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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2009

 

-OR-

 

¨              TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File No. 1-33145

 


 

SALLY BEAUTY HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

36-2257936

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification
No.)

 

 

 

3001 Colorado Boulevard
Denton, Texas

 

76210

(Address of principal executive
offices)

 

(zip code)

 

Registrant’s telephone number, including area code: (940) 898-7500

 


 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES  x   NO  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer  ¨

 

 

 

Non-accelerated filer  ¨

 

Smaller reporting company  ¨

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)  YES  o    NO  x

 

At May 1, 2009, there were 182,058,952 shares of the issuer’s common stock outstanding.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

Page

 

 

PART I — FINANCIAL INFORMATION

 

 

 

ITEM 1.  FINANCIAL STATEMENTS

6

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

26

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

45

ITEM 4.  CONTROLS AND PROCEDURES

46

 

 

PART II — OTHER INFORMATION

 

 

 

ITEM 1.  LEGAL PROCEEDINGS

47

ITEM 1A.  RISK FACTORS

47

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

47

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

48

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

48

ITEM 5.  OTHER INFORMATION

48

ITEM 6.  EXHIBITS

49

 

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In this Quarterly Report, references to the “Company,” “Sally Beauty,” “our company,” “we,” “our,” “ours” and “us” refer to Sally Beauty Holdings, Inc. and its consolidated subsidiaries for periods after the separation from Alberto-Culver Company (“Alberto-Culver”) and to Sally Holdings, Inc. and its consolidated subsidiaries for periods prior to the separation from Alberto-Culver unless otherwise indicated or the context otherwise requires.

 

Cautionary Notice Regarding Forward-Looking Statements

 

Statements in this report which are not purely historical facts or which depend upon future events may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” or similar expressions may also identify such forward-looking statements.

 

Readers are cautioned not to place undue reliance on forward-looking statements as such statements speak only as of the date they were made. Any forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from the events or results described in the forward-looking statements, including, but not limited to, risks and uncertainties related to:

 

·                  the highly competitive nature of, and the increasing consolidation of, the beauty products distribution industry;

·                  anticipating changes in consumer preferences and buying trends and managing our product lines and inventory;

·                  potential fluctuation in our same store sales and quarterly financial performance;

·                  our dependence upon manufacturers who may be unwilling or unable to continue to supply products to us;

·                  the possibility of material interruptions in the supply of beauty supply products by our manufacturers;

·                  products sold by us being found to be defective in labeling or content;

·                  compliance with laws and regulations or becoming subject to additional or more stringent laws and regulations;

·                  product diversion to mass retailers;

·                  the operational and financial performance of our Armstrong McCall, L.P. business;

·                  the success of our new Internet-based business;

·                  successfully identifying acquisition candidates or successfully completing desirable acquisitions;

·                  integrating businesses acquired in the future;

·                  opening and operating new stores profitably;

·                  the impact of a continued downturn in the economy upon our business;

·                  the success of our cost control plans;

·                  protecting our intellectual property rights, specifically our trademarks;

·                  conducting business outside the United States;

·                  disruption in our information technology systems;

·                  natural disasters or acts of terrorism;

·                  the preparedness of our accounting and other management systems to meet financial reporting and other requirements and the upgrade of our existing financial reporting system;

·                  being a holding company, with no operations of our own, and depending on our subsidiaries for cash;

·                  our substantial indebtedness;

·                  the possibility that we may incur substantial additional debt;

·                  restrictions and limitations in the agreements and instruments governing our debt;

·                  generating the significant amount of cash needed to service all of our debt and refinancing all or a portion of our indebtedness or obtaining additional financing;

 

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·                  changes in interest rates increasing the cost of servicing our debt or increasing our interest expense due to our interest rate swap agreements;

·                  the potential impact on us if the financial institutions we deal with become impaired;

·                  the representativeness of our historical consolidated financial information with respect to our future financial position, results of operations or cash flows;

·                  our reliance upon Alberto-Culver for the accuracy of certain historical services and information;

·                  the share distribution of Alberto-Culver common stock in our separation from Alberto-Culver not constituting a tax-free distribution;

·                  actions taken by certain large stockholders adversely affecting the tax-free nature of the share distribution of Alberto-Culver common stock;

·                  the voting power of our largest stockholder discouraging third party acquisitions of us at a premium; and

·                  the interests of our largest stockholder differing from the interests of other holders of our common stock.

 

Additional factors that could cause actual events or results to differ materially from the events or results described in the forward-looking statements can be found in our Annual Report on Form 10-K for the fiscal year ended September 30, 2008, as filed with the Securities and Exchange Commission. The events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. As a result, our actual results may differ materially from the results contemplated by these forward-looking statements. We assume no obligation to publicly update or revise any forward-looking statements.

 

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WHERE YOU CAN FIND MORE INFORMATION

 

Sally Beauty’s quarterly financial results and other important information are available by calling the Investor Relations Department at (940) 297-3877.

 

Sally Beauty maintains a website at www.sallybeautyholdings.com where investors and other interested parties may obtain, free of charge, press releases and other information as well as gain access to our periodic filings with the SEC.  The information contained on this website does not constitute part of this Quarterly Report on Form 10-Q.

 

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PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

The following are our consolidated balance sheets as of March 31, 2009 and September 30, 2008; our consolidated statements of earnings for the three and six months ended March 31, 2009 and 2008 and our consolidated statements of cash flows for the six months ended March 31, 2009 and 2008.  In November 2006, Sally Holdings, Inc. was converted to a Delaware limited liability company, was renamed “Sally Holdings LLC” and became an indirect wholly owned subsidiary of Sally Beauty Holdings, Inc. in connection with our separation from the Alberto-Culver Company (“Alberto-Culver”).  In these financial statements and elsewhere in this Quarterly Report on Form 10-Q, we refer to these transactions as the Separation Transactions.  See the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008 for additional information about the Separation Transactions.

 

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SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
(In thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net sales

 

$

641,511

 

$

643,346

 

$

1,287,087

 

$

1,299,133

 

Cost of products sold and distribution expenses

 

339,399

 

344,922

 

681,431

 

694,540

 

Gross profit

 

302,112

 

298,424

 

605,656

 

604,593

 

Selling, general and administrative expenses (a)

 

218,420

 

221,090

 

443,948

 

445,631

 

Depreciation and amortization

 

11,471

 

11,821

 

23,218

 

23,573

 

Operating earnings

 

72,221

 

65,513

 

138,490

 

135,389

 

Interest expense, net (b)

 

31,969

 

47,642

 

71,642

 

94,125

 

Earnings before provision for income taxes

 

40,252

 

17,871

 

66,848

 

41,264

 

Provision for income taxes

 

15,657

 

5,475

 

26,194

 

14,525

 

Net earnings

 

$

24,595

 

$

12,396

 

$

40,654

 

$

26,739

 

 

 

 

 

 

 

 

 

 

 

Net earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.14

 

$

0.07

 

$

0.22

 

$

0.15

 

Diluted

 

$

0.13

 

$

0.07

 

$

0.22

 

$

0.15

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares:

 

 

 

 

 

 

 

 

 

Basic

 

181,682

 

181,135

 

181,630

 

181,065

 

Diluted

 

183,025

 

182,931

 

182,990

 

182,914

 

 


(a)                                  Selling, general and administrative expenses include share-based compensation of $1.6 million for each of the three months ended March 31, 2009 and 2008 and $5.2 million and $7.2 million for the six months ended March 31, 2009 and 2008, respectively.

 

(b)                                 Interest expense is net of interest income of $0.1 million and $0.2 million for the three months ended March 31, 2009 and 2008 and $0.2 million and $0.4 million for the six months ended March 31, 2009 and 2008, respectively. Interest expense includes income of $2.2 million of marked-to-market adjustments related to interest rate swaps for the three months ended March 31, 2009 and expenses of $8.6 million of marked-to-market adjustments related to interest rate swaps for the three months ended March 31, 2008; and expenses of $0.8 million and $14.3 million related to these adjustments for the six months ended March 31, 2009 and 2008, respectively.

 

The accompanying condensed notes, together with the Notes to Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008, are an integral part of these financial statements.

 

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SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except par value data)

 

 

 

March 31,
2009

 

September 30,
2008

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

104,678

 

$

99,788

 

Trade accounts receivable, less allowance for doubtful accounts of $2,112 at March 31, 2009 and $2,702 at September 30, 2008

 

36,391

 

44,481

 

Other receivables

 

31,361

 

22,692

 

Inventories

 

538,816

 

598,195

 

Prepaid expenses

 

17,360

 

19,748

 

Deferred income tax assets

 

20,841

 

20,742

 

Total current assets

 

749,447

 

805,646

 

Property and equipment, net of accumulated depreciation of $246,783 at March 31, 2009 and $243,185 at September 30, 2008

 

146,610

 

156,260

 

Goodwill

 

410,731

 

424,963

 

Intangible assets, net of accumulated amortization of $21,134 at March 31, 2009 and $18,203 at September 30, 2008

 

78,815

 

85,434

 

Other assets

 

47,571

 

54,720

 

Total assets

 

$

1,433,174

 

$

1,527,023

 

Liabilities and Stockholders’ Deficit

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current maturities of long-term debt

 

$

14,470

 

$

100,601

 

Accounts payable

 

185,726

 

171,962

 

Accrued expenses

 

147,065

 

154,708

 

Income taxes

 

12,615

 

11,177

 

Total current liabilities

 

359,876

 

438,448

 

Long-term debt

 

1,712,310

 

1,724,684

 

Other liabilities

 

36,123

 

23,711

 

Deferred income tax liabilities

 

27,806

 

37,256

 

Total liabilities

 

2,136,115

 

2,224,099

 

Stock options subject to redemption

 

5,623

 

5,884

 

Stockholders’ deficit:

 

 

 

 

 

Common stock, $0.01 par value. Authorized 400,000 shares; 182,054 and 181,812 shares issued and 181,701 and 181,516 shares outstanding at March, 31, 2009 and September 30, 2008, respectively

 

1,817

 

1,815

 

Additional paid-in capital

 

627,992

 

622,511

 

Retained deficit

 

(1,295,321

)

(1,335,975

)

Treasury stock, 5 shares

 

(22

)

 

Accumulated other comprehensive (loss) income

 

(43,030

)

8,689

 

Total stockholders’ deficit

 

(708,564

)

(702,960

)

Total liabilities and stockholders’ deficit

 

$

1,433,174

 

$

1,527,023

 

 

The accompanying condensed notes, together with the Notes to Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008, are an integral part of these financial statements.

