Sally Beauty Holdings, Inc. (SBH) Q1 2021 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Sally Beauty Holdings Fiscal 2021 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 Mr. Jeff Harkins. Please go ahead.

Thank you. Good morning, everyone, and welcome to the Sally Beauty Holdings First Quarter Earnings Conference Call. With me on the call today are Chris Brickman, President and Chief Executive Officer; and Marlo Cormier, Chief Financial Officer. Before we start, I want to remind everyone that we have made a presentation available for today's call, that can be viewed from the link provided on our investor site at sallybeautyholdings.com/investorrelations. I would also like to remind you that management’s remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements, as a result of various important factors, including those discussed in the risk factor section of our most recent annual report on form 10-K, and other filings with the Securities Exchange Commission. Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligations to update them. 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. Now, I'd like to turn the call over to Chris to begin the formal remarks.

Thank you, Jeff, and good morning, everyone. We hope that you are all safe and well. At SBH, we are fortunate to have an incredible community of team members, customers, and partners, that continue to help us navigate this dynamic environment. In the first quarter, our associates across the organization, delivered strong execution, despite the ongoing challenges of the pandemic. During a time of significant retail disruption, they remained focused on safely serving our customers, and continued to implement the key initiatives we outlined on our year-end earnings call in November. This allowed us to deliver strong gross margins, profitability, and cash flow, despite topline headwinds caused by the pandemic. Indeed, for much of the quarter, especially in the latter weeks, we were operating against the backdrop of temporary store closures, capacity restrictions, salon shutdowns, and an acceleration in COVID rates, that most certainly impacted traffic in our open locations. As a result, enterprise same-store sales declined 3.7%. For added perspective, at the end of the quarter, approximately 45% of our store locations were under some level of capacity restriction or closure across the globe. During the quarter, we saw ongoing strength in hair color, which is our chief recruitment vehicle for new customers, both for the retail consumer, and the professional stylist. Hair care is closely linked to color, while other categories like nails, skin, and wax, are incremental and drive additions to the basket. Despite the topline disruptions, hair color was up 19% at Sally US and Canada. In addition, vivid colors remained on trend and delivered another quarter of strong performance of approximately 50% at Sally US and Canada over the prior year. In Q1, vivids accounted for 25% of our total color sales, and they continue to attract a new and younger customer to our stores. Finally, nails were up 7% at Sally US and Canada, and salon supplies were up over 50% at BSG, compared to the prior year. Although we were operating under challenging circumstances, our expanded digital capabilities enabled us to serve our customers through multiple fulfillment options. These include buy online, pickup in store, curbside pickup, and ship-from-store at Sally Beauty, and same-day delivery and curbside pickup at BSG stores. Additionally, our e-commerce business achieved strong growth, up 48% versus a year ago. Despite the external pressures of the macro environment, our teams also did an excellent job on margin and expense control, which resulted in first quarter adjusted EPS of $0.50, up 6% on a year-on-year basis. We ended the quarter with inventories down 10% compared to the prior year, and approximately $538 billion of cash on the balance sheet. Subsequent to the close of the quarter, we made the strategic decision to repay the outstanding balance on our fixed rate term loan, making further progress towards deleveraging our balance sheet. More on this from Marlo later in the call. As we reflect back on the investments we've made, and the hard work of our teams over the past three and a half years, today, we have a business that is well positioned from a strategic operational and financial perspective. During our successful transformation journey, we accomplished a number of objectives that set us up to scale over the long term. One, we refocused the business on owning professional hair color and care for both the DIY enthusiast and the professional stylist. Two, we improved our retail fundamentals. Three, we advanced our digital commerce capabilities. Four, we modernized our supply chain. Five, we improved the shopping experience, both in-store and online. And six, we strengthened our retail leadership team. Today, we are executing against a well-defined operating strategy and growth plan. In fiscal 2021, we are focusing on three major priorities. By the end of the year, we expect to have completed the key elements of our transformation, including the full implementation of JDA, and the replatforming of our BSG e-commerce site. Second, we expect to be leveraging all of our new capabilities and tools in service of our mission to recruit and retain color customers. And third, we expect to further reduce our debt leverage ratio closer to our target of 2.5. From a tactical perspective, in fiscal 2021, our teams are working to optimize the transformation investments