SBH 2022Q4

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. 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 and thanks for joining us today. With me on the call today are Denise Paulonis, 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 sallybeautyholdings.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 factors section of our most recent annual report on Form 10-K and other filings with the SEC. Any forward-looking statements made in 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 and 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 achieved this by leveraging our people, platforms and scale to support our core Sally Beauty customers and BSG stylists amidst persistent inflationary pressures and supply chain disruptions. 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, advanced digital commerce capabilities, and an 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 will focus on over the long term and provide our long term growth algorithm that we will execute 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, as we entered fiscal 2022, inflationary pressures continued 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 baskets when they shop with us. While the situation has not improved, we believe our focus on customer service and our pro quality for less marketing is resonating, limiting additional pressure on sales. In BSG, our Sally focused on saving time and maximizing profitability. We continue to see them purchasing closer to need while responding positively 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 at fiscal 2023, we're expecting a similar operating environment to what we saw at the end of fiscal 2022. Turning to wins in fiscal ‘22, I am pleased to share several highlights. Throughout the year, we remained at the forefront of product innovation across the Sally and BSG segments. This includes our strong partnerships with premier brands like Wella, Matrix, Joico, Olaplex, and our own brands like Ion and Strawberry Leopard. We also grew our loyalty program; as you know, our loyalty program drives the majority of our sales at Sally U.S. and Canada, and it's 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 businesses. The rewards credit cards comprise 9% of BSG sales for the fiscal year. New conveniences and increased personalization enable us to better serve our loyal customers. Initiatives ranging from Sally's virtual color expert and two-hour deliveries to personalized shopping journeys were met with tremendous customer response and continued to gain traction. Another important means for better serving our customers 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. We made great strides last year towards increasing speed to market and improving our in-stock levels, notwithstanding macro related supply chain disruptions. 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 5000 plus Regis locations. 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 enthusiast and professional stylist. 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're 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 initiatives 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 enhancing BSG and our diversity, inclusion and belonging commitment. 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 BSG. Designed to drive continued growth at BSG, we're 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 will be 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. Salon HQ is a customizable digital storefront platform that gives our stylists the ability to curate a product selection from thousands of choices, enabling 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, they'll have the ability to sell the full line of the issue products and increase the profitability of their businesses. 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 of Salon HQ, we're 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 unrivaled 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 on-site in our stores. We began piloting this convenience in the first quarter of last year and found that our Sally customers love 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. DIY 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 launch this concept and the results tell us that there's a great deal of excitement among not only our core customers, but also potential 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 U.S. 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 important to our operating growth model for years, this remains crucially important 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 Sally and BSG and it's 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 stylists' 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 new trends to ensure that we're on-trend and in-stock with focused assortments beyond our core. Additionally, we see great opportunities in growing our high margin owned brands. This includes powerful brands that were 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 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 and adds tremendous value for customers. We're incredibly proud of this innovation, which leverages our vast knowledge of haircare, addresses the growing consumer demand for powerful hair repair solutions and fills the void in the market for bonding products at accessible price points. 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 let's turn to our final strategic initiative: increasing the efficiency of operations, and optimizing our capabilities. We'll focus on three opportunities in this area, including optimizing our stores, consolidating and leveraging our enhanced supply chain, and capturing efficiencies by rethinking the way we work. First, store optimization. Our investments in recent years have allowed us to build a robust omni-channel platform that will serve us well into the future. As we focus on delivering a seamless omni-channel experience, we've enhanced our digital offerings to meet customers where and when they want to. In turn, our channel mix has shifted, and we expect it to continue to evolve. In response to the 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 targets. 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 closing in December of 2022. Most of the closing stores are Sally stores based in the U.S. This optimization program allows us to improve productivity and profitability while delivering a convenient omni-channel experience that benefits our customers. Moving on to our supply chain. The progress we've made in modernizing our supply chain enabled 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 serve 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 Regis partnership, with sales volume expected to double from fiscal 2022 to fiscal 2023. The visibility and strategic importance of its expanded relationships raise our profile among other brand partners and establish a solid foundation for future chain growth. Last but certainly not least, we 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 Sally 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, gross margins over 50%, and low double digit operating margins. I am 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, even in the face of the 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 anticipate. Additionally, we are operating 117 fewer stores at the end of the period compared to a year ago. Foreign currency translation 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 margin decreased 60 basis points and 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 bonuses. In fiscal 2023, we expect our distribution center consolidation and store optimization programs 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 pilots. However, the store closures will result in some reduction in overall sales. The net result as we expect a positive impact on 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 controls 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 $0.50. 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 operations 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. A 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 Keratin declined 7%. At Sally, U.S. and Canada color increased by 6% with great coverage of 9%, while SKU sales were up 1% and comprised 27% of the total color categories. While total transactions and units per transaction were down at Sally U.S. and Canada's average unit retail and average tickets increased. These dynamics have been fairly consistent for the past three quarters as our Sally customers stretch their visits and minimize 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 margin came in at 14.5%. We delivered growth in the BSG segment with net sales of 1% with 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 sale 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 back stock inventory, as some of their customers are stretching time between coloring services and raw material shortages. Our haircare increased 9% versus a year ago, due to our expanded regional partnerships and better in-stock levels with key brands. Adjusted gross margin at BSG 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 margin 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 a billion dollars in Q3, excluding the Q4 non-cash write down of $90 million of goods related to the distribution center consolidation and acceleration of our store optimization program, year-end inventory 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 reverse historical patterns as we progress through fiscal 2023 and expect to return to free cash flow generation in the range of $175 million 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 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. They are reflected in our fiscal 2023 outlook. For the full year, we expect the following: 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 key categories they'll transfer from store closures or 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 from 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 through our store optimization plan net of a small number of new store openings. Gross margin is expected to remain above 50% and 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 with a $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 that have been outlined in our 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 operator to open the call for Q&A.

