Sally Beauty Holdings Inc (SBH) 2008 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 fiscal 2008 second quarter financial results. (OPERATOR INSTRUCTIONS.)

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

Sandy Martin. 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 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 its most recent 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 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, Mark Flaherty, Acting Chief Financial Officer and Vice President, and Greg Coffey, 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 fiscal 2008 second quarter earnings call, and as always thank you for your interest in Sally Beauty Holdings.

Today, we reported an increase in consolidated net sales of 5.6% compared to our fiscal 2007 second quarter, and a same store sales increase of 2.8%. Our net earnings for the second quarter were $12.4 million or $0.07 per diluted share. After adjusting for $5.5 million in noncash interest expense, due to changes in the fair value of our interest rate swaps, our adjusted net earnings for the second quarter were $17.9 million or $0.10 per diluted share.

We also reported second quarter adjusted EBITDA of $79 million, an increase of 10.6% from the $71 million in the second quarter of '07. Given the soft macroeconomic environment for retailers, we are pleased with our second quarter performance.

Turning to the segments, Sally Beauty Supply's second quarter net sales were $406 million, an increase of 6.3% versus the year ago period, which included incremental acquisition related revenue of $11 million or 2.8%. Same-store sales for our Sally segment strengthened in the second quarter to 1.4%, which compares favorably to our first quarter number of 0.3%.

Given the generally weak retail environment during the first quarter of fiscal '08 and with similar trends continuing into January, we made the decision to increase marketing efforts. In March we successfully employed additional print and radio media into key marketplaces of southern California, Florida, and Arizona, targeted specifically towards the professional and Hispanic customer. These incremental promotional efforts, combined with the fact that Easter occurred in March, pressured gross profit margins in the Sally segment.

During the second quarter we grew the Sally Beauty Supply store base by 13, and have added 97 new stores over the past 12 months. The Sally segment reported second quarter operating margins of 16.7% of sales, down from the year ago quarter of 17.7%. Our second quarter decline in operating margins compared to the first quarter of '08 and the prior year quarter was due to increased promotions and advertising for the Sally stores, higher fuel costs due to -- higher freight costs due to fuel surcharges, and the dilutive impact of our Sally International business.

In the first six months of 2008, Sally USA and Canada represented 82% of segment revenues, and Sally International represented 18%, as compared to 87% and 13% in the first six months of 2007. As we have discussed, the Sally Salon Services stores located in the UK are generally stores with 85% professional sales and 15% retail sales, thus producing lower gross profit and operating margins. Our plan is to improve margins over time by integrating the businesses and, similar to Sally U.S. stores, to grow our retail customer base while increasing exclusive label product sales.

Yesterday we completed the acquisition of Pro-Duo Beauty Supply for $19.3 million Euros or approximately $29.8 million. Pro-Duo is located in Belgium and operates 40 stores in Belgium, France, and Spain. This business had fiscal 2007 revenues of approximately $31 million, and we see this acquisition as a critical step in our Sally Beauty Supply international growth strategy. The acquisition of this Company allows us to gain an important geographic foothold throughout key areas of western Europe.

Turning now to BSG, second quarter '08 revenues were $237 million, up $10 million or 4.5% from the prior year. Same-store sales increased 6.9% in the second quarter. This continuation of strength in our same store sales reflects our broad and diverse assortment of professional exclusive brands represented in our BSG stores. As evidenced by our results, the BSG segment has recovered all of the revenues lost following the L'Oreal contract changes at the beginning of fiscal 2007.

We surpassed our own expectations by replacing the lost revenue of approximately $120 million within 12 months. Due to the acceleration of store openings in the first quarter of fiscal '08, BSG's new store growth for our first six months was 31 net new stores. During the past 12 months, BSG has opened a net of 58 new stores.

Operating margins for BSG in the second quarter were 7.6% of sales, compared to 5.5% in the year ago quarter. However, second quarter operating margins were down sequentially from the first quarter due to BSG warehouse optimization charges of $1.7 million, higher freight charges, and incremental new store costs due to the acceleration of openings in the first quarter that impacted second quarter margins. Setting aside the impact of distribution project expenses, we expect BSG operating margins to return to historical levels during the second half of fiscal 2008.

During this past quarter, BSG acquired certain assets and distribution rights from a distributor of JOICO and ISO products in California, Arizona, and southern Nevada. In addition, we acquired certain assets and distribution rights from a distributor of Paul Mitchell products in southern and central Texas. The geographic marketplaces and brands added to our BSG store and sales consultant network throughout north America are important to our growth strategy as we provide our customers a comprehensive offering of brands.

Now, Mark will provide financial results for the second quarter. Mark?

Thanks, Gary.

