Sally Beauty Holdings Inc (SBH) 2008 Q1 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 financial results for the fiscal 2008 first-quarter. All participants have been placed in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time.

Now, I would like to turn the call over to Sandy Martin, Vice President of Investor Relations for the Company.

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 meanings of Section 21-E 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, should, expect, anticipate, estimate, assume, continue, project, plan, believe 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 Holdings SEC filings including it's 2007 annual report on Form 10-K. 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 adjustments, 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, Greg Coffey, Vice President and Treasurer, Mark Flaherty, Chief Accounting Officer and Controller. 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 fiscal 2008 first quarter earnings call. Today, we reported total net sales of $656 million for the three months ended December 31, 2007. This represented an increase in consolidated revenues of more than 4% from last year's first quarter and a 2.1% comp store sales increase. Our net earnings for the first quarter were $14.3 million, or $0.08 per diluted share and adjusted EBITDA was $87.2 million, an excellent start to the new fiscal year.

For Sally Beauty supply, first quarter same store sales gains of 0.3% were not as strong as we would have liked, however we were please with a positive comp during a generally weak retail selling season, especially given the tougher Q-1 comparison of 3.4% from a year ago. Looking at December, we believe weather as well as a weaker retail selling environment, resulted in softer sales of our appliance category. Our company is unique, in that almost one-third of our Sally U.S. revenues and 100% of our BSG revenues are generated through sales to salons and salon professionals. As a result, more than half of our consolidated revenues are generated from sales to these professionals and not to the retail consumer. In addition, our company does not follow a retail calendar, which makes comparability to other retailers more difficult. Historically, our Sally North America sales have not followed seasonal patterns like most other retail companies. And similar to past years, our monthly sales remained relatively evenly spread in a range of approximately 8% to 9% per month of annual revenues.

We were extremely pleased with BSG's comp sales of 7.5%, proving our ability to continue attracting brands and expanding distribution territories. I want to quickly update you on BSG's supplier changes. During the first quarter, we acquired certain assets and distribution rights from two Goldwell distributors in four states. In addition, we began distributing Goldwell products in 13 more states, including store only distribution in part of New York. Also during the first quarter, BSG began distributing Henkel's Schwarzkopf brand in stores and the DSC channel in four northeastern states. In January, we acquired the assets and distribution rights from a distributor of brands in Shiseido, Joico and Iso brands in California. Following L'Oreal's announcement of the acquisitions of Beauty Alliance and Maly's West, BSG was awarded distribution rights in January for Joico and Iso in stores and the DSC channel in six states, including Florida and Michigan. Also in January, we expanded our Farouk distribution in BSG stores and the DSC channel throughout California.

Now David will provide financial details related to the first quarter, and then I will finish with a few more remarks. David?

Thanks, Gary. Consolidated net sales for the first quarter were $655.8 million, an increase of $25.9 million or 4.1% over the year ago period. First quarter's consolidated gross profit was $306.2 million or 46.7% sales improvement of 150 basis points from last year's 45.2% of sales.

Both operating segments, Sally Beauty Supply and BSG, experienced gross margin improvement during Q1. Gross margin increased with Sally Beauty due to among other things a continued increase in sales with exclusive label products and margin increases on certain products. These improvements were partially offset by the diluted margin impact of adding Sally international acquisition related revenues with its lower margins. For BSG, margin improvements that are franchise business as well as the shift of revenue towards higher store sales versus DSC revenue positively impacted gross profit margins.

First quarter SG&A expenses were $224.5 million or 34.2% of sales, compared to $213.2 million or 33.8% of sales in the year ago period.The increase was primarily due to addition SG&A related to this salon service acquisition in the UK. Additionally, SG&A expenses included BSG's retention incentives of $1.7 million for DSCs during Q1 due to the contractual changes with L'Oreal last year. First quarter SG&A expenses also included $5.6 million of share-based compensation, of which $3.1 million represented the accelerated recognition of option expense for certain retirement eligible employees. Last year's Q1 SG&A costs included $5.7 million of share-based compensation, of which $5.3 million related to early vesting triggered by our separation from Alberto-Culver.

Unallocated corporate overhead costs, including share-based comp, our included component of SG&A expenses are $22.8 million for the first quarter of 2008, compared to $22.7 million for the year ago quarter. For fiscal 2008, we expect unallocated corporate overhead expenses to be approximately $80 to $85 million including estimated share-based compensation expense of approximately $10 million.

