Jeff Harkins - Sally Beauty Holdings, Inc. Christian A. Brickman - Sally Beauty Holdings, Inc. Aaron E. Alt - Sally Beauty Holdings, Inc..

Mark R. Altschwager - Robert W. Baird & Co., Inc. Rupesh Parikh - Oppenheimer & Co., Inc. Ross Collins - Cowen and Company Simeon Avram Siegel - Nomura/Instinet Olivia Tong - Bank of America Merrill Lynch Simeon Ari Gutman - Morgan Stanley & Co. LLC Linda Bolton Weiser - D.A. Davidson & Co.

Stephanie Wissink - Jefferies LLC William Michael Reuter - Bank of America Merrill Lynch Carla Casella - JPMorgan Securities LLC.

Ladies and gentlemen, thank for standing-by. And welcome to the Sally Beauty Holdings Q4 and Full Year Results Conference 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 Mr. Jeff Harkins. 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 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

Many of these forward-looking statements can be identified by the use of words such as believe, project, expect, can, may, estimate, should, plan, target, intend, could, will, would, anticipate, potential, confident, optimistic 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 Aaron Alt, Senior Vice President, Chief Financial Officer and President of Sally Beauty Supply.

Chris will provide a brief overview of our performance for the quarter and give you an update on our transformation plan and we'll then discuss our fourth quarter and full year financial results in more detail in addition to our fiscal year 2019 guidance. Now, I'd like to turn the call over to Chris..

Thank you, Jeff, and good morning, everyone. As our quarterly results demonstrate, we are making solid progress on our transformation plan. Both the business segments had sequential improvement in same store sales. Sally reported flat same store sales for the first time in seven quarters.

BSG saw improving trends and positive progress against the supply chain issues that hampered this segment last year.

Overall, we experienced a slight decrease in consolidated net sales, flat gross margin and slightly higher selling, general and administrative expenses due primarily to additional operating expenses from our first quarter Canadian acquisition, resulting in a decline in adjusted operating earnings. However, the benefits of the U.S.

tax reform and a lower share count helped drive double-digit growth in adjusted diluted earnings per share. We continue to refocus our team on the defensible categories of hair color and hair care and improving the execution of basic retail fundamentals. We are enabling that effort by taking significant steps to optimize our cost base.

Our cost optimization efforts, over time, will permit necessary investment in the business and provide us with opportunities to take further profit to the bottom-line. While progress is being made and we are beginning to see results, significant work remains to be done.

Nevertheless, I firmly believe our efforts are putting Sally Beauty Holdings on the right track long-term. The fourth quarter saw significant change at Sally Beauty Holdings and I'd like to highlight some of the steps we took in the quarter as well as the beginning of the first quarter.

In regards to our differentiated core of hair color and hair care, we continued to mold our assortment through new product launches, new partnerships, and new approaches to categories. First, as we disclosed in September, we launched new sets of color kits or boxed color options online and in all U.S.

Sally Beauty Supply stores, including two entry level options. One, being our private label brand ion Intensive Shine Hair Color Kit and the other a national third-party brand Clairol Pro Color Kit.

This initiative is grounded on consumer research that we conducted that shows that a high percentage of our loyal Sally Beauty customers still rely heavily on the simplicity and ease of boxed color.

This is a new opportunity for Sally Beauty as our research showed that a significant portion of our existing guests were buying boxed color elsewhere due to a fear of complexity. It was clear that our customers desired a boxed color solution. So we responded by providing a professional quality option for them.

While it is early days in the launch process, we are pleased with the results and our early read is that these sales are incremental units to the basket and generally not cannibalistic on our broader professional color lines. On that basis, we have approved launching 10 additional ion color SKUs in March and 10 more in late fiscal 2019.

On the other side of the house, Beauty Systems Group signed a new distribution agreement with the prestigious hair color brand, Pravana. We moved quickly to implement this new partnership and inventory is available online and is also on shelf in all BSG stores in the U.S.

Pravana is known for its groundbreaking innovation, particularly its vivid colors and has a loyal following among stylists and we are seeing genuine excitement from our customers associated with this launch.

Continuing this effort, Beauty Systems Group has also signed an exclusive distribution agreement with the Swedish vegan hair care brand, Maria Nila. This is an important assortment gain for BSG as Maria Nila is a rising premium brand that appeals to recent industry trends around natural products.

We intend to get this product to the shelf quickly beginning in Q2. Lastly, BSG is taking aggressive action in the electrical appliance space. As many of you know, the electrical appliance category has been challenging for BSG as it has faced heavy competition.

To better address the headwinds from this category, Sally Beauty Holdings has made an enterprise asset available to the BSG team for the first time. That asset is the ion owned brand portfolio.

The ion brand is Sally Beauty Supply's largest owned brand and is responsible for approximately one quarter of the $800 million of owned and exclusive brands sales within Sally Beauty Supply. ion's assortment covers categories such as hair color, hair care, and electrical appliances.

Because of our scale with ion in the electrical appliance category, we have access to innovation that is unavailable to our competitors. Because it is a known brand, we also have attractive economics for us and for our customers. On November 1, BSG launched a curated assortment of ion electrical appliances on shelf and online.