Consolidated net sales for the second quarter was $643.3 million, an increase of $34.1 million or 5.6% over the prior year ago period. The second quarter's consolidated gross profit was $298.4 million or 46.4% of sales, compared to 46.5% of sales in the fiscal 2007 quarter.

As Gary had mentioned, we increased marketing promotional efforts in the second quarter for the Sally Beauty Supply segment which lowered gross profit margins, compared to the prior quarter and last year, and we are experiencing higher freight costs due to fuel surcharges.

We continued to experience margin pressure from adding Sally International acquisition related revenues with reduced margins. In February of 2008 we anniversaried our Salon Services acquisition and continued to work on the integration of our Sally UK business. Our goal is to expand the Sally International operating margins to 10% in fiscal 2008.

For BSG gross margins improved due to a shift in revenue towards store sales which carry higher gross margins and improved margins on certain franchise based revenues compared to last year's second quarter.

Second quarter SG&A expenses were $221 million or 34.4% of sales, an improvement from 34.8% a year ago. SG&A expenses increased $8.9 million during the second quarter over last year, which included $3.5 million of the acquisition related expense, and $2.3 million in increased rent expenses, primarily due to new store openings.

Second quarter SG&A expenses also include $1.6 million of share based compensation compared to $600,000 in last year's second quarter. Unallocated corporate overhead costs including share based comp are included as a component of SG&A expenses, and were $20.2 million for the 2008 second quarter compared to $19.5 million for the year ago quarter.

For fiscal 2008 we expect unallocated corporate overhead expenses to be approximately $80 million to $85 million including estimated share based compensation expense of approximately $10 million.

Second quarter interest expense net of interest income was $47.6 million, and this amount included $8.6 million of noncash expense due to the mark-to-market changes in the fair value for interest rate swap transactions. These mark-to-market adjustments are proper GAAP accounting treatment for a swap that does not meet the hedge accounting requirement. Our swaps took $500 million floating rate debt and fixed the cash interest expense through the life of the swaps. When interest rates decline, the value of the swaps decline, and this causes us to recognize additional noncash interest expense based on the changed market value.

As of March 31st, 2008 we reported a liability of $17.3 million, which represented the current market value of the swaps as of our balance sheet date. Assuming the swaps are held to the full term and no further changes in interest rates occur, the liability will reverse and noncash interest income will be reported over the remaining life of the swaps. The first swap agreement for $150 million expires in November of 2008, and the remaining $350 million expires one year later, in November of 2009.

Our pretax earnings for the second quarter of fiscal 2008 was $17.9 million, and the provision for income taxes for the second quarter was $5.5 million. The Company's effective tax rate for fiscal 2008 is currently projected at approximately 35.5%.

In today's release and going forward, we are providing adjusted net earnings and adjusted EPS solely for the purpose of adjusting for noncash interest expense from mark-to-market changes in the fair value of our interest rate swaps. We believe that excluding this noncash mark-to-market adjustment provides investors with a better depiction of the Company's core operating results, and provides a more informed baseline for modeling future earnings expectations.

For the fiscal 2008 second quarter, our adjusted net earnings were $17.9 million or $0.10 per diluted share after adjusting for $5.5 million or approximately $0.03 per share net of tax and noncash interest expense from our interest rate swaps.

For the fiscal 2007 second quarter adjusted net earnings were $12.1 million or $0.07 per diluted share after adjusting from $1.1 million or approximately $0.01 per diluted share net of tax and noncash interest expense.

On a GAAP basis, net earnings for fiscal 2008 second quarter increased 12.3% to $12.4 million or $0.07 per diluted share, compared to $11 million or $0.06 per diluted share for the fiscal 2007 second quarter.

Our adjusted EBITDA for the second quarter was $79 million, a $7.6 million increase or 10.6% compared to the prior year quarter. Our reconciliation of GAAP net earnings and EPS to adjusted net earnings and adjusted EPS and adjusted EBITDA is included in the schedules that are part of today's news release.

Turning to the balance sheet, we paid down our ABL facility to $33.9 million during the second quarter, primarily due to lower inventory level from the first quarter and timing of interest payments. Keep in mind, however, that our Pro-Duo acquisition was funded through $29.8 million in cash and borrowings on our ABL facility.

We explained earlier this year that working capital improvements will be constrained by the introduction of new brands in the BSG segment, coupled with the seeding of a new warehouse as we consolidate a number of our facilities this year.

Inventories at our Sally North American business remained below prior year levels on an increased store basis. Capital expenditures for the six months ended March 31st, 2008 totaled $25.7 million. Net capital expenditures for the fiscal year 2008 are expected to be approximately $60 million, excluding potential acquisitions. Our $60 million CapEx budget includes approximately $15 million for our BSG warehouse optimization project, which we will discuss shortly.

