Ulta Beauty Inc (ULTA) 2010 Q1 法說會逐字稿

Greetings, and welcome to the Ulta Salon, Cosmetics & Fragrance Inc.

first quarter 2010 earnings 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) As a reminder, this conference is being recorded.

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

Thank you, Ms.

Malkin, you may now begin.

Thank you.

Good afternoon.

Before we get started, I would like to remind you of the Safe Harbor language, which I'm sure you're 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 risks and uncertainties, all of which are described in the Company's filings with the SEC.

Separate from our first quarter earnings release, the Company also announced today that it filed a registration statement with the SEC regarding certain of its shareholders' intention to sell 9.8 million shares of common stock through a secondary offering.

As you know, we are not legally allowed to discuss this on today's call.

And, therefore, we will only be able to take questions related to our business performance today.

And now I'd like to turn the call over to Ulta's CEO, Lyn Kirby.

Thanks, Allison.

Good afternoon, everyone.

Thank you for joining us to discuss our first quarter results for fiscal 2010.

On the call with me today are our recently appointed President and Chief Operating Officer, Chuck Rubin, and Chief Financial Officer, Gregg Bodnar.

Following my opening remarks, Gregg will review our first quarter financial highlights and second quarter outlook, and then Chuck will provide some remarks after which we will turn the call over to the Operator so that we can answer the questions that you have for us today.

We had a very good start to the fiscal 2010 year, reporting strong sales and earnings with our performance accelerating from our positive results in 2009.

Specifically, for the first quarter, net sales increased 19.1% to $320.2 million.

Comp store sales increased 10.8% and included increases in both traffic and tickets.

Our comp store sales performance followed a 2.3% decline in the first quarter last year and therefore represents a two-year comp increase of 8.5%.

Gross profit margin increased 300 basis points to 32.6% and included a 70 basis-point increase in merchandise margin.

Operating margin more than doubled to 7.3% and net income increased 178% with net income per share rising to $0.23 from $0.08 in the first quarter last year.

We attribute our strength to the success of our ongoing focus on our three priorities that we established in 2009.

First, driving profitable market share growth, second, delivering prominent cost reductions to improve operating margins, and, third, generating annual free cash flow while investing in our long term growth.

We continued our positive momentum in the first quarter reporting comp sales that accelerated from our strong fourth quarter performance.

During the quarter, we drove market share gains and better than expected profitability by capitalizing on the advantages of our business model with dynamic marketing, compelling brands and providing our customers with the preferred beauty shopping experience.

Our top line growth and our market share gains included a strong performance during both our gift occasions such as Valentine's Day, Easter and Mother's Day, as well as the non-holiday periods.

As you may have heard me say before, in this tough economic environment, we can't rely on our customers to spend more, but we can utilize our marketing to increase the number of customers visiting our stores, and entice our existing customers to shop with us more often.

As a result, our first quarter marketing strategies continued to focus on creating top customer traffic, which was successful, and led to an 8.8% increase in traffic within our comp store base.

In the fourth quarter we saw the more discretionary categories of our business, fragrance and styling tools, move in the right direction.

We leveraged this change in consumer sentiment in our marketing during first quarter to drive average ticket.

In addition, we continue to drive growth in prestige color and skin with exciting new brands.

Combined, these categories delivered a 2% increase in average ticket.

We also saw good performance across mass color, skin, and hair, as well as private label.

We continued to deliver our comp store sales growth, while simultaneously reducing our advertising rate as we continue to gain leverage from our increasing scale.

Importantly, this comp store sales rate was also achieved while simultaneously delivering a 70 basis-point increase in merchandise margin for the quarter.

As you may recall, during the difficult economy in last year's fourth quarter we made a modest investment in merchandise margin to drive customer traffic.

Over the two years, we delivered a 20 basis-point improvement in merchandise margin.

We continued the expansion of our advertising to television with commercials that ran for two days over the first quarter covering 174 stores in 18 markets leading up to Mother's Day.

We will continue to test television advertising strategically in advance of key holidays and other peak traffic times of the year to expand and drive customer traffic and brand awareness.

We also expanded our national print branding campaign to include a cross over to digital with make over videos online.

In the first quarter, we continued to benefit from the strategies we implemented in 2009 that led to permanent cost savings and greater efficiencies in our supply chain.

In fact, during the quarter we advanced our supply chain initiatives and saw a further improvement in our average inventory per store at quarter end.

While our comp store sales were entirely driven by our retail business, we were pleased to see salon return to positive comps in the first quarter.

We are seeing our customers begin to increase the frequency of their visits, and she appears more willing to spend a little bit more on herself as evidenced by an improvement in hair color services during the quarter.

During the quarter, we introduced the Rodney Cutler spring hair cut collection representing the continuation of our Runway Your Way program, which was initially introduced in fall 2009.

The spring collection was introduced in April and we are very pleased with the early response.

In regards to our store expansion, during the quarter we opened two new stores, relocated one store, and closed one store.

We continue to be pleased with our new store performance and we remain on track to open 46 stores, relocate 6 stores, and remodel 13 existing locations in fiscal 2010.

Our eCommerce business delivered double-digit sales growth for the quarter and we continue to improve the site shopping experience with expanded assortments and increased features and functionality, which is expected to fuel further gains in this channel.

Turning to second quarter, we continue to have traction from the strategies we put in place last year and expect our strong results from fourth and first quarters to continue.

As outlined in our guidance, we expect to continue to see strong customer response to our top line strategies and expect to continue to deliver strong earnings growth.

