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Sally Beauty Holdings Inc. (NYSE:SBH)

F2Q2013 Results Earnings Call

May 2, 2013 11:00 AM ET

Executives

Karen Fugate - Vice President, Investor Relations

Gary Winterhalter - Chairman, President and CEO

Mark Flaherty - Senior Vice President and CFO

Analysts

Simeon Gutman - Credit Suisse

Meredith Adler - Barclays

Erika Maschmeyer - Baird

Jason Gere - RBC Capital Markets

Taposh Bari - Goldman Sachs

Christopher Ferrara - Bank of America Merrill Lynch

Ike Boruchow - Stern Agee

Linda Bolton Weiser - B. Riley

Jill Caruthers - Johnson & Rice

Operator

Good morning, ladies and gentlemen. And welcome to the Sally Beauty Holdings Conference Call to discuss the company’s Fiscal 2013 Second Quarter Results. All participants have been placed in a listen-only mode. After managements prepared remarks, I will facilitate a question-and-answer session, and initially each caller will be limited to two questions. Additional instructions will be given at that time.

Now, I would like to turn the conference over to, Karen Fugate, Vice President of Investor Relations.

Karen Fugate

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 the words such as may, will, should, expect, anticipate, estimate, assume, continue, project, plan, believe and similar words or phrases.

These matters are subject to a number of factors that could cause actual results to differ materially from expectations. Those factors are described in Sally Beauty Holdings’ SEC filings, including its most recent annual report on Form 10-K for the fiscal year ended September 30, 2012. The company does not undertake any obligation to publicly update or revise its forward-looking statements.

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

With me on the call today are Gary Winterhalter, Chairman, President and Chief Executive Officer; and Mark Flaherty, Senior Vice President and Chief Financial Officer.

Now I would like to turn the call over to Gary.

Gary Winterhalter

Thank you, Karen, and good morning, everyone. Thank you for joining us for our fiscal 2013 second quarter earnings call. I’ll begin today’s discussion with a high level review of our financial results and business initiatives. Mark will then take you through the second quarter into more detail.

As you may have seen from our press release this morning, our fundamental business drivers are solid and we executed well on our operating initiatives. Sales performance during the quarter was challenging and reflects in part the difficult comparisons against record sales growth in the prior year.

Our consolidated same store sales decreased by 0.8%, after growing by 9.1% in the second quarter of last year. If you remember, on our first quarter earnings call in February, we were optimistic that same store sales growth would be in the low single digits for the second quarter based on our sales performance in January.

We also commented that March results would need to be strong to offset the difficult year-over-year comparisons and two fewer days in the quarter. Unfortunately, the unexpected softness in our non-Beauty Club traffic, the difficult comparisons against record growth in certain categories and 180 basis point impact of two less sales days contributed to weaker than expected results. Unfavorable weather compared to last year also played a part.

Consolidated sales in the second quarter were $898 million and grew 1% versus 10.9% in the prior year quarter. This sales growth is attributed to net new stores while partially offset by softness in retail traffic. Sales growth was adversely impacted by two less selling days, which we believe equated to approximately $15 million in loss sales compared to last year.

Gross profit margin in the second quarter reached 49.5%, a margin expansion of 40 basis points driven by all our business units. Net earns were $64.9 million, down 4.3% from the prior year quarter. Earnings per share were $0.36 or growth of 2.9%.

During the quarter, we repurchased 7 million shares of our common stock for a total of $191 million, completing our $300 million authorization launched in October and beginning our new $700 million authorization announced on March 5th.

I’m pleased with our capability to drive shareholder value via our stock buyback initiatives. It’s only been a year since we first began to buyback our stock and we’ve already repurchased 19.6 million shares.

Turning to segment performance, starting with Sally Beauty Supply. As you know, Sally Beauty was up against the strongest comps in the history of our company. This combined with softness in retail traffic and certain product categories contributed to our first negative comp quarter at Sally.

Although I’m disappointed we broke our long standing track record of same store sales growth, I believe the second half comparisons will be easier and the core fundamentals of our businesses are sound. Same store sales for Sally Beauty in the second quarter declined 1.6% versus a record growth of 9.3% in the prior year.

Net sales reached $556 million, an increase of 0.4% versus growth of 12.9% in the prior year. Sales performance at Sally was impacted by the continuation of difficult comparisons against record growth in the nail, hair extension and appliance categories and lower retail traffic driven in part by two fewer days.

Traffic from our non-Club customer was particularly soft this quarter. We are not overly concerned with this because our sales and average ticket from our Beauty Club customer continues to increase in our core categories hair care and care color are growing nicely.

Beauty Club Card membership increased 9.1% to 7 million members and sales from our BCC members increased 7.7% versus growth of 31.7% in the prior year. The ongoing shift in product and customer mix, and improvement in our consolidated international business, drove gross profit margin expansion of 30 basis points to reach 54.5%.

Operating earnings were negatively impacted by sales performance and declined 4.7% to $106 million with operating margin of 19.1%, a decline of 100 basis points from the prior year.

In the U.K., we are pleased with our distribution initiative, as we are ahead of schedule and under budget as of mid-March we are shipping from the new facility. Store count for Sally Beauty ended the quarter at 3,357, an increase of 129 stores over the prior year.

