Sally Beauty Holdings Inc (SBH) 2007 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Sally Beauty Holdings Conference Call to discuss the company's second quarter fiscal 2007 results.

(OPERATOR INSTRUCTIONS)

Now I would like to turn the call over to Sandy Martin, Vice President of Investor Relations for the company. Please go ahead, ma'am.

Thank you. Before we begin, I would like to remind you that certain comments, including comments on matters such as forecasted financial information, contracts or business and trend information made during this call, may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Many of these forward-looking statements can be identified by the use of words such as may, will, expect, anticipate, estimate, assume, continue, project, plan, and similar words or phrases.

These matters are subject to a number of factors that could cause actual results to differ materially from expectations. Those factors are described in Sally Beauty Holding's SEC filings, including its most recently filed annual report on Form 10-K and its most recent quarterly reports on Form 10-Q. The Company does not undertake any obligation to publicly update or revise its forward-looking statements. The Company has provided a detailed explanation and reconciliations of its adjusting items and non-GAAP financial measures in its earnings press release and on its website.

With me on the call today are Gary Winterhalter, President and Chief Executive Officer; David Rea, Senior Vice President and Chief Financial Officer; and Greg Coffey, our new Vice President and Treasurer. Now I would like to turn the call over to Gary.

Thank you, Sandy. And good morning everyone. Thank you for joining us for our second quarter earnings call.

In light of the challenges we faced during the quarter, we are pleased with the Company's solid second quarter results. Net sales increased nearly 5%, and comp store sales grew by 3.8% compared to the year ago quarter. This quarter's top-line growth was helped by acquisition. But even without any acquisition-related revenue, net sales were up over 1% despite bad weather in January and February as well as L'Oreal revenue losses at Beauty Systems Group.

As reported in our press release this morning, Sally Beauty Supply had a comp store sales increase of almost 2% for the second quarter, and Beauty Systems Group store comps grew 11%. In addition to acquisitions, the comparisons to last year's second quarter include a number of non-comparable items that David and I will detail in the discussion of our second quarter operating and financial results.

Before we get into the details, I know that a number of you are interested in our opinions on the continued consolidation in the beauty industry. As many of you know, L'Oreal recently announced the acquisition of the remaining 70% of Beauty Alliance. We estimate that Beauty Alliance, based in the Southeastern United States, is a $350 million revenue company. We intend to rapidly build our BSG store presence in the Beauty Alliance core market of Florida.

As we have already shown with the expansion of exclusive brand distribution this quarter, we believe BSG will continue to gain additional suppliers over time that do not wish to distribute their brands through a competitor's distribution network. Now that L'Oreal has confirmed their intent to own their distribution in the U.S., we expect them to purchase other L'Oreal brand distributors in geographies not covered by Beauty Alliance. We see this as further opportunity for BSG to gain brands and geography.

Turning to the operating results, Sally Beauty Supply's total net sales increased 8% over last year's second quarter, including $13.6 million in revenue from Salon Services, the UK-based business that we acquired in February. Excluding this acquisition total sales for Sally Beauty Supply during the second quarter increased 4%. Quarter revenue growth was primarily the result of continued unit expansion and a nearly 2% same store sales increase.

Segment operating margins improved to 17.9% of sales, primarily due to continued growth in revenues of higher margin products as well as a favorable sales mix between the retail and professional customers.

In addition, the Sally division did a good job of controlling costs during the quarter. Weather was a factor during January and February, particularly in January when Sally store comps were effectively flat. Given these challenges, we are pleased with the sales growth and the solid profit performance for the quarter.

One of tools we are working on to continue our solid revenue growth is the expected launch of our first e-commerce site for Sally Beauty Supply. We intend to initially offer customers the ability to purchase professional electrical appliances like hair dryers and styling irons on the site. We plan to update you more on this initiative during the third quarter call in August.

Looking ahead for the remainder of the year, we are expecting Sally Beauty Supply to continue its solid performance into the third and fourth quarters with continued unit growth and margin improvement.

As we have previously disclosed, BSG faced a revenue challenge beginning in February due to the changes in L'Oreal's distribution that primarily impacts revenue through our BSG sales force. Not withstanding this hurdle, second quarter sales were basically flat with the year ago period due to strong comp store sales of 11% and acquisition-related revenues of approximately $8 million.

During the months of February and March of 2006, we had approximately $20 million of L'Oreal revenue in our full service channel that we did not have this February and March due to the changes in the L'Oreal distribution agreement. BSG made up for this revenue shortfall with revenue growth of non-L'Oreal products, increases in comp store sales, and incremental revenues from the Salon Success acquisition last June, which contributed about $8 million of incremental revenue for the three months ended March 31.

Revenue and cost initiatives for BSG are well underway and I want to provide you with an update on a number of these items. We discussed in our first quarter call, we expected a decline of about $20 million for ancillary non-L'Oreal business this year. However, so far through the second quarter, our non-L'Oreal related sales have exceeded prior year levels in the DFC channel with very strong growth in the stores. While it is too early in our transition through these changes with L'Oreal, we are encouraged by the early indications of BSG's non-L'Oreal revenue growth.

