Jeff Harkins - Sally Beauty Holdings, Inc. Christian A. Brickman - Sally Beauty Holdings, Inc. Donald T. Grimes - Sally Beauty Holdings, Inc..

Rupesh Parikh - Oppenheimer & Co., Inc. Mark R. Altschwager - Robert W. Baird & Co. Inc. Oliver Chen - Cowen & Co. LLC Jason M. Gere - KeyBanc Capital Markets, Inc. Linda Bolton Weiser - D.A. Davidson & Co.

William Michael Reuter - Bank of America Merrill Lynch Carla Casella - JPMorgan Securities LLC Simeon Avram Siegel - Nomura Securities Stephanie Wissink - Jefferies LLC Simeon Ari Gutman - Morgan Stanley & Co. LLC Lauren Frasch - Wells Fargo Securities LLC.

Ladies and gentlemen, thank you for standing by and welcome to the Fiscal 2017 Fourth Quarter Earnings Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session; instructions will be given to you at that time. And as a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Jeff Harkins, Vice President of Investor Relations for Sally Beauty. Please go ahead..

Thank you, Cynthia. 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 21E of the Securities Exchange Act of 1934.

Many of these forward looking statements can be identified by the use of words such as may, will, should, expect, anticipate, estimate, assume, continue, project, plan, believe, and similar words or phrases. These statements are subject to a number of factors that could cause actual results to differ materially from expectations.

Those factors are described in Sally Beauty Holdings' filings with the Securities and Exchange Commission including its most recent Annual Report on Form 10-K. The company does not undertake any obligation to publicly update or revise its forward looking statements.

The company has provided a detailed explanation and reconciliations of its adjusting items and non-GAAP financial measures in its earnings press release and on its website. With me on the call today are Chris Brickman, President and Chief Executive Officer; and Don Grimes, Senior Vice President, Chief Financial Officer, and Chief Operations Officer.

Now, I would like to turn the call over to Chris..

Thank you, Jeff, and good morning, everyone. Thank you for joining us for our 2017 fourth quarter earnings call. First, I will provide a brief overview of our performance for the quarter and review the progress we have made on our strategic initiatives. Don will then discuss our fourth quarter and full year results in more detail.

Even after considering the impact of the natural disasters in the quarter, which impacted August and September, our fourth quarter sales fell short of our expectations. We experienced a slight decrease in revenue and essentially flat gross margin.

However, we benefited from the savings from our previously announced restructuring plan, the recent debt refinancing, and share repurchase activity to still deliver meaningful growth in adjusted earnings per share.

We will continue to execute our balanced approach to managing our business in a challenging retail environment, which combines long-term strategic investments with an intense focus on operating discipline and organizational efficiencies.

As you know, earlier this year, we recognized the need to right-size our cost structure in light of the current retail environment and launched a restructuring and cost reduction initiative with the goal of lowering our full year 2017 operating expenses.

We have continued to execute against these initiatives, resulting in almost flat adjusted operating expenses for the quarter and full year despite growth in our total store base and the continuing impact of wage inflation in our stores and distribution centers.

In addition, we announced this morning the commencement of an international restructuring plan focused on significantly improving the profitability of our international businesses, with particular focus on our European operations.

In support of this initiative, we expect to incur restructuring charges in the range of $12 million to $14 million with approximately $10 million to be recorded in fiscal 2018, and we expect to realize annualized benefits in the range of approximately $12 million to $14 million from the initiative with a benefit of approximately $8 million realized in fiscal year 2018.

Regarding our long-term strategic investments, in fiscal 2018, we plan to accelerate our investment and our e-commerce capabilities, with the goal of providing two-day delivery to more than 90% of U.S. households by the end of Q2.

We believe this will significantly improve the customer experience and improve conversion, which today is well below comparable benchmarks. In addition, we intend to embark on the implementation of a new merchandising and supply chain platform, consisting of several modules that will be phased-in over the next few years.

This important capital project will add several benefits, including increased sales from a more tailored product assortment and meaningfully lower out-of-stock inventory, gross margin expansion from reduced inventory obsolescence, and lower inventory levels from better visibility and forecasting capabilities.

Finally, BSG will be implementing a new point-of-sale system in the latter part of fiscal year 2018 that will improve the customer store experience, enhance our CRM and marketing efforts, and allow for EMV-compliant credit card processing. In both our Sally and BSG segments, we executed on many of our core initiatives during the quarter.

With respect to pricing, we are always trying to balance being promotional to drive short-term sales with a focus on maximizing gross profit for the long term. For Sally, in the fourth quarter, benefits from zone and tactical pricing contributed to consolidated gross margin expansion of 10 basis points.

The BSG pricing initiatives were launched late in the fiscal third quarter and contributed gross margin expansion of 10 basis points in the fourth quarter with expectations of continued full-year gross margin improvement in fiscal year 2018.

I'll now spend a few minutes focused on the unique strategies designed to drive growth in each of our core business segments. In Sally, we plan to reinvest some of the margin we have captured through price increases, as well as additional vendor support, in order to be more competitive on SKUs that overlap with mass competitors.

We believe that lowering prices on these select SKUs will reinforce our value position with customers. We are implementing this change now, prior to the holiday shopping session, and they will be prominently communicated in our stores and communication materials.

This will not change the depth or frequency of our promotional strategy designed to deliver value and drive traffic throughout the year. We also continue to focus on innovation as a means to drive top line growth in our domestic Sally stores.

We are excited to be launching COL-LAB this month, a new cosmetic line jointly developed with Sally and several influential beauty bloggers. Beyond this, we will also be launching a vibrant new color line, Arctic Fox, an easy-to-apply professional line that is backed by a major social media influence.

Other launches planned for this year including important new vibrant color line developed by Cody, a new appliance launch which will bring BaByliss tools to Sally for the first time, a new professional hair care line, and a new multicultural hair care brand, (07:48) In addition, we will continue to monitor the test of our loyalty program in approximately 300 stores in Florida and Georgia.

The primary goals of this test file are twofold. First, we want to transition current Beauty Card Club members to the new program without disruption. Second, we want to increase traffic over time by acquiring more loyalty members and engaging with them on a regular basis via email and direct mail communications.