This is the first introduction of the ion brand into the BSG segment and, as we carry forward, will allow us to bring cutting edge technology to our professionals and better position BSG in a highly competitive and price-sensitive category.

At this point, we view this as a category-specific launch in a segment of the business that has faced significant disruption and intense competition. Turning to progress on our retail fundamentals. Sally Beauty Supply completed the national rollout of its new loyalty program, Sally Beauty Rewards, to all U.S. and Canadian stores.

The new program allows customers to enrol for free and to accumulate points for a $5 reward certificate for each $50 of spent. Current Beauty Club members are automatically enrolled into the new program and receive points credited to their loyalty account based upon the number of months remaining on their current membership.

Initial results have been positive and we are seeing adoption rates in many stores that are almost twice as high as adoption rates of the old program. With the change to the new loyalty program Sally Beauty Supply stores are also executed a complete repricing, including switching from a three-tier program to a two-tier pricing model.

We expect the overall economic impact to be approximately break-even for fiscal 2019 with incremental benefits to be delivered over time as we build a larger database of loyalty members.

On our cost savings initiatives, we completed the work on store hour labor optimization within our Beauty Systems Group segment, which is partially offsetting the store wage increases that were recently implemented in our BSG stores.

In addition, we expanded the implementation of our sourcing, store labor, and G&A optimization to our European and Mexican operations. As you can tell from the progress I have just highlighted, there is a significant amount of work underway at Sally Beauty Holdings.

The efforts I have referenced are in process, but are only the first steps in our overall transformation. As we move through the rest of fiscal 2019, our transformation journey efforts will continue and I'd like to give you some highlights of what is to come on the operation side of the house before Aaron provides our financial guidance.

First, playing to win. As I have highlighted on this call, we are intensely focused on finding new exclusive products, building awareness around new product launches, and providing education and training of our store associates as we view them as a key source of competitive advantage.

Both business units will continue to focus on driving exclusive innovation in our core categories going forward. Beyond this, BSG will continue to look for additional opportunities to expand its distribution rights whether through new partnerships, acquisitions or expanding current distribution agreements.

Turning to our next key objective, retail fundamentals. This is a central area of progress for us over the course of fiscal 2019, impacting our technology, our people, and our processes. Here are a few highlights; stores, as I have mentioned in the past, we are designing and testing new store concepts for both business segments.

We are at a point in our concept evolution that we will be rolling out all of our changes from assortment to store layout, to marketing, to technology, all in one full market. Importantly, we will be assessing both Sally Beauty and CosmoProf in the same market, so that we can evaluate synergy opportunities.

The preparation work is underway and we expect to discuss our results on this important test later this year. Next technology, we are implementing a new Oracle point-of-sale system in both business segments. Testing will begin in stores in both segments this quarter with national rollout starting in the second half of the fiscal year.

While a new point-of-sale system may not sound particularly cutting-edge, it is an important part of the customer-centric flywheel that we are creating.

The combination of our CRM implementation which is already complete, our loyalty program which has now been launched nationally, our new digital commerce website and apps which are coming soon, and the new POS systems mean that, for the first time, Sally Beauty and BSG will be able to identify our customers regardless of channel, will be able to serve them on an individualized basis, and will be able to remove friction from the shopping experience for them.

There are many moving pieces but this is a big deal for us. Now merchandising and supply chain. The company will use the remainder of fiscal year 2019 to build out the infrastructure and begin testing phase one of the new JDA merchandising and supply chain platform. This will be a multiphase project taking place over the next two to three years.

The benefits of this project will include improving the product assortment by store and reducing out-of-stocks. Additionally, the merchandising team will have better visibility and forecasting capabilities of inventory, which will lead to a reduction in inventory levels including slow-moving SKUs.

Finally, we have a complicated supply chain that is the product of many acquisitions over the years. Our team is assessing our options with respect to our supply chain assets in the context of the overall transformation of our business and how best to support our customers across both retail and wholesale channels.

Expect that we will have more to say on our supply chain strategy later this fiscal year. On to our third key objective, having a robust digital service platform.

As we have stated in previous quarters, we have already completed the e-commerce investments in the Sally warehouses and begun the marketing effort around our two-day shipping capabilities to over 95% of the U.S. and one-day shipping capabilities to over 30% of the U.S.

We continue to see improvements with approximately 30% year-over-year growth in both our U.S. and international e-commerce businesses, driven primarily by increased conversion rates. For both U.S. segments, we are in the process of completing the design work on our new mobile-first e-commerce sites.

We anticipate the completion of our efforts for Sally Beauty by March with BSG following later in the fiscal year. Additionally, Sally will be expanding its test of endless aisle during the first quarter, a process where a store will be able to order out-of-stock product through a store iPad and have it shipped directly to the customer.

This is a much needed fix to allow us to better participate in the digital world. Turning now to cost optimization, given the guidance that Aaron is about to describe to you, our cost reduction program will continue to be focused on finding additional operating efficiencies and improvements to direct and indirect sourcing.

We expect that the majority of the financial benefits generated from this program will be reinvested into enhanced marketing analytics, new merchandising and store concepts, and the acceleration of technology investments.

