Sally Beauty Holdings Inc (SBH) 2012 Q3 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 2012 third quarter results. All participants have been placed in a listen-only mode.

After management's prepared remarks, I will facilitate a question-and-answer session and initially each caller will be limited to two questions. Additional instructions will be given at that time.

I would now like to turn the conference over to Karen Fugate, Vice President of Investor Relations.

Thank you. Before we begin, I would like to remind you that certain comments, including matters such as forecasted financial information, contractor 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 the Sally Beauty Holdings SEC filings, including its most recent annual report on Form 10-K for the fiscal year ended September 30, 2011. 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, and Mark Flaherty, Senior Vice President and Chief Financial Officer. Now I would like to turn the call over to Gary.

Thank you, Karen, and good morning, everyone. Thank you for joining us for our fiscal 2012 third quarter earnings call. Although we released third quarter results a couple of weeks ago, Mark and I will provide more color on those results and review some of our third quarter accomplishments.

I'll start with consolidated results. Same-store sales growth for the third quarter was 5.2%. For the first nine months of fiscal 2012, same-store sales grew 7.1%. We believe that over the long term same-store sales will grow 4% to 5% versus our historical run rate of 3% to 4%.

Consolidated sales were $887 million, growth of 6% over last year. Sales growth is primarily due to same-store sales and new store openings. The negative impact of foreign currency exchange offset sales growth by 132 basis points.

Adjusted net earnings in the third quarter increased by 28.3% to $71.6 million, or $0.38 per share, after adjusting for $2.1 million net of tax in unamortized deferred financing costs. Fiscal 2011 third quarter net earnings are adjusted for an after-tax credit of $13.4 million from a litigation settlement net of nonrecurring expenses.

In the third quarter, GAAP net earnings were $69.5 million, a 0.5% increase when compared to 2011 third quarter earnings. GAAP earnings per share were $0.37, flat when compared to prior year GAAP earnings per share.

And finally, adjusted EBITDA in the third quarter was $155.7 million, strong growth of 17.3% over the prior year. We ended the quarter with a store count of 4,434, an increase of 172 stores, or growth of 4% over last year.

Turning to our segment performance, starting with Sally Beauty Supply, same-store sales growth for Sally Beauty was 5.2%. If you recall, in the second quarter, Sally comps reached a record high of 9.3%, due in part to extraordinary circumstances such as an extra day in February, favorable weather comparisons and Easter promotions falling in March versus April last year.

Net sales reached $553.4 million for strong growth of 7%. An increase in total transactions and higher average ticket continued to be the primary drivers behind our strong sales performance. Gross profit margin at Sally Beauty increased 100 basis points to 55.4%. Favorable customer and product mix were the primary drivers of this year-over-year performance.

Operating earnings reached $117.6 million for growth of 13.9%. Operating margin was 21.3%, an improvement of 130 basis points over last year's third quarter. Operating margin improvement was primarily due to strong gross margin expansion and SG&A leverage in our Sally North American businesses.

During the third quarter, our Beauty Club Card memberships grew 20%. Sales from our club members were up 23% and were a key contributor to transaction growth and higher average ticket.

Now turning to BSG. Our BSG segment had same-store sales of 5.3% growth. Net sales were $333.6 million, growth of 4.4%. This performance is primarily due to higher transactions and continued success in adding new brands and territory rights in more of our geographies.

BSG's gross profit margin was up 100 basis points to 41.4%. This strong performance was due to favorable customer and product mix.

Operating earnings for BSG were $46.7 million, versus $56.7 million in the prior year quarter. BSG's operating results in the fiscal 2011 third quarter reflect a net positive impact of $19 million from a litigation settlement and nonrecurring charges.

In summary, Sally Beauty Holdings had an excellent third quarter with strong sales, EBITDA and EPS growth. We refinanced our term loan B and repurchased over 7 million shares of our stock. Our business performance continues to be consistent in the countries in which we operate, despite an unpredictable global economy.

Before I turn it over to Mark, I'd like to acknowledge our former private equity partner, CD&R, who played a key role in our launch as a separate public company over five years ago. In October of last year, they sold their first tranche of SBH shares with subsequent block sales in February and May.

Last month they sold their remaining shares of Sally Beauty Holdings. The folks at CD&R have been terrific partners and shareholders for our Company. I congratulate them on their success and wish them well in their future endeavors.

Now Mark will provide more financial detail for the third quarter. Mark?

Thanks, Gary. Net sales for the third quarter were $887 million, an increase of 6%. Same-store sales for the same period grew 5.2%. During the first nine months of fiscal 2012, consolidated same-store sales grew 7.1%. Consolidated gross profit was $444 million, or 50.1% of sales, 100 basis point improvement from the fiscal 2011 third quarter.

