Sally Beauty Holdings Inc (SBH) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to Sally Beauty Holdings fiscal 2013 third-quarter results. At this time, all lines are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given to you at that time. (Operator instructions). As a reminder, today's conference call is being recorded.

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

Thank you. Before we begin, I would like to remind you that certain comments, including matters such as forecasted financial information contracts or business and trend information, may during this call 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 the most recent year-end report on Form 10-K for the fiscal year ended December 30, 2012.

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 adjusted items and non-GAAP financial information in its earnings press release on all its websites.

With me on the call today are Gary Winterhalter, Chairman, 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 2013 third-quarter earnings call. I will begin today's discussion with a high-level review of our financial results and business initiatives. Mark will then take you through the quarter in more detail.

I'm sure you saw from our press release this morning that sales performance for the quarter was mixed. Sales growth from our BSG, Sally International and Sally US Beauty Club Card customers was strong. However, traffic from the Sally non-Club customer was down and impacted overall sales growth.

Although we are disappointed with the performance in our Sally US business, we have identified several opportunities to improve customer traffic that I will discuss in a moment.

Despite soft revenue performance, our overall financial execution was good with a 50.1% gross margin, 50-basis-point improvement in SG&A leverage and double-digit earnings per share growth. Our consolidated same-store sales increased by 0.7% after growing 5.2% in the third quarter last year. Although we knew third-quarter comps would be softer than the fourth quarter, this performance was well below our expectations. The driver that led to this shortfall was the decline in our Sally US non-Beauty Club traffic.

Consolidated gross profit in the third quarter reached 50.1%. This performance represents the second time in Company history that gross margin reached over 50%. The first time was last year in the third quarter.

Now turning to segment performance starting with Sally Beauty Supply, same-store sales for Sally Beauty declined 0.8% versus growth of 5.2% in the prior year. This underperformance is primarily due to the decline in traffic from our non-Club customer. We believe the primary reason for this decline is due to a change in our marketing tactics. Historically, we took a very targeted approach to identifying a potential customer. We sent direct mailers with incentives to entice this profiled customer to visit their nearest Sally store. Several months ago, we changed our marketing approach to reach a broader audience of potential customers, which proved to be less successful than our prior approach. Consequently, as of July we have returned to our original approach. Since it generally takes multiple direct mailers before a potential customer visits a store, I expect it will take a few months to get back to positive traffic growth from this customer segment.

Another potential traffic driver is the new product and brand additions that will roll out in Sally US stores over the next few months. You may be aware of a new curling tool called Curl Genius. It is now available at most of our Sally US stores. We had terrific success with the professional version of this appliance at BSG and expect it will be well received by the Sally customer.

In addition to Curl Genius, we are expecting several new brands to be available at Sally stores in the near future. I'm optimistic that the return to our original marketing program and introduction of new products will boost our non-Club traffic and increase Beauty Club Card conversions.

Net sales for Sally Beauty Supply reached $559 million, an increase of 1% versus growth of 7% in the prior-year quarter. Sales performance at Sally was also impacted by the difficult comparisons of 12% growth in the nail and hair extension categories last year. The sales comparisons for these categories should be easier in our fourth quarter as growth was under 3% in the fourth quarter last year.

Beauty Club members remain loyal, as evidenced by a 6% sales increase this quarter. Club membership also grew 9.6% to 7.2 million. The value proposition for our Sally customer has not changed and is demonstrated by the continued sales growth in our core categories, hair care and hair color, which continue to grow in the mid-to high-single digits. Among our Beauty Club customers, these are top-selling categories with high-single-digit to mid-teen growth rates.

Gross profit margin for the Sally segment hit a record high of 55.6% for the quarter. The 20-basis-point increase over last year was primarily driven by improvement in the Sally European business.

Our international business performed exceptionally well this quarter. Same-store sales were strong, which led to gross margin expansion, SG&A leverage and strong EBITDA growth. We feel very good about the direction of this business. In fact, we just signed a lease to open our first Sally store in Peru this fall. We continue to believe South America represents a great growth opportunity for our business.

Operating earnings were $117.7 million, flat when compared to last year's third quarter. Operating margin was 21% versus a record 21.3% last year. The 30-basis-point decline is primarily caused by higher depreciation expense in Sally US due to IT initiatives.

I want to provide an overview of our IT enhancements, starting with the Sally US point-of-sale conversion. We have converted roughly 80% of our US stores and remain on track to complete the rest by fiscal year end. The new POS system gives the sales associate the ability to look up customer information via phone number, last name or email address at the point of sale. We have seen a 32% increase in Beauty Club Card renewals as a result. We have the capability to more deeply identify customer purchase patterns as well as other behavior, which in turn provides enhanced opportunities for targeted promotions.

We completed the implementation of our international ERP in Belgium on schedule. Subsequently, we expect to implement the system in the remaining European countries over the next 12 to 18 months.