Along those lines, we will be integrating our Mexico and South American operations into one Latin America business unit to gain further efficiencies and consistent execution. To summarize, we are playing to win by refocusing our business around our differentiated core of hair color and care.

Improving our execution of basic retail fundamentals and advancing our digital commerce capabilities. We continue to drive cost out of the business, which is enabling investment in our transformation program. However, we recognize that we still have work to do.

With our key accomplishments from this quarter and the recent management changes we have implemented, we are confident that we are moving in the right direction. Now I will turn it over to Aaron to discuss the financial results in more detail..

Thank you, Chris, and good morning, everyone. I'd like to start by expressing our thanks to our associates at the Sally Beauty, CosmoProf, and Pro-Duo stores. In a quarter in which we were executing significant changes as part of the makeover of our business, they have continued to focus on our customers' needs and deliver a much improved quarter.

Well done. I'm pleased to be here to review financial details for the quarter as well as a short summary of the full year results before detailing our fiscal 2019 guidance. We are making measurable progress against our transformation efforts. We have a plan. Our Q4 efforts were executed consistent with that plan.

Fourth quarter consolidated revenue was $966 million, a decrease of 0.8% versus the prior year, was a modest revenue contribution from our first quarter acquisition in Quebec, Canada, offset by an unfavorable impact from foreign exchange translation, a 0.2% decline in consolidated same store sales, and reduction in sales for our full-service business.

Foreign currency translation had an unfavorable impact of approximately $4.6 million or 50 basis points on reported revenue growth.

We did see improvement against supply chain issues that materially impact the Beauty Systems Group segment during the third quarter, but service levels were still not completely back to normal by the end of the fourth quarter. This is reflected in both same store sales and in our overall revenue line.

The BSG team has estimated that there was $2 million unfavorable impact to sales attributable to external supply chain issues or the equivalent to approximately 60 basis points of same store sales for BSG during the quarter. Our consolidated gross margin for the quarter was 49.5%, which was flat compared to the prior year.

In our largest business, the Sally Beauty segment, an 80 basis point margin improvement was driven in the U.S. by targeted price increases in core categories and from the optimization of promotional activity, and was driven in Europe via the retail mix and price increases on owned brands.

In the BSG segment, margin decreases were driven primarily by category mix shift, timing of vendor allowances, and promotional activities. Selling, general and administrative expenses including depreciation and amortization expense were $365.9 million in the quarter, an increase of $3.6 million or 1% from the prior year.

The benefits from our transformation efforts and tight controls over discretionary expenses were offset by investments made in marketing, store wages, and technology, and the operating expenses from our Canadian acquisition. We have excluded restructuring charges from both adjusted operating earnings and adjusted diluted earnings per share.

Additionally, we have excluded the true-up adjustment of the onetime net benefits of U.S. tax reform from adjusted diluted earnings per share. Adjusted operating earnings and adjusted operating margin were one $112.2 million and 11.6%, respectively, compared to $120.2 million and 12.3%, respectively, in the prior year.

Adjusted diluted earnings were $0.51 per share, growth of 13.3%, compared to the prior year's $0.45 per share driven by the impact of the U.S. tax reform on our consolidated effective tax rate and reduced share count from share purchases. The company continues to generate strong cash flow from operations. It equaled $90.7 million in the quarter.

Operating free cash flow was $66.8 million in the quarter. Inventory was up 1.4% from the prior year to $944.3 million driven by incremental inventory related to the Canadian acquisition that closed in the first quarter and the expansion of distribution rights for our the Beauty Systems Group segment which was partially offset by a stronger U.S.

dollar on reported inventory levels. On the first day of the fourth quarter before we announced changes to our capital allocation strategy, the company repurchased and retired a small number of shares totaling less than 90,000 shares of common stock at an aggregate cost of $1.3 million.

As the quarter progressed, we deployed our free cash flow to invest in our business and then to reduce the outstanding balance of the asset-backed revolving line of credit from $63.5 million at the end of the third quarter to zero at the end of the fourth quarter.

As mentioned on the third quarter earnings call, for the foreseeable future, we will prioritize needed investments in our business that we believe will deliver value for shareholders, then focus on measured debt repayment within our ratings guidance and only then will we consider return of capital to shareholders.

We are still in a leverage position toward the high-end of our preferred leverage ratio of 2.5 times to 3 times EBITDA as defined by our credit agreements. While supporting the business, over time, we intend to continue to make progress against our leverage levels.

One of the strengths of this business is its strong cash flow and we think there is ample cash flow to achieve our goals. We will continue to take a balanced approach to capital allocation with all of our constituents in mind.

Regarding our full fiscal year financial results, consolidated net sales were $3.93 billion, a decrease of just 0.1% and same store sales declined 1.5% for the year. Foreign currency translation had a favorable impact of approximately 80 basis points on the full year consolidated sales growth.

Reported diluted earnings for the full fiscal year were $2.08 per share, growth of 33.3% compared to the prior year. Adjusted diluted earnings in the fiscal 2018 year were $2.16 per share, growth of 20% compared to the prior year. Share repurchases for the full fiscal year were 10 million shares at a cost of approximately $165.9 million.