Both businesses contributed to our gross margin expansion. Third quarter SG&A expenses were $291.5 million and represented 32.9% of sales versus 31% in the prior year. As a reminder, the fiscal 2011 third quarter SG&A expenses include a $21.3 million credit from a litigation settlement net of nonrecurring charges.

This credit is reflected in the BSG segment and in the unallocated corporate expenses in the amount of $19 million and $2.3 million respectively. Excluding the $21.3 million credit, SG&A leverage in the fiscal 2012 third quarter would have been favorable over the prior year. Unallocated corporate expenses, including share-based compensation, were $27.7 million, or 3.1% of sales.

Consolidated operating earnings in the third quarter reached $136.5 million. Operating margin was 15.4% versus 16.3% in the prior year quarter. Year-over-year performance was impacted by the litigation settlement credit of $21.3 million in the fiscal 2011 third quarter.

Interest expense during the quarter totaled $26.9 million, a year-over-year decrease of $0.8 million. This decrease is due to lower average outstanding borrowings and lower interest rates on the long-term debt. The Company's debt, excluding capital leases, totaled approximately $1.5 billion at June 30, 2012. On May 18th we closed on the public offering of $700 million of senior notes due 2022 priced at 5.75%.

The proceeds from the offering were used to pay the outstanding principal accrued and unpaid interest on the term B loan facility, as well as a $91.1 million repayment towards the outstanding principal on the ABL, which was used in the Company's repurchase of 7.6 million shares of its common stock in May of 2012. At June 30, 2012, the balance of our ABL facility was approximately $53 million.

For the fiscal 2012 third quarter, our effective tax rate was 36.6% versus 36.3% in the fiscal 2011 third quarter. We continue to estimate that our annual effective tax rate for the fiscal 2012 year to be in the range of 37% to 38%.

Adjusted EBITDA for the third quarter grew 17.3% to $155.7 million compared to $132.7 million in the prior year's quarter. This strong performance is primarily due to gross margin expansion and SG&A leverage.

And turning to the balance sheet, inventories increased by $54 million, or 8.1%, compared to ending inventory on June 30 of 2011. This year-over-year increase is primarily due to sales growth in existing stores, additional inventory for new store openings and acquisitions.

Capital expenditures for the first nine months of the fiscal year were $44.3 million. For the fiscal 2012 year, we continue to expect capital expenditures excluding acquisitions to be in the range of $65 million to $70 million.

With the completion of our refinancing efforts, we believe that our debt profile is optimal for the time being. We continue to have discussions with our Board regarding other uses of excess cash, whether it is in the form of a share repurchase or dividend program. However, our first priority is to continue to grow the business.

We believe that there is plenty of opportunity to grow organically and through acquisitions in Europe, South America, as well as North America. While there is no specific direction I could share with you at present, as always, we will keep you updated as our direction crystallizes in the near future. Gary?

Thanks, Mark. In summary, we had a great third quarter and our year-to-date performance is outstanding. For the first nine months of fiscal 2012, net sales are up 8.6%, driven by same-store sales growth of 7.1%.

Our consolidated gross margin is up 70 basis points with operating margin expansion up 70 basis points as well. With one quarter remaining, we believe fiscal 2012 will be another outstanding year for Sally Beauty Holdings.

As always, thank you for your interest in our Company, and now we will turn it back to the operator to take your questions.

Thank you. (Operator Instructions). Our first question comes from the line of William Reuter with Bank of America. Your line is open.

Good morning.

Good morning.

I was wondering if you could talk a little bit about what you've been seeing in trends in terms of Europe, whether those trends have been showing weakening signs in light of the challenging environment there.

Actually, we haven't. Our only challenge in Europe right now is the UK with our distribution issues. Those are continuing and they're going to take a little longer to work out of than we originally anticipated, but the rest of Europe is actually performing pretty well for us.

Okay. And then you kind of actually touched upon my next question, which you guys have commented that bringing UK distribution in-house is going to negatively impact your margins for a while. I'm wondering at what point you guys think kind of your goal is to get through those, when those won't be a drag.

We will be completely through at the end of our second quarter. They should start to improve in our second quarter of 2013, January through March.

Okay. And then just lastly, your thoughts on shareholder friendly, either share buy-backs or dividends, how you guys are thinking about your uses of free cash flow at this point. Thank you.

As we said in kind of the prepared remarks is that the Board is having a fairly active dialogue on this topic right now, which is pretty timely considering that we're in the beginning throes of our annual plan for 2013 and also all of our other uses of cash that typically are necessary for achieving the plan next year as far as CapEx and what we may target for our growth rates organically as well as some of the acquisition targets that may or may not come to fruition over time.