We will continue to apply our successful marketing strategies to drive customer traffic and also expect to see positive average ticket growth.

To this end we will continue to provide great value with exciting offers in our mass and our private label businesses.

In addition, we continue to see positive trends in the more discretionary areas of our business, that include fragrance and styling tools, and are effectively driving this growth with strong gift with purchases and prominent placement in our marketing mailers.

We also continue to see a very positive response to our new prestige color and skin brand introductions, and are very excited about our upcoming launch of Philosophy skin care.

Philosophy skin care will be introduced to our entire store chain in second quarter.

Currently we offer Philosophy in bath and fragrance, and are pleased to add skin care to our offering for this key brand.

We also plan to grow market share with our new store and remodel program.

In the second quarter, we plan to open ten new stores and remodel one existing location.

Our fiscal 2010 new store program continues to include 46 new stores and represents 13% growth in square footage.

We also remain on track to remodel thirteen existing locations.

As I have mentioned previously, when we remodel an existing store, it is just like opening a new store.

Upon completion of the remodel, our stores look brand new and have more selling footage which enables us to add to our assortment particularly in prestige brands and boutiques.

Following quarter end, Chuck Rubin joined Ulta as President and Chief Operating Officer.

We're delighted to have Chuck on board.

He has immersed himself into our organization and is a great fit with our corporate culture, and we are smoothly progressing towards his transition to CEO.

And now, I'll turn the call over to Gregg to review our first quarter results and guidance in more detail.

Thanks, Lyn.

Our first quarter results were above our expectations and driven by better than expected comp store sales growth and continue to execute our cost management initiatives.

We delivered a 19.1% increase in total sales, a 10.8% increase in comp store sales, a 300 basis-point increase in gross profit margin, and a 60-basis points of SG&A leverage.

All of which led to a 400 basis-point increase in operating margin, and 187% increase in first quarter earnings per share.

As Lyn mentioned, we are very pleased with our results and believe our initiatives will enable us to continue to deliver strong results in the second quarter and the balance of the year.

Turning to a review of the income statement.

First quarter net sales increased 19.1% to $320.2 million, and comp store sales rose 10.8%, which was in line with the increased expectations we provided on April 26, 2010, and well ahead of our initial guidance of a 4% to 6% increase.

The 10.8% comp represents a two-year increase of 8.5%.

Our comparable store sales were driven by an 8.8% increase in traffic and a 2% increase in average ticket.

We attribute our strong results to our merchandising and marketing strategies, which continue to provide us with profitable market share growth.

Our improving trends in average ticket, coupled with the solid positive results in the more discretionary areas of our business suggest that our customers are feeling better about spending.

All of our major categories generated positive comp growth in the first quarter.

During the quarter we opened two new stores, relocated one and closed one.

Ending the first quarter with 347 stores and expanding square footage by 9% from last years' first quarter.

Gross profit dollars in the first quarter increased 31.5% to $104.5 million from $79.5 million last year.

Gross profit margin increased 300 basis points to 32.6%.

The increase is primarily attributed to 160 basis points of improved leverage and fixed store costs, 20 basis points of improvement in supply chain.

We also realized a 70 basis-point improvement in merchandise margin this year as compared to a modest 50 basis-point investment last year.

SG&A expenses were $80.7 million, or 25.2% of net sales compared to $69.4 million, or 25.8% of net sales in the prior year.

The decrease in SG&A as a percentage of net sales reflects 20 basis points of leverage, in-store operating costs on stronger sales, and 40 basis points of leverage in marketing expense reflecting the continuing benefit of efficiencies identified during fiscal 2009.

Pre-opening expenses totalled $500,000 in the quarter, which compares to $1.2 million in the first quarter last year.

Better than expected sales growth, margin expansion, and our expense management initiatives, in conjunction with our planned lower store opening program, resulted in operating margins more than doubling from last years' 3.3%, to 7.3% this year.

Interest expense of $118,000 represents fees associated with our credit facility.

We did not utilize our credit facility during the quarter and ended the quarter with no outstanding borrowings.

Net income for the quarter increased 178% to $13.6 million, or $0.23 per diluted share from $4.9 million, or $0.08 per diluted share last year.

Now turning to the balance sheet and cash flow.

Merchandise inventories at the end of the quarter were $228.1 million, compared to $230.3 million at the end of the first quarter last year.

Average inventory per store decreased 8.7% from the prior year driven primarily by our continuing management initiatives.

The reduction in inventory per store is evenly split between our store and DC network.

We have accomplished these reductions while maintaining the offering and customer experience we have delivered in the past while achieving a 10.8% comp store sales increase.

The average inventory per store decrease was partially offset by the addition of twenty-seven net new stores opened since May 2, 2009.

We believe we have appropriately positioned our inventory as we progressed through the second quarter.

Capital expenditures for the quarter were $7.7 million and depreciation and amortization for the quarter was $15.9 million.

Now regarding our outlook.

As we continue to build upon the success of our focused priorities previously discussed, we currently estimate for the second quarter of 2010, net sales in the range of $311 million to $317 million compared to actual second quarter 2009 net sales of $273.5 million.

This assumes a comp store sales increase of 7% to 9% and the opening of ten new stores.

In the second quarter last year, our comp store sales declined 1.7% and we opened thirteen new stores.

We expect pre-opening expenses to be approximately $2.4 million for the quarter and approximately $9 million for the full year.

Before I turn to the EPS outlook for the second quarter, I want to provide some insight regarding the expected financial impact from the addition of our President and Chief Operating Officer.