 

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SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)

(Unaudited)

 

 

 

Six Months Ended
March 31,

 

 

 

2009

 

2008

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net earnings

 

$

40,654

 

$

26,739

 

Adjustments to reconcile net earnings to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

23,218

 

23,573

 

Share-based compensation expense (net of deferred tax benefit of $1,480 in 2009 and $2,237 in 2008)

 

3,715

 

4,973

 

Amortization of deferred financing costs

 

4,201

 

4,247

 

Excess tax shortfall (benefit) from share-based compensation

 

226

 

(264

)

Net (gain) loss on disposal of leaseholds and other property

 

(18

)

213

 

Deferred income taxes

 

681

 

1,042

 

Changes in (exclusive of effects of acquisitions):

 

 

 

 

 

Trade accounts receivable

 

5,761

 

5,374

 

Other receivables

 

(9,795

)

(1,773

)

Inventories

 

39,716

 

(20,490

)

Prepaid expenses

 

933

 

(363

)

Other assets

 

801

 

(24

)

Accounts payable and accrued expenses

 

18,010

 

(25,113

)

Income taxes

 

2,155

 

(12,591

)

Other liabilities

 

(6,038

)

14,558

 

Net cash provided by operating activities

 

124,220

 

20,101

 

Cash Flows from Investing Activities:

 

 

 

 

 

Capital expenditures

 

(16,789

)

(25,699

)

Proceeds from sale of property and equipment

 

66

 

162

 

Acquisitions, net of cash acquired

 

(1,987

)

(17,445

)

Net cash used by investing activities

 

(18,710

)

(42,982

)

Cash Flows from Financing Activities:

 

 

 

 

 

Change in book cash overdraft

 

(1,633

)

 

Proceeds from issuance of long-term debt

 

94,639

 

244,235

 

Repayments of long-term debt

 

(192,995

)

(230,001

)

Proceeds from exercises of stock options

 

386

 

518

 

Excess tax (shortfall) benefit from share-based compensation

 

(226

)

264

 

Purchase of treasury stock

 

(22

)

 

Net cash (used) provided by financing activities

 

(99,851

)

15,016

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

(769

)

1,013

 

Net increase (decrease) in cash and cash equivalents

 

4,890

 

(6,852

)

Cash and cash equivalents, beginning of period

 

99,788

 

38,272

 

Cash and cash equivalents, end of period

 

$

104,678

 

$

31,420

 

 

 

 

 

 

 

Supplemental Cash Flow Information:

 

 

 

 

 

Cash paid for:

 

 

 

 

 

Interest

 

$

68,976

 

$

76,698

 

Income taxes

 

$

24,475

 

$

26,580

 

 

The accompanying condensed notes, together with the Notes to Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008, are an integral part of these financial statements.

 

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Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

1.   Description of Business and Basis of Presentation
 

Description of Business

 

Sally Beauty Holdings, Inc. and its consolidated subsidiaries (“Sally Beauty” or the “Company”) sell professional beauty supplies, primarily through its Sally Beauty Supply retail stores in the U.S., Puerto Rico, Mexico, Canada, Japan, the United Kingdom and certain other countries in Europe. Additionally, the Company distributes professional beauty products to salons and professional cosmetologists through its Beauty Systems Group (“BSG”) store operations and a commissioned direct sales force that calls on salons in the U.S., Canada, the United Kingdom and certain other countries in Europe, and to franchises in the southern and southwestern U.S. and in Mexico through the operations of its subsidiary Armstrong McCall, L.P. (“Armstrong McCall”). Certain beauty products sold by BSG and Armstrong McCall are sold through exclusive territory agreements with the manufacturers of the products.

 

In November 2006, the stockholders of Alberto-Culver approved a plan to separate its consumer products business and its Sally Beauty Supply/BSG distribution business into two separate, publicly-traded companies. Sally Holdings, Inc. (“Sally Holdings”) was a wholly-owned subsidiary of Alberto-Culver until November 16, 2006, when it was converted to a Delaware limited liability company, was renamed “Sally Holdings LLC,” and became an indirect wholly-owned subsidiary of Sally Beauty. Sally Beauty was formed in June 2006 and became the accounting successor company to Sally Holdings upon the completion of the Separation Transactions. Please see the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008 for more information about the Separation Transactions.

 

Basis of Presentation

 

The consolidated interim financial statements include the accounts of the Company and its subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. In the opinion of management, these consolidated financial statements reflect all adjustments which are of a normal recurring nature and which are necessary to present fairly the consolidated financial position as of March 31, 2009 and September 30, 2008, the consolidated results of operations for the three and six months ended March 31, 2009 and 2008, and the consolidated cash flows for the six months ended March 31, 2009 and 2008.

 

All references in these notes to “management” are to the management of Sally Beauty. All references in these notes to the “Company” are to Sally Beauty and, prior to November 16, 2006, Sally Holdings.

 

2.    Significant Accounting Policies
 
Accounting Principles
 

The consolidated interim financial statements included herein are unaudited and have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. These consolidated interim financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008.  The Company adheres to the same accounting policies in the preparation of its interim financial statements.  As permitted under GAAP, interim accounting for certain expenses, including income taxes, are based on full year assumptions.  Such amounts are expensed in full in the year incurred.  For interim financial reporting purposes, income taxes are recorded based upon estimated annual effective income tax rates.

 

The results of operations for these interim periods are not necessarily indicative of the results that may be expected for any future interim period or the entire fiscal year.

 

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Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

Recent Accounting Pronouncements
 

The Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 161, Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133 (“SFAS 161”) effective on January 1, 2009. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), establishes, among other things, the disclosure requirements for derivative instruments and for hedging activities. SFAS 161 amended and expanded those disclosures to also require qualitative disclosures about the objectives and strategies for using derivative instruments, quantitative disclosures about the fair value of and gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in the derivative instruments.  SFAS 161 also requires companies to disclose information about how derivatives and related hedges are accounted for under SFAS 133 and how the hedges affect the entity’s financial position, financial performance and cash flows, including the location and amounts of derivative instruments in the entity’s financial statements.

 

As required by SFAS 133, as amended, the Company records all derivative instruments on its balance sheet at fair value.  The accounting for changes in the fair value of derivative instruments depends on the intended use of the derivative, whether the Company has elected to designate a derivative instrument in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivative instruments designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the impact on earnings of the hedged transaction or transactions. The Company may from time to time enter into derivative contracts that are intended to hedge certain economic risks even though hedge accounting does not apply or the Company elects not to apply hedge accounting to such derivative contracts. Please see Note 8 for more details about the Company’s derivative instruments and hedging activities as of March 31, 2009.

 

The Company adopted the provisions of SFAS No. 157, Fair Value Measurements (“SFAS 157”), as it relates to its financial instruments, effective on October 1, 2008.  SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement does not require any new fair value measurements; rather, it amends other accounting pronouncements that require or permit fair value measurements.  SFAS 157 defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date.  SFAS 157 establishes a three-level hierarchy for measuring fair value and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

This valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date.  The three levels of that hierarchy are defined as follows:

 

Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities

 

Level 2 - Unadjusted quoted prices in active markets for similar assets or liabilities; or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs other than quoted prices that are observable for the asset or liability; or inputs that are derived principally from or corroborated by observable market data

 

Level 3 - Unobservable inputs for the asset or liability

 

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including interest rate swaps. Although the Company has determined that the majority of the inputs used to value its interest rate swaps fall within Level 2 of the valuation hierarchy, the credit valuation adjustments associated with its interest rate swaps utilize Level 3 inputs, such as estimates of current credit spreads to assess the likelihood of default by the Company or a counterparty. However, at March 31, 2009, the Company has assessed the relative significance

 

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Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

of such estimates to the overall valuation of our interest rate swaps and has concluded that the Company’s valuation inputs as a whole predominantly fall in the Level 2 hierarchy. In accordance with SFAS 157, the Company categorized certain of its financial assets and liabilities based on priority of the inputs to the valuation technique for the instruments, as follows (in thousands):

 

 

 

As of March 31, 2009

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Liabilities

 

 

 

 

 

 

 

 

 

Hedged interest rate swaps (1)

 

$

18,592

 

 

 

$

18,592

 

 

 

Non-hedged interest rate swaps (1)

 

8,447

 

 

 

8,447

 

 

 

Total

 

$

27,039

 

 

 

$

27,039

 

 

 

 


 (1) Interest rate swaps are valued using internal models based on market observable inputs, including market interest rates.

 

In October 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) FAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (“FAS 157-3”), which clarifies the application of SFAS 157. FAS 157-3 was effective upon issuance and its adoption did not have a material impact on the Company’s financial statements.

 

In April 2009, the FASB issued FSP-FAS No. 157-4,  Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FAS 157-4”).  This FSP provides guidance to determining fair values when there is no active market or where the price inputs available represent distressed sales transactions. As allowed by FAS 157-4, the Company early-adopted the provisions of FAS 157-4 and its adoption did not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

 

In April 2009, the FASB issued FSP-FAS No. 107-1 and APB 28-1, Disclosures about Fair Value of Financial Instruments (“FAS No. 107-1/APB 28-1”). This FSP extends to interim periods certain disclosures about fair value of financial instruments for publicly traded companies and amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. This FSP is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company’s adoption of FAS No. 107-1/APB 28-1, effective January 1, 2009, did not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

 

Effective on October 1, 2008, the Company also adopted the provisions of SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment of FASB Statement No. 115 (“SFAS 159”), which permits entities to choose to measure certain financial assets and liabilities at fair value. The Company elected not to measure at fair value any additional assets or liabilities that were not already measured at fair value prior to such adoption.  As a result, the adoption of SFAS 159 did not have an impact on the Company’s consolidated financial position, results of operations or cash flows.

 

We have not yet adopted and are currently assessing any potential effect of the pronouncements discussed below on our consolidated financial statements.

 

In June 2008, the Emerging Issues Task Force reached consensus on Emerging Issues Task Force Issue No. 08-3, Accounting by Lessees for Nonrefundable Maintenance Deposits (“EITF 08-3”). Under EITF 08-3, lessees should account for nonrefundable maintenance deposits as deposit assets if it is probable that maintenance activities will occur and the deposit is therefore realizable. Amounts on deposit that are not probable of being used to fund future maintenance activities should be expensed. EITF 08-3 is effective for fiscal years beginning after December 15, 2008. Early application is not permitted.

 

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Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

In April 2008, the FASB issued FSP-FAS No. 142-3, Determination of the Useful Life of Intangible Assets (“FAS 142-3”). FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). The objective of the Staff Position is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141 (Revised 2007): Business Combinations (“SFAS 141R”) and other GAAP. FAS 142-3 is effective for fiscal years beginning after December 15, 2008. Early application is not permitted.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51 (“SFAS 160”), which requires, among other things, that the noncontrolling interest (previously referred to as minority interest) in a consolidated subsidiary’s equity be reported as a component of equity separate from the parent’s interest and that net income or loss attributable to the noncontrolling interest be included in consolidated net income on the face of the income statement. In addition, purchases and sales of equity interests that do not result in a change in control will be accounted for as equity transactions and, upon a loss of control, the interest sold, as well as any interest retained, will be recorded at fair value with any gain or loss recognized in earnings. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008.  Early application is not permitted.

 

In December 2007, the FASB issued SFAS 141(Revised 2007), Business Combinations (“SFAS 141R”). Among other things, SFAS 141R generally requires that an acquirer recognize the assets acquired and liabilities assumed measured at their “full fair values” on the acquisition date. This practice replaces the practice, under predecessor SFAS 141: Business Combinations, of allocating the cost of an acquisition to the individual assets acquired and liabilities assumed based on their relative estimated fair values.  SFAS 141R further requires that acquisition-related costs be recognized separately from the related acquisition. SFAS 141R must be applied prospectively to business combinations consummated on or after the first annual reporting period beginning on or after December 15, 2008.  Early application is not permitted.

