Ulta Beauty Inc (ULTA) 2010 Q2 法說會逐字稿

Greetings and welcome to the ULTA Salon, Cosmetics & Fragrance, Inc second 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, you may 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 which of are in the Company's filings with the SEC.

And now I'd like to turn the call over to ULTA CEO Lyn Kirby.

Thanks, Allison.

Good afternoon, everyone.

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

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

For our call this afternoon I will review our second quarter performance.

Then Chuck will highlight the strategies that we believe position us for a strong third quarter.

Following this Gregg will review our second quarter financial performance and outlook in more detail and after some closing comments, we will take the questions you have for us today.

We are very pleased to report excellent second quarter results which reflect both our consistent ability to achieve key objectives we established in fiscal 2009 and the ongoing benefits from the continued execution of these objectives in 2010.

For the last 18 months we focused on three primary objectives, driving profitable market share growth, delivering permanent cost efficiencies to improve operating margin and generating annual free cash flow while investing in our long term growth.

We are particularly pleased with the continued momentum on the top line of our business on both a one year and a two year basis.

Our ability to continue to change the way women shop in the beauty segment has led to consistent and sustained market share growth for our Company, despite a slower than expected economic recovery.

In fact, in both our new and existing doors our customers continue to respond to our business model, our dynamic marketing, our compelling merchandising, our new brand introductions and our continued leverage of our powerful loyalty program.

For the second quarter net sales increased 17.6% to $321.8 million, comp store sales increased 10.8% with an increase in both traffic and ticket following a 1.7% decline in the second quarter last year.

So, on a two-year basis our comp store sales increased 9.1% and accelerated from our first quarter two year comp store sales trend of 8.5%.

Gross profit margin increased 350 basis points to 32.3% and included a 120 basis point increase in merchandise margin.

Operating income more than doubled to $22.3 million and operating margin increased to 6.9% from 3.7% last year.

Net income per diluted share increased 120% to $0.22 including a $0.03 per diluted share nonrecurring comp charge, which compares to $0.10 in the second quarter last year.

And adjusted income per diluted share excluding the non-recurring compensation charge was $0.25, or a 150% increase compared to second quarter last year.

We also maintained a strong balance sheet including increased levels of cash and inventory per average store flat with a year ago reflecting the ongoing benefits of our supply chain initiatives.

During the quarter we drove market share gains and continued our positive momentum from first quarter reporting comp sales performance that represented an 8% increase in customer count, and average ticket growth of 2.8%.

As you've heard me say before, over the last 18 months we could not rely on our customers to spend more, but we could utilize our marketing to increase the number of customers visiting our new and existing stores and entice our existing customers to shop with us more often.

As a result, our second quarter marketing strategies continued to focus on increasing customer traffic which led to the 8% increase in customer traffic within our comp store base.

We saw a strong response across our marketing events including our gift occasions, both Mother's Day and Father's Day, our value events such as our mass cosmetics buy one eye shadow and get a mascara for free, and our back to school event which traditionally begins at the end of second quarter.

As you know, back to school is not a significant peak for us, as it is for the apparel category.

Nonetheless, it is an important event and we are very pleased with the performance this year and the continued momentum at the end of the quarter.

Our comp sales performance and market share gains were also broad based across all major categories with the higher ticket categories contributing to the continued growth in average ticket.

As we continued to see consumer sentiment shift positively towards the more discretionary categories of fragrance and styling tools, we leveraged both our marketing and our merchandising to drive growth.

We continued to utilize our GWP strategy as well as introduce exciting new fragrance brands such as Chanel Chance Eau Tendre, Sarah Jessica Parker, NYC, Burberry and Gucci Sport for men.

Average ticket was also driven by a strong performance in Prestige Color and Prestige Skincare.

During the quarter we successfully launched Philosophy Skincare to all of our doors.

We are very pleased with the performance of Philosophy which we believe is attracting new customers to our store, as well as contributing to average ticket.

We continue to leverage our loyalty program using the data on our 7 million members as a core tool to drive traffic and average ticket.