So this is a very active and fluent conversation right now. They're weighing both pieces in terms of whether or not a dividend program or a share repurchase program makes sense at this time, and the only thing I can say is that it's a very actionable conversation, and we'll keep you posted as more develops.

That's fair. Thank you.

Thank you. Our next question comes from the line of Karru Martinson with Deutsche Bank. Your line is open.

Good morning. When we look at the gross margin here, and especially in Sally Beauty, the retail side, what's the mix of professional customers versus the retail customers and where do you guys see that kind of going over time?

We really update that, Karru, on an annual basis, and I believe for 2011 it was 74/26. It continues to swing toward the retail side, and we generally have seen about a point shift per year in that, so I would fully expect it at the end of this fiscal year to be somewhere in the neighborhood of 75/25.

Okay. And do you feel that's being driven by your CRM program, or what's kind of behind that?

Well, a lot of it is the CRM program, yes, but also you have to consider that there is a finite number of professional customers out there that we can sell to as professionals. And obviously there is a much larger number of just general women out there, the public. So I think the potential market is much, much larger on the retail side than the professional side.

The good news for us is our professional business does keep growing each year. It's just not growing at the rate that the retail business is.

Okay. And when we look at product categories as the drivers of sales, hair extensions were big for a while, feathers were big. What are the next kind of growth drivers to help you guys drive that organic growth going forward?

Actually the nail category has been extremely strong for the last two years. However, one of the things that slightly affected our comps, I believe, in the third quarter here was we anniversaried a couple of major launches in the nail category. Last year at this time, Crackle was just peaking and the gel polishes were really just getting started, particularly with Sally, and our nail categories were growing almost 30% in the third quarter last year, and we had to anniversary that this year, so it was significantly less than that.

But that's the beauty industry. We had that happen with hair extensions in the past. Our color business, which to me is our most important category, is very consistent and still outpacing our overall sales growth.

Okay. So you guys aren't seeing a big jump in the caviar nail category going forward?

Caviar nail category, no.

Got you. And then just lastly, when we look at the competitive landscape, you have one major competitor out there in the US in particular. Where do you see the industry, especially for the mom-and-pops, going? I mean is there opportunity for more consolidation there? Is it ultimately going to just end up being a duopoly, or what's the end game there?

You're switching over to the BSG side now.

Yes, exactly.

I think that small distributors have a lot of opportunity out there. This is an easy industry to get started in. There's a lot of small ones that are out there selling new brands. There is still opportunity for consolidation, such as the Paul Mitchell distribution we brought in last fall into our BSG organization.

But you're right, there are two major players there, our organization and L'Oreal SalonCentric, and it's -- that's come from consolidation over the years, and I think like in many industries it obviously does put some pressure on the smaller distributors.

But the larger distributors, such as us and SalonCentric, that have multiple brands, can actually have a very good store organization, and that's very difficult to do for this smaller distributor that is really only selling one or two brands.

Thank you very much. Appreciate it.

You're welcome.

Thank you. Our next question comes from the line of Simon Gutman with Credit Suisse. Please go ahead.

Thanks. It's Simeon.

Good morning, Simeon.

Good morning. A couple questions going back to the distribution changes in the UK. Can you just give us a bigger background on that process? I think initially we were targeting maybe by the end of summer to see that transition complete.

And then can you also talk about the gross margin which bounced back nicely despite that transitioning continue? So can you just talk about some of the drivers? Was it still a drag on the gross margin, implying that the core business is up even more than it looks, and then how should we think about that progression going forward?

Okay, yes. First of all, let me address your second question. The drag on margin is not as bad in the third quarter as it was in the second, and the additional distribution costs do hit the gross profit margin line. The other comment you made is true, but maybe not to the degree that you might think in that if you took that margin dilution out, the rest of the Sally business margin even grew a little better, that's true.

Where are we going with this and why is it taking longer? The answer to that is real simple.

When we got into the -- when we first got into the 3PL issue over there, we had a distribution center in the Midlands, in Blackburn, that our lease was coming up on. It was a very old building. It was not a building that allowed us to distribute very efficiently out of.

We knew we had to do something, and because of the -- we thought the potential of looking at a third-party distribution may be a necessity in some of the smaller countries that we get into. Eventually we decided, and we also know that a lot of the major retailers in the UK do use a third-party distribution system, so we decided that we would try it, and bottom line is within the first six months we realized it was a mistake.