 

 In April 2009, the FASB issued FSP-FAS No. 141(R)-1 Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies (“FAS 141(R)-1”). This FSP amends and clarifies SFAS 141R and applies to assets acquired and liabilities assumed that arise from contingencies in a business combination.  FAS 141(R)-1 must also be applied prospectively to business combinations consummated on or after the first annual reporting period beginning on or after December 15, 2008.  Early application is not permitted.

 

3.  Net Earnings Per Share

 

Basic net earnings per share is calculated by dividing net earnings by the weighted-average number of shares of common stock outstanding during the period. Diluted net earnings per share is calculated similarly but includes potential dilution from the exercise of stock options and stock awards, except when the effect would be anti-dilutive.

 

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Table of Contents

 

Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

The following table sets forth the computations of basic and diluted earnings per share (in thousands, except per share data):

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net earnings

 

$

24,595

 

$

12,396

 

$

40,654

 

$

26,739

 

Total weighted-average basic shares

 

181,682

 

181,135

 

181,630

 

181,065

 

Dilutive securities:

 

 

 

 

 

 

 

 

 

Stock option and stock award programs

 

1,343

 

1,796

 

1,360

 

1,849

 

Total weighted-average diluted shares

 

183,025

 

182,931

 

182,990

 

182,914

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.14

 

$

0.07

 

$

0.22

 

$

0.15

 

Diluted

 

$

0.13

 

$

0.07

 

$

0.22

 

$

0.15

 

 

At March 31, 2009, options to purchase 9,187,246 shares of the Company’s common stock were outstanding but not included in the computation of diluted earnings per share, since these options’ exercise prices, ranging from $5.24 to $9.66, were greater than the average market price per share of the Company’s common stock during the three and six month periods ended on March 31, 2009. At March 31, 2008, options to purchase 7,179,894 shares of the Company’s common stock were outstanding but not included in the computation of diluted earnings per share, since these options’ exercise prices, ranging from $8.77 to $9.66, were greater than the average market price per share of the Company’s common stock during the three and six month periods ended on March 31, 2008.

 

4.   Comprehensive Income (Loss)
 

Comprehensive income (loss) consists of net earnings, foreign currency translation adjustments and deferred gains on interest rate swaps as follows (in thousands):

 

 

 

Three Months Ended March 31,

 

Six Months Ended March 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net earnings

 

$

24,595

 

$

12,396

 

$

40,654

 

$

26,739

 

Other comprehensive income (loss) adjustments:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments (a)

 

(7,227

)

1,726

 

(39,510

)

(2,730

)

Deferred loss on interest rate swaps (b)

 

(1,336

)

 

(12,209

)

 

Comprehensive income (loss)

 

$

16,032

 

$

14,122

 

$

(11,065

)

$

24,009

 

 


(a)          There were no income tax amounts related to foreign currency translation adjustments recorded in other comprehensive income (loss) for the three and six months ended March 31, 2009 and 2008.

(b)         Amounts are net of income taxes of $0.7 million for the three months ended March 31, 2009 and $7.7 million for the six months ended March 31, 2009.

 

5.   Share-Based Payments
 

The Company accounts for stock option and stock award plans, which we refer to as share-based payment plans, in accordance with SFAS 123(R) Share-Based Payment. Accordingly, the Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognizes compensation expense on a straight-line basis over the vesting period or to the date a participant becomes eligible for retirement, if earlier. During fiscal year 2007, the Company adopted the Sally Beauty Holdings 2007 Omnibus Incentive Plan (the “2007 Plan”), a share-based compensation plan which allows for the issuance of up to 10.0 million shares of the Company’s common stock.

 

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Table of Contents

 

Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

The Company granted approximately 2.7 million and 2.6 million stock options to its employees and consultants during the six months ended March 31, 2009 and 2008, respectively, under the 2007 Plan. Upon issuance of such grants, the Company recognized accelerated share-based compensation expense of $2.0 million and $3.1 million in the first quarter of fiscal years 2009 and 2008, respectively, in connection with certain retirement eligible employees who are eligible to continue vesting awards upon retirement under the terms of the 2007 Plan.

 

The following table presents the total compensation cost charged against income and included in selling, general and administrative expenses for share-based compensation arrangements and the related tax benefits recognized in our statements of earnings (in thousands):

 

 

 

Three Months Ended 
March 31,

 

Six Months Ended 
March 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Share-based compensation expense

 

$

1,584

 

$

1,618

 

$

5,195

 

$

7,210

 

Income tax benefit related to share-based compensation expense

 

$

102

 

$

216

 

$

1,480

 

$

2,237

 

 

Stock Options

 

Each option has an exercise price that equals 100% of the market price of the Company’s common stock on the date of grant and generally has a maximum term of 10 years. Options generally vest ratably over a four year period and are generally subject to forfeiture until the four year vesting period is complete, subject to certain retirement provisions of the 2007 Plan.

 

The following table presents a summary of the activity for the Company’s stock option plans for the six months ended March 31, 2009:

 

 

 

Number of 
Outstanding 
Options (in 
Thousands)

 

Weighted 
Average 
Exercise 
Price

 

Weighted 
Average 
Remaining 
Contractual 
Term (in 
Years)

 

Aggregate 
Intrinsic 
Value (in 
Thousands)

 

Outstanding at September 30, 2008

 

8,272

 

$

8.01

 

 

 

 

 

Granted

 

2,707

 

5.23

 

 

 

 

 

Exercised

 

(124

)

2.00

 

 

 

 

 

Forfeited or expired

 

(322

)

8.64

 

 

 

 

 

Outstanding at March 31, 2009

 

10,533

 

$

7.35

 

8.2

 

$

5,966

 

 

 

 

 

 

 

 

 

 

 

Exercisable at March 31, 2009

 

3,972

 

$

6.99

 

7.1

 

$

4,770

 

 

The following table summarizes information about stock options under the Company’s option plans at March 31, 2009:

 

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Table of Contents

 

Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

 

 

Options Outstanding

 

Options Exercisable

 

Range of 
Exercise 
Prices

 

Number 
Outstanding 
at March 31, 
2009 (in 
Thousands)

 

Weighted 
Average 
Remaining 
Contractual 
Term (in 
Years)

 

Weighted 
Average 
Exercise 
Price

 

Number 
Exercisable 
at March 31, 
2009 (in 
Thousands)

 

Weighted 
Average 
Exercise 
Price

 

$2.00

 

1,296

 

5.3

 

$

2.00

 

1,296

 

$

2.00

 

$4.79 – 9.66

 

9,237

 

8.6

 

8.10

 

2,676

 

9.40

 

Total

 

10,533

 

8.1

 

$

7.35

 

3,972

 

$

6.99

 

 

The Company uses the Black-Scholes option pricing model to value the Company’s stock options for each stock option award. Using this option pricing model, the fair value of each stock option award is estimated on the date of grant. The fair value of the Company’s stock option awards, which generally vest ratably over a four year period, is expensed on a straight-line basis over the vesting period of the stock options or to the date a participant becomes eligible for retirement, if earlier.

 

The weighted average assumptions relating to the valuation of the Company’s stock options are as follows:

 

 

 

Six Months Ended March 31,

 

 

 

2009

 

2008

 

Expected lives (years)

 

5.0

 

5.0

 

Expected volatility

 

47.9

%

37.5

%

Risk-free interest rate

 

2.6

%

4.0

%

Dividend yield

 

0.0

%

0.0

%

 

The expected life of options represents the period of time that the options granted are expected to be outstanding and is based on historical experience of employees of the Company who have been granted stock options, including grants under stock option plans of Alberto-Culver prior to the Separation Transactions. Expected volatility is derived using the average volatility of both the Company and similar companies (based on industry sector) since it is not practicable to estimate the Company’s expected volatility on a stand alone basis due to a lack of sufficient trading history. The risk-free interest rate is based on the zero-coupon U.S. Treasury issue as of the date of the grant. Since the Company does not expect to pay dividends, the dividend yield is 0%.

 

The weighted average fair value of the stock options issued, in the six months ended March 31, 2009 and 2008 to the Company’s grantees at the date of grant was $2.33 and $3.46 per option, respectively. The total intrinsic value of options exercised during the six months ended March 31, 2009 was $0.2 million.  Cash proceeds from these option exercises were $0.3 million and the tax benefit realized for the tax deductions from these option exercises was $0.1 million.

 

At March 31, 2009, approximately $12.0 million of total unrecognized compensation costs related to non-vested stock option awards are expected to be recognized over the weighted average period of 2.8 years.

 

Stock Awards

 

Restricted Stock Awards
 

A restricted stock award is an award of shares of the Company’s common stock (which have full voting rights but are restricted with regards to sale or transfer), the restrictions over which lapse ratably over a specified period of time (generally 5 years). Restricted stock awards are independent of stock option grants and are generally subject to forfeiture if employment terminates prior to these restrictions lapsing, subject to certain retirement provisions of the 2007 Plan.

 

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Table of Contents

 

Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

The Company expenses the cost of the restricted stock awards, which is determined to be the fair value of the restricted stock award at the date of grant, on a straight-line basis over the period (the “vesting period”) in which the restrictions on these stock awards lapse (“vesting”). For these purposes, the fair value of the restricted stock award is determined based on the closing price of the Company’s common stock on the grant date.

 

The following table presents a summary of the activity for the Company’s restricted stock awards for the six months ended March 31, 2009:

 

Restricted Stock Awards

 

Number of
Shares (In 
Thousands)

 

Weighted 
Average Fair 
Value Per Share

 

Weighted 
Average 
Remaining 
Vesting Term 
(In Years)

 

Non-vested at September 30, 2008

 

296

 

$

8.44

 

3.8

 

Granted

 

123

 

5.17

 

 

 

Vested

 

(61

)

8.54

 

 

 

Forfeited

 

 

 

 

 

Non-vested at March 31, 2009

 

358

 

$

7.30

 

3.8

 

 

At March 31, 2009, approximately $2.4 million of total unrecognized compensation costs related to non-vested restricted stock awards are expected to be recognized over the weighted average period of 3.8 years.

 

Restricted Stock Units (“RSUs”)
 

The Company grants RSUs which generally vest into deferred stock units less than one year from the date of grant pursuant to the 2007 Plan. To date the Company has only granted RSU awards to its non-employee directors. RSUs represent an unsecured promise of the Company to issue shares of common stock of the Company. RSUs are independent of stock option grants and are generally subject to forfeiture if service terminates prior to the vesting of the units. Participants have no voting rights with respect to non-vested RSUs.

 

The Company expenses the cost of the RSUs, which is determined to be the fair value of the RSUs at the date of grant, on a straight-line basis over the vesting period (generally less than one year). For these purposes, the fair value of the RSU is determined based on the closing price of the Company’s common stock on the grant date.

