Sally Beauty Holdings Inc (SBH) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Sally Beauty Holdings FY16 third-quarter earnings call.

(Operator Instructions)

And as a reminder, today's conference call is being recorded. I would now like to turn conference over to Karen Fugate. 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 for 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 of1934. 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. The Company does not undertake any obligations to publicly update or revise its forward-looking statements. The Company has provided a detailed explanation and reconciliations of its adjusting items and non-GAAP financial measures in its earnings press release and on its website.

With me on the call today are Chris Brickman, President and CEO, and Mark Flaherty, CFO. Now, I would like to turn the call over to Chris.

Thank you, Karen, and good morning, everyone. Thank you for joining us for our FY16 third-quarter earnings call. I'll briefly provide an update on our business performance, and Mark will discuss our third-quarter results in more detail. On a consolidated basis, third-quarter results were solid, with sales growth of 3.1%, gross margin expansion of 30 basis points, and 18% per share growth -- earnings growth.

At a segment level, BSG had another terrific quarter with same-store sales growth of 5.4%. However, our Sally North American business fell short of our expectations. Both segments contributed nicely to gross margin expansion. BSG improved 30 basis points, and our Sally Beauty business improved 40 basis points.

As I mentioned, sales in our Sally business fell short of our expectations. We believe some of this was due to some tactical marketing changes which negatively impacted sales growth during the quarter. Specifically, we changed our CRM email vendor to one with better dynamic email and segmentation capabilities, and we upgraded our loyalty database to improve performance. These changes created some disruption in our ability to communicate with our loyalty customers. However, we are now stabilized on a more effective platform.

In addition, we reduced direct mailers with promotions to our loyalty customers, in an effort to fund new marketing tests. We believe we cut back too far, and are in the process of returning to a more balanced mix of direct mail, new marketing campaigns and promotions. Looking forward, now that we have completed our brush category reset, the rollout of the color education center, and the majority of our owned-brand repackaging upgrades, we are now ready to slow down the pace of in-store change, and shift our team's focus to marketing, product merchandising and sales initiatives designed to leverage the improvements we have made to transform the customer experience.

As a result, our agenda for the coming quarters will be focused on the following priorities. First, fully leverage our new CRM capabilities in order to deliver more relevant offers to each customer. Second, introduce a few new brands to our stores that bring a strong following and new traffic. Third, implement a simple selling model for all of our associates that drives increased basket and reinforces our overall value proposition. And finally, continue to find creative ways to communicate our unique value proposition through PR campaigns, digital and social media and our traditional media mix. If we execute on these simple priorities, we believe that we can get back to steady sequential sales improvement over time.

Our Beauty Systems Group performed well in the third quarter. We continue to achieve growth from new lines, product innovation and access to brands in new territories. Same-store sales reached 5.4% versus 5.6% in the prior year quarter. Strong sales growth and gross margin expansion led to operating margin improvement of 20 basis points.

During the quarter, BSG began to roll out a new cosmetic line, The Balm, which will strengthen our cosmetic offering in our CosmoProf stores. On the marketing front, the team continues to build BSG CRM capabilities and customer database. We have already collected over 600,000 salon professional emails in a very short period of time, and we plan to grow this substantially in the coming quarters.

To summarize, our third-quarter consolidated results were solid. BSG continued their strong performance, even as they began to anniversary the acquisition of major brands in the prior year. Our Sally international business also had a good quarter with strong gross margin expansion and operating earnings improvement.

In the Sally US business, we are addressing the short-term issues that occurred over the last few months, and we are closely monitoring these changes. We realize that Sally US continues to be challenged. Although we believe we're past the most disruptive changes that needed to be made to our stores, we also recognize that it will take multiple quarters to return to our same-store sales growth target of 3% to 4%. We will certainly take that into consideration when we provide FY17 guidance next quarter.

In the meantime, we are confident that we are doing all the right things to enrich the consumer experience, entice new customers and add value to our loyalty members. It will just take time and a little patience for sales growth to accelerate. Now, I'll turn it over to Mark.

Thanks, Chris. Consolidated net sales for the third quarter increased 3.1% to $998 million. This increase was driven by same-store sales growth of 2.5% and the addition of 131 new stores. The impact from unfavorable foreign currency exchange in the quarter was $9.1 million, 100 basis points of sales growth.

Gross profit margin was 50%, a 30 basis point increase from the FY15 third-quarter driven by strong performance in both segments. Consolidated gross margin on the year-to-date basis is up 10 basis points, and we now believe that gross margin expansion for the year will fall slightly below the low end of our guidance of 35 to 45 basis points. Third-quarter GAAP SG&A expenses as a percent of sales including charges related to our data security incidences was 34%, a 10 basis point increase from the prior-year quarter. Adjusting for these items, SG&A expenses as a percent of sales were 33.9%. We continue to believe that SG&A expense as a percent of sales will be up during the FY16 year of 10 -- of approximately 10 to 20 basis points over the prior-year metric of 34.2%.

Consolidated GAAP SG&A expenses including unallocated corporate expenses were up 3.5% over the FY15 third-quarter. This year-over-year growth was due in part to incremental expenses associated with our IT upgrades, higher compensation and credit card fees. This expense growth was partially offset by favorable expense adjustments resulting from the decrease in estimated future cash payments in connection with the Company's self insurance programs, and lower expenses related to the data security incidences than in the prior year.