Turning to the segment, Sally Beauty Supply first quarter sales were $408.3 million, an increased of 9.8% versus the year ago period and comp store sales increased 0.3%. Sally's 9.8% total sales increase included incremental acquisition related revenue of $25.3 million or 6.8%. During the first quarter, we grew the Sally Beauty Supply store-based by 32 net new stores, and we now have 95 net new stores excluding acquisitions, more than we did at December 2006. The Sally segment achieved in first quarter operating margin of 17.5% of sales, essentially flat with the year ago comparison of 17.6% operating margin. Operating margin improvements in Sally North America were somewhat obscured by additional Sally international revenues which include results from our salon services acquisition completed in February 2007. Gross and operating earning margins for our Sally international business are below Sally North America, which blends into lower recorded gross and operating earning margins for the segment.

As a point of reference, Sally U.S. and Canada represented 4% of segment revenues during fiscal '07 and Sally international represented about 16%. Another point differentiation is approximately 85% of the international revenues are generated through the professional channel, which is a lower gross profit business. Our plan is to improve gross profit and operating earning margins by integrating the businesses and similar to Sally North America, attempt to grow our store-based and retail customer revenues over time.

For BSG, first quarter revenues were $247.5 million down $10.4 million for the prior year and comp store sales increased 7.5%. Included in last year's Q1 revenues were $9 million of low margin sales in our franchise-based business which were not repeated in this year's first quarter. During the three months of Q,1 we grew the BSG segment store-based by 31 net new stores and increased our BSG store count by 69 net new stores during the 12 months ended December 2007. BSG achieved strong first quarter segment operating margins of 8.5% of sales, compared to 7.3% in the year ago quarter. Last year's first quarter was the last full quarter revenue prior to the changes in our L'Oreal contract. This year's first quarter reflects the solid efforts of the BSG team to replace this revenue as well as to address expenses as part of our efforts to return BSG to prior levels of profitability. That said, last year's results include a number of items that make this year's comparison a bit easier. These prior year items are outlined in our press release today.

First quarter interest expense net of interest income was $46.5 million. Please note that this amount includes $5.7 million of non-cash expense due to the marked- to-market change in fair value for interest rate swap transactions. As a reminder, these marked-to-market adjustments are the proper GAAP accounting treatment for swap that does not meet the hedge counting trade requirements. The swaps took $500 million of our floating rate debt and fixed the cash interest expense for live of the swaps. As we have discussed in prior quarters when interest rates decline, the market value of the swaps change so that it causes us to recognize additional non-cash interest expense. As of the end of Q1, we have recorded a total liability of $8.7 million on our balance sheet, representing the market value in this case of liability not an asset of our swap obligations at that time.

As you also know, after the end of Q1, the Federal Reserve board decided to cut federal funds rates twice in the month of January with a total change of 125 basis points. This type of significant decline in short-term interest rates typically causes swap rates to decline as swell and will likely cause us to recognize additional non-cash interest expense in Q2. As of the end of January, our swap liability had grown to approximately $16 million, or our change in the month of January of about $7 million of additional non-cash interest expense. Assuming the swaps are held in the full term and no further changes in interest rates occur, then the liability will reverse itself over the course of the remaining life of the swap, and show up in our income statement as a non-cash interest income offset interest expense so that the market value of our swap obligations at the end of its dated term should be zero.

Our pre-tax earnings for the first quarter were $23.4 million, and the provision for income taxes for Q1 was $9.1 million. The Company's effective tax rate for fiscal 2008 is currently projected to be approximately 36%. Net earnings for the first quarter were $14.3 million or $0.08 per diluted share compared to $3.1 million or $0.02per diluted share in the year ago quarter. As I mentioned this year's Q1 includes $5.7 million of non-cash interest expense for the swap.

Each quarter, we provide an adjusted EBITDA number which begins with narrowing based on GAAP as that depreciation and amortization, share based compensation expenses, all separation related fees and expenses, debt interest expense and the provision for income tax as discussed above. Adjusted EBITDA for Q1 was $87.2 million, a $10.2 million increase, compared to prior year quarter. Adjusted EBITDA increased as a result of additional income from acquisitions, as well as from improvements in both of our business segments. Our reconciliation of GAAP and earnings to adjusted EBITDA is included in the schedule as part of today's press release.

