Sally Beauty Holdings, Inc.

Good morning, ladies and gentlemen, and welcome to the Sally Beauty Holdings conference call to discuss the company's fiscal 2022 fourth quarter results. All participants have been placed in a listen-only mode. After management's prepared remarks, there will be a question and answer session. If you have a question, please press 1, then 0 to place your line in queue. As a reminder, this conference is being recorded for replay. 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, sir.

Thank you. Good morning, everyone. Thanks for joining us. With me on the call today are Denise Polonis, President and Chief Executive Officer, and Marlo Cormier, Chief Financial Officer. Before we begin, I want to remind everyone that we have made a presentation available for today's call that can be viewed from the link provided on our investor site at sallybeattieholdings.com. I would also like to remind you 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 factor 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.

Thank you, Jeff, and good morning, everyone. In fiscal 2022, we delivered full-year net sales of $3.8 billion, gross margin over 50%, and adjusted EBITDA of more than $500 million. We did this by leveraging our people, platforms, and scale to delight our core Sally Beauty customers and BSG stylists amidst persistent inflationary pressures and supply chain disruption. I'm particularly proud of our team's ability to navigate the numerous macro challenges of the past few years, becoming a more agile and focused organization overall. Importantly, during our transformational period from 2017 to 2021, we built the infrastructure and key foundational elements to take our business well into the future, including our CRM platforms, our advanced digital commerce capabilities, and our enhanced supply chain. On today's call, we'll be sharing our vision for the Sally Beauty holdings of the future, including new strategic initiatives we'll be focused on over the long term, and we'll provide our long-term growth algorithm that we'll be executing towards over the coming years. Ahead of that, let me take a moment to comment briefly on the current operating environment as well as share a few highlights from fiscal 2022. First, the operating environment. As we ended fiscal 2022, inflationary pressures continue to influence customer and stylist behavior. In Sally US and Canada, the inflationary environment continues to cause some of our customers to color less frequently and reduce the size of their basket when they shop with us. While the situation is not improved, Of note, we believe our focus on customer service and our pro quality for less marketing is resonating, limiting additional pressure on sales. In BSG, our stylists are focused on saving time and maximizing profitability. We continue to see them purchasing closer to need while responding favorably to promotional bundles and education for express services. We believe salons had a healthy back-to-school season followed by some softening of demand once customers transitioned into their fall routine. On the supply chain front, while improving, some of our vendors are still experiencing raw material shortages, which is impacting stock levels in a few of our top performing SKUs. As we look to fiscal 2023, we're expecting a similar operating environment to what we saw at the end of fiscal 2022. Turning to wins in fiscal 2022, I am pleased to share several highlights. Throughout the year, we remained at the forefront of product innovation across both the SALI and VSG segments. This includes our strong partnerships with premier brands like Wella, Matrix, Joico, Olaplex, and WeDad, as well as owned brands like Ion and Strawberry Leopard. We also grow our loyalty programs. As you know, our loyalty program drives the majority of our sales at Sally U.S. and Canada and is an important indicator of customer retention. As of year end, the number of Sally U.S. and Canada active loyalty members was 17 million and represented 77% of sales for the fiscal year. At BSG, our rewards credit card continues to benefit our pro customers in helping them manage their working capital needs for their business. The rewards credit card comprised 9% of BSG sales for the fiscal year. New conveniences and increased personalization enable us to better serve our ROA customers. Initiatives ranging from Sally's virtual color expert and two-hour deliveries to personalized shopping journeys were met with tremendous customer response and continue to gain traction. Another important means for better serving our customer is the advancement of our supply chain. As a top destination to shop for professional color and care, our goal is to be in stock in these core categories every time for our customers. And we made great strides last year towards increasing speed to market and improving our in-stock levels, notwithstanding macro-related supply chain disruption. The underlying strength of our supply chain also allowed us to significantly expand our partnership with Regis Salons during the latter part of 2022. After a multi-quarter rollout, we now have full distribution for all 5,000 plus redislocations. Finally, we further strengthened the balance sheet in fiscal 2022 with the full repayment of $300 million outstanding