We continue to judiciously move towards converting additional stores to our new loyalty program and at the end of second quarter we had 24% of our stores on the new program.

Our comp store sales were achieved while simultaneously delivering a 120 basis point increase in merchandise margin.

As you may recall, we made a modest investment in merchandise margin to drive customer traffic during second quarter 2009.

We have more than recovered this investment and over the two year time period we have delivered a 90 basis point improvement in merchandise margin.

We also continued to deliver our comp sales growth while simultaneously reducing our advertising rate.

Our marketing impressions were up during the quarter while our advertising rate was down, as we continue to gain leverage from our increasing scale.

We were pleased to see salon continue its positive comp performance in the second quarter which improved sequentially from the positive salon comp delivered in first quarter.

Our customers are continuing to increase the frequency of their salon visits and appear more willing to spend a bit more on themselves as evidenced by an improvement in hair color service and increased keratin treatments during the quarter.

In addition, we are seeing our Rodney Cutler hair cut collection which was first introduced in the fall of 2009 bring new customers into our salons and continue to reinforce ULTA as the fashion authority for our customers.

With regard to our store expansion, during the quarter we opened 10 new stores, remodeled three stores, relocated one store and closed one store.

We are pleased with our new store performance and continue to experience the same strong consumer response to our marketing strategies in our new stores just like our existing stores.

We remain on track to expand square footage by 13% this year as we intend to open approximately 46 stores, relocate six stores and remodel 13 existing locations.

Our eCommerce business experienced very significant sales growth in the quarter as we continue to improve the site shopping experience with expanded assortments such as Philosophy, Chi and Dermalogica and increased features and functionality.

We have also reengineered our inventory management platform which has led to an improvement in our in stock position and our customer conversion at the checkout process.

And finally during the second 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 our supply chain initiatives enabled us to end the quarter with flat average inventory per store well below our double digit comp store sales gain.

I said many times that we believe consumers will continue to buy beauty products in a challenging economy as you will continue to replenish your makeup and shampoo.

In a slower than expected economic recovery, we believe our business will be more resilient than others such as apparel, but that does not guarantee results.

Our success is driven not only by being in a consumable category, but by our market share strategies in the last 18 months and our ongoing implementation of these strategies.

We will continue to capitalize on the significant market opportunity we see for our Company as we grow new and existing brands, deliver traffic generating marketing, utilize our powerful loyalty program to more effectively communicate with our customers and expand our reach as we open new stores and expand eCommerce sales.

We are pleased to see our strategies yield better than expected growth in the first half of the year and expect the momentum to continue.

By the end of the second quarter, we completed the CEO transition with Chuck now having full responsibility for all areas of the business and so after this call I will step down as CEO and Chuck will take the helm.

I look forward assisting ULTA as a member of the board through March of next year and watching ULTA grow and take its place in the future as one of this nation's great retailers.

And lastly, I want to thank the ULTA team.

It has been my honor and privilege to lead ULTA in the last 10.5 years and I leave with tremendous pride in the Company that we have built together.

And now I'd like to turn the call over to Chuck to highlight our third quarter initiatives in more detail.

Thanks, Lyn, very much and good afternoon, everybody.

We're very excited about our business as we begin the second half of the year.

We expect our strong performance to continue as a result of our key growth initiatives.

Let me touch on just a few of these.

First we plan to continue to grow our market share which includes our new store and remodel program.

In the third quarter we plan to open 28 new stores and remodel 10 existing locations.

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

We also expect to remodel 13 existing locations.

As has been mentioned in the past, when we remodel an existing store, it's just like opening a new store.

Upon completion of the remodel our store looks brand new and presents a terrific shopping environment for our guests.

A remodeled store also has more selling square footage which enables us to expand our assortment, particularly with our prestige brand offerings and boutiques.

Our second key growth initiative is to continue to infuse newness into our already strong product offering by adding new brands.

During the third quarter we will introduce Tarte, a high performance and natural prestige cosmetic line to all doors.

Also to all doors we will add Bliss, a prestige skincare line.