We had also previously targeted the transition of L'Oreal sales from the street business to the stores as an initiative to offset revenue declines due to the contract changes. During the second quarter, we did not see a significant shift to the stores. And we did see a negative margin effect due to the loss of exclusive sales rights. We believe the margin pressures on our remaining L'Oreal revenues will continue for the rest of this fiscal year. Nevertheless, we also think it is too early to determine to what extent we will be shifting some of our lost street business to the store network.

I also want to update you on BSG's supplier changes. As we told you last quarter when we announced our new agreement with P&G, we expect to continue adding additional brands to our distribution network. As part of our revenue initiatives during the second quarter, we expanded distribution of the TIGI brand to BSG stores in seven additional states and to our franchise business in three more states.

Also during the second quarter, the BSG stores and full service channel expanded distribution of Shiseido's JOICO and ISO brands into 15 more states. The Rusk brand was expanded into eight additional states for BSG stores and three more states for our franchise business.

In Florida, BSG stores and sales people were awarded the distribution rights for Aquage, formerly distributed by Beauty Alliance. BSG now has exclusive distribution for Aquage in the majority of the country.

We did experience a supplier loss during the second quarter as well. The distribution agreement with Farouk, covering parts of our BSG operations, excluding our franchise business, was terminated. We expect to offset this loss over time through the sale of products from other manufacturers, including GHD.

Based on the L'Oreal changes this year, we have implemented cost initiatives and completed a short-term right-sizing of the business, which cost us about $2.5 million in reducing the number of sales consultants and closing warehouse facilities during the period.

BSG has also begun implementing a store name change for all BSG stores throughout the United States. Through an acquisition a couple of years ago, BSG acquired the name CosmoProf, which is a recognized and respected name in the beauty industry. The renaming of all U.S. BSG stores to CosmoProf is expected to provide brand consistency, streamline our marketing message, and save advertising dollars. We estimate that all BSG signs will be changed by the end of fiscal 2007.

Finally, we have made the decision to pursue a longer term project of BSG warehouse consolidation and distribution optimization, which is expected to save the company approximately $10 million annually upon completion over the next two years. There will likely be some transition expenses associated with achieving these savings. And we will update you on these as we begin to implement that project.

Now I would like to turn the call over to David to further discuss second quarter results. David?

Thanks, Gary. We are pleased to welcome Greg Coffey, our new Vice President and Treasurer. Greg brings finance and treasury experience with three other public companies. He will oversee capital markets activities, cash management, risk management, and financial planning analysis.

Net sales for the second quarter were $609 million, an increase of $28 million, or 4.8% versus the year ago quarter. And comp store sales increased 3.8%. As Gary mentioned, revenues for quarter were hurt by the absence of approximately $20 million of L'Oreal revenues at BSG in February and March of this year, which is offset by the addition of revenues from two acquisitions that contributed approximately $21 million of revenue in the second quarter of this year. Second quarter consolidated gross profit was $283 million or 46.5% of sales, even with the year ago period.

Selling, general and administrative expenses increased 7.6% to $212 million in the quarter, which represents 34.8% of sales. SG&A expenses for the second quarter included $2.5 million of expenses related to the BSG's right-sizing costs and facility closures due to the L'Oreal contractual changes announced in the first quarter. SG&A expenses included $600,000 of share-based compensation compared to $1 million in last year's second quarter.

Year-to-date SG&A expenses include $5.3 million of share-based compensation expenses for early vesting of equity awards from the separation transaction from Alberto-Culver. Last year's second quarter SG&A costs included a sales-based service fee of $7.2 million and a direct allocated overhead charge of $3.6 million, both representing the expenses from Alberto-Culver that ceased after completion of the November separation transaction.

Turning to the segment operating earnings, second quarter earnings for Sally Beauty Supply stores were $68 million, an increase of 11.9% over the year ago quarter with operating margins growing to 17.9% of sales this quarter. Although harsh weather in January and February somewhat hurt sales in the quarter, the combination of sales of higher margin products, a higher retail customer mix and solid cost controls made up for the sales issues during the quarter.

For BSG, revenues were almost flat with the prior year, and segment operating earnings were $13 million, a decrease of approximately $8 million, or 38%. Segment operating margins were 5.9% of sales for the quarter versus 9.5% in the prior year quarter. BSG's operating earnings were primarily impacted during the second quarter by the lost L'Oreal sales, $2.5 million right-sizing expenses, lower gross profit margins, a $2 million decline in the profitability of our franchise business, and approximately $1 million of retention incentives paid to the DSC sales force during the period.

While we do expect that BSG will continue to experience some margin pressures as we work through the loss of L'Oreal revenues, we would expect the ongoing cost of the retention incentives to decline over time. The incentives are structured as a commission subsidy that will decline and ultimately terminate within 12 months. We are also working on returning our franchise business to more normal levels of profitability.

As Gary discussed, we're beginning to get indications of the impact of the L'Oreal changes on our ancillary business as well as our BSG store sales. However with only a couple months of results, we believe it is still too early to determine the ongoing impact of the lost L'Oreal revenue. We are very focused on both short- and long-term revenue and cost initiatives for BSG that we expect could mitigate some of the negative impact for the remaining fiscal year and into fiscal 2008.

