Sally Beauty Holdings Inc (SBH) 2010 Q3 法說會逐字稿

Welcome to the Sally Beauty Holdings third-quarter financial results conference call. At this time, all participants are in a listen-only mode, and later we will be conducting a question and answer session. Instructions will be given at that time. (Operator instructions.) As a reminder, this conference is being recorded.

I'd like to now turn the conference over to our host, Ms. Karen Fugate. Please go ahead.

Thank you. Before we begin, I would like to remind you that certain comments, including comments on matters such as forecasted financial information, contracts for business and trend information made during this call may contain forward-looking statements within the meaning of Section 21-E of the Securities and 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 for the fiscal year ended September 30th, 2009.

The Company does not undertake any obligations 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, and Mark Flaherty, Senior Vice President and Chief Financial Officer.

Now, I would like to turn the call over to Gary.

Good morning, and thank you for joining us for our fiscal 2010 third-quarter earnings call. I will begin today's discussion with a high level review of our results followed by an overview of our business initiatives. Mark will then take you through the financial results in more detail.

As you saw from our press release this morning, Sally Beauty Holdings had another outstanding quarter with both business segments reporting strong sales and earnings growth. On a consolidated basis, same-store sales grew 4.6% contributing to strong revenue growth of 10.3% while gross profit margin expanded by 140 basis points.

And for the first time during the quarter, adjusted EBITDA exceeded the $100 million mark. During the quarter, we paid off the remaining balance of our Term Loan "A" facility via a $54.7 million prepayment. Our total debt reduction year to date is $105 million or 69% of our operating cash.

We ended June with a worldwide store count of 3,986. During the quarter, we opened 33 net new stores for a total of 165 stores opened year to date. On July 19, we celebrated the opening of our 4,000th store. Store expansion is a key component of our long-term growth strategy, and we believe that there is plenty of opportunity to open more stores in North America, South and Central America, and Europe.

Turning to segment highlights. For the third quarter, the Sally division reported same-store sales growth of 3.6%. Net sales were $467.4 million, strong growth of 7.5% percent driven primarily by transaction growth and a higher average ticket. A key contributor to this performance is the success of our CRM campaign to bring in new customers and entice existing customers to visit the stores more often.

Sales from our Beauty Club Card customers continued to grow as a percent of our retail sales. As we've said before, our data tells us that a Beauty Club Card, or BCC member, spends more on average and visits the store more often than a non-BCC customer.

Gross profit margin at the Sally segment expanded 170 basis points and reflects the continued shift in product and customer mix, as well as solid margin improvement in the international business.

We continued our CRM initiative and experienced the highest reduction rates since the launch of the campaign. As I mentioned before, we are taking a different approach in our target marketing efforts by working across all geographies starting with the highest potential customers. Based on our recent data, we believe this approach will yield even better results than our previous method of targeting individual geographies.

The Sally UK business had a good quarter with marked improvement in net sales, same-store sales growth, and gross profit margins. We continued our efforts to retrofit the UK stores and remain pleased with the increased performance from the stores we've already completed. The UK team has done a great job of turning this business around.

Now turning to BSG. BSG had strong same-store sales growth of 7.4% compared to growth of 0.6% in the third quarter last year. Net sales grew 15.5% to reach $275.5 million including 9% growth from acquisitions. In addition, growth in store traffic and stronger performance in the franchise business also contributed to our positive results.

Gross margin for BSG was up 60 basis points over last year and reached 40% for the first time. Gross margin performance was due to favorable customer and product mix resulting from targeted marketing initiatives. The BSG segment ended the third quarter with 1,013 stores including 158 franchise locations for a year-over-year increase of 8% or 71 stores. The number of sales consultants totaled 1,055 in the quarter.

In conclusion, we had another outstanding quarter. Our business continues to perform in line with historical trends, and we believe this underscores the stability and consistency of our business model. We do not expect these trends to change in the foreseeable future. Now Mark will provide more financial detail for the third quarter. Mark?

Thanks, Gary. Consolidated net sales for the 2010 third quarter were $743 million, a 10.3% increase. This increase was driven by same-store sales growth of 4.6%, growth from acquisitions of 5%, and net new store growth of 1.4%. Consolidated gross profit was $360.9 million or 48.6% of sales, a 140 basis point improvement from the fiscal 2009 third quarter.