We ended the second quarter with approximately $318 million of borrowing capacity on our ABL facility. We also paid down approximately $4 million on our term loans during the second quarter, and as of March 31st, 2008 long-term debt, including capital leases, was approximately $1.8 billion.

We are pleased on March 25th, 2008 that the Standard & Poor's rating service revised our outlook on our debt to positive from stable. They also reaffirmed Sally's ratings, including a single B corporate credit rating.

And now I'd like to turn it back over to Gary.

Thanks, Mark.

We're excited about today's announcement of our new Paris Hilton hair extensions. They are being sold exclusively in our U.S. and Canadian Sally stores. We are holding a national press conference in New York this morning, led by Mike Spinozi, the President of the Sally business, showing these high quality, versatile extensions to fashion editors.

We anticipate print and television coverage this week, and have launched a website featuring the collection. This micro site can soon be accessed from our retail website at SallyBeauty.com. Paris Hilton is a celebrity that continues to rank in the top five search engine hits, and we believe this strategy will attract a younger customer to shop our Sally stores.

A related effort to attract a younger customer is through our e-commerce site, which we have expanded to more than 300 professional products. Our plans are to carry the entire Sally Beauty assortment with over 5,000 products by the holiday season, and eventually to add exclusive online items not available in our stores.

We will also continue to closely monitor sales for our existing stores. Our plans are to allocate marketing dollars to our highest return on investment areas. For example, in the second quarter we began direct mail customer acquisition efforts in 140 stores and e-mailed promotions to existing customers. Our new CRM program began testing in 110 stores on March 1st, and initial results have been encouraging with membership base, visits, spend level, and renewals all positively impacted. We hope to roll-out the CRM program to our entire Sally store base in 2008.

In addition, Sally's latest partnership with e-Dialog should improve our ongoing efforts to target e-mail customers and produce an improved database marketing effort. We are also profiling our top beauty club shopper to determine key attributes that we can utilize to attract new retail customers.

Leading the charge on our Sally marketing initiatives is Sue Davidson, our new Vice President of Marketing. She brings a wealth of retail experience and creativity, most recently with Things Remembered, and prior to that with Zale Corporation. We are pleased to have her as part of our Management Team.

We are still planning to complete our BSG warehouse optimization project this year. Beginning in fiscal 2009 I would expect to see inventory and expense improvements from increased productivity and other efficiencies at our BSG distribution facilities. We continue to project an annual savings of approximately $10 million from this program, beginning in fiscal 2009.

Our planned 2008 capital expenditures for this project are approximately $15 million, with fiscal '08 restructuring expenses estimated at $4 million. YTD facility and severance costs, including noncash expenses, like depreciation, were $2.1 million.

We continue to move forward with our growth plans and execute on our profit initiatives for the Company. We plan to continue to use available cash to grow the business through new store openings and by seeking potential acquisitions that maximize shareholder value by providing a revenue stream with little or no infrastructure costs.

In fiscal 2008 we expect to execute on our goal of growing the company's store base, combining both Sally and BSG stores, by 4% to 5%. For the year we expect to open 140 to 180 net new Sally and BSG stores, not including acquired stores.

We continue to prudently manage operating cash, working capital, debt levels, and available liquidity. Our coverage multiple is currently above two times EBITDA to interest, and I expect us to generate cash flow from operations to pay down our debt as scheduled.

For the remainder of 2008, we have an additional $8 million in debt maturities, and in fiscal years 2009 and 2010 we are scheduled to pay down another $24 million per year. We believe that our capital structure is appropriate, as is reflected in our current bond valuations, given our ability to generate free cash flow for store growth and acquisitions that meet our investment criteria and long-term growth strategy, as well as to retire debt.

Our stock price volatility in recent weeks has been frustrating; however, we remain focused on producing solid financial results and carefully managing the business. Our growth plans have not changed, and we believe that the stability and consistency of our industry remains a solid foundation for achieving sales and profitability goals this year and into the future.

Thank you for your continued support of our Company. And now I would like to open the call for questions.

(OPERATOR INSTRUCTIONS.)

Your first question comes from Karru Martinson with Deutsche Bank.

Good morning. I was wondering if we could talk a little bit about what you're seeing in terms of consumer traffic trends going forward here? It sounds like we're going to be doing a little bit more advertising. I mean you certainly singled out some of the weaker housing markets, and then what we're seeing on that front.

Well, it was actually encouraging this quarter. Our traffic showed some slight improvement over the first quarter. You're correct, we focused some promotional efforts in those three key states, which we have identified in the past as states that we saw some unusual weakness, which I agree with you has probably had something to do with the housing market and the economy in general there.

