Ladies and gentlemen, thank you for standing by and welcome to the fiscal 2017 second 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]. 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. 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 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 with reconciliations of its adjusting items and non-GAAP financial measures in its earnings press release on its website. With me on the call today are Chris Brickman, President and Chief Executive Officer and Don Grimes, 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 2017 second quarter earnings call. First, I will briefly provide an overview of our performance for the quarter, including the successful execution of the restructuring plan we announced last quarter and review progress on our strategic initiatives. Don will then discuss our second quarter results in more detail. Our financial results in the second quarter reflect our team's sharp focus on gross margin management and operating expense discipline, both of which enabled us to deliver solid mid-single digit growth in adjusted operating income and high single digit growth in adjusted earnings per share despite topline challenges. Store traffic in both of our core businesses was especially challenging in late January and the first three weeks of February. We believe that late tax refund checks and the administration change in Washington had a dampening effect on demand amongst some key target customer segments. However, sales and traffic rebounded significantly during the last five weeks of the quarter and April revenue performance was in line with our expectations going into Q3 and these results are reflected in the updated guidance that Don will review shortly. Last quarter, we announced our plan to restructure and reset our business. We recognized the need to right size our cost structure in light of the current retail environment. During the second quarter, we acted quickly to execute our restructuring plan and implement other cost savings initiatives to realize our goal to reduce operating expenses by more than $30 million this year. We believe all of these initiatives are on track. In our Sally U.S. business, to better align with a best-in-class retail model, we restructured the field organization and support center operations team. In the field organization, we expanded spans of control…

Thank you Chris and good morning everyone. We clearly recognize that we continue to operate in a challenging retail environment. Nevertheless, we are pleased with the execution of our restructuring plan in the second quarter as well as the team's implementation of cost reduction initiatives to drive additional efficiency gains across both segments of our business. We continue to believe the steps we are taking to run the business in a more efficient manner, along with the actions that Chris noted earlier to improve customer traffic in the back half of the year, will allow us to achieve solid growth in full year adjusted operating income and even higher growth in adjusted earnings per share. Turning to our detailed results for the second quarter. Consolidated revenue was $966.5 million, a decline of 1.4% versus the prior year period. The incremental sales from 140 new stores was more than offset by a 2% decline in same-store sales and a negative impact of the stronger U.S. dollar versus the British pound and Mexican peso. Foreign currency translation hurt reported revenue by approximately $10 million and reported revenue growth by approximately 1%. In addition, the quarter was impacted by one fewer selling day due to the prior year being a Leap Year, only partially offset by an additional day of selling due to the shift of this year's Easter holiday to April. The net result of these two calendar items negatively impacted same-store sales growth in the quarter by approximately 60 basis points. Gross margin in the quarter was 50.5%, an improvement of 80 basis points versus the prior year. The excellent gross margin performance was driven by both tactical and strategic pricing efforts, including an expansion of Sally's zone pricing initiatives that we have discussed in prior earnings calls, lower promotional activity…

[Operator Instructions]. And our first question will come from the line of Simeon Siegel with Nomura Instinet. Your line is open.

Great. Thanks. Good morning guys.

Good morning Simeon.

So Chris, obviously really nice gross margins. Can you talk about your view on the trade-off between discounts and comps, maybe going forward, your view on just the landscape in general? And then can you guys quantify any of those gross margin drivers for this quarter, maybe helping us to think about what would carry forward and maybe the further opportunity for pricing and vendor allowances? Thanks.

So that's a really big question. I am going to let Don handle the gross margin part. I think on the promotional piece, the reality is, we are always trying to strike the right balance between being promotional to drive short-term sales, but also then making sure we maximize gross profit. My guess is, we have probably dialed it back a little bit farther than we normally would in the quarter, but not a lot. And you may see us shift more to the middle going into the next two quarters. But the reality is, I think we will still get good gross margin expansion and I think a little bit of additional promotional activity will help us drive comps in the back half a little bit as well. Net net, I think the biggest message I would send is, we are not going to chase sales from a standpoint. We are really going to be very focused on profitable sales. That's our number one focus. And obviously that implies some gross margin expansion along the way and we are going to tightly control costs in this environment. And I think that's the right strategy for us. So we are trying to find the right balance. Both businesses, I think, probably pulled back a little too far, but not dramatically so. And Don, I don't know if you want to talk about the elements of gross margin.