Turning to our balance sheet, we increased our ABL borrowings to $53.4 million during the first quarter primarily due to higher inventories based on new and expanded BSG brand distribution, inventory [build] of certain products in the Sally division and the timing of our interest expense payments. Last quarter, we discussed that this fiscal year would be a more challenging year in terms of working capital improvements in light of the heating of our new BSG warehouses and the introduction of new BSG brands. Purchases of certain inventory of Sally adds to this challenge. Nonetheless, most of the inventory increased over prior year Q1 come from BSG, which continues to show strong same-store sales growth and is a by-product of our ongoing brand expansion and distribution restructure initiatives. Inventories at our Sally North America business remain below prior year Q1 levels on an increased base of stores, while our Sally international inventory levels were up primarily due to the acquisition of salon services. Nonetheless, we remain focused on this opportunity and hope to show improvements from our current levels during the second half of fiscal year excluding the effects of any potential acquisitions, so that we are positioned to realize further efficiencies in fiscal 2009.

Net cash used by vesting activities for Q1 was $15.3 million, and includes current year acquisitions of $3.1 million net of cash acquired. Net capital expenditures for fiscal 2008 are projected to be approximately $60 million, excluding potential acquisitions. The $60 million CapEx budget includes about $14 million for our BSG warehouse consolidation project planned to be completed this year with savings of approximately $10 million expected beginning next fiscal year. During Q1, we spent approximately $4 million of the $14 million of CapEx planned for this warehouse project.

As in prior quarters, I want to walk you briefly through our liquidity, and current financial position. For Q1, we ended the quarter with approximately $312 million of additional borrowing capacity on the revolver. In addition we paid down approximately $4 million on the Senior Term Loans during the first quarter. We ended the quarter on December 31, 2007 with long-term debt, including capital leases of about $1.8 billion. Remaining debt maturities for fiscal 2008 are $12.5 million and fiscal years 2009, 2010 are $24.2 million each year respectively, excluding any potential repayments related to our excess cash flow test under the term loan. Schedule E, from our Q1 press release, has our table of debt maturities including capital leases. Now I would like to turn it back over to Gary.

Thanks, David. I would like to make a few additional remarks regarding our future outlook. From a unit growth perspective, we continued to believe that the Sally store concept currently has potential for 3,000 total U.S. stores based on recent population and demographic studies. We plan to continue opening new stores in Canada and Mexico and believe there is potential for 250 stores in each of those countries. We remain excited about our international expansion and see potential acquisition and unit growth opportunities in the European Union and eventually into South America.

[Chad Salvage] recently joined SBH in a newly created position, Vice President of Business Development for South America. Chad brings a wealth of operational experience and hands on expertise in Central and South America. Over the short-term, we intend to remain focused on improving the profitability of our Sally international business. During this fiscal year, we expect to continue the integration of last year's UK acquisition with the goal of having the Sally international business performing at a 10% operating income margin.

Earlier I discussed the fact that macropressures had a some what dampening effect on Sally's comp sales for the first quarter, especially in December. On a geographic basis for Q1, comp store sales in California were flat with the prior year. Historically, our large representation of Sally stores in California had outperformed the Company average for comp store sales. In contrast, Texas represents our largest marketplace in terms of store count and Q1 comp store sales outperformed the Company average. We are currently analyzing geographic data and we'll work on methods to improve sales in certain areas. Although fiscal '08 may turn out to be a more challenging environment for our Sally business than we initially expected, I believe the longer term outlook for our Sally business remains strong and is based on years of consistent growth in the professional beauty industry through a variety of macroeconomic situations.

In addition to seeking top line growth, we'll continue to focus on obtaining margin improvements through our various initiatives such our exclusive label products As part of our top line efforts at Sally, we continue to work hard on marketing and merchandising initiatives in our Sally Beauty Supply stores. Since we launched our E-commerce site for Sally in late October, we have experienced good online traffic and sales results considering the limited number of items offered. This spring we plan to increase the offering on the site from about 50 to 300 skews. We also continue to work on CRM projects. and target marketing efforts to address challenges with our customer traffic and drive higher transaction accounts in our Sally stores.

On the BSG side, we expect to continue the increase of new product introductions and expanded distribution of others throughout the country. We also believe that we will complete our warehouse project this year. And beginning with the 2009 fiscal year, I would expect to see inventory and expense improvements as we bring more efficiencies to the BSG distribution network with a projected annual savings of approximately $10 million. Our focus at BSG remains on improving operating margins after setting aside the costs from the BSG warehouse project. We plan to continue to grow BSG's revenues through unit expansion in North America and by adding brand distribution and potential acquisitions that could provide our revenue stream with little or no infrastructure costs.