In fragrance we will be adding Big Pony from Ralph Lauren, DKNY Pure, and Peace, Love and Juicy Couture and finally we will complete the full line rollout of our Philosophy Skincare offering which began in Q2.

The newness in innovation also continues in our salons as we introduce three new trend right hairstyles all designed by celebrity hair stylist Rodney Cutler.

Our third key growth initiative includes the intensification of our marketing efforts to attract new guests and capture greater share within our existing loyal base.

Let me highlight just a couple of examples.

Starting on September 4, we will kick off our 21 days of beauty, a prestige event that features compelling brands, new trends and great values.

This fun promotion will include exclusive in-store events along with great value GWPs.

Also in October our windows of love social marketing campaign will be held for a second year during breast cancer awareness month.

Our windows of love event supports a great cause while helping us to create a powerful and long lasting emotional connection with our customers.

We will once again invite breast cancer survivors and supporters to share their stories which will be displayed in our store windows across the country.

At the same time we will offer our customers the opportunity to donate to support cancer research.

Last year we raised over $600,000 for this very important cause and we are setting our goals even higher for this year.

These events are just two examples of the excitement that we will highlight in our marketing media.

We will continue to leverage our successful print media campaigns as well as increase our utilization of digital marketing and e-mail communications to our guests.

Finally the last growth initiative I'll highlight today is eCommerce.

We expect our online revenue will continue to grow quickly.

We will add to our brand offering while also upgrading the user experience with new enhancements like product zoom in an expanded content offering that will include more guest friendly information on topics ranging from color trends to skincare recommendations.

We believe eCommerce has an enormous runway ahead of it and are focused on maximizing this opportunity.

We expect these growth efforts along with our disciplined control of inventory and expenses and most importantly the hard work of our energized and dedicated team of associates all across our Company will continue to deliver strong sales and operating results.

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

Thanks, Chuck.

We are pleased to deliver better than expected second quarter results which were driven by a strong comp store sales and margin performance, resulting in sales and earnings above our guidance range.

We delivered a 17.6% increase in total sales, a 10.8% increase in comp store sales and a 350 basis point expansion in gross profit margin, all of which led to a 320 basis point increase in operating margin and a more than doubling in second quarter earnings per share as compared to a year ago.

Turning to a review of the income statement, second quarter net sales increased 17.6% to $321.8 million and comp store sales rose 10.8% which exceeded our guidance of 7% to 9% increase.

The 10.8% comp represents a two year gain of 9.1%.

Our strong sales performance is attributable to our overall consumer proposition as outlined earlier which we believe will continue to provide us with profitable market share growth.

During the quarter we opened 10 new stores, remodeled three, relocated one and closed one ending the quarter with 356 stores and expanding square footage by 7% from last year's second quarter.

Gross profit dollars in the second quarter increased 32.1% to $104 million from $78.7 million last year.

Gross profit margin increased 350 basis points to 32.3%.

The increase is primarily attributable to 160 basis points of improved leverage in fixed store costs and 30 basis points of improvement in supply chain from operating efficiencies.

We also realized 120 basis point improvement in merchandise margin this year as compared to a slight decrease last year.

SG&A expenses were $79.7 million, or 24.8% of net sales, compared to $66.5 million, or 24.3% of net sales in the prior year.

Excluding the planned non-recurring charge, SG&A as a percentage of net sales declined by 40 basis points from the prior year.

Preopening expenses totaled $1.8 million in the quarter which compares to $2 million in the second quarter last year.

Better than expected sales growth in margin expansion combined with our continued expense management disciplines resulted in operating margin expansion of 320 basis points to 6.9% from 3.7% last year.

Interest expense of $214,000 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.

The income tax rate for the quarter was 40.7%.

Net income for the quarter more than doubled to $13.1 million, or $0.22 per diluted share, including the $0.03 non-recurring compensation charge.

This compares to $5.8 million, or $0.10 per diluted share last year, representing 120% increase.

Excluding non-recurring compensation charge, adjusted net income per share increased 150% from the prior year quarter.