GAAP consolidated operating earnings in the third quarter were $134 million, an increase of 2.5%. Adjusting for the data security charges, operating earnings were $135.5 million, flat compared to the prior year. Adjusted operating margin was 13.6%, a 40 basis point decrease from the prior-year metric of 14%. Interest expense was $26.7 million, down $2.5 million from the year ago quarter. This decrease is due to the December [2015] refinancing of our $750 million senior notes to a lower interest rate.

Our effective tax rate was 36.7%, down 180 basis points when compared to our prior-year effective tax rate. The lower effective tax rate was primarily due to a decrease in the losses subject to a valuation allowance in the FY16 third quarter. We continue to expect the effective tax rate for the fiscal year to be in the range of 37.5% to 38.5%.

GAAP net earnings in the FY16 third quarter were $67.9 million or $0.46, compared to the FY15 third quarter net earnings of $62.5 million or $0.39. Adjusted net earnings, excluding charges associated with the data security incidences were $68.8 million or $0.47, compared to the FY15 third-quarter adjusted net earnings of $62.5 million or $0.41.

And looking at our balance sheet as of June 30, 2016, inventories increased by $34.7 million to $909 million or 4%, compared to ending inventory on June 30, 2015. This year-over-year increase was primarily due to additional inventory from new store openings, and the addition of new brands in BSG and Sally. We continue to expect inventory to decline, as we head into the FY17.

For FY16, year-to-date capital expenditures were $106 million. We believe the capital expenditures for FY16 will be at the high end of our previously stated range of $125 million to $135 million.

In turning to the segment performance for the third quarter, starting with Sally Beauty, net sales were $597 million, up 1.4% compared to sales of $589 million in the prior year quarter. The unfavorable impact of foreign currency exchange on sales was $7.4 million or 1.3% of sales. Same-store sales were 1.3%, versus 2% in the FY15 quarter.

Gross profit margin at Sally Beauty was 55.3%, up 40 basis points from the prior-year quarter. Gross margin in the US business was up over the prior-year, primarily as a result of selective price increases in certain geographical areas of the US, fewer promotions than in the prior year, and a favorable shift in product mix. Operating earnings were $104.8 million, with an operating margin of 17.6%, down 60 basis points from the third quarter prior-year metric of 18.2%.

Sally Beauty ended the quarter with 9.5 million active beauty club card members, an 11% increase over the prior year. Sally opened 95 net new stores, for a total store count of 3,750.

In turning to Beauty Systems Group, BSG had another good quarter with same-store sales growth of 5.4%, compared to 5.6% in the prior year quarter. Sales grew 5.7% to reach $401 million. This performance includes the impact of unfavorable foreign currency exchange of $1.8 million or 50 basis points of sales growth.

BSG's gross profit margin in the third quarter was up 30 basis points to reach 42.1%, and operating margin improved 20 basis points to reach 16.3%. BSG opened 36 new stores or a growth of 3.5%, for a total store count of 1,322. We also ended the quarter with 952 sales consultants. Chris?

Thank you, Mark. On a consolidated basis, we had a solid financial quarter, and executed on several important initiatives. I feel confident that we are now at a point in our Sally US business, where we can slow down the pace of the physical in-store changes, and instead focus intensely on a simple agenda that drives sales growth.

Before I turn it over to the operator for Q&A, I'd like to take a moment and welcome Erin Nealy Cox, former managing director of Stroz Friedberg to our Board of Directors. Erin is an expert in the cyber security field, and has been a trusted advisor to me and the Board, as we navigated through the complexities of cyber security and data protection. I am very pleased to have Erin join our board. She is an accomplished business leader, and I am certain she will be a strong addition to our Board of Directors.

Now, I will turn it back to the operator to open it up for questions. Thank you.

(Operator Instructions)

Simeon Gutman, Morgan Stanley.

Thanks. Good morning. Chris, I want to ask, in regards to the [1.3%] at SBS, can you just give us some context, how the US is business is doing relative to that number? Because I guess, all things considered, it's not comping terribly, right, you have had three positive years at least in this quarter. It's short of your goal. But my question is more on the EBIT side as well. The EBIT in that business has stalled over the past couple years. And so, now the business is back to something respectable on the top line. Do you have to -- are you -- should you be spending more to improve it? Or on the flip side, if you stop spending to invest, and you are still comping [1.2%], if the EBIT rate of the business, the dollars start to grow, would that be a better outcome?

Yes, I think the reality is, Simeon, is that there is a lot of moving pieces to that. If you take it -- if you put this into a bigger context, right? In the last 9 to 12 months, we've pushed a great deal of change through the stores, and not just through the stores, through our technology platforms and to our marketing. So that includes upgrades to major categories, that includes refreshing our packaging. That includes changing our marketing analytics platform and CRM platform. And obviously, it includes lots of experimentation with our media mix. All of that was the set up to, beginning to get to something that we believe can grow in the future.

The good news is, I think we are getting to the end of that. And so, lot of the costs associated with those changes will start to diminish some. But on the other hand, there's also some labor inflation coming to the business, that we are pursuing covering through gross margin expansion. And I think where we're at now is, we really believe we're getting to a media mix that we're comfortable with.

I don't think radical change in spend is going to change that. I think it's more about getting the right mix, targeted in the right way, which really comes down to digital and social media to drive an advocacy-based model, PR to support that advocacy-based model, and then a core of direct mail to keep our current customers going, as well as CRM capability.

So I feel like we're past the most disruptive elements. The cost of all of those changes should start to slow down now, as well as the disruption from it. Now, we can focus on a much more simple agenda. But I don't think substantially increasing the spend is going to change the dynamic. I think it's now about getting past all these changes we've driven through, letting those settle in. And then getting the most out of those with our customer base.

