Sally Beauty Holdings Q4 2007 Earnings Call Transcript

Sally Beauty Holdings, Inc. (SBH)

Q4 2007 Earnings Call

November, 29 2007 11:00 a.m. ET

Executives

Gary G. Winterhalter - President and Chief Executive Officer and Director

David Rea - Senior Vice President and Chief Financial Officer

Greg Coffey - Vice President and Treasurer

Mark Flaherty - Chief Accounting Officer and VP Controller

Sandy Martin – Vice President Investor Relations

Analysts

Greer Martinson - Georgia Bank

Fran Jordan - Wachovia

Linda Weiser - Openheimer

Justin Hott - Bear Stearns

Laura Richardson - DBNT

Reed Kim - Merrill Lynch

Emily Shenks - Lehman Brothers

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the Sally Beauty Holdings Conference Call to discuss the company’s fourth quarter and fiscal year 2007 financial results. (Operator Instructions) Now I would like to turn the call over to Sandy Martin, Vice President of Investor Relations for the company.

Sandy Martin

Thank you. Before we begin I would like to remind you that certain comments including comments including on 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 21E of the Securities Exchange Act of 1934. Many of there forward looking statements can be identified by the use of words such as may, will, should expect, anticipate, estimate, assume, continue, project, plan 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 2007 Annual Report on forms intake [ph 00:06:40]. The Company does not undertake any obligation to publicly update or revise these forward-looking statements. The Company has provided a detailed explanation and reconciliation for these 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, President and Chief Executive Officer, David Rea, Senior Vice President and Chief Financial Officer, Greg Coffey, Vice President and Treasurer, and Mark Flaherty, our new Chief Accounting Officer and VP Controller. Now I would like to turn the call over to Gary.

Gary Winterhalter

Thank you, Sandy, and good morning, everyone. Thank you for joining us for your fourth quarter and fiscal year 2007 earnings call.

Today we reported consolidated net sales for fiscal year 2007 of 2.5 billion, an increase of 5.9% from last year, and constore [ph 00:07:34] sales gains of 4.5 %. Our net earnings for fiscal ‘07 were 44 million or 24 cents per diluted share. The last 12 months have been both exciting and challenging. A year ago we successfully completed the transaction that separated our company from Alberto-Culver. And we began operating as an independent public company.

During this first year, our Sally Beauty Supply business continued its history of strong performance. We also added to our international business with an exciting acquisition. Fiscal ’07 was not however without its share of challenges. In addition to the efforts needed to transition to an independent public company, Beauty Systems Group faced significant challenges in its supplier base.

I’m happy to say that in our first year as a public company, I believe we demonstrated the ability to shift initiatives, right-size the business and retain key employees in BSG. I’m extremely proud of the dedication and hard work of our employees. And despite the difficult year, our team stepped up and delivered solid financial results in fiscal 2007.

For the fourth quarter, ended September 30, consolidated revenues were 640 million, an increase of 5.5% fro the year ago period. And constore sales increased 4.3%. Turning to the segments, Sally Beauty Supplies fourth quarter sales were 411 million, an increase of 14.3% versus the year ago period. And constore sales increased 2.4%.

Sally’s strong top-line performance was primarily attributable to 9.6% of acquisition related revenue, a continuation of new unit expansion and constore sales increases of 2.4%. Sally Beauty Supply achieved strong fourth quarter segment operating margins of 17.4% compared to 15.5 in the year ago quarter. We continue to improve the Sally Beauty Segment profitability through new store openings, successful of higher market products, margin improvements in certain products, and sales growth in certain merchandise categories.

In Fiscal year 2007 sales grew to approximately 1.6 billion in the Sally segment, an increase of 10.4% over the prior year. Similar to the quarter, acquisition related revenues contributed 5.2% and constore sales for the year increased 2.7%. The Sally segment produced operating earnings of 17.4% of sales in fiscal year ’07, an impressive increase over last year’s operating earnings of 16.6%.

We are excited to announce the launch of our Sally e-commerce site, SallyBeauty.com. In this initial phase, we are offering about 50 items on the site, such as professional grade electrical appliances including: hairdryers, electric rollers and specialty irons. We also continue to work on initiatives relating to advertising, our loyalty program and Sally’s CRM program.

We are testing various target marketing to customers based on proved demographic and psycho-graphic profiles that match our best Sally customers. This year we have increased our e-mail marketing reach to 1.6 million customers.