In terms of the gross margin expansion, the benefits from pricing across the board within the Sally segment and the BSG segment and reduced promotional activity was about equal. Those were the two biggest drivers in terms of the gross margin expansion was across the entire company. And I would say the higher vendor allowances was a positive contributor but less meaningful contributor to gross margin than that of pricing or reduced promotional activity. And then the last part of your question was the outlook for that going forward. Clearly, we continue to try to exert the leverage that we have working with our vendors. But some of the vendor allowances are in fact driven by timing of inventory purchases. So there may be a little bit of volatility on that particular component to gross margin in quarters depending on when the inventory is purchased.

Got it. And then you mentioned the timing shifts impact on this quarter's sales. So are there any margin impacts to keep in mind?

Not really. None that I see. There is a little bit of additional pricing activity that happened late in the quarter, especially in our BSG business. So that may get full benefit, obviously in the next two quarters, but nothing significant.

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

Thanks Simeon.

Thank you. Our next question comes from the line of Rupesh Parikh with Oppenheimer. Your line is open.

Good morning and thanks for taking my question. So maybe Chris, just to start off with the promotional environment. As we look around you, Walgreens has been more promotional with these Buy 2 Get 1 Free promotions. Ulta is running the same type of promotions. So just curious, as you guys look out there, how do you characterize their promotional environment?

Well, listen, I think we would all characterize retail and general as a challenging environment and retailers in a challenging environment are resorting to more promotional activity. So I think we all would admit that's true. That being said, we have a fairly unique offer that we provide customers. And I don't think we are quite as exposed to it as others. But we are also trying to find always the right balance between the promotions that prompt an additional visit versus capturing more gross margin. I think, again, that message that we are not going to chase sales is the message we would want to convey today. We want to focus on profitable sales. And that will have some impact but overall I think we are well positioned as we go to the back half.

Great. And then from a category perspective, clearly we have seen weakening categories in many CPG categories lately. So just curious, as you look on the Sally side and on the professional side, what are you seeing from a category growth perspective at least, I guess, during Q1?

You mean in our big categories or total categories?

I guess, your bigger hair care, hair color. Just curious if there's been a deceleration there during Q1.

Yes. I mean, obviously, all categories took a little bit of a hit there, especially during that four or five week period where it seemed like there was a real change in consumer behavior that then normalized as we finished the quarter. What I would say is, the categories that continue to suffer the most for us is electricals. That one's been down quite a bit in the category on the BSG bets and the Sally side. On the BSG side, interestingly enough, it's the promotional bundles category. And this is a little bit of a self-inflicted wound that we are fixing now. What happens with professional bundles is, you buy a unique bundle of products that cannot be broken down and put back on the shelf. So if you overbuy in that category, you end up having to sell it at a deep discount through alternative channels, usually through our shows. We cut back on that pretty dramatically to try and control inventory and capture margin. We probably pushed that lever too far. As a result, we took some of our sales out that were good sales that drove incremental purchases and we are going to be fixing that. The team's already has been working on it. We will be fixing that in the next two quarters. So that's actually the biggest category in BSG that's suffering. The core categories are doing quite well.

And I will add to that. Chris was talking about some of the big categories that have struggled. Within the Sally business in the U.S. and Canada, the multicultural category was up high single digits in the quarter. That's kind of continuation of a very positive trend that we have experienced recently and we are going to continue to capitalize on that with additional brands as well as possibly additional shelf space in the stores. And within BSG, hair care and hair color was up mid single digits, each of those two categories. So there are some bright spots in the different category performance.

Okay. Great. Thank you.

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

Great. Good morning. Thanks for taking the question. And nice progress on your margin initiatives. I wanted to dig into the comps a little bit. Are you seeing a bigger picture? What gives you the confidence that the approximately flat comps are achievable this year? Comparisons do ease and there are some timing shifts that clearly impacted Q2. But the guidance would still imply that back half acceleration on a one and two year basis at both divisions. So just curious, what you are embedding from a traffic perspective to get there? And any color you can provide on the comp run rate you were seeing in March and April would be great.

Yes, I can't go into detail on March and April other than to say it was significantly better than what we experienced in February. That being said, if we segment the businesses, so BSG, not only do we no longer have to lap the 7% plus comps that we saw in the first half of fiscal 2016. So the comps we are lapping are much slower. In addition, there is some great innovation that hit late in the quarter for BSG, especially the Guy Tang #mydentity line, but also ColorProof and Babe Lash. So some terrific innovation that's hitting our stores very late last quarter. So we will get the full benefit of it as we get into the back half of the year. And then finally, there is fixing some of the big drag on BSG comps so far this year, which is the promotional category and the team has been working hard on that and I expect we will make some progress on that. So all three of those things make us feel pretty buoyant about BSG. On the Sally side, again I think the reality is, I think we can readjust our promotional strategy and make sure we got very great value messages out there in a competitive market. We probably reined that in too far during this quarter and you will see us be a little more aggressive with that going into next quarter while still achieving a gross margin expansion. In addition, we have got some additional pricing activity that will help. Obviously, it help on both the margin and the comp line to a certain extent. And finally, there's some good innovation we are looking at late in the year. So overall, it feels like the right pieces are in place to drive comp improvement and obviously, also the rest of the P&L in terms of gross margin expansion and good cost control leads us to be fairly excited about where we are positioned.