We then started searching for our own distribution center, which took a little longer than we expected, but we really felt like we want to do this right because it's a long-term commitment, it's a fair amount of CapEx, and it will help us greatly going forward. So we finally found another building, which happened to be in Blackburn as well, which the good news there is it's very central to our whole store base in the UK.

There were actually two choices. The choice that was the best choice financially, long-term, needed some work in the building. The bottom line there is we had to remove and replace the floor, and that once we got the lease negotiated, which was just about a month ago, and got this process started, that is adding 12 or 13 weeks to the project schedule.

So when we first talked about having this behind us by the end of the fiscal year, that was before we had really even decided -- I think if you look back, we were talking like that on our second quarter call, but when we realized it was going to take a little longer to find a spot, to get the lease negotiated properly, and then, unfortunately, the better of the two, as I said, sites financially was going to take a little more time to get this floor issue resolved.

End result of all that is we won't be finished with the floor until sometime in September, and then the fit-out and the racking and all the automation that needs to go into it will happen. We don't want to try and really do anything that would affect the stores anymore in the holiday season, so we will start actually moving into this place in the beginning of the second quarter and be finished completely by the end of March.

And I feel like that's a good date now. It shouldn't be pushed back because there aren't any more variables, at least that we're aware of, that can happen.

A couple of points that I'd like to make, though, is when we talk about gross margin, there is POS margin, which is actually the selling price margin, difference between cost and selling price. That margin in the UK is fine. Where we're getting hit is distribution costs go into the margin line as well, and that's tearing our margin line up over there badly.

But the way I'm looking at it is, look, the business is fundamentally okay. Do we have stock-outs that we shouldn't have? Yes. Are we operating as efficiently as we should be? Absolutely not.

But as long as we are seeing the margins hold up and our service levels are in the upper 80%s or around 90%, which isn't acceptable, and it is affecting our top line sales a bit, I do think we see the end and it's not going to be a problem, that once it's solved will be difficult to get us back on track.

And setting all that aside, the UK with all the remodeling we've done on stores and just the other things we've been working on from an improvement standpoint over there, systems and everything else, and as we mentioned last quarter, we are starting to put the fundamentals of a Beauty Club Card system in place over there, but I don't want anyone to get too excited about that because it takes a long time to build the database where it's usable. And as I think you know here in the US, the BCC program is a retail program for Sally, and the UK's retail business is only about 20% of its total.

So not only is it going to take longer, but it's a very much smaller base to start with, so it's going to be a long time before we start seeing some tangible significant benefits out of that program over there.

And to clarify on that, does that mean, given the performance we saw this quarter, that the bulk of disruption from the margin standpoint is behind, meaning the performance this quarter will be more indicative of what to expect, or I think what happened in the second quarter where some of those issues were enough to overwhelm the overall gross margin?

Well, the hardest hit is behind us. It will start getting better sequentially over the next two quarters, and there is a couple reasons for that.

The 3PL, we are very limited in the amount of product we can ship out of there. So we do have another distribution center that has been used for our mail order business, our salon furniture business and our student kit business, which is another significant piece of our business. That warehouse is in Glasgow.

So what we've done there is kind of move a lot of that business into an off-site facility, particularly the salon furniture and the student kits, because it isn't a day in, day out business. We already have racking in there, so we are now using our own facility to supply stores with some of the faster-moving SKUs so that we're not dependent on the 3PL.

So we have our vendors drop-shipping, the major vendors drop-shipping a lot of product to the stores. We have our own Glasgow facility shipping the higher volume, but non-major-vendor items. And then we have the 3PL essentially down to shipping the CND items for us.

Now is that ideal for stores to be getting product from three different points? Absolutely not, but it is helping us to improve the margin hit, and it will get a little better this quarter, a little better in the first quarter of 2013, and then we'll see a little bit of it left over in the second quarter and should be completely out of it at the end of the second quarter.

Okay. And then my follow-up question is, among the competitors, the branded manufacturer competitors, on the professional side, the ones that do distribution themselves, can you talk to the competitive environment there? Has it changed any, and do you see that those -- any trends changing as far as manufacturers doing more of the self-distribution?

Nothing's really changed there, Simeon. The numbers that I see and the input that I get is I don't think any of them are particularly happy with the results of that, the ones that have done it. And as I think we've talked about in the past, Wella, for example, which is a P&G company, has been giving us back chunks of distribution that we already had the store business in, but they were handling the street business, and I think that they're finding that in certain geographies, whether it be markets or entire states, it's just not economical for them to do that. Which I guess if you put a pencil to that, it was probably always true, but it's just taken them a while to figure that out.

Thank you.

Thank you.

You're welcome.

Our next question comes from the line of Meredith Adler with Barclays. Your line is open.