Overall, I believe we are up to a great start at BSG toward returning this business to prior levels of profitability.

In summary, we are confident in our growth plans and we'll continue to execute on our profit initiatives for the Company. During fiscal '08, we believe we can grow the store-based by 4% to 5% combining both Sally and BSG stores, which would be an increase from 140 to 180 new stores, excluding acquisitions. Now I would like to open the call for questions.

Thank you. (OPERATOR INSTRUCTIONS) Your first question comes from the line of Grant Jordan with Wachovia.

Thanks for taking the call. A couple of questions, not looking for any guidance but maybe you could just update us on what you are seeing from that retail Sally customer since the beginning of the year as has it continued to see further pressure? Or do you think you are just going to see general weakening from last year's levels?

I assume you are talking about the beginning of the calendar year, Grant.

Yes, sir.

What we are seeing is really the same trends continuing that we experienced in Q1. Fortunately, looking at the other retail numbers that came up this morning, our comps in the Sally division per January were positive. And BSG continues to run very strong and consistent with Q1.

Great. That's very helpful. Second question. You mentioned you got the benefit on the gross margin from the higher control in private label and the Sally stores. Do you have the percentage that that's up to now?

For Q1, David, it was - -

Well last year for the full year, it was around 40%, which was up, as I recall, almost three percentage points from the year prior to that. And the quarter is now exceeding that 40% level to 42%. So, it continues to grow nicely for us. And as we said, that certainly is helping drive those margins.

Do you have a goal for that percentage?

No, we really don't. I have said in the past that I believe that it will continue to go up. Probably not as dramatically as it has the last two years for the foreseeable future. What we have experienced longer term is about a 1 or 1.5 point increase per year. And that's where I would expect it to settle in at after this fiscal year.

Okay. And then my last question, it looks like you have certainly done a good job getting more brands into the BSG side of the business. As the competition between yourself and L'Oreal continues, have the level of calls, the discussion with other suppliers, has that picked up? Do you feel like you are gaining more momentum getting new brands into the BSG business?

Absolutely. I think as more of the manufacturers and brands out there see that L'Oreal intends to be in the distribution business, I would expect on a national basis, I think they are really evaluating what where their future should be.

Great. Thank you. That is very helpful.

Your next question comes from the line of Karru Martinson with Deutsche Bank.

Good morning. I was just calling in regards to your gross margins here. You guys posted a couple quarters here of nice elevation. Is that how we should look at the business going forward?

Well, Karru, good morning. As I just said, significant amount of that right now is being driven by the increase in control private label or exclusive brands. And that, as David mentioned, was up about 3 points last year and is running for Q1, about two points ahead of that. I do expect that growth rate to slow a little bit, because it has to do with some major project, product introductions, we have done this year and last. So, I do expect it to continue and the gross margin to continue to be affected by that but possibly not at the rate that it has been this year and the last.

The other thing to keep in mind we talk about prior quarters and we mentioned today as well was the some what diluted affect on a segment basis or the additional Sally international revenues. So, once we get to that we did the acquisition in February, then you are talking on more of an apples to apples basis and one of the initiatives that we have discussed is to improve the overall profitability of that business, both on an earnings basis as well as a gross margin basis and that's, you know, hopefully one of the things that will help drive the overall segment margins going forward.

The softness in appliance sales that we saw here in the past quarter, how much of a drag was that on the Sally's comps?

I don't have that in terms of the percent on the number. But as Gary said in the past, when you look at the business, that 's one of the areas that has some seasonality to that. Things like styling appliances, curling irons, flat irons, hair dryers, et cetera are items that we do see and believe are purchased as holiday gift items whereas things like hair color typically are not. So, you do see that in this quarter our first quarter. And that's where we did see some weakness.

And then the contractual, the retention costs for the consultants. Those are going to roll off here at the end of February, correct?

The majority of those roll off in February, that's correct. There may be a very small amount that we decide to move forward with in some specific geographies, where we still haven't replaced enough brands. But it will be significantly less than it's been.

So, if we are going to look at the second half of the year, there is probably just in that second half, another say $3 million or so that would drop to the bottom line?

Well, compared to last year's retention bonuses, yes, I would say it's at least that, isn't it David?