Now turning to our BSG segment. BSG had same store sales growth of 1.3% versus growth of 8.7% in last year’s second quarter. Net sales grew 2.1% to reach $342.3 million. This growth is attributed to same store sales, net new store openings and our full service business, while partially offset by lower traffic driven by the loss of two sales days.

BSG’s gross profit margin was 41.3%, up 50 basis points over the prior year quarter. Operating margin at BSG improved by 100 basis points to reach 14.6%. This strong performance was primarily due to sales growth and SG&A leverage. Store count at BSG ended the quarter at 1,201, an increase of 37 stores. Our direct sales consultants decreased by 119 to 994 as we continue to streamline our sales force.

To summarize, it was a challenging quarter for Sally Beauty Holdings. But we executed well on our operating initiatives and our fundamental business drivers are solid. During the first half of this fiscal year, we were up against record performance from the first half of 2012. We believe the comparisons will get easier as we head into the second half of the year.

Now, I’ll turn it over to Mark to provide more financial detail for the second quarter. Mark?

Mark Flaherty

Thanks Gary. Consolidated net sales for the second quarter were $898 million, an increase of 1%. This increase was primarily driven by 166 new store openings and partially offset by the decline in same store sales of 80 basis points.

As you know, we are counting against record same store sales growth in the first half of 2013. Looking ahead, we are optimistic that same store sales growth for the second half of fiscal 2013 will be in the range of 3% to 4% and resulting in full year comp growth of 2% to 2.5%.

Consolidated gross profit was $444 million or 49.5% of sales, a 40 basis point improvement from the fiscal 2012 second quarter. This margin expansion was driven by both business segments.

Second quarter SG&A expenses were $299 million, growth of 3.5% from the prior year and below our expectations. SG&A as a percentage of sales was 33.3%, an increase of 80 basis points over the prior year primarily due to lower sales growth during the quarter, expenditures related to our IT projects and the completion of our warehouse facility in the U.K.

Unallocated corporate expenses including share base compensation were $27.9 million or 3.1% of sales versus the fiscal 2012 second quarter expenses of $25.3 million or 2.8% of sales.

Consolidated operating earnings in the second quarter declined 2.9% to reach $127.8 million. Operating margin was 14.2%, down 60 basis points primarily due to softer sales growth.

Interest expense including the amortization of debt refinancing costs totaled $26.8 million, an increase of $4.4 million over the prior year. That increase is primarily the result of higher outstanding principle balances compared to the year ago quarter.

Adjusted EBITDA for the second quarter was $148.3 million, compared to $150.5 million in the prior year’s quarter.

For the fiscal 2013 second quarter, our effective tax rate was 35.8% versus 38% for the fiscal 2012 second quarter. On the year-to-date basis our effective tax rate was 36.9% and we continue to believe that our annual effective tax rate for the fiscal 2013 year will be in the previously stated range of 36.5% to 37.5%.

Net earnings for the second quarter were $64.9 million, a 4.3% decrease compared to the fiscal 2012 second quarter net earnings of $67.8 million. Earnings per share for the fiscal 2013 second quarter was $0.36, a 2.9% increase over the fiscal 2012 second quarter earnings per share of $0.35.

Looking the balance sheet, inventories increased 30 -- $63.4 million or 9.2% compared to ending inventory on March 31, 2012. This year-over-year increase is primarily due to recent softness in same store sales for the Sally Beauty U.S. business, additional inventory from new store openings and the ramp up of inventory for our new U.K. warehouse.

As of March 31, 2013, our debt excluding capital leases totaled approximately $1.6 billion and included $22.5 million of loans outstanding on our ABL facility.

Capital expenditures for the first six months of fiscal 2013 totaled $434.1 million and reflect expenditures required to open new stores, expenditures on existing stores, the U.K. warehouse and IT specific projects.

Before I turn the call back over to Gary, I’d like to provide an update on our IT system initiatives starting with the Sally U.S. point-of-sale conversion. We recently have converted roughly 450 Sally stores bringing our total stores converted up to 1,050. This keeps us on target to substantially complete all of our 2,600 stores by fiscal year end.

The international ERP implementation is also on track and live in Mexico, with the next launch due to occur in June in our Belgium headquarters. Subsequently, we expect to implement the remaining European countries over the next 12 to 18 months. Gary?

Gary Winterhalter

Thank you, Mark. Although our second quarter was challenging in topline performance, we continue to execute on our operational objectives. Improving gross margin by 40 basis points and growing earnings per shire by almost 3%. Our top priority over the next few months is to stay focused on our long-term growth opportunities and other activities that will lead to the best shareholder return.

Thank you again for your interest in Sally Beauty Holdings. Operator, please open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question goes to the line of Simeon Gutman with Credit Suisse. Please go ahead.

Simeon Gutman - Credit Suisse

Hi. Good morning.

Gary Winterhalter

Good morning, Simeon.

Simeon Gutman - Credit Suisse

Gary -- good morning. Can we talk about the sales environment, I don’t know if you endorse a number, I guess the collective headwind from the tough compare. But I think if you use somewhere like 300 basis points it would show that the underlying growth rate is more like in the low single digits, so if that’s right? Can you just remind us of some of the drivers whether it be inflation, industry growth or CRM? How you view them? How we should think of them?

And then does the POS system is layering that in with CRM? Does that change the algorithm with how much, I guess, control or how much you can drive the comp by using those two platforms?