Store count for Sally Beauty ended the quarter at 3379, an increase of 121 stores over last year.

Now turning to our BSG segment, BSG had a terrific quarter with same-store sales growth of 4.6% and net sales growth of 5.8%, reaching $353 million. This growth is attributed to same-store sales, our full-service business and net new store openings. Contribution from the acquisition of Essential Salon Products was immaterial, as it happened on May 31.

BSG's gross profit margin was 41.5%, up 10 basis points over the prior-year quarter. Operating margin at BSG improved by 90 basis points to reach 14.9%. This strong performance was primarily due to sales growth and SG&A leverage.

Store count at BSG ended the quarter at 1223, an increase of 47 stores. Our sales consultant comp is 995, a decrease of 115. As we mentioned last quarter, this year-over-year decline is primarily due to a change in reporting total sales consultants to only full-time consultants by our franchisees.

I would like to summarize the most important takeaways from the quarter. First, our customer traffic across the Company, with the exception of Sally's non-BCC customer, was in line or exceeded internal expectations. Second, we believe the return to our original targeted marketing approach and the introduction of new brands will help drive traffic into Sally US stores. Third, our fiscal 2013 strategic initiatives, including international ERP and Sally's POS implementation, are on track and will play an important role in generating operational efficiencies and enhancing the customer experience.

Before I turn it over to Mark, I want to inform you of two leadership changes in the Sally Beauty Supply segment. Mike Spinozzi, the President of Sally Beauty Supply, is retiring. He will stay with us until November 8. I would like to thank Mike for his contribution and wish and the best.

Coincidentally, we recently made an offer to an outside candidate, Tobin Anderson. Tobin will oversee the Sally Beauty merchandising and marketing departments. Tobin brings over 25 years of retail experience with over 15 years of merchandising and marketing experience in the beauty and fragrance business. Tobin will start his employment next week and we look forward to his contribution and anticipate he will be a likely candidate for the role of President of Sally Beauty Supply.

Now I turn it over to Mark to provide more financial detail for the third quarter. Mark?

Thanks, Gary. Consolidated net sales for the third quarter were $912.1 million, an increase of 2.8%. This increase was primarily driven by 168 net new store openings and same-store sales growth of 70 basis points.

Consolidated gross profit was $457.1 million or 50.1% of sales compared to 50.1% of sales in the fiscal 2012 third quarter. Although gross margin was up 20 basis points at Sally and 10 basis points at BSG, on a consolidated basis, gross margin was flat year over year due to a higher mix of professional sales.

Third-quarter SG&A expenses were $295.7 million, growth of 1.4% from the prior year and below our expectations. SG&A as a percentage of sales was 32.4%, an improvement of 50 basis points over the prior year, primarily due to expense management across the Company.

Unallocated corporate expenses, including share-based compensation, were $27.8 million or 3.1% of sales versus the fiscal 2012 third quarter expenses of $27.7 million or 3.1% of sales.

Consolidated operating earnings in the third quarter increased 4.4% to reach $142.6 million. Operating margin was 15.6%, up 20 basis points primarily due to the strong performance in our BSG business.

Interest expense, including the amortization of debt financing costs, totaled $27 million, which was flat to the prior year's quarter. Adjusted EBITDA for the third quarter was $164.6 million compared to $155 million in the prior year's quarter.

For the fiscal 2013 third quarter, our effective tax rate was 37.3% versus 36.6% in the fiscal 2012 third quarter. On a year-to-date basis, our effective tax rate was 37% and we continue to believe that our effective tax rate for the fiscal 2013 year will be in the previously stated range of 36.5% to 37.5%.

Net earnings were $72.5 million, up 4.3% over the fiscal 2012 third quarter GAAP net earnings of $69.5 million and up 1.3% from the adjusted net earnings of $71.6 million.

Earnings per share was $0.42, a growth of 13.5% over the fiscal 2012 third quarter GAAP earnings per share of $0.37 and up 10.5% when compared to adjusted earnings per share of $0.38.

In looking to our balance sheet, inventories increased $61.2 million or 8.5% compared to the ending inventory on June 30, 2012. This year-over-year increase was primarily due to additional inventory from new store openings and new product offerings. As of June 30, 2013, our debt excluding capital leases totaled approximately $1.7 billion and included $75.5 million of loans outstanding on our ABL facility.

Capital expenditures for the first nine months of fiscal year 2013 totaled $64.6 million and reflect expenditures to open new stores, expenditures on existing stores and IT-specific projects. We expect to end the fiscal year within our previously-stated range of $85 million to $90 million.

On July 26, we amended our ABL facility and increased the maximum availability from $400 million to $500 million and reduced our borrowing spread by a range of 75 to 100 basis points. Other benefits include relaxed restrictions on our ability to make restricted payments and extension of maturity to July 26, 2018, and other approved covenant terms.