under our senior secured notes, while returning $130 million to shareholders through the repurchase of almost 7 million shares. Our historically strong cash flow generation and our healthy balance sheet leave us well positioned to invest in new business models and services to drive growth and return value to shareholders. As I shift my comments to our longer-term vision and strategic initiatives, I think it's important to reiterate that underpinning our advancements in fiscal 2022 is our operating model centered on owning professional hair color and care, for both the DIY enthusiasts and professional stylists. At Sally Beauty, we are distinguished by our differentiated core in color and care for home use, and this is supported by the unparalleled expertise, education, and content we provide to our customers. At BSG, we are the largest North American distributor of professional color and care, and we offer stylists and salons the most extensive portfolio of third-party brands in the market, most of which are under exclusive distribution rights. Beginning in fiscal 2023, we will be leveraging and building upon these core competencies and competitive advantages as we embark on our new strategic initiative to drive growth and profitability. Our three strategic initiatives are as follows. Enhancing our customer centricity. Growing high margin owned brands at Sally Beauty and amplifying innovation. and increasing the efficiency of our operations and optimizing our capabilities. Moreover, we'll also be focused on advancing our ESG and our diversity, inclusion, and belonging commitments. Let's dive into our strategic initiatives. Our first initiative is enhancing our customer centricity. I'll start with how this comes to life at VSG. Designed to drive continued growth at BSG, we are building a services ecosystem for our stylist community, designed to empower them to operate more value-added and profitable businesses. This fall, our first step in these efforts was the launch of a new strategic partnership with Salon HQ, which enables our stylists to increase retail sales through strategic customer engagement while carrying less inventory. PlanHQ's customizable digital storefront platform gives our stylists the ability to curate a product selection from thousands of choices and enable clients to purchase directly from their shops without having to hold inventory. By providing our stylists with a digital storefront, a seamless funnel, and powerful support pools, they'll have the ability to sell the full line of BSU products and increase the profitability of their business. In addition, stylists and salons will be able to engage their customers using advanced marketing tools to present product recommendations and follow up on previous orders. Initial response from the stylist community has been tremendous and the concept is gaining traction. As we look beyond fiscal 2023 for BSG, in addition to our stylist platform with Salon HQ, we are exploring additional value creating services while continuing to amplify innovation and leverage our exclusive distribution rights to help our stylists grow their businesses. On the retail side of our business, we know how much our customers value the inspiration, education, and advice they get from Sally. We're leveraging this core competency to create an unraveled platform for the future. We already have certified color consultants who provide in-store education and advice. And for more complex needs, Sally customers can access next level expertise by connecting with our virtual color experts through a live video call conducted onsite in our stores. We began piloting this convenience in the first quarter of last year and have found that our Sally customer loves this incrementally higher level of touch and counseling. We currently have 45 stores offering virtual color experts and plan to expand this to approximately 30 additional stores as well as our Sally website in fiscal 2023. Building upon this high-touch service offering, we've created Studio by Sally, a new concept store that includes a DIY-centric salon. Studio by Sally allows for personalized appointments with a licensed stylist who will train and educate the consumer on how to color their own hair and achieve their desired results. This is a new and inventive way to engage, educate, and empower consumers using interactive experiences to showcase our on-trend color and care expertise and ensure drive product sales. We conducted extensive market research to vet this concept, and the results tell us that there's a great deal of excitement among not only our core customers, but also lapsed customers and non-Sally customers alike. Studio by Sally will have a digital first focus from virtual check-in and digital education throughout the store to DIY demos streaming at the storefront and take-home videos from individual salon teaching sessions. We plan to pilot an initial six stores in fiscal 2023 and believe there's an opportunity to grow this concept to 100 locations throughout the US over the next three to four years. Turning to our second initiative, growing our high-margin owned brands penetration, and amplifying product innovation. While you note that delivering product innovation has been a core tenet of our operating and growth model for years, this remains