While we are encouraged by the positive feedback received from our customers and associates indicating that the move from a pay-for-discount program to a rewards-based program has been relatively seamless, early learnings have revealed that we need to refine and improve the communication to our customers and training for our associates in order to drive more traffic.

Additionally, in December, we will be adding a parallel program for the professional customer in the test stores. This customer was largely neglected in the first phase, and we plan to fix this going forward.

Over the first half of fiscal year 2018, we will continue to assess and refine the test pilot before making a final decision regarding rolling the program to all North America Sally stores.

Beyond our CRM and loyalty efforts, we continue to refine our integrated marketing approach so that we can deliver a clear and compelling value messages across all marketing vehicles to drive traffic to our stores.

As previously mentioned, we have developed a calendar of events that extends throughout 2018 in order to align with vendors and integrate the message across all marketing mediums and store materials.

In order to expand the impact of this approach, we are leveraging the power of DIY social media beauty influencers who will share Sally's value proposition, creating a low-cost customer acquisition strategy.

To engage and educate these beauty influencers, we have been hosting blogger events in major cities across the country, including events already held in Atlanta, New Orleans, Chicago, Washington D.C., and at Beautycon in Los Angeles which reached millions of beauty enthusiasts.

The fun atmosphere of these events, along with the educational beauty tutorials and free products, encourages live postings and increases our social media presence. We are excited about the prospects of this viral marketing campaign, and intend to host regular events going forward, including upcoming events in New York and Dallas.

We also continue to utilize our girlfriend-in-the-know selling model which is designed to create a genuine connection between customers and associates.

By actively and authentically engaging customers, our sales representatives are able to appeal to new shoppers and inspire loyalty in existing customers, which we believe will drive increased customer conversion and a higher average ticket value.

In addition to the e-commerce delivery investments I mentioned earlier, we are testing new programs aimed at raising awareness of Sally's brand and reaching new customers that currently don't shop our stores. For example, we continue to partner with Amazon Prime Now to test a two-hour delivery model in Dallas.

There has historically been very little overlap between the Amazon Prime Now's customers and Sally's existing customers. And while we hope to attract new customers to this – and we hope to attract new customers to this rapid delivery model.

While the program is still undergoing testing, we plan to work with Amazon to include Sally in Prime Now in other metropolitan cities in the future.

The objective of the investment to achieve two-day delivery for our online customers and the testing of same-day delivery with Amazon is to increase customer access, and we plan to build on this omnichannel journey going forward.

We have a great portfolio of own brands that differentiate us from the competition, but we clearly need to make them more accessible for consumers.

Now, turning to BSG; as you're aware, our BSG business is the leading distributor of professional beauty products in the U.S., and the CosmoProf brand is a trusted partner for the vast majority of beauty professionals. As one stylist recently put it, CosmoProf is to stylist what Nike is to athletes.

Given this strong strategic position, it is not so surprising that both revenue and traffic were up when compared to the prior year's quarter even with the negative impact of the hurricanes. In addition, operating earnings were up over a prior year driven by sales growth and gross margin expansion.

In support of its leading position, the BSG team continues to drive top line growth by winning exciting new brands. For example, Celeb Luxury, Puff.ME, Mydentity, Babe Lash and ColorProof continue to drive additional sales since being introduced over the last few quarters.

New products and brands are lifeblood of the industry, and we will continue to work with our vendor partners on new brand development and acquisition while pruning slower moving lines and SKUs in order to deploy our working capital more efficiently.

In order to efficiently market these brands, BSG has worked to develop a community of social media influencers in the professional beauty space. In 2017, we launched our first CosmoProf Artistic Team made up of major influencers with broad followership within the hair and beauty community.

In 2018, we will be expanding this team to broaden our social media reach and impact. We believe this investment gives us and our brand partners the loudest voice and greatest reach within a stylist community that uses social media as the primary vehicle for sharing ideas and designs, recruiting new customers, and learning new techniques.

Meanwhile, our CosmoProf mobile app continues to experience solid growth in the number of downloads and active users, as well as garnering positive feedback from professional stylists. Additionally, we successfully launched the app in Canada during the month of July.

We now have the capability to push notifications, and we are developing an iPad version of the app in order to improve usability for the stylist.

On the CRM front, we continue to build our email database to drive incremental traffic and sales by targeting promotions to specific customers in large quantities in order to drive customers to our website and our stores. To summarize, we made solid progress in the fourth quarter, but we can do better.

And we are confident that the strategic actions we continue to take should enable us to run the business more efficiently and position us for future success. Now, I will turn the call over to Don to discuss the results in more detail..

Thank you, Chris, and good morning, everyone. As Chris noted, even after considering the impact of natural disasters, the fourth quarter's revenue result did not meet our expectations.

However, we believe the steps we are taking to run the business more efficiently, including the international restructuring plan announced today, will enable us to fund many of the important strategic initiatives that Chris just discussed.

And we believe the successful execution of these initiatives will position us well going forward into fiscal 2018 and beyond. Turning to some of the details of the quarter. Consolidated revenue was $974.2 million in the quarter, a very slight 0.2% decrease versus the prior year, and same-store sales decreased 1.4% in the quarter.

Hurricanes Harvey, Irma, and Maria resulted in a number of store closures from late August through the end of our fiscal year. The negative impact of the hurricanes on both sales growth and same-store sales growth was approximately 80 basis points.

Additionally, foreign currency translation had a favorable impact of approximately 60 basis points on reported revenue growth. Gross margin in the quarter was 49.5%, essentially flat to the prior year.

The margin in the quarter benefited from both tactical and strategic pricing initiatives in both segments, and a favorable shift in customer mix in the Sally segment, but those benefit essentially offset by unfavorable shift in segment mix.

Adjusted selling, general, and administrative expenses excluding depreciation and amortization expense were $333.9 million in the quarter, almost flat versus the prior year, as benefits from the restructuring plan we announced earlier in the fiscal year focused primarily in North American operation were offset by a higher labor and occupancy costs associated with the net increase in the store count and negative foreign exchange translation.

