Sally Beauty Holdings Inc (SBH) 2017 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Sally Beauty Supply FY17 first-quarter earnings call.

(Operator instructions)

As a reminder today's conference call is being recorded.

I would now like to turn the conference over to Karen Fugate. Please go ahead.

Thank you, Cynthia. 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 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 other similar words or phrases. These statements are subject to a number of factors that could cause actual results to differ materially from expectations.

Those factors are described in Sally Beauty Holdings' filings with the Securities and Exchange Commission including its most recent annual report on form 10 K. The Company does not undertake any obligation to publicly update or revise its forward-looking statements.

The Company has provided a detailed explanation and reconciliations of its adjusting items and non-GAAP financial measures in its earnings press release and on its website.

With me on the call today our Chris Brickman, President and CEO and Don Grimes our new Senior Vice President, Chief Financial Officer and Chief Operations Officer. 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 FY17 first quarter earnings call. I will briefly provide an update on our business performance and then Don will discuss our first quarter results in more detail and provide updated guidance on our expectations for the full fiscal year.

As you saw from our press release this morning, we had a disappointing start to FY17 with consolidated reported sales up 0.2% versus the prior year and gross margin down 30 basis points. In our Sally Beauty segment our revenue growth was negatively impacted by a challenging retail environment, our inability to drive additional traffic to our US stores through promotional activity and a stronger US dollar.

In our beauty systems group segment solid revenue growth was offset by lower gross margins that was driven by incremental promotions and the negative shift in product mix. In response to these unfavorable results and the expectation of continued sluggish retail trends, we are launching a comprehensive restructuring plan and other aggressive cost reduction actions that we expect will lower our FY17 operating expenses by more than $30 million versus previous expectations.

We believe we can accomplish these reductions without compromising our ability to serve our customers or execute on our strategic priorities. We expect that these actions will enable us to deliver low to mid-single-digit adjusted operating income growth despite lowering our outlook for full year consolidated same-store sales growth to a range of flat to low single digits.

During the first quarter the Sally US team completed the rollout of our new selling model to all store managers and associates which focuses them on methods to cross sell categories and increase units per transaction. Although it is too early to realize a meaningful change, we did see a slight increase in units per transaction and conversion.

Also in the quarter, we launched our grassroots marketing campaign by engaging influential beauty bloggers on social media to showcase and endorse our Sally products. We believe social media is an effective and cost efficient way to build our brand and communicate our unique value proposition.

Looking ahead we plan to launch a new well known nail polish brand, Essie. We believe the addition of Essie combined with our already large selection of nail polish brands, such as OPI and CND will give us some market leading nail assortment and we plan to market that advantage to consumers.

In addition, we are very excited that Sally will test a new loyalty program this Spring in a couple of select geographies here in the US. And obviously the team will continue to focus on improving customer engagement and conversion through our marketing and CRM efforts.

In BSG, our mobile app launched just last month and has already received terrific feedback from our stylist customers with the number of downloads far exceeding our expectations. With features that allow the stylists to better manage their entire business and a steady offering of app-only promotions we expect the app to drive stylist loyalty, and supplement our CRM initiatives.

During FY17, we expect BSG will continue to add new brands and brand exclusivity. On the marketing front the team continues to build out BSG's CRM capabilities and customer database. We believe that these efforts will differentiate BSG from the competition, and drive additional customer loyalty.

To summarize, we are confident that we are doing the right things to enrich the consumer experience, attract new customers and create added value for our existing customers. However, we recognize the necessity to right size our cost structure in the light of a challenging retail environment, and we are acting aggressively to execute on that priority.

Over the long term we will remain focused on evolving our business model to better meet the needs of our customers, drive profitable growth, and create value for shareholders. Now I will turn it over to Don.

Thank you, Chris, and good morning everyone. I believe that I know some of you on the call today from my seven year stint in the footwear space. I look forward to reconnecting or in many cases meeting some of you for the first time when Karen, Chris and I are on the road over the next few months.

As Chris mentioned earlier, our results in the first quarter of FY17 were below our expectations. However, the restructuring plan we are announcing today coupled with aggressive cost reductions elsewhere in the business will drive efficiency gains that we believe will help us achieve full-year growth in both adjusted operating income and adjusted Earnings per share.

Turning to some details for the first quarter, consolidated revenue in the first quarter was $999.6 million, growth of 0.2% versus the prior year. Same-store sales growth of 0.4% and incremental sales from 141 new stores were offset by an approximate $16 million unfavorable impact from foreign currency, primarily the British pound and Mexican peso.

Revenue growth on a constant currency basis was 1.8%. Gross margin in the quarter was 49.2%, a decline of 30 basis points from the prior-year driven by a negative mix shift between the Sally and BSG segments, unfavorable product mix shift within BSG in particular, lower vendor allowances in our Sally segment driven by the timing of inventory purchases, and higher promotions within both segments particularly late in the quarter designed to drive traffic.

Selling general and administrative expense in the quarter excluding depreciation and amortization expense was $347.4 million, growth of 0.23% driven partly by the incremental store count. SG&A as a percentage of sales was 34.8%, an increase of 80 basis points versus the prior-year, driven by store and distribution center wage increases designed to improve competitiveness within the market and reduce turnover, higher expenses due to ongoing upgrades to information technology systems and incremental expenses from new stores that are ramping up to full productivity.

Consolidated operating income in the first quarter was $117.5 million, a decline of 11.2% from the prior-year's adjusted operating income of $132.3 million driven by the lower gross margin and operating expense deleverage. The prior year's reported operating income was $130.9 million. Diluted earning were $0.39 per share, down 9.3% versus prior year adjusted diluted earnings of $0.43 per share.