On the BSG side fourth quarter revenues were 229 million, down 18 million from the prior year. Of the estimated 30 million of lost L’Oreal revenues in our DSC channel during the quarter, BSG recovered 12 million primarily from constore sales increases of 10.1%.

We are very pleased with our sales and earnings performance this quarter, especially given the L’Oreal announcement of less than one year ago. We believe BSG will continue to attract brands and expand distribution territories through the execution of our initiatives.

BSG’s operating margins for the fourth quarter were 7.2% of sales compared to 7.8% in the prior year period. For fiscal 2007 BSG’s operating earnings were 65 million or 6.8% of sales versus 9.3% in fiscal ’06. BSG’s earnings in fiscal ’07 declined 23.8 million. This decline was at the low end of the potential range that we discussed with you nine months ago and reflects the dedicated efforts of our BSG team to adapt to a changing competitive environment.

I want to quickly update you on BSG’s recent supplier changes. During the fourth quarter we acquired certain assets and distribution rights from two distributors of Goldwell products, covering nine states. In addition we acquired certain assets from C.B. Sullivan of Texas and were awarded distribution rights for Paul Mitchell products throughout north Texas.

Due to L’Oreal’s announcement of the acquisition of Maly’s West, BSG began distributing Schwarzkopf & Henkel brand in BSG stores and the DSG channel in four western states including California. This follows the Paul Mitchell change from Maly’s announced last quarter.

Also during the fourth quarter BSG began the distribution of P&G’s Wella, Sebastian and Glam web brands in BSG stores in one additional state, Shiseido’s Joy Calyso [ph 00:03:33] in stores and the SBG channel in four states and the TG brand in BSG stores in five states.

Now David will provide additional financial details related to the fourth quarter and year end results for 2007. Then I will discuss our fiscal ’08 business outlook. David.

David Rea

Thanks, Gary. Before I begin, I want to welcome Mark Flaherty, our newest of the finance team. Mark is our Vice President, Chief Accounting Officer and Comptroller. He brings over 20 years experience to the company where his prior responsibilities included senior management positions with two public companies. Welcome, Mark.

Our total net sales for the fourth quarter were 639.7 million an increase of 33.6 million or 5.5 percent over the prior year ago period. FY ’07 consolidated sales were 2.5 billion and increase of 5.9% over fiscal year ’06. In comparative store sales increased 4.5%.

As Gary mentioned our top-line growth for the year was primarily a result of the positive impact of our acquisitions, top-store sales gains and continued unit expansion with a net total of 183 Sally stores, which includes the acquired stores, as well as .6 net stores added for BSG.

Fourth quarter’s consolidated gross profits was 295 million of 46.2% of sales an improvement of 110 basis points form last years 45.1% of sales. For the fiscal year our gross profit totaled approximately 1.2 million and the gross margin and the percent of sales were 45.9% up slightly from 45.8% in fiscal 2006. Those margins in the Sally segment were positively impacted by a continuation of higher sales and exclusive label products which expanded to 40% in US sales in FY ’07.

Also for Sally we experienced marked increases on certain products as well as a continuation of a favorable trend and sales mix. For the fourth quarter, Sally general administrative expenses were 32.9% of sales, an improvement from 33.5% of sales from the year ago period. Last years fourth quarter SG&A included a direct allocated overhead charge of 2.8 million representing expenses from Alberto-Culver after the separation transaction.

SG&A expenses for this year’s fourth quarter included 3 million of share-based compensation compared to 1.1 million in last year’s fourth quarter. In October the company issued new equity awards to employees. And going forward we expect annual equity awards to occur in the first fiscal quarter of each year.

Fourth quarter SG&A expenses also included 1.9 million related to BSG’s retentions in Center Cross [ph 00:06:35]. For fiscal 2007 SG&A cross were 34.1% of sales compared to 33.6% of sales in fiscal 2006. FY ’07 included 13.1 million of which 5.3 million related to early vesting of equity awards from the separation from Alberto-Culver, and 2.6 million was due to an accelerated expense related to certain retirement eligible employees.

For the year SG&A expenses also included a total of 8.6 million of BSG retention incentives for our distributor-sales consultants, as well as right-cycle costs that were necessary following last year’s contractual changes with L’Oreal. In addition, we recorded 1 million of consulting fees for BSG during the first quarter of FY ’07.