Third-quarter SG&A expenses, included unallocated corporate costs and share based compensation, were $255.6 million or 34.4% of sales, a 110 basis point increase from the 33.3% in the year-ago quarter. Fiscal 2010 third quarter SG&A expenses increased 14% due in part to higher expenses associated with the Company's loyalty programs, international expansion, and restored pay increases that were suspended in the year -- in the fiscal year 2009. In addition, expenses associated with opening new stores and acquisitions such as rent, occupancy, and payroll expenses contributed to the year-over-year increase.

Unallocated corporate expenses including share-based compensation were $22.6 million or 3% of sales versus the fiscal 2009 third-quarter expenses of $20.2 million and 3% of sales. Consolidated operating earnings for the quarter were up 12.6% to reach $92.6 million. Operating earnings as a percentage of sales increased 30 basis points to 12.5%. This increase is primarily due to higher gross margins in both business segments.

Interest expense net of interest income for the third quarter was $28.3 million, a decline of $2.8 million over last year's quarter primarily due to a lower debt balance and the rates on our term loan facility.

Income taxes were $23.2 million with an effective tax rate of 36.1% for the fiscal 2010 third quarter. For the 2010 year, we expect our effective tax rate to be approximately 38%. Our net earnings for the fiscal 2010 third quarter were $41.1 million with earnings per share of $0.22. Net earnings growth over the fiscal 2009 third-quarter GAAP and adjusted net earnings were 30.6% and 37.1%, respectively.

Adjusted EBITDA for the third quarter was $107.8 million, an increase of 12.9% compared to the $95.5 million in the prior-year quarter. This increase is primarily due to higher gross margin in segment operating earnings.

And turning to the business segments, starting with Sally Beauty, same-store sales for Sally Beauty Supply grew 3.6%. Net sales reached $467.4 million, an increase of 7.5%. Sales growth was driven by same-store sales and new store openings, as well as acquisitions. Gross profit for the quarter was $249.5 million or growth of 11% over the year-ago quarter with a gross margin of 53.4%, a 170 basis point improvement. Gross profit margin was positively impacted by a shift in product and customer mix and improved performance in the UK business. The Sally segment reported third-quarter operating earnings of $85.1 million, up 10.9%. Operating margins were 18.2% of sales, up 50 basis points from the 17.7% in the fiscal 2009 third quarter.

Turning to the BSG business, during the third quarter, our BSG segment grew same stores sales by 7.4%. Net sales were $275.5 million, up 15.5% over the prior year's quarter. This sales increase is attributed to growth in same-store sales, new store openings, improvement in the franchise business, as well as recent acquisitions. Gross profit for BSG in the third quarter increased 19.6% to $111.3 million with gross margin of 40.4%, 140 basis points higher than the prior year's quarter. Gross profit -- gross margin expansion was primarily due to improved sales and product mix, expansion in new and existing territories and improvement in the franchise business. Segment operating earnings for BSG in the third quarter increased 17.4% year over year to $30.1 million. Operating margins at BSG reached 10.9%, a 20 basis point improvement over the prior year. This margin improvement is the result of cost reduction initiatives, improved gross margins, and savings from the warehouse optimization initiative.

And turning to our balance sheet for fiscal 2010 third quarter, cash and cash equivalents at June 30, 2010 were $28.3 million and working capital was $345.6 million, an increase of $3.9 million. Capital expenditures for the first nine months of fiscal year 2010 totaled $36 million. For the full year, we continue to expect capital expenditures to be in the range of $45 million to $50 million. We ended the quarter with $5 million outstanding on our ABL facility and approximately $341.5 million of borrowing capacity.

Our debt at the end of the quarter excluding capital leases totaled approximately $1.58 billion. During the quarter, we paid down $54.7 million of our long-term debt completing the prepayment of our senior term loan A facility.

On May 28 of 2010, Standard & Poor's Rating Services raised its corporate credit rating on Sally Beauty Holdings to BB- from a B+ with a stable outlook. As I mentioned on previous earnings calls, we are in discussions with our ABL lenders regarding the renewal of our facility and now anticipate the completion of a new facility in the fall of 2010. At this time, I do not expect any material changes to the existing terms and conditions. As always, we will let you know more about our progress in the months ahead.

Gary?

Thank you, Mark. In closing, we had a terrific quarter. Same-store sales grew 4.6% with net sales up 10.3%. Our gross margin expanded by 140 basis points, and net earnings were up 30.6%. And lastly, we continued to de-lever the Company by paying down $54.7 million of long-term debt. As we head into the fourth quarter, we believe we will have a strong finish to fiscal year 2010.

We will now turn it over to the operator to take your questions.

Thank you. (Operator instructions.) And we do have a number of people that are queuing up. The first question is coming from Grant Jordan. He's with Wells Fargo. Please go ahead.