We will incur a cash and stock compensation charge that will impact EPS by $0.06 per share for the balance of the year.

The impact by quarter is $0.03 in the second quarter, $0.02 in the third quarter, and $0.01 in the fourth quarter.

As a result of this, we now expect an effective tax rate of 41.2% which will have a full-year impact of $0.01 per share versus our tax rate of 40.3%, in fiscal 2009.

This compensation charge, an increase in our effective tax rate, relates only to 2010.

Now regarding second quarter EPS guidance.

Income per diluted share is estimated to be in the range of $0.19 to $0.21 per share excluding the previously mentioned $0.03 compensation charge.

Including the charge, we expect second quarter EPS in the range of $0.16 to $0.18.

This compares to income per diluted share for the second quarter of fiscal 2009 of $0.10 and represents an increase of 100% at the midpoint of our range excluding the charge, and 70% including the charge.

The midpoint of our EPS range reflects gross margin improvement of approximately 310 basis points and SG&A deleverage of approximately 110 basis points.

The gross profit improvement is driven primarily by fixed store leverage, merchandise margin expansion, and continued supply chain efficiencies, while the SG&A deleverage is primarily driven by the executive compensation charge previously mentioned.

Now, regarding qualitative elements of the fiscal 2010 year which remain unchanged from our March communication.

We plan to open approximately 46 new stores in 2010, representing a 13% increase in square footage.

Building onto two new stores we opened in the first quarter, the approximate flow of store openings by quarter is 10 in the second quarter, 26 in the third quarter, and 8 in the fourth quarter.

We expect capital expenditures to be approximately $100 million, representing at 47% increase from fiscal 2009 levels.

This includes approximately 46 new stores, 13 remodels, 6 relocations, as well as continuing to make the necessary investments in our technology infrastructure including supply chain loyalty and eCommerce.

We expect depreciation and amortization to be approximately $68 million.

We also continue to identify specific initiatives to further reduce our average store in total DC inventory levels.

We expect average inventory per store to decline approximately 5% by the end of fiscal 2010.

We expect to generate approximately $5 million in additional permanent cost savings in 2010 primarily in the areas of supply chain and store operating costs.

Again, no change to the outlook for these elements of our business, as we believe we are on track with all of our strategies.

When dealing comps on a two year and three year basis, along with the strength of our strategies, we believe we can continue to generate solid comparable store sales growth for the two remaining quarters in the year.

We also believe that with our ability to generate earnings growth and drive cost efficiencies and working capital improvements, we can generate free cash flow again in 2010.

In closing, we have demonstrated we can operate successfully in this economic environment.

We will continue to manage the business along our three key priorities.

To drive profitable market share expansion, earnings growth, and deliver free cash flow.

We believe we have been executing the right strategies and are well positioned to achieve our long-term growth targets.

Now I'd like to turn the call back to Lyn.

Thanks, Gregg.

We are very pleased with our start to fiscal 2010 and for second quarter as outlined in our guidance.

We expect to continue to see strong customer response to our top line strategies and expect to continue to deliver strong earnings growth in second quarter.

We believe we have a successful game plan in place for 2010 and we'll continue to implement our strategies to deliver increased value for our shareholders.

Now before we go to Q&A I want to take this opportunity to introduce to you to the newest member of our team, Chuck Rubin.

Thanks, Lyn, and good afternoon, everyone.

I'm very excited to join Ulta and to be able to contribute to the Company's continued growth and the creation of additional shareholder value.

During my first weeks, I visited with many of our associates in our stores and distribution network along with some of our key vendors.

I have found an energized team that is committed to serving our customers and growing our store and eCommerce channels.

For those of you I don't know, let me take a moment just to share a bit about my almost 30 years of retail.

My first 11 years were spent in the department store industry.

Here I gained a strong foundation in trend merchandising and building relationships with prestige brands, two skills that have continued through my career.

My experience includes buying cosmetics, including some of the same brands offered by Ulta today.

Additionally, I bought women's apparel and was a merchandise manager of kids' apparel.

I then spent six years in the sporting goods specialty business leading merchandising and marketing efforts.

Here again, trend merchandising, whether it was fashion or technological advances, along with collaboration with prestige brands was paramount.

This was then followed by six years with Excentra Consulting where, as a partner, I focused on merchandising, marketing, and value creation projects across department, specialty and eCommerce venues.

Finally, the last six years I've been with office depot where I joined as Executive Vice Pesident and Chief Merchandising and Marketing Officer, and was later promoted to President of North American Retail, their largest division.

I was attracted to the opportunity to join Ulta as President and COO in transition to CEO, given its strong record, invisible growth opportunities, and compelling point of differentiation.

Clearly by the results we issued today and our positive outlook, I am joining at a terrific time.

Our strategies are working and serve as a strong foundation for future growth.

I'm looking forward to getting to know the investors and analysts on the call with us today in the months ahead.

With that let me turn the call back to Allison.

As a reminder please limit your questions to the information provided on this conference call, as legally we cannot take questions related to the registration statement,.

And now, I would like to turn the call over to the Operator to begin the question and answer portion of the call.

Thank you.

We'll now be conducting a question-and-answer session.

(Operator Instructions) Our first question is from Sam Panella from Raymond James.

Thanks and congratulations on a terrific quarter.

Gregg, can you just talk about the opportunity for gross margin improvement in the second half of the year?

And when do you anniversary the supply chain savings?