Finally fiscal ’07 included a million of direct overhead charges from Alberto-Culver for the period prior to separation. Unallocated corporate overhead costs are included as a component of SG&A expenses and were 84 million for the fiscal year. Unallocated corporate expenses for fiscal year 2007 include a shared service and overhead costs, share-based compensation expenses, and direct allocation expenses for Alberto-Culver up to the time of separation.

For the year, unallocated corporate overhead expenses came in less than previously expected due to lowering the forecasted cost of certain overhead areas, as well as the reclassification of certain corporate expenses to the operating segments. As part of our year-end review process, we reclassified certain expenses that we can now more appropriately identify as belonging to the business unit and prior year results were conformed to current-year presentations in both the corporate overhead area, as well as the operating segments. These changes are reflected in the segment data we provided, schedule B of the press release.

For fiscal year 2008, we currently expect unallocated corporate expenses to be approximately 80 to 85 million which includes approximately 8 million of share-based compensation expenses for the year. By turning to the segments, fourth quarter earnings for Sally Beauty Supply Stores were 71.5 million an increase of 28.3% over the year ago quarter. And operating earnings as a percent of sales were 17.4% compared to 15.5% in the year ago quarter.

Operating earnings for Sally North America Stores continue to improve due to the growth of the number of stores, enhanced profit margins for selling a mix of higher margin products, marked improvement on certain products, and sales growth on certain merchandise categories and customer types.

Our Sally International business also had a strong quarter with nice increases to revenues and margins. Part of this increase was due to approximately 8 million dollars in additional sales in Q4 over Q3 sales with our newly acquired salon services business. This business unit provides cosmetology school kits once per year to students enrolling in a professional cosmetology school.

Notwithstanding the increases in our international business gross margin and operating segment margin improvements in our Sally North America business are somewhat obscured by growth of our Sally International business, which brings our average margin for the entire segment down.

After completing a significant UK acquisition during fiscal ’07, we expect our Sally International business to consolidate infrastructure between Sally UK and Salon services. We see opportunities to improve gross margins, take out costs, and grow our store base with a strong brand name, Sally Salon Services.

For fiscal 2007 Sally USA and Care represented about 84% of segment revenues and Sally International which was primarily the UK represented 16%. Our plan is to improve gross profit and operating margins for our international business over time.

For BSG revenues of 229.1 million were down 17.7 million for the quarter versus last year. BSG segment operating earnings were 16.5 million down 14% form the year ago quarter. However SBG segment operating margins sequentially improved from Q3 and were 7.2% of sales for the quarter versus 7.8% in the prior year’s fourth quarter. For fiscal 2007, BSG sales of 946.4 million were down only 7.4 million from FY ’06 a significant accomplishment given the lost L’Oreal sales through the DFB channel for eight months of the fiscal year.

Operating earnings for fiscal year 2007 were 64.7 million or 6.8% of sales compared to 88.4 million or 9l.3% of segment sales in the 4year ago period. We expect BSG to continue to experience market pressure from the loss exclusivity of L’Oreal revenues. Retention incentives paid to BSG’s for subsidies and guarantees in fiscal ’07 that continue into fiscal ’08 are expected to terminate completely by February ’08.

Fourth interest expenses amount if interest income was 47 million versus 37 million in Q3. For the three months ending September 2007, the company recognized 6.3 million of non-cash interest expense based upon a changing fair value of our interest rate swaps. A reminder, this is the proper GAAP treatment for a swap that does not meet the heavy accounting requirements and the swaps take 500 million of our debt and fix the cash interest expense for the life of the swaps. For the year, interest expense, not of interest income was 146 million, which includes 3 million of non-cash interest expense due to hard market changes in fair value for the swaps.

Our pre-tax earnings for the fourth quarter were 25.8 million and the provision for income tax for Q4 was approximately 9 million. Excluding the impact of the non-deductibility transaction costs related to our separation from Alberto-Culver the company had a 39.2% effective tax rate for fiscal 2007. Net earnings for the quarter were 16.9 million or 9 cents per diluted share. And net earnings for the 12 months ending September 30, 2007 were 24.5 million or 24 cents per diluted share.

