million for the quarter and $65.5 million for the first nine months of fiscal 2009.

Typically, we would expect to increase our borrowings under the credit facility during the third quarter as we fund our seasonal inventory build in advance of the holiday period.

This year, however, we intentionality flowed inventory slightly later in the quarter, and as a result, the payment for some of these goods flowed into the fourth quarter, which improved our free-cash flow position for the third quarter and optimized our supply chain network.

Based on the progress of our cash-flow initiatives, we now expect to generate approximately $75 million of free-cash flow in 2009, which exceeds our previous target of $50 million.

Capital expenditures for the quarter were $19.6 million, and depreciation and amortization for the quarter was $15.4 million.

Regarding our outlook, we are pleased to see continued improvement in our comp store sales trends compared to the second quarter, which were driven entirely by our retail business.

However, we expect the macroenvironment to remain challenging and consumers to spend cautiously for the remainder of the year.

Before discuss our fourth quarter guidance, as a reminder, I will quickly highlight our performance during last year's fourth quarter.

During the 2008 holiday period, we were competing for gift-giving share in one of the most extraordinary promotional environments anyone has seen.

We chose to maintain a balance between driving sales and earnings, and delivered earnings per share of $0.21, which represented a 9% decrease from the prior year period on a 5.5% comp decrease.

While we were not happy with these results, we did not see the deep negative comps, dramatic declines in merchandise margin and operating profits that most of the rest of the industry experienced.

For the fourth quarter of fiscal 2009, we currently estimate net sales in the range of $362 million to $376 million.

This assumes comparable store sales in the range of a decrease of 3% to an increase of 1%, compared to a decrease of 5.5% in the fourth quarter of last year.

As we previously noted, we have seen an improvement in our sales and traffic trends in third quarter, driven by the impact of our strategic marketing and merchandising initiatives, which is reflected our guidance range.

Consistent with our approach in prior quarters, the wider comp sales range continues to reflect the uncertainty regarding any potential unexpected impacts to current consumer trends, as well as the uncertainty regarding the ultimate level of gift-giving expenditures this holiday season.

Income per diluted share for the fourth quarter of fiscal 2009 is estimated to be in the range of $0.22 to $0.26.

This compares to income per diluted share of $0.21 for the fourth quarter last year.

The midpoint of our EPS guidance range reflects gross profit margin expansion of approximately 50 basis points, and deleverage in SG&A of approximately 50 basis points.

This deleverage is driven by 80 basis points of increase in incentive compensation versus the fourth quarter last year.

With regard to new stores, as Lyn mentioned, we have now completed our 2009 new store program with the opening of our final three stores in early fourth quarter.

The final count was 37 new stores, which included two additional stores compared to our previous guidance.

The two additional stores will have a minimal impact on 2009 sales.

We will also be closing two stores after the holiday as part of our normal real estate upgrade process.

Since our last call, we have continued to build our 2010 new store pipeline and expect to increase our rate of square footage growth next year.

We remain confident in our ability to attain our 1,000-store long-term potential.

With respect to CapEx, we expect capital expenditures to be approximately $71 million for the year.

In closing, we continue to believe that consumer spending environment will remain difficult.

We have and will continue to take the necessary actions to control what we can control.

We will continue to manage the business driving earnings and generating free-cash flow and reinforcing our ready strong balance sheet and liquidity position.

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

Thanks, Gregg.

We do not know the ultimate level of promotional activity that will occur in the marketplace or the ultimate level of consumer spending this holiday season.

Accordingly, we have provided a wider guidance range for the fourth quarter.

We believe that we have created a compelling marketing and merchandising program that consumers will find exciting this holiday season.

We are confident that we have identified the right strategies to continue our positive performance during a challenging fourth quarter environment.

With that, I would like to turn the call back over to the operator and we can begin our question-and-answer portion of the call.

Thank you.

We will now be conducting a question-and-answer session.

(Operator Instructions).

One moment while we poll the questions.

Our first question is from line of Brian Tunick with JPMorgan.

Please proceed with your question.

Hi, good afternoon and congrats.

I guess two questions.

The TV, obviously, seems pretty impactful here.

And we were just curious, is it, Lyn, now that you're comfortable with where the size of the chain is, or was it the advertising rate that came down?

But maybe just talk about why you have decided now to do TV and what kind of message we'll be seeing in a couple of weeks.