we've made, and unlock more robust functionality across retail fundamentals, digital commerce, and supply chain. Let me take you through our key initiatives. First is our expanded delivery service model. As I mentioned earlier, our new capabilities are enabling us to serve our customers with multiple fulfillment options, which we believe will ultimately foster greater customer loyalty and stickiness. It's early days, but adoption rates are growing fast. For example, at Sally US and Canada, BOPIS accounted for 11% of our e-commerce sales for the quarter, after launching nationwide in November. And BOPIS sales surpassed 20% of our e-commerce sales for the month of December, while ship-from-store represented 31% of our e-commerce sales during the quarter. On the BSG side, same-day delivery is adding tremendous value to our professional stylists, by providing them with the flexibility to quickly react to the needs of their customers, and adeptly manage their business. In the second half, we'll be adding the rollout of both the BSG segment, providing another element of convenience for our stylists. The second initiative is replatforming the BSG digital storefront, which is on track for completion in early Q3. This new, more robust platform, will enable deeper and more effective digital engagement with our stylists, as we move along the customer funnel, from recruitment to transaction. The digital journey begins with a focus on education, innovation, and tools that enable them to more effectively and profitably run their business, including features like product reorders, easy bulk orders, simplified tax reporting, and navigation enhancements. Turning now to our third area of focus, loyalty and CRM. We are rapidly gaining traction on the rollout of our private label rewards credit card to both Sally and BSG customers in the US. At the end of the first quarter, we had 163,000 cardholders, and our rewards card accounted for 2% of sales in the Sally segment, and 5% in the BSG segment. We're capturing critical insights into customer needs and purchasing behavior, and expect this program to grow significantly in the coming months and quarters. In addition, we have bolstered our marketing team in recent months, and now have the talent to exploit this data and utilize CRM to develop highly targeted digital programs, and strengthen the connected shopping experience across marketing, commerce, and service. We expect loyalty to become another critical differentiator for SBH, and something that further expands our competitive moat. The fourth key initiative for fiscal 2021 is completing the rollout of JDA, our new merchandising and supply chain platform. Both JDA and our new North Texas distribution center, are running smoothly in the initial months, and our teams are working to bring JDA to our remaining DCs in the latter part of this year. This will be a significant milestone, as it represents the final step in our multi-year transformation journey. Through our thoughtful investments and strategic repositioning over the past three to four years, we have evolved SBH into a market leader, with a solid infrastructure and robust digital capabilities that position us to own professional hair color and care. Underlying this is our continued focus on generating strong profitability and cash flow, and returning value to shareholders. There is certainly more work to do, as we shift from the heavy lifting of our transformation, to a new phase of growth that will see us optimize and drive scale. We believe our ability to generate strong cash flow, carefully manage inventories, and prudently control discretionary spending, will allow us to continue to strategically invest in capabilities, tools, and themes, in support of our mission, to recruit and retain color customers. As we move through the first half of fiscal 2021, it is clear that the environment will continue to be choppy, creating additional topline headwinds, at least in the near-term. Today, we are operating under mandated store closures in Europe, Canada, and Latin America, capacity restrictions in several domestic markets, and reduced capacity at salons in California, which were closed for most of January. Because these disruptions are continuing, and there is still a great deal of uncertainty related to potential restrictions going forward, we expect net sales to decline in our second fiscal quarter, softening modestly from Q1 levels. During this time, we are remaining agile, and our teams are running the business with operational and financial rigor, to preserve profitability and prudently manage cash. Most importantly, with our transformation journey nearing completion, we feel highly confident in our competitive positioning, the strong foundation we've built, and the capabilities we've established, and the ability of our teams to execute. In short, we believe SBH is positioned for a return to consistent topline growth when pandemic headwinds abate. Before turning the call to Marlo, I want to express my appreciation to all of our team members and associates around the globe for playing an important role in our successful transformation, and continuing to work tirelessly in service of our customers, as we navigate the dynamic COVID environment. I also want to say how pleased we are to have Marlo in the role of Chief Financial Officer. After joining us last spring as Senior Vice President of Finance, she has quickly and seamlessly transitioned to the new position, and serves as a valuable member of our executive team. Now, over to Marlo to discuss the financials.

