Sally Beauty Holdings, Inc.

Good morning, ladies and gentlemen, and welcome to the Sally Beauty Holdings Conference call to discuss the company's fiscal 2023 first 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. Additional instructions will be given at that time. Now I would like to turn the call over to Jeff Harkins, Vice President of Investor Relations and Treasurer for Sally Beauty Holdings.

Thank you. Good morning, everyone, and thank you 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 would like to remind everyone that managers' 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.

Thank you, Jeff, and good morning, everyone. We're pleased that fiscal 2023 is off to a solid start as our teams remained focused on serving our customers and made excellent progress on our new strategic initiatives to drive long-term growth and profitability. First quarter net sales came in at $957 million. Comparable sales increased 1%, versus last year, and 7% on a two-year stack basis. Adjusted gross margin remained strong at 51%. Adjusted EBITDA was $126 million, and we generated positive free cash flow of $30 million. Our business remains resilient as we delivered strong performance in the first quarter against the backdrop of persistent inflationary pressures. Purchasing behavior among both our Sally customers and BSG stylists remained fairly consistent with the trends we've seen in recent quarters. At both Sally and BSG, average ticket increased, driven primarily by average unit retail, while transactions were down slightly compared to the prior year. Promotional activity was up modestly at both Sally and BSG in the quarter as our customers responded to value messaging. Of note, This increased promotional activity was funded by support from our vendors, enabling us to maintain our strong gross margin profile. During the quarter, we successfully implemented our distribution center consolidation and store optimization plan, which strengthens our supply chain network and positions us to maximize the value of our large store portfolio going forward. Inventory from our Oregon and Pennsylvania DCs has been successfully transferred to larger facilities and the majority of our 350 planned store closures were completed with minimal disruption. Early reads on sales recapture are trending in line with our expectations, and we look forward to sharing a broader update next quarter. In the first quarter, e-commerce sales increased 14% and comprised 9.5% of total sales, driven by the strength of our convenient fulfillment options, including two-hour delivery and buy online, pick up in-store. On our last earnings call in November, we shared our vision for the Sally Beauty Holdings of the future and outlined the three new strategic initiatives we'll be advancing in the coming years. As a reminder, these include enhancing our customer centricity, growing high-margin owned brands at Sally Beauty and amplifying innovation, and increasing the efficiency of operations and optimizing our capabilities. Let me update you on our progress across each of these. First, enhancing our customer centricity. As an organization, we're focused on our loyal customers as well as acquiring new customers through our marketing program, differentiated product offerings in professional color and care, and our strategic initiative. Our goal is to provide our customers with an unparalleled experience whenever and however they engage with us. We have 17 million active loyalty members at Sally US and Canada, representing 77% of our sales in Q1. And our rewards credit card at BSG comprised 9% of sales for the quarter. Additionally, our net promoter scores continue to remain at all-time highs, with Valley at the low 80 and BSG in the high 60s. We know who our customers are, we understand their needs, and we're building on this strength to drive increased engagement and lifetime value. At VSG, the launch of our strategic partnership with Halon HQ is meeting with positive response as we begin to onboard stylists, help them create their digital storefront, and provide them with marketing tools to engage their customers. This new platform was created for our stylist community as a means to empower them to build more value-added and profitable businesses, and we're pleased with the initial traction we're seeing. Turning now to Sally. where inspiration, education, and advice are key tenets of the business. Our associate and certified color consultants take tremendous pride in serving our customers in-store, and we're expanding upon this core competency by increasing our virtual color experts and piloting our Studio by Sally stores. Our virtual color experts are accessible through live video calls conducted on-site in our stores. Bringing our customers this higher level of touch and professional advice ensures they are set up for success across every step of their hair color journey and further elevates Sally as the leader in professional hair color and care. Following a successful pilot, we brought this to 45 locations in fiscal 2022 and added another 30 stores in Q1 for a total of 75 at quarter end. Next, we'll be piloting this service on our Sally website, offering both scheduled appointments and on-demand consultations. beginning in the second half of fiscal 2023. Turning to our new Studio by Sally concept stores, we're on track to launch our first pilot location in Dallas during the second quarter and plan to open an additional six studio stores this fiscal year. As a reminder, these stores will include a DIY-centric salon where customers will receive education and training on how to achieve their desired results. Studio by Sally will allow us to leverage our competitive advantages and omni-channel infrastructure to engage, educate, and empower our customers utilizing a digital-first focus. We believe there's an opportunity to grow this concept to 100 locations throughout the U.S. over the next three to four years and look forward to keeping you updated on our progress in year one. Moving on to our second strategic initiative, growing our high-margin own brand penetration in Sally and amplifying product innovation in Sally and VSG. We're staying at the forefront of innovation and have demonstrated good progress towards our goal to grow our high-margin own brands in Sally. In the first quarter, we completed the initial rollout of BondBar, our new line of pro-quality bonding products at accessible price points, and expect to be fully launched with all SKUs by the end of Q2. Also notable during the quarter was the strong performance of our Wunderbar hair care brand and XP100 color brands in Europe. Own brand sales penetration for the Sally segment reached 34% of sales in the first quarter, up from 33% of sales at year end. And we believe we can grow that to 50% penetration over the next four to five years while growing our overall sales low to mid single digits. We're also bringing newness to key categories through store resets. For example, we're seeing positive customer response to our nail reset at both Valley and BSG. Additionally, we're leaning into textured hair space with the recent introduction of five new brands in our Cosmoprof stores, supported by a broad-based marketing campaign that will kick off this month. Turning now to our third strategic initiative, increasing the efficiency of our operations