I guess the follow up is, if you achieve the goal of 3% to 4%, would SBS EBIT dollar growth outpace that, in other words, you should get margin expansion? I'm guessing the answer is yes. And if -- but let's say the business does something more like a 2%, 3%.

Yes.

Could the business expand the margin? In other words, what would EBIT dollar growth look at that point? Could it be in line with sales growth, still grow, which would be positive, just not as much margin expansion?

Yes, I think it can. Because what you'll see, as you will see a slow down at some point in the labor cost inflation we're seeing, as well as a slow down in the incremental investments we have to make. In fact, you'll start to see that slow down, probably sooner than the labor cost will slow down.

Okay. Thanks.

Yes.

Oliver Chen, Cowen and Company.

Hi, Chris and Mark, and welcome, Erin. Chris, on the Sally side, the comment on, it will take multiple quarters to return to your target, can you help us identify how you're feeling now, versus previously, and what's kind of changed? If you could update us on the list customer dynamic? I'm just curious about -- it sounds like a lot of demand initiatives were at stake in the stores, where you want it to be.

How would you have done this differently? Would you have dual-tracked some of the programs instead of switching over so quickly, because I know you have a history of testing things before you do them? So a few questions along that -- (multiple speakers)

So let me try to hit them, and remind me if I miss one. So listen, the list customer was positive again this quarter, as it was last quarter, and that's a good thing. The BCC customer is where we saw the continued slow down from last quarter. Again, we think a lot of that has to do with some of the disruption around the shift in marketing spend, and the shift in our CRM vendor as well as other factors.

And the reality is we're moving quickly to address those changes right now, and that'll change going into this quarter, as well as change going into 2017. So we continue to believe we'll start to see that recovery. In terms of doing things differently, I'd say this, right? We took a lot of medicine in 9 to 12 months. There's no doubt that there's some disruptive impact to that. But I also think it puts us in a position where we can now pivot. And we can pivot away from physical changes to stores, and physical changes to packaging that might confuse a consumer, pivot away from actually having to shift email vendors, things like that. And focus much more on the sales driving efforts that we wanted to get to.

I think the experimentations with the media mix were necessary evils, to understand exactly what's going to work with our target customers. So obviously, you never like to go to a point where you really start to disrupt your business. And yet at the same time, if you don't test it, the marketing analytics were telling us that we could cut back further, but we did find a point where we probably cut back too far.

We had a test TV, I think it was the right thing to test. We don't think that was a highly productive investment for us, and we think there's better media mix venues for us to go through. But I think it was the right thing to test, for us to understand what's the right media mix going forward, and we're starting to isolate down on that.

So listen, I don't know if I would have done a lot differently. I probably would have set more realistic expectations about the length of time it would take. But I'm glad we were able to push this much change through fast. And in the broader context, if you think about it, despite pushing all that change through, we've managed to comp positively in a tough retail environment. We've managed to expand margins, and we've managed to drive EPS growth. Now we're not satisfied with where we're at, and we want to drive more growth. But considering how much change we pushed through, I think we feel actually pretty good about that, because it now sets us up for the future.

Okay. And for people who are skeptical about returning to the target of 3% to 4%, and also the reality of rising competition across multiple channels, what are your thoughts, and what would you say are the key risk factors? Will it continue to be more on the BCC side in terms of -- if there is an elevated risk, where would it be on that side of the business?

Yes, I mean, I continue to believe that there's a couple of moving pieces. I think BCC will return to where we want it to be, which is that mid to high single-digits growth. List will be a challenge [into growth] we want, because we obviously have to shift them out of other retailers. And so, we have to find the right message and story to shift them out. We've made some progress there, but there is more to go. In the meantime, I think over time, you'll probably see a slow decline in the Pro customer, as they shift, and it's more convenient for them to shop at places like CosmoProf. And that is probably the right place for them to be served in many cases over time.

So I don't think -- I think we will get to that. I think the issue is time. I think what's great now is we're past the biggest pieces of the change process that needed to be implemented. We managed to do that without too much disruption, but some disruption. And hopefully, now we can start focusing on what I'll call a simpler agenda to drive sales growth.

Okay. And just lastly, as we look at our models, Mark, on the change in the gross margin guidance, what was the main driver there? Was it a little bit because of the deleverage on the comp line? Just so we know, are clear about that?

Oliver, I think a little bit of it was, when you go back to the second quarter, we comped, we were down 10 basis points, and part of that was mix. And overall, both Chris and I are very -- we're actually very optimistic about our margin expansion in the Sally business. We saw nice margin expansion this quarter. It was sequential over what we saw in the second quarter, when you talk specifically about North America. We expect a similar cadence in the fourth quarter. And the other side of it is, we have an easier comp in the fourth quarter.

There's also, just remind you, and certainly, you remember this, there is about 10 basis points of downward pressure in that gross margin comp in the fourth quarter, for the liquidation of some of our store closures in Germany last year. So we do have an easier comp in the fourth quarter, and we like the trajectory that we see all the international businesses on Sally, as well as what we see in North America. However, we put ourselves a little bit behind in what we saw in the second quarter. So from a conservative measure, we felt that it made sense to kind of reiterate the guidance in being a little bit short of that lower end trajectory.

But overall, we still expect to see sequential improvement. And the only other headwind that's out there, is a little bit of the currency headwind in Mexico. We've seen nice turnaround in Europe, not so much from the currency side, but just from their overall operational aspects of their margin profile. So it gives us a lot to be encouraged about.