Thank you, Chris, and good morning, everyone. I've been at the company now for 10 months. So, I was really able to hit the ground running when I assumed the CFO position in November. I've enjoyed the opportunity to speak with some of you at recent virtual conferences and marketing days, and look forward to continuing to get to know our SBH shareholders. Turning now to the financials. You heard from Chris that COVID disruptions put tremendous pressure on the topline in the quarter. After a strong start in October, new restrictions set in during November, and by the end of Q1, approximately 45% of our stores globally were operating under capacity restrictions or closures. This resulted in a consolidated same-store sales decline of 3.7%. In our open locations, traffic was choppy and declined on a year-over-year basis. Despite lower traffic, we saw increases in average ticket, units per transaction, and average unit retail, versus the first quarter of fiscal 2020. Our global e-commerce business remained strong in Q1, with consolidated sales at 48% versus a year ago. As we continue to optimize our new digital capabilities, we expect e-commerce to become an increasingly larger part of the overall business over time. Looking now at gross profits. Our fewer bigger, deeper strategy, continues to drive underlying margin strength. First quarter gross margin came in at 50.3%, up 190 basis points to last year. The year-over-year increase reflects strength in the Sally segment, particularly in the US and Canada. This was partially offset by margin pressure at BSG, as lower inventory levels drove higher capitalized costs. Looking at the remainder of fiscal 2021, we anticipate that our targeted promotional strategy will allow us to continue to deliver strong consolidated gross margin in the range of 50%. SG&A expenses totaled $366 million in Q1, down $12 million versus last year. The savings can primarily be traced to lower field labor and advertising costs, and reflect our ability to pull expense levers as needed while pandemic headwinds persist. As we expected, as a percentage of sales, SG&A, deleveraged on a year-over-year basis, coming in at 39.1%, up 50 basis points from Q1 of 2020, due to lower sales volume. Looking at Q2, we expect SG&A dollars to be flat to up slightly on a sequential basis from Q1. This primarily reflects investments in digital marketing in both the Sally and BSG segments, as well as IT spending, as we continue to deploy and scale our new tools and capabilities. These investments will be partially offset by lower field labor costs and variable expenses. On a full year basis, we expect SG&A dollars to increase versus fiscal 2020, with spending primarily directed toward additional marketing and IT spend in the back half of the year. As a reminder, we will also be lapping last year's furloughs and rent abatement. As Chris said, we are pleased with the success of our transformation journey, and the investments we have made to date, are clearly bearing fruit. If we begin to see pandemic headwinds abating, we will make selective investments in other key growth areas during the latter part of the year. Turning to earnings. Our solid gross margins and careful cost controls, allowed us to deliver strong performance across operating income, EBITDA, and EPS. In Q1, adjusted operating margin was up 130 basis points to 11.2%. Adjusted EBITDA increased 5% to $134 million, and adjusted diluted EPS grew 6% $0.50. Moving to segment results. I'll start with Sally Beauty. The first quarter same-store sales decline of 3.3%, can largely be traced to expensive closures and restrictions in Europe and Latin America. In the US and Canada, same-store sales declines were less than 1%, and gross margin remained strong, reflecting the effectiveness of our new promotional strategy. This drove a significant increase in segment operating margin, which expanded 440 basis points to 17.4%. E-commerce remained strong, up 46% versus a year ago. In our BSG segment, same-store sales declines of 4.6%, primarily reflect restrictions on store capacity across several territories in the US and Canada, and salon closures in California and parts of Canada. E-commerce remains strong, delivering growth at 51% over the prior year. Gross margin decreased by 40 basis points, reflecting higher capitalized costs due to lower inventory purchases. Looking at the balance sheet and cash flow. We ended the first quarter with $538 million of cash on the balance sheet and a zero balance on our $600 million revolving line of credit. Inventories at quarter end totaled $896 million. That's down 10% versus a year ago, and reflects our efforts to return to more optimal levels. As we talked about on our Q4 earnings call, we exited the year with a focus on rebuilding inventory. We made good progress, and significantly improved our in-stocks during Q1. That said, we did face some COVID disruption and port delays, particularly in the BSG segment. As a result, first quarter cash flow from operations came in better than we anticipated, at $39 million. And we anticipate this will pressure cash flow in Q2. Capital expenditures totaled $15 million, and were deployed mostly towards store repair and maintenance, and digital capabilities, most notably buy online pickup in store, which as you heard from Chris, is gaining good traction. Free cash flow was $24 million for the quarter. At the end of Q1, our leverage ratio stood at 2.78. For comparison purposes, the leverage ratio that we often cite, as defined in our loan agreement, where the impact of cash on hand is capped at $100million for net debt calculation purposes, was 3.73. After the close of the quarter, we further reduced our debt levels by another $213 million in early January, which is consistent with our philosophy to deleverage the balance sheet. Going forward, we expect to continue to utilize excess cash, to reduce debt, and return value to shareholders. In fiscal 2021, we expect to make additional progress toward bringing our debt leverage ratio closer to our target of 2.5. As we look at the balance of the year, we expect the environment to remain choppy, as COVID disruptions persist. With closures and restrictions continuing thus far into the second quarter, we anticipate that Q2 net sales trends will soften moderately from Q1 levels. Until we see a definitive shift in the macro factors affecting our topline, we will continue to operate prudently, and remain focused on the operating initiatives Chris talked about, which we believe are setting us up to achieve consistent growth and long-term success. We appreciate your time this morning, and now we'll ask the operator to open the call to Q&A.