 

The following table presents a summary of the activity for the Company’s RSUs for the six months ended March 31, 2009:

 

Restricted Stock Units

 

Number of 
Shares (In 
Thousands)

 

Weighted 
Average Fair 
Value Per Share

 

Weighted 
Average 
Remaining 
Vesting Term 
(In Years)

 

Non-vested at September 30, 2008

 

 

$

 

 

Granted

 

94

 

5.24

 

 

 

Vested

 

 

 

 

 

Forfeited

 

 

 

 

 

Non-vested at March 31, 2009

 

94

 

$

5.24

 

0.5

 

 

At March 31, 2009, approximately $0.3 million of total unrecognized compensation costs related to non-vested RSUs are expected to be recognized over the weighted average period of 0.5 years.

 

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Table of Contents

 

Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

6.   Goodwill and Other Intangibles
 

The change in the carrying amounts of goodwill by operating segment for the six months ended March 31, 2009, is as follows (in thousands):

 

 

 

Sally Beauty 
Supply

 

Beauty Systems 
Group

 

Total

 

Balance at September 30, 2008

 

$

65,188

 

$

359,775

 

$

424,963

 

Additions, net of purchase price adjustments

 

398

 

221

 

619

 

Foreign currency translation

 

(6,944

)

(7,907

)

(14,851

)

Balance at March 31, 2009

 

$

58,642

 

$

352,089

 

$

410,731

 

 

The following table provides the gross carrying value and accumulated amortization for intangible assets with indefinite lives and intangible assets subject to amortization by operating segment at March 31, 2009 (in thousands):

 

 

 

Sally Beauty 
Supply

 

Beauty Systems 
Group

 

Total

 

Balance at March 31, 2009

 

 

 

 

 

 

 

Intangible assets with indefinite lives:

 

 

 

 

 

 

 

Trade names

 

$

18,225

 

$

33,424

 

$

51,649

 

Other intangibles

 

 

6,053

 

6,053

 

Total

 

18,225

 

39,477

 

57,702

 

Intangible assets subject to amortization:

 

 

 

 

 

 

 

Gross carrying amount

 

6,505

 

35,742

 

42,247

 

Accumulated amortization

 

(1,758

)

(19,376

)

(21,134

)

Net value

 

4,747

 

16,366

 

21,113

 

Total intangible assets, net

 

$

22,972

 

$

55,843

 

$

78,815

 

 

Amortization expense was $1.4 million and $1.2 million for the three months ended March 31, 2009 and 2008, and $2.9 million and $3.1 million for the six months ended March 31, 2009 and 2008, respectively. There have been no material changes to the Company’s future amortization expense schedule since September 30, 2008.

 

7.   Long-Term Debt
 

In connection with the Separation Transactions on November 16, 2006, the Company, through its subsidiaries (Sally Investment Holdings LLC and Sally Holdings), incurred $1,850.0 million of indebtedness by (i) drawing on a revolving (asset-based lending) facility (the “ABL facility”) in an amount equal to $70.0 million, (ii) entering into two term loan facilities (term loans A and B) in an aggregate amount of $1,070.0 million and (iii) together (jointly and severally) with another of the Company’s indirect subsidiaries, Sally Capital Inc., issuing senior notes in an aggregate amount of $430.0 million and senior subordinated notes in an aggregate amount of $280.0 million.

 

The term loan facilities and the ABL facility are secured by substantially all of our assets, those of Sally Investment Holdings LLC, a wholly-owned subsidiary of Sally Beauty and the direct parent of Sally Holdings, those of our domestic subsidiaries and, in the case of the ABL facility, those of our Canadian subsidiaries. The term loan facilities may be prepaid at our option at any time without premium or penalty and are subject to mandatory prepayment in an amount equal to 50% of excess cash flow (as defined in the agreement governing the term loan facilities) for any fiscal year (commencing in fiscal year 2008) unless a specified leverage ratio is met. In January 2009, the Company made a mandatory repayment on the term loan facilities in the amount of $16.7

 

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Table of Contents

 

Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

million. Amounts paid pursuant to said provision may be applied, at the option of the Company, against minimum loan repayments otherwise required over the twelve month period following any such payment, under the terms of the loan agreement. Additionally, borrowings under the term loan facility would be subject to mandatory prepayment in an amount equal to 100% of the proceeds of specified asset sales that are not reinvested in the business or applied to repay borrowings under the ABL facility.

 

The senior notes and senior subordinated notes are unsecured obligations of the issuers and are jointly and severally guaranteed on a senior basis (in the case of the senior notes) and on a senior subordinated basis (in the case of the senior subordinated notes) by each material domestic subsidiary of the Company. Furthermore, the agreements underlying the Company’s credit facilities contain terms, which significantly restrict the ability of Sally Beauty’s subsidiaries to pay dividends or otherwise transfer assets to Sally Beauty. Please see the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008 for additional information about the Company’s long-term debt.

 

Details of long-term debt are as follows (in thousands):

 

 

 

As of March 
31, 2009

 

Maturity 
dates 
(Fiscal 
Year)

 

Interest Rates

 

ABL facility

 

$

 

 

 

(i)  Prime plus up to 0.50% or;

 

 

 

 

 

 

 

(ii) LIBOR plus (1.00% to 1.50%)

 

Term Loan A

 

120,902

 

2013

 

(i)  Prime plus (1.00% to 1.50%) or;

 

 

 

 

 

 

 

(ii) LIBOR plus (2.00% to 2.50%)

 

Term Loan B

 

892,954

 

2014

 

(i)  Prime plus (1.25% to 1.50%) or;

 

 

 

 

 

 

 

(ii) LIBOR plus (2.25% to 2.50%)

 

Other (a)

 

2,372

 

2009-2014

 

4.05% to 7.00%

 

Total

 

$

1,016,228

 

 

 

 

 

 

 

 

 

 

 

 

 

Senior notes

 

$

430,000

 

2015

 

9.25%

 

Senior subordinated notes

 

280,000

 

2017

 

10.50%

 

Total

 

$

710,000

 

 

 

 

 

 

 

 

 

 

 

 

 

Capitalized leases and other

 

$

552

 

 

 

 

 

Less: current portion

 

(14,470)

 

 

 

 

 

Total long-term debt

 

$

1,712,310

 

 

 

 

 

 


(a) Represents pre-acquisition debt of Pro-Duo, N.V.

 

Maturities of the Company’s long-term debt are as follows (in thousands):

 

Fiscal Year:

 

 

 

2009

 

$

2,200

 

2010

 

24,781

 

2011

 

39,617

 

2012

 

84,503

 

2013

 

9,380

 

Thereafter

 

1,565,747

 

 

 

$

1,726,228

 

Capital leases and other

 

552

 

Less: current portion

 

(14,470

)

Total

 

$

1,712,310

 

 

19



Table of Contents

 

Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

We are a holding company and do not have any material assets or operations other than ownership of equity interests of our subsidiaries.  The agreements and instruments governing the debt of Sally Holdings and its subsidiaries contain material limitations on their ability to pay dividends and other restricted payments to us which, in turn, constitute material limitations on our ability to pay dividends and other payments to our stockholders.

 

Under the agreements and indentures governing the term loan facilities and the notes, Sally Holdings may not make certain restricted payments to us if a default then exists under the credit agreement or the indentures or if its consolidated interest coverage ratio is less than 2.0 to 1.0 at the time of the making of such restricted payment.  As of March 31, 2009, its consolidated interest coverage ratio exceeded 2.0 to 1.0.  Further, the aggregate amount of restricted payments it is able to make is limited pursuant to various baskets as calculated pursuant to the credit agreement and indentures.

 

The agreements governing our ABL facility generally permit the making of distributions and certain other restricted payments so long as borrowing availability under the facility equals or exceeds $60.0 million. If borrowing availability falls below this amount, Sally Holdings may nevertheless make restricted payments to us in the aggregate since the date of the Separation Transactions, together with the aggregate cash amount paid in acquisitions since said date, of not greater than $50.0 million, together with certain other exceptions.  As of March 31, 2009, borrowing availability under the ABL facility exceeded $60.0 million.  As of March 31, 2009, the net assets of our consolidated subsidiaries that were unrestricted from transfer under our credit arrangements totaled $201.6 million, subject to certain adjustments.
 
8.    Derivative Instruments and Hedging Activities
 

Risk Management Objectives of Using Derivative Instruments

 

The Company is exposed to a wide variety of risks, including risks arising from changing economic conditions. The Company manages its exposure to certain economic risks (including liquidity, credit risk and changes in interest rates) primarily (a) by closely managing its cash flows from operating and investing activities and the amounts and sources of its debt obligations; (b) by assessing periodically the creditworthiness of its business partners; and (c) through Sally Holdings, by the use of interest rate swaps.  The Company uses interest rate swaps, as part of its overall economic risk management strategy to add stability to the interest payments due in connection with its term loan obligations. Interest payments related to the term loans are impacted by changes in LIBOR. Interest rate swap agreements involve the periodic receipt by the Company of amounts based on a variable rate in exchange for the Company making payments based on a fixed rate over the term of the interest rate swap agreements without exchange of the underlying notional amount. At March 31, 2009, the Company did not purchase or hold any other derivative instruments or hold any derivative instruments for trading or speculative purposes.

 

Designated Cash Flow Hedges of Interest Rate Risk

 

Effective May 2008, the Company entered into two interest rate swap agreements with an aggregate notional amount of $300 million. These interest rate swap agreements are designated and qualify as effective cash flow hedges, in accordance with SFAS 133.  Accordingly, changes in the fair value of derivatives designated and qualifying as cash flow hedges are recorded quarterly, net of income tax, in accumulated other comprehensive (loss) income (“OCI”) until the hedged obligation is settled or the swap agreements expire, whichever is earlier. Any hedge ineffectiveness, as this term is used in SFAS 133, is recognized in net interest expense in our consolidated statements of earnings. No hedge ineffectiveness on cash flow hedges was recognized during the three or six month periods ended March 31, 2009. Please see the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008 for additional information about the Company’s interest rate swap agreements.

 

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Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

Amounts reported in OCI related to interest rate swaps are reclassified into net interest expense, as a yield adjustment, in the same period in which interest on the Company’s variable-rate debt obligations affect earnings. During the three and six month periods ended March 31, 2009, net interest expense of $2.3 million and $3.0 million, respectively, resulted from such reclassifications.  During the twelve months ending March 31, 2010, the Company estimates that an additional $7.5 million of the amount reported in OCI will be reclassified into interest expense.

 

Non-designated Cash Flow Hedges of Interest Rate Risk

 

Interest rate swaps not designated as hedges are used to manage the Company’s exposure to interest rate movements but do not meet the hedge accounting requirements of SFAS 133. In connection with the Separation Transactions, effective November 2006, the Company entered into four interest rate swap agreements with an aggregate notional amount of $500 million. Interest rate swap agreements with an aggregate notional amount of $150 million expired in November 2008 and interest rate swap agreements with a notional amount of $350 million expire in November 2009. These interest rate swap agreements are not designated as hedges and, accordingly, the changes in fair value of these interest rate swap agreements (which are adjusted quarterly) are recorded in net interest expense in our statements of earnings. Please see the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008 for additional information about the Company’s interest rate swap agreements.