That's very helpful. Thank you. And following up on your last comment there, just on SG&A, I think that compared favorably to most of our models because when you look at that for the rest of the year, would you expect dollar growth to remain in negative territory? And looking forward, how should we think about the normalized growth rate in SG&A once these cost savings are fully realized? I mean, do you think you can leverage on a flattish comp?

Leveraging on a flattish comp? Then we are going to get full year benefits on the restructuring plan in fiscal 2018 compared to partial year benefit in fiscal 2017, but I will say some of that gain, I think, we will look to reinvest in some areas that need to be incrementally invested in, in particular, e-com. But I would say that delivering leverage on flat comps would be, I am not saying that we can easily do that, but going to the first part of your question, SG&A year-to-date as a percent of sales is 34.6%. We guided full year of 34.1% to 34.3%. So that suggests, obviously, back half SG&A as a percent of sales of lower than 34.1% to 34.3% to get to that range clearly, getting more benefits on the restructuring plan kicking in, in Q3 and Q4 versus the $1.5 million of benefits that we have realized in Q2, which was only a partial quarter, obviously. So we are driving hard to run the company as efficiently as we can, yet also realizing that we have to make investments where investments are needed but clearly, looking for opportunities to get rid of extraneous SG&A.

Thank you. And best of luck.

Thank you.

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

Thanks. Good morning guys. I may have missed some of the prepared remarks and I just heard your answer, Chris, on March and April. Can I ask if you clarified if the bounce back, was it evenly distributed among the divisions? Or was it one division? Did one division bounce back more than the other?

No. Both divisions bounced back. They both suffered a downturn in February and both bounced back in March.

Got it. Okay. And then can you talk about, it goes towards the confidence you have in the pickup. Can you talk about the test of the new loyalty program? How long, if any length of time, it's been in place? And then any other top line drivers? You mentioned new brands. I have on my sheet here, social media influencers. Anything else that you believe you are starting to gain traction as it relates to traffic driving?

Yes. I think the loyalty program is a little too early for us to extrapolate anything. The reality is it's three weeks in the market. We are in approximately 50 stores now. We will be increasing that to 300 stores over the coming weeks and then we have got to give it some time. Now the great news is, all the feedback we are getting from customers is very positive. The few potential things we could improve on, we are fixing. And we are seeing a nice conversion, nice pickup, all the data we want to see. We have got to see that in 300 stores for a period of time before we make a decision to roll it out. But certainly, the start feels pretty good. In terms of the things that make us a little more excited about the back half and this is a little redundant, but let me hit them again, is simply that first of all, with BSG, this Category Y, which is our promotional category, this was the category where we have had the biggest drag year-over-year on sales within the BSG business. We clearly overcorrected in terms of cutting back our purchases of that inventory to sell through and there was a good reason why. We didn't want to overbuy that category and then have to break it down and take a margin hit clearing it out. That being said, we went too far. So you will be seeing us add that category back. It's a pretty simple add. We have got some great innovation that just hit BSG and then we have got some pricing activity that just hit BSG in March. And on the Sally side, you have got some of the same things, where we probably overcorrected on some of the promotional activity. I think we will find a better balance there. We pulled back a little too far and we will extend that out and have clear and more robust value messages in the next two quarters. In addition to that, we have got some innovation coming and finally we have got some pricing activity coming. So all of those things make us feel pretty comfortable that there's an opportunity to outperform on revenue versus the first half of the year.

And the items in which there's prices maybe going up a little? Are you pleased with the impact on the volume? And has volume suffered as a result of any other price lifts?

Interestingly enough, it's a combination of things. It's zone pricing as well as the tactical pricing by unit and we continue to track it very closely. Obviously, we have been pretty methodical about this, right? We went up less than 1% in total last year and my guess is, we are in the same range this year. So we are not jumping and leaping to huge price increases. We are trying to be very methodical about it. We are tracking the results. Everything says we make more money doing this than not. So we will continue to do it as long as that's true.