Hi, guys.

Hi, Meredith.

I think I'll segue into something you had talked about, I don't know if it was last quarter or not, but about things that were happening in Europe in terms of getting product that you had never carried before in your stores. Is that a trend that continued, or are there any changes in what you're seeing in that way?

No. Our European businesses continue to bring in new brands, whether they be from Europe or whether they be US brands. Obviously with a lot of the regulatory issues that are happening in Europe, the REACH issues as they're called, that's presenting some challenges for companies that manufacture outside the EU to make sure that their products are compliant from an ingredient and packaging standpoint, so that -- it's just put a new wrinkle to it.

But I think that most of the big players that have to address that are well on their way to taking care of those issues. But a lot of the new product that we bring in to our European organization isn't necessarily coming from the US because in many cases the freight is just prohibitive to do that, but we are continually adding brands in Europe from other parts of Europe.

And then maybe talk a little bit -- there wasn't anything said today about acquisitions. Presumably nothing happened in the third quarter. Are you still seeing opportunity in Europe to do acquisitions, or will you really rely on organic growth?

And then has anything changed in Latin America? Is there any more prospects of finding decent quality assets?

Well, addressing Europe first, there is a tremendous amount of opportunity in Europe. Our issue there, as we started talking about at least a year ago, is we are in the process of putting all of our businesses there on an international ERP system. Today we operate, our business in Europe is a combination of about five or six different acquisitions, and they're still operating on independent IT systems.

So one of the things that we need to do in order to be able to get real aggressive from an acquisition standpoint is to have an IT platform that's common through all of these companies that we operate. And that will give us a lot of efficiencies and a lot of access to information across all of the businesses there. That will be very helpful.

So we just finished rolling that out in Mexico. That was kind of our test, and it went well there. We are starting this fall with Europe, and it will probably take us at least a year is my guess. That doesn't mean we won't be making small acquisitions in Europe in the meantime, or possibly even a large acquisition that's capable of standing on its own until we get it converted to the IT platform. But it will be much easier to do acquisitions, small or large, much more rapidly once this system is in place.

South America, same story. I think there is a lot of opportunity there. The problem there seems to be more of getting prospective sellers to be willing to indemnify you for -- us for anything that had happened in their business prior to our purchasing it, so it's -- South America reminds me a lot of southern Europe. It's just a different mentality, and it's a whole different thought process when it comes to taxes and who's responsible for what and that sort of thing.

But we're very happy with the business we have in Chile. We're very, very happy with Mexico. Of course, that's been 11 years there already. And I do believe that we will get started in some of the larger countries in South America. It's just taken a little more time, for the reasons I just mentioned, than we expected.

And I just have one final question about sales. I mean I understand that the second quarter was just exceptionally good and you had factors that were driving that. First quarter was also better, especially at the stores, than the third quarter.

I'm just wondering if there was anything particular that made that happen, and when we think about the fourth quarter, should we be prepared for either tough comparisons or anything that's going to be helpful?

Well, first of all, the first quarter, you're absolutely right. We had an excellent first quarter which was very much driven by holiday. We just had a marvelous December, and there is a lot of reasons for that, but the fact is it was just a great December which drove Q1. In Q2 we've talked about all of the reasons why that was strong.

And if you look at Q4 we do have strong comparisons, no question about that. I believe if you look back, we were better than 6% comps for the total company last year, but I think on the long-term if you kind of model the guidance we try and give, that we believe comps will stay in that 4% to 5% range, you are going to have some upside surprises to that occasionally, which we did in Q1 and Q2, and actually Q3 was above the 5% level.

I feel good about giving you that as guidance, but, hey, there's -- we are up against strong comps from last year, Q4. I don't think there's any question that traffic in retail in general has slowed a bit. I'm not sure how much of that isn't due to the extreme weather that we've been having. I read all of our fields' monthly reports every month, and the reports from the northeast and the Midwest and people that are just not used to this kind of heat, and I'm not blaming our third quarter or giving you any negative guidance for the fourth quarter based on weather, but I do think that's a factor with all of retail.

And we are, to some degree, a retailer that lives off traffic, especially for new business, in shopping centers. So when you hear traffic being soft for players like Walmart and Target, and so forth, it's going to have a minor impact on our business.

Great. Thank you very much.

Thank you. Our next question comes from the line of Jason Gere with RBC. Your line is open.

Okay. Thanks. Gary, just kind of following up on the line of questioning from Meredith. I think when you guys did your pre-announcement, and then your conference call I think the following day, you did talk about reiterating kind of that 5% to 7% comp for this year, also that I think comps would be better than 6%. So now just with all of the puts and takes out there, and I hear you on some of the traffic in retail slowing a little bit, but are you still comfortable with kind of that dialogue that you laid out two weeks ago?