Below the EBIT line a modestly higher effective income tax rate driven by the absence of one-off benefits recorded in the last year's first quarter was more than offset by lower weighted average share count. The prior-year's reported diluted earnings were $0.28 per share. Cash flow from operations in the quarter was $90.5 million, up approximately 31% versus the prior year and operating free cash flow was a robust $62.4 million.

The Company repurchased a total of 2.5 million shares of common stock during the quarter at an aggregate cost of $67 million. At quarter end there was approximately $498 million remaining on the Company's $1 billion stock repurchase authorization.

Although this particular repurchase program expires this coming September, we expect to continue to pursue capital allocation strategies that return a meaningful portion of the Company's strong cash flow to its shareholders. Inventory at quarter-end was $907.8 million, down $4.6 million or 0.5% versus the prior-year despite 141 additional stores, reflecting both the benefits from the stronger US dollar on reported inventory levels and our proactive approach to inventory management during the challenging retail market.

And finally capital expenditures in the first quarter were $28 million primarily for information technology projects, new store openings and distribution facility upgrades. We intend to subject our capital investment to rigorous financial analysis to ensure that we deliver returns commensurate with driving incremental shareholder value. As such, we now anticipate capital expenditures for the full fiscal year to be in the range of $115 million to $120 million versus prior guidance of approximately $135 million.

Turning to segment performance for the first quarter starting with Sally Beauty Supply, sales for Sally Beauty were $509.9 point million down 1.9% from the prior-year's first quarter. Negative foreign-exchange hurt the segment's revenue growth by 260 basis points. Additionally revenue growth was impacted by the challenging retail environment and our inability to drive additional traffic to US stores with incremental promotional activity.

These items were partially offset by incremental sales from a quarter-end store count that was 104 higher this year versus quarter-end in the prior-year. Same-store sales declined 0.6% in the quarter, and store count at quarter-end was 3,815, up 2.8% versus the prior year.

Gross margin of Sally Beauty was up 10 basis points to 55%, driven primarily by margin improvements in the UK and continental Europe and were partially offset by incremental promotional activity in the US and the lower vendor allowances. Operating income for the segment was $92.5 million, down 13.1% from the prior-year's first quarter driven by the sales declined, store labor cost inflation and new store opening costs, partially offset by the modest gross margin improvement.

Now turning to the Beauty Systems Group, revenue was up 3.3% to $409.8 million in the first quarter. Foreign-exchange had only a minimal impact on reported revenue for the BSG segment. Same-store sales grew 2.6% on top of a very strong 7.2% growth in the prior-year's first quarter.

A higher store count with 37 more stores at quarter end versus the prior year and the acquisition of Peerless Beauty late in FY16 also contributed to the sales growth. Store count at quarter-end for the BSG segment was 1,340, up 2.8% versus the prior year.

Gross margin declined 40 basis points to 40.9% driven by unfavorable product mix shift and higher promotions. BSG recently launched several gross margin initiatives such as pricing rationalization and vendor negotiation strategies that we believe will result in improved gross margin performance over the remainder of the year.

Operating income for BSG was $63.6 million, down 2.9% from the prior-year driven by the lower gross margin and higher SG&A costs related to new stores only partially offset by the revenue growth in the quarter. As Chris noted, we are today announcing a comprehensive restructuring plan that includes a wide range of organizational efficiency initiatives and other cost reduction opportunities.

We have closely reviewed our cost structure and recognize the opportunity to right-size our expense base relative to our revised sales growth outlook. We expect to incur aggregate charges of approximately $12 million to $14 million related to the plan, most of which will be recorded in our second fiscal quarter.

We expect to generate analyzed pretax benefits in the range of $17 million to $19 million from the initiatives contemplated by the restructuring with pretax benefits over the balance of FY17 in the range of $10 million to $12 million. Although you likely have questions regarding the specifics of the restructuring plan, I want to let you know before the Q&A session that we won't be providing any further details until after the initiatives have been implemented. As such we will share appropriate details during our second quarter earnings call in April if not before.

Repeating what Chris alluded to, we have carefully considered the actions contemplated by the restructuring plan. We are committed to a seamless execution of the various initiatives and we firmly believe that these initiatives will not impact our ability to service our customers or carry out our important business strategies.

In addition to working on the restructuring plan, we have closely examined all elements of discretionary SG&A, such as purchase services, supplies, travel and entertainment and certain areas of our marketing spend and have identified opportunities to further reduce operating expenses over the balance of the year.

Those opportunities combined with a revised view of full-year incentive compensation expense total approximately $20 million. Our goal is to continue to operate the Company as efficiently as possible, and these cost reductions are aligned with that goal. Combined the FY17 benefits from the restructuring plan and the additional cost reductions are in the range of $30 million to $32 million.

Turning now to the revised full-year outlook, we now anticipate consolidated full year same-store sales growth in the range of flat to low single digits. In addition we anticipate net new store growth in the range of 2% to 3%.

We expect the foreign exchange will continue to be a modest drag on reported revenue growth though to a lesser extent than we experienced in the first quarter. Consolidated gross margin is expected to expand in the range of 20 to 30 basis points from the prior year. Both Sally and BSG have launched specific gross margin improvement initiatives that give us confidence we can achieve the expected gross margins.

Including the benefits from both the restructuring plan and the other cost reduction initiatives, we now expect adjusted SG&A in the range of 34.1% to 34.4% of sales, which combined with the revenue and gross margin outlook leads to low to mid-single-digit growth and adjusted operating income in FY17. To be clear, adjusted operating income excludes the one-off charges related to the restructuring plan. And finally as previously noted full-year capital expenditures are now expected in the range of $115 million to $120 million.