Adjusted operating earnings and adjusted operating margin, which excludes the $8.4 million of restructuring charges related to the 2017 Restructuring Plan, were $120.2 million and 12.3%, respectively, down slightly compared to the prior year's adjusted operating earnings and adjusted operating margin.

The hurricanes negatively impacted operating earnings by approximately $7.7 million representing both the impact of loss revenue from store closures and costs related to both inventory write-off and asset impairment. Adjusted diluted earnings were $0.45 per share, growth of 9.8% compared to the prior year's $0.41 per share.

The hurricanes negatively impacted both reported and adjusted diluted earnings per share by approximately $0.03. We were very pleased to deliver such strong growth in earnings per share in a continued challenging retail environment, which was exacerbated by the impact of the hurricanes.

We deployed our free cash flow to repurchase a total of 3 million shares during the quarter, at an aggregate cost of approximately $59.5 million. Share repurchases for the full fiscal year were 16 million shares at a cost of approximately $346.1 million.

Inventory at quarter-end was $930.9 million, up 2.6% versus the prior year, reflecting 31 additional new stores, the addition of new brand, and the impact of a weaker U.S. dollar. For the full fiscal year, consolidated net sales were $3.94 billion, a decrease of 0.4%, and same-store sales declined 0.7%.

The hurricanes negatively impacted both full-year sales growth and full-year same-store sales growth by approximately 20 basis points. Foreign currency translation had a negative impact of approximately 80 basis points on full-year consolidated sales growth.

In addition, an extra day of selling in fiscal year 2016, which was a leap year, negatively impact its full-year consolidated sales growth and same-store sales growth in fiscal year 2017 by approximately 40 basis points. Reported diluted earnings for the full fiscal year were $1.56 per share, growth of 4% compared to the prior year.

Adjusted diluted earnings in fiscal 2017 were $1.80 per share, growth of 4.7% compared to the prior year. The hurricanes negatively impacted both reported and adjusted diluted earnings per share in the fiscal year by approximately $0.03.

Turning to segment performance; in the fourth quarter, our Sally Beauty segment generated revenue of $584.4 million, a decrease of 0.8% from the prior-year period. Foreign currency translation boosted the segment's revenue of growth in the quarter by 80 basis points.

Reported same-store sales decreased 2.5% with the hurricanes contributing approximately 90 basis points of the decline. Gross margin the segment was up 10 basis points to 55.1% due primarily to strategic pricing initiatives and a favorable shift in the customer mix between retail and professionals in the United States.

Operating earnings were $91.2 point million, a decrease of 7% versus the prior year. Operating earnings were negatively impacted by the sales decline and inventory write-off and repairs related to the hurricanes. Operating margin was 15.6%, a 100-basis-point decrease from the prior year.

Now, turning to our Beauty Systems Group segment; BSG revenue in the quarter was $389.8 million, up 0.7% versus the prior year, driven by growth in same-store sales, incremental sales from acquisitions, and an increase of 30 net new stores, partially offset by the negative impact from the hurricanes.

Foreign currency translation increased BSG's revenue growth by approximately 30 basis points. Reported same-store sales grew 1%, including a negative impact from the hurricanes of 40 basis points. BSG's gross margin was up 10 basis points to 41.2% in the quarter, driven by the benefits from strategic pricing initiatives.

Operating earnings for BSG were $61.1 million, up 0.4% from the prior year, driven by the modest revenue growth and gross margin improvement. Operating margin in the quarter was 15.7%, essentially flat to the prior year. We completed our 2017 Restructuring Plan during the fourth quarter.

As noted earlier, we recorded $8.4 million in restructuring charges in the quarter, bringing the full-year restructuring charges to $22.7 million. We now estimate annualized benefits from the 2017 Restructuring Plan of approximately $20 million, representing an excellent financial return.

We recognized approximately $10 million of the benefits from 2017 Restructuring Plan in fiscal 2017. The total restructuring charges ended up in excess of our previous guidance due primarily to costs associated with the planned strategic store optimization of the Sally U.S.

footprint that was accelerated into the fourth quarter, costs associated with the revised approach to our Loxa e-commerce site, and the closure of an unprofitable CosmoProf store in Mexico.

As noted our last earnings call, we did a lot of the heavy lifting in the third quarter to effect a debt refinancing that wasn't finalized until early in our fiscal fourth quarter. This refinancing provides additional operating flexibility, while also lowering our overall cost of debt.

More specifically, on July 6, we redeemed $850 million of our 5.75% senior notes due 2022. We funded the redemption by entering into a seven-year lower cost $850 million institutional term loan.

The new term loan is comprised of a $300 million fixed rate tranche bearing interest at 4.5% and a $550 million floating rate tranche that will bear interest at LIBOR plus a spread of 250 basis points, or 3.75% on the day the deal closed.

The financing environment is still favorable to borrowers, so we were able to negotiate a covenant-lite deal that in many respects mirrors our remaining high yield notes indentures.

In order to protect our downside on the floating rate debt, we also purchased interest rate caps to come into play if LIBOR exceeds 3%, which means the worst-case scenario on a floating rate debt is an all-in cost of 5.5%, which is still lower than the cost of the high yield notes that were redeemed.

In addition to the new term loan, we simultaneously amended and extended our $500 million ABL credit agreement. The amended five-year agreement provides us with improved pricing and a greater margin of flexibility with respect to financial covenants.

Turning to guidance for fiscal year 2018, we expect both a continued challenge in retail environment in the U.S. and a lingering impact from the hurricane particularly from Hurricane Maria in Puerto Rico in the first half of the fiscal year.

As such, we expect full-year consolidated same-store sales to be approximately flat with more challenging comparisons in the first half of the fiscal year versus the second half of fiscal year.

More specifically, including the impact of the hurricane, we expect same-store sales to decline approximately 1.5% in the first quarter before turning positive against easier comparisons in the second quarter.

Additionally, we also expect a number of new store openings to be offset by strategic store closures, resulting in approximately flat net store count versus the prior year.

Full-year gross margin is expected to expand approximately 10 basis points, driven by strategic pricing initiatives in both segment, a continuing favorable customer mix shift in the Sally U.S. business, and an increase in vendor allowances, only partially offset by unfavorable segment mix shift and modest pricing adjustment in the Sally U.S.

business typically on low velocity SKUs designed to support the brand's value proposition.