Good morning. Thanks for taking the questions. My first question -- it sounds like the CRM continues to really drive good performance. Can you give us some stats in terms of like number of users and the penetration rate that you think you've achieved with it so far?

Grant, we really don't break out that kind of detail. As I said in my prepared remarks, we're seeing -- in this particular quarter, we saw the highest redemption rate that we have seen so far in attracting new customers. And I think that's also, for the reason that I gave, we're focusing on what we believe are the highest potential customers on a wider basis than in the past. We were taking specific geographies at a time and drilling a little deeper as opposed to taking our total geography and going not quite as deep. But, the results are very good. And we're encouraged by them, and I think it'll continue.

Just in terms of like a percent of kind of where you want to be at the end of the project, I mean, are you 50% of the way there? Are you more or less?

As I said in my remarks, they -- our BCC customers now represent about 40% of our retail business, which is about 70% of our total business. So, I think that getting to 50% over the next several years should be very realistic. Going beyond that, we still have a lot of customers that are infrequent users and don't purchase a lot. And I think there will always be that group out there that will not join a loyalty club because they don't think they shop often enough to get the value out of it. So, it's a little difficult for me to say beyond 50% where this could go. I think we'll have a much better feel for that when we get to 50%.

Okay. My last question, where did inventory end up at the end of the quarter?

Hold on just a second. Let me --

Sure.

Getting that for you. Right at about $586 million.

And do you feel like with the sales growth that Sally's experienced, do you think there's opportunities to take inventory levels up or do you feel pretty good about where you are?

Grant, as we said previously in our outlook for the year is is that we expect that working capital to be a slight source. It won't be the large source of cash that it was in the prior year from the warehouse optimization program and the consolidation of the warehouses. What you're going to see is is that typically in our ongoing efforts is is that you'll see inventory go up marginally for new store growth or for acquisitions. However, we are seeing internally our inventory turns have improved over time.

Yes, definitely. Okay. So you feel like based on the sales level that you can continue to get the improved turns it sounds like?

On a very modest basis, yes.

Okay. All right. That's all I had, and thank you.

Thanks.

We'll now go to Emily Shanks with Barclays Capital. You may go ahead.

Good morning, everybody.

Good morning, Emily.

Hi. I was hoping you could give us a little color around Sally comps specifically. I was curious if you could give us a sense of traffic versus ticket and then also if you're seeing anything differing by geography.

Both ticket and transactions are up. I would say in this particular quarter that average sale drove it a little more than traffic, but it's been pretty much an equally shared increase there. And what was the second part of your question?

Just around if there were any significant geographical trends across the country that you are seeing, underperformers or outperformers.

Nothing new. As I stated, I think, two quarters ago, we are seeing the softness in southern California, Florida, Arizona, and Nevada picking up, but that's been happening now really since about the first of the calendar year.

And sorry, just to be clear, when you say the softness has been picking up, do you mean it's continuing to get more soft or it's reversing trends?

No, no, no. It's reversing. 2009, those markets that I just mentioned were particularly soft given their historical trends, but that turned around for us and they've been doing much better this calendar year.

Okay. Great. And were comps fairly consistent intra-quarter?

Consistent -- you mean across geographies?

No, apologies. Just month to month.

Month -- oh, month to month through the quarter -- we really don't give a lot of detail on that, Emily, but I think we followed retail trends through the quarter. I think the way Memorial Day fell this year it affected most retailers May and somewhat June because it was so late, but nothing significant.

Okay, great. And then just my last question is around the positive benefit of product mix on gross profit margin both at Sally and at BSG. Can you just run through with us what the exact product lines are that have been a higher saturation of sales?

Not so much the product lines. On the Sally side, obviously, it continues to be growth in our controlled label brands and our LCC project. On the BSG side, it -- oh, also on the Sally side, it has a lot to do with the retail professional mix of customers, which retail obviously continues to grow faster than professional, which helps the margins.

On the BSG side, it really is more a mix between the stores and the sales consultants. As we've said many times, the store sale for BSG is a more -- a higher gross profit sale than the sales consultant. So, when the stores grow significantly faster than the sales consultant business, and as you saw from BSG's same-store sales, that's happening, that adds to their margin and has more of an effect than the particular brand combination.

Great. Thank you. Good luck.

Thank you.

Our next question is coming from Erika Maschmeyer with Robert W. Baird. Please go ahead.

Hi. Good morning. Nice quarter.

Thank you, Erika.