Will it be brand-specific or price-driven?

And then maybe, Gregg, if you want to talk a little more about the private label penetration that helps the gross margins and where we think private label can grow next year.

Brian, on the TV, it is actually both of the reasons that you spoke to.

We are a big enough chain that in key regions around the United States, it actually is financially viable for us to spend money.

It is why it is not 100% of the chain at this point in time, but in those areas where it makes the most sense for us.

And it's not so much that the ad rates are great at all at the moment.

We're finding it actually a very competitive environment to purchase TV, and hence the reason that we're keeping it very surgical, so that we can get the optimal return on it.

On the message itself, the message is definitely brand-specific and product-specific.

And it is exciting value that offered in a very brand-enhancing manner and environment.

And we hope that we will be able to attract, certainly an additional visit from existing customers, but also reach a customer base that we can't necessarily reach with our existing marketing alone.

And Brian, on private label penetration, it was up slightly in the quarter.

It is not the single biggest driver of the improvement in gross margin compared to last year.

It still represents about 5% of our business on an annual basis.

We do believe that there continues to be longer-term potential there, and we'll describe those initiatives more carefully as we head into giving guidance for 2010 in March.

Brian, a little bit more broadly, just on the merchandising margin expansion that we did experience.

Certainly a little of the private label as Gregg spoke to, but it was also a planned mixed shift.

It was part of the strategy for the quarter that we went after in terms of mix shift, and we also have flat coupon redemption, versus prior year.

We are finally [anniversarying] that deeper coupon redemption that was impacting some of the margin opportunity.

So there's a couple of the other factors in the margin improvement.

If I could ask just one last one, we're assuming 13% square footage growth next year.

Is that what you mean by "inacceleration"?

We're not ready to comment on our 2010 program at this point in time.

What we can tell you, to give you some comfort, is that we do have 40 stores that have been approved --40 sites for next year at this point in time.

Stay tuned on the final guidance when we come back at the beginning of next year.

Thank you very much, and good luck.

Thank you, Brian.

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

Please proceed with your question.

Hi, good afternoon.

Let me add my congratulations as well.

So were salon and styling tools the only segments that comped negatively?

And do you have -- I'm sorry if I missed it -- specific marketing events targeted towards fragrance to drive that business during the holiday?

Hey, Liz.

As you know, we really don't comment on any individual category performance, other than if we think that there is a shift in the trend that is important for you to understand.

So, hence, the commentary on the salon styling tools and the fragrance category particularly, as that is a shift in the trend that we have been seeing in the earlier quarters this year.

But beyond that, we can't, for all the competitive reasons that we speak to, give you any more color than that.

In terms of the fragrance category, we do historically do two major fragrance events in fourth quarter, and we intend to anniversary both of those.

We have already anniversaried the first one for the quarter, and we break the second one in the not-too-distant future, which is the robe that we do in the holiday season.

And of course, we do have exciting newness.

It is not just our marketing events, but we have got some exciting newness in the fragrance category as well for the holiday season.

Okay.

Can you talk about the sensitivity next year to an improvement in sales trend on the SG&A line?

Like, if we get into an environment where you are consistently comping positively, and growth is accelerating a little bit.

What sort of SG&A growth should we be thinking about?

And even if you can't provide that specifically, maybe what sort of categories will you be leveraging and where might you need a little bit more investment?

Let me describe it the way I normally do, Liz, and I think this will help you.

As we look into next year and we're developing and finalizing our plans, I would expect on a very, very low single-digit comp that we would be able to start to leverage SG&A.

We have made a lot of progress this year in permanently altering the expense structure of the business.

So none of that is going to come back into next year.

We do, as we have for the last couple of years, we have some specific strategic projects in the technology area as we continue to improve our technology platform and, more importantly looking forward, continue to add business value in that particular area.

So low single-digit -- very, very low-single digit to start the leverage.

There is nothing extraordinary, if you will, in terms of one-time meaningful investment next year.

It's really just a continuation of continuing to develop our technology platform, like we have been for the last couple of years.

Okay.

Congrats again.

Tremendous results.

Thanks, Liz.

Our next question comes from the line of Daniel Hofkin with William Blair & Company.

Please proceed with your question.

Good afternoon and great results.

Just looking at -- your practice this year has been to look at the current comp trend and allow for the possibility of unforeseen events going forward.