Gary Winterhalter

Let me try and take that kind of in the reverse order as you presented it Simeon. First of all, we believe that we will have a lot better information when the next-generation POS is completely rolled out which is the end of September that, as I have said all along, will give us the ability to get a lot deeper into the customer’s product usage and therefore be able to market to them much more intelligently. As far as the traffic, look, I’m not quite sure I understood what the 3% was referring to that you mentioned?

Simeon Gutman - Credit Suisse

If you take, I guess, the leap day and the Easter and maybe tough weather, just sort of a collective, the 9% from last year, if you’re trying to strip out some of the one-time things where the underlying businesses growth rate maybe?

Gary Winterhalter

Oh!. Okay. If you take that out, yeah, obviously you normalize from a calendar standpoint. Our big issue though was still the fact that the three categories that we’ve been talking about for close to a year now represent about 30% of our business, all three of those categories combined.

Last year they were up, I believe it was 20% and this year those three categories were actually down 1%. So it still primarily an issue of lapping the nail polish or the gelish introduction, primarily along with the appliance softness and the hair extensions issue.

And as we have also said all along, that really starts to normalize this quarter, the April June quarter and that what gives me a lot of confidence that the back half of the year, we’ll be in more of the normal range.

However, having said that, I will tell you that our traffic particularly on the non-Club retail customer was slow this quarter. I think some of that is relative to weather and I think weather and other issues affect that customer more so than the others.

If you recall, we are very much a destination stop for our professional customers and to our Beauty Club Card customers, who we communicate with on a regular basis, those people are almost like the professionals in that they are very predictable and they become destination customers as well.

So it’s really the customer who’s not a frequent buyer for us or who just stops in to visit us because they are in the shopping center. Those are the ones where we are seeing the weakness.

And I think that kind of makes sense when you consider that, hey, particularly if it is bad weather, you’re not going to make an extra stop unless you really have a reason to go there being you need something specific if you are professional or if you are a Beauty Club Card customer you’ve got an offer that you want to take advantage of, or you are out of something just like a professional that you buy from us. So, yeah, that’s not totally surprising to us. If you recall the third quarter of last year, we saw some of that.

The other thing that I will tell you is I think the category in general and I say this not only for the professional industry, but I think in retail and in mass, you are starting to see a little bit softer comps and a little bit softer business. And I know when I talk to a lot of our suppliers, the first quarter particularly February and March were difficult.

Simeon Gutman - Credit Suisse

Okay.

Gary Winterhalter

Did I answer all parts of your question?

Simeon Gutman - Credit Suisse

Yeah. That’s helpful. And then my second question on gross margin. Was there -- first of all, the performance in Sally was fine. I mean, we aren’t that far away from I guess that 50 basis point sort of natural progression. But related to that, was there any promotional spending within that number? And second of all, as the business reaccelerates over coming quarters, does the sort of natural shift of the business accelerate as well, meaning the business goes back up to that 50 basis point margin expansion?

Gary Winterhalter

Well, I think the 15 basis point margin expansion is still a good target for this year. And I say that for a couple of reasons, one of which is everything that you just said. But the other thing, to keep in mind, is, we’ve been telling you for about a year now that the three P.O. costs that are in the U.K. are in their gross profit margin line. Those costs go away -- or went away at the end of the second quarter.

So we are going to see a nice pop in the U.K. gross profit margin, which should be a big enough pop that we are going to feel it on the whole Sally segment, because it’s been significant. Now that’s not saying that all the costs are gone with the U.K. distribution project. I’m just saying the three P.O. costs that were in the gross profit line are gone.

We still have a duplicate warehouse that we are paying some rent on, and still have some labor in and we still have some clean up costs but those will be in SG&A and not on the gross profit line. As far as promotional activity, we -- we did run a -- not really unexpected or unplanned sale, but we did some things in the U.K. to try and stimulate the business.

Another thing that we did, which really didn’t effect the margin is we have a -- once a quarter promotion at BSG here in the U.S. It’s a two-day sale, we call it. And we actually planned and advertised that for the first weekend in March. Turned out, it was not a wise move to do it that early in the month, because our advertising for it did not get to the customer on time. It is the normal monthly flier that we send out, so we got terrible results from.

The good news is we realized that quickly and came back and did basically the same sale to the customers that did not come in the early March sale. And obviously because of CRM. And what we are able to read into customer business, we know who those customers were. So we had a huge event, that wasn’t advertised as far as print goes. But it was advertised via social media, via email and via store communication. And it ended up when you look at the two combined it was the best sale we had ever had. And the margin was planned for that as it is every quarter. So but again, that was a promotional activity. On the Sally U.S. side, we didn’t do anything particular in promotional activity.

And one of the reasons for that I have told you in the past, pantry loading doesn’t work well for us. So, typically when we do something to really give margin and drive topline, we end up just giving back these sales in the following 30 or 60 days, whether it be the Beauty Card customer, or particularly the professional customer because they only use so much product.

And yeah, if you give them a really good price on something, they may come in and buy an extra week or two supply. But you just end up losing the, the following week and you gave up margin at the same time. So, I think we have always been very good at protecting our margin, even when sales are difficult.

And believe me, the temptation is there by the business units when they are having a difficult month or quarter, to try and drive business with that. But historically, it has not worked for us and I just encourage them to bite the bullet and keep your margin and it isn’t going to work for anyway and in the long run it is a better strategy

Simeon Gutman - Credit Suisse

Okay. Thanks.