Thank you for your time this morning. Now I would like to turn the call back over to the operator to take your questions.

(Operator Instructions)

Rupesh Parikh, Oppenheimer.

Thanks for taking my question. First I want to just touch on traffic. As you look at your outlook for the balance of the year, especially on the Sally Beauty side, what are the key efforts that you guys are doing that you think could actually help to improve traffic to your stores?

I think we have a number of levers for that, right? So one is to increase email contactability so that we can increase the effectiveness of our CRM program. We are currently around 60% to 65% email contactability. We were probably closer to 50% to 55% just three months ago before we really put this program in place. And we think we can get that up to 85% to 90%, and then of course the long-term will be to grow the program dramatically through loyalty.

In addition we have to continue to bring new brands into our store that drive new traffic into our store. So we had already launched CND in our store late Fall. We are launching Essie into the category right now and we are working on a new color line for Sally which would also bring new traffic in. Finally we've got to continue to perfect the model around how do we use social media and beauty influencers to drive new traffic and connect with new customers.

So we are working on all three of those levers. We have to take accountability for bringing the traffic in and we are working on that.

Secondly, currently the brick-and-mortar environment is very challenging so as you look at the strip centers where your stores are located, has traffic deteriorated to the centers if you compare to maybe summer or even earlier last year?

Traffic is declining in the centers we are in, which is why we have to build the ability to bring our own traffic to our stores. That's what the email contactability does.

Most importantly, that's what redesigning the loyalty program will do over time and that's also what bringing new brands to our store that drives new traffic to our store will do. So we have to operate in the reality that traffic will slowly decline in these operating centers. I think deteriorate might be a little strong of a word but it will slowly decline in the centers. Therefore we have to bring our own traffic to the stores.

I would add to that, that strip center traffic has declined at a lower rate than we believe mall traffic has declined. So if there's a silver lining to this, it's that our stores are not mall-based but strip center based, still challenged and still pressured, but not as much as what you are seeing in each shopping mall.

Okay, great. Thank you.

Simeon Gutman, Morgan Stanley.

Thanks. Good morning. My first question is related to promotions in Q1. Can you talk about I guess how much worse the earnings ended up being, because I don't know -- it sounds like promotions that you just hurt on margin or dollars but didn't get the return, and how are you confident that the comps will respond or improve with ratcheting those back?

I think there's a number of factors in there, Simeon, and by the way good morning, great to hear from you. There's a number of factors in there, so one factor was that traffic especially in Sally came very late in the month and in the quarter, especially in December, which pushed more of the purchases towards a time when we would be running clearance sales at the very time of Christmas and after, so that was a pretty significant hit to margins there.

Another piece of it was, we were trying to clear out some discontinued inventory in both businesses but especially in BSG and as we cleared out that discontinued inventory we were overly promotional there. The good news is we've taken out a lot of that inventory and you see that in our inventory numbers, but we did take a hit this quarter for it.

That also as we reduced purchases, hurt our allowances a little bit as well, because we reduced our purchases from vendors coming in, which lowered our total allowances. Overall the team has taken a hard look at their promotional activity. I think we are trying to strike the right balance between driving traffic through promotional activity and improving our margins. I think we've got the right balance going forward so we feel reasonably confident about it.

Okay, that's helpful. And I guess that is connected to my follow-up. Because if you take the first quarter, right, the EBIT dollars of the business looked like they were down like $13 million. If you take that shortfall and you add back let's just say $30 million or so in savings for this year, which both of your programs are targeting, you do get to the guidance of EBIT dollars being up low to mid single.

But it strikes me that in the Q2 to Q4 period, that means the business, let's say excluding some of the savings, would need to act flattish on a year-over-year basis, which would be a nice improvement obviously from the first quarter. And that's where I am trying to get at, what was sort of the margin that you sort of gave away because it still implies that the business itself is going to rebound in 2Q to 4Q, if that's fair.

Don, do you want to take the margin conversation?

Sure. We've looked really hard at our margin outlook for Q2 through Q4 because we have questions and I'm sure you have questions regarding the improved gross margin outlook over the balance of the year versus what we experienced in the first quarter. And there are a number of gross margin initiatives within both the Sally Beauty segment as well as the BSG segment.

They range from realizing full benefits from our global sourcing initiatives to select vendor negotiations to things that are as mundane as select price increases, rationalizing discounts, price rounding opportunities, and then the more normalized vendor allowances, we had the lower vendor allowances in the first quarter because of the timing of inventory purchases.

So when you look at our consolidated gross margin in the quarter, down 30 basis points and there are a number of ways to analyze gross margin from quarter to quarter, but a full two-thirds of the decrease in gross margin was a mix shift between the higher gross margin Sally segment and the lower gross margin BSG segment.

So when you peel it back that way, that explains two-thirds of the consolidated gross margin decline and when you go down to the segment level to your first question, clearly the biggest driver across both segments was the higher promotions in the first quarter, which we intend to have fewer promotions in the back half of the year and our revenue outlook reflects that expectation regarding promotional activity.

Okay, thanks, guys.

You bet, Simeon.

Mark Altschwager, Robert W. Baird.

Great thank you, good morning. Maybe just following up on the traffic question and the recent comp guidance, how would you assess the impact of factors like elevated retail competition, Amazon, and generally the channel shift we are all seeing to e-commerce?

And then if you are able to reaccelerate to say that 2% to 3% comp at Sally medium to longer term, does e-commerce need to play a bigger role there and if so, will that require some step-up investment?