Thinking about comparing to last year, I seem to recall it was principally leading up to Christmas where the environment got especially challenging.

Just wondering if you might be able to provide some general commentary, given some of the other retail results that we saw out this morning.

What November might have looked like, or just some sense for whether things at least quarter to date, how that is progressing, if there is anything that you can share regarding that?

Dan, as we operate from that practice of giving interim monthly results last quarter, what I would tell you is we were down 5.5% last year, and we have continued to say and believe that it continues to be that case, it is what's more relevant in this consumer environment as we cycle those results from last year is our current trends.

So coming out of the third quarter with a plus 1.5% comp and understanding the trends that we're running in the time leading up to this call, we have set a comp guidance range of about the results that we achieved in the third quarter.

And then the wider guidance range is exactly as you stated and exactly as we have stated in past.

At the end of the day, we don't know if there is another consumer event that might be a distraction for them, or ultimately what their level of gift-giving purchases are going to be for the quarter.

Thus the wider comp guidance range.

Just to paraphrase that, not anything that you have experienced or seen thus far, just allowing for either continuation or the possibility of something unforeseen going forward, kind of as you have been doing?

Yes, the wider comp guidance range is consistent with our prior practices.

Secondly, within the gross margin, any other color you might be able to provide beyond what you and Lyn discussed within, let's say, the merchandise margin and the shift in the sales mix?

Yes.

If you take the components of the third quarter margin performance, we're up about 70 basis points.

About 40 basis points was driven by pure merchandise margin.

We talked about the mix and some of the strategic buys that were opportunities as we were able to apply in advance, unlike last year's third quarter.

Fixed store experiences represented about 20 basis points of deleverage, which has been coming down quarter on quarter because we are getting into the slower square footage growth for the twelve months behind us.

And then the rest of the improvements, to get to the 70 basis points was really out of the supply chain and a continuation of the initiatives that have been executed thus far this year.

Regarding mix, just so I'm clear on that area, that is separate from the strategic buys or -- ?

There were two elements that drove the 40 basis points of improvement in merchandising gross margins.

One was the planned strategies that drove sales into higher mix categories.

Private label was one of which we mentioned, and the other was the opportunity to plan for some of the strategic buys to improve our margin compared to last year.

Good luck for the fourth quarter.

Thank you, Dan.

Our next question comes from the line of Erika Maschmeyer with Robert W.

Baird & Company.

Please proceed with your question.

Hi, thank you.

Great quarter.

Could you talk a little bit about your declines in inventory per store.

I know those have come through your supply chain, but how long do you expect these declines to last, what inning are we in these improvements?

And how do you think about them throughout the year in 2010?

We are planning for some further opportunities, primarily still focused in the supply chain as we head into next year, Erika.

It won't be to the same order of magnitude.

As we indicated, we will plan to end this year, down on per-store basis at about 9%.

And then we will have similar opportunity that we will plan for next year, just not for the same order of magnitude.

Okay.

That makes sense.

And then, could you talk a little bit longer term about your potential timing for a 1,000 store target.

Do you anticipate getting back to 20% to 25% unit growth after 2010, maybe when the environment normalizes a little bit?

Could you talk about your decision-making process here?

The decision-making process is basically the same as what we have always used, Erika, which is quality first, not number of stores.

And it will really unfold as the environment unfolds and the opportunities.

And we are in a position where we can be opportunistic.

If there are multiple sites that become available, as some retailers might perhaps fail.

So that is always opportunistic for us, but we will continue with the strategy of driving our growth in existing centers.

If the new center development is still slow in a slow economic environment, we still have considerable opportunity with existing centers, as was demonstrated with the program this year and with the pipeline that we have begun to build for 2010.

So it is not as if there is a rate that we are targeting year to year at this point.

It is more that it will unfold.

Having said that, we do expect some increase in rate for the next year's program, versus the 11% that we delivered this year.

Great.

Can you give any color on your comp trend during the third quarter?

Erika, we don't report comps on a monthly basis and have not disclosed intraquarter trends in the past.

Great, thanks so much.

Our next question comes from the line of Randy Konik with Jefferies & Company.

First question for Lyn.

Could you just give us color on what you think the promotional environment looks like out there thus far during the holiday season?

Are you seeing a rational pricing environment thus far?

And I guess a question for Gregg, you guys have done a very good job of generating free cash flow.