Full-year SG&A, including depreciation and amortization expense, is expected to be approximately 37.7% versus 37.2% in fiscal year 2017, reflecting the operating expense impact of key investments to accelerate e-commerce growth, investments in both the new inventory merchandising and planning systems to support the U.S.

and Canadian businesses and the new point-of-sale system for our BSG business, continued installation in both store and distribution center wages, and the expectation of a normalized level of incentive compensation expense in fiscal 2018, all partially offset by benefits from both the 2017 Restructuring Plan and the international restructuring plan that Chris discussed earlier.

Capital expenditure for fiscal 2018, including the investments behind the strategic initiatives noted earlier, are expected to be approximately $110 million. Reported operating earnings are expected to increase slightly due primarily to lower restructuring cost in fiscal year 2018.

Adjusted operating earnings, including the impact of the hurricanes in both years, are expected to decline slightly due to the strategic investments just noted.

However, we expect full year benefits from our recent debt refinancing and lower average share count to result in solid growth in both full year reported diluted earnings per share and full year adjusted diluted earnings per share.

While working to execute important strategic initiatives, including the test of the new Sally loyalty program, a more effective social media-based marketing platform, compelling new product introductions, a refined promotional strategy, and the implementation of the new BSG point-of-sale system and new merchandise and supply chain platform, we will continue to seek opportunities to run our business more efficiently, both within our own organization be in more productive partnerships with outside service providers.

Thank you for your time this morning. Now, I'd like to turn the call back over to the operator for Chris and I to take your question..

Thank you. Our first question will come from the line of Rupesh Parikh with Oppenheimer. Your line is open..

Good morning and thanks for taking my question. So, I wanted to touch on the BSG segment. Trends again slowed this quarter even with a much easier comparison.

Just want to get a sense, from your vantage point, what you guys are seeing out there in terms of what could be driving that slowing, and if there's any changes on the competitive front? Thank you..

Thanks, Rupesh. What I would say is this, which is, we tripped over our shoelaces a bit in the BSG segment, and we've been pretty transparent about that.

If you look at the core categories in BSG, color and care, we've seen strong growth throughout the year; a little hiccup around the election and the inauguration, but overall strong growth throughout the year.

The reality is, the miss in BSG was really associated with the promotional category where almost a year ago, the team cut back dramatically on funded bundled promotions from vendors in order to reduce obsolete inventory. The problem was they cut back too far; we let the pendulum swing too far. We've made changes to our team in merchandising in BSG.

We've been working for the last six months on trying to get that back on track. And, in fact, in November it's turned positive for the first time in the year. So, I feel quite confident in the environment. BSG is in a great strategic position.

I think it's ill-conceived to think that it's somehow eroding like the rest of retail; it's a very differentiated business with great scale in its segment. And the reality is, we just need to fix some of the things and the mistakes we made..

And I guess related to BSG too, there's been some chatter out there like Amazon has been getting some of the products that may have been exclusive before.

Just any thoughts in terms of, I guess, what you guys are seeing for your exclusive products and if any changes versus the past?.

No. I mean, it's really – on the retail side, so these professional brands obviously do sell at retail both in salons, at Ulta, and now at Amazon, and you're seeing channel shift in the retail side. We're just not seeing it on the wholesale side..

Okay. Great. And then my last question, just on e-commerce, if you look at the growth in e-commerce going forward, do you have a vision in terms of how big e-commerce could become for the Sally Beauty segment? And I just want to also get a sense of how you're thinking about profitability for that business..

I don't want to set unrealistic targets, but we think it needs to be much bigger, multiples of where it's at today. The reality is our conversion levels are well below comparables, and they're multiples below.

We think the investment we're making right now to get to 90% of the country covered by two-day delivery by the second quarter should really help us improve those conversion levels. And so, we're expecting big growth going forward.

That being said, historically, the profitability at e-com has been a little lower, it's been more focused on equipment and segment business. We need to shift that to more of our core categories, and we think profitability will improve with that. It is profitable, but it needs to be more profitable.

And we also think it will help, as we shift distribution to multiple shipping points instead of shipping it all out of Dallas as we've been doing as we end up with four shipping points by the second quarter that should dramatically reduce our cost as well..

Rupesh, this is Don; both delivery cost itself as well as the picking cost. The picking cost in the one facility where we have gone live is about half of what it was in our Denton, Texas facility. So, that in and of itself will improve the profitability of the e-com business.

And then to the first part of your question, our most heavily penetrated region for e-com is in the UK where we're in a high single-digit penetration rate, and we would expect the U.S. business to trend towards that in the short to medium term rather than the long term..

Thank you and best of luck with your efforts..

Thanks..

Thank you. Our next question will come from the line of Mark Altschwager with Baird. Your line is open..

Great. Good morning. Thanks for taking the question. Just on the sales line, I mean, excluding the hurricane impact, comps came in below your expectation.

As you look at some of the strategic priorities on the top line – the social media-based marketing, product intros, refined promotions – where do you think you're seeing benefit at this point, where do you think you're seeing less traction? I think you said a down 1.5% comp is what you're expecting for the first quarter which doesn't presume much change from Q4 despite some of the hurricane headwinds abating, so just trying to have a better understanding of how you're thinking about the puts and takes driving the comp into next year..

So, let me start that and then I'll let Don chip in. There is a fairly significant amount of impact on Puerto Rico on the Sally business in Q1. And then, hopefully, that will begin to dissipate as we go throughout the year. As you may know, Mark, Puerto Rico is a fairly large portion of our Sally business, larger than most retailers.

So, that does create a bit of a headwind in Q1. Our feeling is obviously we've gone through significant leadership change and change in strategy in Sally over the course of the year.

I think we're just now beginning to see some of these initiatives come to fruition, both our e-commerce initiatives, our focus on pricing and trying to get more competitive on the overlapping SKUs which we're going to make a pretty big deal out of in the coming days and weeks, as well as some of the new brands that are launching in our core categories like color and tools.

So, I think we're going to make a lot of progress this year in improving Sally. The reality is, there's clearly some missteps both on the marketing front and other front and some disruption that occurred associated with the leadership change. That being said, I'm really excited about the team that's there right now.