As I mentioned, Mark, I think we have to reset and rethink our e-commerce strategy and accelerate that.

In the immediate term, that is not going to change the game for us because it is going to take time to build that, so we are very focused on a couple of things to drive traffic in the medium term. So I think this issue around email contactability so that we can take the number of our BCC customers that we can email to and promote two very efficiently up from 65% to more like 85% or 90%, that will be a big driver for us.

Some of the new brand activity including SC and other new brand activity will help. In addition, we're pushing a new natural segment, which we think there is a lot of demand for that so we will be pushing that into the marketplace probably early Q3.

So we have to work on our own ways to drive traffic and obviously using beauty influencers is another way to do that and we are really perfecting that model as well. In the long term you've got it exactly right.

One, we've got to redesign the loyalty program so that we can talk to a lot more consumers very efficiently over time, and I know lots of retailers have done that to great benefit. Some disruption in the interim but great benefit over time. And then the second is we have to really rethink our e-commerce strategy and have a much more aggressive strategy in there over time.

So we are working on both a medium term, which is the rest of this year, as well as the longer term, which will extend into 2018 and 2019 and hopefully pull on the right levers there.

That's helpful, thank you. And then on some of the store-level selling initiatives you've been rolling out, can you just give us an update on where you are with that process and how you see that impacting the Sally comp performance throughout the year?

Are you talking about merchandising activities, such as new category sets, or are you talking about some of the store selling activity?

I'm talking about some of the store selling activities.

It's a very simple model and a good question, Mark. The reality is we haven't historically. We put experts in our store who can offer beauty advice, but we oftentimes didn't teach them how to sell specialty retail products. Nor did we reward them all the time for those sales.

We oftentimes focused them on metrics that weren't as sales oriented, so we are shifting the selling model to be more focused on additional items in the basket and then changing the reward and compensation structure to reflect that as well, that priority as well. We expect that will help us over time and help us not just convert more customers but more importantly add more to their basket while they are in store.

Thanks, again.

Thank you.

Oliver Chen, Cowen and Company.

Thanks a lot, good morning, Chris and Don, thanks. Chris, regarding the quarter, what do you think happened with the inability to drive traffic through promos?

What's happening in the marketplace and if you had to re-think about what you would have done this past quarter, what are some key learnings in terms of what this means for changes? And then, you -- should we be cautious that your guidance is still elevated on the comp line, relative to what you are seeing at the Sally business?

Because it still seems like a work in progress, given how the traffic turned out.

Oliver, there's a lot in that question so let me try to pick it apart and give you the best answer I can. I do think there is consumer uncertainty that played a role here. I do think that the shift to e-commerce is accelerating and that played a role here, and there's obviously other retail traffic reports and same-store sales reports have indicated that as well.

For ourselves, I think the most important message for us is that there will probably be an environment of slowly declining traffic in the malls we are in, which means we need to get better at -- in a very efficient and low-cost way bringing our own traffic to our stores. And I know that I've been beating this drum on this call so far, but clearly email contactability is huge there.

And so there was a realization late last year and early this fiscal year that we didn't even have email connectivity with 100% of our BCC database. It was only about 55% to 60% so we are putting a big push on that because that allows us to efficiently communicate to a larger group of users. There will be a big focus long-term on redesigning the loyalty program, which allows us to get a much larger group of people.

We've got to put focus on merchandising so we've got to continue to bring new brand news to our stores that allows for consumers to be excited about coming because of new brands and expanded category penetration, so that is really the driver around Essie, around the new color line, and in addition to that very much around -- excuse me, a natural segment because we've heard a lot about that.

And finally we've got to get better at marketing and using beauty influencers and social media to find a way to reach consumers in an efficient way. You know as we've learned over time, the mass-marketing techniques tend to be wasteful in that they reached too many consumers that just aren't interested in our unique value proposition.

It's not a bad thing to do, it's just not efficient. So using beauty influencers and social media with customers and influencers with customers who are very focused on our segment and our categories, that's the way to drive traffic. So the big wake up call for me in all of this is that we have to be responsible for finding a way to drive traffic to our stores even when the mall itself is slightly declining. And that's the world we are going to live in and we have to adapt to that world.

And quickly to your last question, we don't believe that the comp guidance is too aggressive. Including what that might imply or suggest regarding the Sally Beauty comp.

And of course the comp compares do get easier as we go throughout the year here.

Chris, you've been pretty vocal and helpful and proactive about knowing about a lot of these topics previously, so what changed, and should there just have been a more conservative view coming into this quarter? And then -- it really sounds like you have an aggressive cost reduction effort going forward.

Is there any way to link that program to having more confidence in the top line? It sounds like you are going to really try to protect the front customer facing, but is there any linkage between that and thinking about revenue growth?

Oliver, I think what changed was as we went through last quarter, I think the size or speed of change in the marketplace seemed to accelerate and it made us think to ourselves that we need to get our cost base right. And so that put our immediate focus on protecting the bottom line and making sure that everything we were spending money on was efficient and driving -- either driving sales in top line or cut it, and we've made obviously a lot of efforts to do that. I'm not saying we are all done but we've done a lot of that obviously.

Now in terms of the long term, we've started focusing on what's going to really drive the needle for us. Because we've been testing a lot of things over the last two years trying to reinvent the value proposition and we think we've got the brand value proposition about right. The issue is what's the most efficient way to communicate that?

And there's no doubt that over time it's going to be through two major levers. One lever is going to be our loyalty program and a much bigger loyalty program than we have today, and the second has got to be through social media and beauty influencers, and we are really beginning to shape the team around those two essential priorities as a way to get the message out.