Turning to the segment performance, in the fourth quarter, our Sally Beauty segment generated revenue of $576.6 million, a decrease of 1.3% compared to the prior year. Foreign currency translation had an unfavorable impact on the segment's revenue growth in the quarter by 50 basis points.

Same store sales for the first time in seven quarters were flat. As we disclosed in our one-time pre-release of selected financial information October 16, the U.S. and Canadian business was modestly positive, offset by trends in the European business for the quarter. We also continue to make meaningful progress with Sally's U.S.

and Canadian e-commerce business this quarter which helped deliver e-commerce revenue growth of 41.9%. We expect to continue to invest aggressively in improvements to the overall online customer experience. The story in Sally Europe was similar with e-commerce revenue up 47% in that market.

Gross margin for the segment was up 80 basis points to 55.9%, driven primarily by increases in the U.S. through the personal (22:59) optimization of unproductive promotional activity moving to fewer, bigger, and deeper promotions and targeted price increases in core categories, and in Europe via the retail mix and price increases on owned brands.

Segment operating earnings were $91 million in the quarter, a decrease of $0.2% versus the prior year, driven by the decline in total revenue related to a lower store count versus the prior year mostly offset by higher gross margin.

Now turning to our Beauty System Group segment, BSG's revenue in the quarter was $389.4 million, a decrease of 0.1% versus the prior year, driven by an unfavorable impact of foreign currency translation of approximately 40 basis points.

And as I noted earlier, the negative impact on total sales due to the lingering supply chain issues mostly offset by the revenue contribution from the acquisition in Canada that closed in this year's fiscal first quarter. BSG's same store sales declined by 0.8% with approximately 60 basis points attributable to the remaining supply chain issues.

BSG's gross margin was 40% in the quarter, down 120 basis points from the prior year, driven primarily by category mix shift and timing of vendor allowances.

Segment operating earnings for BSG were $53.7 million, down 12.1% from the prior year, driven by lower gross margin and operating expenses related to the Canadian acquisition from the first quarter. Now let's turn to our guidance for fiscal year 2019.

It is important to note that the company's guidance reflects the impact of our significant transformation agenda, which includes making significant investments to drive long-term growth as well as reaping the benefits of cost saving initiatives that are already underway, and which are expected to offset the majority of these investments.

The company expects full year consolidated same-store sales to be approximately flat, while we do not provide quarterly guidance. I refer you to the text of the earnings release and Chris's comments, which provide a sense of timing relative to key initiatives.

As a result of the timing of the implementations referenced there, we expect progress to be weighted modestly toward the back half of the year. Full year gross margin is expected to be approximately flat compared to the prior year.

Full year selling, general and administrative expense including depreciation and amortization expense are expected to be down slightly, due to lower restructuring charges as compared to the prior year.

Full year adjusted selling, general and administrative expenses including depreciation and amortization expense are expected to be up slightly versus the prior year as a result of timing of investments being made in the business, partially offset as more of our operating efficiencies start to reach full run rate status towards the second half of fiscal year 2019.

In that vein, we have already made investments in wage rate at our stores across the country. These investments are also offset by efficiencies within our store operations and elsewhere. Nevertheless, with unemployment at historic lows and big box retailers increasing wages, we are carefully watching how wage inflation may impact our business.

Full year GAAP operating earnings and operating margin are expected to increase by mid-single-digits, primarily due to an improvement in same store sales and lower restructuring costs as compared to the prior year.

Full year adjusted operating earnings and operating margin are expected to decline slightly as compared to the prior year, driven primarily by improvement in same-stores sales offset by the slightly higher adjusted selling, general and administrative expenses I called out earlier.

The company expects consolidated effective tax rate for the year to be approximately 27% and lower average share count and lower interest expense from reduced indebtedness should result in mid-single-digit growth in both full year GAAP diluted earnings per share and full year adjusted diluted earnings per share.

Capital expenditure for the full year is expected to be approximately $120 million. Cash flow from operations for the full year is expect to be approximately $340 million, reflecting our margins offset by an effort to speed payments to vendors to achieve cost of good savings. Free cash flow was expected to be approximately $220 million.

Now before I close, I do want to provide the answer to one question that I'm getting a lot, impact of tariffs. With respect to our product acquisition cost and the impact of existing and proposed tariffs, I can say this. Based on what we know today, we expect the impact of tariffs to be less than $1 million and that's immaterial.

Much of our products is produced in Europe and in the United States. And for those items produced in Asia, our teams are already moving production to jurisdictions not expected to be drawn into the administration's approach to trade negotiations.

In summary, we are confident that we are doing the right things to improve the business and to set Sally Beauty Holdings up for success as we move forward. We understand the challenges. We understand the need to execute. We are marshaling our resources in such a way as to promote the success of our plans. Thanks for your time this morning.

Now I'd like to turn the call back over to the operator so we can take your questions..

Thank you. And our first question will come from the line of Mark Altschwager with Baird. Your line is open..

Great. Good morning. Thanks for taking my question. And congrats on the strong finish to the year. I wanted to follow-up on the comp guidance flat for the year.

Just – can you give us a sense directionally how you're thinking about Sally Beauty versus BSG?.