Gary Winterhalter

You’re welcome.

Operator

Thank you. Next, we go to the line of Meredith Adler with Barclays. Please go ahead.

Meredith Adler - Barclays

Thanks. I guess I’m going to stick to the topic of sales. And do you have any sense of why the whole industry, the whole category is seeing some kind of slowness? You have been doing this a long time. Do you have the sense that this is fairly temporary? I think the first quarter was a bizarre quarter for most retailers and even other consumer companies or do you think there’s some new trend here?

Gary Winterhalter

Meredith, I don’t think it’s a new trend. You hear a lot of different views on this and some of it has to do with the payroll tax and some of it has to do with other uncertainties in the economy and the lingering unemployment rate and all that sort of thing. As I have said many times in the past, I just have never been able to see anything like all of those or gas prices or anything impact the industry significantly. We are still in the beauty industry. It is the most resilient and recession resistant industry that I can think of. And when I look at it, in particular and I mentioned this in my prepared remarks, that our fundamental basic two categories are hair care and hair color.

And those two categories account for over 30% of our business. And they were up strong single digits during this quarter. And that’s really the backbone of our business. So if I start to see trends that affect those two categories, then I’m going to start wondering if women don’t care about their hair being gray any more or -- things like that, which I would consider a very fundamental shift in the industry. And I think you can carry that through into a lot of mass companies, even the cosmetics and fragrance people. They all seem to be soft this quarter.

Obviously, at the manufacturing level, that just reflects what is going on in retail and as you said a minute ago, it seems like most retailers had a difficult quarter. And I don’t really talk much about weather unless it is significant as it was -- actually last year compared to the year before we had unseasonably warm weather last year, really everywhere in the world that we operate so.

Then, you come back with this year, where you had extremely difficult weather conditions all throughout the Midwest, the Northeast and then in the U.K. in Europe, so there is an impact to that. I think it is very difficult to quantify that. I don’t throw it out certainly as an excuse, because it is there for everybody. But having said that and seeing that everybody is kind of reporting a difficult second quarter, there was some impact to that.

Meredith Adler - Barclays

My second question would be about expenses. And it looks like you did a pretty good this quarter job of managing them. Maybe talk a little bit about how you accomplish that and do you have the flexibility if this sort of sluggishness continues, do you have the flexibility to manage that going forward?

Mark Flaherty

Well, I believe that we do. The two largest expenses in our stores are rent and payroll. Payroll is variable to a degree. Rent, as I have said over the last couple of years. Back when the economy was very difficult, we were getting very good renewal rates. And even new store lease rates back in the 08-09 period. And those are -- either it is a renewal or a new lease.

They are five year commitments usually with options. So we are still benefiting from the fact that we renewed a lot of leases during those couple years at very good rates. And as far as store payroll goes, it is variable, like I said, to a degree, one of the things that we did not do this past quarter and haven’t done all this year even though sales have been a little tough is cut back on our advertising expense.

I believe that only adds to the problem and we will make other cuts in the business before we cut back on advertising as long as we believe that advertising is giving us a return. We also added new stores in Europe, more so in a quarter than we normally do. We added seven stores in Western Europe. And that adds a fair amount of expense that in Europe is compared to the U.S. They don’t start contributing quite as quickly as the Sally stores do here in the U.S. Now those are pretty much the controllables.

What I want you to keep in mind though this year is on the SG&A line. We’ve said along this year that we were going to have some U.K. distribution issues, the majority of that is behind us, but we still have -- we will have some expenses over the next couple of quarters in the SG&A segment.

And we do have expenses associated with the Sally POS rollout here in the U.S. Which will also be completed in September and then the international ERP system roll out is really just beginning. So there were some expenses in Q2. And that will be with us, in my opinion, for a year. Our IT people say less than that, but we will see.

Meredith Adler - Barclays

Okay. Great. Thank you very much.

Mark Flaherty

Thank you.

Operator

Thank you. And next we gross to the line of Erika Maschmeyer with Baird. Please go ahead.

Erika Maschmeyer - Baird

Thank you, good morning.

Gary Winterhalter

Good morning, Erica.

Erika Maschmeyer - Baird

Just going back to the sales line, I wanted to get your sense for how confident you are in the 3% to 4% back half guidance. I guess why it led you to lower the guidance from what you had implied previously. Is the business trending in that range now? Or do you need improvement in the remainder of the quarter?

Gary Winterhalter

Well, the previous guidance assumed that we hit our guidance in the first half of the year and then a decent or kind of on the strong side of decent second half, would have kept us in that 4% for the year comp range. Given that after two quarters now, we are only at a 1% complaint. I still believe the back half of the year will be in the range that Mark said, which will end up giving us somewhere in the neighborhood of a 2.5% to 3% comp for the year. And I feel fairly confident in that.

When I look at the comps that we’re up against from last year, not only in total but in the certain categories that have been creating problems for us. I think we are on the right track to either anniversarying those issues or solving them, if it is something that we can have more impact on than just competing with a huge increase from last year.

Erika Maschmeyer - Baird

Could you talk a little bit about what you expect to see coming down in the pike in the back half of the year? Is there innovation that you’re excited about, or is it more just that you won’t be cycling some of these big launches from last year?