Thank you. Our first question comes from Rupesh Parikh at Oppenheimer. Please go ahead.

Good morning, and 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 do store closures impact that longer term sales growth? And if there's any timing regarding when you think you'll be able to start delivering those targets?

Sure, thanks for the question, Rupesh. I will start and Marlo can jump in as we need to here. I think in the very near term, we really spaced 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 when we're looking to 2023 and our priority is to get that low single-digit comp number. Key sources of growth will be leaning in on owned brands, that's Ion, that's Strawberry Leopard, that's Bondbar, rebuilding our nail category. We have a new nail wall set in both Sally and BSG stores and seeing good responses there, nearly doubling the Regis business that we have, which really leverages the e-commerce platform we built. And then when we think about the store optimization and 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. 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 will be ramping up; it's only been a test market right now, and we really want to work out all the kinks to make sure it's just right before we fully roll that out. Our virtual color expert experience will roll out online later in the year as well, and we think that that will start to give benefit and scale as we come through. When we get into 2024, further own brand growth, new innovation from our vendor partners, continued tailwinds from the virtual color expert and the e-commerce piece. When we talked about and of course, the stylist platform, and when we talked about Studio by Sally, it's a bit longer term. We're going to pilot in fiscal ‘23, with a small number of stores. We're going to look at those results. With positive results, we would 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 run-a-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. As we work our way through '24 and '25, that's when we're really targeting that low to mid single digit comp trajectory, total sales trajectory.

Great. Thank you. 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.

So from a quarterly cadence perspective, a lot of it is about what happened this past year in 2022. As you recall, we started Q1 very strong, and then as we were going into the holiday season, we were up against a COVID spike. As we came out of that's about when we saw the pivot to the inflationary, the intense inflationary pressure that really started to change customer behavior. 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 most of the closures, the Q1 costs in sales will be challenged. We'll start to see improvement as we go through the rest of the year.

Great. Thank you. I'll pass over. I am sorry.

One more on that. If you're looking at net sales, keep in mind FX. We had some FX movements towards the end of this year that we won't get until we get to Q4 for sure.

Our next question comes from the line of Oliver Chen, Cowen. 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's your assumption 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 on the topic of inflation? This is pervasive across the consumer. Thanks a lot, Denise and Marlo.

Oliver, there's a lot there for us to unpack, and let's work through store closures and promotion. We might need you to clarify the BSG question. I'm not sure exactly what you were after there. But 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 we've been running over the course of the last year delivered good sales recapture rates, actually above the industry average, and for the stores that we're going to be closing, we're assuming about a 40% sales recapture rate. The important point to note in the stores that we are closing is that they are all EBITDA positive. So 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 recaptures is what we're looking for, and that will really start to play into the results 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, looking around and being very choiceful in the decisions that they're making. What we've been focusing on is what most resonates with our stylists. We've gone to types of promotions, like bundle offers, that there is a discount involved, but it actually drives more unit sales, and we actually believe is getting us more share of wallet. The absolute level of promotional investment has remained relatively steady. We’ve seen great support from a number of our vendor partners where they are leaning in to help fund some more enticing promotions for their specific product as they want to do that throughout 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 BSG. I think you're referring to the BSG gross margins being down. So just to talk a little bit about what we're seeing there is it's really a mix shift. When you look at it on an individualized basis or SKU level, the merchandising margins are strong. But we’re seeing a shift away from stores and into full service. A lot of that has been driven through the expansion of our Regis business. And of course, where we've gotten higher distribution and freight costs. But when we look forward as a consolidated business, there are going to be puts and takes, and we see for the combined business continued strong and healthy margins above 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. 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've tested it. Thanks a lot.