Just wanted to follow up on the increase in average ticket. What was really driving that? And could you also give us an update on your new product launches and maybe the impact of those on your comp, if that was material or not?

What's driving the average ticket, again, is some of the success of the CRM and Beauty Club Card program, as I stated. That customer tends to purchase more with us when they visit, so that has a lot to do with driving average sale. From a category standpoint, hair extensions, which is a pretty high ticket item for us still, are performing extremely well, and our electrical appliance business, which is also a fairly high ring for us, did quite well.

Okay, thanks. And then your gross margin expansion has accelerated this quarter pretty meaningfully from prior quarters. You're really above the prior run rate at Sally and BSG. Yes, I know you've had the same sort of drivers in your business for a long time, but, I mean, I guess really what caused that acceleration and do you expect that factor or those factors to continue to the same degree going forward or was this kind of more of a one-time blip?

I think this was somewhat of a one-time blip. I don't expect that level of increase to go forward. I think, as we've said many times, our gross profit margin on the Sally side tends to increase about 50 basis points a year. I think this particular quarter, first of all, we were up against a fairly weak gross profit comp from last year. And secondly, it's just kind of a lot of things came together that affected the margin this quarter that just don't always happen. Our control label products were good. As I mentioned, the BCC program did quite well and the hair extensions and electricals. Not only are they a high ring for us, but they're a good gross profit margin sale, as well.

On the SG&A side, when do you expect to really sort of cycle your major investments, compensation expense, loyalty program costs?

The compensation we did anniversary in the third quarter. The CRM and loyalty costs will anniversary in the fourth quarter. So, going forward into next year, that will be back in line, and as I said at the beginning of the year, and have said, I think, every quarter, that next year our SG&A will be back in line with historical trends.

And then quickly just the amount of warehouse optimization savings that you realized this quarter and I guess year-to-date.

Year to date I think is $2.2 million.

Correct.

And the quarter was about $230,000.

Great. Thanks so much.

Our next question is coming from Harry -- or, excuse me, [Henry Kaplan] from Oppenheimer. Please go ahead.

Hi. Good morning, and thanks for taking my questions. I guess just digging a little deeper into kind of the change in strategy for the CRM program, is there any way you could talk about kind of where the successes come from? I know you talked about targeting more profitable consumers, but is that changing the impact to costs?

No. It doesn't change the impact to costs at all. What we do is, as I've said in the past, we profile these most likely potential customers based on the data that we get from our best retail customers. So, rather than choosing a specific geography and going deep into that group, what we're doing is putting them into deciles and we are now taking it across all geographies and saying let's start with the most likely or the highest decile first and go wide on that instead of going into a particular geography and maybe going three or four deciles deep. So, we felt like what should be obvious is that the highest deciles as far as the likelihood of becoming a customer should respond better and they are.

Okay, great. And in terms of the kind of the expansion of the CRM program, can you talk about how far you are in terms of expanding that program with this new kind of strategy?

Well, we are -- I think as we put it last time, somebody wanted to compare it to a baseball game. We're probably in the second or third inning of it.

Okay. So, this should last more -- this should be a multi-year process, I'm assuming?

Well, I see this as an ongoing process because once we get through the top deciles, then we'll slide down to the second or third deciles, but then you re evaluate the whole base periodically and establish a whole new top decile that have not become customers. So, I mean, it's just something that -- it should go on and on. You don't ever stop attempting to bring in new customers and this has just proven to be our most successful way in achieving that. Some people do it through media and normal, traditional ways of advertising. I've said in the past that's never been successful for us. We have a very unique business model and a very unique purpose for being to most women and once we can determine that they have the attributes of some of our best retail customers, we're going to keep going after them.

Got it. And then just the last question I have is can you talk about just the competitive landscape in your business? I know that's different from geography to geography, but sort of in totality, are you seeing the kind of the competitive threats change at all?

Not really on the Sally side of our business. As I've often said, it's difficult to define a direct competitor for Sally because of the niche that we fill. I don't think that has changed. On the BSG side of our business, we do have competitors, but since it is more of an exclusive distribution business, the competitors are other brands that we don't carry as opposed to us carrying the same brand as the competitor across the street kind of thing. So, obviously, you have to fight to keep the brands you represent in the marketplace growing faster than the brands you don't represent. And I believe that's exactly what we're doing and I believe we are picking up share with that strategy and I believe that we obviously are growing faster than any of the industry trends that you hear about. So I can only assume from that that we are taking share.

Great. Thank you very much.

And Jill Caruthers from Johnson Rice has a question. You may go ahead. And Jill, your line is open.

Oh, good morning. Can you hear me?