Thank you. [Operator Instructions] And our first question will come from the line of Simeon Gutman with Morgan Stanley. And your line is open.

The first question is on the softer Q2. Can you talk about, is it entirely due to closed stores? Are you seeing anything else that it wouldn't be related to? And then with regard to your Omni-channel, are you seeing that part of the business pick up as the store traffic declined, given some of the restrictions?

Thanks, Simeon. Here's what I would say. Yes. Yes, it is due to store restrictions, closures, and decline. So, obviously as we look at Q2, Europe's been significant, closures across Europe for all of January, heading into February, and we're not sure how long that will extend. It could easily extend into March. Canada has had some significant closures that are continuing. We had salons closed in California, and Latin America has some significant store closures as well. So they just seem to be a little deeper and more extensive and lasting longer as we get into this quarter. And that's really the driver of why we’re being conservative in our view of Q2. And yes, we are seeing increases in the Omni-channel. As an example, in Europe, we're seeing significant increases in our Omni-channel sales, due to the extensive closure. Same is true in Canada. But the reality is, it doesn't make up for the fact when you have 60% of your stores closed in Europe, you're not going to make up that with Omni-channel.

Got it. Okay. And then my follow-up is, the gross margin is being - it's benefiting right now from your promotions. Can you talk about what you learned on the promotion side? What can you tell us? What kind of promotions were most prevalent in - prior pandemic? Ones that you may not need to repeat so we could try to assess the sustainability of some of these gross margin trends.

Yes. Let me start, and Chris will jump in with more color, but what we found is, we really don't need to promote in our core category of color to win the customer. Promo is really not how you recruit a new color customer. So what we found was that the promotions in color, were really just leading to pantry loading. And so - and it was pantry loading of our existing customers. So instead, what we're doing is using the promotions on a very selective basis to drive traffic into basket adds. And so we're seeing that prove out, and it's working for us. We started the shift kind of at the height of the pandemic last year, and we're seeing that play through. we're shifting the marketing on the other hand to drive that traffic into more meaningful and educational content. So, we think it's working. It’s looking - it's proving in the margin, and we started to see it last third quarter. We see it in the fourth quarter where we were above 50%. Again, we delivered a solid 50% this quarter as well. So the shift is working and we are directing it more towards the basket add, not to the core.

And I think that's right on target, Simeon. The only extra I'd add to that is we're going to - we're still optimizing this. I think it's - one of the things we've learned is that this - probably some promotional activity will return to BSG, because so much of it was vendor funded. So we think we'll - we’re probably going to add back a little bit more there, especially in the heavily vended funded - vendor funded categories. At Sally, Marlo is correct. Color doesn't make much sense to promote, but some of the adjacent categories and brands, oftentimes may, especially the ones where those are well-known brands. And so, we’re still optimizing and learning this, but the long-term trend is definitely fewer, deeper, bigger.

All right. Thank you both. Take care.

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

Good morning. Thanks for taking my questions. Hey, Chris. So, I guess my first question, with the vivid color, very strong growth this quarter. Just curious how you’re thinking about the stickiness of the trend, especially coming out of the pandemic?

Yes. This is one we've debated quite a bit. So I think it's a great question. The reality is, I do think there is a general - we've seen the trend, by the way, before the pandemic hit as well. So there has been a long-term trend, multi-year trend of vivid colors growing. So I do think a significant portion of it is sustainable, as people just feel more free to express themselves through air, but there may be additional experimentation that was created and opportunities to experiment that was created by the pandemic. So I would guess it will settle some, but your guess is as good as mine. I think what's great about it is that we're the clear leader in a category that's on trend and growing. We have a much bigger assortment than anybody else out there, and we love how it's bringing a new consumer to our stores.

Okay, great. And then a follow-up question, just, I guess as we look at the BSG segment, I would say the decline was - I would say fairly limited considering some of the restrictions out there. Any sense how your market share held up during the quarter, just given some of the restrictions out there?

Here’s what I would say, I don't know. We don't have any sign that says we're losing market share. We do believe - we do some indications that we're gaining color accounts, and we've had a lot of color conversions. So we feel strongly that that's the core of gaining share in the professional business, because color is so sticky for a stylist. So the best indicator we have is that we are seeing an increase in color conversions, which would suggest that we're gaining some share.

Okay, great. And then my last question, shipping expense has been a headwind in recent quarters. Just curious, with the buy online pickup in store, like how that's progressed versus your expectation. And just in terms of how that's helping reduce maybe some of the shipping headwinds that you guys are seeing.

Yes. We have more work to do on this, but the reality is that both - this was a key lever for us in terms of driving down our shipping expense. So we're excited about the early adoption we're seeing. And of course, we're excited to put that into our BSG business as well in the coming months. So the reality is that over time, we expect that more of our business will be supplied from the store in either in the form of buy online, pickup in store, curbside, or same-day delivery. And that that will lead to a better average shipping expense overall over time. But this is going to all settle out. This behavior will settle out in the coming months. Our job is to make sure we have all the right fulfillment options available to the consumer, and then optimize against those.

Okay, great. Thank you. I’ll pass it along.

Thank you. Our next question comes from the line of Oliver Chen with Cowen. And your line is open.

Hi. Thank you. You've done a really good job focusing on standing for haircare and color. Chris, what do you think about the non-hair haircare and color categories, and how you may focus strategies there, and what's ahead? Would also love your thoughts on traffic and traffic at Sally Beauty, what's controllable at the Sally stores, and what do you see happening ahead to maximize traffic - the traffic opportunity. Thank you.