Again, I think, we would expect, Mark, that both will show improvement, Sally's already established that it can achieve that level but we expect both to show improvement. Sally on the back of a revamped promotional strategy and new products that it's launching.

BSG on the back of adding Pravana and then reduced supply chain impact from some of our vendor disruption issues. So we're expecting an improvement in both businesses year-over-year. And so I don't think there's a lot of texture to that. They both will be better..

Okay, thanks. And just one more guidance clarification. I apologize if I missed this. But the gross margin guidance, again flat for the year.

Would that also be slightly weighted to the back half? Or how should we be thinking about the shape of the year from that perspective?.

We're not going to break it down across the year. You can take some learning from the progression you saw over the course of this year and our cost saving initiatives are well underway..

Okay. Thank you. And just one last one on loyalty, if I may. First, congratulations on the launch. We are getting a lot of questions regarding how this is going to flow through the P&L this year. I know you said break-even for the year.

It sounds like you're going to be losing the card revenue then you're getting the benefit of the price increases but some offset from the cost of the free item. So a number of puts and takes there that net out to break-even.

So I guess the question is, one, am I thinking about that the correct way? And, two, is there an initial gross profit headwind that needs to be made up later in the year to get to break-even or just any further clarity on the tests and what those have shown would be helpful as we model out the year? Thanks so much..

So couple thoughts. Of course, we have deferred BCC revenue which we will bring into income during Q1 with a small portion continued to be deferred thereafter which is reflecting the liability that we're building a connection with a point system in the new program.

So we will see a positive impact earlier in the year offset by a negative impact as we move through the year as we build up that accrual..

But those are relatively small across each quarter. So although it will be a little bit of forward-weighted, it's not a dramatic impact in any one quarter..

Correct..

That's really helpful. Best of luck this year..

Thanks..

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

Good morning, and thanks for taking my questions.

So to start off, two colors on the boxed hair color launch, anything that has surprised you so far with the efforts that you've done in store? Is there – and then is there anything that you can share in terms of how you're thinking about the sales build over time?.

Thanks, Rupesh. Here's what I tell you.

We knew when we were launching this product that we were targeting an existing Sally guest already in our store that was walking out the front door having purchased other products to buy their boxed color somewhere else in part because they were, perhaps, somewhat intimidated by Pro Color for home and not knowing what to do with that.

The reports back from our stores have been that our expectations on who the targeted customer would be have proven to be correct where we are converting those same customers, leading to it being an additional basket add. Initial results have been favorable for us. We are pleased with what we're seeing in stores.

We're pleased with the customer reaction to the product. We'll continue to optimize that as we carry forward and we have decided based on the initial results to launch two additional tranches of additional colors, 10 in March and 10 later in the year as well. So while very early days admittedly, we're pleased with the results we're seeing..

And two other things I'll add that are I'd call surprising. One is that the ion brand is so far significantly outselling the third-party brand which is quite exciting. And second of all is that that is actually at a higher price point.

We launched ion at $9.99 a box, and third-party brand at $8.99 a box, and ion insignificantly outselling even at a higher price point due to perceptions of quality that we learned about during the research. So those are both exciting pieces of news..

Great. And then on your guidance, so the gross margin guidance sort of flat this year.

Can you help us understand the puts and takes in terms of how you're thinking about some of the drivers for this year?.

Well, I think it's – a couple of important puts and takes. The first is, as we've been talking about now for a couple of quarters, we are very focused on our cost of product acquisition and working with our vendors both on the owned brand side of the house and on the branded side of the house to make sure that we are optimizing those costs.

At the same time, we are very focused on ensuring that we have the right value proposition across the board and that impacts both pricing and our promotional cadence. We want to drive traffic to the stores admittedly, but we also want our customers to understand the value they're receiving as we carry (33:53).

So starting first the Sally business and increasingly with the BSG business as well, we're focused on optimizing both the cost of the product acquisition as well as the pricing and promo structure around it..

Okay. Great.

And then I'll quickly slip in one more, on capital allocation, is there any more granularity you can give us in terms of how to think about debt pay-downs versus share buybacks embedded in your current guidance range?.

Yes, we are assuming that we will not repurchase shares in fiscal 2019 with the important caveat, as I've called out before, that we're going to invest first in the business where we need to, then we will pay down debt to our guided leverage ratio of 2.5 to the bottom of the range. And only then will we consider repurchasing shares.

We'll see how the year materializes..

Okay, great. Thank you..

You bet..

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

Hey, good morning. This is Ross Collins on for Oliver. Thanks for taking our questions.

Just to hear a bit more on the cost efficiencies mentioned, can you just speak a bit more to kind of which of these initiatives are expected to inflect in the back half of 2019, kind of, as embedded in your guidance versus what the longer term opportunity to think about?.

Well, we won't get too specific. But just to give you some examples, when we resource, as an example, our owned brands, sometimes that's a direct price change where you stay with the same vendor and they just change their price by winning a bidding process. And in that case, it flows to the P&L pretty quickly.

In other cases, you're moving a significant amount of production from one vendor to another, and in other cases, we've actually not only moved the vendor, we've also changed bottle and packaging suppliers and that takes longer to get done.