If we think about longer term here, is there some sort of sustainable minimum level of free cash flow that you think this business can now generate over the long-term now?

Thanks.

Randy, let me answer your first question.

Relative to the promotional environment, so far it is exactly what we have been expecting.

We have seen break, literally today and earlier this week, some discounting in the beauty category from some other retailers.

So that is very much what we had expected and planned for.

So no surprise there.

As it relates to the broader retail environment and the department store environment, again, so far very much what we have expected.

And we are certainly planning for more promotional activity than what we have seen up to this point in time in the season and are well-prepared for what we think we will see.

And then Randy, as it relates to long-term free cash flow, keep in mind the biggest driver of that is going to be the rate of increase in our store program on an annual basis, okay?

As we look forward with some slight increase in it next year, I do expect with the continuation of some of the initiatives, some of which I referred to earlier on the working capital side, that we will be in a good position to generate free cash flow again next year.

Then with an assumed, gradual increase back to our normal rate of square footage expansion that we have historically performed at, I would expect that free cash flow generation will be more of a reality in the years following 2010.

But the greatest driver in that is going to be the change in the rate of square footage growth.

And the offsetting benefit to that is the fact that our store investment, where historically has been $1.6 million to build a new store.

With all the progress we have made so far in the last 18 months ,we're probably closer to $1.1 million.

Just lastly, just on the working capital line items, you have gotten some benefit from payables and inventory, et cetera.

Do you foresee that becoming uses of cash next year?

Any comment there?

I think with the rate of expansion of square footage growth, Randy, that along with some of the other initiatives that we will be executing next year, that I don't expect the increase in store count to be a big drag on free cash flow.

Great, thank you.

Our next question is from the line of Sam Panella with Raymond James.

Please proceed with your question.

Thanks, and congratulations on the quarter.

With respect to the 0.2% increase in the average ticket, can you give us color on that and what you are seeing -- spending habits with your customer, relative to Prestige and [mass] brands?

Again, not too much color on anything too specific, Sam.

But in terms of what we're seeing, it is certainly average selling price more than units, in third quarter.

And it is predominantly across the categories that we spoke to, the fragrance category.

And Prestige Cosmetics and Color continue to be strong performers for us so that versus prior year.

And versus the trend that we have seen in the last couple of quarters, the styling tools category is helping lift the average ticket versus the prior couple of quarters as well.

Thank you, and Gregg, with respect to the TV ads, how is that impacting SG&A in the quarter?

What we have effectively done is taken some of the efficiencies that we would have otherwise realized in the fourth quarter, specifically in the advertising line, and reinvested into the TV campaign.

We're not going to disclose the dollar amount of it, because it will give some indication it terms of the size of the program, but it's a very modest impact in the fourth quarter.

Great.

Thank you, and good luck for the holiday.

Thanks, Sam.

Our next question comes the line of Evren Kopelman with Wells Fargo Securities.

Please proceed with your question.

Thank you, good afternoon.

A couple of questions.

First as you are signing new leases for next year, can you update us on what you are seeing in terms of rent out there?

Especially given you will be opening more in more existing centers versus new centers?

How is that going to look for you year-over-year?

And the second question is with the acceleration in the rate of square footage growth, obviously we're going to think about the deleverage of the fixed store expenses again.

I know you have talked about you lowered the cost to build a new store.

But are there any other initiatives to potentially lower that deleverage, such as accelerating the time to get the store open, things like that after you take it over?

Thanks.

A couple of things, consistent what we have said in the past as we are building the 2010 program, we are seeing reductions in rents versus historically what we would be spending on a cost per square footage basis.

It typically range about 15%.

It depends on the real estate.

The extraordinarily high quality real estate is still closer to historical cost per square foot, just because of the scarcity value.

So if you go up the East Coast, is an example.

Mainstream real estate we're seeing about a 15% decline in cost per square foot.

As it relates to the mix between existing versus new centers, we had a balance this year of about 45% to 50% in existing centers and the rest in new centers.

As we head into next year, with the slowdown in the development of new centers, I would expect most of the expansion, 90%, to be in existing centers.

As it relates to deleverage going forward, certainly the lower cost structure from a rent standpoint is going to help that.

The lower build-out cost that we were talking about -- going from the $1.6 million, down to the $1.1 million to build a new store, is also going to help put some downward pressure on overall new store costs.