Yes, Jill.

Oh, sorry. A question on the BSG expense gross in the quarter. It looked like on a dollar basis it was up about 20%. Could you dig in a little bit more on what's driving that growth, if that's maybe tied into some of the payroll recovery or something else?

On the BSG side of the business, it's almost exclusively swallowing the Schoeneman acquisition. You should start to see significant improvement there as we get the synergy starting in Q4, and it will look quite good going into '11.

Okay. Okay. And then just a couple questions on merchandise updates. It looks as though BSG is now an exclusive distributor of one of Sephora's lines like Living Proof. And then you've seen some movement of professional brands into the retail setting like Bumble and Bumble. Could you just kind of talk about some of the movements in there and how do you feel that that will impact your distribution business?

Well, first of all, I think that's a very unique test that Sephora is doing with Bumble. It's a very limited distribution line to begin with, and it's quite popular in the Northeast. It's an expensive line. It'll be interesting to see how that test works out. Living Proof is a little bit different in that it's a very unique line from a technology standpoint. And they initially had distribution in Sephora and John Golliher who's the president of BSG made an arrangement with them to take the brand into beauty. But I don't look for the brand to expand its retail distribution beyond what it is today and I think that there's a great market for salons to get involved with this brand. And keep in mind that I think Sephora's reach is somewhat limited not only in the number of stores and where their stores are, but also in the demographics of the customers that they deal with.

Okay, and are you seeing kind of more of these opportunities arise in this type of kind of uncertain environment or -- ?

I can't say we're really seeing much of those type of opportunities coming up. I do think that some of these exclusive brands are always looking for ways to increase their retail penetration. But I also believe that for the most part they are choosing to do that through the professional industry as opposed to letting these brands leak out into retail. Actually, if you look at the retail diversion numbers for the last three or four quarters, they've been coming down significantly with the exception of a few brands. The majority of the brands are seeing declines there. That's something that could've been driven by the price points and the recession effects over the last 12 to 18 months, but I also believe just from our involvement with some of these brands that they are making more of an effort to keep the brands in the professional channel.

Okay, and then just last one. Any update on maybe product costs? We're hearing a lot of about it across the consumer group -- if you're seeing any cost inflation or what not. Thanks.

We aren't yet, but as I've said many times, with our price points, the ingredients and the packaging and the raw materials on a percentage basis represent a lot lower piece of the overall cost than a lot of the retail brands that are feeling that. I think -- if packaging is 10% or 15% of your product cost and it goes up, you're going to feel that. If packaging is 2% or 3% and it goes up, it isn't going to be as significant.

Appreciate it. Thank you.

(Operator instructions.) And we have a question from Mimi Noel from Sidoti & Company. Please continue.

Good morning.

Hi, Mimi.

Most of my questions have been answered, so thank you for the added color. But I do have one residual one and that is regarding your store expansion strategy. And can you remind me of where in particular the North American expansion -- where do you see opportunity there? Is it more weighted towards Sally, more weighted towards BSG? What sort of targets have you set for yourself?

As far as just raw store count, it's more on the Sally side because we are so under-saturated in Canada.

Okay.

[Still] in Mexico, and just because of the nature of Sally's business being heavily retail, there is just opportunity for a lot more stores with Sally in North America, including the US, than there would be for BSG.

Okay. And as you look at your expansion strategy overall, it's safe to say that the opportunity is more international than it is domestically?

Well, I think on a percentage basis that's definitely true. On a raw store count basis, I would say that we are still opening more stores in North America than outside of North America and probably will for the foreseeable future.

Okay. And I think you've provided it before. Would you mind reminding me what a reasonable target for annual square footage growth is?

Yes, it's 3.5% to 4%, generally not including acquisitions. Sometimes depending on the size of the acquisition, if we swallow something that's particularly large, we might back off on organic openings just to digest it, but typically we've been able to maintain 3.5% to 4% --

Okay.

-- on top of acquisitions.

And have you ever talked in much detail about the productivity of stores in their first year, how they might compare to, say, a five year old or a seven year old store? They at about 50%? Is it more like 75%?

No, no, no. Productivity wise it's probably 25% --

Okay.

-- in the first year or two.

Okay. Thank you for the extra detail.

You're welcome, Mimi.

I'll now turn the call over to Mr. Winterhalter. Please continue.

Thank you, operator. We're pleased with the strong results in our third quarter. We intend to stay the course with our long-term objectives to invest in Company growth via acquisition and organic growth while reducing our long-term debt. Thank you for your continued interest in Sally Beauty Holdings.

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