During the quarter, we repurchased approximately 3.1 million shares of our common stock at an aggregate cost of $93.8 million. For fiscal year to date, we repurchased 15.1 million shares or 7.5% of our float for a total of $407.2 million at an average stock price of $26.89. As of June 30, we have approximately $559 million remaining under our $700 million authorization. Gary?

Thank you, Mark. Despite soft top-line performance, our overall financial execution was good with a 50.1% gross margin, 50-basis-point improvement in SG&A leverage and double-digit earnings per share growth.

Our BSG and Sally International business had an outstanding quarter and we expect this performance to continue. In the Sally US business, we have returned to our original marketing approach and believe traffic will begin to pick up as a result.

We have some exciting product rollouts coming soon and believe the buzz around these new products and brands will encourage customers to visit our stores. I am confident in the steps we are taking to improve retail traffic, but it might take a few months. While we may see a modest improvement in the fourth quarter as comps become easier, I believe the rebound is likely to come in early fiscal 2014.

Operator, please open up the line for questions.

(Operator instructions) Simeon Gutman, Credit Suisse.

Gary, first, how do you distinguish between an execution issue with the marketing our CRM versus the program maybe just having delivered good results for a long period of time just going through a normalization now?

I would say that the drop-off that we saw was too quick for it to be a problem with the program. It's really obvious to me looking back now what we did, when we did it at the change that it made. There's still too many profiled customers out there that we haven't approached that just tells me that that's not the issue.

Okay. And then, I think on the last call, it was mentioned that April started out little better. Was that better across all of the customers? Was it better with the non-Club customers, and then how did it go from there?

You are absolutely right, which is why on the last call, which was the early part of May, I was encouraged about this quarter bouncing back into the range that we stated. But May and June softened up significantly. April did show weakness in the non-Beauty Club Card, but the other parts of the business on the Sally side, Sally US, were actually pretty good. Some of that could have just been time of year; some of it could have been promotional activity, but it certainly didn't follow through in May and June.

And then two more, I will ask them together and then get off. How much longer could you continue to get this good expense leverage if the comps remain soft?

And then the second part is not related. The change in leadership that you just mentioned at Sally Beauty -- what does it mean for the business, and then what does it mean for you, Gary?

Let me address the first one. A lot of the SG&A leverage that we get when sales are soft, we obviously keep a close eye on store payroll when that happens. We also -- during the year, we are always accruing for bonuses. And as the performance isn't there, you take that accrual down significantly, and obviously bonuses this year will be significantly less than they were last year. So that's part of it.

Mark has also done an excellent job in controlling expenses on the shared services part of the business. So I think that -- I certainly don't want to have to do that on an ongoing basis, but we have always told all of you that we believed that we could leverage expenses on a very low comp. And, if nothing else, I guess we proved it the last couple of quarters. That can't go on indefinitely, obviously, but I don't think it will have to. I think we know what our issue is and I believe that we can solve the issue. But a lot of those things will stay in place as long as sales continue to be soft -- store payroll, we will have a close eye on that, and just overall expenses. We have always been a tightly-run company, so we are used to having issues like this. If you recall, several years ago when we ran into the supply issue on the BSG side of the business, we really reeled in some expenses there and made it through quite well.

Your second question was regarding Mike. Obviously, I'm disappointed with Mike retiring. I've always felt like Mike's a successor would most likely come out of that division, since is the largest and most profitable division. It's kind of the driver of the entire Company, so that's disappointing. Tobin -- we have been talking to Tobin for quite awhile anyway, and I think he's a very likely candidate to succeed Mike when he leaves in November.

Does the fact that -- how long you think of, I guess, running the business?

Myself?

Yes.

No, it really doesn't affect it. I didn't have any plans on retiring, anyway. I like what I do. I feel a big commitment not only to the Company, but to 27,000 people that work here. And I've got a terrific Board that I would never leave hanging in any way. As long as I'm breathing, I'm going to do what's right for the Company as far as succession is considered.

Okay, thanks.

Meredith Adler, Barclays.

I would like to start by just going back to the issue with the marketing. Why did you go to this broader effort to begin with? Were you not happy with the more targeted approach?

We were very happy with the targeted approach, Meredith. Your question is a very good question. It was a mistake, looking back on it. Part of the problem that we had was, it's not like we turned off one and turned on the other in a particular month. It was a gradual shift trying to get more exposure. We were very happy with what was happening. But you are always looking to better things, so we gradually shifted toward another method.

And I'll try to explain why it was difficult to catch. First of all, like I said, it didn't happen overnight. It wasn't like we turned off the hot and turned on the cold at all. It was a gradual change, so that made the results a little more difficult to read. The other thing is, for years now, our list business, our list customer count increases have been declining, but it was because those customers were joining the Beauty Club Card. So we missed the inflection point where the total traffic was starting to grow at a much lesser rate, and then, ultimately, the total traffic slipped slightly negative, which was the situation that we are in right now.