of crucial importance for our company, and you can expect to see us build upon our already strong track record in the quarters and years ahead. Indeed, innovation has been a key differentiator for both Valley and BSG, and is expected to be an important driver of growth going forward. We will continue to cultivate differentiated products through strong relationships with the best innovators and beauty companies in the world. We see our customers and stylist reach as an exceptional asset in driving joint growth with our vendor partners. As part of this effort, we'll also be prioritizing secondary categories, notably nails, to ensure that we're on trend and in stock with focused assortments beyond our core. Additionally, we see great opportunity grow our high-margin owned brands. This includes powerful brands that we have built from the ground up, like ION, which today is a $280 million brand. Strawberry Leopard is another great example of our innovation engine. We're pleased with the traction we've gained with it in just one year. We will continue to be highly selective in our approach to developing proprietary brands, focusing on areas where we can leverage our expertise to fill a void in the marketplace and garner meaningful share. Our latest innovation, BondBar, showcases this strategy. As we announced back in October, BondBar is a new line of pro-quality bonding products that we are bringing to market at a tremendous value to customers. We're incredibly proud of this innovation, which leverages our vast knowledge of hair care addresses the growing consumer demand for powerful hair repair solutions, and fills a void in the market for bonding products at accessible price points. As we look ahead, we believe owned brand penetration at Sally can increase from 33% of sales in fiscal 2022 to over 50% in the next four to five years. Now I'll turn to our final strategic initiative, increasing the efficiency of our operations, and optimizing our capabilities. We'll focus on three opportunities in this area, including optimizing our store base, consolidating and leveraging our enhanced supply chain, and capturing efficiencies by rethinking the way we work. First, store optimization. Our investments in recent years allowed us to build a robust omni-channel platform that will serve us well into the future. As we focus on delivering a seamless omnichannel experience, we've enhanced our digital offerings to meet customers where and when they want. In turn, our channel mix has shifted, and we expect it to continue to evolve. In response to this shift and continued expense inflation, during the past year, we conducted a 90-store optimization pilot, which yielded positive results, with sales transfer exceeding our target. After extensive analysis of those sample stores, We've made the decision to accelerate our store optimization program and close approximately 350 additional locations with the majority closings in December of 2022. Most of the closing stores are Sally stores based in the US. This optimization program allows us to improve productivity and profitability while delivering a convenient omnichannel experience that benefits our customers. Moving on to our supply chain, the progress we've made in modernizing our supply chain enables us to increase efficiency while supporting growth. On the efficiency side, we'll be closing two small distribution centers in Oregon and Pennsylvania and transferring the volumes to larger distribution centers. While continuing to delight our customers, these actions will enable us to realize cost savings and serve as an important offset to inflationary headwinds. Further, the muscle we have built within our supply chain in recent years has become a source of growth. Notably, it has enabled us to significantly grow our Regus partnership, with sales volume expected to double from fiscal 2022 to fiscal 2023. The visibility and strategic importance of this expanded relationship raises our profile among other brand partners and establishes a solid foundation for future chain growth. Last, but certainly not least, we have launched a Fuel for Growth initiative that is focused on rethinking the way we operate our business over the longer term, supporting our longer term operating profit margin objectives. Our teams are energized by our new strategic initiatives and remain committed to delivering innovation to both our SALI and BSG customers across product, services, and education. Over the long term, We believe these initiatives will enable the business to generate low to mid single digit net sales growth, gross margins over 50%, and low double digit operating margins. I'm confident in our strategies and impressed by our team, whose passion, perseverance, and creativity are allowing us to build upon our core strengths and create new pathways for growth in the face of a highly dynamic external environment. Looking ahead, I have tremendous conviction that our ability to leverage our infrastructure and capabilities while introducing exciting new initiatives will set us up to deliver improved top-line growth and profitability. We appreciate the support of our shareholders as we embark on a new set of initiatives to drive growth and create long-term shareholder value. Now I'll turn the call over to Marlo to cover the financials.