Yes. For this year, yes, our nine-month comp right now is 7.1%. So I mean even if we fall in the 5% range, which would be the high end of our 4% to 5% guidance, that still puts us over 6% for the year, so, yes, I'm very comfortable with what I said two weeks ago.

Okay. Great. No, just thanks for the clarity there. And then I guess this second question that I had was just about the operating margins at Sally, which I think hit a record high this quarter even with some of the -- a little bit of the issues with the UK.

I was just wondering like how do you measure some of the productivity of deals that are out there? When you see that there is a deal that could drive sales, do you sometimes forgo that because it's just not productive enough or profitable enough, meaning that you would rather take a little bit more margin than taking sales that the returns are not as good?

I was just wondering if there is anything in that third quarter that might have reflected that because the margins were still so good even with a couple of the issues that you mentioned.

No. First of all, obviously it's a balance to keep strong promotions and margin in check. But you have to remember something about our business. We don't have a six-pack of Coca-Cola that we can run a great special on and generate a tremendous amount of traffic and drive sales. Our products are basically replenishment products and are bought as product is used or it's needed.

Hair color, for example, our largest category, we can put a tremendous sale on hair color and possibly get somebody to buy two or three tubes in one visit as opposed to the one tube they would normally buy and then come back next month for the second. That could drive some short-term sales, but you're going to lose that customer the following two months. So we don't really have a lot of commodities that we would take business from someone else, because so much of our business is our own brands, and do some cupboard stuffing.

So that's not to say that we're just saying, hey, we want our margins going up X and we don't care what happens to top line. That's not the case at all.

We are very aggressive with our suppliers to keep our pricing right because one of the things that we are known for, particularly in our professional segment of the Sally business, is price. We are a price leader to the open line customer professional. And to the consumer, even though many of our products are higher cost than a shampoo would be in mass or something, we're generally selling larger sizes and with more of a concentrate so the value is there.

And it just isn't easy for us to take an item or two or a promotion or two and really rip the price on it and accomplish anything other than, like I said, you might drive a little bit of short-term sales, and you're going to give up some margin, and you're going to just give it back though in the following months.

Okay. No, I understand. And then when you look at the margins, both again BSG and Sally kind of hit highs, what's the ceiling as you look out the next couple of years? Do you see more upside in the BSG business, and that's kind of I guess factoring in some acquisitions down the road as you kind of get the synergies there or, how do you look at Sally? Because for a specialty retailer, it's best in class.

Well, with Sally, nothing has changed since we started Sally, and particularly since we spun out and I first started explaining to people that Sally has three margin drivers. Our retail business is a better margin for us than our professional, and it's growing faster than professional. Our own brand business, or as some people would call it private label, is also outpacing our overall sales growth rate, and that's a much better margin, and we also get a little bit of margin help each quarter from direct import sourcing.

I don't see -- I said this five or six years ago, that I didn't see that changing, and I still don't see that changing in the foreseeable future. It's just the way our business is. The retail is growing faster than the professional, and I mean we're thankful for that and it's nice for our margins, but the truth of the matter is there's not a lot we can do about that because there's just more retail people out there than there is professionals.

And the own-brand business, as we acquire more brands and as we do a good job marketing the brands that we own, that is also going to improve, and I've said many times that I enjoy taking investors into a store and challenging them to tell me which brands are ours, and what's really funny is our own employees don't know it half the time. So it's not like we're out there hammering these private label brands at the expense of our branded goods. If we do a better job marketing the product, we get the sale. And it isn't price driven because our branded goods are not necessarily and in many cases not the lowest priced brand on the shelf.

Now BSG. BSG margins will continue to improve slightly as the business continues to shift more to the stores. That's another phenomenon that we don't really control. It's really driven by the proliferation of booth renting in the US, and the booth renter is a store customer. The stores just operate on a higher margin because we don't have all the sales expense and delivery and carrying the account, and all that, that we have on the other side of the business.

Now we have no intention of doing anything that would force that along. We just want to make sure that we're offering the customer the shopping choices that they expect, and as the industry moves more toward booth renting it's going to be more into the stores.

Now the other thing that affects BSG's margin is the synergies that we get out of acquisitions. Actually the smaller fold-ins, as you would expect, give us better synergies very quickly. There are those out there, so I think BSG's operating margin improvement in the future will be as much cost driven, cost reduction, or expense reduction driven, as it will gross profit-margin driven because on that side of the business we're selling exclusive brands, and they more or less have a price that the manufacturer, via their advertising and deal sheets, and so forth, establishes.