Okay. Thanks. Thanks for the details, and we definitely like what we're seeing in stores. So best regards.

Thanks, Oliver.

Steph Wissink, Piper Jaffray.

Thank you, good morning, everyone. Just one follow-up question actually to Oliver's earlier question, talking about some of the changes you've pushed out to the field level. Could you give us a sense and characterize those changes, as either bringing you in line with the marketplace when you look at the competitive dynamics. Or do you see some of those changes as kind of setting you ahead now, and as you move into some of your simplified agenda items, better responsiveness in the model? Just curious how you're kind of thinking about benchmarking yourselves today, after all of those initiatives relative to the competitive set?

We have such a different box and different competitive position, that's a little hard to do. But what I would say is this, right, which is I think our stores look a lot cleaner than they ever have. And we heard a lot about that a long time ago, when we started doing initial research, that we needed to clean up the stores, brighten them up, make the sections easier to shop, and simpler to understand. Our packaging, we've actually refreshed virtually all of our primary owned-brand packaging lines, in terms of their packaging. So they're a lot better-looking and more modern, more salon quality looking than they've ever been.

We've also done a lot in terms of simplifying the front of the stores as well, cutting down a little bit of the clutter in-store. Our marketing is a lot fresher. It's a lot more dynamic. It also is, what I like about it is communicates some clear messages, it's not just price points and products. There are some clear messages about how we stand out, and what our position in the market place is.

And finally, we're now on a much more dynamics CRM platform than we've ever been on, in terms of our ability to segment customers and make offers much more unique. So what I would say is, although it's hard for me to compare it to [Aldo] or to Walmart sections or Target section, for the most part, those are about the same as they were a couple of years ago. I think our stores are a lot brighter, our packaging and product looks a lot better, our capabilities look a lot better. And the net result is, we should be better positioned to kind of communicate our value proposition and bring new customers in over time.

Okay, thanks. And just Mark, really quickly, you mentioned a pricing increase. If you could just give us a sense of what that magnitude might have been in terms of contribution? And then, on the BCC customer specifically, have you discovered that she is cross-shopping more aggressively between your CosmoProf and your Sally stores? And is there a benefit or a cannibalistic effect that we're seeing in the comp from a shift, from one of your segments to another?

With the Pro customer, they've always traditionally shopped both segments, at both the BSG for the professional brand of products, particularly on the hair care and hair color side. And they've typically shop Sally for the sundry items, and their basic shop implements for what they need to do to perform their services. So generally speaking, that hasn't had a big impact from that shift, or that mix between the two as far as what we've seen on our comp.

Really, getting back to your other question there, the majority of what we have seen certainly is a pricing, certainly pricing has had a lot to do with what we've seen in the Sally segment. The BSG segment, in terms of their very consistent 10, 20 basis point margin expansion, has been just that traditional shift from the full service to the store business. And that still has not -- that hasn't changed, that phenomenon has continued to progress very nicely.

But certainly, some of the pricing actions had -- have been a great driver to what we've seen in the Sally business. Overall, unit sales are positive, but they've been somewhat choppy at times. But it has been really a pricing initiative that's really driven the growth.

Thank you, guys.

Simeon Siegel, Nomura Securities.

Thanks. Hey guys, good morning. Might sound a little weird, but I just follow up on Simeon's question initially. To your point about the shift from store investments to marketing, what is the leverage point at SBS now? And then, can you guys just quantify what you'd expect that minimum wage pressure to be?

Yes, I mean, think we'll build that into our 2017 plans. The reality is we're absorbing some minimum wage pressure right now this year, which is part of the reason why we went down the path of some of the price increases. And there'll be some additional next year, as well as the FSLA. We built that into our plans and we're building it into our plans for next year, and we believe we can mitigate most of it through margin expansion and through cost reduction.

The reality is that, that part is going to continue on for a while. The part that should start to slow down is some of the investments we've had to make here, whether that be in new talent and capability, or in store changes or in technology platforms. And obviously, there are some center platforms we'll continue to invest in. But at least relative to our Sally business, we've done a lot of investment in the last 12 months, with a lot of physical changes in store and physical changes to our team and our platforms, that should start to slow down now as we simplify the agenda.

Great. Thanks a lot, guys.

Ike Boruchow, Wells Fargo.

Hi, good morning, everyone. Thanks for taking my question. I guess, Chris, maybe on the zone pricing, I think October of last year is when that initiative went into full effect. Are there more levers you can pull there, in terms of maybe regions where those pricing opportunities that you didn't hit with the initial launch? I'm just curious, how we think about that, in regards to your gross margins for next year?

I think we're going to see a shift, Ike, which is we've been pushing zone pricing. We kind of slowed it down last quarter. I think now what you'll see is we've implemented a Revionics platform that allows us to do price optimization at the SKU level. And so, you're going to see our pricing tactics, as we go into next level be more about individual SKU and category-based, and a little less about zone pricing.

I think we feel comfortable with the stores, we have moved into the zones right now. We will probably let us settle out for a while. I am not saying we won't do any more of that, there may be. But that won't be the focus here for the next couple of quarters. Going forward, it will be really about leveraging the new analytics tool we have, to do more of a SKU by SKU, and category by category pricing assessment.

Got it. And then, just a quick follow-up on the SG&A side. So I mean, I think we've got ongoing hourly wage inflation, overtime increases, and you're still investing more in the Sally stores. Is there any thought process around SG&A dollar growth next year versus this year? Should it be similar, or are there incremental investments that could take that growth rate a little bit higher, and maybe cause a little bit more deleverage into next fiscal year?