So, yeah, given that, I think we're starting to get some real traction and that should build throughout the year. And Don, I'll let you talk about Q1..

I will just add a little color on the expectation for Q1 comps. We're actually expecting more of an impact in Q1 from the hurricanes, the lingering impact of the hurricanes particularly in Puerto Rico than we experienced from all three hurricanes in Q4.

So, it's about – we're estimating about double the negative revenue impact from the hurricanes in the first quarter which is contributing to that outlook for a minus 1.5% comp. But we won't have the inventory write-off and asset impairment charge that we had in Q4 in Q1; just, it's more of a revenue and gross profit impact..

That's helpful color. Thank you. And then, Don, just any update on your plans for inventory.

Are you targeting reductions this year, and what would be the impact there on vendor allowances?.

Yeah. We're driving the teams hard to improve inventory turnover. We have some antiquated systems, the investment that Chris talked about in his remarks on the new inventory planning and allocation system.

One of the biggest financial benefits from that is a kind of a permanent reduction in inventory as you have better inventory visibility and forecasting capabilities. We won't start to see the benefits of that until late in fiscal 2018, early fiscal 2019.

Having said that, Chris also mentioned new leadership on the BSG merchandising team, and we are clearly working hard to bring in less of the wrong inventory and more of the right inventory to improve fill rates.

And there's an impact, and there's – if you purchase less, there could be a negative impact on vendor allowances, so we are working hard with our vendors to reallocate dollars and increase in vendor allowances is one component to our outlook for gross margin in fiscal 2018, and that applies not just to BSG but to the Sally business globally..

That's great. Thank you. Best of luck..

Thanks, Mark.

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

Hi. Thank you. Our first question was regarding the Amazon Prime Now relationship. So, which factors are you monitoring as this unfolds, and what are your thoughts on different scenarios? Also curious if there's any interesting findings with respect to the category dynamics and the types of demographics. It sounds like there's attractively less overlap.

And our next question is just about the loyalty program. If you could speak to what she's looking for in this program and early learnings here as we look forward to more developments here? Thank you..

So, let me hit both of those, Oliver. The Prime Now relationship, our number one thing we were looking at was overlap with our customer base to make sure that the sales were incremental given the cost of same-day delivery, obviously. And what we've found thus far is that there's virtually no or very little overlap with our current customer base.

So, given that, we are excited about it. It's done well in the stores we've implemented. We would be pursuing expanding that and, obviously, there's other priorities for Amazon, and so we'll work with them as well as their capacity allows them to expand that.

The other side I would say in terms of categories, you mentioned there, it does tend to be a little more heavily focused to cosmetics than our overall business, which is fine with us. We've been expanding that category. But other than that, it's not radically different than what we see in terms of other orders.

It just tends to skew a little bit more towards cosmetics than our average sale. On loyalty, I think, the reality is again, as we mentioned earlier, number one is, let's make sure we're not aggravating customers with the change. We're not seeing that.

We are seeing significant increase in sign-ups into the program which allows us to obviously digitally communicate to a much larger group of customers. So, we've seen a big increase in the percentage of customers who sign up the program obviously because it's free. So that's the positive side.

What we're not seeing yet is a sufficient incremental traffic such that it obviously pays back the loss of the card revenue.

And I think some of that is communication, some of that is the way the rewards are delivered and communicated, some of that was the lack of a professional tier because they were excluded from the program, and we're addressing those issues now. A lot of that work's going in now and December.

Our hope is that we're going to continue to close the gap in terms of overall payback on the program, but we've got to continue to refine it before we'll be ready to do that..

Okay.

And a final question is a relevant question we're getting from investors in relation to just your overall view of real estate and store count, and what's happening with rent expense, and as you think about different flexible options and how different dynamics are playing out with digital versus physical, would love your thoughts on what we should focus on for your strategies..

So on real estate, let's start the rent inflation part, that's obviously diminishing quickly. It's still positive but slightly positive at this point. Our hope would be to continue to drive rent inflation down. Our expectation is that that's possible.

In terms of our store footprint, what you're seeing is we're net negative in the Sally segment that we are still opening a few stores but our strategic closures have exceeded our net new openings; whereas BSG continues to be positive as it gains share and gains new brands and then internationally we're still opening some stores; and the net of all of that is roughly flat.

I think that's where we see we're likely to be. If e-commerce suddenly changed the game, if we've got tremendous growth in e-commerce here in the coming years as we improve our service levels, obviously that could change the game in some extent or that might allow us to just steal share from competitors. We'll figure that out as we go.

We're certainly going to continue to watch our store base. We don't have a lot of stores. In fact, we have virtually no stores that lose money.

So, at this point, if we're closing stores in our bottom decile, we're closing stores that are either breakeven or marginally profitable, which means we have to create a significant amount of sales in order for us to make more money as an organization. So, we have to be careful about this in terms of what we do.

We don't have obvious losers we can just cut the tail off..

Okay. Thanks for that. Best regards for holiday..

Thanks, Oliver..

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

Okay. Thank you. Maybe the first question and one of the benefits obviously for your business is the health of the category, especially on the beauty side, but when you look at – and I think you've been talking a little bit about being behind the curve on e-commerce and even with the new loyalty card, the points.

When you start to look at other retailers out there, do you try and figure out what's the deficit that you're seeing in your business now versus where you could be once you get that ramped up to the optimal level? So I guess another way of saying is that once you get these kind of factors to the level that you want to be, do you still see this business as kind of being able to grow low single-digits or just with the changing environment out there with the disrupters out there, just wondering how you think about the long-term algorithm?.

Yeah. I think that's a good question, Jason. The reality is, is that we do have a very differentiated business model – and I assume you're really focused in on Sally here.

We do have a very differentiated business model because what we do is we go direct to salon manufacturers in many case or to contract packers with salon formulas, and we develop salon-quality products and offer them at a significantly better value. And the vast majority or a big majority of what we sell is obviously exclusive or owned brands.

So, we don't have an overlapping portfolio of brands we're selling in many cases.

