Sally Beauty Holdings, Inc. (SBH) Q1 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Sally Beauty Supply Fiscal 2017 First Quarter Earnings Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given to you at that time. [Operator Instructions] And 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, Sophia. Before we begin, I would like to remind you that certain comments, including matters such as forecasted financial information, contracts or business, and trend information 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 Securities and Exchange Commission, including it’s 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 are 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 fiscal 2017 first quarter earnings call. I’ll 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 fiscal 2017, 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 U.S. stores through promotional activity and a stronger U.S. dollar. In our Beauty Systems Group segment, solid revenue growth was offset by lower gross margin that was driven by incremental promotions and a negative shit 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 fiscal 2017 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 expected that these actions will enable us to deliver a 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 U.S. 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’s 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 unique, 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 a 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 U.S. And obviously the good team will continue to focus on improving customer engagement and conversion through our marketing and CRM efforts. In BSG, our mobile app, just last 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 fiscal 2017, 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’ve recognized 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’ll 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 years spent 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 fiscal 2017 were below our expectations. However the restructuring plan that 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 segment, 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 during the quarter, excluding depreciation and amortization expense, was $347.4 million growth of 2.3%, driven partly by the incremental store account. 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 with the market and reduced turnover, higher expenses due to ongoing upgrade 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 earnings 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 last year's first quarter was more than offset by a lower weighted average share count. As 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 it’s shareholders. Inventory at quarter-end was $907.8 million, down $4.6 million or 0.5% versus the prior year, despite the 141 additional stores, reflecting both the benefits from the stronger U.S. dollar on reported inventory levels and our proactive approach to inventory management during the challenging retail environment. And finally capital expenditures in the first quarter were $28 million, primarily for Information Technology Project, new store openings and distribution facility upgrades. We intend to subject our capital investment to rigorous financial analysis to ensure that we deliver return commensurate with deriving 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 $589.9 million, down $1.9% from the prior year's first quarter. Negative foreign exchange, hurt the segments revenue growth by 260 basis point. Additionally revenue growth was impacted by the challenging retail environment, and our inability to drive additional traffic to U.S. 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 at Sally Beauty was up 10 basis points at 55%, driven primarily by margin improvements in the UK and continental Europe that were partially offset by incremental promotional activity in the U.S. and the lower vendor allowances. Operating income for the segment was $92.5 million, down 13.1% from the prior years first quarter driven by the sales decline 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 years 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 fiscal 2016 also contributed to this 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 annualized pre-tax benefit in the range of $17 million to $19 million from the initiatives contemplated by the restructuring, with pre-tax benefit over the balance of fiscal 2017 in the range of $10 million, to $12 million. Although you’d 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 and 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 purchased services, supply, 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 the revised view of full year incentive compensation expense totaled 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 for fiscal 2017 benefits from the restructuring plan and the additional cost reductions are in the range of $30 million dollars 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 that Foreign Exchange will continue to be a modest drag on reported revenue growth, but to a lesser extent than we experienced in the first quarter. Consolidated gross margin is expected to expand in the range of 20 basis points 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 outlooks leads to low to mid-single digit growth and adjusted operating income in fiscal 2017. 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 a range of $115 million to $120 million. Thank you for your time this morning. Now I'd like to turn the call back to the operator to take your questions.

[Operator Instructions] Our first question will come from the line Rupesh Parikh with Oppenheimer. Your line is open.

Thanks for taking my question.

Good morning.

Hi Chris, I first want to just touch on traffic. So as you look at your outlook for the balance of the year, especially on the Sally Beauty side what are the key uppers that you guys are doing that you think could actually help to improve traffic to your stores?

Well Rupesh, I think we've got a number of levers for that right. 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've got 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 at late fall. We're launching Essie into the category right now and we're 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're working on all three of those levers. We have to take accountability for bringing the traffic in and we're working on that.

And then secondly, I mean clearly there the brick-and-mortar environment is very challenging. So as you look at the strip centers that your stores are located, has traffic deteriorated to the centers, as you – I don’t know, if you compare maybe to the 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 is 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 these centers. Therefore we have to bring our own traffic to our stores.

And I would add to that, that strip center traffic has declined at a lower rate than we believed mall traffic has declined. So there's a silver lining to this that our stores are not mall based but strip center based. There is still challenges, there is still pressure but not as much as what you're saying in each shopping malls.