I think it's a little premature to give you guidance are now, because we're still going through our annual plan process, as far as 2017 and kind of that dialogue with the Board. Certainly, as we get past a lot of these major initiatives, certainly we'd like to see the shape of that change. But is a little premature right now to give you hard guidance.

We still feel very comfortable about what we put out there for this year, that 10 to 20 basis points. We've been falling very nicely within the 10 basis points on a year-to-date basis, as well as for the quarter. And even some of the big initiatives that we articulated, in terms of new business development for this year, where we said roughly, there's $16 million worth of SG&A costs in there for new business development. We've actually been tracking very closely to that. We actually are probably a little bit under, and I expect that certainly in the fourth quarter, we'll certainly continue that trajectory of being slightly under that, just with the timing of some of those investments, namely with what we're doing in Brazil, where Brazil always takes a lot longer, and our spend has been flexed accordingly.

Got it. Thank you.

Mark Altschwager, Robert W. Baird.

Good morning. Thanks for taking the question. I just wanted to follow-up on the Sally comp one more time. Chris, I know you mentioned, optimistic on sequential comp agreement there. But to clarify, are you saying sequential comp improvement from the 1.3% level this quarter, or a return to sequential comp improvement from the low 2% range that you were seeing in the early part of the year? Along those lines, understandable, it's going take time to get to the 3% to 4% goals, but a widening gap between current run rate and that goal? So maybe just help us connect the dots, as we look to model that business over the next several quarters?

Yes, I mean I don't want to get -- trying to doing quarter by quarter guidance here or anything like that. I think the answer is sequential is what it means. First, we'll get back to where we were, and then we'll go beyond that would be my guess.

The reality is, what we see is that the disruptive changes we had to make in the last couple of quarters are in the past now. We don't see any of those really coming in the next couple of quarters. There's only one category reset we may do next year, which is really appliances, and I don't think it will be nearly as disruptive. We won't be shifting any email vendors. I think we're settling down on a media mix, that we feel is a viable media mix that works well.

So I just think -- that's the real point which is, a lot of the experimentation that we had to do to really understand what was going to work for this brand going forward, is in the past. And I think we feel like that experimentation is done. Now, let's simplify the agenda and focus on growing this. I wish we hadn't had to go through all of that, but I actually think we had to, right?

You had to test limits of how much you could pull out of direct mail, in order to know what you could invest in these other channels. You had to push through some of these in-store changes, or else as you brought new consumers in, you just weren't going to recruit them on a permanent basis. And we had to change our email vendor, because we were experiencing some real interruptions and disruptions with our previous vendor, who just wasn't executing the campaigns the way we wanted. So those were necessary evils. I think they're doing what we wanted them to do. We feel good about where we are at now, that we can now simplify that agenda going forward.

Thank you. That's helpful. Switching gears real quick to marketing. You're having some nice success with the list customer. What are your views on the loyalty program, beyond the current BCC program? And as you evolve the CRM, is there perhaps more value in the customer data you could capture from a broader program, versus the fee-based BCC program today?

I think there absolutely is, and we're looking at it hard. The first thing we want to do is make sure we have email capture for as many, or all of our current BCC members which we don't have 100% execution there. So there's some growth there.

But the second is, I think over time, we'll probably want to redesign this program, and either go to all free, or go to at least a free tier. And the team is going to be testing that next year, we've built the into our plans for next year. I don't think it will roll out until 2018, but we're looking to test it next year.

Thank you, and best of luck.

Thank you.

William Reuter, Bank of America.

Hi guys, this is actually Janani on for Bill today. Thanks for taking our questions.

Thank you.

First from us, you mentioned the rollout of a new cosmetics line, The Balm at BSG in the quarter. Can you talk about the pipeline for rollouts of other new lines for the remainder of the year?

Well, The Balm has just started rolling out actually. So it's only in a few stores right now. It will be rolling out rest of the stores, mostly during this quarter. So that's a great opportunity.

We do have some new lines that we're negotiating for Sally right now. I can't tell you what those are because they are still in negotiation, and there's a few that are very close. What we're really looking for there is some brands that bring us some additional new traffic to the stores.

So we've had great success, as an example with OPI in Sally. That brand has done very well for us. We want a few brands that bring us that name recognition and traffic, so that then we can also then pair that up to a nice mix of our own brands, as well as kind of well-known open brands. But the reality is, that those that are in negotiation right now. So I don't want to say that we're definitely doing them, before we finalize that negotiation.

Great. No problem. And then on the last call, you mentioned there's some territory acquisitions you could add in the back half of this year that you were looking at aggressively. So could you just provide an update on that, and if you are still planning to do that?

Yes, there's one that's kind of reaching culmination here, hopefully that will come to fruition this quarter. But we'll probably be presenting it to our board this quarter. But so there's probably one that will happen before the end of the fiscal hopefully. If not, it will happen soon after hopefully. And then, there is another one that's on the horizon there, that probably is more likely in early an 2017, a FY17 opportunity.

Great. And then, lastly from us on, how did your online business perform in the quarter, and was performance in line with your expectations?

Yes, it's up 16% and traffic continues to be well up. But what we're seeing is we're not doing as well as we can be at conversion. So visits are well up, but sales are not up as much as visits. The reality is what we want to do is really focus in on conversion now. So we're spending some money and some time reworking the website, to make the user interface better, and the transaction interface better, to hopefully really drive conversion in the coming years. So that will be the immediate focus now. And we're getting progress there, but we need to go faster.