A big portion of which is sitting in fixed store expenses.

As it relates to a leverage point going forward, Erika, I think the combination of all of that will probably take us to a point where we can start to leverage fixed store costs with a slight increase in square footage expansion next year, in a low single-digit count.

Thank you.

Our next question comes from the line of Jill Caruthers with Johnson Rice.

Please proceed with your question.

Afternoon.

Just another question on your fourth quarter comp guidance.

If you just look at your guidance on two-year stack, even at the high-end, it is showing quite deceleration from year-to-date trends.

If you could talk about anything different you are seeing, because I know you addressed the promotional environment as expected and things of nature.

Jill, it is more about -- and I mentioned this to one of the early questions.

It really is more about what our current trends are.

The fact that consumer gift-giving was down in the fourth quarter last year, in our mind, that has set a new low point or starting point for gift-giving.

So if we were down 5.5% last year and part of that was gift-giving, I don't expect that consumers, based on all the reports that I'm reading and I'm sure you're reading as well, are going to increase their level of gift-giving spend.

And that is why, as it relates to the fourth quarter, we believe that current trends are more relevant than the two-year stacked comp that you are referring to.

Jill, I will remind you, if we do see more optimism from consumers out there than what we're planning for, we do have some flexibility in our inventory strategy to be able to satisfy that increased consumer spend, if it does, in fact, occur.

Okay.

And then if you could talk about Benefit.

I know you have had some good response there.

You mentioned in second quarter, about 25% of your store base had full assortment of that product.

Where do you stand now and are you still fine tuning it for the holiday?

No, no more fine tuning.

We are locked and loaded for holiday at this point.

We do have about 133 stores at this point in time that have Benefit boutiques, and the boutiques are either the traditional boutique that you have seen in the center court of the store.

It could be a boutique off the wall of the store, so same 200 square feet.

Or it could be what we are calling a "linear boutique," which is especially designed gondola run for Benefit.

So, we have that in about 133 stores, and basically in the rest of the store base, we have more of an etagere and end-cap presentation of a more limited selection of the line, which we will be gradually transitioning into the boutique strategy over the next 18 months.

All right, thank you.

Our next question comes from the line of Maria Vizuete with Piper Jaffray.

Please proceed with your question.

Thank you.

It's Maria on behalf of Neely.

Congratulations on a fabulous quarter.

Thank you, Maria.

I'm wondering if you can talk a little bit more about your promotional cadence heading into holiday?

Should we expect more couponing, or are you working with your vendors in advance for more product-specific promotions?

It is - because we are anniversarying that heavily deteriorated economy from last year, from last fourth quarter, it is not about the couponing.

As we saw in third quarter, we actually did not see an increase in coupons over prior year, coupon redemption rate that did not impact the margin.

And we are not expecting that behavior in fourth quarter, and nor are we planning to put any significant increase in coupons out in the market.

What the focus for value is more focused on is where you were just a second ago, which is strategic buys that we have made with our key vendors and then offering that value through to our customer base.

And a really good example I had mentioned is on the front cover, our newspaper insert, literally this week, we have a Chi flatiron out there for just a little bit below $80, $79.95 and we are seeing very good consumer response.

When the value is there, there is not resistance to the average ticket.

Great.

Thanks, and then I'm just curious if there has been any change in how the Prestige mineral category has been trending?

Again, we don't comment too specifically on it, but we have in the past, commented on the trade down from Prestige to mass as there were more brands available.

Not a reflection on the brand strategy, but on the availability of mass brands.

We are seeing some stabilization of that trend at this point in time.

It's not that it's going back the other way so much as we're not seeing it continue to trade down.

Great, thank you.

Our next question comes from the line of Henry Cappellin with Oppenheimer.

Please proceed with your question.

Great, thanks for taking my questions.

I guess the first one is in the press release, you mentioned that you expect the holiday season to be challenging.

I was wondering if you could comment on whether you think that is going to be more or less than what you saw last year?

Henry, we are planning for not --the deeply discounted, extremely, extraordinary discounts of last year.

We think that the marketplace has brought inventory in a different fashion by and large to what they did last year.

Nonetheless, it is one of the things that we cannot control, and hence, one of the factors for us putting a wider guidance range in there than what we have in the last couple of quarters.

So it's possible.