Having said that, fiscal 2007 will likely be a challenging year for BSG. As we work through these changes we expect to incur additional cost to reengineer the BSG business over the near term but we expect the benefits of these costs to pay off over the long run. We continue to believe that the primary driver for minimizing the revenue loss from L'Oreal is in finding replacement revenue or shifting revenue to the stores and we'll continue to see opportunities to do this. We plan to update you again on our progress with BSG's revenue and cost initiatives during our third quarter call in early August.

Last quarter I explained how we excluded certain corporate and shared costs from the operating segments and how we intend to apply this approach going forward. These unallocated general and administrative expenses include, in addition to general overhead costs, direct allocation from Alberto-Culver up to the time of separation as well as share-based compensation expenses, both of which were discussed as part of SG&A.

We currently expect unallocated G&A expenses to be approximately $85 million for the fiscal year 2007. This projection includes $1 million of Alberto-Culver allocated overhead charges incurred in the first quarter and share-based compensation expenses including $5.3 million of option expense recognized in the first quarter related to the separation.

Since the company's debt was outstanding for the entire second quarter, interest expense, net of interest income, increased to $43 million versus $19 million recognized in Q1, which was a partial quarter with the new capital structure. For the three months ended March 31, 2007, the company recognized $1.7 million of additional non-cash interest expense based upon changes in the fair value of our interest rate swaps. Although this is the proper GAAP accounting treatment for swaps, it does not meet the hedge accounting requirements. It is still important to remember the swap does take $500 million of our floating rate debt and fixes the cash interest expense for the life of the respective swap.

Our pre-tax earnings for the second quarter were $18 million and the provision for income taxes for the second quarter was $7 million. The year-to-date tax provision of nearly $21 million may look a bit unusual, given our pre-tax earnings for the first six months were $35 million, but the first quarter tax provision reflects the non-deductibility of a majority of the separation transaction expenses recognized in that quarter. Excluding the impact of these amounts, the company currently expects to have a 37% effective tax rate for fiscal year 2007.

Net earnings for the quarter were $11 million, or $0.06 per diluted share, which includes the $2.5 million of BSG-related restructuring charges as well as the $1.7 million of additional non-cash interest expense previously mentioned. Net earnings in last year's second quarter was $31 million.

In an effort to provide you with other metrics that we believe are useful in understanding our results, we have included in the press release a supplemental schedule that provides certain non-GAAP disclosures and reconciles these numbers back to the equivalent GAAP financial measures. We have provided an adjusted EBITDA number, which begins with net earnings based up on GAAP, adds back depreciation and amortization, share-based compensation expenses, transaction expenses, net interest expense and the provision for income taxes. Adjusted EBITDA for the quarter was $71.4 million versus $73.8 million in the prior year quarter, or a decline of $2.4 million. This year's second quarter includes the $2.5 million of right-sizing expenses as previously discussed.

In terms of our capital requirements, we are focused on managing inventory and other working capital in an effort to make them a source of cash without adversely impacting the business. Our intentions for cash are to grow the business, invest in new stores, make strategic acquisitions, and pay down debt. Since the end of the first quarter, excluding the acquisition recorded in February, inventories declined by approximately $14 million as of the end of the second quarter.

The company's goal for the full fiscal year is to reduce consolidating inventories by over $40 million, excluding acquisition-related inventory. We project that capital expenditures in fiscal 2007 will be between $45 and $50 million, which is higher than the previously projected $35 to $40 million when the first quarter results were released.

We plan to rename BSG stores for a consistent CosmoProf brand presentation, implement the BSG warehouse project previously discussed, continue to open new stores and use capital for other corporate needs. Projected capital expenditures do not include any potential acquisitions. During the second quarter we opened 12 net new Sally Beauty Supply stores, excluding the Salon Services acquisition and 11 net new BSG stores. In Florida, BSG and Armstrong McCall had six stores as of the beginning of the second quarter and plan to open an additional 29 net new stores in that state by January 2008.

We ended the first quarter with borrowings on the revolving ABL facility of $21 million. During the second quarter, we borrowed $59 million for the Salon Services acquisition in February and continued to pay down outstanding borrowings for the remainder of the second quarter. We ended the quarter with $58 million borrowed and approximately $284 million of available capacity on the ABL facility.

In addition, we paid down $2 million of both the senior term A loan and senior term B loan during the second quarter. The company's total debt increased by $32 million during the three months ended March 31, 2007, and we ended the second quarter with long-term debt, including capital leases, of about $1.8 billion.

Assuming the company spends between $45 and $50 million of capital expenditures and nearly $70 million for acquisitions during fiscal year 2007, we would currently expect to have sufficient cash flow to pay down additional debt during the second half of fiscal 2007.

As Gary stated, while BSG is faced with a revenue challenge this year, we are working hard to rebuild BSG's revenue stream and transition to improved cost structure. As we work through these issues, we would expect to exit 2007 with solid momentum. In the meantime, Sally Beauty Supply continues to deliver solid performance. And we expect the driving forces behind Sally, mainly unit growth and margin improvements, will continue into the second half of fiscal 2007. With that, we'd like to now open the call up for questions. Thank you for your interest in our company.

Operator? Luanne?

(OPERATOR INSTRUCTIONS)

Your first question comes from Linda Bolton Weiser with Oppenheimer.