Yes, as you recall, in the first half of the year we made gross margin investments primarily to continue to drive positive traffic.

In the second half of the year, we started to deliver some improvements in gross margin.

So the 300 basis points that we delivered in the first quarter, and the 300 basis points we're expecting to deliver in the second quarter, I would expect to slow down a little bit going into the fourth -- third quarter and into the fourth quarter.

The supply chain initiatives last year in the first quarter we delivered about 50 basis points, second quarter was about 80 basis points, and then back half of the year was 60 basis points and 30 basis points respectively.

Okay.

Thank you.

And in terms of the $5 million in additional savings, how much of that did you realize in the first quarter this year?

It was about $750,000.

Okay.

And then lastly if you could just update us in terms of the real estate opportunities that you're seeing and your ability to accelerate square footage growth beyond the 13% as we move past this year?

Thank you.

Sam, I'll take that one for you.

Again, not much has changed since our last call on our outlook on real estate.

We continue to not see new developments come out of the ground, so that will not be an opportunity.

But we do continue to see a good pipeline in existing centers, which is what we have been focussed on, as you know, particularly for what we will be executing this year.

And feel comfortable with the numbers that we have spoken to in the past, which is a modest acceleration next year moving towards that 15% to 20% growth, closer to 15%, and next year.

Great.

Thank you.

And good luck, and welcome to Chuck.

Thanks.

Thank you.

Our next question comes from Brian Tunick from JPMorgan Chase.

Thanks, good afternoon.

A couple -- I guess one question for each of you.

I guess, Lyn maybe, we're starting to see some of the department stores offer some more open selling, so I was curious if you have heard anything from your vendors, whether or not the department stores are finally starting to realize sort of what's happening out there with you guys and Sephora?

For Gregg, maybe, as far as the comp drivers go, either this quarter or looking forward, if you would, could rank, maybe, do you think the boutiques, the loyalty program rollout, or the remodels, you know, what, in order has been, you know, the biggest comp drivers?

And, Chuck, maybe talk about any holes on the team, or what the bench looks like as we're certainly going to miss Lyn?

Well, thank you for the last compliment, Brian.

But there really is a great team in place.

But, thank you.

In terms of the department store world, the first thing I would say to you is competition makes us stronger, Brian.

I've always said that and I do believe that.

So, yes, we are seeing the department store respond to the experience we have been offering for some time.

But I will remind you the open seller is just one piece of our total experience.

Our total experience in those five E's that we always talk about is more complex than that.

And then, of course, our super-store attributes that you're very familiar with, the real estate strategy itself, the off-mall, the value proposition and our marketing strategy, all leave us still, I believe, in a very strong position versus just that one piece of total strategy that we're seeing offered at Macy's.

Gregg, you want to take the call?

Then, Brian, boutiques, remodels, and loyalty, not in any particular order in terms of their impact.

The remodels do deliver some comp store sales growth, but the 10.8% growth that we referred to and then the guidance we gave for the second quarter, continues to be primarily the result of strong merchandising marketing strategy, the consumer differentiation as Lyn was just alluding to, which is elements of our overall strategy.

The boutiques in and of itself are not a material individual comp driver.

What's more important is the overall prestige strategy.

As we continue to go forward, and you heard Lyn describe that we're launching Philosophy in the second quarter here, and we believe that that will be a nice comp driver in the back half of the year.

And then the loyalty program continues to be, you know, paramount to our strategy.

We have the significant number of loyalty customers, you know, about 7 million, a significant number of which shopped the last twelve months and, again, that is just another additive ingredient of the overall strategy that continues to deliver the results that we're achieving.

I'm sorry was TV marketing a big driver for this quarter?

No, Brian, TV -- if I can -- the most fundamental thing to remember on the TV is, two days out of all the days in the quarter, that is all it is.

So it still remains very much in a -- a test mode, so that we continue to do it modestly, so that we can continue to learn.

So it is, if you just remember the number of days that are covered, very, very modest.

But hopefully a nice growth strategy, a nice runway for us going forward.

And Brian, remember we did that in front of Mother's Day and Mother's Day is, albeit its our second largest holiday, it is a very small holiday in relation to the first quarter.

And Brian, your question to me -- I appreciate that first question -- concerning the team, I've been very impressed with the team.

What I have found is a group of people who are very energetic and very passionate who have worked collectively to put the strategy together, which is obviously working.

And it's a team made up of people with experience in other large retailers, so they know how to scale Ulta even larger.

And it's a team made up of people who have been here for a number of years, as well as some people who have been here for less time, but have got experience that they can bring into the group so we can, I think, properly respect the legacy since it has worked so well, and then build upon that as we go forward.

So, in a word, or two words, very impressed with my -- with the team here.

All right.

Good luck to everyone.

Thanks, Brian.

Thanks, Brian.

Thank you.

Our next question comes from Neely Tamminga with Piper Jaffray.

Oh, great, thanks.

I've got one question here for Lyn, and then two very quick housekeeping questions, if I may.

The real big question I have for you, Lyn, is as we're kind of turning the corner out of what we just saw with the depths of despair of the consumer and now she's clearly coming to spend more on herself.

How do you guys think about your marketing, your promotional mix as you look into to (inaudible) holiday versus last year?

Are we going to be doing more of the vendor-partnered promotional events?

Will it be more of the Ulta driven gift-with-purchase, or private label specials?

Or more the percent-off, dollar-off coupons?