We have planned for a very aggressive promotional environment, but not necessarily believing that we're going to see quite that level of extraordinary discount we saw last year.

Okay.

So an improvement essentially from what you saw last year, but not anything dramatic is what you are saying?

An improvement from last year, if I wanted to put [inaudible] on it, not as aggressive as last year, but deeper than 2007 is what we are planning for.

Got it.

And then just piggy-backing on your comment about the guidance, I'm still trying to figure out for same-store sales guidance in the fourth quarter, you are saying down 3% to positive 1%.

But you did 1.5% in the third quarter, and yet, you also have an easier comparison in the fourth quarter.

So I'm just trying to figure out how you came to that same-store sales guidance for the fourth quarter?

Henry, as I have mentioned, we believe that the current trends in this environment are more representative, if you will.

We finished the third quarter at plus 1.5%.

That was taking into consideration when we set the top end of that guidance range of a 1.

The fact that we have expectations out there for consumer environment and the gift-giving space to be flat to down slightly, would suggest that the comparison for the fourth quarter is less relevant.

To us, what is more meaningful is the current trends that we are running.

As it relates to the bottom end of the guidance range, it is as simple as what we have described in the past.

Not sure if there is another consumer event that would be a distraction out there around the corner that would cause consumers to pull back slightly on spending.

We can't be entirely sure in this economic environment, what the ultimate level of gift-giving spending will be in this fourth quarter.

So the easier comparison is last year.

I think the consumer has set a new precedent in terms of what their ultimate level of gift giving is.

So it does not make for necessarily an easier comparison.

That is why the current trends are more relevant.

Got it.

The last question I have was, the traffic trends, while they were positive in the third quarter, it was a slight deceleration from what you saw in the second quarter.

Just wondering if there was any commentary that you could provide around that?

Henry, the primary commentary is actually the strategy for the quarter.

As we begin to develop our marketing and merchandising strategies for the quarter, we take a look at the prior year.

And in the prior year, in third quarter prior year, we had a 6% increase in count, and we had a decrease in average ticket.

So as we strategize third quarter this year, the biggest opportunity, we believe, is in average ticket and not to expand aggressively on the customer count.

We had been very aggressive on going after customer count third quarter last year, not just in reaction to the economic environment and the deterioration, but we had planned for investment in count, anticipating a lot of hesitancy during that pre-election time period.

So with that resource investment and the base line to count, we put a modest amount to drive count in third quarter this year and more aggressively drove against opportunity to drive average ticket and hence, focused on some of the categories that I have been speaking to while on the call that are clearly higher ticket categories, fragrance, the styling tools category and the continued focus we have on Prestige color and skin.

Got it.

Thank you very much.

I appreciate it.

Our next question is from the line of Anthony Lebiedzinski with Sidoti & Company.

Please proceed with your question.

Good afternoon, thank you for taking my question.

Just wanted to follow up on the previous question about the free cash flow.

So it sounds like you expect positive free cash next year, but perhaps not at the same level that you are seeing this year.

It definitely, Anthony, will not be at the same level that we experienced this year.

Okay.

It will ultimately depend mostly on the rate of expansion of our new store program.

Right.

And you mentioned that the CapEx, on average now, is about $1.1 million, versus $1.6 million before.

Is that correct?

The total new store investment.

Historically, back 18 months, we would spend about $1.6 million between CapEx, net inventory and pre-opening costs to open a new store.

And at this point in time, based on all the initiatives, we're down closer to $1.19 million, which helps as we start to expand square footage, again, helps to buffer some of the cash flow (inaudible).

What has driven the $0.5 million decrease?

There has been numerous things.

One, we have reduced the cost per square foot to build new stores and we have strategically done that over the last 18 months with no impact to the consumer experience.

We have also, if you have heard us talk about, have taken about 10% of the inventory costs to build a new store, to fill a new store.

And our pre-opening costs have progressively come down over time.

Okay.

Thank you.

(Operator Instructions).

Our next question is a follow-up question from the line of Liz Dunn with Thomas Weisel.

Please proceed your question.

I'm sorry, my question has been answered.

Thank you.

There appear to be no more questions in the queue at this time.

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

Thanks again for joining us today.

On behalf all of us at ULTA, I would like to wish you all a very happy and healthy holiday and New Year, and we look forward to speaking to you on your next call, which will be in March of next year.

Thank you everybody.

Good night.

This concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.