Great. I will pass it on to others. Thanks.

Thank you.

Jason Gere, KeyBanc.

Okay. Thanks, good morning, guys. I guess I wanted to go back to the comps, particularly on the Sally side. And I know that you are talking sequentially. I mean, the way a lot of us look at it, is on the stack rate. So when we look at both Sally, and even on BSG which continues to I think -- continues shine in this portfolio, despite some tougher comps, how are you -- should we be looking at the two-year stack rate as sequentially improving over the next few quarters? I know you're still trying to assess the longer-term growth of the Sally business, but I guess, I'm just trying to think about if -- how is the best way for us to look at that, and kind of assess some of the progression that you're calling for over the next year?

Well, I think we've been saying for a while that we thought BSG would slow down somewhat here, as they overlap some of the new brand acquisitions they've had. So I think we're thinking more like a 4% to 5% comp going forward here with BSG, just because we aren't going to picking up quite as much new brands. We will see about what happens with territories here.

With Sally, I think our expectation is that now that we're past some of the disruptive changes and improvements we wanted to make, that in fact we should see that progression. And that's what we are looking for, is that the Sally should be a larger percentage of the comp growth going forward. BSG, we'll probably pull back just a little bit, and international is on a good trajectory. We've got a little bit of currency headwinds in Mexico, but overall, international is on a good trajectory.

Okay. That's fair. I know it's hard to look at your performance versus I guess from a market share perspective, because you really compete with a lot of different channels. But is there anything that you could say, maybe about your hair care sales, or if you have any internal metrics that look at how sales were at other points of distribution? My understanding is that hair and hair color were strong, and obviously the nails and electrics were a little bit weaker. So I was just wondering, if you look at from maybe a category perspective, where you actually saw better performance, maybe versus some of your peers?

Yes. So our core as you know is color and care, and that was up in mid-single-digits which is very nice. Our ethnic category was up great as well. We are seeing great growth there, which is a terrific bode for the future for us from a demographic standpoint.

The reality is, you point to our weakest categories continue to be hair extensions. We think we're starting to get that more under control now. Appliances are starting to flatten out. Nails have been a little weak this year, as we have had some confusion with the customer. I think now that we've got four different types -- we've got gel, soak-off gel, extended wear and the traditional shellac. So I think, sorting that out and simplifying that for the customer is a big priority for us.

But our core categories that we're most differentiated on, which is color and care are up strong. We feel good about that. We want to keep driving that, and then address some of these categories like extensions where we've had a gap for a while.

Okay. No, that's good. Okay, so then, okay, leading into my last question. So obviously next year, we'll -- I think expectations for Sally sales will probably be tempered a little bit, and BSG I think stays in line. You've talked about being able to offset some of these costs, such as labor with maybe some pricing that comes through, and store investments start to come down. So as you look at the earnings growth for next year, and we're not talking about buybacks at this point. If you look at the core earnings growth, do you expect that trend similar to how it is this year, double-digit growth? And then, what's your view on buyback, especially if you look at today, and how the stock is reacting. What is your capacity? (multiple speakers)

We're not going to release guidance now. We'll do that after the next quarter, and after our Board has had a chance to go through it with us and challenge us. But you have most of the pieces right, you just described in what you said to me. Our philosophy on buybacks hasn't changed. We'll continue to return excess cash to shareholders.

So I think you should expect that as you model that out, about the same. And I think you're right, some steady progression in Sally, a little bit of a slow down in BSG, but not much. Still some labor cost inflation coming next year, but try to mitigate most of that through margin expansion. I think that's kind of describes where we're at.

Okay. So it doesn't sound like there would be --I mean, obviously, the top line might change a little bit. But it sounds like the bottom line still should be in the historical range that we've come -- that we've been accustomed to seeing?

Well, I think the answer is, it'll depend on what happens on some of these cost drivers, and how much of that we can mitigate with margin, and we're working on that right now. So again, I'm not going to release guidance early. But I think you have most of the pieces of the model accurate.

Okay. And did you benefit next year from the accounting rule on stock-based compensation? Is there -- will there be any change in your tax rate for next year? Just I think a lot of companies are talking about it now, just wanted to see if that applies to you?

It does, but it's very minor.

Very minor?

Yes. You really have to have pretty large exercises, and typically our cadence of exercises has been pretty steady, with the exception of a couple of the management changes in the prior year. So it's not a real driver or impactful item to our effective tax rate going forward.

Okay. Thanks, and thanks for taking my questions.

Rupesh Parikh, Oppenheimer.

Thanks for taking my question. So Chris, I want to go back to some of your commentary on marketing. I know you're done a lot of testing in the past several months. I just want to get a sense, going forward, do you believe you guys have identified the right vehicles to drive better traffic with BCC and non-BCC customers at this point?

Yes. I think we're getting really close. I think we feel like TV will probably not represent a major part of that platform. Radio will probably be selective. There are certain demographics where that seems to work very well. I think you're going to see a lot more about PR, picked up through social and digital media, where we really try and emphasize some of the secrets that are available at Sally, where we can offer a much better value on professional quality products. And I think you'll see a core of direct mail that we've now settled as about the right mix.

So I think you are right. I think the media mix is now settling down. We have a pretty good feel for what works. We've got the message. I think we're fine now, and you'll see a much more focused media spend and less experimentation next year.

And on the direct mailer side for your core customers, where there any changes this past quarter versus what you had in Q2?