It's a shift, I agree. We were trying a lot -- it's a less of a shift as it is a narrowing of the things we are testing and believing we've got it right, but we've got to learn how to do that very well.

Just lastly -- thanks both of you for the detail, are you feeling really good about where your stores are? Because last year was a lot about the renovation program and making sure that different layers of the store were where you wanted them to be.

Are there edits to the philosophy around that -- it sounds like it's a lot more around driving customer demand in a personalized matter versus stores and service, although aren't you also focusing on training and development?

Yes, I think you've got it right which is, I think the physical stores we feel we've made a lot of progress with, both in the category resets we did as well as the refreshes. There's a little bit of incremental we'll do around the natural category but other than that I think we've made a lot of progress.

A lot of progress also in making our products in store look better, so I'm really excited about that, but now, you are right. The two things we've got to do is focus on traffic, traffic, traffic and using both new marketing techniques as well as our loyalty program to drive traffic, and then in store execution once the customer shows up, so those are the focuses going forward. We feel pretty good about the other pieces right now.

And Oliver I will go back to your question regarding the cost reduction. Clearly our goal in evaluating the entire cost reduction program whether it's a restructuring plan or the other cost-reduction initiatives was to identify efficiency opportunities that would not impact our ability to deliver the top line. So I think your question was along the lines are the cost reductions going to help accelerate top-line growth?

I wouldn't say that. I'd say we identified opportunities to reduce SG&A in a way that would not impact the top line.

Okay. Thank you very much. Best regards.

Thanks, Oliver.

Ike Boruchow, Wells Fargo.

Good morning, everyone, thanks for taking my question. So I'm just going to ask one question. I just wanted to step back and ask a big-picture question if I could.

Sally has been having problems driving new customers into the stores, and you have said in the past that little things like moving categories around or changing packaging has caused a little bit of confusion and disruption with your loyalty guests. So my question is, what gives you the confidence that what seems like a more meaningful change, eliminating store-wide discounts for the BCC member with this new loyalty initiative, won't create even more disruption for your customers, at least temporarily? I am just kind of curious how you guys are thinking about that.

The new loyalty program -- I am really excited about it. It's tested very well in what I'd call a research environment, and now it needs to test well in a practical environment in stores. The reality is, it changes the model, so rather than a pay-for-discount model, which is what we have today, we are not pulling off all the benefit away.

It's an as you pay you get benefits, so in fact the value proposition is if you spent $50 in our store you choose any product you want up to $10 for free. That has tested extremely well with consumers because it's very simple.

And in many cases, we are going to test whether as consumers shift over from the old BCC program to the new BCC program, they will actually get to choose a product for up to $10 for free as part of that transition, and that has tested very well also. So yes, it's a big shift.

Inevitably when you have a shift like this, you have to test it thoroughly and understand what the potential sources of disruption are. But if we can get to that shift and not have to sell the card because at this point in time we have to sell an enormous amount of cards just to keep the program stable. If we don't have to sell those cards, we can expand the program dramatically.

I would love to see it be 20 million or 25 million members at some point in time, and that, that increases our email connectivity with a vast new number of customers, which then allows us to promote to them in a very efficient way and drive traffic back to our stores.

So I think it's an essential part of our strategy. I think the team has simplified the model in a way that should be compelling, but we have to test it and that's what we are going to do.

Got it. Thanks, Chris.

Thank you. Jason Gere, KeyBanc Capital Markets.

Thanks, good morning, guys. I want to talk a little bit about BSG. I know last quarter we had a little bit of a slowdown. It seems like this quarter you got some of that back, although there were some promos in there. So, A, as SBS resets the trend back toward positive comps, can you talk a little bit about the reliance back on BSG similar to what we saw probably about a year and a half ago?

We saw similar trends when Sally was having some difficulties getting the comps higher, so can you talk about the dynamic between the two there?

We said as we came into this year that we didn't expect BSG to grow quite as fast as it had in the previous years. And that came down to there wasn't as much new brand activity as there'd been in terms of exclusive brands coming over. That being said, this was our toughest compare quarter and we knew it would be for BSG, and therefore we expect it to have a strong year, still.

Listen, it's well positioned in its market. It has market-leading share, it has all the best brands, we've launched our app which connects us to stylists in a really unique way, we are building out the best CRM database in the industry and we continue to add new brand coverage.

So I am really actually quite bullish on BSG overall. I think it's well positioned -- it's a well-positioned company in a marketplace that it has a great position in and I can't see how it won't grow at a nice strong steady basis rate. There will be some ups and downs, and we expected the first quarter to be the toughest compare quarter for it.

Okay. So I guess it changes back to the Sally stores, and I know we saw the negative comp last quarter, so as you think about flat to low single digits and BSG obviously being a big driver, with the $30 million of savings you are getting, just in cutting costs really flowing to the bottom line, really not reinvested, how should we think about the cadence of Sally getting better?

Did January show any improvement from December as you start to turn on some of the email connectivity that you are talking about? I am just trying to think about how the Sally side -- in terms of setting the expectations right for that part of the business.

We don't obviously release inter-quarter comps. I think the way to think about it is this, it's less about cutting, which there is some savings here, but it's about narrowing our focus on what we've discovered and learned are the highest return investments we can make over time.

So Sally obviously, A, we come up against lesser comps and easier compares in the next three quarters, which is great. B, we are expanding our email conductivity; C, we have new brand activity and some pricing activity we will be launching in the Sally segment as well. And then finally, I think we are getting better at just understanding how to leverage our CRM and how to leverage beauty influencers and social media to drive traffic to our stores.