Now turning to the balance sheet and cash flow, merchandise inventories at the end of the quarter were $224.3 million, compared to $209.2 million at the end of the second quarter last year.

Average inventory per store was flat to the prior year which reflects the efforts of our continuing supply chain initiatives and the 10.8% comp increase.

We believe we have appropriately positioned our inventory as we enter the third quarter and remain on track to reduce average inventory per store by approximately 5% at year-end.

Capital expenditures for the quarter were $24.9 million and depreciation and amortization for the quarter was $15.7 million.

Now regarding our outlook, for the third quarter of 2010, we currently estimate net sales in the range of $324 million to $330 million, compared to actual third quarter 2009 net sales of $284 million.

This assumes a comp store sales increase of 7% to 9% and the opening of 28 new stores.

In the third quarter last year our comp store sales increased 1.5% and we opened 12 new stores.

We expect preopening expenses to be approximately $4.7 million for the quarter and approximately $8.5 million for the full year.

We continue to expect to incur a non-recurring compensation charge that will impact EPS by $0.02 in the third quarter and $0.01 in the fourth quarter.

We continue to expect an increase in our effective tax rate as a result of this compensation charge for the full year.

We expect our full year effective tax rate to be approximately 41%, compared to 40.3% last year.

This compensation charge and increase in our effective tax rate will not recur past this year.

We expect our fully diluted share count to be approximately 61.5 million for the third quarter and fourth quarter, and approximately 61 million for the full year.

Income per diluted share for the third quarter is estimated in the range of $0.18 to $0.20 including the previously mentioned $0.02 compensation charge.

Excluding the charge we expect third quarter EPS in the range of $0.20 to $0.22.

This compares to income per diluted share for the third quarter of fiscal 2009 of $0.14 and represents an increase of 36% at the midpoint of our range including the charge and 50% excluding the charge.

The midpoint of our EPS range reflects gross profit margin improvement of approximately 200 basis points and SG&A deleverage of 40 basis points.

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

Now I'll provide some qualitative elements for the fourth quarter of fiscal 2010.

For the quarter we plan to open approximately six new stores which will result in 46 new store openings for 2010 representing a 13% increase in square footage growth.

We expect our gross profit rate to expand by up to 50 basis points as we continue to benefit from our merchandise margin and supply chain initiatives while we anniversary the 170 basis point improvement in gross profit margin we achieved in last year's fourth quarter.

We also expect SG&A to be approximately flat to last year including the $0.01 per comp per share compensation charge resulting in an overall increase in operating margin in Q4.

In addition, this year unlike 2009, we've planned our new store opening program later which shifted more of our new stores opening in the third and fourth quarter this year as compared to a more balanced opening cadence last year.

As a result, our new store openings in the later part of this year will not have as robust a benefit from the development of a loyalty member base as stores that opened earlier in the year.

This will slow our fixed store leverage expansion as compared to prior quarters.

This expected impact is consistent with our store model and historical performance.

Let me be very clear.

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

For the full year we expect the following.

Capital expenditures are approximately $105 million, representing a 54% increase from fiscal 2009 levels.

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

Depreciation and amortization of approximately $67 million for the year, we also continue to identify specific initiatives to further reduce our average store and total DC inventory levels.

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

In addition, we plan to deliver approximately $7 million in permanent operating efficiencies.

We believe our ability to generate earnings growth and drive cost efficiencies and working capital improvements will result in a generation of free cash flow again in 2010.

In closing, we will continue to manage the business along three key priorities of driving sales growth, earnings expansion and delivering 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 over to Chuck.

Thanks, Gregg.

In summary, we believe we are well positioned to continue our positive momentum.

Our strategies are proven and leading to sustained market share gains for our Company.

We can continue to innovate in our marketing and merchandising to deliver excitement to our customers.

Our new stores are performing well and we possess a passionate and dedicated team.

I look forward to continuing ULTA's success over both the near and long term and now I'd like to turn the call back over to the operator and open it up for some Q and A, please.

Thank you.