In an effort to provide you with other metrics we believe are useful in understanding the results, we have included in the press release a supplemental schedule that provides certain non-GAAP disclosures and reconciles them back to theses numbers back to their equivalent GAAP financial measures. Each quarter we provide an adjusted EBIDAT number which begins with net earnings based upon GAAP, back to depreciation amortization, share-based compensation expenses, Alberto-Culver transaction fees or expenses, net interest expense, and the provision for income taxes discussed above.

Adjusted EBIDAT for the fourth quarter was 88 million a 16.2 million increase compared to the prior year quarter. Fiscal year 2007 adjusted EBIDAT total 309.5 million compared to 293.7 million for fiscal 2006. I did mention that we are extremely proud of the company’s progress this year and the expansion and adjusted EBIDAT of over 5% during a difficult year. Our reconciliation adapted earnings to adjusted EBIDAT is included in the schedules as part of today’s press release.

Turning to our analyst sheet, we paid down 32.5 million of debt during the fourth quarter. Net cash used by investing activities for fiscal 2007 was 121.4 million and includes 76.4 million for acquisitions net of cash. Net capital expenditures for the year totaled 45 million and we currently project fiscal year 2008 cap-backs to be approximately 60 million excluding potential acquisitions.

The $60 million cap-back budget includes about 14 million for our BSG warehouse consolidation project this year with significant savings expected next fiscal year. We also expect to incur approximately 4 million of restructuring expenses related to warehouse consolidation project in fiscal ’08; it will be detailed each quarter.

As discussed in our quarterly calls in fiscal ’07 we worked to tighten working capital. Inventory was a 40 million source of cash in fiscal 2007 after excluding inventory from our acquisitions. Our intentions for cash continue to be, grow the business, invest in new stores, make strategic acquisitions and pay down debt. During the fourth quarter we increased Sally Beauty Supply Store base by 18 net new stores and added 14 net new BSG stores.

Lastly I want to briefly walk you through our liquidity and current financial position. Last quarter we ended with borrowings under the revolving ABF of about 40 million. By the end of Q4 we paid down the ABF to 11 million with approximately 335 million of available buying capacity on the revolver. In addition, we paid down approximately 2 million of Senior Term 'A' Loans and Senior Term 'B' Loans during the fourth quarter.

We ended the fourth quarter with long term debt including capital leases, of about 1.7 billion. Net maturities for FY ’08 of 16.7 million and fiscal years ’09 and ’10 are 24.2 million each year respectively, excluding any potential repayments we made into our excess cash fund under the term loan. Schedule E from our press release has the table of debt maturities excluding capital leases.

Looking that the cash flow statement during fiscal year 2007 the business generated approximately 192 million of net cash provided by operating activities, with about 40 million of that coming from better inventory management. We spent approximately 45 million of that cash on capital expenditures, net of proceeds from the sale of property and equipment and excluding acquisitions. In addition we spent about 76 million on acquisitions primarily related to our Sally International business.

Now Gary will take you through our fiscal 2008 business outlook. Gary.

Gary Winterhalter

As we look into fiscal 2008, I’m optimistic and excited about the overall momentum in our business. On the BSG side as we mentioned earlier, we will be working on our distribution project. We expect to incur some cost associated with this facilities restructuring this year. But I believe this project could save us $10 million beginning next fiscal year. We will provide you with updates on our progress during the coming quarters. On the working capitals front, I was pleased with the progress we made with our inventory management in 2007. I recognize however that this same type of working capital improvement will be much harder to achieve in 2008 in light of the number of product introductions at BSG, as well as the anticipated seating of the new or expended distribution centers.

Having said that, once we are through this process I would expect to see further improvements in this area as we bring more efficiencies to the BSG distribution network. Overall our focus at BSG remains on improving operating margins. Although we expect BSG’s constore sales gains to moderate as we enter strong comps, we also expect segment operating margins for BSG to return toward historical levels during the second half of fiscal ’08 setting aside the cost from the BSG warehouse project.

In addition we plan to continue growing BSG revenues through unit expansions, both stores and BSG’s, brand additions and through potential acquisitions that can provide a revenue stream through added distribution while adding little associated infrastructure costs.

On the Sally side of our business, we are excited about our international expansion opportunities. As a specialty retailer and distributor of professional beauty products, we see tremendous growth opportunities throughout Western Europe. Longer term, we also plan to investigate expansion into several countries throughout South America.