Gary Winterhalter

It’s a little bit of both. And again, I’ll address the nail category. It seems for the last couple of years and you read this anywhere you look, even en masse and the nail category is just on fire. I think that gelish was the biggest innovation from a technological standpoint that that category has had in years. Now, there are other -- there’s a new polish hitting right now, that is a -- it doesn’t take as long to cure as the gelish and it is much easier to get off.

It doesn’t last quite as long, so it’s kind of like the in between and I think that’s going to have a nice run. It will not -- it will not comp what gelish did. But it’s going to help that category. Now, even without that, we are seeing positive comps in nails and again, it’s on top of 30% and 35% increases this time last year.

Erika Maschmeyer - Baird

No real fundamental slowdown in nails. Just tough comparisons?

Gary Winterhalter

No, not at all. If anything I think more and more women are looking at nails as a fashion expression. You are just seeing it everywhere and it’s not just with us. I have been reading a lot from the mass publications. Drug Store News and some of those and they are all talking about the strength of the category.

Erika Maschmeyer - Baird

Yeah. I have seen that as well. And on the hair extension side, are you still seeing the kind of good demand for the in between price points, the synthetic and natural hair combinations?

Gary Winterhalter

Yeah. We are. Those price pointers are similar to what human hair was, a year or 18 months ago. So it isn’t that those are inexpensive. And there’s a lot of things you cannot do with a blend, because there is synthetic in it, so the human hair category is still very strong. It’s just that the prices have literally doubled in the last 12 to 18 months. So, I think that our, on the sales line will actually start seeing improvement there. On unit growth, it is still going to be negative because of the price points.

Erika Maschmeyer - Baird

That makes sense. Thanks so much.

Gary Winterhalter

You are welcome.

Operator

Thank you. Next, we go to the line of Jason Gere with RBC Capital Markets. Please go ahead.

Jason Gere - RBC Capital Markets

Okay. Thanks. Good morning.

Gary Winterhalter

Good morning, Jason.

Jason Gere - RBC Capital Markets

Hey, a couple of questions. I guess the first one, just going on the topic of SG&A, so obviously we saw a big step up this quarter, but without really any sales leverage there. So I was just wondering as you break down the second quarter, S&A and we think about the back half of the year.

Should we expect to see SG&A come down a percentage of sales? I know you did say there’s some IT, some of the cost there. And there’s still the trickling effect of the U.K. I guess I’m just trying to think about the sales leverage, that we didn’t see -- how material that was really to the second quarter SG&A?

Mark Flaherty

Jason, from the standpoint of -- in terms of total dollars we were up about 3%. From an overall basis point change a lot of it was in areas where, I think, as Gary alluded to is that some of the -- when we saw some slowdowns in previous years. One of the things that we didn’t want to do kind of looking at it in retrospect was slowdown our store growth trajectory over the year, because we found that when we did that, that kind of actually had a double-edged sword to it. As well as the other category that he alluded to which was advertising, because advertising does -- it does have a direct impact to the topline in terms of our CRM efforts in that investment that we make.

So, yeah, there was a little bit of a deleveraging impact in terms of the basis point impact for the quarter. But it was certainly not something that we deemed as material. We also expected throughout the year in the guidance that we gave that we were going to be having some experience of a negative leveraging effect on SG&A throughout the year.

And we kind of gave our initial guidance at the beginning. And a lot of the areas where we have seen that have been very consistent in terms of where they are occurring. Such as the U.K. warehouse and the additional expenses with that as well as our IT initiatives in terms of the POS rollout as well as our ERP initiatives in Europe.

With that said, I think we are on the down side of some of the more heavier negative leveraging events for the quarter and for the remainder of the year. However, there is still some -- there is still some transitional issues in the back half of the year, that certainly will have a bit of a drag, but nothing to the extent that you are seeing in the first half.

Jason Gere - RBC Capital Markets

Okay. If it put it in another way, given that the first half of the year your margins were actually down, are you expecting operating margins to be up for the year? I mean, in the last couple of years you have been delivering over 100 basis points and I do understand that the investments that you are making right now, that benefit obviously the longer term. But as we think about the full year, you are saying gross margin probably close to 50 basis points. Do you think that there still will be operating margin improvement in that and I’m not going to quantify it but in the course of the year?

Mark Flaherty

Yeah. Absolutely. I think that’s given the -- if we get back to those historical levels that we have forecasted for the remainder of the year, certainly the flow through leverage just on the gross margin side, we should still see some modest expansion in our operating earnings.

Jason Gere - RBC Capital Markets

Okay. And then the second question is about the buyback and obviously you started up with the second buyback in there. If you look at your history, once you guys kind of do a buy back, you complete it pretty quickly before the time allotted. So how are you guys thinking about cash flow use right now? Are you thinking, we should continue to buy back stock or the M&A environment out there if there are any distribution opportunities out there on BSG?

Mark Flaherty

Well, first and foremost, the one thing that we have always said and Gary had certainly echoed this frequently is we are going to grow the business. We are going to grow the business organically and certainly as a tool, acquisitions will still be part of the tool kit with which to grow the business. Now, with that said, we have articulated the environment out there is still been pretty quiet, or been for the most part the deals that we have seen are on the smaller side of what we have historically done.