Thank you, Denise, and good morning, everyone. our fourth quarter results saw trends remain steady with sales landing around our expectations. We concluded the year with fourth quarter net sales of $962 million, down 2.8%, and comparable sales approximately flat to last year. The results reflect a few key factors. First, the transitory pressures that Denise outlined, the ongoing effects of inflation impacting consumer behavior in both our retail and professional divisions, as well as the continued supply chain disruptions at BSG, although improving as we anticipated. Additionally, we were operating 117 fewer stores at the end of the period compared to a year ago. Foreign currency translations had an unfavorable impact of 170 basis points on consolidated net sales for the quarter. And comparable sales held flat on growth of our e-commerce business. Our expanded REGIS partnership at BSG and positive comp growth in our Sally International business. At constant currency, global e-commerce sales increased 30% to $90 million, representing 9.3% of total net sales. E-commerce is beginning to comprise a larger percentage of the business as we scale our digital capabilities and utilize our new tools and resources to drive customer engagement. Looking at gross profit, we maintained adjusted gross margins north of 50%, Compared to a year ago, fourth quarter adjusted gross margins decreased 60 basis points, as higher product margin from pricing leverage at Sally Beauty was more than offset by a sales mix shift between Sally Beauty and BSG, and we incurred higher distribution and freight costs in both segments. Moving to operating expense, SG&A totaled $398 million. That's up about $11 million versus a year ago, and can primarily be traced to increased labor costs. partially offset by lower bonus expense. In fiscal 2023, we expect our distribution center consolidation and store optimization program to serve as a partial offset to wage inflation. As we announced today, we expect our distribution center consolidation and store optimization acceleration plan to generate expense savings of approximately $50 million in fiscal 2023. The sales recapture rate is expected to be strong and similar to our pilot, However, the store closures will result in some reduction in overall sales. The net result is we expect a positive impact to adjusted operating income of approximately $10 million. In the first quarter of fiscal 2023, we expect to incur an additional charge of approximately $20 million to close out these optimization efforts. Turning now to earnings, we maintained our healthy gross margin profile and continued to deliver good cost control with prudent spending focused on investments for strategic priorities. Fourth quarter adjusted operating margin was 8.7%. Adjusted EBITDA came in at $112 million, and adjusted diluted EPS was 50 cents. For the full year, on an adjusted basis, we delivered operating margin of 10.3%, EBITDA of more than $500 million, and diluted EPS of $2.16%. Looking at segment results, Sally Beauty's net sales declined 5.4%, primarily reflecting inflationary pressures that impacted our lower-income Sally customers. Additionally, foreign currency headwinds had an unfavorable impact of 270 basis points, and we had 110 fewer stores in operation versus a year ago. Comparable sales were down 1%, with the sales decline concentrated in the U.S. and Canada, which had a negative comp of 2%, and accounted for 80% of segment net sales in Q4. At constant currency, segment e-commerce sales increased 20% to $33 million, or 6% of segment net sales for the quarter. For the global Sally segment, color was up 2% and care declined 7%. At Sally US and Canada, color increased by 6% with gray coverage of 9%, while Vivis were up 1% and comprised 27% of this total color category. While total transactions and units per transaction were down at Sally US and Canada, average unit resale and average ticket increased. These dynamics have been fairly consistent for the past three quarters as our Sally customers stretched their visits and minimized basket ads in response to the inflationary environment. Adjusted gross margin at Sally expanded 60 basis points to 58.3%, reflecting solid product margins driven primarily by pricing leverage partially offset by higher distribution and freight costs. Segment operating margins came in at 14.5%. We delivered growth in the BSD segment, with net sales up 1% and comparable sales increasing 1.5%. While we continue to be impacted by supply chain disruptions, we did see some improvement in Q4 and expect the situation to normalize as we move through fiscal 2023. We estimate that the sales loss from raw material shortages was approximately $5 million or 120 basis points of impact on net sales growth. Additionally, at constant currency, segment e-commerce sales increased 37% to $57 million, or 13.9% of segment net sales for the quarter. The color category was down 5% in the quarter, driven mainly by stylists reducing their backstock inventory as some of their customers are stretching time between coloring services and by raw material shortages. While hair care increased 9% versus a year ago, due to our expanded Regus partnership and better in-stock levels with key brands. Adjusted growth margin at BSD decreased 180 basis points to 38.9%, primarily driven by lower product margin from a sales mix shift between stores and full service, and higher distribution and freight costs. Segment operating margins came in at 8%. Moving to the balance sheet and cash flow. We ended the year with $71 million of cash and cash equivalents, and $69 million outstanding under our asset-based revolving line of credit. Our net debt leverage ratio stood at 2.2 times. We brought down inventories to $936 million at year-end after peaking just north of $1 billion in Q3. Excluding the Q4 non-cash write-down of $19 million of goods related to the distribution center consolidation and acceleration of our store optimization program, year-end inventories would have been about $955 million. As supply chain disruptions began to ease, we're pleased to return to more normalized levels entering the new fiscal year. We generated free cash flow of $75 million in the fourth quarter and $57 million for the full year. We anticipate that our working capital requirements will revert to historical patterns as we progress through fiscal 2023 and expect to return to free cash flow generation in the range of $175 to $200 million, with the majority of that coming in the back half of the fiscal year. From a capital allocation perspective, we will continue to prioritize investing for growth and returning value to shareholders. Turning now to guidance. It is clear that the external environment will remain challenging for the foreseeable future, most notably inflationary pressure that is affecting consumer spending and also driving increased labor costs. We remain encouraged by our new strategic initiatives and the growth drivers we have just discussed, and they are reflected in our fiscal 2023 outlooks. For the full year, we expect the following. Capital sales, notwithstanding a notable change in consumer behavior, are expected to increase by low single digits compared to the prior year, driven by growth in key categories, sales transfer from store closures, our expanded REGIS distribution, and new strategic initiatives. Net sales are expected to decline by low single digits compared to the prior year. This reflects approximately 150 to 200 basis points of net unfavorable impact of store closures and expected sales recapture rates from our optimization efforts, as well as approximately 150 basis points of anticipated impact from FX headwinds. At the end of fiscal 2023, store count is expected to be down in the range of 6% to 7% compared to the end of fiscal 2022 due to our store optimization plan, net of a small number of new store openings. Gross margin is expected to remain above 50%. An adjusted operating margin is expected to be 9% at the midpoint of our guidance range. This is inclusive of our investment in store labor as we lean in to elevating the expertise of our associates to drive our growth in the coming years. In addition, we expect to partially offset this labor investment by the $10 million benefit to operating earnings from our distribution center consolidation and store optimization plan. While the uncertain macro backdrop is impacting our outlook for fiscal 2023. Our teams are energized by the opportunities ahead and the growth plans Denise outlined in her remarks. We are focusing on our new strategic initiatives and laying the groundwork to drive solid top line growth, build scale, and further optimize our operating model to return to double digit operating margins in fiscal 2024 and beyond. We appreciate your time this morning. Now I'll ask the operators to open the call for Q&A.