And I would say, we have some great new analytical tools that the business unit finance teams are using to kind of track and monitor incremental gross profit delivery, trading off pricing and volume. So the goal is to drive incremental gross profit and if that comes via pricing, then so be it.

Great. Thanks guys.

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

Hi. Good morning guys.

Good morning.

This is Lauren Frasch, on for Ike Boruchow. I just wanted to dig a little more into vendor allowances.

Sure.

I know last quarter they were actually a headwind and this quarter a tailwind. So it seems like it's a little volatile. How are you guys able to project that out going forward? Thanks.

Well, you are right. As I have said in response to an earlier question, there is some volatility or spikiness to vendor allowances that are driven specifically by inventory purchases. But there are a range of vendor contributions that we include in the bucket called vendor allowances, so things that we will negotiate for special deals on certain categories or certain brands. So when you ask the question which is, how we project it? The answer is very carefully, which is kind of dig into expected inventory purchases and anticipated vendor negotiations over the next six months and then drop it into the forecasted P&L into the particular month or quarter in which we think we would record it. So there's a lot of work behind the scenes that go into rolling up to a vendor allowance number and a forecast or actually what we record in a given quarter. So they are probably, when I look at the decomposition of a vendor invoice, there are probably four or five line items on there that would have to be a co-op contribution to advertising or kind of a reduction in cost of sales. So it's a pretty, I think, complicated process. It's not like putting the man on the moon, but there are a lot of moving pieces to it.

Great. Thanks so much. I just had one more question about your lower footage guidance. Is this primarily coming from Sally Beauty?

Lower what?

The lower footage guidance.

Lower number of new stores.

I am sorry. Probably just proportionally weighted towards the Sally Beauty segment. Yes, that's a fair statement.

Great. Thank you so much.

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

Hi everyone. It's Courtney Willson, on for Oliver today. Kind of along the same lines as the prior question, on the store opening strategy, can you update us a bit on your strategy here just given what we have seen with anchor store closures in malls? I know you are in primarily strip centers. But has this impacted your thoughts at all in terms of store expansion over the long term? And then along those lines, as you consider your own e-com business, is there any update to how you are thinking about this channel? Thanks so much.

Yes. Courtney, I think, yes, clearly, it's impacted our thinking, especially on the Sally side. The reality is that as we look at it, as I have mentioned before, we don't have a lot of money-losing stores. So we don't have a big bottom 10% that we can just lop off. We do have markets where we probably opened too many stores and we have stores that are breakeven or just barely profitable, where if they close, some of those sales would go back to other stores and the net result is we would make money in the marketplace. And we are looking very hard at those scenarios for next year. I don't think it's unlikely to think that Sally could be flat to slightly declining in terms of total store count next year. As we identify those opportunities with them having a few new opportunities, we might want to open as well. But we are clearly setting the threshold higher and we are digging in to make sure that if there are markets where we would make more money with fewer stores, then we take advantage of those opportunities. I don't think it's going to be lots and lots of stores, but there are unique opportunities that we believe exist and we are going to be working on those next year. And remind me what the second part of your question was? I know, it's e-commerce. Well, I think the next thing I would say is, first of all, we just hired a terrific new head of our e-commerce business. So I am very excited about him getting going. My guess is we will be making some additional investments in the team around him. And it will be a focus and a priority for us next year, both in our core e-commerce business as well as some partnerships we are pursuing in that area. So I am excited about it. I think it's an area of investment that we will be focused more on as we go into the coming years.

Great. Thanks for all the detail.

You bet, Courtney.

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

Okay. Thanks. Good morning guys. Two questions. I guess one, just talking about the restructuring and the cost cutting on the SG&A line. How often do you guys benchmark your SG&A structure versus some of your other competitors out there? I would say, retailers have focused more on the low-end consumer and I do know that in the SG&A, you do have some of the BSG kind of compensation. But I was just wondering, have you taken kind of a broader look at how much more could come out of the SG&A just on a corporate wide basis.