Okay, great. Thank you.

You bet.

Thank you. Our next question comes from Simeon Gutman with Morgan Stanley. Your line is open.

Thanks and 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 of I don't know – it sounded like promotions that you just got hurt on margin or dollars but didn't get the return and how are you confident that the comps will respond or improve with fewer, or with ratcheting those back?

And I think there's a number of factors in there Simeon and by the way good morning great to hear from you. 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 there 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. Over all the team is taking a hard look at their promotional activity, I think we're 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's connected to my follow-up. Because if you take the first quarter, right the EBIT dollars of the business, they look 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 the EBIT dollars being up low to mid-single, but that – it strikes me that means in the Q2 to Q4 period, that means the business let's say excluding some of this 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 what I am trying to get out 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.

Well, Don do you want to take some of the margin…

Sure, we’ve looked really hard at our margin outlook for Q2 to Q4 because obviously we had questions, and I'm sure you would have questions regarding the improved gross margin outlook over the balance of the year versus what we’ve experienced in the first quarter and there are a number of gross margin initiatives. But then both 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 discount, price rounding opportunities and then the more normalized vendor allowances. We had to 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 a lower gross margin BSG segment. So when you peel it back that way, that explains two thirds of the consolidated gross margin decline and then 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.

Thank you. Our next question comes from the line of Mark Altschwager with Robert W. Baird. Your line is open.

Great, thank you, good morning. Maybe just following up on the traffic question and reset comp guidance, how would you assess the impact of factors like elevated retail competition Amazon, in general the channel shift relative to e-commerce. And 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 therein 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’s not going to change the game for us because it's going to take time to build that. So we're very focused on a couple of things that drive traffic in the medium term. So I think, this issue around email contactability, so that we can take our, the number of our BCC customers that we can email to and promote to 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 Essie and other new brand activity will help. In addition we're pushing a new natural segment, which we think there's a lot of demand for that. So we'll be pushing that into the marketplace, probably early Q3. So we've got to work on our own ways to drive traffic. And obviously using beauty influencers is another way to do that. And we're 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 re-think our e-commerce strategy and have a much more aggressive strategy over there – in there over time. So we're working on both the 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 kind of where you are with that process and how you see that impacting the Sally comp performance throughout the year.

Are you talking about merchandising activity 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 is a very simple model and good question Mark. The reality is we haven't historically, we’ve put experts in our stores, 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 sales oriented. And so we're 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, more importantly add more to their basket while they're in store.

That's great. Thanks again.

Thank you.

Thank you. Our next question comes from the line of Oliver Chen with Cowen and Company. Your line is open.

Thanks a lot of 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 rethink about what you would have done this past quarter. What are some of key learnings in terms of what this means for changes and then are you, should we be cautious that your guidance is still elevated on the comp line, relative to what you're 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 and pick it apart to 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 an obviously other retailer 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’re in, which means we need to get better at, in a very efficient and low cost way of bringing our own traffic to our stores. And I know I've been beating this drum here 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're putting a big push on that because that allows us to efficiently communicate to a larger group of users. There is going to 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's really to drive around Essie around a 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 then finally we've got to get better at marketing and using beauty influencers in social media to find a way to reach consumers in an efficient way. As we've learned over time that the mass marketing techniques tend to be wasteful and that they reach too many consumers that just aren’t interested in our unique value proposition. It's not a bad thing to do it just doesn't, 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're going to live in and we have to adapt to that world.

And Chris it sounds like a lot of the

Quickly to your last question, we don't believe that the comp guidance is too aggressive, we believe in that and – 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.

But 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 as we. It really sounds like you're doing you have a 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're going to really try to protect the front customer facing but will, 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're spending money on was efficient and driving either driving sales in topline 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 and then it 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 that’s got to be through two major levers. One lever is got to be our loyalty program and a much, much bigger loyalty program than we have today. And the second is got to be through social media and beauty influencers. And we are really beginning to shape the team around those two essential priorities as the way to get the message out. And it’s a shift I agree, we were trying a lot – its less of a shift as it is a narrowing of the funnel of test things we are testing and really believing that we’ve got it right. But we’ve got to learn how to do that very well.

Okay. 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 you – is that are there edits to the philosophy around there, it sounds like it’s a lot more about driving customer demand in a personalized manner 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 feel like we 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 got to do is focus on traffic, traffic, traffic in 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.