One thing I want to be clear on, the promotional efforts that we will be going forward with in this quarter impacted Sally's operating margins more than they should going forward, simply because a lot of our normal promotional activity was already in place for Q2 and we added some. Going into 3 and 4, we will be reallocating some promotional dollars, and we also have gone to our vendor community and received a fairly significant amount of support in the way of additional advertising allowances to fund a lot of what we plan on doing the rest of the year.

And just for the second question here, I was wondering if you could kind of break-out your costs for the acquisitions of the certain assets for the California, Arizona, and also the Texas?

We really don't give the -- that kind of detail, but I will tell you this, these BSG acquisitions, as I've said in the past, when we made both those acquisitions we took on no overhead. We purchased sales, and by adding these product lines to our stores, which neither one of these companies had stores, and picking up a few of the sales consultants, but then opening these brands up to our own sales consultants, we have a tremendous flow-through, and they're very, very accretive acquisitions for us, but they're very small.

Thank you very much. I'll go back into queue.

Your next question comes from Todd Harkrider with Goldman Sachs.

Yes, congratulations on another strong quarter.

Thanks, Todd.

I was wondering, to take up on the traffic issues, I was wondering if you can elaborate a little bit more on your same store sales growth, the Sally Beauty stores, since most retailers are reporting worse same store numbers, and you're actually improving.

I know you have a healthy remodeling and relocation program, how much do you think that's actually helping you out, to continue to reporting positive same store sales right now?

I don't think that's having any plus or minus impact. Our relocation program is ongoing and has been for many, many years. We relocate a store when either we lose anchors in a shopping center or we see just general changes in the neighborhood. But our relocations are well in line with general retail. We relocate approximately 5% of our stores every year, but that hasn't changed in a long time, and I don't think that has anything to do with our results right now.

Okay. And can you talk a little bit more about the Pro-Duo acquisition, since Belgium, France, and Spain are new countries for you? How many stores do you expect to have in these countries down the line? Should we assume that you're finding it more difficult to grow in the UK, Canada, and Mexico, or just it was a great opportunity, and you wanted to go ahead and grab it while you could?

Well, we're not finding it more difficult to grow. As I've said before, in Canada our challenge is just finding real estate. In Mexico we're still growing very rapidly, but we saw this as an opportunity to really get a foothold in western Europe.

We primarily have operated in the UK, and I will tell you that we now have I think about 275 stores in the UK, so I do expect us to see some growth challenges in the UK, because it's a fairly small country, and we have a lot of stores there already. But this will enable us to grow significantly in a couple of key countries in western Europe, being France and Spain.

Pro-Duo is pretty well saturated in Belgium, but they are just scratching the surface in France, and the -- they're a Spanish business, we had a small business in Spain from the Salon Services acquisition from February of '07. This will add to that and give us a base to rapidly expand there. Those are both very densely populated, very beauty conscious countries, and we expect to have a very nice business there going forward.

Okay. One last question, if I may? I mean you've done a great job of de-leveraging the balance sheet over a full tur] in the past 18 months. If the right opportunity came along, would leveraging back up to six times be on the table, or do you think CD&R would be willing for a transaction to have an equity component to make it leverage mutual?

You know, I guess you'd have to ask CD&R that. I'm, as I said in my prepared comments, I'm quite comfortable with the debt level we have today. We have more than a 2-to-1 coverage EBITDA to interest. I'm not sure that leveraging up any more right now would -- I guess we are, to a degree, with some of the acquisitions that we're making, but we've generally been able to put it right back down below the six times pretty quickly. So, but as far as what CD&R's views on that might be, you'd have to ask them.

Okay. I appreciate the comments. Congratulations.

Thanks, Todd.

Your next question comes from Reade Kim with Merrill Lynch.

Thanks. Gary, I was wondering if you could talk a little bit more about some of the competitive dynamics you saw in the quarter at BSG? It is a nice result, obviously, but I guess people might be interested in hearing how the competitive environment is, especially in those areas where you line-up against the L'Oreal stores, especially? And then also just given the slower economy whether you see any sort of trade-down behavior among your professional customers? And whether there was any category strength or weakness you'd care to call out?

We didn't really see any category strength or weakness, particularly on the BSG side. As far as competing with L'Oreal, it still continues to be kind of favorable to us, as we get more and more brands that don't really want to be distributed by L'Oreal owned distributors, so we'd still continue to pick-up business from that whole effect. And I haven't really seen much of anything change.

As far as people trading down, I think you have to keep in mind that BSG does not distribute the very, very high end brands, like an [Ovata], or a Kerastase, which are the really expensive ones. And I would expect if there's any kind of trade-down it might be from those brands down into the BSG brands, which are Paul Mitchell, and Wella, and JOICO, and some of those, which compared to the Sally brands they're higher, but they are not the really premium, premium brands that are out there. They're more mass.