Well, we don't benchmark it every month or even every quarter, but in my four plus months as CFO, I have seen some benchmarking analytics of us versus other specialty retailers on multiple line items on the P&L. And if you focus on just SG&A, unfortunately there is not consistency across all retailers in terms of what goes into cost of sales and what goes into SG&A. We tend to have fewer costs in cost of sales and more in SG&A. So our SG&A looks high and we look like we are fat compared to others. So when you look at the operating margin, we tend to fare fairly well, kind of in the top quartile, if you will. Having said that, that does not mean there aren't additional opportunities to drive the company towards greater efficiency. The restructuring plan that we did that was expanded with this morning's announcement, slightly expanded. And the discretionary SG&A reduction that we talked about in the last earnings call, so we are talking about $30 million plus coming out of what would have had been planned SG&A in fiscal 2017. Clearly, opportunities to look harder and look deeper, but most of the additional SG&A reductions we had beyond the restructuring plan were really open positions, just not filling those. In my comment to Chris and others, if we have been able to get by eight or nine months without filling those open positions, in my mind, those are positions that may need to stay open permanently, if you will. But there will be some rearrangement of the furniture on the deck, if you will. But we are going to continue to look for ways to, there are certain things that are impacted by inflation that we can't control. But those things that are going up at some rate of inflation, we have to look to cover that via efficiencies elsewhere. So it's an ongoing process and we are not ignorant of what's going on within our specialty retail competitive peers. And it's something that we do think about and look at on a regular basis.

Okay. Because one thing, I mean, clearly, you guys have among the best operating margins, especially on the Sally side in specialty retail. So just trying to think about, I mean, I think your peak was probably 20% or even above that. Couple of years ago, you were in the 17%-ish range. So just wondering how you guys think about, if there is room to kind of get back to those peak levels and obviously, a lot of it is predicated on the sales coming back. And just wondering if you can give a little bit of context into how you think about your operating structure right now versus where it potentially could go, since it's very, very good to begin with?

I think, Jay, if I can take this one. I think the reality is that we have a combination of an intense focus on cost control that is, everybody in the company has gotten that. We recognized it's going to be a tough environment and we are prepared for that. So I don't want anybody to think that we have suddenly stopped looking for additional cost savings or restructuring opportunities. We have not. That being said, we also recognize we have a few investments we need to make, whether that be loyalty on the Sally side or some IT investments across our organization or e-commerce investments in both businesses. And one of these we are really pushing the team on is, rather than make those investments incremental, let's redeploy and let's work really hard to redeploy investments towards those opportunities. And it's an evolving process. We work on it every day. All I can say is, we are intensely focused on it and we believe we are going to have to keep our SG&A as low as possible in order to compete in the market that's going to be a little tougher here for the next 18 months.

Related to the underinvestment, I was in a meeting with an investor of ours about six weeks ago and he said, we realize that for a handful of years, you guys underinvested and overearned. And so that phrase kind of stuck with me, particularly the overearned part. And so the 20% operating margin that you are referring to, I am not saying we can't get back there and aren't striving to get back there, but the decline in the operating margin for the Sally segment, for example, is making some necessary catch-up investments that we think are the right thing to do and not doing so would be irresponsible. Obviously, with improved top line performance, we can claw our way back closer to that historically high operating margin.

Okay. And then if I can just squeeze one last in. Chris, can you just talk maybe a little bit about what's going on in the professional product? I mean, we saw your biggest competitor out there not have a great quarter out there. I am just wondering from an inventory perspective, maybe just looking, whether it's the wholesale business of BSG, you have confidence in the back half of the year. But is there a lot of inventory out there? Are you seeing slowdown at salons? What do you think caused, I guess, some of that slowdown that we saw from and BSG went up against a tough comp, but your other competitor out there talked about some softer trends as well. So just wondering if you can give a lay of the land of what you are seeing in the retail environment?

Well, we did see the similar slowdown in our professional business, our wholesale business between late January and late February that we saw on the retail side. And I am not going to try and get into the mind of a stylist and understand why. But the reality is, I think there was some slowdown in probably consumer take-through as well as some slowdown in what stylists were inspired to do as well and the risk they wanted to take both in purchasing and reselling product. But that being said, it bounced back pretty well in March. And if you look at the core, as Don mentioned earlier, the core categories in BSG are doing quite well. Color and care is doing quite well. I think the more interesting issue here is, we did have this category, promotional category, where we probably shot ourselves in the foot a little bit. And we have got to fix that, because that drives some incremental purchases in sales at store level and that's been a significant negative drag. I mean, that category is down dramatically year-over-year and we have got to fix that going into the next two quarters. I know the team's intently focused on it, but we have got to fix that.

Okay. Thank you. I appreciate it.

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

Hi. Good morning guys. Thanks for taking my question.

Good morning.

So I guess, I just want to step back a little bit here. With Sally Beauty's comp being one of the weakest comps we have seen in quite some time and if we put that in the broader context of the overall retail environment, whether that's Amazon or your competitors investing in one of the categories, I guess, how do we get comfort even beyond the back half of the year with your ability to really drive improvement in comps? What are the initiatives if you could rank them for us to really get comfort in longer term growth?