Yes, last year in Q2, DSC incentives paid was about $1.2 million last year and Q3 was about $2.3 million and Q4 was about $1.9 million as we previously reported.

And, Karru, we neglected to say this. But we are going to only take a couple of questions from each caller.

Not a problem at all. Thank you.

Thank you.

Thank you. Your next question comes from Carla Casella with JP Morgan.

Good morning.

Good morning.

You seem to be doing very well with the acquired brands. I'm wondering if you can talk about are the acquired brands, are they typically higher margin brands as well or is it's a margin opportunity there?

They are -- the margins are comparable with other BSG margins, with the brands like Goldwell and the PNG brands and Joico and Iso. So, we do think that there is margin opportunity, more from the standpoint of when we pick up these brands, it is on an exclusive basis.

Right. Okay. Great. So you have an opportunity to grow, even from the level where they are now as you expand the distribution?

Yes.

Okay. Do you think there is any more potential fallout in terms of additional brands coming available out of the L'Oreal, because of the L'Oreal acquisitions that they have made?

Well, as I said earlier, I think as they make other geographic acquisitions, that the brands that are represented by those acquired distributors are going to be giving some serious thought as to where they see their future being. So, the answer to that is yes.

Okay. Then just one follow-up, one other question. On the salon business, I'm wondering if in past down turns, has that business always held up better than the kind of retail business?

Absolutely. I think the salon business, as we've said many times in the past, when you look at it from a sensitivity to the economy, is somewhat similar to the liquor business. It seems to hold its own through all kinds of economic situations. And I think it makes sense. People basically, regardless of the condition of the economy to some degree, want to still look good and feel good.

Okay. Great. Thanks a lot.

Thank you.

Your next question comes from the line of [Jay Artibello].

First question is on the Sally Beauty side and the weakness in the sales. Any sense of whether or not that was more from traffic or more from average ticket?

Well, as we said, we saw some challenges with traffic, particularly in December. A little of that was weather related. And I think a little of it was just general weakness on the retail side that really shows up with us in the appliance category more than any. So, yes. In other words, same-store transaction is down, but comp store sales are being driven by inflation and mixed change.

Even in California and Texas where weather typically isn't a major factor?

Well, it is interesting weather was a bit of a factor in California this year. But yes, in general that's correct.

Secondly, just some housekeeping items for David. The life of the swamps. Can you tell us when those come off? And the lost L'Oreal revenue in the March quarter of last year?

The swap, we have one swap that will roll off in November of 2008. And that's $150 million. And then $350 million rolls off in November 2009.

The answer to the second half was in Q2 last year, the lost L'Oreal revenues.

In Q2 or --

In the March quarter, yes.

In Q2, were approximately two out of the three months, which was about $20 million.

Great. Thanks.

Thank you. Your next question comes from the line of Laura Richardson with BB&T.

Hi, everybody. I wanted to get a sense for Sally. I thought the Sally store customer mix shifted between the December quarter and the rest of the year more toward professionals out of December? And can you help me understand the magnitude of that shift?

I'm not sure I completely understand the question. But basically our customer mix doesn't change a whole lot in the Sally division. We have been running about 70% consumer and 30% professional. On a year-to-year basis that's been shifting about 1% a year. But we don't really see any significant differences from month to month to month.

I guess I misunderstood that then, Gary. I thought in the holiday season you might have a little heavier than 70% regular consumers.

It could, let's take a look at it. It could very slightly, Laura. But it isn't significant.

Okay. Thanks. Then this is kind of a question and also request in terms of the interest rates swap. I think I heard David basically say where rates stand right now, there could be a $16 million non-cash charge in Q2 because of the interest rates swaps.

Yes. Let me clarify that. What I said was as of the end of January, the liability in our balance sheet would be approximately $16 million, which means the additional interest expense for January would be set. We already had some of that on our balance sheet at the end of Q1. The PNL, if you will, where rates stood at the end of January with an additional roughly $7 million non-cash charge embedded in interest expense which shows up in Q2. As I said, you hold all other things constant, meaning no changes in interest rates and holding the swaps through to their -- to the term that ultimately that $16 million liability that's on our balance sheet as of the end of January, will have to reverse off so that the value of the swaps at the end is zero. And that will reflect itself as effectively non-cash interest income. In our income statement over time.

Okay. I kind of understand that. I guess the request part here is maybe in the press release you could make a head line that says operating EPS of X. So, we can all be modeling toward something that excludes this highly volatile interest rate swap stuff. Because that's been a big swing in the quarters three to four of the last year.

