Sally Beauty Holdings, Inc. (NYSE:SBH) Q2 2023 Earnings Call Transcript May 6, 2023

Operator: Good morning, everyone, and welcome to the Sally Beauty Holdings conference call to discuss the company’s fiscal 2023 second quarter results. All participants have been placed in a listen-only mode. After management’s prepared remarks, there will be in-state. Now I would like to turn the call over to Jeff Harkins, Vice President of Investor Relations and Treasurer for Sally Beauty Holdings.

Jeff Harkins: Thank you. Good morning, everyone, and thank you for joining us. With me on the call today are Denise Paulonis, President and Chief Executive Officer; and Marlo Cormier, Chief Financial Officer. Before we begin, I would like to remind everyone that management’s remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our most recent annual report on Form 10-K and other filings with the SEC. Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligation to update them.

The company has provided a detailed explanation and reconciliations of its adjusting items and non-GAAP financial measures in its earnings press release and on its website. Now I’d like to turn the call over to Denise to begin the formal remarks.

Denise Paulonis: Thank you, Jeff, and good morning, everyone. We’re pleased to report another solid quarter in fiscal Q2 with notable strength in our Sally division, which delivered comp sales growth of 9.1%. On a consolidated basis, net sales increased 1% to $919 million and comparable sales grew 5.7%, with e-commerce sales up 9% year-over-year on a constant currency basis. Solid gross margin performance and prudent cost control enabled us to deliver adjusted EBITDA of $105 million. The results reflect strong execution by our team and demonstrate that our strategies are working in what continues to be a dynamic macro environment. In the quarter, comparable transactions at Sally were up low single digits, with average ticket up mid-single digits driven by higher average unit retail prices and flat units per transaction.

On the BSG side, comparable store transactions were down slightly with average ticket up low single digits, driven by higher average unit retail prices, partially offset by lower units per transaction. The color and care categories remained strong at Sally, up 6% and 2%, respectively, on a total sales basis, which includes the impact of store closures. Color continues to see strong momentum with great coverage up 14%. Turning now to BSG. Color was up 4% on a total sales basis and nails, skincare and cosmetics performed well in the quarter. Care was down 2%, reflecting Sally’s continuing to buy closer to need and the lapping of some new product launches last year. Of note, in both segments, we have made great progress on inventory. Our in-stock levels are the best we have seen since 2019 with lower total weeks on hand, enabled by our investments in planning and allocation and supply chain technologies.

Taking a bit broader look at the Sally consumer, we saw customer purchasing behavior hold steady in January and February as compared to Q1, with some softening in transactions and ticket at the end of March that continued in April. We’re closely monitoring this trend and focused on actions around newness and value that inspire our customers to shop. Additionally, cost control remains a priority. Halfway through the year, we’re particularly pleased to be on track with our fiscal 2023 priorities and delivering financial results consistent with the goals we laid out last November when we shared our vision for the Sally Beauty Holdings of the future. We believe the execution of our 3 strategic initiatives is unlocking our future growth potential as we enhance customer centricity, fuel innovation and increase operating efficiency.

Today, I’ll provide a few highlights on each one. Let’s start with customer centricity. In Q2, we had 17 million active loyalty members at Sally U.S. and Canada, comprising 78% of sales. And our rewards credit card at BSG represented 9% of sales for the quarter. We pride ourselves on serving as a trusted resource for our DIY customers and professional stylists and they continue to award us with high NPS scores and high engagement with our brands in store, on our website and across multiple social media outlets. At BSG, we’re seeing strong stylist engagement with our salon H2 platform, which has now surpassed 1,000 new digital storefronts in the first territory we’re piloting. During these initial months, we’re working closely with our stylists to ensure they have the resources they need to utilize this is a powerful selling tool to grow their businesses.

We’re excited about the potential for this platform, which advances our goal to build a services ecosystem that empowers our solid community to operate more value-added and profitable businesses. Turning now to our Sally business. Our virtual color expert program continues to perform well with great customer response and feedback. When customers utilize this service, we see average ticket trend higher by about 40%, driven by color and color accessories. Additionally, NPS scores are 16 points higher than our already strong baseline. Virtual color expert is currently in 75 stores. As we look to scale the initiative, we remain on track to roll out this to our e-commerce platform in the second half of the year. Moving on to our new Studio by Sally concept.

We are on track with the initial store rollout and opened our first pilot location in Dallas at the end of fiscal Q2. The store looks fantastic and we’re thrilled to be bringing this experiential retail concept to market. With Studio by Sally, we’re essentially updating and modernizing our proven sally formula, making it more interactive and engaging for our customers. We are ideally positioned to do this by leveraging our DIY authority and utilizing our core competencies across color and care, education and digital. Customer response in the initial weeks has been positive, and we have 5 additional locations slated to open this fiscal year. Moving on to our second strategic initiative, owned for brand penetration and product innovation.

At BSG, after a few years during which vendors were focused on overcoming pandemic-related supply chain issues, we are starting to see the innovation pipeline pick up in the pro channel. We are bringing newness to our stylists in color and care, including new bonding products from 2 of our marquee vendor partners, including Wella Ultimate Repair and Paul Mitchell Bond Rx, both of which recently launched. Additionally, we expanded our distribution with ColorView to approximately half of our stores and partnered with Danger Jones for the exclusive U.S. launch of their new Vivid color line in all BSG locations. Danger Jones is a highly creative and edgy direct-to-consumer brand, recently brought to market by the makers of Pulp Riot, which has an incredibly strong following.

This is a more intense color line. It’s considered highly artistic and has the potential to bring a new customer to BSG. This is a great example of our authority in color and ability to stay at the forefront of the category. Lastly, BHG’s biggest launch in fiscal ‘23 will be in the third quarter when we introduced Amica, a fun clean vegan haircare brand, which will be carried in the majority of our U.S. stores. At Sally, we’re continuing to bring newness to our customers, focusing on both vendor innovation and owned brands. In the second half of the year, we’re excited about several new brand launches from our vendor partners across key categories like hair color, hair care and textured hair. On the owned brand side, we completed the full launch of our new bond bar line in the second quarter, which is performing well and bringing in new customers who have not shopped at Sally previously.

On brand sales penetration for the Sally segment was 34% of sales in the second quarter, up compared to the prior year. Turning now to our third strategic initiative, capturing efficiencies and optimizing our capabilities. Our store optimization program is enabling us to improve productivity and profitability while delivering a convenient omnichannel experience to our customers. In the initial months following our recent store closures, sales transfer has been strong and was a contributor to our 9% comp sales growth at Sally this quarter. From a supply chain perspective, we’ve continued to increase efficiency as macro-driven disruptions have begun to recede. As a result, I am pleased to note that we are approaching the second half of fiscal 2023 with healthy inventory, and as I mentioned earlier, strong in the stock level.

Lastly, our Fuel for Growth initiative is ongoing and remains an important component of how we think about the future and deliver on our profitability targets. As an example, we are currently testing a new shipment frequency to our stores that we believe will reduce our transportation costs and drive better labor productivity in both our stores and DCs while maintaining healthy in-stock levels. In the current environment, we remain focused on driving forward our long-term growth agenda while managing expenses. We’re staying close to our customers, providing them with engaging experiences and leveraging our authority in color and care to bring newness in services and assortment to both our DIY customers and professional stylist communities.

We’re confident that our competitive advantages and strategies will drive sustainable growth and value for our shareholders in the coming years. Now I’ll turn the call over to Marlo to discuss the financials.

Marlo Cormier: Thank you, Denise, and good morning, everyone. Our second quarter results reflect another solid quarter of progress and execution across our 3 strategic initiatives. Second quarter net sales increased 1% to $919 million on 378 fewer stores and 80 basis points of unfavorable foreign currency impact. Comparable sales grew a healthy 5.7% with Sally’s delivering 9.1% growth in BSG returning to positive comps. Digital performance remained strong with global e-commerce sales up 9% on a constant currency basis to $87 million and representing 10% of total net sales. We maintained strong adjusted gross margins, which came in at 50.7%. Increased product margin at Sally Beauty driven by pricing leverage and higher owned brand penetration was more than offset by lower margin at BSG due to a channel mix shift between stores and our expanded Regis business as well as a shift in some distribution center costs from SG&A expense into gross margin.

Turning now to operating expense. Adjusted SG&A totaled $390 million. That’s up $12 million versus a year ago, in line with our expectations and reflect higher labor, accrued bonus and advertising costs, partly offset by savings from our previously announced distribution center consolidation and store optimization plan. It’s early days, but we’re pleased to see our wage investments begin to bear fruit in the form of improved retention and stronger conversion in store. Additionally, we are on track to achieve expected expense savings of approximately $50 million this year from our distribution center consolidation and store optimization plan, which will serve as a partial offset to macro-driven wage pressure. We expect to capture the majority of those savings across the second quarter through the fourth quarter at approximately $15 million each quarter with a small portion that occurred in the first quarter.

Looking forward to the third quarter, we expect SG&A on a dollar basis to be up low single digits to the prior year, driven primarily by increased labor costs and higher accrued bonus expense. Ongoing cost control, combined with our strong gross margin performance drove solid bottom line performance. Adjusted operating margin came in at 8.3%, adjusted EBITDA margin was 11.5%, and adjusted diluted earnings per share was $0.41. Looking at segment results. Sally Beauty’s strong 9.1% comparable sales increase reflects strong sales recapture from recently closed stores, contributing just under half of the increase as well as the comparison to a challenging second quarter last year, which included the impact from Omicron supply chain challenges and the onset of inflationary pressures, particularly at Sally U.S. and Canada.

Segment net sales increased 1% despite 356 fewer stores in operations versus a year ago and 90 basis points of unfavorable foreign currency impact. At constant currency, Sally e-commerce sales increased 7% to $34 million, representing 6.4% of segment net sales for the quarter. Notably, we’re seeing that our Klarna buy now, pay later payment option is driving higher average order value and bringing a new and younger customer to Sally. For the Global Sally segment, color was up 6%, driven by great coverage and care increased 2%. At Sal U.S. and Canada, color increased by 8%, while care was down 1%, including the impact of store closures. Gross margin at Sally expanded 100 basis points to 59.8%. There are 2 key drivers here. First, product margins remained strong, driven primarily by pricing leverage and higher owned brand penetration.

Second, there was a favorable true-up of the noncash inventory write-down we took in the fourth quarter of last year related to the distribution center consolidation and store optimization plan. Strong sales and gross margin performance drove 200 basis points of segment operating margin expansion, which came in at 17.4%. Moving to the BSG segment. We saw second quarter trends that were consistent with our first quarter comparable sales growth of 1.3% compares to a disruptive quarter last year that was impacted by supply chain challenges in Omicron. Net sales increased 1% on 22 fewer stores in operation versus a year ago and 50 basis points of unfavorable foreign currency impact. On a constant currency basis, BSG e-commerce sales increased 11% to $53 million or 13.7% of segment net sales for the quarter.

The color category remained strong and was up 4%, while care declined 2% at BSG on a total sales basis. As our stylists continue to purchase closer to need and we lap some new product launches from last year. The mail category was particularly strong, up 17%, reflecting strong response to our resets in the latter part of last year. Gross margin at BSG decreased 160 basis points to 38.9%, primarily driven by lower product margins due to the sales channel mix shift between stores and our expanded regions partnership as well as a shift in some distribution center costs from SG&A into gross margin. Segment operating margin came in at 9.6%. Moving to the balance sheet and cash flow. We ended the quarter with $62 million of cash and cash equivalents and $34 million outstanding under our asset-based revolving line of credit.

Our net debt leverage ratio stood at 2.2x. During the quarter, we were able to further strengthen the balance sheet by taking advantage of a narrow opening in the market to refinance our $406 million term loan. Most notably, the loan has an extended maturity date and is covenant light, substantially mirroring the covenants under our [5 and 5/8%] senior notes due 2025. Under the new agreement, which matures in February 2030, the term loan has an aggregate principal amount of $400 million and bears interest at a floating rate equal to 1 month term so for, plus a spread of 250 basis points. The term loan was priced with an original issue discount of 99 in the quarter and includes mandatory quarterly amortization payment of 25% of the original loan amount.

Subsequent to the end of our second quarter, we entered into a 3-year interest rate swap agreement on April 28, which swaps a notional amount of $200 million of the new term loan from the floating term interest rate to a fixed rate of 3.705%. Looking at inventory. We are particularly pleased with the substantial progress we’ve made across composition and in stock levels. The combination of our improved capabilities and receding supply chain disruptions have enabled us to return to a healthy overall position. Quarter end inventories came in slightly above $1 billion versus $963 million a year ago. That’s up 6% and primarily reflects higher vendor pricing, improved in-stock levels as well as the timing of receipts. We expect our inventory to finish this year just below $1 billion.

Second quarter cash flow from operations was $25 million and capital expenditures totaled $17 million. For the full year, we continue to expect to return to free cash flow generation in the range of $175 million to $200 million, providing us with the financial flexibility to invest in our strategic initiatives to drive long-term growth. Turning now to guidance. I’ll start with some comments on cadence. Given the challenging macro conditions we’re lapping in the second quarter, we expect that this would be our highest comp performance of the year. Looking at the second half of fiscal 2023, we expect third quarter comparable sales to be in the low single digits and remain on track to achieve our full year guidance as follows. Comparable sales are expected to increase by low single digits compared to the prior year, driven by growth in key categories, sales transfer from store closures related to our store optimization efforts, our expanded Regents distribution and new strategic initiatives.

Net sales are expected to decline by low single digits compared to the prior year, reflecting the unfavorable impact of store closures from the company’s store optimization efforts, net of expected sales recapture rates and the anticipated unfavorable impact from foreign exchange headwinds. At the end of fiscal 2023, store count is expected to be down 6% to 7% compared to the end of fiscal 2022 due to our store optimization plan and a small number of new store openings. Gross margin is expected to remain above 50% and adjusted operating margin is expected to be in the range of 8.5% to 9.5%. We — this reflects increased investments in store labor, partially offset by an expected benefit to operating earnings of approximately $10 million related to our distribution center consolidation and store optimization plan.

We appreciate your time this morning. Now I’ll ask the operator to open the call for Q&A.

Q&A Session

Operator: Thank you. [Operator Instructions] One moment, please, for our first question. That will come from the line of Oliver Chen with PD Cowen.

Operator: We’ll go next to the line of Korinne Wolfmeyer with Piper Sandler.

Operator: We’ll go next to line Ashley Helgans with Jefferies.

Operator: We’ll go next to the line of Olivia Tong.

Operator: We’ll go next to the line of Simeon Gutman with Morgan Stanley.

Operator: Anything further Mr. Gutman?

Operator: And I’ll now turn it over to Denise for some closing remarks.

Denise Paulonis: Thank you, and I appreciate everyone joining us this morning. We continue to be very excited about the path that Sally Beauty Holdings is on and look forward to providing additional updates in the future. And as a final note, as always, thank you to all of our associates across the world for all you do every day to help serve our customers.

Operator: Thank you. And as a reminder, today’s conference was recorded for replay. Please refer to the company’s press release for that replay information. That does conclude our conference for today. Thank you for your participation and for using AT&T bond Conferencing. You may now disconnect.