So we feel pretty good about the back half of the year. We did obviously want to make sure the guidance was reasonably conservative and we wanted to structure our cost base around that. I think that's an important first step.

We had to recognize we had a tough quarter and act aggressively against that, but I don't feel that we cut anything that's going to compromise our ability to deliver on what we laid out as our forecast for the full year.

I agree.

So one thing you just said about feeling good about the back half of the year, so with the second quarter, the March quarter coming up, should we see a little bit more of the same? And then as some of these programs really start to kick in then it becomes a little bit more back-half weighted, or -- I mean I know the costs side of things are going to start to come through probably as you announce it so there will be some benefit this quarter, more in the second half.

But from a top-line perspective, I mean I guess I'm trying to understand what the drivers will be in terms of the sales reacceleration. Do you expect a better retail environment out there, or do you think that what we saw in the December quarter kind of lingers through margin and the back half gets better?

We aren't going to comment on the cadence of our expected quarterly comps, but I will say, as Chris said earlier, the comps get easier at the back half of the year, if you look at the comps last year for both the Sally segment and the BSG segment.

Okay. That's it for me, guys, thanks.

Thank you.

Kelly Halsor, Buckingham Research.

Hi, guys, thanks for taking my question and welcome to the team, Don. I just want to follow-up on the loyalty program test.

If all goes the way that you hope it will, is this something we should expect to be implemented in 2018? Or before? Any color there would be helpful.

That's the goal. Obviously we will test it as long as we have to test it to get it right, and if it proves to go faster we will accelerate it as much as we can, but it's being tested significantly in about 300 stores. That will go in the market in mid-March I believe but be tested and rollout from there. But the bottom line is it needs to be tested thoroughly before we're ready to roll that out.

As you've seen from other retailers, there's been some disruption at times but over time a great benefit. We will try to test it such that we minimize the disruption part and focus on the benefit part.

I will add to that, that one of the things that I've done in my less than two months here -- a lot of things I guess but, dug into the financial analysis or the financial model behind the revised loyalty program and I was relatively pleased to see the level of sophistication behind the analysis, taking the existing loyalty customers and stratifying them into deciles and modeling expected behavior under the new loyalty program.

And so if things play out as modeled, then this could be a great thing for the Company, but obviously we are going to test and then study the results of the test market quite closely before we go national.

Sure, that makes sense. And then just to understand this better, you talked about this up to $10 for free promotion -- I would assume that's to sign up but then otherwise are you talking a points-based model here?

It's a really simple model where every $50 consumer spend they get to choose whatever product they want up to $10 in the store and take that home for free. But they have to cross the threshold and come back and pick up that product which drives additional visits to the store.

Okay and then my second question is just on pricing. You mentioned there's going to be some additional pricing actions. Could you just remind us of the actions you took last year, and then where you see some comfort in being able to do that and the customer's response?

Why don't I cover the last year part of that and then I will let Don cover the upcoming pricing activity?

So if you remember correctly it was mostly in our Sally segment last year, it was around zone pricing was one, so I believe we took a total of about 500 or so stores and that's an approximate into a slightly higher-priced zone because it's a higher cost to operate, and that pricing we felt was better suited to those environments. In addition we also launched some tactical pricing although not a great deal.

Last year we plan to do more of it this year. And finally we did some work last year on reducing some of the coupon stacking, although I don't think we got much value last year. I think most of that will come this year, but those were the initiatives for the most part last year. And then, Don, if you want to talk a little bit about the activity we have planned in the remainder of 2017?

Yes, I mean the price increases that are in our forecast apply to both the BSG and the Sally segments and they range from select price increases in certain categories and with certain vendors to, as I mentioned earlier, some kind of price rounding if you will, going up to the $0.99 or $0.79 area or whatever it might be to get a few extra pennies on each sale.

In markets like Mexico, where a lot of their -- a majority of their products are sourced in US dollars, where the devaluation of the peso has significantly hurt the profitability in the market, which is relatively small for us, but in addition to some price action we are taking earlier in the fiscal year, we anticipate taking some additional pricing over the balance of the year to recoup that in-country margin.

So the pricing activities are somewhat across-the-board, but will be done in kind of a judgmental selective way but -- that's embedded in the gross margin outlook we provided.

And expanding on the FX side of that, we are also taking price in Canada as well where we've had some degradation in our margins due to FX, so we will execute that as well.

Okay, and then just really quickly, my last question is around your new storefront activity. It seems to have ticked down -- we've seen it tick down for the last couple of quarters.

Is there any thoughts in maybe, Don, you have some color here to add just around where you think the store growth goes from here? Do you think maybe in this new environment where traffic continues to be a headwind that you could be shifting dollars away from new stores towards e-commerce or other investments?

Kelly -- this is Chris. I think it's something we have to look at on a holistic strategy basis.

As you know, we make money in most of our stores. We do have some questions about whether in certain markets when we've added stores we've actually taken down total profitability, so we are going back and taking a look at that as well to see if even though a store may make money, would we make more if we changed our footprint slightly in those markets?

I think overall we are going to raise the bar little higher in terms of stores we open, and we will be aggressively looking at our e-commerce strategy and understanding do we need to invest more to drive that faster?

All right, guys, thank you very much.

Olivia Tong, Bank of America.

Thank you. First just in terms of the comp guidance, flat to low singles, given your starting point it does look like you are looking to exit the year closer to 3, so first if you could comment on that? And then broadly speaking, I am hoping you can clear a few things up for me because there's obviously a few comps that came in below and you adjusted your full-year expectations.