With that said, I don’t see us doing anything out of the ordinary that what we have already articulated, particularly as it relates to our leverage and our financial policy of operating between that two and two and a half times leverage. So, I would say that we should -- you should see a very consistent performance from us. You should see a performance that is consistent with what we have already done and what the Board has already mandated.

Jason Gere - RBC Capital Markets

Okay. And then I just have a housekeeping question here. Just on e-commerce, how is that classified in your numbers? I know some retailers are including in same store-sales. I’m just wondering if could just enlighten us on your policy? Is that built into your three to four and a back half and on that topic, how was e-commerce in the second quarter?

Mark Flaherty

E-commerce is growing very quickly for us but it is still insignificant, less than 1% piece of our business. So you have to keep that in mind and how we treat it. From the beginning, we have wanted our store folks to embrace this. So based on the zip code the order comes from, that order is credited to that store.

So it does affect their comps in a very, very minor way. But it’s always been that way. So I would tell you that the impact on it at this point is almost meaningless. But again, we know that our customers return some products to the stores that they have bought via e-commerce. And the store takes the hit for that return.

And like I said, we have wanted the store people to encourage customers to use our e-commerce site. So you don’t want to have the store people talking negatively about it because it impacts at least in their mind their business, that’s the rationale.

Jason Gere - RBC Capital Markets

Okay. Terrific. Thanks a lot.

Mark Flaherty

You’re welcome.

Operator

Thank you. Next we go to the line of Taposh Bari with Goldman Sachs. Please go a head.

Taposh Bari - Goldman Sachs

Hey, good morning, guys. Gary, I’m having hard time reconciling your comments and the actual comp performance at Sally’s. So if you could just hear me out, your core business you said is about 30%, up strong single digits. The three categories that you keep on referring to, 30% of your business is well, down 1%. Yeah, when I look at Sally’s comps they were down 2%, which tells me that the remaining 40% of the business had to be down more than 1%. So what am I missing there?

Mark Flaherty

Well, first of all, Sally comps were down 1.6%. And secondly, keep in mind that the Sally comp encompasses all of the international businesses. And the comments we are making specific to categories are only relevant to the U.S. and Canada and Mexico because we do not have the systems in Europe to be tracking that.

Now, our European businesses had decent comps for the quarter, mid-to-upper single digits. So that helps the overall Sally comp calculation, but then you can’t apply the comments we make regarding categories because they don’t include Europe.

Taposh Bari - Goldman Sachs

Okay. That’s helpful. Thank you. And then again just sticking on these three categories that seems to be a major area here. How are you thinking about -- how are you planning that business for the second half of the year? So it has gone from up 20 last year to down one year-to-date. How should we be thinking about that business? When you report 3Q and 4Q, where do you expect that to be?

Mark Flaherty

I expect it to be mid to slightly above mid single digits.

Taposh Bari - Goldman Sachs

Okay. And then the second question, I had was just longer term. You have a 4% annualized square footage growth rate, your U.S. businesses fairly saturated roughly, 85% to 90%, based on the comments that you’ve provided in the past. How much of that 4% is actually international square footage growth? And at what point do you expect international to really become -- to really inflect?

Mark Flaherty

Well, I think the international store growth rate is already surpassing the Sally absolute store growth rate. Now, that does include Canada and Mexico as being international and the European business. We are opening more stores in those three areas today than we are in Sally U.S. Quite a bit more. So I don’t know if that answers your question, but it’s already impacting that 4% significantly.

Taposh Bari - Goldman Sachs

So if you are putting up roughly 200 stores per year, how many of those are international?

Mark Flaherty

Well, we are opening 4% on what we have is closer to 165 stores. And you have to first take out about 35 or 40 for BSG. And if you take out another 50 to 55 for Sally U.S., the rest is outside.

Taposh Bari - Goldman Sachs

Okay. And the last one I have for you is, if you care to comment on, how April has shaken out in light of weather normalizing. And then if you could provide how much stock you have acquired subsequent to the second quarter. Thank you.

Mark Flaherty

I’ll comment briefly on April, only by saying that it’s in the range to accomplish the renewed -- or the revised guidance that we have given for the year.

Taposh Bari - Goldman Sachs

Thanks a lot.

Mark Flaherty

You’re welcome.

Operator

Thank you. Next we go to the line of Christopher Ferrara with Bank of America Merrill Lynch. Please go ahead.

Christopher Ferrara - Bank of America Merrill Lynch

Hey. Thanks guys. And I think it’s a good sort of transition into this. So understanding that it’s difficult to predict comps on a quarterly basis, but the three to four you are looking for in the back half of the year, obviously it’s a little bit below the three to five that you have -- into last year viewed as your long term run rate. Does that mean that the difficulty that you experienced in March is already sort of baked into your guidance for the back half of this year?

Mark Flaherty

Definitely. March shipment for full first half is baked into the guidance for the back half.

Christopher Ferrara - Bank of America Merrill Lynch

Right. But I mean, so in other words you are baking in a slowdown in overall beauty in the back half of this year.

Mark Flaherty

Well, what we are saying is we believe we will be in the 3% to 4% range in the back half. And if you combine that with a 1% for the first half, that’s where you come up with the 2.5% to 3%.

Christopher Ferrara - Bank of America Merrill Lynch

Right. I understand the first half drag. But just for the back half, you are looking for three to four, which is below, sort of, what you would view as your long-term compound rate. I guess I’m just wanted to hear why you guided that way?