The other thing that disguised a little of it was the strength in the categories that we have been talking about last year. I think we accepted too much of the results for the last couple of quarters, given the calendar changes and the category performances from last year that we were trying to compete with, so that disguised a little of it. And primarily, it had a lot to do with us paying too much attention to redemptions on a lot of these mailers and other ways we went to market and not enough attention to the actual traffic counts.

So I know that's a lot, and it's probably hard to understand, but it's part of the reason we didn't catch it as quickly as we should have.

And let me ask you whether you think you need to do anything else. I'm going to speak a little bit as a customer here, that the stores are not appealing. Even when you first walk into the store, there's nothing that reaches out to a non-core customer; it's so very aimed at the professional customer. Do you think there's anything you can do or should do at the stores to make them more appealing?

That's a very good question. It's one that we struggle with all the time. We do strongly believe that it's that professional aura and that professional look that actually gives us that professional umbrella that actually attracts a lot of retail customers.

Now, I will also say that, given the traffic increases that we were seeing a year ago, and for the 18 to 24 months prior to that when we were really in the middle of the marketing program that we were doing, our traffic was growing nicely. And all of the research that we do, believe it or not, does not point that out as a major issue.

Now, I'm the first one to admit that when you walk into one of our stores, you don't feel like you are walking into an Ulta. But, again, we really don't want to create that feel. First of all, we are a bit limited in what we can do with 1600 square feet. They are not huge stores. Secondly, the professional, which is still 25% of our business at Sally, doesn't expect to be walking into a high-end, boutique-ish type of store because they look at us as a wholesale supplier. And I think the consumer that really appreciates what we are also looks at us as a wholesaler.

Now, we consistently are contesting new looks for the stores. We've got a couple stores here in Dallas that are -- well, they are going on a year now of a completely changed look. And to be honest with you, it's not showing any results in traffic or in sales. So I'm hesitant to devote a lot of capital expenditure to doing something to the stores that may be the wrong thing and doesn't prove itself out.

I'm having a lot of those conversations with Tobin as we speak, because most of his background was at Bath & Body Works, and Bath & Body Works is a very pleasant, nice-looking store when you walk into it. But, it's not going after the customer that we are really going after, and that's kind of the beauty aficionado that is more interested in the products we are selling than what the environment really looks like.

So I don't know if I am answering your question as well as you would want me to answer it, but that's kind of the way we look at it.

No, I mean on the packager testing thing, is really what I like to hear. I have one final question. You have now redone your bank facility. Given the softness in some of the sales, is there any reason you wouldn't borrow to buy back stock right now?

Mark, do you want to take that?

Meredith, yes, we have been very successful this year buying back stock. We've certainly been able to do it within the confines of what we said our targeted leverage is. We've migrated to the top end of that, and a lot of that is just that the historical and very protectable cash flow characteristics of this business allow us to do so.

With that said, going above 2.5 to 2.6, 2.7 for a short period of time -- certainly, we have done that. We are doing it currently in this quarter. But in terms of actually migrating our leverage target up further than that, that's not something that we feel is necessary right now in order to continue to effect the share repurchase program that we have under authorization and feel very comfortable with all the overall capital structure and where we stand today.

Meredith, I would also keep in mind that, even though we had sales difficulties in one piece of one of our businesses, our EBITDA was still above the street expectations and our margin improvement continued as it has. So at this point, we have a sales issue that we think we have identified and I don't expect that we would be changing any of the other things that we have done and continue to do because of what I believe is a short-term sales issue.

Thank you for the very thorough answers; I appreciate it.

Ike Boruchow, Sterne Agee.

Gary, my question is, on the last call you had given an outlook for a 3% to 4% comp for the back half of your fiscal year. Obviously, Q3 came in late. Is there a new outlook? I'm just trying to figure out how we should think about Q4 because it sounds like towards the end of -- May and June softened. I'm curious; is there any comment you can give us on July quarter-to-date and just how to think about the cadence? Because it sounds like you are saying it's going to take a few months for some of the changes that you are implementing to really take place.

Yes, you are absolutely right. I would tell you at this point that I think we will end up with comps maybe slightly better than 1% for the year. I don't think that there's enough that we can do in Q4. And as I said, when we turn this marketing thing around, we know from experience in the last time that we did this, it takes a few mailers to get the customer to react.

We are doing some other things in the way of retail advertising for the first time, not really because of this issue, but more related to what I said in our prepared remarks regarding some of the new brands that we are bringing in. If you recall, in the past, I have always told you that we don't do traditional retail advertising because the brands that we have are not well known to the consumer. So it's difficult to come up with a message that they would react to. We do have some brands coming in that are very well known to the consumer, and it's something for us to shout about. I think it's something that will drive traffic, so we are going to try that as well.