Margins weren't where you wanted them to be and you're launching restructuring to address that. So I appreciate how aggressive the plan is, but you are looking for probably the biggest gross margin improvement that you've done in the last five years in the face of fairly significant sales challenges, so you can you help me understand how you expect all this to come together and how you ensure that you don't cause further disruption to sales when your margin expansion seems pretty dependent or mostly dependent on the plan you just announced?

And also, sorry for the long question but can you give an order of magnitude of the key initiatives in the other $20 million of savings you're looking for, the non-restructuring piece?

Yes, I will address two and three and I didn't quite catch one -- maybe Chris did but we will come back to that.

But if you look at what impacted our gross margin in the first quarter, beyond the mix shift between the BSG and Sally segment, the biggest single drivers were the lower vendor allowances driven by the timing of inventory purchases and the incremental promotions/discounts that were designed to drive traffic into the stores.

So our outlook for comp store sales over the balance of the year reflects a meaningful reduction in promotional activity, which will benefit our gross margin and reflects a more normalized inventory purchase pattern, which should get vendor allowance back to a more normalized level. So I think the drag that we saw in Q1 shouldn't be as much of a drag if any of a drag, in Q2 through Q4.

Secondly, the price increases, which we talked about a couple of times on some earlier questions, will be a meaningful contributor to gross margin performance in the back half of the year. And as I mentioned earlier, we will start to see benefits from global sourcing initiatives and select vendor negotiations.

So we've had significant internal conversations regarding the gross margin outlook, because I recognize that the full-year outlook vis-a-vis the first-quarter performance would generate questions both with our Board of Directors last week as well as with the investment community today, and so we feel good about the gross margin outlook for the full-year recognizing that it does represent a pretty meaningful uptick from where we were in the first quarter.

And I think on traffic -- we don't have quite the same expectations, Kelsey, or I'm not sure how you are getting to the data in terms of a big uptick in the back half of the year or in the last quarter of the year. The reality is we do see the comps being a little bit easier, and we do think that we have some good activity plan --

Excuse me this is Olivia, I apologize. And we do have some good activity planned, both in some new brand activity in both businesses as well as some promotional activity in both businesses, so the combination of that suggests we believe we will do better than the first quarter, but I don't think we are expecting any big acceleration in comps throughout the year.

Got it. That's very helpful.

To your latter question quickly on the $20 million other cost reduction -- it pretty much runs the gamut. It's kind of what I call good old-fashioned belt-tightening.

It's looking at all of your purchase services, nonessential travel and entertainment, supplies expense, we did revise our full-year outlook on incentive compensation and certain areas of marketing spend that we thought were being less productive that we've taken out of the outlook. So this represents -- we've talked about $20 million, it represents a reduction from what we had previously planned to spend, not necessarily a reduction from prior-year spend.

Got it, that's helpful. So that $20 million is a delta, not necessarily a $20 million year-over-year change.

That's correct.

Got it, and specifically on nail care as you add Essie, does this impact your relationship with OPI in any way?

I don't think so. We are growing fast with OPI, the brand has done very well for us, especially the extended wear is just off the charts. So our biggest issue now is to take what is a market-leading assortment, which now includes OPI, CND, China Glaze, Essie, or Orly and market the fact that we have such a great selection for the customer. All the best brands in one place.

And that's what we really want to get to is take that to draw more traffic to our stores and make hay out of that. So I think you'll see us very active in social media with that, using our influencers to talk about that, so overall we're very excited about that. It's a great addition to our lineup and I think it really does give us the best assortment in nails by far.

Great, thanks guys.

Joe Altobello, Raymond James.

Hey, guys, good morning. First question, I wanted to go back to on the concept you were talking about earlier about email contactability.

You mentioned you have email addresses for about two-thirds of your beauty club card customer base. How do you communicate with the other third? Is it exclusively direct mail?

In some cases, yes, but in some cases we don't contact them at all. If they don't justify as a customer getting a direct mail piece then we may not actually be in contact with them, which is why having email contactability is a great value, right?

There's 3 million consumers out there who visit Sally on a reasonably regular basis, certainly regular enough that they want to sign up for a BCC card but we can't send them promotional ideas. We can't prompt them with new product launches. We can't prompt them with new beauty trends that are coming in the season and that is a miss.

And just as loyalty, if it allows us to expand our user base and allows us to contact 20 million people through the program rather than 10, will drive up our traffic, so will increasing it from 6 million to 9 million or 10 million so we are very focused on this.

We tested the dialogue in stores during the fall of last year, to make sure that we weren't angering customers as we insisted on email addresses, but we are finding that it's working quite well. We've closed the gap probably about 10 percentage points in just a few months and our hope is that we can get that up into the 90% range pretty quickly.

Is it that these customers don't want to give you their email addresses or they don't have an email address?

There's a variety of reasons. Sometimes they don't get asked, sometimes they don't have one, sometimes they won't give it and we are really making it mandatory as part of the program. If you want to be in the program, you have to give your email address. And what we are finding is that more and more consumers are actually willing to do that, and in many cases they would rather give their email address than their actual address.

Okay, and just going back to Olivia's question for a second, the $20 million, just so I'm clear, that $20 million is not an actual savings number, it is off of what you budgeted coming into this year in terms of spending.

It's a reduction from what was embedded in the guidance we gave at the beginning of the fiscal year.

And that's mostly SG&A it sounds like?

It's all SG&A.

Okay, and one last one. And this has come up a lot in this call, but if you look at the lack of responsiveness that you guys had to promotion activity in the December quarter and lack of foot traffic that it drove, it sounds like that you are going to be sort of pulling back on that promotion spending to drive margin expansion throughout the rest of this year or at least partly to drive margin expansion throughout the rest of this year.