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

(Operator Instructions) Our first question is from the line of Brian Tunick with JPMorgan.

Please go ahead with your question.

Thanks and good afternoon.

Lyn, we're going to miss you, of course.

Thank you, Brian.

So, I guess -- so two questions, I guess, first one for Gregg and maybe for Chuck.

So, for Gregg, I guess outside of the compensation charge can you remind us what your comp leverage point is going forward and sort of how you're thinking of longer term operating margins over the next couple years?

And maybe for Chuck, there's been a lot of noise around your marketing strategy, the 20% off coupon.

Can you maybe just talk about sort of what are the lead times regarding your ability to flex the marketing strategy and maybe also talk about how TV has or has not had a change in your thought process of how to reach out to customers.

Brian, on the operating margin SG&A leverage, as we look forward beyond this year once we're past the non-recurring charges that we incurred this year, we continue to believe that we can start to deliver SG&A leverage at a 2% to 3% comp.

Given our performance over the last couple quarters, our previous expectation of reaching an 8% to 9% operating margin by 2012, 2013, we now believe that we can be into that 8% to 9% operating margin range in the next 12 to 18 months which gives us continued belief and stronger belief that this will be a double-digit operating margin business in the not too distant future.

Brian, as far as your two questions, on the 20% off coupon I think you're referring to some news that was out there this week, firstly, that was a coupon that was 20% off our mass brands.

It had exclusions on our prestige brands.

It also was an anniversary event of one that we did the same time last year and, in fact, we've done them a couple of times overall for the year.

Clearly based on our second quarter performance and the guidance that we're giving today, we feel that our business is performing well and we're not discounting excessively to capture the sales that we've been able to get.

So, I think it was misrepresented potentially as an attempt to capture some additional sales at a discount.

As far as the marketing strategy is concerned, I think Lyn touched on it in her opening comments.

The Company has a very strong foundation in our marketing area.

We have a very successful print media campaign.

We have a loyalty program of 7 million members that is just an incredibly rich database that we've been able to utilize, but still has far greater potential to it.

When you look out into the future, you mentioned TV.

TV has been a very small part of the mix.

It was run last holiday and again during Mother's Day, but it was a very small part.

So, I think that there are opportunities for us to build upon the marketing foundation that the Company has been using as we go forward.

TV may be part of that, but there's also lots of other components in digital marketing and leveraging the web better than we have today.

If I could just -- Brian, just because it was so topical, the 20% off just as reference base, we have done that in third quarter for the last five years.

So, it's a very long standing event for us.

Okay.

That's what it seemed like.

Okay.

Terrific, thanks and best luck to everyone and Lyn, we'll speak to you soon.

Thanks, Brian.

Thanks, Brian.

The next question is from Neely Tamminga with Piper Jaffray.

Please go ahead.

Great, good afternoon and congratulations on fabulous results.

Hi, just three -- or two quick questions actually.

So, are you getting the lift when you do this conversion in the loyalty program?

Is there a benefit to kind of reengaging with the customer when you do the loyalty program conversion and then maybe related to that, is there a timeline that you expect to complete this?

I don't remember hearing that.

Thanks.

Neely, this is Chuck.

I don't think we've commented.

I don't know all of what we've said publicly, but obviously we wouldn't be converting if we weren't pleased with the results.

The loyalty program has been very successful and we -- I think in Lyn's comments, noted that we're about 24% converted for our store base onto the new program.

As far as the timing is concerned, the Company has approached that in a very measured fashion.

We'll continue to do that.

So, we'll continue to convert stores over and we'll keep you up to date as that proceeds.

But just broadly, is this a three year program or kind of in that 12 to 18 month sort of time frame?

It's sooner than three years.

Okay.

And hi, Gregg, just a real housekeeping question, when you said SG&A is flat, just again clarify.

Do you mean dollars or rate?

Our rate.

Rate, okay and just lastly, Lyn, we wish you well.

We have a high degree of respect for you over the years, my friend and we thank you for your steadfastness and your goals and know that you are passing this off into good hands.

So, thank you very much.