These are really good question. So the first is, we're going to continue to build dominance and leadership in our color and care category, especially color, because that's the core recruitment vehicle for business. And we have such a strong leadership position there we want to build on. The reality is that the other categories are basket adds outside of color and care. And when an enthusiast, whether it's a stylist or a consumer, walks into our store for color, she's going to add to her basket, or he's going to add to their basket, with these other categories. I think our job is to make sure they have a good selection there, that it's optimized so that it's efficient so we don't have too much inventory, so we get better turns and productivity out of it. So I guess my message to you would be, we'll still be in those categories. We may lean the assortments out some, and we make sure that we've got the right brands and products that are most likely to select as they're coming in. but we will focus on winning with color and recruiting color customers, and then use the other categories as basket fills. And that's the way the strategy works, and we'll continue to do that - execute against that strategy. On traffic, it'll be interesting to see how traffic settles post pandemic. Obviously, right now, what we're seeing is people making fewer trips, but buying more when they come. And that I think is across all of retail. The question, of course, is that some consumers within that mix are probably making almost no trips. And you can imagine some of the older consumers who are concerned about their health. And what we don't know is how much that will return in the natural course of things, as people get vaccinated and feel secure, and how much of it will people shift to new behaviors that they learned during the pandemic. That is all to sort out. If I had to guess, I would guess that traffic will be down some as more consumers use Omni-channel as their way of purchasing, but it won't be down to the level it is now, as some consumers return to their previous behaviors. That’s - your crystal ball is as good as mine on that one, but that's how I see it likely settling out.

Okay. That's very helpful. And a final question is, Chris, as you think about the store fleet across both concepts, what's on your mind in terms of modernization and renovation and how refreshes may go? And also any evolving thoughts on footprint as the environment continues to rapidly change? Thank you.

Yes. Oliver, evolving is exactly the right use - word to use there, right? We are deep into the assessment right now. Part of what we need to do is put all of these new delivery service functionalities in place, and let the consumer tell us, what do they want? Do they prefer BOPIS? Do they prefer same-day delivery? Do they prefer visiting the store and talking to our associates? We need to put all the right delivery service and fulfillment options in place, and then let them kind of guide us in terms of what's the right footprint over time. We are - I guess the message I would say to you is, we are deep into analyzing this. We're going to watch how behaviors emerge. We're going to do a lot of analysis of store profitability, the shift as we do different forecasts of Omni-channel. And then from there, we'll make the right decision on what's the long-term strategy for footprint. In terms of the store experience, we are working now also on, how do we think about a store experience that's truly centered in color, but also that has Omni-channel built into it as well, as we expect stores to do - to play a major role in fulfilling the customer order. So those two factors, the fact that we want the business to be centered in color as the core recruitment vehicle, that's going to change how we assort our stores, and you're going to see changes there over time. And two, we have to set up the front of the store so that it's easy for those Omni-channel customers who want to either do BOPIS, or as an example, have a delivery service like Postmates pick up, that it's easy for them to get in and out of the front of the store. So there's going to be significant changes at the front of the store as well to make that work seamlessly. So all of that is coming. We are looking at it and doing the analysis on it. Some of it is we need to see what the post pandemic reality looks like. And from there, we're going to be setting a course that will involve significant footprint changes and store design changes over time.

Thank you. Very helpful. Best regards.

Thank you. Our next question comes from the line of Mark Altschwager with Baird. And your line is open.

Good morning. Thanks for taking my questions. Wanted to follow up on the margin, and your really nice margin performance this quarter, I think the second quarter of solid growth in operating profit, which we haven't seen in in some time. I guess, how should we think about the sustainability there and the normalized growth algorithm as the COVID disruption abates? I would think that number is going to accelerate as we left COVID, but moving forward, I think you've spoken to consistent positive comps, and we see some nice gross margin tailwinds. So maybe it ultimately comes down to what a normalized SG&A growth looks like as we look at all the puts and takes on the cost front. So just any thoughts there would be great.

Yes. So let me start there at the topline. I think we've referenced the sales disruptions. We’ve experienced the choppiness. We’re in times where there's not restrictions pre-COVID. Going into last March, we were positive low single digits. We had - Q4 was another period of low single digit growth. Again, that was a period when the restrictions were lifted and it was lower issues from the pandemic during that time. Of course, then in November, the restrictions come back on. So we’ve seen the choppiness, but I think the way we're thinking about it and the way we've proven to ourselves, I think, is that we are a low single digit grower. And we believe when the pandemic headwinds abate that we are well positioned. We have new capabilities, better tools, better teams to continue. And we focused on that during the entire time of the pandemic, to continue to build out those capabilities. So we believe we're in a great position to deliver consistent, sustainable growth. Again, we've got to get past the pandemic. From a margin perspective, gross margin perspective, again, the sustainability of the - around 50%, is definitely something that we've proven. We believe the promotional strategy is working. The shift in marketing strategy is working as well. So we believe that that is something that we will see and continue to deliver going forward. From an SG&A point of view, that - we will have some headwinds there. There is wage inflation over time, but we will continue to work to optimize that. We’re getting better at the e-comm profitability. We will continue to look at, as Chris just mentioned, the store fleet is under analysis as well. So we look for improvements that we can make there. And then in terms of the other things we can do in margin, we've got pricing opportunity, we believe. Again, we've got a differentiated core that we believe we can leverage. So we feel confident that we can drive leverage on SG&A over time once we get to a point past the pandemic where we can grow the topline and those low single digits. So again, we're positioned really well for the long-term. And again, given all the capabilities and new tools that we brought to our business model, we're now at a good pivot point. Once the pandemic abates, we will be able to deliver on that.