Okay. And then I know even on the professional side, you're very slowly bringing in some of your own house brands. I was just wondering if that's a fairly immaterial boost to gross margins, or whether that's something that will show-up in the numbers. And then just to keep it to two questions, I was curious if you could tell us how the trip down to South America went and what the outlook is for maybe acquisitions down there, down the road? Thank you.

Sure. Answering your first question, our control label business is only on the Sally side. We don't have any control labels on the BSG side of our business, and as far as how that's going, it's going quite well. We are seeing increased margins in our brushes and our electrical appliances, which were the two categories that we started bringing in directly at the end of the last calendar year.

The -- what was the second half of the question?

South America.

Oh, South America, yes. I spent a little over a week down there, gosh, about six or seven weeks ago, and it was the first time I'd been in Chile and Argentina. I think we got a good read on what the business is down there. I would tell you it kind of compares to Mexico as compared to some of the other countries we do business in, and I believe we'll have some acquisition opportunities, however, they'll be very small. But, I've said in the past, we kind of like to go into new countries with a small acquisition, just to get some management, first of all, and some local country infrastructure, and then grow from there. So I would hope that sometime between now and the end of fiscal '09 we could get started down there.

Your next question comes from Grant Jordan with Wachovia.

Hi. This is [Mike Shuels] in for Grant. What is your private label penetration up to in the Sally Beauty business?

For this quarter it was right around 41%, which was comparable to Q1.

Okay. Thanks. Can you give us a little color on sort of the M&A dynamics for the BSG segment? Are there a lot of opportunities out there? Is it just you and L'Oreal? Give us a feel for that?

Well, there are not a lot of opportunities out there for large acquisitions for BSG, but what we've said in the past, and what we continue to execute on, just like the ones I talked about in our prepared remarks, are just getting additional geographies or adding brands to our existing network.

Now, sometimes that's coming at no cost to us as a brand wants to pull away from L'Oreal distribution, or sometimes as we did here with the Paul Mitchell distribution and the JOICO/ISO, we buy the distribution rights, but again, as I mentioned a few minutes ago, typically these are DSC only businesses, they don't have stores, so we're not adding stores that would probably overlap with our stores, since we already operate in these geographies. Therefore, we're not taking on any expenses. We generally are buying a revenue stream.

We're not taking on any additional distribution centers. We're not adding stores, as I mentioned. We selectively take on sales consultants, and then we put these brands through the existing store network and give them to our existing sales force, and we get a very nice flowthrough on that. And that's what I see going forward for BSG, more very small acquisitions such as these.

Great. Thanks. That's all I had.

Okay. Thank you.

Your next question comes from Linda Bolton Weiser with Caris.

Thank you. When you were part of Alberto-Culver, I always remembered Howard Bernick talking about the international Sally business, and discussing how the business model was a little different, because you needed to have kind of more expensive real estate to generate the consumer retail sales, and it was a little different than what had been achieved in the U.S.

Is something changed? Are you seeing some different things that you can do in the strategy? Because what you're talking about doing doesn't mesh with what he always talked about the business being outside the U.S. being a little different.

Well, it's different from a couple standpoints. When you operate outside North America, the stores, the businesses that we have are really kind of a combination of Sally and BSG, because we are the store partner for a lot of brands outside the U.S. that would be considered BSG brands in the U.S.

So what Howard was referring to is if you really want to have a retail business, you typically have to get on, in London, for example, what they call the high streets. But we've really found over the last few years that the rent that you pay on those high streets are not really worth it and the return isn't there. So we've gone and more expanded in the traditional way that we had been over, particularly in the UK, and Pro-Duo, the company that we just acquired, operates in a very, very similar manner to Sally UK.

So what that means is that the retail growth in those countries will be probably similar to what it's been in the U.S. here. Over 20 or 25 years we've gone from an 85% professional business in the U.S. to a 70% retail business in the U.S. And I would expect that to be similar to how it happens outside the U.S.

It's not something that happens overnight, and if you try and force it to happen overnight, by taking these high street locations, you get some retail business, but you sacrifice the core of the business, because the professional, they want parking, they -- you have to have larger stores for the professional, because you have to carry the brand assortment.

So I wouldn't look for us to be in a lot of high profile retail space outside the U.S. And, truthfully, we're not in the high profile retail space in the U.S. with Sally. We basically are not in malls in the U.S. We operate best in strip centers and in a lot of smaller towns just in convenience type centers.

Thank you. That's very helpful. And then can you just give a few, a couple factors, why the BSG margin was actually down sequentially from the first quarter?