Yes. I get your concern. It makes sense to me. I think there's a couple of things I would point to. First of all, I really do see the four or five week period that happened in this quarter as a bit of an anomaly. And whether it's due to late refund checks or whether it's due to an administration change in Washington, I don't want to try and conjecture how all this happened, but there was an anomaly in purchases that occurred and it occurred across many retailers, including us. So I don't think we are going to repeat that as we go into the back half of the year. I certainly hope we don't. Beyond that, I think there are some categories in Sally that are doing quite well, especially the multicultural category and some of our core categories and a few that have been weaker. And I think you are going to start to see those level out. We have got some good pricing activity in Sally that's going through, that we will be testing. And then in addition, we have got some new brands that are coming in. And finally, I think the biggest lever is, I think we, in Sally, missed the mark a bit in our promotional work that we did in January and February. We didn't have a clear value message at a time when retailers were struggling and fighting. We didn't turn that into offers to specific customers as quickly and as effectively as we needed to. We started to fix some of that in March, April and we have seen an upturn in sales. I think we can do that without significantly hurting our margins. But the reality is, I don't think we delivered on having strong promotional messages that drove action from our customers during a couple of those months and we will be correcting that in the back half of the year. So those are the pieces that I think lead me to believe the back half looks better than the first half. We will be continuing to focus on controlling our costs to make sure that whatever develops we will be ready for it and we will make sure that we are expanding our gross margins wherever we can to make sure that more money is flowing through the bottom line.

And the medium to long term outlook or the more positive outlook is driven probably by our view on the loyalty program in terms of what we can bake into it.

And if we could actually dig into that a little bit, I mean, how is that breakdown, how are the BCC customers behaving? And what is the funnel of new customers coming in? What is that looking like in Q2 and then as we look out to the back half of the year and beyond?

Well, three weeks into it, I am not going to throw that much into it. If you think about, are you specifically talking about the loyalty program?

I am just talking about your BCC customer growth and prospects for new customers coming in.

Yes. Here's what I would say. The biggest drag on Sally comp is the pro customer moving over and buying in the pro channel. And that's been a significant negative drag on Sally comps. My guess is, some of that's going to keep happening for a while and then slow down as it levels off, because there are a set of pro customers who are always going to buy at Sally, both because it's very convenient. In many cases, their salons are sitting in the same shopping mall 20 or 30 feet down from where the Sally store is. And in addition to that, there's some who are very attached to the color lines that Sally sells and those tend to be older pros that have been in business long time, but they will still continue to buy from Sally. So I think you are going to see eventually a leveling off of the movement of the pro customer from Sally over to the pro channel. And I think in addition to that, our expectation is the loyalty program is the big breakthrough or the redesign of that program, in terms of us expanding our BCC membership over time. Because if we can suddenly move to a free program that allows them to participate and be inspired by that program and drive traffic, we can sign a whole bunch of more people up to the program and then market to that consumer base much more efficiently than if we have to try and use media channels that obviously we don't control. So talking within our own community of e-mailable customers is a much better strategy for us over time. And that's what the redesign of our loyalty program is designed to do. I think it's a big game changer for us. The team's done an excellent job of defining the value proposition, but we have got to test it before we roll it out.

All right. Thank you guys.

Thank you. Next we will go to the line of Joe Altobello with Raymond James. Your line is open.

Thanks guys. Good morning.

Hi. Joe.

So first question, I guess, since we are talking about the loyalty program, I will start there and I apologize if I missed this. Did you guys give the contactability number in terms of your loyalty members this quarter versus last quarter?

Yes. We did not. It is slightly up. I think there are a set of customers within the current program where it's a pay program who are proving a little harder to push. So we moved it up quickly between October and now in the first quarter. It's moved up a little bit slower in the second quarter. My view is the loyalty is the way to really expand contactability in a radical way and we expect to do that. What we are offering, it's really interesting, Joe, when the consumer walks into the store with their old program and shifts over to the new program, they actually get to pick out a free product of their choice as they do that as long as they offer their e-mail address and sign into the new program. That is working really well. And obviously that's just in the pilot stores, but it's working really well. So we see the big breakthrough long term of how to get our contactability up is to launch the new loyalty program.

Okay. Understood. And then just shifting gears a little bit to the trend improvement you guys saw, it sounds like in both BSG and Sally in March and April, how much of that was your tweaking of the trade promotion? And how much do you think, at least for the month of April, was just better weather versus last year?