Thank you. Ladies and gentlemen, if you would like to ask a question, please press 1, then 0 on your telephone keypad. You may withdraw your question at any time by repeating the command of 1, then 0. Once again, if you have any questions or comments, please press 1, then 0. And our first question comes from the line of Rupesh Palka Oppenheimer. Please go ahead.

Good morning. Thanks for taking my question. So I just want to go back to your longer-term sales targets for low- to mid-single-digit growth. Just curious, what are the key drivers to get there? Your confidence in being able to get to that level, just given some of the challenges in recent years. How store closures impact that longer-term sales growth, and if there's any timing in terms of when you think you'll be able to start delivering those targets.

Sure. Thanks for the question, Rupesh. I'll start. Denise and Marlo can jump in as we need to here. You know, I think in the very near term, we really space out how we think about these growth initiatives. And let me walk you a little bit through year by year what we see coming online, which influences the numbers. You know, when we're looking to 2023 and our priorities to get that low single-digit comp number, right, key sources of growth there will be leaning in on own brands. That's Ion, that's Strawberry Leopard, that's Vaughn Barre. Rebuilding our nail category. We have a new nail wall set in both Sally and VSG stores and seeing good response there. Nearly doubling the Regus business that we have, which really leverages the e-commerce platform we've built. And then when we think about the store optimization DC consolidation pieces, they're a great help to operating performance for about $10 million this year. But we did talk about the fact that that store optimization We're expecting about a 40% recapture rate. And so with that recapture rate, there will be some pressure on the top line that comes through. But of course, that recapture delivers comp sales. As we work through 2024 into 2025, we see the new initiatives start to come online. So later in 23, Our stylist platform with Salon HQ, we expect to be ramping up. It's only in a test market right now. We really want to work out all the kinks, be sure it's just right before we fully roll that. And then our virtual color expert experience will roll out online later in the year as well, and we think that that will start to give that benefit and scale as we come through. And then when we get into 2024, further into 2024, it's when those things really start to ramp up. So further own brand growth, new innovation from our vendor partners, continued tailwinds from the virtual color expert and the e-commerce piece. And then when we talked about, and of course the stylist platform, then when we talk about Studio by Sally, it's a bit longer term. So we're going to pilot in fiscal 23 with a small number of stores. We're going to look to those results, and with positive results, we'd add some stores in 24. But we really believe it's going to be beyond 24 where we can get to perhaps up to 100 locations in the U.S. So when we think about the sales cadence, this year we're going to run positive comp sales. As we turn into next year, after we eliminate the drag that comes from the store consolidation work right now, net sales will turn positive. And as we work our way through 24 and 25, that's when we're really targeting that low to mid-single digit total sales trajectory.

Great. Great. Thank you. And then maybe just one follow-up question. Maybe for Marlo, as we look at this year, your guidance, anything you can share just from a quarterly cadence perspective?

Yeah. So from a quarterly cadence perspective, a lot of it's about what happened this past year in 2022. As you recall, we started Q1 very strong, plus six comp. And then as we were going into the holiday season, we were up against a COVID spike. And then as we came out of that, that's about when we saw the pivot to the intense inflationary pressure that really started to change customer behavior, and that pretty much held on throughout the rest of the year. So when you're looking at it from a year-over-year basis and then also taking into consideration what's happening this year with store closures, which is happening mainly in December for the bulk of the closures, the Q1 comp and net sales will be challenged, and then we'll start to see improvement as we go through the rest of the year. If you're looking at net sales, also keep in mind FX. We had some FX movement towards the end of this year that we won't lap until we get to Q4 this year.

Great. Thank you.

Our next question comes from the line of Oliver Chen, Cohen. Please go ahead.