Thanks. Can you just explain a little bit more about the Farouk, the loss of the business there? And it was hard for me to understand, did you lose electricals and shampoos and conditioners, and you're replacing it with electrical? And if so, what does that mean for the margin mix of the replaced business versus what you lost?

Linda, I'll handle that. This is Gary. Good morning. We carry -- the bulk of our Farouk business is in our franchise division, Armstrong McCall. About 75% of Farouk's business with us is in electrical appliances, the CHI products. We no longer carry those in the geographies that the rest of BSG carried.

However, it was not throughout the whole BSG system. And there as well, about 75% of the business is in the electricals. We have struck a deal with a European company called GHD, which has an excellent quality iron with margins that are a little better than we were receiving from CHI over the last year or so, primarily because of our having to sell the CHI irons in many cases at a reduced cost because of the retail diversion of CHI.

So I don't know what happened with Farouk. I can tell you that the owner of the company was concentrating on building their business in Europe and one of his minority partners took over the operation of the business, hired a national sales manager in January. They terminated the relationship with us in February. Then Farouk came back and fired that guy, and his minority partner is no longer active in day-to-day operations and Farouk is back to running the company.

So I don't know where this is all going to shake out. We enjoyed our business with Farouk. We've got a huge business with Farouk at Armstrong-McCall. Armstrong-McCall is by far Farouk's largest distributor. So we'll just have to see what happens here.

The distribution went to various distributors around the country. The Beauty Alliance did pick up a little bit of it in the southeast and west coast went to other distributors as well as the Midwest. We feel like the GHD product is an excellent quality product that's very, very comparable to the CHI irons. We do a lot of business with them in the UK today. And we feel like we can do a lot to replace that business reasonably quickly.

And just to clarify, in terms of the termination. The pieces of revenue that were terminated represented about 3% of BSG's year-to-date revenues. In Armstrong, Farouk is a significant part. Obviously Armstrong, our franchise has also changed the rights under L'Oreal's sales matrix. And that is also a large product within that group.

Okay. Can you name a few other suppliers to BSG that represent as much as 3% of BSG sales? Are there a couple that you can name or are there a lot of them that are that big?

A lot of them that are that big, well the P&G brand, Wella/Sebastian are that big. Or actually they're significantly larger than that. There is a lot of them in the 3% or 4% range, not as heavily concentrated in electrical appliances. We do carry other electrical appliances. But no, there aren't many of them that are above that.

As we previously disclosed before the changes in L'Oreal, L'Oreal and related brands within L'Oreal represented our largest vendor prior to that change, which now, obviously, given that changes that occurred have brought that down. But we still have a significant piece of business with L'Oreal in the store as well as at Armstrong. So they are still the largest, and it comes down from there.

But as we talked about in the press release and in our comments, one of the things that's happening in the business is the growth in non-L'Oreal brands, both in the street business as well as in the stores, is really starting to compensated in part for the loss on that we have seen in February, March that we talked about.

Linda, our next largest vendor that would be significantly more than that is Paul Mitchell. And that brand is just showing enormous growth with us right now with their hair color. And I think the fact that the A.C. Nielson diversion report for the first quarter of '07 came out a few days ago. And I find this almost hard to believe, but I think it's wonderful. The Paul Mitchell numbers were down 40% over the year ago quarter for diverted products. I think they're doing a marvelous job and we're doing everything that we can to help them basically get the diversion business taken care of. And I think that's being reflected in our sales increases as salons want to move more and more to the lines that they don't have to compete with retail on.

Okay. Thanks. That's helpful. And a little bit related to that, we noticed that L'Oreal recently announced the acquisition of another professional hair care brand. And of course they own several already. What's the dynamic with that? Do you think that manufacturers will leave their distribution? And do you think that will benefit you? Would you ever consider buying professional hair care brands?

Well the answer to your first question is, yes, I think they will. They already are starting to, as we just discussed with Aquage, and obviously the Wella and Sebastian brands earlier this year. Would we consider a brand? That's something that we may consider in the future. Right now we think our forte is distribution and we've got great relationships with people like Paul Mitchell and Shiseido, it's JOICO and ISO brands, and Wella now. So that's kind of where our focus is. But that's not out of the questions, long term.

Do you distribute any of the brand that they just bought?

No, we don't.

Okay. And can I just ask about the $10 million of cost savings related to the warehouse and supply chain and all that. How's that going to go over the next two years? Can you break it down between the two years? And also, does that change that range that you gave of 18% to -- I forgot the exact range, but the percentage of the lost sales that drops to the bottom line. Does that change that guidance range or were you thinking of these cost savings when you provided that guidance range?

No, the flow through example that we gave last quarter was, as we said, really just a very simple, high-level example of what the loss in revenues through L'Oreal could do to us in looking at the various costs associated with that. What we also said was -- and that was at the high end was 28%. We were trying to take actions to then drive that down towards the lower end of the range. And the biggest initiative related to that is finding replacement revenues. But we also were looking at changing our cost structure. And this quarter we did have some costs associated with some of the right-sizing. That's the $2.5 million.