Oliver, I just want to go back to the – your question regarding the cost reduction. Clearly our goal in evaluating all – the entire cost reduction program whether it’s a restructuring plan or the other cost reduction initiatives. But to identify efficiency opportunities that would not impact our ability to deliver the top line. So I think your question was online so the cost reduction is going to help accelerate top line growth. I wouldn’t say that, I would 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.

Thank you. Our next question comes from the line of Ike Boruchow with Wells Fargo. Your line is open.

Hey, good morning everyone. Thanks for taking my question. So I’m just going to ask one question. So I just want to step back and ask a big picture question if I could. So Sally's been having the problems driving new customers in to the stores and you guys 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? 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'm just kind of curious how you guys are thinking about that?

Well, the new loyalty program, I’m really excited about is, it’s tested it very well in what I call 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're not pulling off all the benefits away. It's a – as you pay you get benefit so in fact the value proposition is if you spend $50 in our store you choose any product you want up to $10 for free. That is tested extremely well with consumers because it's very simple. And in many cases, what we're doing we're going to test whether as consumers shift over from the old BCC program to the new BCC program. They'll actually get to choose a product for up to $10 for free as part of that transition. And that is 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'd love to see it be 20 or 25 million members at some point in time. And that increases our e-mail contact 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 is simplified the model in a way that should be compelling. But we have to test it and that's what we're going to do.

Got it, thanks Chris.

You bet.

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

Okay, thanks and good morning guys. I guess 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 I just – I guess as SPS kind of resets kind of the trend back towards 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 kind of getting the comps higher. So can you keep talk a little bit about the dynamic between the two there?

Well, BSG we've 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 so there wasn't as much new brand activity is 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 expected to have a strong year still. 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're building out the best CRM database in the industry and we continue to add new brand coverage. So I'm really – actually quite bearer bullish on BSG overall I think it is in a 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 then I guess change back to the Sally stores and I know that we saw the negative comp last quarter. So as you think about flat to low single-digit in BSG obviously being a big driver and with the $30 million of savings that you're getting just from cutting costs really kind of flowing to the bottom line really not reinvested. How should we think about the cadence of Sally getting better I mean did January show any improvement from December as you start to turn on some of the e-mail connectivity that you're talking about. So just trying to think about how that the Sally side in terms of setting the expectations right for that part of the business?

We don't obviously release inter-quarter comps but I think the way to think about it is this is it's less about cutting which there is some savings here but it's about narrowing our focus on what we have 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're expanding our e-mail connectivity. C, we’ve got some new brand activity and some pricing activity that will be launching in the Sally segment as well. And then finally, I think we're 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 that 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. Don, I don't know if you want to add anything.

No, I agree.

Okay, 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 and then it becomes a little bit more back half weighted or I mean I know the cost side of things are going to start to come through probably as you announced 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?

Yes, we're not going to comment on the cadence of our expected quarterly comps but I will say as Chris said earlier the comps get easier in the back half of the year. If you look at the comps last year for both the Sally’s segment and the BSG’s segment.

Okay, that’s it for me guys. Thanks.

Thank you.

Thank you.

Thank you. Our next question comes from the line of Kelly Halsor with Buckingham Research. Your line is open.

Hi, guys. Thanks for taking my question and welcome to the team, Don.

Thank you.

Just want to follow-up on the loyalty program test. I mean if all goes the way that you hope it will, I mean is this something that we should expect to be implemented in 2018 or before, any other color there would be helpful?

Yes. That’s the goal. Obviously, we tested as long as we have to test it for to get it right and if it proves to go faster. We'll accelerate it as much as we can. But it’s being tested significantly in about 300 stores that will go into 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 are ready to roll that out. As you’ve seen from other retailers there has been some disruption at times. But over time a great benefit. We're going to try and test it such that we minimize the disruption part and focus on the benefit part.

And just to make…

And I will add to that, one of the things I've done in my less than two months here, done 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 itself. If things play out as modeled then this could be a great thing for the company but obviously we're going to test and then study the results of the test markets quite closely before we do, 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 for – to sign up but then otherwise are you talking a point based model here?

Yes, it’s a really simple model where every $50 consumer spends, they get to choose whatever product they want up to $10 in the store and take that home for free.