And yet you are also looking for comps to accelerate, so I guess my question is -- I am sort of skeptical that you can do both. You can drive margin expansion and drive traffic at the same time.

I think there's a number of pieces to that, Joe, so number one is, a lot of the increased and promotional activity had to do with the fact that consumers shifted, so there was a real shift in consumer buying behavior where they came very, very late in December and in many cases came after Christmas, which actually shifted them into a very promotional period for us where we are selling through discontinued items and clearing out our stores.

And so some of it was due to that and it was more of just a traffic shift during the quarter. Some of it was the fact that, you know, December and the Christmas quarter is always a very noisy quarter with competition in terms of promotional activity because every retailer is on deal during the quarter and our promotions get lost.

And if that happens where you are promoting something and you fail to bring new traffic to the store, then you're just giving money away to customers who would have come anyways. So we don't feel there's going to be as much noise around our promotional activity. We are going to be more surgical with it, and finally, we don't think we will have the same change in buying behavior that will shift them into the heavier promotional periods like it did in December.

Okay, thank you, guys.

Simeon Siegel, Nomura Securities.

Thanks, guys, good morning. It looks like the Sally OpEx grew mid single this quarter, can you quantify how much of that was wage, and then just in light of the conversations around the cost, what you expect the Sally OpEx growth in the year?

What was the latter part of that question?

What you expect the same -- the Sally segment for the OpEx dollar growth for the rest of the year?

We're not commenting on segment outlook. The impact of the wage increase was really not just in stores, it was also in some distribution centers as we tried to reduce turnover in order to impact productivity. But in terms of our outlook for the balance for the year, we will stick with consolidated SG&A as a percent of sales.

Okay, and any way of quantifying just general labor cost impact?

In terms of hourly wage increase?

What I would say, Joe -- excuse me, Simeon, I apologize, is just directionally we're seeing a little less pressure on rent. That seems to be declining and in addition to that we're past what we think is the biggest chunk of the labor cost inflation. And we expect that to start to tail off, especially as we get into 2018. So I am hoping actually that we are going to start to see a lower rate of inflation in our store level operating costs both in rent and labor as we enter 2018.

Great, thanks a lot, guys. Best of luck for the rest of the year.

You bet.

Steph Wissink, Piper Jaffray.

Hey, good morning, everyone. Most of my questions have been asked but I do have one follow-up question on the nail care investment.

Can you talk a little bit about that category in terms of frequency relative to your other categories? Is there an opportunity to drive traffic through frequency with that investment?

I think there is. So the category obviously did very well about five or six years ago with the innovation of nails. In the last year and a half or so, it suffered as extended wear came in and traded a lot of consumers down from gel to extended wear at a lower price point and that took value out of the category. I think we are past most of that negative impact.

And now this is about saying, okay, it's time for this category to start growing again and we really wanted to have a market-leading position in the category. So we are going to actually be spending some marketing dollars to talk about the news of us having the best assortment, the broadest assortment, the most colors, the most brands and drive new traffic to the stores using our beauty influencers, social media, as well as promotional and emails and other paid search type activity to drive new traffic to the stores.

So we will be investing around it. I think it's great opportunity to reinvigorate a category that's been a laggard for us the last two years.

And just a second follow-up, the question was asked earlier about your commitment to store growth even with the comp pressure, can you talk about your CapEx forecast for this year? I know your store growth targets didn't change, but where are the dollars coming out of in terms of investment?

And then what are you seeing in terms of the trend line of productivity per unit as you think about kind of your multi-year waterfall model?

In terms of the capital plan, obviously with the arrival of a new CFO we had the opportunity to do a deep dive on the capital expectation for the full fiscal year, and we just had some projects that are good projects. They wouldn't have been on the original list, they weren't that we decided just to simplify our focus on some of those projects were pushed into the latter part of the year so some of the capital will bleed over into FY18.

Some of the projects have been pushed completely to FY18, so they are some distribution investments, IT investments, less on the store side. Our outlook for new store openings is consistent with where we were before, so it's more on the IT and distribution side and really pushing the projects out a bit, and I think it's the right thing for the Company.

And to your point, we have seen some declining productivity in store performance. It doesn't mean they don't make money, as you know our stores breakeven at very low thresholds, but we are taking a very hard look at our store base.

Our current footprint as well as planned new right now, and we will be rethinking that strategy to optimize productivity and performance over time.

I have a question just related to your mix of categories. I know it's been something you've been digging into more closely and it sound like there may be a color program coming.

Can you talk a little bit more about how you're thinking about the balance of categories within your Sally Beauty Supply business?

I think Sally still has to be all about hair in the end, hair color and hair care represent more than half of our total business. So we are going to lead without first always, and the goal there in the color category will be to potentially add a new color line, which we haven't done in a number of years, which would bring some new customers, both professional and retail customers to the store.

So we are looking for an established line that has brand reference and credibility, and we are in negotiations on that right now. So I think we will always be a hair first company, I think that's who we are and that's what our value proposition is. That being said, I think we can continue to bring new innovations those categories, in hair care it's about the natural segment and in hair color it looks like it will be about a new color line.

Thank you, best of luck.

Speakers, I would like to turn it over to you for any closing comments.

In summary, I think it's all clear that we had a very slow start to the fiscal year, but we believe we have taken the necessary actions to align our cost structure to drive earnings growth.

We will remain focused on evolving our business model to better meet the needs of our customers and to create value for shareholders. I would like to thank all of you for joining us today, and I look forward to seeing you in the coming weeks. Thank you.

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