So the margins there, I don't want to say they're fixed margins because you do have competition with other brands, and in some cases overlap competition with the same brands. But it's not as easy to raise the gross profit margin in BSG other than simply having the business shipped to the stores, which does a little of that, but that's still more on the expense side than the gross margin side.

So the short answer to your question is I don't see any of those dynamics changing on either side of the business, so I expect our margins to increase. And, again, I would not look at a 100 basis point margin increase as the norm. We have given guidance there that it generally gets us about 50 basis points of operating margin in a year, and the majority of that comes out of gross profit margin, which is mostly driven on the Sally side, and some of it comes out of the BSG side from great expense synergies with small and some large acquisitions.

Okay. Thanks. And the last question, just on the inventories I know it's up 8%. On a per-store basis I think the growth was a little bit higher than the last two quarters. I was just wondering if that was in particular weighed by the UK issues out there or if there's anything that you would kind of call out.

Yes, a little bit of it is the UK issue, but also on the Sally side we have been expanding some product selection in the Sally stores. Gelish is a good example of that. It's a very high-priced gel polish line, and they've been expanding shades, which is running up our inventory a little bit, but there is a lot of things that we've been doing assortment-wise there.

We also as we -- I mentioned we put Mexico on our ERP system this quarter. When you first do that, it's kind of counterproductive to inventory because as you get this thing up and running you want to make sure the stores are properly stocked in case you have anything happen in the short term. You don't want it to hurt revenues. So that adds a little bit. I mentioned the UK.

And we also deliberately on the Sally side, one of the things that historically we've done, and I think we've talked about this in the past, but our bonus systems around here for executives are primarily revenue, EBITDA and working capital driven. Now I think that we put together an inventory schedule at the beginning of the year, and we would hold to that come hell or high water, whether sales were running 4% or 5% above that or right at plan.

Well, the problem with that is when we were running, as you saw in first and second quarters, significantly above our own sales plan and your expectations and everyone else's, it was putting pressure on our inventory. We were seeing stock-outs that we shouldn't have, but kind of the people managing the inventory were saying, okay, great, that's driving our working capital number way down, and it's going to great for bonuses, but it wasn't helping sales.

So around the first of the year, calendar year, January, we made a conscious decision to let our inventory drift a little more with our sales rate. So if our sales were running 4% or 5% ahead of our plan, we're letting our inventory drift up, maybe not 5%, but at least 3% or 4% instead of holding it flat.

Now that may not be the best thing for all of our bonuses, but it's the right thing to do for the business. And we are also looking at a better way to look at that for bonus purposes so there is actually not an incentive to kind of hurt our service levels.

Okay. Great. Thanks for all the color.

You're welcome. Thank you.

Thank you. The next question comes from the line of Chris Ferrara with Bank of America. Your line is open.

Hi. Thanks. I guess can you talk a little bit about the retail environment again? And I guess to your point you've seen retail traffic slow. You're saying it has a little bit of an effect on your business, but I guess can you talk about the quarterly, I guess kind of the cadence of the comps through last quarter or through this Q3 and maybe how it's progressed? Have you seen a progressive weakening related to the economic environment out there?

Well, if you look at our comps for the last three quarters, it hasn't been a progressive weakening. We had unusually high comps in the first quarter, then again in the second quarter. In the third quarter, if you look at our average over the last two or three years, we were very much in line.

Last year our comps in total were 6% and change. I believe that that will be the case this year going into the fourth quarter with three quarters of 7.1% comps. Obviously you would have to have a real train wreck in the fourth quarter to fall below 6%.

So I don't look at it as a weakening of our comps. I look at it as really being back a little more toward our norm, and I gave the reasons for the second quarter comps being as strong as they were.

But the other thing that I look at, even more than sales comps, is traffic comps, and our traffic comps are good, they're positive, and I also look at our average ticket, which is up nicely in both of our businesses, BSG and Sally. And for us, that's really more important.

And I also look at the issuance of Beauty Club Cards because I know that when a person joins that program long-term, we're going to see them more often and they're going to spend more. So when I see that number going up 20% for the quarter and the sales to the club members going up 23% for the quarter, I'm very encouraged by that.

The only weak spot we saw was retail non-Beauty Club Card sales. It was still positive, but if there was one piece of the business and I'm looking at, okay, we've got the -- and I'm talking Sally now, we've got the professional piece and we've got the retail piece, but the retail piece is really Beauty Club Card members now and non-Beauty Club Card members now.

So the bit of softness we saw was the non-Beauty Club Card members, and those are the very infrequent retail customers. And as I said, when you see traffic slow a little in the center, those are the ones that you're not going to see. Because the ones that are already in the Beauty Club Card program, we're communicating with them on a monthly basis and they are very much destination shoppers after they get into the program.