During fiscal year ’08 we will continue integrating our acquisition and seeking to achieve the benefits of combining these businesses. Our goal is to have this business unit perform at approximately a 10% operating margin for 2008. Here in the US where we make the majority of our profits, we believe the Sally Beauty retail concept currently has potential for 3,000 stores. Additionally we continue to roll out stores in Canada and Mexico where we believe there is potential for 250 stores in each of those countries. In fiscal ’08 our store growth plans for Sally Beauty Holding are an increase of 4% to 5%, which we equate to approximately 140 to 180 net new stores, excluding acquisitions.

We ended 2007 with solid performance and are committed to creating shareholder value through increased sales and profitability each year. With that I would like to open the call for questions.

Question-and-Answer Session

Operator

Your first question comes from Greer Martinson of Georgia Bank.

Greer Martinson - Georgia Bank

Good Morning. In terms of the retail space everyone has talked about and consumer pressure, higher energy costs, I was wondering what you’re seeing there for the impact on your target consumers and the outlook going forward?

Gary Winterhalter

Greer, this is Gary. Historically we have not followed retail patterns very closely, we’ve said that many times. Having said that, in our first quarter, which is the holiday season, we do see some seasonality in the electrical category, which is hair dryers and curlers and things like that that are used for gifts. We expect that if overall retail gets very soft this holiday season we could see a little pressure on that particular category.

But our experience and as you see here in our fourth quarter, our comps were pretty good even in a quarter where general retail was starting a down trend. We did see some choppiness in the quarter. We see that often times. We have to keep in mind too, that we’re not on a retail calendar. When we have for example five Sundays in a month, it affects us in a negative way in comps. It’s a little confusing because we generally bounce back the next month, just because the calendar works in our favor.

We haven’t yet seen any significant impact, but as I said, our first quarter, as we’ve said many times in the past, the holiday selling season is the only part of our year that you can say is a little bit seasonal, and it’s primarily driven by that one category.

Greer Martinson - Georgia Bank

Okay. In terms of gross margin’s very strong numbers this quarter, is that kind of the run rate that we should be thinking of? Or was there something else that contributed to that upside?

Gary Winterhalter

As we mentioned here in the script, that we did see a continued slight shift in our customer mix. We saw some nice increase in particular categories that in this particular quarter were hair extensions which are a very strong category for us right now, with very strong margins. We also saw an increase in our control-label brands, which David mentioned, which also helps our margins. It’s kind of across the board, and I think that’s what I’ve been saying all along is that we kind of have three or four things going for us that have a natural enhancement to our margins just because of the nature of the growth of our business.

David Rhea

Just to add to that, if you look over the entire fiscal year there’s a couple of different things going in here. One is the rebound at BSG from Q2 to Q3 to Q4 and some improvements that have occurred there and recovering from the L’Oreal announcement adding in new brand additional revenue. That obviously has a nice impact as that process goes along in the overall segment operating earning margin.

The other thing that Gary mentioned, the continuation of the general trend that has been in place at Sally for the shift toward the retail customer, the additional sales within the control label area and that type of thing. Then as Gary mentioned are our efforts to integrate the Sally International side of the business there. In the fourth quarter as I mentioned there were some additional sales within that particular business segment which helped with the overall margin, about $8 million of revenue there, which is really a once-a-year type of event.

But overall those are the types of things that we would anticipate going into ’08 to see those similar types of trends continuing. Improvements at BSG, improvements at Sally International as we integrate that and the Sally North America side expansion and leveraging our business there.

Greer Martinson - Georgia Bank

Just lastly, if we could quantify some of the brands that you’ve picked up, from Maly’s and the Goldwell KMS, are we talking about $10 million type brands or are we looking above and beyond that?

Gary Winterhalter

Some of them are above that. A lot of them are below that. The important thing ion a lot of these brands that we’re picking up is we don’t really have an acquisition cost to them and when you’re just pumping more volume through an existing infrastructure a lot of that falls through.

Operator

Your next question comes from Fran Jordan of Wachovia.

Fran Jordan - Wachovia

Great, thanks for taking the questions. You talked about seeing the BSG margin improve as the anniversary of the last L’Oreal contract – should we see that happen in the June quarter, when we start to see that margin come back?

David Rhea

As we said what we expect to see is the BSG segment margin work towards the historical levels we’ve had in the past. If you look at ’06, the segment margin for BSG was about 9%. Obviously we were not at that level for this year. But we improved quarter to quarter to quarter during the year. We would hope to see that trend continue and during the second half of fiscal ’08 we hope to see that that would be at those types of levels. That’s what we’re aiming for.