There has had impacts on each quarter. One quarter, there was an income item. The other quarter was additional expense and we have tried to highlight that on a pre-tax basis for you, so you can decide what you want to do with that in terms of your numbers. We will continue to make sure you understand.

Right. You're giving -- I'll talk to Sandy later. Maybe there is a way to just make it more obvious in the press release so you don't get credit for bidding what's on a swap or missing what's on a swap and we just focused on the operations.

Yes, Laura, the attorneys won't let us highlight it too much in the bulletin and so forth.

Okay. Thank you.

Thank you. Your next question comes from Ted Bernstein with UBS Securities.

Good morning. I understand the inventory-related explanation. But I was still surprised by the amount borrowed under the ABL facility as of the end of the quarter. Can you tell us has the ABL balance has been paid down subsequent to December 31?

There is a couple of things going on in that borrowing. One is just the timing of interest payments under our high yield note. So that has an impact on just the timing of borrowing and repayment.

Gary, if you want to add anything to that.

That is the biggest driver we see. We have large payments due each quarter on the term loans and semi-annually on the senior subnotes. November and May are the biggest buying months. We had about $55 million in interest, cash interest expense that was paid out in November.

So, since you paid twice a year between then make a payment for that swing could hurt your crude expenses more capital from that perspective due to the timing of those.

Would you tell us where the borrowing is currently?

I don't have that figure right in front of me. But what I would tell you is, because of that type of working capital change, similar to what, frankly we saw last year, excluding any type of acquisition effect, is that, I would continue so see or I would expect to see the ABL facility would come down over time. Probably not much in Q2. But by the end of the year, it would be my expectations excluding acquisition impact that all of that would be paid off.

All right. Is the business overall becoming more cyclical with a greater focus on retail consumer sales on the SBS side of the business?

I don't think so. We are still running approximately between 8% and 9% of our business every month. The holiday season, as we become more and more retail, we do see a fair amount of fluctuation in that, primarily in the electrical category. Because it's such a big gift item. But other than that, and as I started out saying, with 50% of our total revenues including BSG, going to the licensed cosmetologist and salon, that business is extremely steady throughout the year.

I wasn't really interested in seasonality so much cyclicality of the overall economy. I thought you said earlier that same sort of trends you saw in the SBS segment in December were continuing into the current quarter.

What we said was the trends we saw for the full quarter 1 in terms of sales in BSG and Sally are contained in January, meaning Sally U.S., international, same store sales positives but not a lot and continue strong growth at BSG.

Thank you.

Thank you. Your next question comes from Emily Shanks.

Good morning. Nice quarter. Thanks for taking the question. Most of them have been answered. But I do want to follow-up on the inventory. I want it to be very clear. Did I hear you say in the last question that the majority of the draw down on the term loan was because of interest? So you would say the inventories are a less than reason?

Well, there are both things happening there. As we said, one of the fundamental parts of the BSG business plan is to bring in those additional brands so as we said in the fourth quarter, that we were anticipating from again inventory working capital perspectives, this can be a more challenging year. For sure BSG inventories are due to that. Just from a timing perspective. Yes, the ABL also has an impact in terms of the timing. There are results of those things going on.

That is helpful. As it relates to increase inventory within the Sally segment I think I heard you right that North America is actually down but international is up?

Yes. When you look total basis, we did the salon services acquisition in February. So when you do a comparison to the prior year, meaning December 2006 versus December 2007, Sally U.S. inventories are down over that December time frame, but international is up in large part when we did the acquisition.

Okay. Thank you. And I just want to, what I wanted to follow-up on, there is not one specific category on the international basis. It is just the overall business, right?

In terms of inventory?

Yes.

Yes, the inventory for salon services at the time we acquired it was roughly $25 million or so. So, that's kind of the biggest difference.

Great. Thank you. Then if I could one follow-up housekeeping question. I know at the end of your comments, you all had stated that the new store growth would be targeted 140 to 180. I know in the last call you said for '08 you were looking for 140 to 150. Is that number for '08 still good and the 140 to 180 more of a long-term view?

I think that we have said in the last couple of calls that historically we have increased space 3% to 3.5%. And that going forward, we would increase it 4% to 5% not including acquisitions.

Right. As Gary mentioned in his earlier remarks, our expectation is to open between 140 and 180 new stores excluding acquisitions on a combined basis for both Sally and BSG this year.