Okay. It seems like that would -- the comments that you made, I think it's a little bit above a 1 for the year would kind of imply like a 1 to 2 positive comp for Q4. Is that fair?

Yes. When you do the math, that's exactly where it is.

Okay. Not to beat it to death, but I guess the question that I have is, if May and June softened, July has been a pretty tough month for retail in general. To get to a 1 to 2, would that take gradual improvement through the quarter?

Yes.

Okay.

Yes. But, when I look at things from last quarter, one that I mentioned on the call where the categories we have really been struggling with were only up 3% last year, so we had to definitely anniversaried those category issues.

I also look at, again, I mentioned this Curl Genius thing. It's a neat electrical appliance that we happen to have a bit of a jump on over our competition. We did really well with it at BSG. I think it's going to add some traffic. It will also add something to sales, obviously, but it's one of those things that's getting a lot of buzz and I think will get a lot of people in, if for no other reason than to just look at it, whether they buy it or not. If they come in the store, we are going to get something out of it.

Okay, and just a quick last question. On the gross margin line, gross margins were flat. I know and appreciate all the drivers that you've had to the business and you have had some great margin expansion the past couple of years. Is this just a one-quarter phenomenon, or should we expect that while the sales remain a little softer than usual, could the gross margin gains be a little slower than usual as well?

Yes. If you put the math to it, it has to be because the piece of the business that's struggling right now is the non-Beauty Club, the list retail customer. That's our highest-margin customer in all of our divisions, everywhere. So when that is soft, it is going to have some impact on the Sally margins.

Now, the margins in other parts of our business are increasing nicely. However, there is still a drag on the total because the Sally margins are the highest to begin with. So I've always said, as international gets to be a larger and larger percentage of our business, and if BSG continues to grow faster than Sally for awhile, that will put some pressure on gross margins.

Now, having said that, we are in the next phase of LCC sourcing, and I've also told you in the past that we took the low-hanging fruit in that project first, and now we are down to things like clips and pins and rollers and shampoo capes and stuff like that, but it all helps. Obviously, we have got a good margin structure on this new curling appliance and a couple of the brands that we are bringing in I was referring to are also going to be very good margins for us. But those may not see much of an impact until Q1 of 2014.

Thank you very much.

Taposh Bari, Goldman Sachs.

I wanted to ask you a question about the marketing tactics. So can you tell us when that change was made? And if you could, it would be helpful if you provide metrics, whether that be comp or traffic, before and after just to help appreciate the magnitude that that change may have felt.

Unfortunately, I can't. It isn't because I would like to, but I said that this change didn't happen like turning one off and turning the other one on. It was a gradual change. We have a lot of graphs that pinpoint it to actually starting a year ago, starting the problem. But as I said a few minutes ago in explaining it, for a lot of reasons it was difficult to read. And it wasn't until probably two or three months ago, really after April when we got into May, we said this is too big of a change too quickly. What are we doing, when did we do it and let's turn it around. And that's when we really started peeling back the onion and figured out what we had done.

So, I wish I could tell you that, hey, this started last September and this was the impact, and we changed it back to July and this will be the impact. But it's not that precise of a science.

The reason why I ask is it sounds like you are pretty convinced that this is the issue with the Sally Beauty non-Beauty Club business. So as we look out over the next call it year or so, just trying to get a better handle around your conviction that that's in fact the problem. Because as I look at other companies in our universe, I wonder if there's a macro issue, if there's a low-end customer issue, if you could just elaborate on what you think about those potential drivers of the business.

I don't think it's a macro issue and I don't think it's a low-end customer issue. I think that at least 90% of the issue is what we are describing. When you look at our customer account going back into the early 2000s, the retail part of our business was the traffic increases percentages had been declining -- and I've made this comment before -- through the early 2000s. And when we started going after this whole Beauty Club Card program, it started increasing pretty significantly. I think you saw in 2011 and 2012 our customer count increases, our traffic increases were really healthy. And again, we can kind of -- fortunately, we have that experience to look at and say, okay, this is what we did and this is what happened. And if I was looking at this, as I said earlier, and looking at a situation where we have exhausted this pool of profiled potential customers, that I would say, hey, we might be, as you guys like to call this, in the eighth or ninth inning of this game.

But I don't see that at all. I see our Beauty Club Card traffic increasing, sales increasing and membership increasing. And that is without the significant funnel of retail customers, which is where most of those conversions come from. That's without that being a full funnel at this point.

So I really believe that the issue is filling that funnel back up, getting retail traffic into the store. And that's going to help Beauty Club Card conversions.

Just a quick follow-up, then. It seems like a lot of focus today is on the non-Beauty Club Card piece, and I guess the two are kind of related. When I look at your -- what I think was your Beauty Club Card sales growth last year north of 20%, this year, at least this quarter, was up around 6%. So there's also deceleration, albeit positive, still a deceleration in that business too. Is that all just a function of the funnel not being there, or is there something else to be said about the Beauty Card (multiple speakers)?