Fran Jordan - Wachovia

Okay, and then you answered some of my question about why we saw a nice improvement in margins, part of it was due to mix in products and a little bit due to acquired international. We heard all that all year, but it seems like it all hit in one quarter. Is there something about this specific quarter that made that all come together for you?

David Rhea

As I said the international thing was a once-a-year event, so that helped on the international. Now understand the fact that we look year over year, having the additional international business in general this year, particularly in Q3 as an example tended to bring the Sally and the Wal-Mart down, the reverse of that is true Q4 with the additional revenues, gross margins et cetera that helped.

We also did some things during the year which had a nice impact to Sally. Some of the initiatives on improving margins on various products had a nice impact on the quarter. We would hope to see that carry through into fiscal ’08 as well. Then as I said on the BSG side it’s really just been a steady march towards refilling the revenues that we lost through L’Oreal with some acquisitions and then adding new brands in.

Operator

Your next question comes from Linda Weiser from Openheimer.

Linda Weiser - Openheimer

Thank you very much. Can you break down the 2.4% Sally same stores sales, maybe you could give us North America then International and the currency translation benefits in the number?

David Rhea

We don’t break down the international versus the US, we haven’t provided that. The figure is without the currency impact, there is none in there.

Linda Weiser - Openheimer

So the 2.4 does that include any currency benefit?

David Rhea

Yes, it’s just on a local currency basis.

Linda Weiser - Openheimer

Can you give some idea as to whether international growth was higher than the domestic, or lower?

David Rhea

It was generally the same type of trends compared to domestic. It tended to be sometimes higher and lower but the same basic trends in the US and International were in place.

Operator

Your next question comes from Justin Hott of Bear Stearns.

Justin Hott - Bear Stearns

Hi, thank you. The first question I have is on BSG, can you give us some idea on the new products that you’ve added in the last year or so, what’s working and not working? Are there any that you’re more particularly excited about? We’ve seen some positive things on Goldwell for example?

Gary Winterhalter

We’re very excited about Goldwell. I think that’s been a sleeper brand in the US because it has not historically had real good distribution and has not had distribution with stores for the moist part. Also, Paul Mitchell is just exploding for us. With them really getting a handle on diverging and driving that down I think it’s helping the professional industry and obviously that helps us.

We are excited about some of TG’s new initiatives. The P&G brands are actually coming back stronger than we experienced with the, two or two and a half years ago before they left. That’s working well for us. Farook continues to be hot particularly in the appliance category, the chi irons are continuing to do well.

We’ve been pretty selective, Justin on the brands that we are getting involved with in a go-forward basis to replace the L’Oreal business. So the ones that we are teaming up with, we feel are good brands and that we have a good future with.

Justin Hott - Bear Stearns

Okay, there are a couple of interesting things about what you said on these brands. The first one, you mentioned adding Schwarzkopf European brand as you expand into Europe. I assume you’d have somewhat of an opportunity there. Secondly you mentioned diversion going down. We’ve seen some recent diversion data, especially with Matrix that looks even worse than we’ve seen before. Can you comment – maybe flesh out those two things?

Gary Winterhalter

We already do a lot of business with Schwarzkopf in the UK and we expect as we continue to expand through Europe that they will be a major partner for us there. And I think we’ll be doing more and more business with Schwarzkopf here in the US. Justin, you may have misunderstood me on diversion I said that Paul Mitchell’s diversion numbers were coming down significantly over the last six months, I did not say that about diversion in general. However I will add to that that the P&G people are doing a nice job bringing down Sebastian diversion, not as dramatically as Paul Mitchell yet, but it is going in the right direction.

The other brands that we are involved with if you look at these diversion numbers, there virtually isn’t any with Goldwell, there isn’t any with Aquage, there’s almost none with Draco and Iso and as I said the Paul Mitchell numbers are coming down dramatically. We’re encouraged that even though diversion in general is getting worse, we’re real disappointed in that the L’Oreal brands are getting much worse, but the brands that our sales consultants are out there promoting today seem to have a very good handle on it. We’re comfortable with them going forward.

Operator

Your next question comes from Laura Richardson from DBNT.

Laura Richardson - DBNT

Hi, I'm trying to get a one name thing to build my model for 2008 and I’m trying to piece together what you said about gross margin related to SG&A expense. Should gross margin extend more next year than SG&A decreases? Because it sounds like you still have some SG&A pressure from the warehouse consolidation and L’Oreal, in the beginning of the year anyway.