Gary Winterhalter

Well, I think part of it is when you experience a first half of 1% even though that was mostly expected. It wasn’t quite -- it was a little softer than expected. So obviously we are being a little conservative with the back half of the year. And I think a moment ago 2.5% to 3%.

Mark’s comment there was if we accomplished the 3% to 4% in the back half, we will finish at 2% to 2.5%, which makes more sense if you average the 3%, 3.5% or even 4% with the 1%, you’re going to come out somewhere in the 2.5% range. So the answer to your question is we’re a little cautious on the back half. Although we think that we’ll be much closer to our normal comp range, which you’re right, in the past, has been 4% to 5%.

Now, keep in mind, for the last two fiscal years we’ve significantly exceeded the 4% to 5%. We have been over 6% for two years in a row. I think you need to keep that in mind as well.

And I also think that the each month for the rest of this year gets a little easier. So when I say 3% to 4% in the back half of the year, you may see that closer to the 3% range, on the third quarter. I don’t know. But when I look at last year and I look at what is going on for the specific categories we have been talking about. I believe that Q4 will be a little better than Q3

And by the end of the year, we will have anniversaried most of all of these issues and we should be back to a very normalized comp range. Now, depending on what happens in the second half of the year, we may well tell you that we’re more comfortable in the 4% to the 4% to 5% for next year. It’s too early to say that.

Christopher Ferrara - Bank of America Merrill Lynch

Great. And sort of on that topic, I guess, on the philosophy of how you guide these comps. And again, look, understanding this is a very hard thing to do. But I think, after a long history of sort of underpromising and overdeliverring on comps, the last couple of quarters, the guidance you have given even at the time seemed like it would have been a little bit of a stretch?

And this is the first quarter where it doesn’t necessarily seem that way. So I’m just curious is there any change to how your philosophy is, regarding how you give those comps out. Or are you just, again still calling it as you see it for today and if it is it is higher it is higher and if it’s lower it’s lower?

Gary Winterhalter

I think that’s all you really can do is call, change the way you see them today. And I think we have tried to do that all along. We have been very fortunate, as you mentioned, that our comps have exceeded. But that has also been driven by things that at the time we have made those comments we weren’t even aware of.

When you look at gel polish, for example, I had no idea that it would have this kind of an impact on the whole industry for the last 12 months. And the 12 months prior to that, it was the whole crackle phenomenon. Again, in the nail category, so things happen, in the industry that this industry has a bit of a fashion touch to it. And that you don’t know -- if something comes along in the appliance category that has anywhere near the impact that flat irons had ten years ago.

That category could be up 10% in a year. And it’s our highest ticket category. That could have a significant impact on comps but you just don’t know that until the product is out there. You get some customer acceptance and see what the repeat is going to be.

Christopher Ferrara - Bank of America Merrill Lynch

Got it. Thanks a lot.

Gary Winterhalter

You’re welcome, Chris.

Operator

Thank you. Next we go to the line of Ike Boruchow with Stern Agee. Please go ahead.

Ike Boruchow - Stern Agee

Hey, guys thank you for taking my question.

Gary Winterhalter

Hi.

Ike Boruchow - Stern Agee

You might have already answered this. I hopped on a little late, just based on the comp guide for the back half of the year, obviously there was 80 basis points of deleverage in Q2 on the negative comp .If you were able to guide in that three to four range, would you expect any leverage on SG&A in Q3 and Q4? And is there any difference, just trying to figure out how the SG&As going to flow in through the P&L in the back half?

Mark Flaherty

Ike, as we have said, certainly we’re going to see sequentially an improvement in our leverage of SG&A. However as we have guided for the entire years, given the initiatives that we have had for the year, particularly the U.K. warehouse transition and some of the transition items around that. We’ll still flow through the back half of the year but certainly not to the impact that they have in the first half.

As well as that, we are going to continue our endeavors through our POS roll out in the U.S. side with some of the expenses incurred in terms of rolling out our Sally POS system in the U.S. and the International ERP, which Gary talked about in some of his remarks earlier. That’s kind of just now beginning to lift off over in Europe. And we’ll see some expenses with that as well. That we will have a negative impact but it’s an investment in the business.

And as we’ve said, from the beginning of the year in terms of our guidance, with respect to SG&A is that it would have a little bit of a negative drag on the business for this year. Now, with that said, it’s that, with 3% to 4% comps, you should see some flow through from our drivers in the business from a gross margin standpoint. So from an operating income perspective, you should see some modest expansion.

Ike Boruchow - Stern Agee

Got it. And then when we think to next year, this is clearly somewhat of an investment year for the company. Is there a way to quantify that x amount of millions of dollars went to the investments you made this year and those won’t repeat next year or anyway -- just as we try to think about potential leverage opportunities for next year?

Mark Flaherty

File, I would say it’s a little premature for that conversation. I think that we’re certainly on the drawing board for what is on deck for next year. Also, bear in mind, is that the international ERP project is a multiyear project. In which we are doing some of the largest footprints right now but we still have a larger -- we still have another large piece of the footprint yet to do that would impact the next fiscal year and beyond which is the United Kingdom. So I think that conversation in terms of where that is going to end up landing is still in the planning process and would be a little premature to speculate.

Ike Boruchow - Stern Agee

Okay. Thanks a lot, guys.