Okay.

But they have to come back – 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 here is just on pricing and you mentioned that 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 and being able to do that and the customers response?

Why don’t I cover the last year part of that, and I’ll let Don cover some of the upcoming price 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 that’s an approximate into a slightly higher priced zone because it’s a higher cost to operate and with those better 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've got planned in the remainder of 2017.

Yes, that mean the price increases that are in our forecast – are applied to both the BSG and the Sally segments and they range from select price increases in certain categories and with certain vendors to some – as I mentioned earlier some kind of price rounding if you will, going up to the $99 or the $79 or whatever it might be to get a few extra pennies on each sale. In markets like Mexico, where a lot of their – majority of their products are sourced in U.S. dollars where the devaluation of the peso has significantly hurt the profitability in that market which is relatively small for us. But in addition to some price action that were taken earlier in the fiscal year, we anticipate taking some additional pricing over the balance of the year to kind of recoup that end company margins. So the pricing activities are somewhat across the Board but will be done and kind of a judgmental selected way but that's embedded in the gross margin outlook that we provided.

And expanding on the FX side of that we're also taking price in Canada as well where we've had some degradation, our margins do the FX and so we’ll execute that as well.

Okay. And then just real quickly my last question is around – that your new store productivity it seems to have tick down, we've seen a tick down for the last couple of quarters, I mean is there any thoughts and 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 continue to be a headwind, that you could be shifting dollars away from new stores toward e-commerce or other investments.

I think its – 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're going back and taking a look at that as well to see. If even though a store may make money would we may more if we changed our footprint slightly in those markets. I think overall we're going to raise the bar a little higher in terms of stores we open. And we will be aggressively looking at an – our e-commerce strategy and understanding do we need to invest more to drive that faster.

Okay. Thank you very much.

You bet.

Thank you. Our next question comes from the line of Olivia Tong with Bank of America. Your line is open.

Thank you. First just in terms of the comp guidance flat to plus low-singles, given your starting point it does look like you're looking to exit the year closer to three. So first if you could comment on that. And then just broadly speaking I’m hoping you can clear a few things up for me. Because there's obviously a few earned comps and they 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're looking for probably the biggest gross margin improvement and you've done it in the last five years in the face of fairly significant sales challenges. So can you help me understand how you expect this to come to – 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 that 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'll address two and three and then I didn’t quite catch one, maybe Chris did. But we’ll come back to that. But if you look at it what impacted our gross margin in the first quarter beyond the mix shift between the BSG and the Sally segments is kind of the biggest single drivers where the lower vendor allowances driven by the timing of the inventory purchases and the incremental promotions last 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 allowances 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'll start to see benefits from global sourcing initiatives and select vendor negotiation. So we've had significant internal conversation regarding the gross margin outlook because I recognize that the full year outlook vis-à-vis the first quarter performance would generate questions both with our Board of Directors last week as well as with 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. I don't – we don't have a quite the same expectations, Kelsey or I'm not sure how you're 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've got some good activity plan – excuse me, this is Olivia, I apologize. We do have some good activity plan 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 will do better than the first quarter but I don't think we're expecting any big acceleration in comps throughout the year.

Got it. That’s very helpful.

I'm sorry to your latter question just quickly on the $20 million or other cost reduction, it pretty much runs the gamut. I mean 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 we are being less productive that we've taken out of the outlook. And so this represents we talk about $20 million, it represents the reduction from what we had previously planned to spend not necessarily a reduction versus prior year spend.

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

That is correct.

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

I don't think so. We're growing fast with OPI, the brands done very well for us especially the extended wear it’s just off the charts. So our biggest issue here is now to take what is a market leading assortment which now includes OPI, CND, China Glaze, Essie and 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 is very active in social media with that, using our influencers to talk about that. So overall, we're very excited about it's a great addition to our lineup and I think it really does give us the best assortment in nails by far.

Thanks guys.

Thank you. Our next question comes from the line of Joe Altobello with Raymond James. Your line is open.

Thanks. Hey guys, good morning. So first question I want to go back to you, the concept that you guys talking about earlier about e-mail contactability you mentioned Chris that you have e-mail 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. 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 e-mail contactability is a great value, right. There's three million consumers out there who visit Sally on a reasonably regular basis, certainly regular and also 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’s 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 we'll increasing it from 6 million to 9 million or 10 million. So we're 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 e-mail addresses. But we're finding that it's working quite well, we've closed the gap probably about 10 percentage points in just a few months. Our hope is that we can get that up in that 90% range pretty quickly.