David Rhea

As I mentioned at our year-end review we did do some reallocations of corporate overhead to the segments. So as we said we expect the corporate overhead for fiscal ’08 to be between $80 million and $85 million including stock option expense. That’s what we think for modeling purposes, is our expectation for corporate overhead.

With respect to the segment operating margins by area, as we stated within BSG in ’06 the BSG operating margin for the year was approximately 9%. And what we would hope to do is to move BSG’s operation margins toward that 9% during the second half of ’08. Obviously we have a tougher comparison in Q1 ’08 because we haven’t yet anniversied against the loss of the L’Oreal revenues.

On the Sally side, the Sally operation margins were over 17% pr the year. As has happened in prior years with the improvements and sales in our control label area, our efforts to integrate an improve margins on the international business we would hope to see margins in the Sally segment also continue to improve in ’08.

Laura Richardson - DBNT

Within those segments, David, it still sounds to me like probably if you’re looking at gross margin or SG&A you’re getting more benefit in gross margin. It looks like you got a lot more if it in 2007 and it sounds like you should get more in 2008 compared to SG&A.

David Rhea

Year over year if you compare – if that end up being the right range of $80 to $85 million for corporate overhead for fiscal ’08, corporate overhead would effectively be relatively flat from ’07 to ’08, whereas we would hope to see continued improvement of BSG debt margins, and the same for Sally.

Operator

Your next question comes from Reed Kim for Merrill Lynch.

Reed Kim - Merrill Lynch

Good morning, thanks, nice quarter. I was curious within the BSG business if you could help us look at the components per the bond memo last year. I just wanted to update that in terms of looking at what each piece was contributing in the top-line.

Gary Winterhalter

When you say each piece, you mean stores versus sales consultants?

Reed Kim, Merrill Lynch

Exactly.

Gary Winterhalter

It’s up to about two-thirds stores and one-thirds sales consultants.

Reed Kim - Merrill Lynch

Okay, related to that, and then I’ll ask my second question at the same time. In terms of the productivity of your sales force, did that increase sequentially and how much do you think that can increase next year with the new products? And then I guess the last question is just on the acquisition front, if you were to acquire any brands to bring in-house, maybe on a dollar or Dow-multiple basis, how large would we see you go? Thanks.

David Rhea

On the sales consultant question, they continue to get more productive every quarter. Part of it goes back to the right-sizing we did earlier in the year. But also as you add more brands and they have more to sell, their productivity obviously goes up.

I assume with the brand question you’re referring to BSG, at this point we don’t have any plans to purchase any brands. We’re aligned right now with some very large multi-national companies that have great R&D, that have great new product flow. And on the BSG side, we will continue to represent the main brands in our industry. We will however continue to look within the BSG segment for acquisitions related to distribution. So if we can pick up a territory of a brand or brands, distribution rights and not take any, or little associated overhead with that, then that would be nice transaction for us to do to fill in areas within the BSG distribution network and add additional revenues for those DSCs to sell.

Gary Winterhalter

As David said it helps to fill out the DSC bag. But it also brings tremendous to the stores. You’re basically getting more sales without any overhead.

Operator

The next question comes from Emily Shenks of Lehman Brothers.

Emily Shenks - Lehman Brothers

Hi, good morning. Terrific quarter, just a couple of questions, one, can you speak to any trends that you’re seeing on a geographical basis?

David Rhea

I can’t really, but it seems the Florida market is a bit softer than we’ve experienced in the past. I recently saw an article where I think ’06 was the first year since 1920 that Florida actually lost population from the previous year. It isn’t significant. Florida and California continue to be great growth states for us. Again, like our business is not really seasonal, there’s not a whole lot of geographic differences that we notice.

Emily Shenks - Lehman Brothers

Great, that’s what I thought. Then just the final question, when you think about the minimum cash balance that you need to run the business, what’s that amount?

David Rhea

We’re typically around - you see at the end of the quarter, we’re typically around a $25 to $30 million level. When you incorporate the cash in transit and cash that’s oversees, that’s about our typical level.

Operator

You have a follow-up question from Justin Hott.

Justin Hott – Bear Stearns

Yes, when you think about same-store sales in Sally and BSG, can you give us, especially in this economic environment, some indication about traffic versus ticket?