Neely, thank you.

That means a lot.

The next question is from Evren Kopelman with Wells Fargo Securities.

Please go ahead.

Thank you.

Good afternoon, everyone.

Hi, Evren.

Congratulations on great numbers.

A question on the supply chain benefits.

How much more opportunity do you think there is going forward and how much, if you could quantify so far, you have seen?

For the second quarter as we mentioned, there's about 30 basis point of benefit.

We're starting to cycle in the back half of the year some of the acceleration of these new programs, but still continue to believe that there's approximately 20 basis points of margin expansion opportunity in the back half of the year from supply chain and then we'll be more normalized next year cycling what was already in place at the beginning of the year.

Okay.

And then on the comp growth, I mean you've had double-digit comp growth all year, do you feel like there's an inflection point maybe in the channel in terms of you gaining market share or is it maybe some of the recent prestige brands you've introduced like Philosophy that's really accelerated the comp growth?

Thanks.

Evren, these strategies have been in place since 2009.

I think what we're seeing here is, particularly on a two year basis, we're seeing some slight acceleration on a two year comp basis and I think that continues to reinforce all of the strategies and how successful they have been attracting customers into our shopping environment.

So, is there an inflection point?

Don't see one in particular.

We are cycling in the fourth quarter a little bit higher comp from last year, but keep in mind, on a two year basis and on a three year basis, we still haven't gotten back all of the benefit of what we lost in 2008.

Evren, this is Chuck.

I would add, the foundation of the Company is incredibly well built.

So, our guests are voting with their dollars and we think that continues.

So, the exact numbers will bounce around obviously, but we think that there's just huge runway on our existing store base and that add onto it the additional store opportunity we have in online and we think that this is a long term growth business and that we're only partway through.

Great.

Thank you.

The next question is from Daniel Hofkin with William Blair.

Please go ahead.

Good afternoon and congratulations on the results.

Just a question, first of all, on Philosophy.

To what degree, I guess just seeing the pickup -- the further pickup in the two year comp trend, to what degree do you think that might have been helped by Philosophy versus just kind of gaining further traction on your marketing strategies that have been in place for the last 18 months?

It'd just be interesting to see how -- because clearly the brand is performing well, but you've obviously got a lot of underlying drivers already in place.

So, it would just be interesting to hear your perspective on that.

That would be my first question.

Let me take that for you.

There's no question that Philosophy is a great add to our business in terms of driving market share and we'll simply bring some new customers in, but nonetheless it is only one lever in the business and you appropriately referenced the other critical levers on the business which is the customer acquisition strategy we embarked on 18 months ago and as we zigged when everybody else zagged we invested to acquire customers.

We did so successfully and then as we acquire customers, we then embrace them in part of our loyalty program, which of course, then drives retention and continues annuity in our customer traffic that we get.

So, it is the fundamentals of the marketing model.

It is certainly a brand like Philosophy as well as some of the other new brands that we spoke to and last and certainly not least, just the creativity of the marketing events themselves.

So, the good news is, as we have said many times, this is not a one lever business.

There are multiple levers for us to pull and you basically hit on two out of three of the key ones.

Great.

And I mean in terms of what -- I think you indicated in the first quarter that sort of the customer offtake, if you will, on couponing or the rate at which they're redeeming coupons was about flat year over year last year that obviously had been up, how would you characterize kind of the end consumer just of your -- in your category at this point versus let's say three to six months ago?

Basically the same, Dan.

We're seeing redemption rates in line with first quarter and not terribly different to the same quarter last year.

So, as always, that increased redemption rate that we got last year in the beginnings of the tough economy, we have not seen that go away, but we have not seen it increase either.

Got it.

And in terms of the expense savings target for the year, it sounds like you upped that a little bit.

I think you were originally planning $5 million.

Any detail on kind of the incremental couple million?

We're seeing a little bit more leverage in some of the cost efficiencies that we started to put in in the back half of last year as it relates to advertising and again, the cost efficiencies, they're not changing the number of impressions.

Got it.

Thanks.