The warehouse project that we're talking about is a multi-year project. And we're really just beginning that. So it is going to stretch out over a couple years. But we think by the time we get into fiscal year 2009 that we could have savings of that, $10 million. Now we will have some right-sizing expenses that will incur between now and then. Most of that should happen in fiscal year '08 as we work through the specifics on the various location changes. So that's kind of how we see that playing out.

Okay. I'm still not sure I'm clear if I should consider it as incremental or just helping you to get toward the low end of that range that you gave.

Well, if you look at BSG on a sort of global basis, that $10 million on the revenues adds about a 1% margin to the business. So again, the example we gave is not meant to be an exact flow through. There's tons of things that are affecting that both ways.

For instance, the incentives that we put forth that are costing us this quarter, that would tend to increase that flow though to the higher end. To the extent that we reduce costs, whether it's through this or other measures would tend to put it down at the lower end. So it was a range on purpose, and it will change as we take management actions to improve. So everything we take, every action we take, obviously, is trying to drive that flow through range towards the lower end.

Okay. And can I just ask one on the Sally Stores side? It seems that -- I seem to think that you were pretty solid on the 5% square footage growth, starting to ramp up pretty quickly. And now you're saying 4% to 5%. Maybe that's a little bit lower end. And it looked like you didn't open that many stores in the quarter, fewer than I projected. So can you just --

Sure. Our guidance has always been the 4% to 5% square footage growth, excluding acquisitions. And you're right. If you look at our store openings to date versus what we're expecting for the full year, we are running a little bit behind. But we're hoping to catch up here in Q3 and Q4.

And are you finding that the sales per store upon initial opening is the same as historical new store openings. Is there any change in sales to expect?

No, there hasn't been any change. A lot of our new stores, Linda, this year are in Mexico and Canada, where those are actually virgin markets for us. So that's actually healthy.

And Linda, we need to go on to the next question, if you don't mind?

Okay. I think that's all I've got for now. Thanks a lot.

Thank you.

Your next question comes from the line of [Steuben Catalia] with JPMorgan.

Hi. It's actually Carla Casella from JPMorgan. I want to make sure I understand you correctly. You said you had expected to lose about $20 million of other sales. And you didn't see that in the quarter as a result of the L'Oreal.

That's correct. We actually saw the other non-L'Oreal related sales increase significantly as opposed to seeing it erode.

Okay. Great.

To just be clear, we had $20 million of L'Oreal-related revenue in February/March of last year. And we did not have that this year due to the changes in the L'Oreal distribution agreement. So we've been making up for that revenue shortfall through revenue growth in our stores and with other brands.

That $20 million would be part of the $110 million in the first nine months of last year. $20 million of that would have been second quarter?

Yes, the $110 million for the remaining nine months of the fiscal year when we announced that, that represents about $90 million related to L'Oreal and then about $20 million of ancillary sales that we assumed we'd also lose.

Okay. So you're not saying any of those numbers have changed?

Well, that was the estimate based upon our looking at the historical revenues of L'Oreal and then making an estimate for the ancillary sales and what the impact would be for the remaining three quarters end of fiscal 2007.

Okay. And then --

And so now what we're reporting back to you on is in those two months of February, March of last year, the number was $20 million of L'Oreal-related revenues, which we did not have this year and how we're doing against that in terms of growth in other brands, comp stores, et cetera.

That's great. Okay. I missed the number you said for how much you had to pay in additional incentives this quarter.

It was about $1 million.

Okay. And can you just talk about where you stand in terms of your direct sales force. Have you made a number of headcount changes or anything related to the L'Oreal? Or is really the only change that's gone on so far is the additional incentives?

No, in January, we reduced our sales force in the affected areas by about 25%. That's part of the $2.5 million -- the risks were part of the $2.5 million in the quarter.

So we kind of right-sized the sales force when this first happened in January. And I think, as we've mentioned before, of the sales people that we identified as keepers, we have retained 88% of those. And that number hasn't changed. We've had very little change since January in our sales force. Actually the total number's gone up by about 14 or 15 people.

Okay. And then so the run rate. First quarter you would have had one month with additional sales people in it. So your run rate SG&A should actually come down in the coming quarters. Is that right?

Well, if the $2.5 million is out of there.

Yes.

Okay. That's the -- okay, I got you.

Right.

And then just one last question. Can you quantify -- you talked about gains in getting eight more states for Rusk and three for the franchises and a number of other gains. Are you quantifying magnitude potential revenue pick up from any of those?

Are you talking about in terms of the new agreements that were signed?

Yes.

Those are -- TIGI, JOICO, those are all smaller dollars in terms of what we're currently doing with them. But obviously that's what we're trying to grow here over time as part of our L'Oreal related initiatives and those are the types of brands, including, as Gary mentioned, Paul Mitchell and others that we're showing very healthy increases both at the stores as well as in the street. Gary, do you have anything to add?

It's difficult when you go into some new geography with some of these brands to really target what the revenue increases are going to be. But when we added the Wella and Sebastian brands back to our store we saw significant increases there. These brands are not as large as those. So we don't expect them to be that.

But it's all geared at making up the roughly $10 million a month in DSC sales that we've lost with L'Oreal. And these brands are included in what we called ancillary business, which was a non-L'Oreal brand. And they were up almost enough to offset what we lost with L'Oreal. And the only thing that was added in there that was not like to like was the $8 million from the acquisition that we made last June.