So the point is is that although some of the margin improvements are probably already in the – are already in the P&L, others are going to take six months or as long as a year to flow through. So it's a slow build throughout the year, which is why it takes time.

There's a lot of work that goes into getting it done, and that's why we expected to build as we go through the year..

Got it. Thank you. And then just secondly on the BSG supply chain side, I guess could you speak a bit more about kind of what has been addressed versus what remains to be done there? And then any sort of timing parameters to be thinking about moving forward? Thanks so much..

You bet. Happy to do that. Listen, as you saw in the numbers we released, it got much better quarter-over-quarter, and Henkel has significantly improved their execution. There are still some lingering issues with Coty going. Last quarter, those primarily focused on the Nioxin brand and OPI.

As we have gone into this quarter, we still see some lingering impact. Nioxin has improved but OPI continues to be an issue. So I guess I would describe it as it continues to get better, but it's not all gone yet..

Got it. Thanks so much..

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

Thanks, guys. Good morning..

Good morning..

Impressive gross margin gains in Sally, congrats there.

And just to follow up on that prior one, given that the concepts have a mix element, so what does the flat guidance look like by concept? I think you mentioned there were COGS savings by speeding up payments to vendors, so could you quantify that at all? And then just could you help put in context the raised prices versus, I think, we had spoken about price reductions earlier in the year.

So are the price reduction – is that story behind us? Thanks..

Couple thoughts. We aren't providing a breakdown across the segments relative to the progress over the course of the year. We've provided guidance on a consolidated basis.

The answer to your question around pricing, in the Sally business, we've converted to the two-tier model from the three-tier model with the expectation that value will still be and will be more apparent to our guests as well. And so, in some cases, that will mean that prices will decline.

In some cases, that will mean prices will be more appropriately where they should be given the relationship we have with our customers as we carry forward..

And the only thing I'd add is, in the last quarter and in going forward quarters, some of the benefit we're seeing with Sally gross margins is around a more focused promotional strategy, what we would describe as fewer, deeper, bigger, which is cutting back on the total number of promotions, but then going deeper in some key categories that we believe will drive traffic to the stores.

That has proved to be effective both from driving improved sales performance, but also margin. So you're going to see that in Sally and obviously we'll try and extend any learnings we can to BSG as well..

Okay. Thanks.

And then just given the constructive commentary around the strategic North America and South Americas, how is Europe doing in terms of profitability versus the Americas?.

So I describe that as the Europe business, as you know, we went through a significant integration between our Continental Europe and U.K. business last year. We took a great deal of cost out which increased profitability year-over-year. And now our focus now that we're past most of the restructuring efforts is really on top-line growth.

It has been a little slow at this point in time, but our expectation is that we'll really focus in on growth going forward..

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

Thank you..

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

Hey, good morning. Thank you very much. I was wondering could you give us a little bit more detail on this two-tier pricing system going from three-tiers to two-tiers first.

And then if you could talk a little bit about the boxed color and the ion margins versus the Clairol margins? How do they compare? Obviously, the price is a little better, so I would imagine margins are better as well. So, if you can give us a little bit of idea in terms of order of magnitude that would be great. Thank you..

Okay. So, the first question, if you remember correctly in our previous program, which was a pay-for-discount program, we had three tiers. We had the list price, we had the BCC price, which is the price that went to a customer who purchased a card – a discount card, and then we had the Pro price.

We have now eliminated the BCC and list that effectively just becomes the normal price on shelf and then there's a Pro price. So, those are the two tiers that exist today.

And the only thing that's different is if you sign-up for a loyalty program, then you get rewards that come to you through email or in the mail that then you can come redeem for free product through $5 discount certificates. So, it's now simpler on shelf. There's not three prices on shelf, there's actually really just one major price.

And then the Pro price is hidden on the ticket. So, it simplifies the consumer and customer experience and, more importantly, it moves us away from a pay-for-discount program which we believe will allow us to significantly grow the database of customers. And I forgot your second question..

Hi. The second question was around the margins, yes..

There is a significant difference in gross margin between the two products. The range I would tell you would be around 1,500 to 2,000 basis points of margin difference between the third-party brand and the ion brand. And the ion brand is accretive to the overall margins of Sally..

Got it. And then in terms of the SG&A being up as a – up year-over-year in fiscal 2019, what, like – I think fiscal 2018 was a relatively heavy investment year.

So, clearly, you laid out quite a few initiatives for 2019, is that the incremental cost? How much of that has already been taken 2018 relative to 2019? And as we go forward, some of the things you talked about for beyond 2019, will there be cost in 2019 associated with those projects whether it be improving your online profile, et cetera? Thank you..

Here's the way to think about it. We did take significant action in 2018 to scoop cost saving initiatives across both margin lines and across virtually every part of the corporation. We did not achieve run rate on some of those savings initiatives during 2018 and over the course of 2019 we will get to run rate on those savings.

The incremental savings that we will achieve in 2019 over 2018 is significant. That said, the investment profile that you heard Chris refer to relative to our initiatives across the four key focus for the company, are also significant.

And what you should take away is we will have a slight uptick in SG&A as a result of scooping the significant cost savings initiatives, the incremental cost savings in 2019, and offsetting that against the OpEx components of the investments we're making.