I think that's two things. Number one, it's partly the funnel not being full. But number two is, it's getting to the law of large numbers at some point also because the percentage increases in new cardholders has to slow at some point. We are at 7.2 million right now, and where the card membership count was going up well over 20% 2 and III years ago, that is not going to continue. It's not realistic to think that it will.

However, I think when you look at the fact that the funnel really isn't there right now, that's a significant part of the problem. But I don't expect Beauty Club Card memberships or Beauty Club Card sales to be over 20% anymore. And if you graph that, you will see that the bigger this thing gets percentage-wise, the lower the percentage of new members and, therefore, sales will be.

Now, another thing that's offsetting that is, as I also mentioned in our prepared remarks and I have mentioned several times in the past, the renewal rate on these members is up 32%. And I put 98% of the reason for that is the new POS, the next-gen POS system that is almost completed in the Sally stores. That's going to help enormously because it's almost like bringing in a new Beauty Club Card customer. However, the new Beauty Club Card customer generally spends more in their first year than the ongoing or the renewal customer. It's kind of like when someone is approached with this and they know they are going to have a savings in joining the club, they spend more than is normal the first couple of visits, and then they get into a pattern where they are spending about 20% more than a normal retail customer and visiting more often, but you don't have that big lump of them first joining.

So when you put all that together, I'm still pretty convinced that over the long haul, the Beauty Club Card business can still grow upper-single- or low-double-digit growth, and the new Beauty Club Card members or the membership growth rate can also be in the mid- to upper-single digits. (multiple speakers) If we get the retail business back where it needs to be, even if it was flat, the retail business, that's still going to give us a comp since both pieces of that are about 50% of the retail business now. That's still going to give us a comp somewhere in the neighborhood of 3 to 4 on the Sally side. So that's the range that we believe we should be operating in.

Okay, well thanks a lot, good luck.

Olivia Tong, Bank of America.

I know you said it's early days, but is there anything you can provide us to give us a sense of early signs of change after the shift in focus of marketing back to the way it was? And what exactly was the change? What was it before and what did it turn into an what is it going back to? And then just following up on that, when you are done with this marketing shift, where do you think that same-store sales rebounds to? Is it to 3 to 4, 4 to 5, 3 to 5? If you could give us some color on that, that would be great.

Well, I believe it may take a little while, but I believe we will get back to the comps that we have always said we believe our business is capable of doing, and that is in the three -- I would say 3 to 5, maybe 3 to 4.

The other part of the question, Olivia -- I don't want to give too much detail on the specifics of what we did. And the reason for that is I always felt like as far as this loyalty program in the Beauty Club Card program that we were kind of a step ahead of our competition in this area. And the mistake that we made I can see could be a common mistake that other people would make. And I really don't want to give out a lot of detail on the specifics of that, just for competitive reasons. I don't want our competitors learning on our mistakes. Let them learn on their own.

Got it. And then in terms of -- you mentioned a couple of new products and innovation. Is the pace of new product introductions changing at all; is it accelerating, or is this a normal pace of new product introductions?

The new product introductions is a normal pace. However, we are bringing in a couple of fairly well-known brands over the next several months that will be different and will cause the -- I guess if you look at all as new product introductions, it will cause that to go up a bit over the next few months. But most of the new product introduction or the normal flow of it isn't really changing; it's the new brands coming in that will add to it.

Got it, thanks. Lastly, it doesn't sound like an answer to a previous question that revitalizing the stores is really part of the equation to get that non -- that infrequent customer into the store. So what kind of things are you going to do to bring that infrequent customer back? Is it additional promo; is it flyers, what have you? What is your thinking process behind that?

Well, it's twofold. One is going back to a very targeted marketing approach to a very well-profiled customer to get them into the store. Number two is the new brands that we are bringing in and the impact that I think some pretty significant retail-type advertising announcing these brands will have on the general retail customer.

Great, thank you very much.

Grant Jordan, Wells Fargo.

This is David Eller are standing in for Grant. On the Sally side, you mentioned that margins improved partially due to improvements in international. Can you talk a little bit about what international areas are outperforming and any underperformers?

Sure. First of all, as I said last call, the distribution issue in the UK is behind us now, and that business looks very positive going forward. That was a very difficult year we went through. Sales were up there nicely, comps were up there nicely and a lot of the SG&A leverage that we got compared to LY was due to not having the additional expense of the 3PL and everything else that we were going through last year in the UK.

Secondly, our European business is performing very nicely. We had a great quarter in Europe. All of the countries, I think all of them, were up double-digit comps. There might have been one that was high-single digit. But right now, we're upping a lot of stores in France. We are actually opening a fair amount of stores in northern Spain. Even though you hear horrible things about Spain, the northern half of the country is performing well for us. So we are opening stores there. Belgium -- we are pretty much built out in Belgium, but we continue to pick up new brands, which helps that business. The Netherlands we are opening new stores in. And I think we might have finally turned Germany around.