 

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the balance sheet as of March 31, 2009 (in thousands):

 

Tabular Disclosure of Fair Values of Derivative Instruments

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

As of March 31, 2009

 

As of March 31, 2009

 

 

 

Balance Sheet 
Location

 

Fair Value

 

Balance Sheet 
Location

 

Fair Value

 

Derivatives designated as hedging instruments under SFAS 133:

 

 

 

 

 

 

 

 

 

Interest Rate Swaps

 

Prepaid expenses

 

$

 

Accrued expenses

 

$

 

Interest Rate Swaps

 

Other assets

 

$

 

Other liabilities

 

$

18,592

(1)

Total derivatives designated as hedging instruments under SFAS 133

 

 

 

$

 

 

 

$

18,592

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments under SFAS 133:

 

 

 

 

 

 

 

 

 

Interest Rate Swaps

 

Prepaid expenses

 

$

 

Accrued expenses

 

$

8,447

 

Total derivatives not designated as hedging instruments under SFAS 133

 

 

 

$

 

 

 

$

8,447

 

 


(1)          At March 31, 2009, the Company estimates that approximately $7.5 million of the fair value of these derivative financial instruments will settle within the twelve months ending March 31, 2010.

 

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Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the balance sheet as of September 30, 2008 (in thousands):

 

Tabular Disclosure of Fair Values of Derivative Instruments

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

As of September 30, 2008

 

As of September 30, 2008

 

 

 

Balance Sheet 
Location

 

Fair Value

 

Balance Sheet 
Location

 

Fair Value

 

Derivatives designated as hedging instruments under SFAS 133:

 

 

 

 

 

 

 

 

 

Interest Rate Swaps

 

Prepaid expenses

 

$

 

Accrued expenses

 

$

 

Interest Rate Swaps

 

Other assets

 

$

1,302

 

Other liabilities

 

$

 

Total derivatives designated as hedging instruments under SFAS 133

 

 

 

$

1,302

 

 

 

$

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments under SFAS 133:

 

 

 

 

 

 

 

 

 

Interest Rate Swaps

 

Prepaid expenses

 

$

 

Accrued expenses

 

$

487

 

Interest Rate Swaps

 

Other assets

 

$

 

Other liabilities

 

$

7,167

 

Total derivatives not designated as hedging instruments under SFAS 133

 

 

 

$

 

 

 

$

7,654

 

 

The tables below present the effect of the Company’s derivative financial instruments on the statements of earnings for the three and six months ended March 31, 2009 (in thousands):

 

Tabular Disclosure of the Effect of Derivative Instruments on the Statement of Earnings for the Three Months Ended March 31, 2009

 

Derivatives in SFAS 
133 Cash Flow 
Hedging Relationships

 

Amount of 
Gain or 
(Loss) 
Recognized 
in OCI on 
Derivative 
(Effective 
Portion), net 
of tax

 

Location of Gain or 
(Loss) Reclassified 
from Accumulated 
OCI into Income 
(Effective Portion)

 

Amount of 
Gain or (Loss) 
Reclassified 
from 
Accumulated 
OCI into 
Income 
(Effective 
Portion)

 

Location of Gain or 
(Loss) Recognized in 
Income on Derivative 
(Ineffective Portion 
and Amount 
Excluded from 
Effectiveness Testing)

 

Amount of Gain 
or (Loss) 
Recognized in 
Income on 
Derivative 
(Ineffective 
Portion and 
Amount 
Excluded from 
Effectiveness 
Testing)

 

Interest Rate Swaps

 

$

(1,336

)

Interest expense, net

 

$

(2,345

)

Interest expense, net

 

$

 

 

Derivatives Not Designated as Hedging 
Instruments Under SFAS 133

 

Location of Gain or 
(Loss) Recognized in 
Income on 
Derivative

 

Amount of 
Gain or (Loss) 
Recognized in 
Income on 
Derivative

 

 

 

 

 

Interest Rate Swaps

 

Interest expense, net

 

$

(541

)

 

 

 

 

 

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Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

Tabular Disclosure of the Effect of Derivative Instruments on the Statement of Earnings for the

Six Months Ended March 31, 2009

 

Derivatives in SFAS
133 Cash Flow
Hedging Relationships

 

Amount of
Gain or
(Loss)
Recognized
in OCI on
Derivative
(Effective
Portion), net
of tax

 

Location of Gain or
(Loss) Reclassified
from Accumulated
OCI into Income
(Effective Portion)

 

Amount of
Gain or (Loss)
Reclassified
from
Accumulated
OCI into
Income
(Effective
Portion)

 

Location of Gain or
(Loss) Recognized
in Income on
Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness
Testing)

 

Amount of Gain
or (Loss)
Recognized in
Income on
Derivative
(Ineffective
Portion and
Amount Excluded
from
Effectiveness
Testing)

 

Interest Rate Swaps

 

$

(12,209

)

Interest expense, net

 

$

(3,013

)

Interest expense, net

 

$

 

 

Derivatives Not Designated as Hedging
Instruments Under SFAS 133

 

Location of Gain or
(Loss) Recognized
in Income on
Derivative

 

Amount of
Gain or (Loss)
Recognized in
Income on
Derivative

 

Interest Rate Swaps

 

Interest expense, net

 

$

(6,187

)

 

Credit-risk-related Contingent Features

 

The agreements governing the Company’s interest rate swaps contain provisions pursuant to which the Company could be declared in default on its interest rate swap obligations in the event the Company defaulted under certain terms of the loan documents governing the Company’s ABL facility. As of March 31, 2009, the fair value of interest rate swaps in a liability position related to these agreements was $27.0 million. As of March 31, 2009, the Company was under no obligation to post and had not posted any collateral related to these agreements. If the Company breached any of these provisions, it would be required to settle its obligations under the agreements at their termination value of $29.6 million, including accrued interest and other termination costs.

 

The counterparties to all our interest rate swap instruments are deemed by the Company to be of substantial resources and strong creditworthiness. However, these transactions result in exposure to credit risk in the event of default by a counterparty. The current financial crisis affecting the banking systems and financial markets has resulted in many well-known financial institutions becoming less creditworthy or having diminished liquidity, which could expose us to an increased level of counterparty risk.  In the event that a counterparty defaults in its obligation under our interest rate swaps, we could incur substantial financial losses. However, at the present time, no such losses are deemed probable.

 

The Company’s foreign operations expose the Company to fluctuations in foreign currency exchange rates and foreign interest rates.  These fluctuations may impact, among other things, the amount of the Company’s past and future cash flows in terms of the Company’s functional currency, the U.S. dollar.  From time to time, the Company may enter into derivative instruments, such as foreign currency swaps, intended to fix the amount of certain foreign assets and obligations relative to its functional currency. At March 31, 2009, the Company did not have any such derivative instruments.

 

9.   Income Taxes

 

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and most state jurisdictions, as well as in various foreign jurisdictions.

 

The Separation Transactions were intended to qualify as a reorganization under Section 368(a)(1)(D) of the Internal Revenue Code of 1986, as amended (the “Code”) and a distribution eligible for non-recognition under

 

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Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

Sections 355(a) and 361(c) of the Code. In connection with the share distribution of Alberto-Culver common stock in the Separation Transactions, the Company received: (i) a private letter ruling from the Internal Revenue Service (“IRS”) and (ii) an opinion of Sidley Austin LLP, counsel to Alberto-Culver, in each case, to the effect that the transactions qualify as a reorganization under Section 368(a)(1)(D) of the Code and a distribution eligible for non-recognition under Sections 355(a) and 361(c) of the Code. Certain internal restructurings also occurred at or immediately prior to the Separation Transactions. As a result of the internal restructurings and Separation Transactions, the Company inherited the federal tax identification number of the old Alberto-Culver parent for U.S. federal income tax purposes.

 

The Company and Alberto-Culver entered into a tax allocation agreement as part of the Separation Transactions. The agreement provides generally that the Company is responsible for its pre-separation income tax liabilities, calculated on a stand-alone basis, and Alberto-Culver is responsible for the remainder. In the event an additional U.S. federal income tax liability related to the period prior to the Separation Transactions were determined, the Company would be jointly and severally liable for these taxes, and there can be no assurance that Alberto-Culver would be able to fulfill its indemnification obligations to the Company under the tax allocation agreement if Alberto-Culver was determined to be responsible for these taxes thereunder.

 

In addition, as the successor entity to Alberto-Culver after the Separation Transactions, the Company relies upon the prior year federal income tax returns of Alberto-Culver and accounting methods established therein for certain calculations that affect our current U.S. federal income tax liability.

 

The IRS examination of the Company’s consolidated federal income tax returns for the tax years ended September 30, 2005 and 2006 were concluded with no adjustments required.

 

10.   Business Segments

 

The Company’s business is organized into two separate segments: (i) Sally Beauty Supply, a domestic and international chain of cash and carry retail stores which offers professional beauty supplies to both salon professionals and retail customers and (ii) BSG, including its franchise-based business Armstrong McCall, a full service beauty supply distributor which offers professional brands of beauty products directly to salons through its own sales force and professional only stores (including franchise stores) in generally exclusive geographical territories in North America and parts of Europe.

 

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Table of Contents

 

Sally Beauty Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

Sales between segments, which were eliminated in consolidation, were not material during any of the periods ended March 31, 2009 and 2008.  Segment data for the three and six months ended March 31, 2009 and 2008 is as follows (in thousands):

 

 

 

Three months ended
March 31,

 

Six months ended
March 31,

 

 

 

2009

 

2008 (2)

 

2009

 

2008 (2)

 

Net sales:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

$

412,338

 

$

406,065

 

$

822,875

 

$

815,629

 

BSG

 

229,173

 

237,281

 

464,212

 

483,504

 

Total net sales

 

$

641,511

 

$

643,346

 

$

1,287,087

 

$

1,299,133

 

Earnings before provision for income taxes:

 

 

 

 

 

 

 

 

 

Segment operating profit:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

$

70,379

 

$

67,911

 

$

135,665

 

$

139,644

 

BSG

 

20,359

 

17,942

 

40,595

 

38,972

 

Total segment operating profit

 

90,738

 

85,853

 

176,260

 

178,616

 

Unallocated corporate expenses (1)

 

(16,933

)

(18,722

)

(32,575

)

(36,017

)

Share-based compensation expense

 

(1,584

)

(1,618

)

(5,195

)

(7,210

)

Interest expense, net of interest income

 

(31,969

)

(47,642

)

(71,642

)

(94,125

)

Earnings before provision for income taxes

 

$

40,252

 

$

17,871

 

$

66,848

 

$

41,264

 

 


(1)

 

Unallocated expenses consist of corporate and shared costs.