Okay. Great. I'm sorry. I forgot to ask did you make comment early on L'Oreal's buy of PureOlogy, any impact you expect from that?

No, we did not distribute PureOlogy anywhere. So it really has no impact on us.

Okay. Great. Thank you.

You're welcome.

Your next question comes from Reed Kim with Merrill Lynch.

Thanks. Good morning.

Good morning Reed.

Good morning.

I'm fine. Thanks. David, I just wanted to maybe get a little bit behind the retail comps number a little bit more if we might. I just wanted to understand in the quarter, maybe you could break out maybe the change in ticket versus traffic. And then also if you would give it maybe what the international comp was and domestic.

Yes, we don't break out the details on that. So I'm not sure on what I can do for you on that. International is growing very nicely, ahead of the domestic. As I said, January in the Sally side of the business really was our tough month with the weather with the comp stores effectively flat. But they increased within the quarter from January to February to March. So we exited the quarter at a pretty decent rate.

Was there any kind of a negative impact on comps from the shift towards your control brands?

No. Our control brands -- one of the driving things within the Sally Store group from a profit perspective is the ongoing shift toward the private label and control brands. And then trend continues. And that's one of the things that has helped basically quarter in and quarter out from a margin and a profit perspective. And we see that trend continuing.

And what was that mix in retail and BSG? I think the fusion of beauty is being rolled out. If you could just give us what that mix was in the quarter.

Well private label and BSG is basically next to nothing. The initiative for private label and control label really is a Sally Store initiative. And that's where the impact occurs.

Okay. And as proportion of sales in the March quarter, can you give us what that was?

It's right around 40%.

Okay. And on the comp question, since you don't want to give a hard number. Can you just comment? Internationally I know that Canada and Mexico have very strong for you, but how you're seeing the business over in for example Japan. And then maybe a little bit of elaboration, maybe this is for Gary, on the European opportunity.

Yes, actually Canada and Mexico aren't large enough to have much of an impact on comps even though the comps are very good there. Where we really are seeing strong comps actually this whole fiscal year has been in the UK. And Germany's been relatively flat. So our international comps are coming out of the UK. As you know, we made an acquisition there in February. And that actually gave us a bit of a presence I Western Europe in Spain, in Norway, and a couple of those countries. And we want to look at expanding in those geographies in the future.

Should we expect to see that more on an organic basis where you use that as a platform to add stores? Or are there other potential acquisitions on the continent?

I think there's a couple of acquisitions on the continent. They would not be nearly as large as the one we made in the UK. But it's a nice way for us to start if we can acquire 20, 25 stores in a country or a geography, it usually is a better way for us to start than trying to do it all organically. And there are a few of those on the continent.

Okay. Just a couple other ones, I think you said that the headcount in the BSG sales force was reduced by 25%.

Yes.

But what is the actual number at the end of the quarter of sales people?

It was right around 1,000.

Yes, it's 1,036.

And keep in mind I said we reduced it about 25% in the affected areas. So the non-affected areas, which are Armstrong-McCall and Canada, were not reduced. So we went from approximately 1,200 down to about 1,000, which is a 200 reduction. But it's about 25% of the roughly 800 we had in the affected areas.

Okay. And Gary, could you comment just a little bit more on that competitive dynamic where you mentioned that margins may be coming under pressure? I guess the way I'd ask the question is in those areas where you may overlap with another professional distributor who has now gained some L'Oreal distribution and maybe they have stores in the same market as you, how are you seeing that play out?

Well that's exactly what the margin pressure that we're referring to is. When you don't distribute a brand exclusively, you inevitably run into some margin pressure. So we expect that to continue was we get more and more competition on the L'Oreal brands. Now keep in mind that every day the L'Oreal brands are a lesser percentage of our store business as these non-L'Oreal brands are growing at a much faster rate.

Okay. Thank you.

You're welcome.

Your next question comes from Justin Hott with Bear Stearns.

Thanks. First question, just to make sure I understand this. So of the $110 million of lost L'Oreal sales about $90 million was from L'Oreal and $20 million would be from ancillary. And the ancillary is doing better than you would expect and then could actually be a gain but L'Oreal is in line with your targets now. Is that correct?

No Justin. First of all, good morning.

Hi.

I would put it this way, that you're correct for the nine month period, $90 million was L'Oreal and $20 was ancillary. The ancillary business that we expected to lose, we did not lose and it actually grew, which offset the lack of L'Oreal business we thought would more to the stores. We did not see nearly as much L'Oreal business move to the stores as we expected.

So if you were to do it all over again, that $90 million might be a higher number?

The $90 million --

No, the $90 million is lost L'Oreal revenue. That's just what we had from a historical fact on a same period last year for the nine months. That's the revenue we no longer have.

But there was another expectation that you would get some other sales, right?

So the $90 million is what we lost in L'Oreal revenue. And the original expectation that makes it $110 million was historically as orders were placed for L'Oreal there were other things ordered at the same time. So the expectation was that non-L'Oreal products would also be lost because we lost the L'Oreal order. And that extra, the ancillary is the $20 million that makes up the $110 million for the nine months ending September 2007.