Hi. Thank you. Regarding the door closure program, what's assumed for transfers and any color on how we should think about the margin impact there. Also, on the BSG division, would love further details on the gross margin and some headwinds there and what you're assuming going forward. That would be helpful as well. And then finally, the holiday period is always somewhat promotional. So what are you seeing in the environment and how you're prepared to compete in the topic of inflation? This is very pervasive across the consumer. Thanks a lot. Denise and Marlo.

Oliver, there's a lot there for us to unpack. Let's work through store closures and promotion, and then we might need you to clarify the BSG question. I'm not sure exactly what you were after there. On the store closure front, it's about 350 stores. It is primarily U.S. Sally stores. The vast majority of those will close in December of this year. The work that we've done and the pilot that we've been running over the course of the last year delivered good sales recapture rates actually above the industry average. For the stores that we're going to be closing, we're assuming about a 40% sales recapture rate. I think the important point to note in the stores that we're closing is the stores we're closing are all EBITDA, four-wall EBITDA positive. The benefit of the closure really comes from the ability to transfer those sales and then get some efficiencies within the labor and rent types of lines coming through. So net-net about 40% sales recapture is what we're looking for, and that will really start to play into as we get from December into January because of the timing of the closures. On the promotional front, I think you're very right. Customers and stylists are both looking for deals. When we think about what they're doing out there, they're being pretty selective. They're looking around, being choiceful in the decisions that they're making. That said, what we've really been focusing on is what most resonates with our stylists. And what we've done is more about changing our tactics versus investing more. So what we've been doing more is going to types of promotions like bundle offers. that there is a discount involved, but it actually ends up driving more unit sales, and we actually believe it's getting us more share of wallet. When people are buying that quantity, it's less that they might buy somewhere else coming through. But the absolute level of promotional investment has remained relatively steady. I would also say we've seen very good support from a number of our vendor partners where they are leaning in to help fund things some more enticing promotions for their specific product as they want to do that through the year. But I would argue it's not been overly elevated. It's more of a mix of the tactics that we're using from what they might have been before that might have been very single unit focused. And then the third question on VSG.

Yeah, I think you were referring to the VSG gross margins being down. So just to talk that through a bit, what we're seeing there is really a mixed shift. When you look at it at an individualized basis or skew level, the merchandising margins are strong. But what we're seeing is a mix away from stores and into full service, and a lot of that's being driven through the expansion of our Redis business. And, of course, we've got the higher distribution and freight costs. But when we look forward, you know, as a consolidated business, you know, there's going to be puts and takes, and we see for the combined business, you know, continued strong and healthy margins, about 50% going forward.

Thank you. Very helpful. The Regis partnership sounds encouraging. If you could give us thoughts on why that's the right partner, that would be helpful. And lastly, on digital, sometimes store closures can have unintended consequences given that they can be great recruitment opportunities for customer acquisition online as well. Have you thought through that and any thinking you have around that? I'm sure you tested it. Thanks a lot.

Sure. So on the Regus front, you know, I think the real benefit in the Regus business is when we think about how many people there are out there who use, you know, Regus franchise salons as their main destination, you know, 5,000 plus salons out there in the marketplace. It's a huge reach and they're not the only chain that is out there. So when we look at the penetration we've got, you've got people early in their careers as stylists, you've got customers through all walks of life who we can introduce to product that can stay with them for the long term. So whether those stylists stay with Regis or they choose to go out onto their own or join another salon, they will have been nicely ingrained with all the types of product that we can offer them, and we'll be building that relationship with them. So beyond the day-to-day sales today, the longer-term view of us becoming a more important part of our stylist's decision-making is really a strong point that we're going after, and it really fits nicely into the idea of the stylist ecosystem that we want to build to help them grow their businesses and to help them be more profitable. So all in all, a good business to be getting into. It comes at a slightly lower margin because it's more managed like our full-service business than it is our store business. But when you think about the longevity of those stylists, it's really something that we think will serve us well longer term. In the store closures, we've spent a lot of time thinking about this. I think it's actually been a number of investors and analysts that have actually asked us why we weren't moving faster. And I think when we reflect on it, we really wanted to take the full year to start to understand how those customers would behave, how they would transfer their sales. Would we have any change in trajectory of new customers coming into the business? All in all, at the 100 stores that we did the test on, we felt very good across all of those metrics. The piece that we're most focused on, as this is clearly a larger tranche of stores to go close, is that early communication to our customers about where their next closest Sally store might be, about how they can shop online, how they can still get both BOPUS and two-hour delivery potential that would just beef out of a different store. Reinforcing to them, by no means are we going away, we just want to transfer them to a different location or a slightly different experience. I think the piece that when we think about how deep the penetration is in things like two-hour delivery into our business model, in fact, that's really no change in behavior for the end customer in that portion of the business. This is definitely a larger tranche, right? We go into it understanding we might see, you know, a few surprises or a few puts and takes that will be, you know, anticipated and really realized in how we're thinking about the numbers, but believe that the benefit we get over the longer term, we are set up and have a good chance here of seeing the results that we are believing that we will see.