The problem we've had is accessibility in terms of, a, our e-commerce platform was not competitive and as a result of that, we weren't creating access in the digital world, nor were we really present for them in social media, so that we couldn't recruit customers and we couldn't talk to the next generation of customers until we built that presence in social media; and the other problem, of course, is that there's lower traffic in the stores.

I don't think it's a big issue of how exciting is the customer experience in those stores, but a big problem was, and I do believe our loyalty program was a barrier in the sense that we're forced to charge which is more difficult to sign people up.

Therefore, if you can't sign people up and get their email address, you can't communicate with them digitally. And as a result, there's not a low-cost way of bringing them back to the store to get the products they're excited about buying. So, I do think we have some big barriers that we're obviously working to overcome.

We're making a lot of progress on the e-commerce side not just in the – in our delivery model but also in our – improvement of our website. We're going to continue to invest in that.

And then I think what you'll see us do is we'll continue to invest in the social media side and digital marketing side so that we're talking to the next generation of consumers on the platform they want to be talked to on as opposed to on older media channels that they no longer utilize.

And then finally, we're working hard to get this loyalty program right so that we can sign more people up and communicate with them in a low-cost, digital format that allows us to bring people back to our stores or back to our websites wherever they want to purchase in a low-cost way.

So, I think we're working on all the right pieces of that and then the issue is, I do think there's a differentiated platform if we can get those things right that should allow for growth in the business over time because we offer a very different set of products and a very different value proposition..

Okay. And Don, I don't know if you mentioned in your remarks and kind of adding on to this, what was the loyalty – with the existing program, what was the loyalty card membership year-over-year change? And then, Sally, the traffic versus ticket? And I do have one other more strategic question..

I'll answer the loyalty part which is it was down year-over-year. I believe it was around mid- to high single-digits, and that some of the dropping of the ball as we change leadership teams in terms of maintaining the focus on our current BCC program while we tested the new loyalty program.

And some of it was just, by the way, we shifted customers in the two states we're testing over to the new program. The net result of that is the team's working hard to make sure that we maintain the pressure on BCC, our current BCC now, so that we can shift over more easily when we're ready..

Average ticket was up driven by the pricing initiatives. UPC (43:42) was about flat, and obviously those were offset by a modest decline in traffic..

Okay..

Thank you. Our next question comes from the line of Linda Bolton Weiser with D.A. Davidson. Your line is open..

Yes. Hi. I was wondering, on the restructuring benefits, could you please quantify – there's some carryover of the FY 2017 benefits into FY 2018 and then the new FY 2018 benefits.

So, is there any way to quantify what we should see in terms of benefits in the first half of 2018 versus the second half of 2018?.

For the domestic, the 2017 Restructuring Plan, there's an incremental $10 million of benefits in fiscal 2018 related to that. You would see that predominantly in the first half of this fiscal year.

For the new international restructuring plan that we're just announcing today, given that most of the benefits are coming from organizational changes, you will see those benefits really kind of starting late in Q1 kind of pro rata over to Q2 through Q4..

And then on the e-commerce front, I was wondering if you could comment on the ordering online for regular retail customers versus salon professionals.

Is there a big difference in that? And the objectives here with regard to your two-day delivery and same-day delivery, is that oriented to regular consumers or salon professionals?.

Okay. So, let me try and hit those. On the BSG side, when a salon professional orders on one of the CosmoProf websites, we've already made the investment over the last 18 months to put what we call batch to put (45:31) capability which is e-commerce capability in the BSG warehouses.

So, they should be seeing a two-day delivery model for ordering online for almost all of our salon professionals now. For Sally, we were way behind on that. We just got our first large facility up and running in Columbus in addition to our previous Denton facility in October.

And so, that gives us two-day delivery to roughly 50% to 60% of the country now, and we should be taking that over 90% in January. And then, Linda, I forgot the last part of your question. I apologize..

Well, I'm trying to get at how much do salon professionals order online versus regular retail consumers? In other words, where is your penetration highest, among the salon professionals or....

It's currently on with the salon professionals and we think part of that is the fact that we've gotten to a higher level of service sooner in that segment of the business. But it is definitely multiples higher with salon professionals today. We think that will change as we improve the service model to our consumer customers..

Okay.

And then, when you talk about the new product lines you're introducing, you did mention several cosmetics type lines and I'm just wondering about that, (46:55) some strategic focus to do more with cosmetics and can you mention how that affects the margin structure of the business; is it higher or lower margin? And then, do you think that private label or exclusive brands work well in cosmetics like they would in hair and nail?.

And so, we mentioned one key line in cosmetics which is COL-LAB, which is a line we developed jointly with social media influencers, and they will be the marketing engine behind it, leveraging their followership base.

I think it's a great line; it's designed to mimic really high-end premium cosmetics but at a much better value, and yet it still offers great margins for us, margins that are actually higher than average for our Sally store.

I don't think it's a massive game-changer for us, but I think what it does is it brings incremental customers to our stores who are going to hear about this through social media and through Instagram influencers who they follow, as an example.

And that gives us a chance to expand the cosmetics category but more importantly bring new people to the Sally store or the Sally website..

Okay. And then, finally, I wonder if Don has an estimate – a rough estimate for interest expense for the year for FY 2018..

The rough estimate is that it depends on where LIBOR goes because we do have some floating rate debt now as opposed to the prior capital structure which was essentially all fixed rate debt in terms of the long-term debt. But a reduction in the $10 million to $12 million range would be a fair estimate..

Okay. Thanks very much..

Thank you..

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

Good morning, guys. I have two questions. The first is that you noted to an earlier question that the vast majority of your products are exclusive or are owned brands. But then also in your prepared comments, you talked about reducing prices in those SKUs that overlap with mass.

So, I guess if you could talk a little bit about what percent of your products are exclusive at this point and kind of how much overlap there is with mass. And then secondarily, a financial question; how you guys are viewing your ratings and your target leverage in light of the tough environment? Thanks..

So, I got one and Don will take two. If you look at the SKUs we're reducing price on now, it's roughly 20% of our SKUs, probably a slightly smaller percentage of our sales.

And the idea is we want those comparable products to be attractively priced so that when the consumers in our stores, if they're matching in their head price-to-price they don't get the perception that Sally is higher priced. Because obviously we communicate value in our salon-quality brands that are owned brands.