And what we're seeing is in fact we did loss the L'Oreal piece because that was the contractual change. But what we are seeing is instead of a decline in non-L'Oreal brand sales, we're seeing an increase and in some cases significantly. The non-L'Oreal product growth, for instance, in the stores in February was up almost 20%, same thing for March. So very healthy increase in non-L'Oreal brand growth in the stores.

What Gary mentioned is what we did not see that we were hoping to see, which is a shift of L'Oreal sales from the street into the stores. In fact our L'Oreal business in the stores was effectively flat in both February, March. So we didn't see a shift of L'Oreal revenues into the stores that we were hoping to. But on the other hand, the non-L'Oreal piece, the ancillary part was better than we expected.

And that $110 million wasn't anything to do with the stores. That was just the DSC revenue.

I guess that just brings up the question of the people who are still going to stores that have lost L'Oreal -- excuse me, going to salons. It would make no sense if they were going to BSG to try to sell your products. Of those people that are going to salons, are they able to transition these salons to the products they're carrying now? How is that going relative to your expectations?

Well I think that it's going well. And I think Paul on his call last week kind of said the same thing. That they're not seeing increases. And he says that he believes a lot of it is due to diversion. But they're seeing much larger increases on non-L'Oreal brands. So I think that's going quite well actually.

And by Paul, you mean Paul Finkelstein of Regis?

Yes, I'm sorry.

Okay. And I'm going to keep this to a couple then I'm going to try to jump back into the queue. Just on Sally for second, even without disclosing international versus domestic comps, obviously you have the Salon Services acquisition. I'm just wondering if you are seeing a deceleration in U.S. same store sales growth and basically if the strategy is to go more international because of that? And how does L'Oreal affect that strategy? Are U.S. comps up for example?

You're talking Sally now?

Sally, yes.

First of all, L'Oreal has no impact on Sally with what they did or anything else.

Nothing strategic at all?

No. We carry their open line product in Sally. But it doesn't really have an impact on the Sally business. To answer your question, we've been running Sally same store sales comps between 2.5% and 3% for several years now. And our expectation this year is that we would continue that.

Now going into next year, we believe that with some of the initiatives we have in place, specifically the e-commerce and a couple of the other things we're doing with our loyalty club program and some of the things Mike Spinozzi is doing that we'll start kicking in, in our fourth quarter, we're looking to get our comps up above 3% next year.

Now as far as the UK acquisition, that's a Sally acquisition number one. And because we operate over there as Sally, our BSG business over there is the smaller, salon success Paul Mitchell distribution. So and of course the Salon Services, the acquisition we just made for Sally over there is not in our second quarter comps obviously. So I'm not sure I'm answering your question.

Not only did you answer my question, you answered the next question as well, too, Gary.

Okay.

Which is why Salon Services was in Sally, not BSG.

It's basically because those are the brands that they represent.

Yes. Question on -- real simple one, can you just explain why you're changing the names to CosmoProf, what that name means in the industry?

Sure. That's an easy one. CosmoProf first of all stands for cosmetology professional, kind of an abbreviation. CosmoProf is also a show name throughout the world that is well known, the CosmoProf show that's held in Las Vegas every year, the big on that's held in Bologna, Italy. There's another one held in Sao Paulo in Brazil. So it's a well-known name.

But the primary reason for the change is today we operate for example on the West Coast as West Coast Beauty Supply, in the Midwest as Heil, in the Upper Midwest as Victory, in the East as Ace, in the Southeast as Davidson and Macon. So we don't get a lot of advertising benefit because we have to do separate advertising breakouts for each one of those trade names that we operate under.

And what we want to do -- this was in the pipe for a long time. Now that we have a national footprint, we would like to do more national advertising. And there's a lot of advertising efficiencies by not having to do 25 or 30 different advertising pieces every month because of all the names we use.

So we think that could for instance save us almost $1 million by having that type of uniform name.

Okay. I'm going to jump back into the queue, let some other people ask questions. But I've got a couple more. Okay?

Okay. Thank you.

Your next question comes from Laura Richardson with BB&T.

Thanks. Hi, everybody.

Hello.

Hi.

May I ask a bunch of questions basically trying to get at things for my model? Actually I think you answered everything about the Sally comps very well. But I was going to ask about BSG comps. That 11%, would you say that that was a reflection of some business shifting from the street to the stores? And then how do you feel about projecting it continuing at that rate?

No. It's kind of interesting. That's kind of what we were saying that at least in the L'Oreal brands we're not seeing the shift from the street to the stores. What's adding to the store comps is the continued rollout of the Wella/Sebastian brands, which is complete now. But it takes awhile for the customer to understand that you have it and so forth.

Right. And to need it.

Pardon me?

And to need it.

Yes, of course. So a lot of it has to do with additional brands. But a lot of it has to do also with what I think is some pretty effective marketing that we're doing. And I would expect these comps to be similar for the rest of this fiscal year but even not quite as strong as they are today, but fairly solid into next year as well.

Okay. And do any of the other brand changes, like Farouk or TIGI, do those affect your BSG comps?

Of course. Yes, any time you add a new brand to the store, you're going to get a bump in that. And we expect to continue adding brands, particularly as I mentioned before as brands may choose to pull away from L'Oreal owned distribution.