Congratulations and all the best Lyn, for everything.

Thanks, Dan.

The next question is from Joe Altobello with Oppenheimer.

Please go ahead with your question.

Thanks.

Good afternoon.

Just want to go back to the marketing side of things for a second.

Obviously your departments or competitors have shown some pretty good numbers as of late and I'm curious if you've seen or anticipating any step up on their part in terms of the marketing spend and the sort of fight for the incremental consumer in the back half of this year.

Joe, I think it's going to be aggressive in the back half of the year in the fourth quarter.

They are every year, but we track this pretty closely.

We haven't seen them be a lot more aggressive in this space.

So, I think that, that -- it will be consistent with what it has been in the past number of years which means for the fourth quarter it will be aggressive.

In the meantime I think that we're in outstanding shape.

Again, back to our guidance for third quarter.

We think that our efforts that have been put in place over the past couple of years are really starting to produce terrific fruit and that will continue into the fourth quarter as well.

Got it.

So nothing unusual on their part in the back half?

No.

Okay.

Secondly, in terms of the management team, obviously, Lyn, I certainly second everyone's sentiments on the call that you will be missed.

I was curious if there are other management departures below the executive level that we should know about.

No.

I think the team -- I commented on this on the last earnings call.

I was very impressed with the team when I came in.

I think we have a very strong core team.

Obviously there -- people there are retirements or people who may have been here for 15 years, but the core team is a strong one and will remain intact.

Got it.

Just lastly for Gregg, the gross margin commentary you mentioned earlier just to clarify, you're looking for up to 50 basis points of gross margin expansion for the back half of the year?

In the fourth quarter.

In the fourth quarter, okay.

Midpoint third quarter about 200 basis points and then approximately up to 50 basis points in the fourth quarter.

Got it, perfect.

Okay.

Thank you.

The next question is from Sam Panella with Raymond James.

Please go ahead with your question.

Thanks.

Let me add my congratulations and, Lyn, you'll certainly be missed.

Going back to the preopening expenses, a little bit lower than expected in the second quarter.

Is that also part of perhaps the lower SG&A, or the greater savings that you're expecting this year?

Actually, no.

The targeted savings that we talked about we identified the $5 million at the beginning of the year was primarily related to some store operating costs unrelated to preopening, supply chain costs as we continue to execute those strategies and the last one, which is the one I referred to that we took up based on the traction we're getting there in the experience, which was advertising.

Okay.

Then -- so what drove the lower than expected -- previously expected preopening costs in the second quarter?

Yes.

A couple things there.

As we continue to with experience and an incredibly capable team that's done a great job continuing to refine this store opening program, particularly as we've thrown more volume at that, they've driven more efficiencies getting the stores open, shortened the set period of time and the marketing team has continued to find creative ways to leverage our existing marketing vehicles that are out there to announce new store openings.

So, a little lower labor and a little lower advertising costs just leveraging the time of year that we're opening these stores.

Okay, great.

And then just turning to your eCommerce business, anything that you could give us in terms of the sales, the increase year over year or perhaps the percentage of total sales and you also talked about enhancements to your site, but anything you can discuss in terms of what you're doing to drive traffic to your site?

Thank you.

Yes.

Sam, our eCommerce business, we said before, is still a very small revenue business.

So, it's growing at a very high percentage clip, but it's on a small base.

We think that it will continue to grow and it will become a more meaningful component to the business.

You mentioned some of the functionality improvements that we've had to the site.

Those will continue.

As we do that, we're leveraging it and starting to advertise a little more aggressively in a variety of digital places and also we have stepped up our use of e-mail.

The mention of our loyalty program gives us a great avenue to be able to communicate with our customers and we're inviting them to come in both to our stores as well as to the website.

So, that's how we're really leveraging the word on that website and as the functionality continues to improve, we think that more customers will come and traffic will continue to increase.

Okay, great.

Thanks, everyone, and good luck.

Thanks, Sam.

The next question is from Jill Caruthers with Johnson Rice.

Please go ahead with your question.

Good afternoon.