I don't see a whole lot of weather difference. I think most of it was, there was a moment of shock, I think, as you had a new administration and then obviously compounded by the late refund checks. I think that's the biggest driver of what happened here in February. We did tweak the promotional work a little bit in March and more of it will happen in April and May. But I don't think that's the biggest driver, especially in BSG. BSG couldn't react that quick on a promotional product because these are bundled products that have to be bought through and then flown through the supply chain. So they could not react that fast. So I would say, there was some benefit to the promotional changes in the Sally business, not much in the BSG business. You will see more of that in the back half of the year.

I would say, there was kind of a malaise in retail. And I am not saying that I think that you don't already know. But in January and February, the weekly retail traffic metrics that we were looking at were just dismal. And that was kind of reflected in some of the results we were seeing in our own business. And then I think the improvement in March and April and I don't want to pat ourselves on the back too much, but I think that was driven in part by what we did in terms of a more focused promotional strategy, but also, I think, some of that malaise lifted and people kind of got back to shopping again. So it was a combination of, it's hard to quantify how much of it was stuff we did versus the environment getting better, but it was clearly a combination of the two and maybe there was some weather impact in April. I don't recall what the weather was last April.

I don't remember a big difference.

Okay. Great. Just one last one, I guess, for Don. You said you got, it was $1.5 million of restructuring savings in the second quarter. How much of the $20 million of belt tightening this year have you guys realized so far?

That would be kind of pro rata. So when we talked about that at the end of Q1, I think it would be fair to say that $20 million would be kind of pro rata over the remaining three quarters. We didn't really try to quantify that.

It might have been a little bit less in Q2.

Maybe it was because we started kind of in January, but not by much.

Okay. Great. Thank you guys.

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

Hi guys. This is Chris Carey, on for Olivia. Similar question to what has been asked, but can you just talk about the balance of same store sales growth versus gross margins? Because obviously, you are expecting an improvement in same store sales in the second half and gross margin expansion even though the gross margin comps are tougher and you are doing more promotions and if anything, competition is becoming more promotional. So if you can just talk about the balance between using promos to drive sales while also preserving gross margins both in the near and longer term.

Yes. I think we stated a couple of times here that we are not going to chase sales. So we are focused on profitable sales and profitable incremental sales. So I think we have probably pulled the pendulum too far, especially in January and February, where we pulled too far back on our promotional efforts both in our BSG business and our Sally business, very different programs. In the BSG business, we under bought bundled promotional items that then sell through with the support of a vendor. And we under bought that because we wanted to not have excess inventory left over from promotions that had to go then into discount channels. Now we are trying to get that more balanced in terms of how much we buy so that we have something that is incremental to sell, that spurs demand in the BSG stores, but that also doesn't create a whole bunch of inventory that has to be sold off through discount channels. And I think we will reach more of an equilibrium there in the back half. In the Sally business, it really came down to not having clear value messages that drove a call to action for customers. We got a little bit too focused on some of the brand messages and not the value messages, while our competitors are obviously moving towards value messages as you have seen. And again, it's not an all or nothing. We are going to be putting that more into equilibrium in the back half and obviously we will use some of the pricing activity to make up some of the margin that we will have to give away to do that. So we continue to expect margin expansion, not as much perhaps as we got in this quarter, but margin expansion. But we think we will get a little bit better pickup in terms of sales.

Yes. Our year-to-date gross margins, as I mentioned earlier, is up 20 basis points over the prior year. We are guiding to full year of 20 to 30 basis points of gross margin expansion. So clearly, we are not forecasting gross margin expansion in Q3 or Q4 similar to what we experienced in Q2, even though we are going to get the benefits of some pricing initiatives, particularly in the BSG business. So I think you can do the math and say, okay, if we are going to get benefit of pricing on gross margin versus Q2, perhaps there's going to be some additional promotional activity that would kind of counterbalance that. And on the topline, I don't want to kind of hang our hat on just the comps get easier, but the reality is that's the math. I mean, we comped kind of plus 4% in the first half of last year and then comps decelerated to plus 2.5% in Q3 and plus 1% and change in Q4. So clearly, the comps do get easier and that will help our reported comps in the second half of the year.

Okay. Thanks. One follow-up. How do you set your product portfolio? Do you think you are in the right categories? Do you think you have exposure to the categories that are currently seeing growth in the broader industry? Or do you think there's an opportunity to change the mix going forward in order to capture some of that higher growth elsewhere? Thanks.