You know, Neely, one of the wonderful pieces about our business and our marketing strategy is that we have many levers to pull and you focussed on the marketing levers and then, of course, we have all the product categories as well that mix into that that give us a multitude of opportunities.

So we are -- at this point, we're only six weeks -- we're six weeks into selling this quarter.

We're basically finishing the marketing for second quarter, and we are just now beginning third quarter and fourth quarter.

So we haven't really started to get into the detailed tactics of the program.

And the reason we haven't is because, as you heard us say many times, we like to keep that really close so that we can really respond to the trends we're seeing on the business.

That would be the over-arching time line to keep in the back of your head.

But that said, we'll do all of the above that you named.

There is not one tactic in there that the team would not be employing as we develop the third and the fourth quarter marketing plans.

The environment itself as much as, you know, we are seeing really good numbers in performance and you've heard us speak to that, I want to remind you that we're seeing slight increases in average tickets.

But the biggest increases for us are in customer traffic.

And so the strategies have focussed on traffic and the traction that we've gotten with that, will still remain a robust part of our plans going forward.

And that requires all of the levers that you described.

It certainly requires us keeping a good value proposition, which is much of what you described there, as well as, you know, the continued trend in growth that we see on our prestige businesses that will help us with the ticket.

Thanks, Lyn, and just quick housekeeping here for you and one for Gregg.

As we lap that benefit launch from last year in Q2 with Philosophy, it would seem to me that Philosophy is actually maybe a higher volume generating brand.

And I'm just wondering, will you be all doors with full skew penetration in Q2?

Or will you build that a little bit as you go into Q3, Q4?

And then for Gregg, I know you guys can't talk about the deal, but, unless I missed it, did you talk about are there any expenses related to the deal embedded already in your Q2 guidance?

Thanks.

Let me take Philosophy for you.

The exciting thing for us with Philosophy is that we were able to partner with them early enough that we actually do have the same selection in virtually the whole chain.

We have a very small handful of doors that get less than 2% or 3% of our doors out where we were not able to fit the fixture in, but other than that, it is the full selection that we have agreed with them to have.

So it is a very exciting launch for us.

Neely, no, no expenses for the deal as we are -- expenses related to selling shareholders, and just also keep in mind that it is non-dilutive.

So these are secondary shares.

Absolutely.

Well welcome to you, Chuck, and best wishes to you, Lyn, you will be missed.

Thank you, Neely.

Thank you.

Our next question comes from Daniel Hofkin from William Blair.

Good afternoon.

Very nice results.

The -- thinking, I guess, about the mix of, you know, average ticket and as you look at the customer basket and overall consumer behavior.

What are some of the things that you're seeing that are either similar to the prior quarter or maybe different, including things like coupon off-take by the consumer?

For example, I think last year around this time you were seeing a little bit heightened level of response to coupons, and my guess is maybe that's -- that has backed off a little bit from the consumer standpoint.

But I would just be interested in any qualitative commentary regarding the basket composition at this point.

And then just had a question for Lyn and Chuck regarding sort of the transition and maybe top initial priorities as you start the role?

Let's deal with the first on first, Dan.

In terms of your question on coupons, you have a good memory.

We did see an increase uptick in coupon redemption in first quarter last year as people were really focussed on value in the tough economic downturn that we had.

We're not seeing people back off that.

So we're not seeing it go deeper, but we're not seeing people back off.

It is one of those examples, I think, that change in headset that will stay with us at least semi-permanently coming out of this economic downturn, that the customers who found the coupons like them and they're continuing to use them.

And that is certainly a piece of -- it is a great example of where we went after market share and we're getting some nice traction, perpetual traction off that.

The customers we attracted with those coupons were staying with us.

In terms of the average ticket, it is much of what I really said in the script, not a lot more color to add to you.

We are seeing a really nice growth across all of our categories, including mass and private label.

So take that as a starting point.

But the average ticket drivers are coming from the continued fast-pace growth out of our high ticket prestige color and skin categories.

That is not new.

That is just a continuation of what we have seen.

The biggest change that's giving us some of the modest average ticket growth is actually more around those two discretionary categories that we have been talking about for a while now, fragrance and styling tools.

They're both high ticket categories as you know.

We started to see the beginning of a turn in the third quarter last year, saw it continue into fourth quarter and then into first quarter as you heard me say, and we continue to expect to ride that consumer predisposition towards those categories going forward.

Of course, it is not just, as you know, it doesn't happen by itself.

We will continue to put the appropriate market resource against that marketing resource to ensure that we're capitalizing on the trend that we saw.

In terms of the transition, Chuck, do you want to take a first pass at that?

And I can --

Yes, I think, I think, Daniel, to your question I think that the transition is going very smoothly.

My priorities in this first part of the transition is really just to quickly understand the strategy and the foundation that's been built.

It's obviously delivering terrific results and has a lot of runway ahead of it.

And to get to know the team.

As I mentioned previously to that, to the earlier question, I think there's a very strong team here and I've been spending time with many of the folks both here at the corporate facility, but as importantly, out in the field whether it was in one of our warehouses or the stores.

And then finally getting to know our key vendors.

So those are really been the top priorities.

Great.

The other thing I will add, Dan, is we have a well orchestrated month-by-month hand off to departments reporting into Chuck.

So that it is really well orchestrated.

There's no confusion by the team as to where the roles and responsibilities are.

And, so far, early days, but it is working very well.

Great.

If I could just follow up on SG&A, any kind of incremental investment or other expenses that took place in the first quarter, either, you know, not sure how it would flow in terms of marketing versus vendor support, but that might have fallen into the first quarter SG&A?