Sure. So on the Regis front, I think the real benefit in the Regis business when we think about how many people there are out there who use Regis franchise salons as their main destination for hair services is tremendous. With 5000 plus salons in the marketplace, it's a huge reach. And they're not the only chain that is out there. When we look at the penetration we've got, you've got people early in their careers as stylists and customers through all walks of life who we can introduce to products that can stay with them for the long term. Whether those stylists stay with Regis or choose to go out on their own or join another salon, they will have been nicely ingrained with all the types of products that we can offer them. We believe this partnership will fit nicely into the stylist ecosystem that we want to build, to help them grow their businesses and become more profitable. It comes at a slightly lower margin because it's more managed, like our full-service business, but when you think about the longevity of those stylists and customers, we believe this will serve us well longer term. In terms of the store closures, we've spent a lot of time analyzing this. I think it’s a common question from investors and analysts why we weren't moving faster. We reflected on it, and we wanted to take the full year to understand how those customers would behave, how they would transfer their sales, and if there would be any change in the trajectory of new customers coming into the business. All in all, at the 100 stores we tested, we felt very good about the metrics there. Our focus is clear communication to our customers about where their next closest Sally store might be and how they can shop online while still getting their products, just from a different store. This larger tranche of stores leads us to anticipate some surprises, but we believe the long-term benefit we will gain is significant.

Thank you. That's great, guys.

Our next question comes from the line of Ashley Helgans, Jefferies. Please go ahead.

Hi, thanks for taking our questions. I know you touched on it briefly, but any more details you can provide us on the trends in salon channels? 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 the salon channels. If we put in our prepared remarks that comment about just what we're seeing, in general, the business improved post back-to-school, but has softened a little bit since more in line with what it had been mid-summer. Our stylists are still discussing having good business but are seeing their customers stretching a little more between services. The inventory purchasing habits reflect how cash conscious they are at this time. We've seen an uptick in interest in express color, which can help their businesses serve clients more expediently. They’ve also been more selective in looking for promotional opportunities. In terms of DIY coloring, during this past quarter, we saw a 9% increase in our gray coverage products and sales, and about 1% increase overall in color sales. This indicates customers are taking more on DIY projects at home. We're pleased with the gray coverage trend and expect it to continue to resonate in the macro environment. Now, regarding the recapture rate, I'll let Marlo discuss the details.

From a recapture rate perspective, we’ve spent considerable time studying this aspect, building a very sophisticated model that provided results better than our initial assumptions. We have data on 75% of our Sally customers and 100% of BSG customers. We can track them closely and get robust insights into their behavior. We found that the 40% recapture rate we quoted comes from our tested pilot. We're confident in our capabilities to continue delivering that.

One additional point, during the pilot period, we initially assumed customers would think about one or two additional stores within their proximity. We ended up seeing that most customers who are transitioning from closed stores were willing to go to four or five different stores. This insight helps bolster our projections for a sticky recapture rate.

Wonderful. Thank you so much for all the color.

Our next question comes from Olivia Tong at 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 an assumption 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 sort of a glide path to get to the low double-digit target over time? Thank you.

How about I will let Marlo take on the current state and where we are, and then we will follow up with the long-term trajectory.

As we're looking forward to 2023, we see that as a transitory year. The reality is we've been operating for the past few years in a very challenging consumer environment. We're pleased to deliver healthy gross margins upwards of more than 50%. However, we are planning for 2023, higher expenses, mainly driven through wage pressures that we've seen. This is a conscious investment in wages; we are not talking about adding headcount. In the retail labor market, it's been challenging over the past couple of years. Our differentiator continues to be our associates, their expertise to help customers gain the confidence to take the leap into DIY color. So when we look at next year, it's about investing in our associates while refilling our bonuses. Beyond optimization efforts, we continue to look for more efficiencies. Denise touched on the longer-term outlook, but we’re keeping an eye on cost control.

When I think about the longer-term focus this year, as Marlo said, was to ensure we’re set up for our initiatives. As we turn into 2024, there's a significant opportunity with owned brands as a contributor to gross margin expansion, moving from 33% to close to 50% over the next four to five years. This comes with significant margin differences. While in 2024, our focus will be on efficiency initiatives, we expect sales trajectory will return positive. Hence, a mix of cost savings, own brands, and the general improvement in operating margins will lead to our target of low double-digit operating margins.

That's super helpful. Maybe if I could follow up on the health of the haircare category, that feels like there's a fair bit of interest and quite a bit of activity in the category. Can you talk a little bit about the balance between driving growth for external brands versus your own brands? What drives customers in thinking about the profit profile between your brands and externals? Just a little bit of color there would be super helpful. Thank you.

First and foremost, we value our vendor partners immensely, whether they are new or long-standing. Our objective is to maintain a healthy balance between owned brands and vendor products going forward. With owned brands, we bring to market products with great price points and efficacy that resonate with our customers. We plan on growing our innovation in areas like textured hair, and our vendor partners continue to deliver great innovation and effective communication with consumers. The synergy is important—it matters that both can grow effectively together. In BSG, we prioritize supporting our vendor partners, and it’s crucial to be clear that in BSG, owned brands relate only to accessories like bowls and brushes. We don’t handle color and care in that space. So our external vendor relationships remain critical.

Thanks so much. I'll pass it on.

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

And ladies and gentlemen, this conference will be available for replay in the company's press release. That concludes our conference today. Thank you for your participation.