Does Farouk take away from that comp too?

Yes. It did slightly. It did.

Okay. And is this a normal or a higher than normal rate of change in the distribution of the brands over the years?

(Inaudible) at the rate of this -- yes, our industry or at least this side of our industry, the BSG side is probably going through more change in the last couple of years and the next couple of years than it's had in its entire history.

Okay. And next question, basically I'm thinking about SG&A now. Did I hear you say, David, you think $850 million is going to be the SG&A expense this year?

$85 million. $85 million is our estimate of the unallocated SG&A for the year.

Okay. And you're factoring in -- obviously all the changes related to L'Oreal, changes related to the CosmoProf brand -- is that -- and then to distribution centers? Is that all true?

Yes. Just to be clear, the $85 million is part of the SG&A. If you go for instance to schedule A's press release --

Right. Right.

-- you'll see a line called --

Okay.

-- something like general administrative. So in the quarter, that was 212. Go to schedule B and you'll see below the segment operating earnings is the unallocated corporate --

Right. Right.

That's really corporate headquarters. And that's not related to the selling and other expenses in (inaudible) --

Okay. Got it. So --

That's the $85 million I'm talking about.

Okay. How about -- but then for the total SG&A for the year, you said you factored in capital for the CosmoProf re-branding. Is there going to be dual branding or your just going to change Davidson into CosmoProf?

Yes, it will just change from Davidson or whatever it is to CosmoProf.

Okay. And there's capital spending factored in for that?

Yes. There are really two reasons for our CapEx guidance to be changing upward. One is the signage that we talked about. The other is the distribution project that we're staring to get underway this year. So those two things increased the CapEx. That really is not part of the $85 million. So now it's kind of allocated corporate overhead.

Okay. I got that, too. But is there going to be some SG&A associate with those changes, I guess, for BSG?

Yes. And just to be clear, the warehouse project we're talking about are BSG related and not Sally related.

Right.

And as I said earlier, I would expect that we will have some right-sizing, one time types of cost associated with that project. Most of which though will be we think in fiscal 2008.

Okay. So the cost savings you think are going to start in fiscal 2009?

We should get some in fiscal '08. But we really won't probably hit it all until '09.

Okay. And have we seen all the usually charges related to L'Oreal, that $2.5 million? Was there more to come?

You've probably seen the largest piece of that. But yes, we've continued to look at and have some things we're working on there. And as we see results we'll react to those and make any further changes in our cost structure. But we do have some other things that are likely to come up as part of third quarter that relate to the right-sizing in response to L'Oreal.

Okay. Thanks.

We'll take one more question. Sorry, Laura.

That's okay.

Your next question comes from Connie Maneaty with Prudential.

Hi. I would like to go back to some of the opening remarks you made about L'Oreal's acquisition of Beauty Alliance. Could you just go over from the top down what your perspective is on how this is going to change competitive dynamics over the next couple of years?

Sure, Connie. As you probably recall, they made a 30% investment in Beauty Alliance last June or July and took out the other 70% of it about a month ago. There was a lot of vendor unrest when they bought the 30% because the other vendors obviously feel like the L'Oreal brands will get all the attention at Beauty Alliance, which kind of stands to reason. And when they took out the other 70%, I think that was more than confirmed.

So I think that as more brands realize that it may not be in their best interested to be distributed by a competitors distribution network, which would be L'Oreal and Beauty Alliance, that they'll be looking for other channels to distribute their product.

Now the reason we're in such a hurry to build out Florida, is that's the one state where Beauty Alliance pretty much owned the whole state. So these other vendors have no options down there. And we're hoping and believe that as soon as we provide them with an option they will make that change, which will also allow them to make the change in other geographies that they may want to make a change but they can't afford to lose Florida right now.

As you look at it, are you viewing this as an opportunity or a threat? And what percentage of Beauty Alliance's sales were dedicated to L'Oreal to start with? What's the split between L'Oreal brands at Beauty Alliance and everything else they sold?

Since Beauty Alliance was a privately held company, we really don't know the answer to that. My guess would be that it's at least half. And we definitely view this as an opportunity because L'Oreal has some great brands, but they still they only have about a 30 or 35% market share. So the other 65% are made up of some other great brands like Paul Mitchell, and JOICO and ISO and Wella and Sebastian and on and on and on.

And we expect our relationship with all of them to solidify and that a lot of the smaller brands in particular that don't feel like they'll get any attention in a L'Oreal owned distribution network will want to make a change.

And what is the schedule for the build out of Florida? When do you think --

We expect to have it build out, and by build out we're talking in the neighborhood of -- well 35 stores by the end of the calendar year.

Okay. Great.

We already operate the sales force down there, actually sales force, a Paul Mitchell sales force from the acquisition of Salon Success last summer as well as a Wella/Sebastian sales force now that also has picked up the Aquage brand, which I mentioned in my comments. So we're already seeing some of that. But a lot of these manufactures want to make sure they have store coverage in a state as well. So that's why we're in a hurry to get that built out.

Okay. Thank you.

You're welcome.

Okay. Thank you very much. This is all the calls we have time for today.

Thank you very much.

Thank you.

Bye-bye.

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