(2)

 

Certain amounts for prior periods have been reclassified to conform to the current period’s presentation.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following section discusses management’s view of the financial condition, results of operations and cash flows of Sally Beauty.  This section should be read in conjunction with the audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2008, as well as the Risk Factors section of that Annual Report, and information contained elsewhere in this Quarterly Report, including the consolidated financial statements and condensed notes to those statements. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. See “Cautionary Notice Regarding Forward-Looking Statements,” included at the beginning of this Quarterly Report, for a discussion of the uncertainties, risks and assumptions associated with these forward-looking statements that could cause results to differ materially from those reflected in such forward-looking statements.

 

Highlights For the First Six Months of Fiscal Year 2009:

 

·                  Our same store sales increased by 1.1% for the six months ended March 31, 2009 (while increasing 2.1 % for the three months ended March 31, 2009);

·                  Our consolidated net sales for the six months ended March 31, 2009, decreased by $12.0 million, or 0.9%, to $1,287.1 million compared to $1,299.1 million for the six months ended March 31, 2008;

·                  Net sales reported for the six months ended March 31, 2009, reflect approximately $50.9 million, or 3.9%, in negative impact from changes in foreign exchange rates;

·                  Our consolidated gross profit for the six months ended March 31, 2009, increased $1.1 million, or 0.2%, to $605.7 million compared to $604.6 million for the six months ended March 31, 2008. As a percentage of net sales, gross profit increased 52 basis points to 47.1% for the six months ended March 31, 2009, compared to 46.5% for the six months ended March 31, 2008;

·                  Our consolidated operating earnings for the six months ended March 31, 2009, increased $3.1 million, or 2.3%, to $138.5 million compared to $135.4 million for the six months ended March 31, 2008.  As a percentage of net sales, operating earnings increased to 10.8% for the six months ended March 31, 2009, compared to 10.4% for the six months ended March 31, 2008;

·                  Net earnings increased $13.9 million, or 52.0%, to $40.7 million for the six months ended March 31, 2009, compared to $26.7 million for the six months ended March 31, 2008; and

·                  Cash provided by operations increased by $104.1 million to $124.2 million for the six months ended March 31, 2009, compared to $20.1 million for the six months ended March 31, 2008.

 

Overview

 

Description of Business

 

We are the largest distributor of professional beauty supplies in the U.S. based on store count. We operate primarily through two business units, Sally Beauty Supply and BSG. Through Sally Beauty Supply and BSG (which operates stores under the CosmoProf service mark), we operated a multi-channel platform of 3,618 stores and supplied 189 franchised stores in North America, as well as in certain European countries and Japan, as of March 31, 2009. Within BSG, we also have one of the largest networks of professional distributor sales consultants in North America, with approximately 961 professional distributor sales consultants who sell directly to salons and salon professionals. We provide our customers with a wide variety of leading third-party branded and exclusive-label professional beauty supplies, including hair care products, styling appliances, skin and nail care products and other beauty items. Sally Beauty Supply stores target retail consumers and salon professionals, while BSG exclusively targets salons and salon professionals. For the six months ended March 31, 2009, our net sales and operating earnings were $1,287.1 million and $138.5 million, respectively.

 

We believe that Sally Beauty Supply is the largest open-line distributor of professional beauty supplies in the U.S. based on store count. As of March 31, 2009, Sally Beauty Supply operated 2,847 company-operated retail stores and supplied 26 franchised stores (all located outside the U.S.). Of these stores, 2,325 are located in the U.S. (with the remainder in the United Kingdom and certain other countries in Europe, Canada, Puerto Rico, Mexico and Japan). Sally Beauty Supply stores average 1,700 square feet and are primarily located in strip shopping centers. The product selection in Sally Beauty Supply stores ranges between 5,000 and 8,000 SKUs of beauty products and includes products for hair care, skin and nail care, beauty sundries and electrical appliances targeting retail consumers and salon professionals. Sally Beauty Supply stores carry leading third-party brands such as Clairol, Revlon and Conair, as well as an extensive selection of exclusive-label merchandise.

 

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We believe that BSG is the largest full-service distributor of professional beauty supplies in the U.S.  As of March 31, 2009, BSG had 771 company-operated stores, supplied 163 franchised stores and had a sales force of approximately 961 professional distributor sales consultants selling exclusively to salons and salon professionals in substantially all states in the U.S. and in portions of Canada, Mexico and certain European countries. BSG stores average 2,700 square feet and are primarily located in secondary strip shopping centers. Through BSG’s large store base and sales force, BSG is able to access a significant portion of the highly fragmented U.S. salon channel. The product selection in BSG stores, ranging between 4,000 and 9,600 SKUs of beauty products, includes hair care and color, skin and nail care, beauty sundries and electrical appliances targeting salons and salon professionals. BSG carries leading professional beauty product brands intended for use in salons and for resale by the salon to consumers. Certain BSG products are sold under exclusive distribution agreements with suppliers, whereby BSG is designated as the sole distributor for a product line within certain geographic territories.

 

Industry and Business Trends
 

We operate within the large and growing U.S. professional beauty supply industry. Potential growth in the industry is expected to be driven by increases in hair color, hair loss prevention and hair styling products, offset by lower sales of electrical products during periods of prolonged economic slowdown. We believe the following key industry and business trends and characteristics will influence our business and our financial results going forward:

 

·                  High level of customer fragmentation.  The U.S. salon channel is highly fragmented with over 228,000 salons. Given the fragmented and small-scale nature of the salon industry, we believe that salon operators will continue to depend on full-service/exclusive distributors and open-line channels for a majority of their beauty supply purchases.

 

·                  Growth in booth renting and frequent stocking needs.  Salon professionals primarily rely on just-in-time inventory due to capital constraints and a lack of warehouse and shelf space at salons.  In addition, booth renters, who comprise a significant percentage of total U.S. salon professionals, are often responsible for purchasing their own supplies. Historically, booth renters have significantly increased as a percentage of total salon professionals and we expect this trend to continue. Given their smaller individual purchases and relative lack of financial resources, booth renters are likely to be dependent on frequent trips to professional beauty supply stores, like BSG and Sally Beauty Supply.  These factors continue to drive demand for conveniently located professional beauty supply stores.

 

·                  Increasing Use of Exclusive-Label Products.  We offer a broad range of private label and control label products, which we generally refer to collectively as “exclusive-label products.” Private label products are brands for which we own or license the trademark and, in some instances, the formula. Control label products are brands that are owned by the manufacturer, but for which we have been granted sole distribution rights. Generally, our exclusive-label products have higher gross margins than the leading third-party branded products and we believe this area offers potential growth. Please see “Risk Factors - We depend upon manufacturers who may be unable to provide products of adequate quality or who may be unwilling to continue to supply products to us” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

 

·                  Favorable demographic and consumer trends.  The aging baby-boomer population is expected to drive future growth in professional beauty supply sales through an increase in the usage of hair color and hair loss products. Additionally, continuously changing fashion-related trends that drive new hair styles are expected to result in continued demand for hair styling products. Changes in consumer tastes and fashion trends can have an impact on our financial performance. Our continued success depends in large part on our ability to anticipate, gauge and react in a timely and effective manner to changes in consumer spending patterns and preferences for beauty products. We continuously adapt our marketing and merchandising initiatives for Sally Beauty Supply in an effort to expand our market reach or to respond to changing consumer preferences.  If we are unable to anticipate and respond to trends in the marketplace for beauty products and changing consumer demands, our business could suffer.

 

·                  International Growth Strategies.  A key element of our growth strategy depends on our ability to capitalize on growth in the international marketplace and to grow our current level of non-U.S. operations.  In May 2008, we acquired Pro-Duo, N.V., a cash and carry retailer of both professional and retail hair products with approximately 40 stores located in Belgium, France and Spain. In February 2007, we acquired Chapelton 21 Limited, a private company based in Scotland with almost 100 stores located in the United Kingdom, Ireland, Germany, France and Spain, which we refer to as Salon Services.  These acquisitions furthered our expansion plans in Europe, a significant part of Sally Beauty Supply’s international growth initiative.  We

 

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intend to continue to identify and evaluate non-U.S. acquisition targets and are actively considering expansion into South America.  Our ability to grow our non-U.S. operations, integrate our new non-U.S. acquisitions and successfully pursue additional non-U.S. acquisitions may be affected by business, legal, regulatory and economic risks. Please see “Risk Factors - We may not be able to successfully identify acquisition candidates and complete desirable acquisitions,” “If we acquire any businesses in the future they could prove difficult to integrate, disrupt our business or have an adverse effect on our results of operations” and “Our ability to conduct business in international marketplaces may be affected by legal, regulatory and economic risks” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

 

·                  Continuing consolidation.  There is continuing consolidation among professional beauty product distributors and professional beauty product manufacturers. We plan to continue to examine ways in which we can benefit from this trend, including reviewing opportunities to shift business from competitive distributors to the BSG network as well as seeking opportunistic, value-added acquisitions which complement our long-term growth strategy. We believe that suppliers are increasingly likely to focus on larger distributors and retailers with a broader scale and retail footprint. We also believe that we are well positioned to capitalize on this trend as well as participate in the ongoing consolidation at the distributor/retail level. However, changes often occur in our relationships with suppliers that may materially affect the net sales and operating earnings of our business segments. Consolidation among suppliers could exacerbate the effects of these relationship changes and could increase pricing pressures. For example, as we announced in December 2006, our largest supplier, L’Oreal, moved a material amount of revenue out of the BSG nationwide distribution network and into competitive regional distribution networks. More recently, L’Oreal acquired distributors competing with BSG in the southeastern and west coast of the U.S. and a supplier that does not currently do business with BSG.  As a result, L’Oreal directly competes with BSG in certain geographic areas. If L’Oreal acquired other distributors or suppliers that conduct significant business with BSG we could lose related revenue. There can be no assurance that there will not be further loss of revenue over time by BSG (including within its franchise-based business) due to potential losses of additional products (both from L’Oreal and from other suppliers) as well as from the increased competition from L’Oreal-affiliated distribution networks. Please see “Relationships with Suppliers” and “Risk Factors - The beauty products distribution industry is highly competitive and is consolidating” and “We depend upon manufacturers who may be unable to provide products of adequate quality or who may be unwilling to continue to supply products to us” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

 

·                  High level of competition.  Sally Beauty Supply competes with other domestic and international beauty product wholesale and retail outlets, including local and regional open-line beauty supply stores, professional-only beauty supply stores, salons, mass merchandisers, drug stores and supermarkets, as well as sellers on the Internet and salons retailing hair care items. BSG competes with other domestic and international beauty product wholesale and retail suppliers and manufacturers selling professional beauty products directly to salons and individual salon professionals. We also face competition from authorized and unauthorized retailers and internet sites offering professional salon-only products. The increasing availability of unauthorized professional salon products in large format retail stores such as drug stores, grocery stores and others could also have a negative impact on our business.

 

·                  Economic conditions.  We appeal to a wide demographic consumer profile and offer a broad selection of beauty products sold directly to retail consumers and salons and salon professionals. Historically, these factors have provided us with reduced exposure to downturns in economic conditions in the countries in which we operate.  However, a continued downturn in the economy, especially for an extended period of time, could adversely impact consumer demand of discretionary items such as beauty products and salon services, particularly affecting our electrical products category and our full-service sales business. In addition, higher freight costs resulting from increases in the cost of fuel, especially for an extended period of time, may impact our expenses at levels that we cannot pass through to our customers.  These factors could have a material adverse effect on our business, financial condition and results of operations.