And also, this isn't European, but we had a supply issue with a couple of vendors that I think I mentioned in Chile for the past 12 months. We have anniversaried that and July is really coming on strong, which we knew it would because this is the 13th month of the issue we had, so we are going to be adding more stores there. I mentioned to you that we are going to be opening a store in Peru this fall. We hope that will be the first of many. I think that market is going to be very similar to Chile. Most of our stores will be in upscale malls, and margins and should be similar to Chile if things are working there.

And Mexico, it's just knocking the cover off the ball. They are really doing well. The Mexican economy, as you have probably been hearing very recently, has been really picking up strength. That's leading to more of these mall developments, which we do well in. We are up to close to 170 stores in Mexico right now. And, when you can open 20 stores on a base of 150 and still maintain double-digit EBITDA, it's a pretty nice thing to see.

And then on the inventory side, it looks like inventory per square foot was up about 4% sequentially and closer to 6% year-over-year. Was any of that growth related to the startup of the UK warehouse?

And then you called out new product offerings as a driver as well, and if you could maybe just detail new price points for those new products and how that compares with prior inventory.

You are absolutely right, the UK was part of it. New product flow is part of. That part of it will probably continue to be an issue from an inventory standpoint through the rest of the calendar year because of the new brands that we are bringing in. Part of it is simply a sales issue at Sally. We have the inventory for the comps we expected. We didn't hit the comps, so you can't slow the inventory down quite as fast as that. So part of it is, we just have too much inventory. We understand that's an issue. Again, barring the new product and the new brands that we are bringing in over the next few months, we are definitely addressing inventory.

Lastly for me, you mentioned exclusive distribution rights to certain haircare brands with the acquisition of the Essential Salon Products. Can you give us a little more color on what brands are included and any additional brands for integrating asset?

Yes, sure. That Essential Salon Products was primarily a Goldwell and Moroccan oil distributor. And what we have done there, I think, was a great thing for us and a great thing for Goldwell. They prefer, particularly in densely-populated areas, to have direct distribution. So it was a unique situation where Goldwell themselves bought part of the business, the street business. We bought the store part of it, and then, obviously, we are their store partner there, but it also enabled us to put the brand in a lot of other stores we already had in that geography. Moroccan oil -- we are the distributor. That did go to our sales consultants, as well as going into our stores.

So it's another one of those little acquisitions I talk a lot about with BSG where we really didn't take on much at all in the way of expenses. We took on a nice hunk of sales at a good margin, and over the next 12 months, even though it's relatively small to the size of BSG, all those things add to the margin improvement that we get at BSG. The synergies are easy to do. We didn't take any distribution assets. So it should be a good thing going forward. But again, it's small in size.

Karru Martinson, Deutsche Bank.

Not to beat a dead horse here, but when we look at the Sally side and the club members, how much of the Sally sales are driven by that club membership?

Half of the retail business. The retail business is 75% of Sally and the Beauty Club Card sales are half of that. So it's about 37% of total retail sales, or half -- I'm sorry, total sales -- and about half of the retail sales.

And when you look at that club membership, did you see a change at all in their basket size or their frequency of visits?

No, we didn't.

Okay, and when you look at the new products that you are bringing in, we have talked in the past about the exclusives or proprietary brand, private label, in other words, that you guys have. Where are you guys in terms of that mix today in a Sally store?

We report that annually. I think we are at 45% or 46% -- through the end of last year, we are at -- 45% of Sally's sales are in brands that we own. And this year should prove to be similar to past years in that that percentage will go up slightly.

Okay. And then when you look at the e-commerce side, were you seeing similar ordering patterns that you were seeing on the retail side in your actual store, or was that customer behaving differently?

No, that customer wasn't behaving any differently.

Thank you very much, guys, I appreciate it.

William Reuter, Bank of America.

This is actually [Spencer] in for Bill; I appreciate you guys taking my questions. I was wondering if you could just give us an update on the new stores that you have opened this year. I think that you were planning on opening 165, and then remind us again what -- the economics differences between domestic stores and international stores.

Absolutely. We are right on target to hit our 4% growth, which I think was 165 stores. The economics of our international stores are not as good as the US stores. They take about another -- first of all, the CapEx to open them is larger. Secondly, they take about a year longer to get the same types of contribution rates and returns that the US stores have. Obviously, a higher and higher percentage of the stores we open each year are in the international space.

Okay, great, that's actually it for me, thanks guys.

Kevin Coyne, Goldman Sachs.