So if there's an at-risk segment that could get hurt a bit by a general retail slowdown, it's going to be that non-Beauty Club Card retail customer.

Now also on the professional side for Sally, and for BSG, if the salon business is slowing a bit, we do get a lot of trade down from do-it-yourselfers and things like that. But when I listen to the numbers that come out of Regis or other salon chains and I see the traffic down, that tells me the salon traffic is a little weak. Now in the long term that could be something good for us because oftentimes those are the people that become do-it-yourselfers, but particularly the short term and more so on the BSG side, that is going to affect their business a little bit.

And I appreciate all the color, and I apologize. I guess I wasn't clear. I guess I just meant, what did June look like. I mean you guys had said April was slower but ahead of your expectations, and I was wondering if you can give a little color on what May and June look like progressively.

And since you gave April last quarter, I will ask you, could you talk a little bit about July now? And maybe you'll shut me down, but I've got to ask.

Yes. We really don't get into months, and I'll tell you why. It isn't so much that we don't want to, but we operate on a calendar month and calendar quarter. So for BSG, for example, BSG does a significant percentage of their business on Mondays in the stores because it's generally the day that salons are closed so that's when professionals shop. In a month that you have five Mondays, BSG is going to look like it's off the charts. In a month where you're up against a month last year that had five Mondays, and this year you have four, it's going to look bad.

So I would be misleading you to -- if we were on a retail calendar, the 4-4-5 where you had exact comparisons, we'd be much more inclined to occasionally talk about that. But we don't because of the way we operate.

And, unfortunately, it's the same thing with Sally. In a month where we have five Fridays and five Saturdays, Sally looks wonderful from a comps standpoint. But when you get the opposite of that and you're comparing to a prior year of five Saturdays and five Fridays, it looks soft. So it would be misleading and unfair to give you detail on a month-by-month basis, which is the primary reason we don't do it.

And then you look at crazy things, and the UK is not a huge piece of our business, but when we looked at the comps in the third quarter, and last year we were up against in I believe it was April the royal wedding, and that absolutely destroyed our comps last year for April. So April this year looked like, oh, man, it was wonderful, but then you got into May, and this year, and you had the jubilee where they actually closed businesses in the UK for a couple of days, which destroyed May's comps.

And now I talk to our people over there, and it's like I talk to people here and they blame things on the snow. Over there they are blaming it on the Olympics. But I think things like that do have a minor impact on business when your business is 80% professional, as ours is in the UK. Sometimes the impact is felt even greater simply because, I can tell you right now, the UK, a hell of a lot of people got out of the country because of the Olympics, and August is a big vacation month there anyway.

So the business is probably going to be a little bit choppy there this quarter, but I still think the majority of it is our own distribution issues, but there are other influencing factors.

And I guess just finally on nail, I know you mentioned that the year-ago comp was 30%, and I guess, what, nail and skin combined are like 13% of sales, but I mean did nail shrink this quarter on that ridiculously high comparison? Because that could be a pretty big drag to your comp in one quarter.

No, it didn't shrink. It was up but nowhere near 30%, and last year I think for the quarter it was closer to 26% or 27%. I think I said between 25% and 30%. But, no.

Fortunately, because particularly the Gelish business I believe is here to stay, where the Crackle was a fad, kind of like the feathers were a fad and the -- what's that thing from the movie?

Oh, The Hunger Games.

The Hunger Games thing was a fad. Those are smaller parts of the nail business, but they're very faddish. The gel business I believe is a technology that is here to stay.

What we're competing with there is it was the introduction in the third quarter of last year for a lot of these gel polishes, so you always see kind of the bubble and then it evens out into a steady business, which is exactly what's happening. But it is at that higher level because we're still seeing positive comps in that category.

All right. Thanks a lot.

You're welcome. Thanks. Operator, thank you.

To summarize, I think we delivered consolidated sales growth of 6% and same-store sales growth of 5.2% in the fiscal 2012 third quarter. We're very pleased with those results. Gross profit margin expanded by 100 basis points, and we achieved EBITDA growth of 17.3%. So, once again, I'd like to thank you for your interest in Sally Beauty Holdings, and we look forward to seeing you soon.

Thank you. And, ladies and gentlemen, today's conference call will be available for replay after 12 PM today until midnight, August 9th. You may access the AT&T teleconference replay system by dialing 800-475-6701 and entering the access code of 255147. International participants may dial 320-365-3844. Those numbers once again, 800-475-6701 or 320-365-3844, and enter the access code of 255147. That does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.