Yes, well, first of all, that's not abnormal for the BSG business, but most importantly we, as we said here, we have a fair amount of the BSG warehouse optimization expenses, operating expenses, that are hitting, that hit the second quarter, we'll have some more in the third quarter, and we, as we continue to try and wrap this project up sometime late summer.

Great. Thank you very much.

You're welcome. Thank you.

Your next question comes from [Chris Sabola] with Bear Stearns.

How are you guys doing?

Good. How are you, Chris?

Doing pretty well. I just have a couple quick questions for you about Sally Beauty. The first one is in regards to the operating margins, which are down about 100 basis points in the quarter.

Yes.

In 2Q '07 Salon Success's results only -- I think they were included for about roughly half of the quarter. If Salon Success's results had been included in all of 2Q '07, I estimate that Sally Beauty's operating margins actually would have been like 50 to 60 basis points higher, is that correct?

Well, yes, but it isn't all because of the international dilution. Some of the margin, operating margin decrease on the Sally side, actually more than half of it, is due to the promotional efforts, as I mentioned, the additional promotional efforts that we expended in March and also these fuel surcharges are a small part of it. The fuel surcharges are going to be with us going forward, it is my expectation. The international dilution will be with us going forward, but the bulk of that drop from 17.7 to 16.7 was the promotional efforts which, as I said earlier, we are reallocating some of our promotional dollars, and we've also got some significant help from the vendor community in the way of increased advertising allowances.

Yes. And also since the Salon Success is like, I guess, would be included in Sally's same-store sales this quarter for only about again roughly half of the quarter, did you discontinue the VAT-free promotion, back in I think it was in June? If I were to back out what I kind of estimate as their incremental sales from that promotion, I'm, estimating that Sally's same store sales would have been up like roughly 20 basis points higher than the 1.4% to 1.6%, is that correct?

Well, I'm not sure I followed you on that one. What I can say is that we made a strategic decision when we bought, you said so on Success, I think you mean Salon Services?

Salon Services, I apologize.

Yes, yes, okay. I knew what you meant. We are not repeating the VAT free sales, and we will anniversary the last VAT free sale in July. Our margins have come up significantly in our international business because we've not followed through with these VAT free sales. So we've had a little bit of pressure on the top line due to that, but our bottom line, our EBITDA percentage has increased very nicely. And once we anniversary the July, VAT-free sale, which was the last one, we will start seeing even more improvement on the top line.

Okay. Perfect.

Your next question comes from Duncan Vise with AIG Investments.

Good morning, guys. Good quarter. Just a couple questions. One, I was trying to understand, the $3.5 million of acquisition costs, can you just let me know, was that in the -- would that be in the Sally Beauty operating income segment or the BSG operating income segment, or was that corporate?

That's in the Sally segment.

Okay, so that's in the Sally, so if we add that -- and I'm assuming this is just deal costs for closing the acquisition?

It's incremental SG&A related to Salon Services.

Okay. So is that viewed as onetime, or is this going to be something that's recurring?

It's something that's recurring.

It will be recurring going forward?

Correct.

Okay.

We're not completely finished with some of the consolidation and integration of that business, so we should see some improvement there, but we basically bought a $100 million business that is going to have some incremental SG&A.

Okay. And then the second question, I guess, is more when I look from -- between your Q2 and Q3, from an operating margin perspective, is there any reason why your Q3 margin should be lower than your Q2 margins on the Sally Beauty side?

Not that I can think of.

Okay, so they should be pretty consistent? Okay. And let me just, last, on the -- your international piece of the business, you guys had talked about targeting a 10% operating margin. Is that still in your plans?

Absolutely.

Okay. Thank you.

You're welcome. Thank you.

Your next question comes from Justin Hott with Bear Stearns.

Gary, how is it going?

Good. Justin, how are you?

Okay. First, one question, following up on what Chris said, can you talk about how much the VAT discontinuation affected comps this quarter?

Oh, boy, that's a tough one. I would have to get back to you with details on that, Justin. It -- those VAT sales generated a lot of top line and just destroyed the margins, and so it's significant but I can't give you a number off the top of my head.

Okay. I'll get back to you on that.

Okay.

And can you, on the BSG business, I mean I guess can you compare the performance of the CosmoProf, well, I guess,of the Company owned stores versus the franchise stores this quarter, what's going right, what's going wrong? Is one performing better than the other?

For the quarter, the --

And in general?

-- yes, well, I would tell you in general, because we were not impacted by the L'Oreal contract change, or we were slightly impacted, it wasn't much of an impact for the franchise business, that business is just kind of motoring along, and the areas where we were impacted is where we've received a lot of help from vendors in the way of changing their distribution, and most of the acquisitions that we've made have been outside the franchise area.