Thank you for all that detail. And just a follow-up kind of on the near-term here as we look at the reclosures across the various markets. Thinking back to last year, you were pretty quick and aggressive about reopening your stores safely, leaning into curbside, and returned to positive comps, I think faster than anybody would have anticipated. So I guess the question is, how do the learnings from last spring and the investments that you've made last year, really affected the near-term strategy as you faced these new closures? I guess maybe wonder if you could speak to your ability to make better capture demand through some of these tools, and just how that might impact your near-term outlook.

Yes. Mark, it's one of those things where we've gotten better at it, and it's one of those things you wish you didn't have to get better at it, but we have gotten a lot better at this, right? So, our teams are pretty agile at this point. They can adapt. Of course, it’s a little easier when you're not closing down all of your stores at the same time as well. But the reality is, our European team is working this on a day-to-day basis. Our Canadian teams are working this on a day-to-day basis, and they adjust accordingly in terms of, what does the federal - the local jurisdiction signal to us? What can we do? Can we move to curbside or not? How much digital can we push? Do we need to furlough teams during this, which of course we have, and then how do we get them back? We've built a lot of muscle around moving quickly in a dynamic environment. And I think that's helped us in the quarter we just finished. It's going to help us in the second quarter as we go through more of the disruption. And then, I'm hoping that we can move that muscle on to other things because dealing with local shutdowns is obviously not the best - not the most fun part of the business. For me, what's most exciting is, it just proves to me that we've built a much stronger retail leadership team. We've added a lot of talent over the course of the last year, year and a half. And we just have a team that's just better able to cope with whatever comes at us. And that team will also be better able to execute as we come out of the pandemic and drive our long-term strategy.

Thanks for all the detail and best of luck.

Thank you. Our next question comes from the line of Steph Wissink with Jefferies. And your line is open.

Thank you. Good morning, everyone. Just a couple of follow-up questions actually to prior questions that have been asked. The first is on margins. And maybe, Chris, you could talk a little bit about the penetration of color in the business now, and how that margin of that category compares to the overall company average. And then the same question on channel mix. How deeply penetrated is e-comm in the business today, and how does that margin look relative to maybe what has been the company average over time?

You bet. Thanks for the question, Steph. I appreciate it. The reality is that color is obviously growing faster than all the other categories, and it is a higher margin category. And by the way, it has proven over time to be a very price inelastic category, because both consumers and stylists are very sticky to their color line. So historically, color was in the high 20s or 30 for Sally. It’s gained. That shares going up. Yes, for BSU it’s more like 40 and that share is going up, as we continue to see color growing faster than the rest of the business. And it is a higher margin category. So we expect that that mix shift is a positive headwinds for margin over time, and we continue to focus on color as our core. In terms of e-comm, as you signal and as other retailers often signaled, in our BSG business, e-comm is actually quite profitable because the orders are very large. So stylists tend to place very large orders. So the distribution expense is easy to amortize across a large order. In our retail business, e-comm is not as profitable as our store business. We have a lot of optimization that we're working on now, and obviously BOPIS significantly improves that profitability. BOPIS and same-day delivery are very close to our store margins. So part of this is, we've got to get better at delivering from the store. And then the other part is, we've got to optimize our ship-from-store and warehouse delivery as well. So that's where we're at today. E-comm across the whole business is about 7% of our total, but it's going to be growing fast, as we should expect. And so, we've got to continue to make it more profitable so that we’re more indifferent to the two channels.

And I would just add to that, that the way that we approach promo and e-comm now is across the board with the company’s total. So before, it was more of a promotional channel. it's not that anymore. It's more of a content delivery method, plus the product that we're delivering online is very similar to our product margin structure that we have in store as well. So I think there's an improvement there. The other thing that we're doing is optimizing the assortment that we're offering online as well. So, all of that in, e-comm profitability is improving. And so, we look forward to actually adding more and getting it to not quite neutral, but more closer to neutral.

That's great. And just two quick follow-ups from some of your recent initiatives. If you could talk a little bit about the DIY hair color trends, and then you recently launched a new digital marketing campaign using some influencers or key opinion leaders. Can you talk a little bit about what you're learning from that venture, what you're learning about your social traction, and how that might affect marketing mix going forward? Thank you.