As we carry forward, we have not provided long-term guidance to you as part of the call, we just guided to 2019. It would, however, be fair to expect that as we carry forward that these cost savings are not going to go away.

And so, once we achieve a run rate investment profile at some point in the future, right, that should be a benefit to the corporation..

Got it. Thank you so much. Appreciate it..

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

Thanks. Good morning. I think Aaron I heard you talk about priorities with cash. I don't know if you mentioned this and referenced that at the last answer, just thinking about the investment cycle, the length of it.

Do you envision the CapEx bump that's happening for next year, does that stay elevated? Can you give us a sense of that? I realize it's early..

Are you asking me beyond 2019?.

Exactly..

As I sit here and think about it today, I would observe that while we do – we will need to continue to invest in the company on a more rigorous and smarter basis than perhaps we have over time that 2019 will be a high point from an investment perspective..

Okay, that's helpful. And I guess for both Chris and Aaron, I guess I'm trying to feel out maybe the sensitivity a little bit to the outlook for next year.

And so I'll ask it this way, if there's upside potential that leans more heavily to comps or margins for next year, which one would be more likely?.

Yeah, that's really hard to think about. I have a hard time answering it, I'd probably guess margin. But I think that's hard to really isolate, Simeon, at this point in time..

Fair..

Yeah, my answer to that, Simeon, would be that we have a lot under way..

Yeah..

Right? We have initiatives which are purposefully designed to help us return the business to growth, but at the same time, we're investing in the cost structure to bring it down to offset our investments in 2019 and to carry forward beyond. And so, I would be cautious about indexing one way or the other.

We've tried to be as productive as we can be from giving you guidance on how the package will fit together over the course of 2019. I can't give you much detail beyond that..

Yeah. No, I think that's fair. Maybe if I can paraphrase and you can comment, I mean if it feels visibility on some of the things you can control especially around costs is better.

But it sounds like you do feel confident about the top line improving, but that's not something that's as in control as margin?.

We would not have provided the guidance we did if we weren't confident that we could hit what we said we were going to do..

Great. Okay. Thanks, guys..

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 just wondering further about your comments on bringing the ion electricals into BSG.

How does that change your plan to reduce overall shelf space for electricals? And then also, do you see any risks with the idea of putting some of the ion brand into BSG? Up until now, the two product lines and brands of the two retailers were very separate and no overlap. So do you see any risk associated with that? Thanks..

Listen, we will continue to pare back, as we've mentioned, our assortment in electricals. And so, as you can imagine, some of that will be third-party brands that will be pared back and we do think there's opportunity to do that. So I don't think it changes our plans there.

And then in terms of risk, we actually think it's good for the ion brand because if consumers see professionals using ion products in their shops or in their salons or suites, we think that continues to build the professional credibility of the ion brand.

And given that our vendors sell their products through multiple channels in categories like electricals, we view it as it's very logical that we should be able to protect that category with our owned brands as well in order to protect our margins and have products that aren't available elsewhere.

So it's a very category-specific strategy and we want to make that clear. But no, we don't see a great deal of risk and we see it as a way to stabilize the category that's been a headwind for us..

Thank you..

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

Thank you. We just have a few housekeeping questions, if we could.

The first is on e-comm, if you could just give us a sense of what percentage of your total sales that is today and how you expect that to grow over the next couple of years? And then just a follow-up to Simeon's question on the CapEx guidance, it's a fairly meaningful step-up year-to-year, but can you give us some sense of where the pockets of the increases are? Are those things that we should expect over the next couple of years will lift the D&A, I think as you have guided just some higher D&A? And then last one if I could just on the pricing increases.

Can you give us a sense of the magnitude? Just trying to reconcile the flat comp with a lift in price versus some of the patterns we've seen in the transactions. Thank you..

Sure. There's a lot there. Let me see if I can rattle it off and you can let me know what I missed. The current digital penetration across the enterprise is just north of 3% as we carry forward – sorry, 3% for this year. We expect that to continue to grow. I don't believe we've guided growth rates by segment for purposes of 2019.

But as you can tell from Chris's comments around where the investments we're making, a significant part of our investment profile is actually in support of the digital platforms and ensuring that we are able to compete effectively as a omni-channel retailer as we carry forward.

I did indicate earlier that this is a high point from our perspective as we sit here today from a capital investment perspective. We are investing really across the house. There is significant capital investment in the POS system that we are rolling out across all of the North American stores. That is a significant investment.

Similarly, the replatforming of our digital e-commerce experience as well as the development of the commerce-based apps for the businesses is a significant investment as well. There are store expansions in BSG in Europe and Mexico, which is an investment, so we have a concept store launch that you heard Chris refer to before as well.

That's a investment buy us as well. And then, of course, we have the continuing investment in JDA, which is carrying over year-over-year, we're already invested there. But those are some of the buckets of new or incremental investment as we carry forward.

Of course, because we are a retailer with a traditional store base, naturally we have run rate, repair and maintenance capital investments that we have to make as well. So those all-in total about $120 million for fiscal 2019..

And on the pricing side, if you think about the shift from the BCC program to a single price, on average, the BCC discount was in that 6% to 7% range. And so, that goes away. But we didn't take it across the board like peanut butter. In some cases, we didn't raise price.