Now, having said that, the Paul Mitchell one we just made in central and south Texas was in the franchise area, and the JOICO/ISO one had some effect for the franchise business in Arizona and southern Nevada, but the bulk of that business was in California, which helped our CosmoProf business that had been affected by the L'Oreal changes.

So I'm not sure I'm answering your question properly but we -- the franchise business is kind of motoring along at the rate that it had been, where we're seeing stronger increases in the CosmoProf area for the reasons I just said.

Sounds -- well, I guess, let me rephrase my question then?

Okay.

Our worry is that you're doing a really good job with your franchise on stores, on the L'Oreal replacement, but if I'm a franchisee and I had a big brand that's been a cash cow for many years, I might not want to go to another brand. So is that being seen in the performance, at all, or --

Okay. But, first of all, keep in mind that the big brand in our franchise business, the two big brands in our franchise business continue to be Matrix and Farouk, and we did not lose that in that business, so.

But there are big changes in Matrix, I guess, though.

Pardon me?

But Matrix, again, being a L'Oreal brand, it's a concern -- I just am wondering if there's any change in performance because of the new -- with the franchisees, even though they still have Matrix, because of what L'Oreal might be doing with their brand?

Well, I think the franchisees probably have a concern about that, just given what the L'Oreal brands did to the rest of BSG a year-and-a-half ago, but and we've obviously have been adding a few brands to the franchise business just to be, oh, I guess somewhat protected in the event that there would be any kind of a brand change at Armstrong McCall.

So we're trying to diversify that business, but at the same time, as I said, the Matrix business is a very important business to us at Armstrong McCall, and we continue to believe that we have a very, very strong contract there, and that everything should be fine. Having said that, I'm sure there's a bit of anxiety on behalf of some of the franchises, given what's happened in the rest of BSG.

And would it be fair to assume that some of the things you've learned in the past year within the Company owned stores would apply to the franchised stores in terms of your new brand?

Yes, that would be fair.

And just one other question, it's sort of the first conference call since your CFO, David Rea, announced he would be leaving. Can you update us on the CFO hunt, and maybe any changes that have occurred?

Sure. Nothing has occurred to this point. We do have a search going to review internal and external candidates, and I would hope that we would have a decision by the time we talk to you next quarter.

Okay. Thank you.

Thank you, Justin.

Your next question comes from David Cumberland with Robert Baird.

Thanks. Good morning. The number of consultants declined from the end of Q1 after it had risen sequentially for a couple of quarters. Why did that group get smaller?

Well, we are continually rightsizing that business. We have some fairly sophisticated routing software that we have been using, and we have really turned up our analysis of the performance of sales consultants, and where we find that we're not getting a return or that a salesman is not performing, we are just consolidating some of those sales routes and trying to get our people focused on the key salons. And I don't think the change there is significant and it could very well go the other way by the next quarter. I think within 50 consultants one way or the other, I think we've settled in to where we will probably be for the foreseeable future.

Related to that, were there any rightsizing costs in the quarter? And then in future quarters are there any remaining retention incentives planned at BSG?

I think we are pretty much through the retention costs, but there were some in the quarter.

There was approximately $800,000 worth.

And going forward, I think most of that is behind us. Now, having said that, as I said a few minutes ago, we still have some distribution, our distribution project, we still have some rightsizing costs there, which we've identified should be about $4 million this fiscal year, of which about $2.1 million has already been spent.

That helps. Thank you.

You're welcome.

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

An expense question, as I'm trying to get a feel for what that margin should be by the end of the year, and so the rest of this year there should not be any margin pressure to BSG from L'Oreal, is that correct? Or we've got $1.9 million more of distribution expense?

Yes, we have $1.9 million more of distribution expense. Once we anniversaried the L'Oreal issue, the margin pressure from that whole issue is no longer with us, so we have -- you always have margin pressure, but as far as it being related to the L'Oreal changes, we've now anniversaried that.

Okay. And then my second question is can you talk at all about how the customer behavior, and especially the economic impact, do you see any differences between the regular consumer and the cosmetologists? And in your marketing, why did you call out cosmetologists and Hispanic customers, is what you were particularly trying to get in those markets you mentioned, where you're putting incremental marketing?

Well, as I said in the last call, we had identified some specific weakness in those three states, and we believe that the economy in those three states has been severely impacted by housing, and a lot of the workers in that industry are Hispanic. We also recognize some weakness in our professional business there, so we just wanted to put some extra promotional effort behind that.