Well listen, I think there are opportunities for us to get better. We have been looking hard at productivities of our store across kind of gross margin and sales dollars per square foot by category. There are clearly opportunities for us to, it's not that we are not in the right categories, it's whether we can shift more focus. As an example, should we have more focus in the Sally store in the multicultural category or on cosmetics and perhaps a little bit less in skincare and some others. We are working on those changes right now and we have got some plans in the works to do that. In our BSG store, we are thinking about where we do have a clear right to win and where don't we. So I think there's going to be some shifts that happen more on an evolutionary basis. It's not going to be radical, but I think you will see an evolutionary shift in our category focus as we get better at understanding our productivity per square foot.

Got it. Thank you.

Thank you.

Thank you. And we have time for one final question. That will be from the line of William Reuter with Bank of America. Your line is open. Q - Janani Ganta Good morning. This is Janani, on for Bill today. Thanks for taking our questions. So first, we are wondering, do you have a leverage goal that you are targeting either for this year or in the longer run?

We are comfortable with where our leverage has been kind of in the 2.6 to 2.8 range. Clearly, if there are opportunities to use our borrowing capacity in a different way, we could be comfortable going a little bit above that. But there is not a theoretical max necessarily. There is a practical max, but there's not a line in the sand that we have drawn as a company. We had this discussion last week with our Board of Directors regarding what level of leverage we would be comfortable with. But in that 2.6, 2.8 range, floating up maybe close to 3.0, we certainly would be comfortable and feel like we have more than sufficient cash flow to handle that level of leverage.

And earlier in the Q&A, you mentioned you are looking to reinvest in certain areas of the business, such as e-commerce. Could you just provide a bit more detail as to what some of those investments you are looking to do might be? And as a follow-up, can you talk about how your e-commerce business performed in the current quarter relative to your expectations?

I will start with the first piece. I think clearly, loyalty is a big one. That's an area where we will be investing over the next year, year-and-a-half. E-commerce and growth in our e-commerce business is one we will be investing in. On the BSG side, I think building out our CRM capabilities and our app will be big investments for us as well as some new delivery options and other ways is to search stylists better. So there are a set of areas where you will see us invest to allow us to build a bigger moat around our business and also to make sure that we are building our core customer base so that we can market to them more efficiently and effectively.

I think more specific to e-com, as Chris mentioned earlier, we just hired a new leader that we are excited about. And I think we need to build a more robust team around him, which we will look to do, clearly as we move into fiscal 2018. And I think some additional marketing investments, specifically to drive traffic to the West side and whether it's affiliate marketing or remarketing investments, there are a number of areas which I am sure our new leaders will have some great ideas about how we can incrementally invest. And going to your last question, the e-com performance in the quarter was mixed. It was kind of mid single digit revenue growth, which is growth and is better than how the stores performed, but it's not at the level that we expect and what we need in order for it to be a more meaningful part of the business. So that's where we have to get better and we intend to do so in fiscal 2018 and beyond.

And then lastly for me. You talked about how you felt as though you under bought some of your bundled promotional items in the BSG segment. However, inventory was up year-over-year in the quarter. So I guess, I am wondering how you feel about current inventory levels? And do you expect them to continue to be up throughout the year?

I mean, the $16 million increase in inventory. We had 140 more stores this year than last year. We factored that and we did a relatively small acquisition on the BSG side. That contributed more than 100% of the inventory increase. On the flip side, we did have benefit of a stronger dollar on reported inventory levels. But it's a big investment of cash. It's over $900 million tied up in inventory. So we have regular meetings with each of the two businesses and their finance leaders on key performance indicators as it relates to inventory. And everyone is clearly aware that fewer dollars invested in inventory is more dollars we have available to invest in other areas. And everyone's incentive comp has a measure of net working capital as a percent of sales. So the teams are motivated to manage inventories as low as theoretically possible. However, I am fond of saying, you can't sell from an empty cart. So we don't want to have the empty spots on the shelf in the stores. So it's a balancing act clearly.

Okay. Thanks so much.

And if I could just summarize. In the fiscal second quarter, we made significant progress executing our planned restructuring and our most important strategic initiatives. The team remains focused on evolving our business model to better meet the needs of our customers and create value for our shareholders. Most importantly, we believe the business is well positioned for the back half of 2017 with an improving top line outlook, gross margin expansion and disciplined cost control. I would like to thank everyone for joining us today.

Thank you. And ladies and gentlemen, today's conference call will be available for replay after 9:30 A.M. today until midnight, May 19. You may access the AT&T TeleConference Replay System by dialing 1-(800)-475-6701 and entering the access code of 422878. International participants may dial (320)-365-3844. Those numbers once again, 1-(800)-475-6701 or (320)-365-3844 and enter the access code of 422878. That does conclude your conference call for today. Thank you for your participation and for using the AT&T Executive TeleConference Service. You may now disconnect.