So a great example is ion, which is a huge brand; it's almost a $250 million brand. That brand is really not comparable in most of the products or virtually all of the products it sells.

But if someone were to come into our store and see a product that's highly comparable with Wal-Mart or Target or CVS, we would want them to see that price be very comparable to the mass prices so that they don't get the perception that somehow ion is overpriced, even though they can't compare the price on that product.

So, the reason to do this is to just reinforce Sally's value proposition. It's not an enormous hit to margin; obviously, our guidance is for margins to improve for the year and this is built-in to that margin guidance, but we think it's important to reinforcing our value proposition in the marketplace.

Question two?.

And, Bill, just on question one, you said that we said the vast majority of our revenue is from exclusive and owned brands. Just to clarify, within that Sally U.S. business, just under half of Sally's U.S. and Canadian revenue is from owned and exclusive brands. So just wanted to clarify that point.

To your second question regarding our ratings and our target leverage ratio, we finished fiscal 2017 with the leverage ratio just under 2.9x on a trailing 12-month basis and that is driven part by the fact that we had $90 million drawn on the ABL at year-end to fund more aggressive stock buybacks in Q3 and Q4 in particular.

We're comfortable with where our ratings are now. We meet with and talked regularly to the rating agencies. We're comfortable with that level of leverage given our strong free cash flow, which was up about 25% for the full fiscal year, our operating free cash flow. I think the rating agencies were comfortable with that as well..

Would you want leverage to go up?.

Not necessarily. I think we're comfortable in the range of 2.7x to 3.0x. As you know, our notes indentures have a – there's a trigger at 3.25 times that kind of restricts our ability – or limits our ability to make restricted payments including stock buybacks. And so, we would likely stay below 3.25x and likely at/or below 3x..

Very helpful. Thank you..

Thank you..

Thank you. Our next question comes from the line of Carla Casella with JPMorgan. Your line is open..

Hi.

Apologize if I missed this, but could you give us your CapEx was for the year?.

$89 million and change; so just under $90 million..

Okay. Great. And if you could give the outlook for – I'm sorry. No..

Yeah. We're guiding approximately $110 million, Carla..

Yeah. Sorry. I have that. So, my other question was on same-store sales, the decline – the ex-hurricane decline, do you think your – I mean, I'm looking at Ulta and the strong same-store sales growth there.

How much of your customers do you think crossed shop Ulta; or if not, where are your customers mostly cross-shopping your stores?.

Well, I think....

(52:47) Sally side, obviously..

I think – the truth is it's both. It's both the mass customers. They cross-shop mass channels such as Target, Wal-Mart, CVS, and Walgreens, as well as they cross shop Ulta.

And one of the things we're specifying here is our weakness in digital marketing and digital media in the past, as well as social media, as well as the lack of a strong e-commerce business to some extent hurts us there. And that's what we're really working to address right now..

Okay, great. Thank you..

Thank you..

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

Thanks. Hey, guys. Good morning. Chris, can you elaborate on the customer mix between retail and professional at Sally, the mix shift you referenced.

Is that driven by greater retail sales, fewer professional, or some blend; I mean, is it tied to loyalty and what do you expect to persist there? And then, Don, just, can you talk to your comfort around the gross margin guide? Maybe talk about the drivers there that are under your control and what levers you could pull if sales remain pressured? Thanks..

Hey, Simeon. Good question. I think the reality is, is that our pro customer at Sally, so I'm not talking about the pro customer at BSG but the pro customer at Sally, has been declining. It's been more rapid than overall same-store sales at Sally. So, it's been a drag. Some of that is that we took our eye off the ball there.

I think some of it will be addressed with some of the pricing initiatives we do, their inclusion and loyalty, as well as just better service of that customer; and some of it is they may be better served over time through alternative channels.

But our overall view is, we have dropped the ball a bit with this customer where we're working to think about how do we get better at selling to them and recoup some of those customers. But they've been a drag right now which, of course, has a positive overall margin benefit, but it's a sales drag right now.

It still represents about 20% of Sally's business, and we think we can do better with this customer base..

Regarding gross margin, I mean, obviously, we feel comfortable with the guidance of gross margin expansion of 10 basis points or we wouldn't have gone public with it today. The drivers of that are the pricing initiatives that were taken in the Sally segment throughout fiscal 2017 which will have a carryover benefits to fiscal 2018.

As we noted, BSG really kind of took its pricing initiatives late in Q3. There'll be a full year benefit from those pricing initiatives in fiscal 2018. Within the Sally U.S. business itself, we expect a continuing customer mix shift, as Chris just discussed, between retail and professional customers which is a positive for the Sally U.S. gross margin.

And those are only partially offset by the pricing adjustments on some of the SKUs within the Sally U.S. business and then the negative segment mix as we expect the BSG segment to perform better than the Sally segment which has – it has a lower gross margin, so there's a negative segment mix related to that.

So, when you put all these into the bucket, you get the guidance that we went forward with today and we believe that is achievable..

Thanks.

And then can you just talk about how you're viewing the consultant business at BSG at this point? Should we still expect declines through Armstrong McCall, and then just any thoughts on the recapture rate you get from those sales?.

Well, listen, I think the consultants are not just in Armstrong McCall. We obviously have consultants across the U.S. that are also within the CosmoProf business. It's really tied to what's happening in the marketplace.

In general, salons are fragmenting over time, and you're seeing more stylists become independent stylists, booth renters and salon suite renters.

As that happens, it's a very positive trend overall for CosmoProf because those customers become store customers and, to a great extent, they also become dependent on CosmoProf as a source of community and education and learning and we're seeing that in terms of the growth of our social media and our education presence.

So, I think you'll see a continued slow trend towards store business, and that really mirrors the marketplace..

Great. Thanks a lot guys. Best of luck for holiday..

You bet. Thank you..

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

Thanks. Good morning, everyone. Just two questions for us on the financial model. The first, with respect to your leverage threshold; I know you've talked over the last couple of years of working to lower the cost leverage threshold.

Could you just give us an update there on how the restructuring actions imply a comp level that you would need to leverage the business. And then secondly, you mentioned wage inflation; I'm wondering if you can just give us a look into 2018 and what kind of inflation you expect.