Operator

Thank you. Next we go to the line of Linda Bolton Weiser with B. Riley. Please go ahead.

Linda Bolton Weiser - B. Riley

Hi. I was wondering if you could explain a little bit more about the POS system upgrade and how it correlates to the CRM program, because my understanding was that the CRM program is something that goes on forever and you can keep sort of fine tuning it and improving it. Is the POS system upgrade just something to enhance it? Or is it, like, necessary in order to continue to get benefits from the CRM?

Gary Winterhalter

It’s actually both, Linda. It was beyond time to upgrade the POS. system in our stores. But the -- I think the biggest benefit of the upgrade has to do with the Beauty Club Card program, which is what drives the CRM program..

Linda Bolton Weiser - B. Riley

Okay. So I mean, after this is completed, I think you had made some comments before that you think that -- can you actually say you think it will accelerate your same store sales growth? Are you willing to quantify any improvement in growth that result from this once it is all implemented?

Gary Winterhalter

What I’m saying is it gives us the ability to do things that should have a positive impact on our customers that we are using the CRM program with. I’m certainly not going to try to quantify that at this point, simply because I can tell you one thing that our Beauty Club Card renewal rates go up 10% or 12% more not as a percentage, but they will from like 40%, to above 50% in renewal rates with the new system.

So that right there is a benefit, because it’s 10% or 12% on 7 million members a year that you have renewed, which means you’re communicating with that customer and gathering more data on that customer. Than you were before. So that’s a very minor thing. But it’s just one of the things that we can’t quantify at this point.

Linda Bolton Weiser - B. Riley

Great. And then, can I ask you about, like -- the same store sales growth in BSG was actually further below my expectation than the family side. And I’m just wondering if -- sometimes you comment on that you are adding brands, there’s always losing brands, adding brand but can you give us a little color on how that is going. And is that something that’s affecting the same store sales growth in terms of somehow losing more brands than usual or something?

Gary Winterhalter

No. Not at all. I will make a couple comments on BSG same store sales. First of all, maybe you have missed it but they were up 8.7% last year. So they also had a very difficult comp. They also have the same two lost days in sales. That the Sally stores had last year.

And whatever impact weather had, they had the same impact. Now, I will also tell you that I have said for a long time that you have to be careful measuring the BSG business on store comps alone. If you look at many of our quarters, our store comp was higher than our total growth.

What that tells you is the sales consultant piece of the business was negative when that happens. This time, you will see that the growth of the overall business was higher than the comps.

That simply means that our full service or our street business was positive for the quarter which is a good thing. But when that’s positive, you never know how much of that may have shifted from the store to a sales consultant or the sales consultants had some very effective promotions.

And the business, for the most part, it’s shifting toward the store on a very predictable basis but you will see quarters or even months where the full service to sales consultant side of the business does better than the stores. And you kind of got to look at that in both ways because it’s still about 35% of BSG’s business is still being done through sales consultants.

Linda Bolton Weiser - B. Riley

Okay. Thanks.

Gary Winterhalter

You’re welcome Linda.

Operator

Thank you. And next we’ll go to the line of Jill Caruthers with Johnson & Rice. Please go ahead.

Jill Caruthers - Johnson & Rice

Yeah. Kind of a follow up on the last question, you did mention on the BSG side that you are streamlining the sales force and we saw a decline in number of consultants. If you could just talk about that? And then the additional question is just what you are seeing on the industry in that regards of booth renting. Is that still a growing phenomenon?

Mark Flaherty

Yeah. Jill, I’m really glad you asked that question because what our comment in there was a little bit misleading. And I will answer it in a couple of ways. First of all, we are seeing nothing slowing down the booth renting phenomenon. Not only here, but I think it continues to accelerate at a fairly rapid pace in Europe and in the U.K.

What I will say about the reduction of I think it was like 119 sales consultants. The biggest piece of that was our Armstrong McCall division starting to count sales consultants in full-time equivalents. So prior to just -- prior to that they were just counting bodies and some of them were part time. They got counted as a full body. So the majority of that reduction this particular time was due to essentially counting two part timers as a full-time equivalent.

Jill Caruthers- Johnson & Rice

Okay. So no real change in that structure.

Mark Flaherty

It was down but it was down like somewhere between ‘15 and ‘20 actual sales consultants as opposed to the 119 that it appears.

Jill Caruthers - Johnson & Rice

Okay. Appreciate the clarification.

Mark Flaherty

You’re welcome. Thanks again for asking that.

Jill Caruthers - Johnson & Rice

Thank you.

Mark Flaherty

Okay. Obviously, it was a challenging quarter for us here. I think we continued to execute well on the initiatives and our fundamental margin drivers and business drivers are still solid. We were up against some significant comparisons which I have talked about for three quarters now.

Regarding the first half of this fiscal year, we do feel the second half of the year the comparisons get much easier and we think we will end up with a respectable year. Thanks for joining us again. We look forward to talking to all of you soon.

Operator

Thank you, and ladies and gentlemen, this conference will be available for replay after 12 p.m. today until may 16th at midnight. You may access the AT&T Executive Teleconference Replay Service at any time by dialing 1-800-475-6701 and entering the access code of 291272. International dialers may dial 1-320-365-3844. Those numbers are 1-800-475-6701 and 1-320-365-3844 with the access code 291272. That does conclude our conference for today. We thank you for your participation, and you may now disconnect.

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