Nothing, nothing incremental.

Nothing incremental, Dan.

I mean, as I said, we delivered about 60 basis points of leverage last year.

Okay.

Thank you very much.

Thanks, Dan.

Thank you.

Our next question comes from Evren Kopelman from Wells Fargo.

Thanks.

Good afternoon.

Question on marketing.

In the first quarter, were your efforts focused more on acquiring new customers or getting existing customers to come back into the store?

And kind of what's the plan going forward?

The answer is, it is a mixture of both, Evren.

The essence of the marketing strategies do two things, our newspaper inserts, of course, are always strategically positioned for new customer acquisition.

And so all the offers we put in that continue to focus on that opportunity, as well as our national print advertising, which we do put gift certificates in, so that absolutely drives traffic.

And then the marketing efforts as we've always executed them and particularly since first quarter last year when we have been going after market share, also focussed on getting our existing customers to buy more frequently.

So we see -- we continue to see both of those responses to our marketing, and that is certainly what is running through our customer account numbers since first quarter of last year.

Okay.

And then another question on this square footage growth, I'm curious what you need to see to feel comfortable before you take maybe the square footage growth rate back up to that long term goal of 15% to 20%?

Do you need to wait for new developments to pick up, or you don't need that?

First and foremost, it's always quality first.

Not chasing a number.

But the heart of it , really is not around the new developments.

At this stage, they would not be able to impact maybe the tail end of our 2012 program and 2013, even if they started building today, which is not happening.

So the focus will continue to be on the strength that we've had, which is existing centers, and we still see a nice pipeline of existing centers.

And as you know we skewed the mix towards single store markets and we still see some nice opportunity there.

So not new development,

Lastly one for Chuck, can you talk maybe about your initial observations on maybe the biggest opportunities you see at the Company?

Thank you.

I think, Evren, what I would say is what I mentioned before.

I think the Company has got a terrific strategy and a very strong team, put up terrific numbers as evidence today, and anticipate that those numbers continue as evidenced by the guidance.

I think there are opportunities to continue to grow.

There is more stores to be -- to be built.

There's more business via eCommerce to be done.

So I think there is a lot of opportunity.

For me to prioritize them right now I think would be a little premature.

Great.

Thanks.

Thank you.

Our next question comes from Liz Dunn from Thomas Weisel Partners Group.

Hi.

Good afternoon, congratulations on a great quarter.

Thank you, Liz.

I guess, my first question relates to sort of your ultimate operating goals.

As I look at the performance in the first quarter, and the guidance for the second quarter, it suggests that you'll likely hit a new high in gross margin, I believe, this year.

And my understanding of your longer term operating margin targets was that the majority was expected to come from SG&A leverage.

So does what you're experiencing now make you rethink at all those longer term operating margin goals?

That's my first question.

And then I just have two quick others.

Yes, Liz, just to quickly frame that out, our long-term operating goals for margin are 8% to 9%.

You know, and as we turned the corner from 2009 and into 2010, I think in the last couple of calls you heard us frame that out.

We believe we can get to 8% to 9% operating margins in a three year to four-year time period.

So 2012 to 2013.

As we turned the corner in 2009 and what we achieved from a supply chain standpoint, and what we achieved from SG&A leverage, and as we look forward with specific strategies that we have to expand gross margin and expand SG&A, we believe that that expansion from the 5.6% last year to our achievement this year, and then into those long-term targets, three years to four years out, will come roughly half from gross margin and half from SG&A.

Okay.

Can you talk about what went right in the salon business this quarter?

You know, was it just that the consumer began doing some of those things that she was delaying, or spacing out, or doing herself?

Or was there some specific strategy employed that began to pay off?

Little bit of both.

The first, absolutely.

We have seen, just as in those other discretionary categories of styling tools and fragrance, salon service is picking up, as are those other discretionary categories.

And we mentioned we see pickup in hair color service, and our marketing strategy in terms of the new haircuts we're doing we're also seeing a nice response to that.

And, of course, that positioning is an authoritative brand in the marketplace.

So nice there -- really nice consumer strategies.

And then in addition we have been focusing on our teams, as well, and looking at ways of helping them improve their productivity, which of course also helps them with their commission.

And so we have been working both ends of the spectrum on salon.

Okay.

Great.

And then my final question.

I think, in the past when you've introduced brands, it seems as though they can be quite additive to the comp.

Can you give us any sort of perspective on, you know, where you are now?

You clearly have a much bigger, more impactful prestige presentation than you've historically had.

So is it fair to assume that new brand introductions won't be quite as -- quite as impactful in terms of affecting the total comp?

Or is that the wrong way to think about it?

You know the -- whenever we introduce new brands, the incrementality is so much dependent on the uniqueness on the brand to the mix that we have, Liz.

And Philosophy is certainly a very strong and unique brand because it does cover fragrance, bath and skin.

So we feel very good about the incrementality of it.

And skin care, as you know, we have good skin care lineup.

We have a more robust color lineup.

So we're feeling very good about Philosophy's addition.

And yes there is some -- there is always some incrementality and the more we can attract new brands so the more unique the brand is to our mix, the more new customers we believe we have the opportunity to attract.

Okay, great.

Thank you, good luck.

Thanks.

Thank you.

Our next question comes from Joe Altobello from Oppenheimer & Company.

Thanks, good afternoon, guys.

Just a couple of quick ones.

First for Gregg.

In terms of the long term target of 8% to 9% operating margin, as you mentioned half from gross margin, half from SG&A.