In some cases, we just reversed the BCC discount and others we actually raised price a little bit. So the price is between 0% and 10%, and it very much dependent on the competitiveness of the category or the brand, the uniqueness of the product we were selling. So we didn't just treat it like peanut butter.

The team did a lot of work using Revionics to look SKU-by-SKU before we did the repricing..

And please don't walk away with the impression that we've raised prices across the house. That's not....

That is absolutely not..

...how this played out. We are optimizing. The value we're providing to our guests in Sally as we carry forward..

That's great, guys.

If I could just, Aaron, one on the EPS baseline, so your guidance is that using the $2.16 as the baseline, the adjusted EPS?.

Yes..

Okay. Thank you very much..

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

Good morning..

Hi. Good morning..

You guys gave some good color on the timing of the Oracle POS system and ERP that you're implementing next year.

I guess can you talk a little bit about how you have tried to position yourself such that you reduce any risks that, I guess, the rollout could have challenges in terms of, I guess, duplicative functions are running parallel processes, I guess maybe giving us a little bit of color around that would be helpful. Thank you..

The road of history is paved with retailers who haven't paid appropriate attention to the risk in connection with ERP implementations. And we are being very careful in our approach to both the JDA implementation as well as how is that impacting and being impacted by the other initiatives that we have underway.

And so, we're taking our time in doing it. We've got an expert team both internally and externally supporting us in doing it. We are going to start the implementation process in a segregated portion of our portfolio so that to the extent that issues arise, it will be on a small piece of one part of our business.

We will test and learn there and then we will expand ever so carefully thereafter as we push ahead. As much as I would love to have the implementation behind us rapidly, this is an area where we know we're going to go slow to go fast as we carry forward..

Okay. And then just one follow-up. You just – one of the previous questions talked about the 3% of the business as a whole that's e-commerce.

Are you seeing any increased competition from online in the professional channel, meaning, I don't know what the competitive dynamics of that segment look like online and whether there are any, I guess, companies that are trying to make headwinds there?.

Yeah. In some cases, yes, but it's isolated. So it's not really in the color part of the business, which is the single biggest part of BSG's business, north of 40% of the business. It does touch categories like electrical appliances, as we've mentioned.

And it's a little bit inherent here mainly on those brands, as we've mentioned that are at the latter end of their lifecycle and are pushing more towards retail. And that has always occurred in the professional segment.

It's just it's a little easier to push into those retail channels whether that be through Amazon or Ulta or others today than it was 10 years ago, say. So I would say, yes, there is competition there.

It's not across the board, and it does focus on specific categories and electricals, and in portions of hair care, more mature brands in hair care would be the areas I would point to..

But it's important to keep – it's always important to keep in mind with respect to the business that one of the competitive advantages that we have with BSG is we have the exclusive brand relationships in key areas. And that makes it much more difficult to compete with us online or otherwise with products that make up the majority of our business..

Sounds good. I'll pass to others. Thank you..

Thank you. We'll go to the line of Carla Casella from JPMorgan. Your line is open..

Hi. Thanks. Can you just give a little more color on store count? I think you've talked about closing 1% to 2% of your stores.

Can you talk about either cadence? Or have you set more specific numbers for this year?.

The update I would provide you is, on our last call, I guided that we were considering closing 1%, 2% of our gross portfolio. With the benefit of now having baked the plans, I would counsel you that or guide you that the number of stores will decline closer to net 1%.

And we will, of course, optimize that across the portfolio and in the context of where we see market opportunities..

Okay, great. And then in terms of the new – you talked about a few interesting new hair care lines and more organic and natural type.

When you're seeing the purchasing habits for those type of products, are you seeing switchover from existing lines or is it bringing in new customers?.

It's both. Clearly, natural is going to be a big push across both business segments. As we go into next year, we're seeing demand from the consumer for it. And what's great is a lot of those products tend to be smaller indie products.

And in many cases, we can get exclusivity, not just in the pro channel, but versus all competitors, complete exclusivity, which is what we got with Maria Nila. So in many ways, actually, we see it as an opportunity for us to push down a path that the consumers are excited about and increase the strength of our exclusive platform..

Okay, great. And then just one last clarification on your same store sales.

Have you given a sense of traffic versus ticket and how that's been trending from third quarter into fourth quarter, and/or if you can give anything month by month?.

No, we really don't break those two apart. But in general, traffic is down slightly but we're getting better at ticket..

Great. Thank you..

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

Thank you, everyone, for your questions today. To summarize, we fully recognize the need to reinvest in our business in order to drive future growth.

And we have aggressive plans both to upgrade our e-commerce platform, our store technology, our merchandising systems, our loyalty and CRM capabilities, our merchandising and store concepts, and our associated compensation strategy. We expect these investments to be funded largely through our previously announced cost reduction program.

Despite retail sector headwinds, we are the established leader in hair color and hair care for the professional and the consumer and these categories of sustained healthy growth while other categories have faced increasing competition.

We believe that these strategic investments will accelerate growth in our highly differentiated categories of color and care and keep us on the path to long term earnings growth. Thank you for joining us today..

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