Okay. Thank you.

Your next question comes from Peter Grondin.

Sorry to keep focusing on this swap interest. But David, just want to be clear. So the extra $5.7 million on top of the base interest charge, then let's say everything stayed stable for the rest of the quarter. So it would have to add on $7 million more to the, whatever the interest was for the quarter? $45million or so? To get the sort of pro forma interest for Q2?

No. What I was saying is in the quarter --

Yes.

We had the, additional charge the non-cash charge for the swap. And then in January, the question is what was the change in the market value or fair value of the swap. What happened post the end of Q1, interest rates in down. So, in January, what we are seeing is an additional interest expense of approximately $7 million. All other things constant, that's what the additional interest expense that we see in Q2, but also recognize that over time, holding interest rates constant, that that liability, whatever it is, on our balance sheet, will have to reverse itself out to zero by the end of the terms of the swap.

Okay. So may be slow here. So you had an extra $5.7 million or so in interest for this quarter, correct?

That's correct.

So I guess what I'm asking is let's say it's March 31 and the interest rates stay where they are at right now. Is it $7 million plus the 5.7? Or is it just whatever your base, whatever my base calculation is for interest based on the debt plus the $7 million? Or is it base plus $5.7 million plus $7 million?

No, it would be the base plus the $7 million.

Okay.

It represents the change.

Got it. I'm there. That's fine. Okay. And the second, you, I think on the last quarterly call, you had said that you were targeting $8 million in compensation expense as it relates to share-based compensation expense? $10 million now, is that right?

Yes, that's correct. Our overall estimate for total unallocated corporate between 80 and 85. That hasn't changed. But the stock option piece went up a little bit. We think some other pieces will come down. So the total range is the same as what we had said.

Do you think it has sort of the same lumpiness? Where you took a lot of it in the first quarter here? Would you take a lot in the second quarter or would it be blended out evenly for the next three?

What's happening there is that the timing of when we issue stock options, awards, is in the first quarter because of that, we anticipate we'll be doing that every first quarter going forward. When we do that, there is a fact because of retirement certain retirement eligible employees that we basically have to accelerate the recognition of all of the stock option expense rather than over the life of the option of four or five years. That tends to make and we'll likely make going forward the largest stock option expense the quarter of fiscal year in this particular quarter, it was $3.1 million that represented the accelerated recognition of those stock options. So then it would likely go down for Q2, 3and 4 and go back up in Q1 next year.

All right. Thanks.

Thank you. Your next question comes from Todd Harkrider.

Yes, I appreciate you taking my call. Done a great job of refilling the contractual loss for [yield] bucket. How much of the BSG same-store sales do you see being pulled forward and should we see on couple of quarters a negative things for sales of BSG after the news [inaudible] of the Goldwell, Joico and Iso is complete or how should we look at that?

At this point, I don't think so. Because a lot of these brands haven't come anywhere near hitting their stride as you can tell from our comments a lot of the additions we made were just in this past quarter. So as we continued to add brands and as those we have added really just get up to speed from an advertising standpoint and sales standpoint, my expectations are that BSG same store sales should be good in quite a ways into the future, I hope.

Having said that the one thing frankly we have been drawing on is we said a number of times because of the growth, very strong growth we had at BSG on same store sales, we were thinking that would moderate and we're going against tougher comparables. We thought that would happen in Q4 and comp store sales of BSG remain strong and same thing really in theory applies to this first quarter they continued to be strong. So I guess what I would say, though, is we are up against a pretty strong comparisons. You know in second quarter of last year, BSG comp store sales were up like 11%, 9% in Q3, almost 10% in Q4. Those are pretty good numbers that are going to be tough to beat. But as Gary said, we continue to add new brands and have been pleasantly surprised that how strong of those have remained with pretty tough comparables.

And my expectation is we would beat those rates, but I think we will still stay very positive with BSG same store sales.

That sounds good. Can you talk a little bit about your relationship with PNG and Paul Mitchell specifically? Do you think it's maybe gotten stronger lately with L'Oreal continuing to buy large distributors with significant store-based? Or do you think it is weakening maybe a little bit since you picked up Joico and Goldwell and so forth?

No, it's absolutely strengthening. In some of the geographies, where we carry, particularly Paul Mitchell, are not necessarily the same geographies that we carry Paul Mitchell or Joico and Iso. They are different geographies. The relationship with both those companies is extremely strong, because I think they, as we said, a year ago, see this as a huge window of opportunity to get more distribution stores and sales consultants, and to have an opportunity to make some significant increases in their market share.