This is Celeste Everett on for Kevin. First, you pulled back on SG&A as a percent of revenue this quarter, even with the shifts in your marketing. So as you return to the targeted marketing to your list customers, with us result in an increase in consolidated SG&A as a percentage of revenue in the near-term? Or, is it more just a redirection of your total marketing spend?

No, it's just reallocating it. We really didn't pull back on our expenditure; we just did it in a different way, thinking we could reach a larger audience with the same expenditure, which -- the math there was true. But unfortunately, it wasn't the right thing to do. We reached more people, but they were not profiled the way our targeted mailing was doing.

Okay, got it. And then with revisions to your ABL covenants, can you please update us on your current restricted payments capacity under the facility? And then what are you ultimately limited to under your governing indentures?

Really, as long as we are below 3.25 times leverage, we really have no restriction. And we operate -- given the fact we were operating in the 2.5 to 2.7 range, there's plenty of headroom to do whatever we need to do from a restricted payment side.

Also, the triggering point in terms of what improved from the last facility was it's just our -- the provision of the availability has actually been reduced to about 15%. So it actually has -- that has improved as well. But from a restriction standpoint today as it stands, really, we are not operating under any restriction.

That's it for me. Thank you.

Linda Bolton-Weiser, B. Riley.

So not to beat a dead horse here, but I'm still not sure I understand. You mentioned that the list of potential people out there to draw into your stores is not less, that you still have lots of opportunity. And yet, I thought you said that the list of potentials actually was smaller for the mailings. And so I guess I'm trying to understand, did you actually send out fewer mailings, or is it just that you changed the nature of what you sent out so the targeting wasn't as effective?

And then, also, just on that topic, is it something where like a low-hanging fruit concept where the first ones that you target are the best customers and are going to provide the highest ROIC, whereas later customers are kind of -- you are more scraping the bottom of the barrel, so the return is going to be less? So i.e., you are increasing our investment to draw those customers into the store? So I guess that's my questions.

That's about 5 in 1. Let me see if I can remember the first part of it.

First of all, I don't believe I said that the pool of retail -- potential retail customers was smaller. Now, if you look at it from the standpoint of once you get one into the Beauty Club Card program, then the pool becomes smaller by one, then I guess you would say that the pool of potentials would be smaller. However, the pool continues to grow because it is constantly reevaluated and people that were not in the pool before can come into the pool and vice versa. So I'm still very comfortable in the size of the pool out there that we believe are profiled and can be good potential customers for Sally.

Now, secondly, we did increase our exposure by the change that we made. But what worked for us was approaching a very highly-profiled customer. And the other approach was much more broad. Even though it was less expensive, particularly on a per-head basis, it wasn't nearly as effective because a lot of the people that were approached were not potential profiled customers.

So the last part of your question, I believe, was, are we spending more money to go after less-profiled people? And at some point in the future, we will probably reach that. But I believe, given the size of this pool that's out there, we are a long way from that. So if we go back to this thing and we go back to our profiled approach and we don't see over the next several months improving traffic, then I would say, look, what you are saying is possibly right. But I just don't see that. If we were much deeper into exhausting what we believe are potential customers, I would have a bigger concern of that.

Thanks, that's very helpful. And then just with regard to your competition out there, Ulta is a very different concept than yours. But when you hear them talk about what has really been driving their same-store sales growth, they really talk a lot about these in-home treatments that people can do at home. Some of them are devices, some are consumables, something like for hair regrowth. These are the hot areas they mention. I keep thinking that you as a professionally-based store are not going to be carrying products that are going to help the customer move their beauty treatments from the salon into the at-home realm. So I wonder if this is a competitive disadvantage you have because of the positioning of your retail.

First of all, Linda, that couldn't be more untrue. Because so much of our business is retail, we carry a lot of the same types of products that they do -- not in the way of the same brand, but we have all of the same type of do-it-at-home treatment things that they do, unless you get into the cosmetic and fragrance businesses, which is really not what you are talking about anyway. We do really well with hair growth kits. We do really well with hair removal at home. We do really well with all of the nail treatments and lights and everything that you use to accomplish that at home. So that really isn't true at all.

With that, speakers, I would like to turn it back over to you for any closing comments.

Thank you, operator. Thank all of you for joining us today.

I would like to summarize by saying that our performance was solid, despite soft revenue growth. We hit another record for gross margin in the Sally segment. We improved our consolidated SG&A by 50 basis points and we grew earnings per share double-digit. As Mark mentioned, during the quarter we repurchased approximately 3.1 million shares of our stock for almost $94 million. And, I am pleased with our progress and returning capital to our shareholders.

As always, thank you for your interest in Sally Beauty Holdings.

Ladies and gentlemen, today's conference call will be available for replay after 12 PM today until midnight, August 8. You may access the AT&T teleconference system by dialing 800-475-6701 and entering the access code of 298475. International participants may dial 320-365-3844. Those numbers, once again, 800-475-6701 or 320-365-3844 and enter the access code of 298475.

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.