Okay, is it that these customers don't want to give you the e-mail address or they don’t have an e-mail address?

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

Okay, and just going back to Olivia’s questions for a second, the $20 million, just want to clear that $20 million is not an actual savings number. It's 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 this fiscal year.

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

That’s all SG&A.

Ok, all SG&A. And then 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're going to be sort of pulling back on that promotion spending to drive margin expansion throughout the rest of this year, at least partly to drive margin expansion throughout the rest of this year. And you're also looking for comps to accelerate. So I guess my question is I'm sort of skeptical that you can do both. You can drive margin expansion and drive traffic at the same time.

Well, I think there's a number of pieces to that, Joe. So number one is a lot of the increased 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're selling through discontinued items and clearing out our stores. And so some of it was due to that and it was just more of a traffic shift during the quarter. Some of it was the fact that December and the Christmas quarter is always a very noisy quarter with competition in terms of promotional activity because every retailers on deal during that 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 I think we don’t feel there is going to be as much noise around our promotional activity. We're going to be more surgical with it. And finally, we don't think we'll have the same change in buying behavior that will shift them in the heavier promotional periods like it did in December.

Okay. Thank you, guys.

You bet.

Thank you. Our next question comes from the line of Simeon Siegel with Nomura Instinet. Your line is open.

Thanks guys. Good morning. So it just 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’d expect that Sally segment OpEx dollar growth for the year? Thanks.

What was the latter part of your question?

What you expect just that same as Sally segment the OpEx dollar growth for the rest of the year?

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

Okay, in any way of quantifying some general labor cost impact?

In terms of hourly wage increase?

What I would say Joe is just – excuse me, Simeon I apologize, it’s just directionally we're seeing a little less pressure on rent that seems to be declining. And in addition to that we're seeing, 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 go into 2018. So I'm hoping actually we're 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.

Thank you. We’ll go to the line of Steph Wissink with Piper Jaffray. Your line is open.

Hey, good morning everyone. Most of my questions have been asked but I do want to 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 category, 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, 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're going to actually be spending some marketing dollars to talk about the news of having the best assortment to 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 e-mails and other search – paid search type activity to drive new traffic to the store. So we'll be investing around it. I think it's a great opportunity to reinvigorate a category. That's been a laggard for us for 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 a little bit about your CapEx forecast for this year I know your store growth targets didn't change so where the dollars coming out of in terms of investment. And then what are you seeing in terms of your trend line of productivity per unit as you think about your kind of multi-year waterfall model?

I mean 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 were written down [ph] on the original list if they weren't that we decided just to kind of simplify our focus and some of those projects are pushed into the latter part of years, therefore some of the capital will bleed over into fiscal 2018 some of the projects have been pushed completely to fiscal 2018. So some distribution investments, some IT investments less on the store side so our outlook for new store openings is consistent with what we will go forward, it was more on the IT and distribution side and really just kind of pushing the project out of that, and I think is probably 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 in very low thresholds. But we are taking a very long hard look at our store base. Our current footprint as well as plan new right now. And we’ll be rethinking that strategy to optimize productivity and performance over time.

I have a question on projects is just related to your mix of categories. I know it's been something you've been digging into more closely, it sounds like there may be color programs coming. So 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 that we're going to lead with that first always, 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're looking for an established line that has brand reference and credibility and we're in negotiations on that right now. So I think we’ll always be a hair first company, I think that is who we are and that's what our value proposition is. That being said, I think we can continue to bring new innovation those categories in hair care it's about the natural segment. And in hair color it looks like it'll be about a new color line.

Thank you. Best of luck.

Thank you very much.

And speakers I would like to turn it over to you for any closing comments.

Well, in summary I think its all clear that we had a very slow start to the fiscal year. But we believe we've 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.

Thank you. And ladies and gentlemen, today’s conference call will be available for replay after 12 PM today until midnight February 16. You may access the AT&T teleconference replay system by dialing 800-475-6701 and entering the access code of 146018, international participants may dial 320-365-3844. Those numbers once again 800-475-6701 or 320-365-3844 and enter the access code of 146018. 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.