 

·                  Controlling expenses.  Another important aspect of our business is our ability to control costs, especially in our BSG business segment, by right-sizing the business and maximizing the efficiency of our structure. During late fiscal year 2007, we began implementing an approximately $22.0 million capital spending program to consolidate warehouses and reduce administrative expenses related to BSG’s distribution network optimization program. We believe that cost savings from this program could range between $5 million and $7 million in fiscal year 2009 and annualized savings of $10 million beginning in fiscal year 2010.  In addition, during the fiscal 2009 first quarter we implemented a temporary hiring freeze for all

 

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personnel, deferred merit increases for upper management and instituted variable expense reductions related to benefits and payroll related costs.  Please see “Risk Factors — We are not certain that our ongoing cost control plans will continue to be successful” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

 

·                  Opening New Stores.  Our future growth strategy depends in part on our ability to open and profitably operate new stores in existing and additional geographic areas. The capital requirements to open a U.S. based Sally Beauty Supply or BSG store, excluding inventory, average approximately $70,000 and $80,000, respectively. However, in response to economic conditions and to allow flexibility to capitalize on potential real estate revaluations in key locations, we have slowed our new store openings. We may not be able to open all of the new stores we plan to open and any new stores we open may not be profitable, any of which could have a material adverse impact on our financial condition or results of operations. Please see “Risk Factors — If we are unable to profitably open and operate new stores, our business, financial condition and results of operations may be adversely affected” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

 

·                  Changes to our information technology systems.  As our operations grow in both size and scope, we will continuously need to improve and upgrade our information systems and infrastructure while maintaining the reliability and integrity of our systems and infrastructure.  The expansion of our systems and infrastructure will require us to commit substantial financial, operational and technical resources in advance of any increase in the volume of our business, with no assurance that the volume of business will increase.  For example, in fiscal year 2008 we upgraded our Lawson financial reporting system and, in fiscal year 2009, are upgrading our distribution information systems (in connection with our capital spending program to consolidate warehouses, as discussed above), are upgrading our AS400 iSeries servers and are planning to install Hyperion software to enhance our financial reporting system. These and any other required upgrades to our information systems and information technology (or new technology), now or in the future, will require that our management and resources be diverted from our core business to assist in completion of these projects. There can be no assurance that the time and resources our management will need to devote to these upgrades, service outages or delays due to the installation of any new or upgraded technology (and customer issues therewith), or the impact on the reliability of our data from any new or upgraded technology will not have a material adverse effect on our financial reporting, business, financial condition or results of operations.  Please see “Risk Factors — We may be adversely affected by any disruption in our information technology systems” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

 

·                  Relationships with suppliers.  We do not manufacture the brand name or exclusive-label products we sell, and instead purchase our products from manufacturers. We depend upon a limited number of manufacturers for a significant percentage of the products we sell, and our relationships with these suppliers change often.  Please see “Relationships with Suppliers.”

 

Relationships with Suppliers
 

Most of our net sales are generated through retail stores with respect to the Sally Beauty Supply business, and both professional only stores and professional distribution sales consultants with respect to the BSG business. In addition, BSG has a number of franchisees located primarily in the south and southwestern portions of the U.S. and in Mexico, which buy products directly from BSG for resale in their assigned territories. A very small percentage of sales are generated through franchisees or sub-distributors (primarily in Europe), which also buy products directly from Sally Beauty Supply or BSG for resale. Sally Beauty Supply/BSG and their suppliers are dependent on each other for the distribution of beauty products. As is typical in distribution businesses, these relationships are subject to change from time to time (including the expansion or loss of distribution rights in various geographies and the addition or loss of product lines).

 

Since we purchase products from many manufacturers on an at-will basis, under contracts which can generally be terminated without cause upon 90 days’ notice or less or which expire without express rights of renewal, such manufacturers could discontinue sales to us at any time or upon the expiration of the distribution period. Some of our contracts with manufacturers may be terminated by such manufacturers if we fail to meet specified minimum purchase requirements. In such cases, we do not have contractual assurances of continued supply, pricing or access to new products and vendors may change the terms upon which they sell. Infrequently, a supplier will seek to terminate a distribution relationship through legal action.

 

Changes in our relationships with suppliers occur often and could positively or negatively impact our net sales and operating profits. For example, during the second quarter of fiscal year 2007, Farouk Systems, Inc., or Farouk

 

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Systems, terminated its distribution agreement with us. Subsequently, effective July 2007, BSG stores and professional distributor sales consultants were once again given approval to distribute Farouk Systems products with an expanded distribution area. In the first quarter of fiscal 2009, Farouk Systems again terminated its distribution agreement with BSG. The agreement through which our Armstrong McCall franchisees are supplied is currently unaffected by this event. In December 2006, we announced the loss of certain L’Oreal distribution rights, including (among other things) distribution rights through our BSG distributor sales consultants and the loss of exclusive rights to distribute L’Oreal products in our BSG stores.  As discussed above, L’Oreal has entered into direct competition with BSG and there can be no assurance that there will not be further revenue losses over time at BSG due to potential losses of additional L’Oreal related products as well as from the increased competition from L’Oreal-affiliated distribution networks. BSG has entered into long-term agreements with L’Oreal under which, as of January 1, 2007, BSG had non-exclusive rights to distribute the same L’Oreal professional products in its stores that it previously had exclusive rights to distribute in its stores and through its sales consultants. Armstrong McCall retained its exclusive rights to distribute L’Oreal’s Matrix professional products in its territories. Although we have focused on developing new revenue and cost management initiatives to mitigate the negative effects resulting from unfavorable changes in our supplier relationships, there can be no assurance that our efforts will continue to completely offset the loss of these or other distribution rights. Please see “Risk Factors We depend upon manufacturers who may be unable to provide products of adequate quality or who may be unwilling to continue to supply products to us” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

 

We expect to continue to expand our product line offerings and to gain additional distribution rights over time through either further negotiation with suppliers or by strategic acquisitions of existing distributors.  Although we are focused on developing new revenue and cost management initiatives, there can be no assurance that our efforts will partially or completely offset any potential loss of distribution rights in the future. Please see “Risk Factors—We depend upon manufacturers who may be unable to provide products of adequate quality or who may be unwilling to continue to supply products to us” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

 

Our Separation from Alberto-Culver

 

In November 2006, pursuant to an investment agreement among Alberto-Culver and certain of its subsidiaries, including Sally Holdings, and CDRS Acquisition LLC (“CDRS”), Alberto-Culver separated its consumer products business and its Sally Beauty Supply/BSG distribution business into two separate, publicly-traded companies.  Sally Holdings was a wholly-owned subsidiary of Alberto-Culver until the Separation Transactions, when it was converted to a Delaware limited liability company, was renamed Sally Holdings LLC and became an indirect wholly-owned subsidiary of Sally Beauty.  Sally Beauty was formed in June 2006 and became the accounting successor company to Sally Holdings upon the completion of the Separation Transactions.  See the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008 for more information about the Separation Transactions.

 

Other Significant Items

 

Interest Rate Swap Agreements

 

The Company is exposed to a wide variety of risks, including risks arising from changing economic conditions. The Company manages its exposure to certain economic risks (including liquidity, credit risk and changes in interest rates) primarily (a) by closely managing its cash flows from operating and investing activities and the amounts and sources of its debt obligations; (b) by assessing periodically the creditworthiness of its business partners; and (c) through Sally Holdings, by the use of interest rate swaps.  The Company uses interest rate swaps as part of its overall economic risk management strategy to add stability to the interest payments due in connection with its term loan obligations. Interest payments related to the term loans are impacted by changes in LIBOR. Interest rate swap agreements involve the periodic receipt by the Company of amounts based on a variable rate in exchange for the Company making payments based on a fixed rate over the term of the agreements without exchange of the underlying notional amount. At March 31, 2009, the Company did not purchase or hold any other derivative instruments or hold any derivative instruments for trading or speculative purposes.

 

The counterparties are deemed to be of substantial resources and strong creditworthiness. However, these transactions result in exposure to credit risks in the event of default by a counterparty. The current financial crisis affecting the banking systems and financial markets has resulted in many well-known financial institutions becoming less creditworthy or having diminished liquidity, which could expose us to an increased level of counterparty risk.  In the event that a counterparty defaults in its obligation under our interest rate swaps, we could

 

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incur substantial financial loss. At March 31, 2009, the aggregate fair value of all our interest rate swaps was a net liability of $27.0 million.

 

Effective in November 2006, Sally Holdings entered into four interest rate swap agreements with an aggregate notional amount of $500 million. Interest rate swap agreements with an aggregate notional amount of $150 million expired in November 2008 and interest rate swap agreements with a notional amount of $350 million expire in November 2009. These interest rate swap agreements do not currently qualify as hedges and, therefore, the change in fair value of these interest rate swap agreements is recorded in net interest expense in our consolidated statements of earnings.

 

Additionally, effective in May 2008, Sally Holdings entered into two interest rate swap agreements with an aggregate notional amount of $300 million. These interest rate swap agreements are designated as effective hedges, consistent with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities.  Adjustments to reflect the change in the fair values of these interest rate swap agreements are recorded in accumulated other comprehensive (loss) income until the hedged obligation is settled or the swap agreements expire, whichever is earlier.  Any ineffectiveness is recognized in net interest expense in our consolidated statements of earnings. Please see “Item 3—Quantitative and Qualitative Disclosures about Market Risk—Interest rate risk” and Note 14 of the “Notes to Consolidated Financial Statements” in Item 8 - “Financial Statements and Supplementary Data” contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

 

Results of Operations

 

The following table shows the condensed results of operations of our business for the three and six months ended March 31, 2009 and 2008 (in thousands):

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net sales

 

$

641,511

 

$

643,346

 

$

1,287,087

 

$

1,299,133

 

Cost of products sold and distribution expenses

 

339,399

 

344,922

 

681,431

 

694,540

 

Gross profit

 

302,112

 

298,424

 

605,656

 

604,593

 

Total other operating costs and expenses

 

229,891

 

232,911

 

467,166

 

469,204

 

Operating earnings

 

72,221

 

65,513

 

138,490

 

135,389

 

Interest expense, net

 

31,969

 

47,642

 

71,642

 

94,125

 

Earnings before provision for income taxes

 

40,252

 

17,871

 

66,848

 

41,264

 

Provision for income taxes

 

15,657

 

5,475

 

26,194

 

14,525

 

Net earnings

 

$

24,595

 

$

12,396

 

$

40,654

 

$

26,739

 

 

The following table shows the condensed results of operations of our business for the three and six months ended March 31, 2009 and 2008, expressed as a percentage of net sales for each respective period shown:

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of products sold and distribution expenses

 

52.9

%

53.6

%

52.9

%

53.5

%

Gross profit

 

47.1

%

46.4

%

47.1

%

46.5

%

Total other operating costs and expenses

 

35.8

%

36.2

%

36.3

%

36.1

%

Operating earnings

 