and optimizing our capabilities. This encompasses three areas of focus, including optimizing our store base, consolidating and leveraging our enhanced supply chain, and capturing efficiencies by rethinking the way we work. As I outlined earlier in the call, our teams have largely completed the DC and store optimization plan with minimal disruption and a successful transfer of product to our larger facilities. I'm also pleased to note that a significant portion of our workforce in the affected stores have accepted positions in other locations. Additionally, the integration of our expanded Regis partnership is complete, and we are on track to double our sales volume in fiscal 2023. Lastly, the work under our Fuel for Growth initiative continues to be underway as we focus on ways to more efficiently steward the business as we seek to maximize profitability and increase shareholder value over the long term. We feel good about how we're positioned and the way we're advancing the business through our new strategic initiatives. We have incredibly talented associates across the organization who are passionate about delighting our customers and inspiring a more colorful, confident, and welcoming world. We are confident that our inventive new strategies, in concert with our core capabilities and infrastructure, provide us a significant runway for growth in the coming years. Over the long term, we believe the business is positioned to generate low to mid-single-digit net sales growth, gross margins over 50%, and low double-digit operating margins. Now, I'll turn the call over to Marlo to cover the financials. Thank you, Denise, and good morning, everyone. We're pleased to begin fiscal 2023 on strong footing, delivering first quarter results in line with our expectations and making consistent progress against our strategic initiatives. First quarter net sales of $957 million declined 2.4%, reflecting the combination of 395 fewer stores and 150 basis points of unfavorable foreign currency impact. Comparable sales were up 1% versus a year ago and up 7% on a two-year stack, We continue to see strong digital performance, with global e-commerce sales increasing 14% to $91 million on a constant currency basis, and representing 9.5% of total net sales. We maintain strong adjusted gross margins, which came in at 50.8%, down 20 basis points to last year. Increased product margin at Sally Beauty, driven by pricing, leverage, and higher own brand penetration, was offset by lower margin at DSG due to a channel mix shift between stores and our expanded retail business. Turning now to operating expense. Adjusted SG&A totaled $391 million, an increase of $7 million versus a year ago, and reflects higher labor and personnel costs. Looking at the full year, we are on track to achieve the expected expense savings we announced last quarter under our DC consolidation and store optimization plan. Total anticipated savings of approximately $50 million is expected to serve as a partial offset to increasing pressure from labor costs as we move through fiscal 2023. We expect SG&A levels for the second quarter to remain similar to the first quarter, affecting the timing of our wage investment and benefits from our optimization efforts. The combination of our healthy gross margins and prudent cost control enabled us to invest in our new strategic initiative while also delivering on the bottom line. First quarter adjusted operating margin was 10%, adjusted EBITDA margin was 13.1%, and adjusted diluted earnings per share came in at 52 cents. Looking at segment results. First quarter comparable sales increased 3% at Sally Beauty and were up 7% on a two-year stack. Net sales declined 2.1%, driven primarily by 210 basis points of unsavorable foreign currency impact and reflects the fact that we had 383 fewer stores in operation versus a year ago. At constant currency, segment e-commerce sales increased 13% to $35 million today. or 6.4% of segment net sales for the quarter. For the global Sally segment, color was up 3% and care declined 4%, including the impact from store closures. At Sally U.S. and Canada, color increased by 5%, while gray coverage was up 10% and comprised 77% of the color categories. Gross margin at Sally expanded 50 basis points to 58.9%, reflecting solid product margins driven primarily by pricing leverage and higher owned brand penetration. Segment operating margin increased to 18%. Moving to the BSD segment, comparable sales declined 1.5% as BSD was lapping last year's strong demand from stylists who were restocking their salons during the reopening. On a two-year stack basis, BSD comps were up 7%. Net sales declined 2.7%, which reflects the 60 basis points of unfavorable foreign currency impact in 12 fewer stores versus a year ago. On a constant currency basis, segment e-commerce sales increased 14% to $55 million, or 13.6% of segment net sales for the quarter. The colors category was down 3% and care declined 2% at BSD as our stylists continued purchasing closer to needs. During the quarter, we did continue to see strong momentum with express coloring products. Adjusted growth margin at BSG decreased 130 basis points to 39.8%, primarily driven by lower product margin due to the sales channel shift between the segment stores and expanded REGIS partnership. Segment operating margin came in at 12.2%. Moving to the balance sheet and cash flow. We ended the quarter with $99 million of cash and cash equivalents and $65 million outstanding under our asset-based revolving line of credit. Our net debt leverage ratio stood at 2.2 times. Inventories have continued to normalize as the supply chain disruptions we experienced in 2022 have mostly subsided, notwithstanding some choppiness with inventory receipts in certain spheres. Quarter-end inventories were $987 million, down 1.9% from a year ago. We generated strong free cash flow of $30 million in the first quarter. For the full year, we continue to expect to return to free cash flow generation in the range of $175 to $200 million, providing us with the financial flexibility to invest in our new strategic initiatives to drive long-term growth. Turning now to guidance. we are reiterating our full year expectations as follows. Comparable 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 some categories, sales transfer from store closures, our expanded redistribution, and our 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 unfavorable impact of store closures net of expected sales recapture 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 6% to 7% compared to the end of 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%. 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. From a cadence perspective, keep in mind that the second quarter is historically our lightest sales quarter. And as I outlined earlier, we anticipate that further investment in wages will begin ramping up this quarter. As a result, adjusted operating margin is expected to decline sequentially from the first quarter to the second quarter. Looking further ahead, we remain confident that our initiatives to drive top-line growth, build scale, and further optimize our operating model will enable us to return to double-digit operating margins in fiscal 2024 and beyond. We appreciate your time this morning. Now I'll ask the operator to open the call for Q&A.