We have been continually cutting that back up until last quarter, or up until right now, just trying to find the limit and we think we found it last quarter. And so, we added a little bit back, both in July and now in August, and I think we'll settle in at that point now. It is still represents a significant reallocation from where it was a couple of years ago, but I think we've kind of found where the cutoff point is.

And I'm not sure if you going to comment on it, but when you started to add this back, are you seeing improvement in your results as a result of adding back the direct mailers?

Yes, I'm not going to comment on the quarter comps, or anything like that. But the point is, it was a fairly simple adjustment to make. It does take a little bit of time to implement, but it's not a hard adjustment to make.

Okay. And then, we spend a lot of time in your stores, and they clearly look a lot better versus a few quarters ago. What's the feedback you get from your customers on the store changes that you guys have made to date?

Interestingly enough, your BCC customer who's your most loyal customer, she's a little bit more positive, but she liked it already. The biggest difference has been with the list customer, where we are seeing a significant uptick in her willingness to recommend, and how much she likes the store. So that's what we want to see, which is more attractive to a broader customer base without alienating your core. The data suggests that's kind of where we're at. Now, we've got to see that flush through. We also got to get them into the stores, so they get the chance to experience it.

And my last question, is it possible to get the traffic and ticket for your BCC and non-BCC customer?

Well, what I'll tell you, is sales growth for BCC was around 2.5%, and it was positive transaction growth as well. Ticket, I don't remember ticket, but it was up as well. (multiple speakers). List was up 1.6%. Traffic was slightly down. Overall, retail sales growth was positive. Transactions were slightly down.

Okay. Thank you.

Joe Altobello, Raymond James.

Hey, thanks, guys. Good morning. Just following up on that pricing question, in terms of the effectiveness and the elasticity. How much of a volume impact did you see in places where you did raise prices? I'm just try to figure out if it was really additive to comps in the quarter?

Yes, I mean, I think it was somewhat additive. I do think there was some negative of impact in the short-term. I think what you'll see is that will be mitigated over time, but there is a little bit -- but it's a net positive, in terms of profitability. And that's part of the reason why we want to slow down the zone pricing, and hold where we're at for right now. And then, focus on more on a --I'll call it targeting price opportunity, by the SKU and category level, using a more analytical approach.

Okay. But it was additive to the comp?

Yes.

Okay. And then, secondly, and I guess more big picture -- the thing that I struggle with here this morning is, you talked about getting back to a 3% to 4% comp on Sally. And I know that will take multiple quarters, and I get that. Your commentary earlier, Chris, about returning to sequential improvement over time, leaves me a little bit worried here. And I know you guys don't want to talk about the quarterly cadence of comps, but I guess, my question is, is this the worst of it? Or do you think things get worse before they get better, in terms of turning that Sally business back around?

I don't think we're thinking things get worse. I think we're feeling like we are past most of the kind of disruptive changes that needed to be made. Now it's time to focus and simplify the agenda and drive growth.

Okay. So we've had two quarters in a row, I guess, of deceleration, but it sounds like hopefully, the disruption has kind of peaked here?

I think that's where we're at.

Okay. That's helpful. Thank you, guys.

Thank you.

Jill Nelson, Johnson Rice.

Good morning. Just to follow up on the list customer, as in comps were positive, but it did slow from second quarter. If you could talk, maybe your promotional cadence to that customer during the quarter, if you slowed some -- we saw a lot of promotional emails and what have you. If you could just talk about the cadence?

Yes, I mean, the reality is that -- well, we had a couple of issues. So one is, some of those promotional cadence was disrupted by some of the technology platform changes we made. I do feel like we're now stabilized, on a much better platform that gives us much better segmentation. We are experimenting with a lot of different promotional approaches that are more tailored, based on past purchases, or based on some level of interest, or something relevant to that individual's, either purchase behavior or her search. So there is a lot of experimentation going on.

Overall, we are net-net trying to be, maybe a little less promotional, but not dramatically so. So say this is a value-oriented customer. This is a trade-up customer from mass for the most part. She does respond to value messages. Some of those value messages are relative to the fact that our products -- we can offer salon quality at a better value, but some of it also is 10%, 20% off or two-for-ones, or things like that. And so, we're trying to get to the right level of promotional cadence that inspires the customer to visit the store, but also maintains our margin structure.

Okay. And then just to follow up on buyback. Was any activity done during the quarter?

No.

Okay. All right. Thanks so much.

Thank you.

Olivia Tong, Bank of America Merrill Lynch.

Great. Thank you. I wanted to get back to the direct mailers that you obviously think you cut back too far, and wanted to see if you could put some numbers behind it? So how did you -- first, how did you go about cutting? Was it fewer mailers nationally, specific regions that you hit, or did you parse out? Can you, and did you parse out your customer database, amongst those who shop a lot, those who shop little? So just a little bit of numbers around that would be great?

Yes, I mean, I don't want to get too granular in the numbers. But the reality is, this is mostly mailers to BCC, Pro and other customers. We have been continually cutting those back for probably a better part of a year and a half, and reallocating dollars. The marketing and analytics around that up until the last couple of quarters, or at least the last three, four months, have suggested that was working and we were not losing customers, as we cut back the mailers. In the last three, four months, I think we've seen more of an impact of it. And as we did the analytics around it, we realized we'd probably cut a little too far. And so, the last move was down about 20%. We'll probably move it back up about 20%, and that's both our BCC mailers, as well as our Pro mailers. We'll move them back up to where they were, going into the beginning of this calendar year, and see where we settle out there. And we'll probably plan for that for most of 2017.