Okay. That is definitely appreciated. Congratulations on a strong quarter.

Thanks.

Your next question comes from Duncan [Bass] with AIG Investments.

Good morning, Duncan.

The first question was just really kind of goes back to some of the comments that you made on the previous conference call on the BSG side. And you guys had talked about sequential operating margin improvement in each of the quarters with the target of returning to historical levels in the back half of '08. Which to me implies 9.5% to 10% operating margins. That still the case? Are you guys doing better than your plan? Or is there one off in the quarter that may have been made these margins better than what I was expecting?

Yes. It's just from a historical point of view, the BSG segment operating margins in 2006, so pre L'Oreal were about 9%.

Okay.

So when we talk about going back to more historical levels, that is what we are talking about. And as we had said, our goal for BSG this year is to drive the segment back towards that type of number during the second half of the year. Obviously, we are happy to have the progress that we did in Q1 toward that, and hope to continue having those types of improvements as we said. But particularly during the second half of the year.

Should we still think of sequential improvement? Or is that now --

No, I think that's fair.

It is sequential meaning from first, second to third or meaning quarter-over-quarter?

First to second, second to third, I guess.

Well, the second and third quarter as we talked about last in last quarter's conference call may have some expenses related to our, our distribution project. As we said, we were anticipating magnitude of about $4 million of expenses related to that. But that is not the capital part of that, that's the operating expense. So to the extent those flow in that statement may not be true but we may have to figure out, the timing of when those occur. But I would anticipated during the second half, Q3 and Q4, to continue to show that type of improvement.

Okay. Then just on the Sally Beauty side, remind me again what kind of a same-store sales comp do you guys need to maintain operating margins?

You know, we have never really discussed that. And because we have the three things that I have commented on many times, all working to our favor in the way of increasing margins, I'm not sure that we necessarily have to have a particular same-store sales increase to achieve that. And those three things are the continued shift of our business toward, a little more toward the retail customer, which is a higher margin business, the continued growth of our exclusive label products, which are significantly higher margin, and the, what we have been doing over the last year to 18 months increasing our low country cost source product. So with those three things adding to our margin, I believe that we can have very minor same store sales increases, which is certainly not our intent. But if that happened, I think that we could still maintain our increases in margin.

And by quarter back for the quarter as you know comp sales for Sally were up slightly and yet gross profit margins for Sally Beauty Supply segment did increase.

So you guys, basically, even with a flat maybe slightly positive same store sales comps, you still think your margins are going to see improvement on the Sally side?

So long as the things like trends control labels, proprietary labels sales within Sally continue, you know that is one of the big drivers, so that is certainly possible.

Okay thanks.

Thank you. Your final question comes from Carla Casella with JP Morgan.

Hi. Just two quick follow ups. In your 10-K it mentioned that your term loan was at an average rate of 8%. Is that the rate it is headed at? Is that the rate we should use until the hedges fall off?

I believe that statement in there, I don't have that in front of me, related to our total debt. So I'm --

Okay. I guess what I'm trying to figure out is, until, you'll get the benefit of the lower [LIBOR] rate as soon as your hedges come off. But until that time I'm wondering what rate rate I should be used for [LIBOR]. You hedged at 5.2% to 5.4% where it was this year or is it at a higher rate?

No, the way to think about it is, we have fixed rate that we pay on our senior subnotes. And on our term loans, $500 million of that we pay a fixed rate on the rest. We pay the floating [LIBOR] rate. So it is going to fluctuate with whatever [LIBOR] moves.

Right but on the fixed portion what's it fixed at? That's what I'm trying to figure out.

I think we published the swaps are about 5%. Then you think of the spread that we pay on top of that.

Right.

Of 250 basis points.

Okay. Great. Then secondly, did you disclose how much of the acquired revenue, how much EBITDA came from the acquired revenue? It looks to me like it is a relatively high%.

No we didn't break out the EBITDA. We did break out revenues, however.

Operator, we are going to take one more call.

Thank you. Your next question comes from Justin Hott with Bear-Stearns.

Good morning, Justin.

You there?

Hello?

Justin, your line is open.

Okay. Justin, give us a call after the call today. Thank you very much for your interest in our company.

Thank you.

Thank you for joining today's conference call. You may now disconnect.