If you could talk about what you learned given you had a significant prestige cosmetic launch benefit last year and then going on top of Philosophy this year and as you continue to do this kind of what are you learning and what did you maybe change from the big launch this year versus last year, just trying to get a handle of how you're improving the effectiveness of the launches.

The answer is each brand that comes on board we treat uniquely because they all have particular aspects to them that we need to pay attention to as we launch.

Benefit was heavily obviously focused on cosmetics, Philosophy more skincare focus as we have relaunched the brand.

So, they are actually quite dramatically different launches, but the principle always remains the same, which is that it gives us an opportunity to speak to new customers as well as speaking to existing customers to get them to come in more frequently and that was why part of my response to Dan was as we launch a brand like Philosophy, it both drives the market share, the average ticket and we do believe brings in new customers.

So, we focus on the same fundamentals, although the nuances of the launch are absolutely different depending on what the brand needs.

Okay.

And then just headed into the key holiday period fourth quarter, are you looking at maybe focusing marketing on certain merchandise or are you focused more on pricing, value?

Is there anything we should look for that will be different from the first of last year?

I think that the foundation right now includes talking about our brands, talking about the services and our stores.

Value is certainly an underlying component, but I think the secret sauce is that we have each of these components working in tandem, the offering, the service, the environment and the store as well as value and I think that will be the foundation for fourth quarter, as well as third.

Appreciate it.

Thank you.

The next question is from Erika Maschmeyer with Robert W Baird.

Please go ahead.

Thanks.

Congratulations.

Thanks, Erika.

Could you talk about your real estate pipeline and how you're thinking about your strategy for next year and then also, Gregg, you mentioned looking for ways to reduce your new store opening costs, how that might look relative to what you've been seeing this year.

Yes.

On the real estate side, I'll take that one, I don't think we've announced what we're looking at specifically next year other than we are trying to get -- we think there's the opportunity to get to about a 15% growth in square footage.

We are finding sites out there.

Obviously new developments have slowed due to the economy, but we have been successful in finding very appealing existing real estate and being creative in how we've worked with landlords for that.

So, we're well into our goal for 2011 and I think that that 15% growth as we sit here today is very realistic.

Great.

And then also on new store costs?

As it relates to total new store investment, we've taken that down to about $1.1 million.

We've lowered the cash and cash payback to about 2.5 years based on all the work that the team has done over the last 12 to 18 months.

We do continue to believe that there are some further opportunities there, not of the same order of magnitude of the $400,000 to $500,000 we pulled out over that 18 month time period.

There's probably a little bit more room in preopening costs.

The capital that the team has done an extraordinary job finding efficiencies in value engineering and the store fit-out that is invisible to the customer and really the last opportunity is to probably leverage the new store inventory.

We have a couple of strategies; as we pursue them, we'll make them known to the market.

Great.

And then could you just talk a little bit more about how your holiday strategies will be different versus last year on the merchandising marketing side?

It looks like it will be another promotional season in the malls and also if you could talk about how your private brands would play into that strategy.

Yes, Erika, I'm not sure we want to go into a whole lot of detail other than to say we have a very effective marketing component as I mentioned a moment ago.

Our strategy will revolve around our brands.

We've introduced a number of new brands this year in all different parts of our business, but we'll augment that with the service that we have in the store, the one-stop shop component.

There will be great values that involve both the promotions as well as gifts that we have to go gift with purchases that we have with fragrances, for instance.

So, I think we're going to be in very good shape and I think that back to Gregg's earlier point, we go against fourth quarter last year where we had a comp increase, but when you look on a multi-year time horizon, we feel very good about how we're looking for the balance of this year.

Great.

Thanks so much.

Welcome, Chuck, and best of luck, Lyn.

Thanks very much.

Thank you.

There are no further questions in queue.

I'd like to turn the call back to management for closing remarks.

Well, thanks, everyone, for joining us today.

This will wrap up our Q2 call and we look forward to speaking to you at the beginning of December for our third quarter call.

Thank you.

This concludes today's teleconference.

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Thank you for your participation.