Thank you. Best regards.

Our next question comes from the line of Ashley Helgens. Jefferies, please go ahead.

Hi, thanks for taking your questions. I know you touched on it briefly, but any more details you can provide us on the trends in the salon channel? And then as consumer spend has started to soften, we're curious if you're seeing a pickup in things like DIY hair color. And then last, just any color you can give us on the recapture rate. Thanks so much.

Sure. So let's start with salon channels and then work our way through. So in salon channels, we put in our prepared remarks some commentary about just what we're seeing in general in the business. We think the salon had a pretty good back-to-school intro to fall season. The business has softened a little bit following that, more in line with what it had been mid-summer. But In general, our stylists are still talking about having good business, but seeing their customers stretch a little bit more between services. And certainly, the idea of stocking up on inventory, everyone's being very cash conscious about where else they need to use their cash in their own personal lives. So those trends haven't really changed. If we look back to what they are trying to figure out, they are trying to figure out how to be even more efficient with their businesses to be able to make more money and turn their chairs more quickly. We have seen an uptick in interest and engagement around express color and what that can do for their business in terms of being able to serve their clients a little bit more expediently. We've also seen them shopping and looking for where those promotions make sense to them, leaning in a little bit more in terms of units that they might have bought versus historical where maybe they weren't as focused on watching for those opportunities. So net-net, as we said, we haven't dramatically increased our promotional intensity, and where we are offering promotions, our vendors have been a great support in building both of our businesses together in doing that. So we're anticipating as we go through the coming year that that same level of A slight bit of sluggishness is going to be what continues to persist in the salons, and we'll be watching quite closely for any trends and changes that might come about there. On the DIY front and about customers' coloring, I think the most notable trend that we saw over the past quarter is we saw a 9% increase in our gray coverage products and gray coverage sales. We saw about a 1% increase in divots. So to me, as I look at that, we really are seeing a customer who's saying, I'm going to do my own hair a little bit more. I'm willing to be buying and knowing that that's going to be the path that I'm on. We felt very encouraged about that gray coverage number, while Vivid still hung in as we've seen them at about 27% penetration. So I think that I'd say interesting trend shift towards the gray coverage, but perhaps not unexpected when you think about what's happening in the macro environment And then I think your third question was on recapture rate. I'll let Marlo talk a little bit about the details of what was built up into there and what we believe go forward. So Marlo?

Yeah, from a recapture rate, as you know, we spent a lot of time studying this, built a very sophisticated model that proved out with results even better than what we had going in assumptions. So the one thing to keep in mind is we have We have data on 75% of our Sally customers, our Sally sales are coming from customers we know, 100% on BSD. So we can track them very closely and really get some robust insights as to what's happening there. And then you combine that with our CRM capabilities to be able to personalize messaging, talk to them, market to them, make sure that they understand where they can go when we close the store. So we feel pretty good about, well, first of all, the 40% that we're quoting now is all coming out of our tested pilot. and from a go-forward basis in terms of being able to continue to deliver that. I feel pretty good about our capabilities to do that.

And I just add one point. I think one of the most interesting observations through the pilot period was we originally had a model that assumed a customer would only potentially think about one additional store or maybe two additional stores that might be in their sphere of where they would go instead of their current store. We actually thought to be a much wider radius. We would see most of our stores that we closed, those sales would transfer to four or five different stores. So back to that idea of the ability of that recapture to be fairly sticky, that was actually a very good indicator for us.

Wonderful. Thank you so much for all the color.

And once again, ladies and gentlemen, if you'd like to ask a question or make a comment, please press 1, then 0. Our next question comes from the line of Olivia Tong, Raymond James. Please go ahead.

Great. Thanks. Good morning. I want to talk a little bit about the margin targets, your expectation for fiscal 23 for 8.5 to 9.5 versus a long-term target for low double digits. Can you talk about how much of this is just a function of some of the macro pressures that are out there? as opposed to the desire to obviously increase investment in some of the strategic initiatives and then just the timing that you expect, you know, sort of a glide path to get to the low double-digit target over time. Thank you.