How much of that is SG&A leverage and how much of that is potentially, which could be incremental to that 8% to 9%, additional cost savings beyond, you know, the $5 million that you're getting right now?

You know, let me take that in two parts.

Specifically in gross margin, Joe, you know, there are a couple of levers, all of which are a continuation of the strategies we put in place last year, which we implement phase one.

And then the next couple of phases that will be implemented this year and the following years.

One specifically is in the supply chain.

You've seen the results that we've been able to generate in terms of delivering incremental efficiencies.

We basically completed phase one last year and we've got a couple more phases into 2010 and 2011, and 2013, that is continuing to expand the intensity and sophistication of those strategies.

So, again, establish strategy, continuation, with that kind of long-term growth rate, with a 3% to 5% comp, we will continue to get leverage in fixed store expenses as we progressively move toward that 15% to 20% square footage expansion.

And then on SG&A, we have a number of strategy, some of which we started to implement last year, that will continue to drive efficiencies in the G&A part of the organization, and we have some specific ones that we're starting this year that's embedded in that $5 million that we'll start to drive some incremental efficiencies on the four wall store contribution.

Okay.

But just in terms of the SG&A piece of it, are there additional savings beyond what you're seeing now that is built into that number?

Or are you just extrapolating what you're seeing now into that 8% to 9% target?

There are some additional savings for some of those additional strategies that I described that we will implement in the future.

Okay.

And that's included in the target.

Okay.

Right.

Got it.

And secondly for Lyn, you've been -- I think -- pretty instrumental in getting some of these prestige department store brands into your doors and with you leaving now, it sounds like Chuck is going to sort of spearhead that.

But first, where do we stand on that?

Second, is that the case?

Is it going to be Chuck who is going to be spearheading that effort?

Let's comment on business strategies, first.

As you know, we continue to knock on the doors of the iconic department store brands and continue to remind them that we're ready when they're ready.

And we still don't know what decisions and what time lines they are thinking about.

So I just want you to remind you that is the framework within which we are operating.

I also want to remind you that those brands are never in Gregg's long-term targets.

Right.

The long-term targets always have some assumption in there on what we'll call mid-tier brands, but the big iconic brands have never been assumed in those targets because we've never been able to rely on them.

So in terms of where we stand, Joe, we're where we always stand on that issue, which is that we continue to hope that our good performance will continue to make us a more attractive opportunity for them to open distribution with us.

In terms of the role of the team and myself, you know, we have a really strong team on our prestige business at the senior merchant level and at our vice-president level, on fragrance, color and skin care.

They have really good relationships with the prestige brands as you know, if you think about it, we already have working relationships with a number of the Lauder brands on fragrance as well as Lancome and Loreal.

So we have very good working relationships at all levels of the Company.

So you should feel very heartened by that.

And then as you heard Chuck say, and I'll let Chuck speak to it also, is you know in Chuck's background and history, he has been dealing with the same issue of attracting prestige brands to his industry as we have here.

And so, let me turn it to Chuck.

Yes, let me reinforce Lyn's point.

I think the merchant team has been obviously very involved, very instrumental in securing all of the brands that have been here, along with Lyn.

And I think that team is very, very capable.

And then to Lyn's point and my background, in cosmetics for a couple of years, admittedly a number of years ago, but then throughout other stops in my career in different industries I have always dealt with prestige brands that have enormous equity in that brand and are very sensitive on how that brand presence is carried within a retail format.

So I have a great deal of experience, a great deal of respect, and a great deal of patience when dealing with those prestige brands and I think that will come in very helpful here to compliment the merchant team that is working that day in and day out.

Okay.

Perfect.

Thank you.

Thanks, Joe.

Thank you.

Our next question comes from Mimi Noel from Sidoti and Company.

Thank you.

Good afternoon.

Hi Mimi.

My first question is for Lyn.

Really a follow-on to Joe's question to make sure I completely understand.

In any negotiations with the iconic brands there really hasn't been any sort of headway or shift, is that correct?

You know we have disclosed that we have a Clinique test in six stores, so we have disclosed that.

Actually seven stores -- I beg your pardon.

And beyond that we have not commented on anything specific.

As you know, we do not comment on tests.

So no comment beyond that, Mimi.

Okay.

And my next question was for Chuck, again, sort of a follow-on to Joe.

Can you identify some of the prestige brands that you've worked with in the past?

Well, in cosmetics years ago, I bought Estee Lauder, I bought Clinique, just to -- and it was the skin care component, just to name a couple.

But I've dealt with Nike, in my sporting goods day, you know, if you know some of these brands and some of those industries, they're all different tiers of product.

This was back in the day when Nike was not distributing their product broadly and certainly not their top tier, so I was very involved in securing that.

Even at Office Depot, in office products and technology, there are prestige brands in computers, whether that was Lenovo or certain lines within Hewlett-Packard that they would not distribute broadly.

So, the prestige component is certainly very evident in the cosmetics industry but there are levels of it that really permeate in many different industries and many of them that I worked in before.

Okay.

That's helpful.

And then the last question, sort of housekeeping for Gregg.

No comment -- or it doesn't sound as though there is any change in the number of loyalty program participants from the end of the fourth quarter, is that correct?

Yes, our loyalty base continues to grow with both our store count and as we continue to drive that profitable market share.

Okay.

And we've talked in the past about certificate-based stores, versus point-based stores, and I think you're sort of in transition there.

Can you comment on that progress?