Our business, as I've told all of you since we spun out of Alberto-Culver, is extremely consistent and extremely non-seasonal, and pretty recession resistant, and that's what we're seeing. Now, is there some impact from gas prices? And I can't tell you that we've seen a specific impact or a specific difference in our customer patterns in the last year that I could blame on gas, so we just kind of motor along, and I'm extremely excited about some of the things that we tested in March. They've been a long time coming, but there was a lot of programming necessary, and I think this Paris Hilton thing has the ability to really bring in a new, younger customer that, that's our future.

Is Paris, herself, going to do any PR for you?

Yes, she's in New York today, for the whole day, doing PR with the fashion editors. This is an interesting relationship. It's not just a licensing agreement, where she gets a check and then hits the road. She's very involved in the business, and she makes money when these things sell, so she has a vested interest in seeing this be successful.

Huh, interesting. Good luck.

Thank you.

Your next question comes from Karru Martinson with Deutsche Bank.

Hi. Just to follow-up on the $8 million debt maturities here. With the free cash flow that you're generating, I mean what are your plans for paying it down beyond that?

As we've talked about, our strategy hasn't changed. Certainly, after we get past the first two items of our strategy, which is new store growth and any of the acquisitions that kind of fit our investment criteria, we use that free cash flow to pay down debt, and we will continue to do so above and beyond what those debt maturities are, anytime we have an outstanding balance on our ABL.

Okay. And if you are able to secure, the opportunity presents, and you're able to secure a greater number of acquisitions or stores than expected, would we see a shift in the store growth CapEx spend here?

I guess if we were to make some large acquisition and then make the decision to integrate that as opposed to opening new stores, you could. But to be honest, I don't see that happening, because I don't see acquisitions in the areas that we're interested in growing that are of anywhere near that size.

Okay. And then just, lastly, in terms of the Paris Hilton business, I mean what are your expectations for the size of this partnership or in terms of the ability to generate sales?

I couldn't tell you what the sales will be specifically in the Paris Hilton hair extensions. I will say that hair extensions have been an extremely hot category and far outpacing our overall growth percentages for the last two years.

And I'll also say that we believe that when this younger customer or this new customer comes in, because of the Paris Hilton hair extensions, that we will get a lot of play into some of our other brands that are geared for the younger generation.

Okay. Thank you very much.

You're welcome.

Your next question comes from [Henry Papillon] with Oppenheimer.

Hi, good afternoon. Just in terms of your -- the call provisions for the 9.25% senior notes and 10.5% senior subordinated notes, can you talk about what those are, you know, given lowering interest rates?

Well, we're not even contemplating calling those notes right now. I mean that's not something that's even on our radar screen. We have other levers to pull, and with paying down debt, we have variable rate debt that's able to pay-down without any call premium, so we're not even focused on that.

Okay. Thank you.

Your next question comes from Linda Bolton Weiser with Caris.

Thanks. I'm sorry if I missed this, but did you give us what operating cash flow was in the YTD?

Well, we haven't given that to you yet, but in terms of what that number is, and certainly we will file our Q here in the afternoon, but I certainly can share with you that from an operating, cash flow from operating activities right now through the six months is approximately $20.1 million.

Thank you.

Your next question comes from Justin Hott with Bear Stearns.

Just as a quick summary, Gary, you've talked a little bit about the quarter, some of the trends you're seeing in the quarter, with 1.4 same store sales at Sally, a good pick-up from the previous quarter, are you seeing those trends extending into April so far?

Yes, we were comfortable with April and, as I said, we've got some great things planned, particularly for later in May and June.

And something we've talked about in the past, are there any, in updating us on individual brands that where we might have seen some sort of step change, an improvement at BSG, is there anything you would call out this quarter?

We're having a great deal of success with Goldwell and Paul Mitchell, also with JOICO. All three of these are large hair color brands. Our partnership with P&G is working well, and it -- there -- we're seeing nice growth across the board as the numbers in BSG kind of reflect.

Okay. Thanks.

Your next question comes from Emily Shanks with Lehman Brothers.

Yes, I just had a quick question around how you track customer data, and if that's a priority for you, and if you're contemplating implementing any additional systems to help you do that?

We have some excellent systems in place now and have for many years, on both sides of our business, and we collect data on every transaction, every customer, and have been using it on the BSG side very effectively, and we are, as I mentioned earlier, our CRM program, I was very impressed with the small test that we did in March with that, and we look to expand that throughout all of our Sally stores yet this fiscal year. But we have a very sophisticated data tracking system that allows us to really know a lot about our customers.

Great. Thank you.

You're welcome.

At this time, there are no further questions.

Okay. Well, again, thank you for your interest in Sally Beauty Holdings. I'm sorry we didn't get any questions about debt swap this time, just a joke. Thanks, and see you next time.

This concludes today's Sally Beauty Holdings fiscal 2008 second quarter financial results conference call. You may now disconnect.