No, I appreciate that, Steph. I'm glad you noticed that. Yes, the DIY, and we actually launched the DIY University. The reality is, is we think that's the way to grow color itself, is to provide education and training and tools so that it's easy - that the barrier to entry is less because correct, we sell professional color to the consumer, as opposed to other retailers sell box color. An all-in-one solution doesn't give you as good of a result, but it’s - the perceived risk is lower for the consumer. And so, one of our real focuses is to create more DIY education so the consumer feels more comfortable with it. And we think there's a strong desire for the consumer to absorb that information both digitally, as well as in-store, and to try and do that themselves. So we're really excited about where that's going. And of course, you just mentioned the SallyCrew, which is our influencer program. And we have some terrific influencers through that. I'd encourage you to go look at - I watch them every day, influencers like Charity Grace and Emily Boulin. The reality is that that they're doing fantastic content that really highlights, in many cases, vivid colors, but other techniques as well that excites the consumer, gets them excited about what they - the look they can generate for themselves, and give some DIY hints about how they can get it done and do it quickly. And so, I think SallyCrew is just at its infancy. It's going to get bigger from here. We'll probably add more influencers over time, and we'll continue to look for people who are good educators, as well as demonstrators. And that's the big difference. Linked to that previous strategy I discussed around DIY, we've got to have influencers who are good educators as well, because part of what we've got to do is share that this isn't impossible. It’s easy to do. You can do it yourself, and we can help you get there. So, I'm glad you've noticed it. We're going to continue to invest in it. We expect it to grow as a marketing investment and channel for us. And hopefully we'll - it'll continue to have the impact we want, which is to really recruit new color customers.

Thanks, Chris. Very helpful.

Thank you. Next, we will go to the line of Olivia Tong with Bank of America. And your line is open.

Great. Thank you. Good morning. I wanted to ask a few questions. First, just a really quick housekeeping one. When you say sales declined in Q2 more than Q1, do you mean down more than 4.5% year-over-year, or that sales will be below the $936 million in fiscal Q1? And then I'll follow up with my other questions.

Yes. It's more the comparison, so your first thought. So the way we think about it is, the way we said is we expect it to soften moderately from the decline in Q1. So what we're saying is, the continued disruption and the choppiness that we're seeing going into Q2, that's going to offset the easy compares that we saw last March. But you also have to remember that last year we were trending positive in the pre-COVID time, so before March. So when we put it together, what we're expecting is that the continued disruption in Q2 this year, up against the strong pre-COVID compare and Q2 last year, is going to offset that easier compare to last year's March. So that's where you get to Q2 sales softening moderately from the 4.5% decline that we saw in Q1.

Got it. That's very helpful. Thank you. And then I got disconnected in the middle of the call, so I apologize if this was asked, but just wanted to get a better feel in terms of the footprint, the retail landscape for beauty and hair, because there are a number of new partnerships geared more towards the face and hair. But what's your view on how the competitive landscape changes with Target Ulta and also Sephora has moved to Kohl's from J.C. Penney. I mean, I suspect it's not a direct comparable, but does this create more competition for you? Or potentially in a positive way, does it put additional focus on the categories in personal care, beauty, hair and you get a halo benefit from that? So just kind of curious how you were thinking about the increased retail partnerships and focus on beauty within the store, or across the store footprint. Thanks.

Thank you for that. I've been thinking about it a lot. Obviously these get a lot of press. The reality is, we're in a very different category. Our category focuses color first. And neither of those partnerships are really focused. They're pretty much focused on cosmetics and skincare and those areas. So the reality is, I don't see it as a major impact or really affects our strategy relative to our focus on color. That being said, it immediately makes you think about, what do you want to do with your own footprint, and are there creative ways to recruit color customers in other locations that we should be considering? So, I certainly think it has spurned interest in terms of, where's the best place for us to reach color customers. And are there other places that we should be in order to do that? but I don't see it as much in the way of direct competition to us, because it's so much more focused on cosmetics, which is not a core category for us and is really just a small basket add category.

Got it. Thanks. Appreciate it.

Thank you. Our next question comes from the line of Carla Casella with JP Morgan. And your line is open.

Great. Thank you. My first question is on the JDA rollout. There were additional DCs. Any more color you can give us in terms of the timing, how many DCs over which quarters?

Yes. I'm not going to go quarter by quarter. we're obviously in North Texas and one other DC is starting up now. Obviously, like any implementation, what you do is you start it up and then work the bugs out of it. And then once you've worked the bugs out of it, you then expand it across the platform because you know it's working well. We’re well down the path of working the bugs out of it, and feeling comfortable in scaling it to full scale. And then as we get past that phase, we'll go facility by facility, and it'll move pretty quickly, because again, once you've worked all the bugs out, you can scale quickly without fear of a disruption. So, we’re in the heavy problem-solving phase. It’s working well, and we expect that by the end of the year, it will be fully implemented.

And how many total facilities will get it, everyone?

Yes, everyone.

Okay. And then you deferred rent last year. Did you get any rent abatements as well? And could you just give us any financials in terms of how much rent will be made up in ‘21?

Yes. No, actually there's not much. The only thing we did when we - when they deferred rent was, they would add an extra few months onto the end of the previous leases. So there's no incremental payment that has to be paid. There's no deferred payment.

Yes. So it's - compare is where you're going to see the difference, right. So we had abatement last year. So this year, you will see an increase relative to last year, but nothing above normal.

Correct. And in general, the trend, as we re-signed leases is, we're beginning to see lease rental rates come down, which is what you'd expect.

Right.

Okay. And then you did a good job with your inventories, low. Is that the right level, down 10%? And did I hear correctly? It sounds like working capital, we should expect to be a use of cash as we go into second quarter.