Got it. I know this was an issue in the past, in terms of the direct mailers. So how do you sort of know that you're not stressing the organization too much? It sounds like it might be a bit much, because this isn't necessarily a new issue that you guys have dealt with? And perhaps, do you need additional personnel to help you work through some of the changes that you've put on the organization?

I mean, listen, I think there's no doubt that we drove a lot of change. But I think that it was a very different issue a couple of years ago, in the sense where they pulled money out of BCC and direct mailers, and they put it into a mailer that was basically a prospecting mailer in a value pack. And not surprisingly, or that turned out to be not very productive. And so, you reduced your spend against your BCC, put into a value pack, still a mailer, but one that went to a whole much -- a larger group of mailed customers. And you've gotten those value packs, in many cases, you just throw whole pack away. And so, the reality was this is a different issue.

This was slowly pulling back on BCC mailers, so that we would understand where was the tolerance level, because we needed to do that, in order to free up dollars to reinvest elsewhere. We have freed up a lot of dollars. And even with the reinvestment we're going to make, we still will have freed up a lot of dollars. We just think we have finally got to the point where we crossed the line, and the net result was we had some impact on our BCC growth in the quarter.

Got it. Thank you.

You bet.

Kelly Halsor, Buckingham Research.

Thank you for taking my question. So I just want to go back to, not to beat a dead horse here, but going back to the Sally sequential deceleration. So the deceleration there was in traffic versus 2Q, versus the ticket kind of remained steady with 2Q?

Ticket was up.

Right. But from a -- when we're looking sequentially from to 2Q to 3Q, the delta there was really traffic?

Yes, that is correct.

Okay. And could you just remind us of, so you had the first round of zone pricing in 4Q last year, or maybe it was 1Q. And then from there, what additional zone pricing have you guys implemented?

We did not implement any more this quarter. We implemented first quarter and second quarter this year, and we didn't implement any more this quarter. And going forward, I doubt we will implement any more. We will focus on a more targeted pricing activity.

Okay. So then, just stepping back here, given that it seems like you might have reached the ceiling, in terms of the opportunity around the zone pricing. And if you go back to call it, 2008, really the only time that Sally Beauty has really comped above that call it, 2% range, was when the nail category was really strong, which was I think FY10 to FY12 or so. So I mean, I guess, what gives you the confidence here that Sally Beauty really needs to do a 3% comp? I mean, why can't Sally Beauty just be kind of a GDP 2% grower?

Well, listen, I mean, we're going to find out how high is up, coming forward from here, right? The first thing we had to do, is we had to address some of our issues in store, and be able to attract new customers to our stores. And that was not just in store in terms of the shelf set and the look at the store, it was also with the product itself. And the good news is, we've addressed most of those things. We've made a lot of progress there, and we're about halfway through refreshing all of the stores, which is not that disruptive but very value add.

We've also made lots of progress on the marketing front. I know we had some setbacks this quarter, in terms of our mix and our technology, but I think even that's now stabilized. So we're going to find out how high is up now. I do think Sally has a very unique value proposition in the market place, right? We do in fact have the ability to go out and source terrific, professional quality products, and deliver them to consumers at a better value.

And the reality is the customer has to believe that. Now is our moment in time to really start communicating that, because we've got better-looking stores. We've got better-looking product. We've got better-looking marketing, and we know the media mix that works. So we'll find out how high is up here, in the next couple of quarters and the next couple of years.

Okay. Yes, and I totally agree that the stores definitely look better. Do you think that there's some opportunity, or maybe some of the issue here is that close to 50% of Sally sales are your own brands? I mean, is there some sort of perhaps dislocation, in terms of the customer is not really understanding the value of some of those privately owned brands? So where your efforts are going to be focused on going forward would be to kind of educate that customer as to --?

That's exactly right. That's exactly the strategy. And part of what you'll see us do also, is to work hard to bring in a couple of more known brands, that bring the traffic in along, and then allow us to do some of those comparisons.

Okay. And then, just lastly on the BSG side, it seems -- with the outsized comps over the last year or so, seems to be kind of correlated with maybe one of your larger competitors on that -- versus CosmoProf, that they maybe have been underperforming. How much of that do you think has been attributable, because I believe you've won some brands away in that region so?

I think there's two parts. So one part of it is winning some brands away, which we've done. I also think our team is executing better, whether that be in terms of marketing or in store execution, number of stores, better service in store. And now what we're really working on is, what I'd call a better digital connection with the customer, and using social media as well as CRM, to connect to them through their smartphones, which is where they tend to live.

So listen, I think they continue to execute better. There won't be quite as many brand wins in the next year probably as there has been, but there'll be some. And it will be focused much more on getting more out of our current customer base, and earning the other customers over.

Okay. Great. Thank you.

Thank you.

And we've reached the top of the hour. Speakers, I'd like to turn back to you for any closing comments.

Well, first of all, I'd just like to thank everyone for joining us today. To sum up for the quarter, our consolidated results were solid, with 3.1% sales growth, gross margin expansion of 30 basis points, and earnings per share growth of 18%.

In addition, we completed several key initiatives in both segments that will position us for long-term success, and we think we can establish very simple agendas going forward that will drive sales growth. Thank you, and I look forward to seeing many of you in the coming months.

Thank you. And ladies and gentlemen, today's conference call will be available for replay after 12 PM today until midnight, August 18. You may access the AT&T teleconference replay system by dialing 1-800-475-6701 and entering the access code of 398712. International participants may dial 320-365-3844. Those numbers once again, 1-800-475-6701 or 320-365-3844, and enter the access code of 398712.

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.