Yes, we -- on the program, or on the progress?

I'm sorry, Mimi.

Actually more the progress, than anything else.

Okay, I -- just wasn't quite sure I heard.

Yes, we have about 15% of our current store base is in the new program, which is the points program.

And we expect to add 50 stores to 60 stores this year.

And then we'll continue the rollout in the -- over the next few years.

And are you still seeing an acceleration or bump in the stores then that are using the points-based program?

Assume so continue -- considering the rollout?

We continue to see improved, which is why we continue to roll it.

We continue to see improvement in all of the fundamental metrics of customer retention, average ticket, earlier signup as we open up new stores.

So we continue to like the metrics that we're seeing on the program.

And at this stage, are investing in the IT infrastructure so that we can roll it across the full chain.

As you can imagine, that is a lot of transactions with a lot of data, with all of those points.

And so we're just readying ourselves now with the IT investments so that that can be rolled out.

Okay, that makes sense.

That's all I have.

In the years ahead.

In the years ahead.

Not this year, in the years ahead.

Got you.

That's all I have.

Thank you.

Thanks.

Thank you.

Our next question comes from Erika Maschmeyer from Robert W.

Baird.

Thanks.

Excellent quarter.

Thank you.

In terms of your market share gains, who do you think that that's coming from, or who do you guess?

Do you think it is mostly the department stores, or from other channels other than the specialty space?

No, we've had gains across all of the areas, so certainly in the prestige categories, yes, department store.

Perhaps other specialty.

You know, it is hard for us to get numbers on other specialty stores, but we think perhaps other specialty.

And then in the mass area, we do have market share gains in mass.

So we believe we're taking it from a mixture of competitors there, perhaps convenience food as well as drug, it is a little hard for us to drill down to exactly who we're getting it from.

And then we are seeing a faster than industry growth rate in salon retail, as well.

So that would be coming from the major salon chains.

So across the board from the obvious competitors is best way I could say it to you, Erika.

Sounds good.

And then in terms of ticket increase, how much of that about would you say would be driven by momentum and prestige brands?

And if you could comment on approximately how many prestige brand tests you might have in the works?

I cannot comment on the number of prestige brands we have in the works, but I will say to you, we've always said to you -- and when I say prestige, I'm not necessarily talking about iconic brands now, but any brand that falls into that category we call prestige -- we've always said we will test and roll, test and roll, every six months and we stay on track to that strategy.

And Philosophy is our first half year roll from the test that we did, and we do have brands planned for the back half of the year.

So we're definitely on track with that.

And I apologize, I forgot the first half of your question.

I know I went to the second half.

What was the first part again?

I guess in terms of how much you think momentum and prestige play into the driven average ticket?

Oh, yes.

Sorry.

It is -- you know the average ticket growth, and the 2% we saw in this quarter, was driven by a mixture of definitely the prestige brands, but also as we stated, some turnaround in the other high ticket categories of styling tools and fragrance.

And beyond that we wouldn't break that out, Erika, I'm sorry.

But it is a combination of both of those trends.

Great.

And then a follow-up on the rollout of the points-based loyalty program.

I know you said that you're going to add another fifty to sixty stores this year.

Can you just provide some color on the timing of that?

Yes, mid-summer basically.

The programs -- we like the programs to begin in the middle of the year, because we don't like the expiration to happen, as you can imagine, during the busy holiday and post-holiday season.

So we begin and end them in the middle of the year and that's when these additional stores come on board.

Great.

So sort the end of Q2?

Basically, I understand --

Yes.

Yes, yes, tail-end, yes.

Great.

Well, we'll miss you, Lyn, and welcome, Chuck.

Thanks.

Thanks very much, Erika.

Thank you.

Our next question comes from Jill Caruthers from Johnson Rice & Company.

Good afternoon, a couple quick questions.

Just on the salon comps it sounds as though you're definitely getting some lift on the ticket when you mentioned hair color pickup.

Are you seeing improved traffic?

And do you feel it is just from given your retail traffic is up so strong?

We're definitely seeing improved traffic.

I think we always benefit in the salon business when our retail traffic is up, but it is also driven just by the salon strategies themselves.

Both the strategies that are focusing on productivity for our teams, as well as some of the pulled strategy, the marketing that we spoke to, the Rodney Cutler is definitely bringing some traffic in, as well.

And then on top of it, your just the category itself and the economy, the pickup there from discretionary.

So it is coming up from different places, a little of everything.

Okay.

And then just digging into the merchandise margin improvement it looks as though, I mean, 70 basis points strong in the first quarter, you look to see some more in the second.

Could you talk about what is driving that?

Is it lower product cost?

Is it better mix?

Or is it purely just less promotional year-over-year?

A couple of things driving that.

As you heard us talk about the margin investments we made in the first half of last year, is we were responding to the environment and knew there was an opportunity to continue to drive traff-- or positive market share gains and traffic.

We made a lot of those investments because we were responding to the environment more on our dime.

And as we worked throughout the course of the back half of last year and into this year, we had an opportunity to work a little closer with our vendors, in some cases.

And then we are also seeing some positive impact from mix, as well.

So it is a combination of those two things.

Thank you.

Thank you.

At this time we have --

Jill?

-- no further questions.

I would like to turn the call back over to Chuck Rubin for any closing comments.

Well, just on behalf of Gregg, Lyn and myself I want to thank everyone for your participation this afternoon.

And we will look forward to speaking with you in early September to discuss our second quarter.

Thank you.

Thank you.

This does conclude today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.