I know you also called out incentive comp; maybe give us some insight into how the wage profile looks corporately over the next year.

And then last question – and, Chris, this is one for you, but just with respect to the Amazon partnership; can you give us some insight into how the accounting for those revenues work? Does Amazon booking the revenue and then paying you a fee to complete the exercise – the shipping exercise, or is it somehow structured differently where you're seeing a flow-through your model as well on the revenue side? Thank you..

You're giving Chris the accounting question?.

Go ahead..

On the latter, we record the revenue and we pay Amazon a portion of the top line revenue and then a small per-transaction fee. So, that's the way the accounting works on that. Going back to your first couple of questions. We guided to SG&A – and from this point going forward including depreciation and amortization expense, it will be cited as SG&A.

We talked about 37.7% of sales deleveraged versus the prior year, and we cited the drivers of the deleverage in the prepared remarks including investments we're making in e-com, investments behind a couple of IT projects, a new inventory planning allocation system, and a new POS system for our BSG business.

But also some headwinds including some of the wage inflation in stores and distributions centers and the normalized level of incentive comp. And those things are only partially offset by the carryover benefits from the 2017 Restructuring Plan and a newly-announced international restructuring plan.

So, when you asked what the level of comp or same-store sales growth would you need in order to deliver leverage in fiscal 2018, obviously it's more than flat comps. Going forward, this is consistent with the conversations we had in the last couple of earnings calls.

I would say, on a go-forward basis, it would be challenging to leverage SG&A on flat comps, which is why we are laser-focused on improving same-store sales performance particularly for the Sally U.S. business.

Everything we do as a senior leadership team from prioritizing operating expense to prioritizing capital is laser-focused on improving same-store sales performance in our Sally U.S. business. And so, we're making the investments that we believe will drive better performance going forward.

Obviously, we're talking about deleveraging on the SG&A line in fiscal 2018. But getting those comps turned around late in fiscal 2018 and into fiscal 2019 is the driver of being able to deliver leverage on the SG&A line going forward. Your more specific question regarding wage inflation; we have – it's kind of a market-by-market assessment.

The businesses, they assess where local minimum wages have gone up, where we have to respond to pressures that have come in to the marketplace to lure our employees away. And we've kind of assessed the landscape and make appropriate adjustments beyond kind of an inflationary merit increase that our associates might otherwise expect.

The goal there is to attract the best talent into the stores, to reduce turnover, and to improve the overall level of customer service by having a more stable employee base. And that applies in both the stores and the DCs.

And so, I'm not going to cite a specific number in terms of SG&A, in terms of dollars or percentage increase, but that is a pressure on our SG&A in fiscal 2018..

Okay. Thank you. Very helpful..

Thanks, Steph..

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

Thanks. Good morning. I have two questions, Chris. First, on the industry, if you could diagnose what's happening. We've heard on the prestige side which you're not participating in as much but there's been some slowing but as well as on the mass side.

What's going on there? Do you think it's a cycling some tough compares and does it make it harder to drive traffic since you participate on sort of the mass side? And as part of it, Chris, if you can remember at all, any new products or brands on the horizon that look promising?.

Yes. I'll take the second one first. Obviously, we feel like we've got some great stuff coming, right. So, we're very excited about COL-LAB which is hitting the stores now, which offers a chance for our customers who are value-oriented customer to buy a prestige cosmetics at a much better value and so we're quite excited to see that.

It's backed by a really terrific team of social media influencers. And I think some of the color lines that we're bringing, they're very easy to apply vibrant color lines. The first one, Arctic Fox, which we're launching soon online and then following in stores is backed by a really powerful social media influencer and has very limited distribution.

And obviously, I don't think we're going to see it beyond more specific channels. It's not going to be in mass. So, we've got some great innovation coming which should help us drive top line. I'm not seeing a big downturn. Obviously, we don't participate significantly in cosmetics today. It's a relatively small category for us.

We've seen our core categories of color and care do pretty well. We're seeing a flattening in nails. The one category I would call out where we continue to see declines is in electrical appliances. That category has been a tailwind for both businesses.

My guess is that some of that is a lack of innovation and some of that is a shift to online as those categories are, a, it's a larger purchase and, b, it's easy to search online for comparable brands. And so as a result of that, I think we're seeing some diminishment in that business as a result of that. So, those are the overall trends.

We're not seeing a big decline. We're certainly not seeing a decline in our pro business, our distribution business. Overall, the core categories there are very strong. And as I noted earlier, (01:03:03) in our promotional category which we're fixing now. But other than that the category looks very strong..

Thank you. Our next question comes from line of Ike Boruchow with Wells Fargo. Please go ahead..

Good morning. This is Lauren Frasch on for Ike. Thanks for taking my question. Sounds like there's a lot of upcoming SG&A in next year. How should we think about the cadence of these expenses throughout the year; are they more weighted earlier or is it more steady throughout the year? Thank you..

It depends on the components. I addressed the restructuring benefits in response to Linda's question earlier in the call, but in terms of the headwind, I mean, the wage inflation that we've called out would be kind of pro rata over the course of the year. Some of the investments related to new systems developments would be more back-end weighted.

And the investment related to incremental business-related (01:04:03) e-com would be more pro rata. So, it's kind of a little bit across the board, but some of the components will be weighted towards Q3 and Q4, and some of it would be more pro rata.

And we're not giving specific guidance by quarter on SG&A percentages but at a more qualitative level that's what you could expect..

Great. Thank you..

Thank you. And with that, speakers, I'd like to turn it back over to you for any closing comments..

Well, again, I'd just like to say thank you for joining us today. Overall, we're excited about some of the investments we're making to strategically change the business.

We will continue to stay focused on driving efficiencies in our business model, improving the effectiveness of our sales and marketing initiatives, and accelerating investments in growth such as e-commerce.

These initiatives combined with our consistent practice of returning significant portions of our free cash flow to shareholders via stock repurchases should allow us to deliver significant earnings per share growth both in 2018 and beyond. Thank you again for joining us today..

Thank you. And, ladies and gentlemen, that does conclude our conference call for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect..