Sally Beauty Holdings, Inc. (NYSE:SBH) Q2 2024 Earnings Call Transcript

Sally Beauty Holdings, Inc. (NYSE:SBH) Q2 2024 Earnings Call Transcript May 10, 2024

Sally Beauty Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, everyone and welcome to the Sally Beauty Holdings Conference Call to discuss the company’s Second Quarter Fiscal 2024 Results. [Operator Instructions] Now I would like to turn the call over to Jeff Harkins, Vice President of Investor Relations and Treasurer for Sally Beauty Holdings. Please go ahead.

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’d 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 obligations 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. Our teams navigated dynamic sales trends during the second quarter while continuing to execute against our strategic priorities and deliver engaging experiences for our customers. Net sales came in at the lower end of our expectations at $908 million, down 1% and comparable sales declined 1.5%. Our sales results reflect notable strength and momentum in our BSG segment, offset by softer sales performance at Sally amidst weather challenges in January and ongoing customer frugality. Adjusted gross margin was 51%, which came in lower than we anticipated due to higher promotional penetration as well as an unfavorable sales mix shift out of our highest margin Sally U.S. business.

. We continue to execute solid cost controls with adjusted SG&A of 1% versus last year, in line with our expectations. The business generated solid cash flow from operations of $37 million, allowing us to return value to shareholders via continued share repurchase activity. We also strengthened the balance sheet with the refinancing of our 2025 senior unsecured notes. More on that later from Marlo. Let’s take a look at performance by segment. At BSG, Q2 comparable sales were up 2%, a bit ahead of our expectations. This represents the second consecutive quarter of positive comps and reflects continuing improvement in salon demand trends paired with a robust flow of product innovation. Comparable transactions increased 2% and average ticket value was flat to the prior year.

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Q&A Session

We are pleased to see momentum returning to BSG with color and care, both in positive territory. It is clear that our stylists are seeking value, which was reflected in the strength of our quarterly customer appreciation sales. In our Sally segment, sales were at the low end of our expectations for the quarter as our customers continue to exhibit cautious shopping behavior. Q2 comparable sales declined 4% with comparable transactions down 5% and average ticket value up 1%. Looking at the cadence of the quarter. As we shared on our Q1 call, we started the quarter with about $10 million of weather impact to January, which put outsized pressure on transactions for the quarter. Subsequently, Sally returned to a more normalized traffic and transaction trend line at the end of the month and into early February.

Although transactions continued to improve throughout the quarter, our Sally U.S. and Canada customers demonstrated price sensitivity, leaning into promotions more heavily than we’ve seen in recent quarters, negatively impacting average unit retail. While promo offerings were approximately flat year-over-year, we believe the macro backdrop had a heightened impact on the increased take rate of promotional items by our lower income consumers who are seeking value in response to the inflationary environment, including elevated credit card and buy now pay later balances with higher interest rates. As we have seen both our stylists and our retail customers increased their promotional purchases in recent months, we are partnering with our vendors and we are adjusting our tactics, including looking at the design, depth and duration of our offers.

We’re taking these actions while remaining intensely focused on retaining and growing loyalty among our shoppers by leveraging our strategic initiatives from innovation to marketplaces and beyond. To that end, our ongoing focus on our core strategic initiatives, enhancing our customer centricity, growing our high-margin owned brands and amplifying innovation and increasing the efficiency of our operations is bearing fruit. In Q2, product innovation, territory expansion and new services contributed over 250 basis points to our comparable sales results, and we remain on track to achieve 200 to 300 basis points of contribution from these initiatives for the full year. There are a number of highlights from the quarter and actions planned for the second half.

Starting with product innovation. This continues to be an important driver of growth and customer engagement in both our BSG and Sally segment. At BSG, we recently secured substantial territory expansion with two important brands. We added key geographies with Moroccan Oil, and we’re now selling Amika across all stores and e-com in the U.S. and Canada. We also added two new compelling brands to our stable, Briogeo and epres both of which have earned a cult following fueled by innovation. Considered a pioneer in scalp care, Briogeo brings a line of clean, plant-based products to approximately 500 CosmoProf locations nationwide. Founded by the scientist behind Olaplex, epres brings a new line of highly innovative bonding products to BSG, providing another efficacious tool to support our stylists as they serve their clients.

From a trend perspective, Blondeing, glossing and express coloring remains strong as well as conscious beauty and textured hair products. In our Sally Beauty segment, innovation is also paramount across both owned and third-party brands. Major trends include dark vivids, toners with built-in color and sustainable products which we are beginning to telegraph under a new mindful banner. In Q2, owned brand sales penetration for the Global Sally Beauty segment was 34%, up 60 basis points over the prior year. During the second half of the year, we have additional innovation forthcoming in skin care and men’s grooming. Our latest marketing campaign, rooted in success demonstrates our focus on creating branding moments that go beyond our Sally Beauty banner.

Launched in connection with Black History Month, the campaign celebrates entrepreneurism and creativity. We’ll be building on this early success and the momentum we’re seeing during other key moments throughout the year, including Pride Month and Hispanic Heritage month. Turning now to customer centricity. Let me start with a few updates on our new concepts and services. Starting with Licensed Colorist OnDemand, this service is available nationwide online and is now linked to all Sally U.S. stores. Momentum continues to build. We saw over 3,000 consultations per week throughout Q2 with growth month-over-month throughout the quarter. In Q2, 40% of customers who engaged in the service were new to Sally. While it remains early days to understand the long-term benefit of the service, I’d note that for existing customers, we are seeing an uptick in visit frequency in the months following their consultation.

Additionally, average ticket value increased to $35 from $33 in Q1. We’re also seeing strong results from our marketplace initiatives with both Amazon and Walmart performing well. Additionally, we are up and running with DoorDash as of March, and we’ll launch Instacart in Q3. We view our marketplaces as an important omnichannel offering for our customers, allowing us to meet our existing customers where they are while also building awareness with new consumers. Looking at Studio by Sally, we are generating key insights around format, store layout, services and education, all of which is informing new ways to engage the customer. Although we’re seeing pockets of strength, results are mixed and we need more time to evaluate our KPIs before we take definitive steps to expand the initiative.

More to come on this in the quarters ahead. Moving now to Happy Beauty Co. As we test the concept and read results, we’re pleased with the performance of our initial 10 pilot stores. Traffic is continuing to build as our teams implement creative marketing strategies around social media, grassroots initiative and DIY events in stores. Gifting continues to be a strong driver, and we’ve been seeing that in the lead up to Mother’s Day this weekend. Average ticket and units per transaction are tracking strongly, and we recently started testing a luxury closeout section on items above $10. Early uptake there is positive. Based on the strength of our initial Happy Beauty rollout, we plan to open up to an additional 10 pilot stores prior to Thanksgiving in the Dallas and Phoenix market.

These additional stores will further test the demographic and co-tenancy profiles that are showing strength. As part of the expanded pilot, we will also test mall locations, which we believe could be well suited for the concept given their inherent traffic and exposure to demographic profiles that are resonating in our pilot to date. Longer term, we have conviction there will be an opportunity for more accelerated expansion in fiscal 2025 and beyond. Profitability remains a priority across the organization, and our teams are coalesced around our Fuel for Growth initiatives. We’re on track to capture previously announced pre-tax benefits of $20 million in fiscal 2024. And as shared on our last earnings call, we have identified another tranche of potential pre-tax benefit totaling approximately $50 million in fiscal 2025 with cumulative run rate benefits in fiscal 2026, approaching $120 million.

In closing, this was a quarter with a number of learnings to build upon as we look to the future. We’re pleased to see momentum return to BSG with comparable sales in positive territory for two consecutive quarters. We believe the path to continued growth there will be driven by a combination of innovation distribution expansion and strengthening forward demand. On the Sally side, we anticipate that macro pressures will persist in the near term and remain sharply focused on controlling the controllables, which includes enhancing customer centricity through our marketplaces and Licensed Colorist OnDemand initiative. As we remain focused on delivering engaging customer experiences and executing our strategic initiatives, we are responding to the continued shift in customer dynamics with thoughtful adjustments to our promotional cadence and maintaining strict cost discipline.

We greatly appreciate the ongoing support of our shareholders, and we remain committed to serving our customers and driving long-term profitable growth and value creation for all of our stakeholders. 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 was a dynamic one. And while we saw points of strength, our profit results came in below our expectations. Of note, sales came in at the lower end of our range, while gross margin relative to our internal expectations was our pressure point, and SG&A was in line. Let me unpack the major drivers of the quarter. First, starting with sales. We were pleased to see BSG deliver slightly ahead of expectations with the second consecutive quarter of comparable sales growth. Turning to Sally, sales came in at the low end of our expectations. We started the quarter with about $10 million of weather impact to January. Subsequently, Sally returned to a more normalized trend line at the end of the month and into early February.

Although transactions continued to improve throughout the quarter, performance at Sally U.S. and Canada was further impacted by a decline in average unit retail prices. As Denise pointed out, we saw customers increase their take rate on promotions, and we attribute this to the inflationary environment that continues to persist. Turning to gross margin. Although gross margin came in above our 50% target range at 51%, this was lower than we anticipated, primarily driven by a higher take rate on promotions across both business segments as our customers sought value, combined with a lower mix of our higher-margin Sally U.S. sales. Now let me take you through the details. Second quarter consolidated net sales of $908 million declined 1.1%, while consolidated comparable sales declined 1.5%.

Global e-commerce sales were $90 million and represented 10% of total net sales. Looking at gross profit, we delivered solid gross margins, which came in at 51% and was flat to the prior year. Excluding last year’s true-up of the non-cash inventory write-down related to the distribution center consolidation and store optimization plan that we executed last year, adjusted gross margin was 51%, an increase of 30 basis points compared to 50.7% in the prior year. Year-over-year increase reflects lower distribution and freight costs resulting from supply chain efficiencies, partially offset by a lower mix of our higher-margin Sally U.S. sales, which I mentioned earlier. Second quarter adjusted SG&A was up $5 million versus prior year to $395 million.

Year-over-year increase primarily reflects increased labor costs as well as higher rent expense, partially offset by lower accrued bonus expense. For the full year, we expect adjusted SG&A dollars to be up modestly versus fiscal 2023. This primarily reflects increased labor costs as well as investments in upper funnel marketing and other expenses related to our strategic growth initiatives, partially offset by the favorable impact of our fuel for growth initiatives. As a reminder, we expect to realize $20 million of pre-tax benefits to gross margin and SG&A that is weighted more heavily towards the second half of fiscal 2024. For perspective, approximately 75% of the benefits will be realized in SG&A. We expect to incur pre-tax cash charges associated with the Fuel for Growth program in the range of $25 million to $30 million in the current fiscal year, including $14 million that has been realized year-to-date.

Additionally, we are working with external partners on additional opportunities and expect to approach $120 million in cumulative run rate benefits by the end of fiscal 2026. Turning now to earnings. Adjusted operating margin came in at 7.6%. Adjusted EBITDA margin was 11% and adjusted diluted earnings per share was $0.35. Moving to segment results. Sally Beauty comparable sales declined 4%, while net sales were down 3%, reflecting the factors I outlined earlier, including the January weather impact and ongoing frugality against the macro backdrop. At constant currency, Sally e-commerce sales were $34 million and represented 7% of segment net sales for the quarter. For the Global Sally Beauty segment, color was down 4% and care was up 1%. At Sally U.S. and Canada, color was down 6% and care was down 1%.

Of note in Q2, we generated 79% of our Sally U.S. and Canada sales from our 16 million loyalty members. Gross margin in our Sally segment was 59.9%, up 10 basis points to last year, reflecting supply chain efficiencies, partially offset by last year’s true-up of the non-cash inventory write-down related to the distribution center consolidation and store optimization plan. Segment operating margin came in at 15%. Moving to the BSG segment. The combination of product innovation, expanded distribution and strengthening salon demand trends drove strong performance in the quarter. Comparable sales and net sales were both up 2%. On a constant currency basis, BSG e-commerce sales were $56 million, representing 14% of segment net sales for the quarter.

The color category was up 6% and care was up 3%. Gross margin at BSG increased 50 basis points to 39.4%, reflecting supply chain efficiencies, partially offset by lower product margin, which was driven mostly by higher take rate on promotions and brand mix. Segment operating margin was 10.9%. Turning to the balance sheet and cash flow. We ended the second quarter with $97 million of cash and cash equivalents and $62 million outstanding under our asset-based revolving line of credit. Our net debt leverage ratio stood at 2.2x. Importantly, during the quarter, we were able to take advantage of an opportunity to further optimize our balance sheet by issuing a new $600 million 8-year senior unsecured notes due 2032. The net proceeds from the transaction in combination with existing cash and a modest draw under our asset-based revolving line of credit were used to refinance our $680 million 5.58% senior unsecured notes due 2025.

A new senior unsecured note was issued with a coupon rate of 6.75%. The lower principal amount of the new note will help offset the majority of the interest expense from the higher coupon rate. Quarter end inventory was up 1.6% to slightly over $1 billion, which is in-line with our expectations and reflects a healthy overall position, including good in-stock levels. We generated positive cash flow from operations of $37 million allowing us to repurchase another 1.5 million shares at an aggregate cost of $20 million this quarter under our share repurchase plan. Turning now to guidance. We are revising our full year operating margin outlook to reflect our second quarter results. We continue to expect full year net sales and comparable sales to be approximately flat.

As a reminder, for the second half of the year, we expect BSG to benefit from continued momentum in new brand innovation and expanded distribution opportunities as well as easier compares from lapping of hair care headwinds from the last several quarters. Additionally, at Sally, we expect incremental improvement on the top line to be driven by the ramp of Walmart marketplace as well as the addition of Instacart and DoorDash. The expansion of Licensed Colorist OnDemand and benefits in Europe from pricing and new brand launches. Given the dynamics from our second quarter results, we are sharpening our guidance on gross margin and now expect the full year gross margin rate to be in the range of 50.5% to 51%. We now expect adjusted operating margin of approximately 8.5%.

Accordingly, we are also revising our operating cash flow outlook to approximately $240 million. Lastly, capital expenditures are still planned to be approximately $100 million. Looking at the third quarter, we expect net sales and comparable sales to be in the range of down 1% to up 1%. We expect the gross margin rate in Q3 to be down slightly from Q2, driven in large part by the Q2 factors I discussed earlier around higher take rate on promotions and overall sales mix. Third quarter adjusted SG&A dollars are expected to be approximately flat compared to our second quarter. Incremental investments in marketing will be offset by the savings from our Fuel for Growth program as expected. Additionally, we expect – we anticipate the third quarter adjusted operating margin will be in the range of 8% to 8.5%.

Lastly, we expect investments in share repurchases in the third quarter to be approximately $10 million. We appreciate your time this morning. Now I’ll ask the operator to open the call for Q&A.

Operator: Thank you. [Operator Instructions] And the question will come from the line of Korinne Wolfmeyer from Piper Sandler. Please go ahead.

Unidentified Analyst: Hi, good morning. This is Sarah on for Korinne. Could you talk a bit about what you’re seeing in terms of stylist sentiment and if you’re still finding stylists shopping closer to their need versus holding more inventory or if that’s improving at all? And then with those recently added brands to BSG, how are you thinking about which brands you’re reducing shelf space for to bring those new brands on.

Denise Paulonis: Yes. Happy to talk about that. We were extremely pleased to see continued stylist trends improve in Q2 and the strength of our BSG business overall, posting a positive comp. As you mentioned, both stylists sentiment and our innovation and territory expansion were contributions to that. So on the stylists sentiment side, we’re still seeing stylists to buy closer to need. With an exception this past quarter, where when there was a discounting opportunity like with our customer appreciation sale, we actually saw better stylist response to that than we had in the past, which suggests to us that search for value on the part of the stylist is the most predominant behavior right now. So certainly not stocking up for just preparing for the future, but we’ll take advantage of those deals when those deals come forward.