Yes. No. inventory level is definitely down, working towards optimal levels, but not quite to where we want them to be. We did improve our in-stock quite a bit. But we did go a little bit low and we're still trying to fill in in some of our areas, just certain areas. Mainly it was in the BSG side of the business. And most of the problem or part of the problem, I should say, is supplier disruptions from COVID. But we also are having some delays from the California port issues that are going on. So, we didn't get all the inventory that we wanted in Q1. We expected it and that's a little more heavily. You also saw our operating cash flow was better than we anticipated, and that's the reason. So we do have some of that inventory that has been delayed, will be received in Q2. So it's spilling over into Q1, or from Q1 to Q2. So really it’s just - it's a timing issue between Q1 and Q2 on the cash side. Obviously, we're trying to get better at our in-stocks and this will help us as we get to course correct it in Q2, just continue the thought on cash. We do still expect strong cash generation for the year. It's back half loaded just as we expected before, and we'll continue to maintain really strong liquidity.

Okay. And then just one other. On hair color, what percentage of your total Sally and BSG sales was that last year, and where could it go this year with your renewed focus on that area?

No, it’s up with the growth there. Obviously, as I mentioned, we're seeing 19% growth in Sally and BSG is positive as well, even with all the disruptions, as is Europe, amazingly. So it's growing as a percentage of our category. It has been historically in the high 20s at Sally. It’s more like 30 - above 30 now, and BSG has always been in the 40 range and it's growing as well. So again, it's our core recruitment vehicle. It'll continue to grow as a share of our total. It also is higher margin, which is great. But it's just a very sticky category and it's where we have the greatest expertise.

That's great. Thank you.

Thank you. Our next question comes from the line of William Reuter with Bank of America. And your line is open.

Good morning. Can you remind us when the changes to the promotional strategy were made, so we can think about when those comparisons are going to be a little more challenging? And then, I'm wondering whether you believe that there may be some component of this that is related to the environment, the COVID environment and reduced promotions across most consumer products, and I guess your confidence that this won't revert to legacy promotional levels once we get out of this.

Yes. First question as to when, we really started to shift the promotional strategy, really at the height of the pandemic in Q3 of last year. You can see it in those - in that margin, although I'll say it's a little complicated when you go back and look at that. We did have some write-offs associated with some clearance activity, as we were cleansing our inventory positions. But when you peel all that back and we did try and show you those pieces in our script last quarter. When you peel all that back, we're at a 50% plus margin. Then you go to Q4 and you clearly see it. We're about 50% there. And then again, now you see it in our Q1. So it's really, once you peel back Q3, you see it there, but that's when you see it flowing through the financials.

Okay. And then on your leverage target, is that two and a half times a net number or a gross number? And do you have an internal expectation of when you might be able to achieve this level?

Yes. The leverage is the net number. As far as timing, it's all dependent on the disruptions in our performance there. So as we stated before, we're positioned really well as the pandemic disruption subsides, to really get back to topline growth. That'll continue to flow through the cash flow, and will put us in a position to continue to work towards that leverage on the EBITDA side. On the debt pay down side, which is the other side of that equation, we're in a great cash position. You saw us pay down debt here just this past January. And we look to continue to rebuild cash and read the environment. We look forward to making more progress towards that target.

And then lastly for me, I had seen an article that suggested that there may be stylists that have left the industry based upon more people doing DIY at home, and all the disruption that's in some areas kind of affected their livelihood. Do you guys have any indications that there may be a reduction in the number of stylists?

I'm sure there is some of that. Some of it may be that people are taking time off because they're reluctant to work in an environment where they don't feel as safe. What we're seeing much more of, though, is fragmentation. So we're seeing larger salons break apart, and stylists either go on their own as suite renters, booth renters, or mobile. And that actually is good for our business, because many of the larger salons were served directly by the big brands. And as they become independents, they're more likely to be store customers and BSG customers. So we think that's the bigger trend that's going to - it was already a trend that was happening, but it's going to be accelerated as you see, I think, a lot of salons that just don't make it through the pandemic, especially in places like California, where you've seen three waves of shutdowns or New York City, or some of the big environments that really suffered here. A lot of salons won't make it. Those stylists will still want to earn a living and they'll go as either suite renters or mobiles. And that's a great target market for BSG in our store platform.

That makes sense. All right. That's all for me. Thank you.

Thank you. And I'm showing no further questions in queue. Please go ahead with any closing remarks.

Well, thank you all for joining us for our Q2 or Q1 fiscal 2021 earnings call. We appreciate your support and your questions. We feel really strongly about the strength of our business, as we manage through the end of the pandemic, which we hope is coming in coming quarters. And we feel like we've positioned the business to really focus on a differentiated core color, and added a lot of new capability and talent to support that. And so, we feel quite strongly about our long-term trajectory. Obviously, there'll be some choppiness in the quarter right in front of us, but once we get past that, we’re excited about where we're going to land here, coming out the back of all of this, that we're going to be a better and stronger company, with a more differentiated core, and greater capabilities to serve that core. Thank you very much.

Thank you. And ladies and gentlemen, 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.