Gary Winterhalter

Sure, before I do, congratulations on your baby.

Justin Hott – Bear Stearns

She’s right here, she’s beautiful.

Gary Winterhalter

That’s great. BSG I think primarily because of the new brands that are available continues to see strong increases in average ticket and customer count. Sally as we’ve said many times in the past, our challenge with Sally for the last several years has been with customer count. That's the primary reason Mike Spinozi was brought in and it’s the primary reason we’re focusing so much attention on CRM programs and loyalty programs and the matching up of the demographic and psycho-graphic target that I mentioned earlier.

I look for Sally’s business to continue seeing average ticket increases. And I expect Sally’s customer count challenges like every retailer out there to continue to be challenging, but that's our focus. Like I said, I think Mike Spinozi’s doing a lot of things that are going to help increase that.

Justin Hott – Bear Stearns

Two real quick ones, One how much control label do you see maybe optimizing out at in Sally, and secondly are you seeing any margin pressure in appliances maybe due to China?

Gary Winterhalter

Actually margins since we’re moving so much of our electrical business to China, or to the Far East, a lot of it is Korea as well, we’re actually seeing an enhancement to our margins which we’ve discussed in the past, as we move a lot of that business there and don’t deal with a lot of the importers that we’ve been dealing with. So I'm not really seeing the margin pressure on electrical there. What was the other part of the question, Justin?

Justin Hott – Bear Stearns

How much control level do you have.

Gary Winterhalter

Right now as David mentioned in his comments we were at 40% in the Sally segment for fiscal ’07, that’s been growing about a point a year for a long, long time. I think it will continue to grow for the foreseeable future, a point or so a year. I don’t know what the top is. I think it could easily get to 50, but I think it could take 7 to 10 years to get there.

David Rhea

If you look within the various categories and we have categories that are well above the 40% and we have others that are well below that. So obviously we’re looking to see where we can take the other categories that are blow the 40% and increase them. We’re seeing some of that through our Ion product.

Justin Hott – Bear Stearns

Okay, thank you.

Operator

You have a follow-up question from Laura Richardson.

Laura Richardson - DBNT

Yes, thanks. I saw a 10% off Sally coupon around Thanksgiving. Is that something you do every year, if not why would it be done this year?

Gary Winterhalter

We do a lot of different promotions, but in particular over the Thanksgiving holiday we did a 10% return coupon for a customer who’d come back in December. We do that a lot. We also do a lot of e-mail to existing Beauty Club Card holders to come in at certain times of the year, or different specials. Yes, it’s a common practice for us to either use it to try and get a repeat visit in the short term like we did over the Thanksgiving holiday to come back in December, or for our e-mail communications with our customers.

Laura Richardson - DBNT

Okay, thanks on that. Then I also want to ask on the cost for the BSG warehouse consolidation, did I hear you say 4 million for the year of expense?

David Rhea

Yes the entire capital project cost is 19 million, so 14 million of that $19 million capital left for fiscal ’08. Then What we said was that we expect to have about $4 million of operating expenses in restructuring charges associated with that project during ’08 and we’ll be talking about those as and if they occur during ’08.

Laura Richardson - DBNT

Okay and those are going to be in the segment operating profit for BSG.

David Rhea

Yes, just like this year when we had the BSG restructuring and some of the charges there, those fall under the BSG earning segment. So these would also fall into the segment and we’ll be providing those for you.

Laura Richardson - DBNT

Okay and do you have any idea now how that’s going to flow? Like a million a quarter or-?

David Rhea

I believe they’re, yes, really throughout the year, but probably more in Q2 and Q3 type thing.

Laura Richardson - DBNT

Okay, thanks a lot.

Operator

You have a follow-up question from Linda Weiser.

Linda Weiser - Openheimer

Yes, thanks, can you just remind us what you said about how much of the $10 million in cost savings from the DC consolidation will occur in FY ’08?

David Rhea

Not much of it, really, it’s more in the following years we said4 in our remarks. It’s mostly in FY ’09 we expect to achieve that. We may get some of that but it’s really a project that won’t be fully implemented and won’t achieve some of the benefits of that until we get towards the end of the year.

Linda Weiser - Openheimer

Okay, thanks.

Operator

There are no further questions at this time.

Sandy Martin

Thank you for your interesting company and have a safe and happy holiday this year.

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