Yeah, so how about I'll let Marla start with kind of the current state and where we are and then we will follow up with the long-term trajectory.

Yeah, so just as we're looking forward, you know, to 2023, we really see that as a transitory year. You know, the reality is, you know, we've been operating for the past few years in a very challenging consumer environment. But, you know, through that all, we've been pleased to be able to deliver the healthy gross margins, you know, upwards in more than 50%, you know, really where we're seeing the pressures on expenses. We are planning for 2023 higher expenses and mainly driven through the wage pressures that we've seen. And just to point out there, it's a conscious investment in wages. We are not talking about adding headcount, but really just looking at the labor markets, especially for the retail worker. It's been challenging over the past couple of years, and really where we see our differentiator is in our associates, the expertise of our associates and in our stores to be able to really help our customers understand and give confidence to to take a leap into the do-it-yourself color. We think it's an important element of our growth driver going forward, and we believe it's a very important investment for us to make. When we're looking at next year, it's really about investing in our associates as well as refilling our bonus pool. Beyond optimization efforts, we are continuing to look for more efficiencies, and I'll let Denise touched a little bit more on the longer term, but certainly are keeping an eye on cost control.

Yeah, and then when I think about the longer term, what we're focused on this year, as Marlo said, was making sure that we're set up for our initiatives to be as productive as they can and reinvesting wages into the organization. But as we turn into 2024, the opportunity with own brands, it is quite significant and will be an important contributor to gross margin expansion. in 2024 and beyond. We talked about on the call moving from 33% own brand penetration in the Sally business north of close to 50% over the next four to five years. That comes with anywhere from 1,000 to 1,500 basis points of margin difference versus branded product. So that really will pick up more in 2024 as we continue our work in that space. When we think about the Fuel for Growth Initiative that I commented on at the end of the call and one of our third pillars about becoming more efficient in what we do, this is not about flashing short-term costs. This is about actually thinking very differently about the way we work, continuing to look at network optimization, continuing to look at sourcing, looking at opportunities around outsourcing, looking at the structure of things like our loyalty programs, And we think that that's also going to start to play out towards the end of 2024 and into 2025 with some improvements on the margin front as well. And then, you know, I think undercurrent to all of that that I know you guys know very well, but as we move past the net sales decline of this year that is happening with the store closures impacting us, you know, and into 2024 start to see net sales turn positive and continue on that trajectory, we'll get some natural SG&A leverage that'll come through in the P&L as well. So a combination of cost savings, longer term, bigger picture cost savings efficiency initiatives, own brands, and then sales trajectory turning positive really add us up to that low double digit operating margin that we are pushing towards.

That's super helpful. Maybe if I could follow up just, you know, in terms of the health of the hair care category, it does feel like there's a fair bit of interest and quite a bit of activity in the category to the extent that the number of new entries can be used as a guide. And obviously you have your own bond bar launch. So at home color bonding, your own brand. So can you talk a little bit about the balance between driving growth for external brands versus your own brands and perhaps, You know, what drives customers in, you know, thinking about the profit profile, obviously, relative to between your brand and externals. Just a little bit of color there would be super helpful. Thank you.

Absolutely. I mean, first and foremost, we greatly value our vendor partners, whether those be entrepreneurs that we bring through the first time, through some of our support programs for newer innovators, or whether that's with some of our longstanding vendor partners. So our objective is to keep a very healthy mix between own brand and vendor product in our Sally businesses go forward. So when we think about that, the own brands and what we're able to do is bring to bear products that are a great price point, great efficacy, that resonate with our customers coming into the stores. We see that. We feel that. We want to grow that. A lot of new innovation, a lot of maybe perhaps more technical products, things tied to textured hair and other elements. Our vendor partners continue to bring great innovation. They do a great job communicating with consumers, and we want to support them as well. So we actually think that both should be able to grow and be a good balance go forward. And then our BSG business, we have great vendor relationships, a lot of exclusive relationships, and the focus of our BSG business is continuing to support our vendor partners. And I just want to be crystal clear about that front. When we think about anything that is owned brand within BSG, you're only talking about bowls and brushes, the basics. We are not talking about color and care in that space. That is a great partnership that we have with our external vendors.

Thanks so much, I'll pass it on.

And at this time there are no other questions in queue.

Great, well thank you all for joining us today. We are very excited about pursuing our new strategic initiatives to drive growth into the business. Our team members, our associates out in the field are our most valued asset and we're excited about bringing these strategic initiatives to them. and growing our businesses together. So I wish all of you a happy holiday season, and we'll talk again in January.

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