11.3

%

10.2

%

10.8

%

10.4

%

Interest expense, net

 

5.0

%

7.4

%

5.6

%

7.2

%

Earnings before provision for income taxes

 

6.3

%

2.8

%

5.2

%

3.2

%

Provision for income taxes

 

2.5

%

0.9

%

2.0

%

1.1

%

Net earnings

 

3.8

%

1.9

%

3.2

%

2.1

%

 

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Key Operating Metrics

 

The following table sets forth, for the periods indicated, information concerning key measures we rely on to gauge our operating performance (dollars in thousands):

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2009

 

2008(a)

 

2009

 

2008(a)

 

Net sales:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

$

412,338

 

$

406,065

 

$

822,875

 

$

815,629

 

BSG

 

229,173

 

237,281

 

464,212

 

483,504

 

Total

 

$

641,511

 

$

643,346

 

$

1,287,087

 

$

1,299,133

 

Gross Profit

 

$

302,112

 

$

298,424

 

$

605,656

 

$

604,593

 

Gross profit margin

 

47.1

%

46.4

%

47.1

%

46.5

%

Selling, general and administrative expenses

 

$

218,420

 

$

221,090

 

$

443,948

 

$

445,631

 

Depreciation and amortization

 

$

11,471

 

$

11,821

 

$

23,218

 

$

23,573

 

Earnings before provision for income taxes:

 

 

 

 

 

 

 

 

 

Segment operating profit:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

$

70,379

 

$

67,911

 

$

135,665

 

$

139,644

 

BSG

 

20,359

 

17,942

 

40,595

 

38,972

 

Segment operating profit

 

90,738

 

85,853

 

176,260

 

178,616

 

Unallocated expenses

 

(16,933

)

(18,722

)

(32,575

)

(36,017

)

Share-based compensation expense

 

(1,584

)

(1,618

)

(5,195

)

(7,210

)

Operating earnings

 

72,221

 

65,513

 

138,490

 

135,389

 

Interest expense, net of interest income

 

(31,969

)

(47,642

)

(71,642

)

(94,125

)

Earnings before provision for income taxes

 

$

40,252

 

$

17,871

 

$

66,848

 

$

41,264

 

Segment operating profit margin:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

17.1

%

16.7

%

16.5

%

17.1

%

BSG

 

8.9

%

7.6

%

8.7

%

8.1

%

Consolidated operating profit margin

 

11.3

%

10.2

%

10.8

%

10.4

%

Number of stores at end-of-period (including franchises):

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

 

 

 

 

2,873

 

2,739

 

BSG

 

 

 

 

 

934

 

905

 

 

 

 

 

 

 

3,807

 

3,644

 

Same store sales growth (b)

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

2.0

%

1.4

%

0.9

%

0.9

%

BSG

 

2.3

%

6.9

%

1.5

%

7.2

%

Consolidated

 

2.1

%

2.8

%

1.1

%

2.4

%

 


(a)

 

Certain amounts for prior fiscal year may have been reclassified to conform to the current year’s presentation.

(b)

 

Same stores are defined as company-operated stores that have been open for at least 14 months as of the last day of a month. Our internet site has generated sales for at least 14 months and, accordingly, internet-based sales are included in same store sales for each of the periods ended March 31, 2009.

 

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The Three Months Ended March 31, 2009 compared to the Three Months Ended March 31, 2008

 

The table below presents net sales, gross profit and gross profit margin data for each reportable segment (dollars in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2009

 

2008

 

Increase (Decrease)

 

Net sales:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

$

412,338

 

$

406,065

 

$

6,273

 

1.5

%

BSG

 

229,173

 

237,281

 

(8,108

)

(3.4

)%

Consolidated net sales

 

$

641,511

 

$

643,346

 

$

(1,835

)

(0.3

)%

 

 

 

 

 

 

 

 

 

 

Gross profit:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

$

214,765

 

$

207,337

 

$

7,428

 

3.6

%

BSG

 

87,347

 

91,087

 

(3,740

)

(4.1

)%

Consolidated gross profit

 

$

302,112

 

$

298,424

 

$

3,688

 

1.2

%

 

 

 

 

 

 

 

 

 

 

Gross profit margin:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

52.1

%

51.1

%

1.0

%

 

 

BSG

 

38.1

%

38.4

%

(0.3

)%

 

 

Consolidated gross profit margin

 

47.1

%

46.4

%

0.7

%

 

 

 

Net Sales

 

Consolidated net sales decreased by $1.8 million, or 0.3%, for the three months ended March 31, 2009, compared to the three months ended March 31, 2008. Company-operated stores that have been open for at least 14 months contributed an increase of approximately $15.8 million, or 2.5%, and sales through certain non-store sales channels contributed an increase of approximately $3.2 million, or 0.5%, to consolidated sales. Other sales channels experienced declines compared to the three months ended March 31, 2008. Sales through our BSG franchise-based businesses declined by approximately $3.1 million, or 0.5%; sales through distributor sales consultants declined approximately $7.8 million, or 1.2%; and sales through new stores declined approximately $6.5 million, or 1.0%. Also, incremental sales from businesses acquired in the preceding 12 months contributed $3.5 million, or 0.5%, less to our consolidated net sales for the three months ended March 31, 2009, compared to the three months ended March 31, 2008. Consolidated net sales for the three months ended March 31, 2009, are inclusive of approximately $26.2 million in negative impact from changes in foreign exchange rates.

 

Sally Beauty Supply.  Net sales for Sally Beauty Supply increased by $6.3 million, or 1.5%, for the three months ended March 31, 2009, compared to the three months ended March 31, 2008.  In the Sally Beauty Supply segment, company-operated stores that have been open for at least 14 months contributed an increase of approximately $9.4 million, or 2.3%; our non-store sales channels contributed an increase of approximately $3.2 million, or 0.8%; and sales through new stores declined approximately $2.0 million, or 0.5%. Sales of businesses acquired in the preceding 12 months contributed $4.3 million less to the Sally Beauty Supply segment sales for the three months ended March 31, 2009, compared to the three months ended March 31, 2008. Net sales for Sally Beauty Supply for the three months ended March 31, 2009, are inclusive of approximately $19.3 million in negative impact from changes in foreign exchange rates.

 

Beauty Systems Group.  Net sales for BSG decreased by $8.1 million, or 3.4%, for the three months ended March 31, 2009, compared to the three months ended March 31, 2008. While company-operated stores that have been open for at least 14 months contributed an increase of approximately $6.4 million, or 2.7%, to net sales and incremental sales from businesses acquired in the preceding 12 months contributed $0.8 million, other sales channels experienced declines compared to the three months ended March 31, 2008. Sales through our franchise-based

 

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businesses declined by approximately $3.1 million, or 1.3%; sales through distributor sales consultants declined approximately $7.8 million, or 3.3%; and sales through new stores declined approximately $4.5 million, or 1.9%. Net sales for BSG for the three months ended March 31, 2009 are inclusive of approximately $6.9 million in negative impact from changes in foreign exchange rates.

 

Gross Profit

 

Consolidated gross profit increased by $3.7 million, or 1.2%, for the three months ended March 31, 2009, compared to the three months ended March 31, 2008, principally due to higher sales volume and improved gross margins for the Sally Beauty Supply segment. This increase was partially offset by lower sales volume and lower gross margins for the BSG segment, as more fully described below.

 

Sally Beauty Supply. Sally Beauty Supply’s gross profit increased by $7.4 million, or 3.6%, for the three months ended March 31, 2009, compared to the three months ended March 31, 2008, principally as a result of increased unit sales volume and improved margins.  Sally Beauty Supply’s gross profit as a percentage of net sales increased to 52.1% for the three months ended March 31, 2009, compared to 51.1% for the three months ended March 31, 2008. This increase was the result of recent marketing efforts, low-cost sourcing initiatives and a shift in product mix (including an increase in sales of exclusive-label products and other higher-margin products).

 

Beauty Systems Group.  BSG’s gross profit decreased by $3.7 million, or 4.1%, for the three months ended March 31, 2009, compared to the three months ended March 31, 2008, principally as a result of lower sales volume and slightly lower margins.  BSG’s gross profit as a percentage of net sales decreased to 38.1% for the three months ended March 31, 2009, compared to 38.4% for the three months ended March 31, 2008. The decrease in gross profit margins reflects unfavorable foreign currency transactions and an unfavorable change in sales mix in BSG’s franchise business.

 

Selling, General and Administrative Expenses

 

Consolidated selling, general and administrative expenses decreased by $2.7 million, or 1.2%, to $218.4 million for the three months ended March 31, 2009, compared to $221.1 million for the three months ended March 31, 2008.   Selling, general and administrative expenses, as a percentage of net sales, were 34.0% for the three months ended March 31, 2009, compared to 34.4% for the three months ended March 31, 2008. This decrease was attributable to lower sales commissions of $1.3 million and lower unallocated corporate expenses of $1.8 million as a result of cost control measures, partially offset by higher advertising expenses in the Sally Beauty Supply segment of $1.2 million. Selling, general and administrative expense for the three months ended March 31, 2008 included approximately $0.9 million for BSG retention incentives for distributor sales consultants (resulting from the L’Oreal contractual changes reported during fiscal year 2007) and warehouse optimization expenses of approximately $1.3 million, with no similar expenses in the three months ended March 31, 2009.

 

Depreciation and Amortization

 

Consolidated depreciation and amortization decreased to $11.5 million for three months ended March 31, 2009, compared to $11.8 million for the three months ended March 31, 2008, due to a favorable impact from changes in foreign exchange rates, partially offset by the expenses associated with businesses acquired in the last twelve months and depreciation related to capital expenditures mainly in connection with store openings in both operating segments.

 

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Operating Earnings

 

The following table sets forth, for the periods indicated, information concerning our operating earnings for each reportable segment (dollars in thousands):

 

 

 

Three Months Ended March 31,

 

 

 

2009

 

2008

 

Increase (Decrease)

 

Operating Earnings:

 

 

 

 

 

 

 

 

 

Segment operating profit:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

$

70,379

 

$

67,911

 

$

2,468

 

3.6

%

BSG

 

20,359

 

17,942

 

2,417

 

13.5

%

Segment operating profit

 

90,738

 

85,853

 

4,885

 

5.7

%

Unallocated expenses

 

(16,933

)

(18,722

)

(1,789

)

(9.6

)%

Share-based compensation expense

 

(1,584

)

(1,618

)

(34

)

(2.1

)%

Operating earnings

 

$

72,221

 

$

65,513

 

$

6,708

 

10.2

%

 

Consolidated operating earnings increased by $6.7 million, or 10.2%, to $72.2 million for three months ended March 31, 2009, compared to $65.5 million for the three months ended March 31, 2008. Operating earnings, as a percentage of net sales, were 11.3% for the three months ended March 31, 2009, compared to 10.2% for the three months ended March 31, 2008. The increase in consolidated operating earnings was due primarily to an increase in the operating profits of both segments, as discussed below.

 

Sally Beauty Supply.  Sally Beauty Supply’s segment operating earnings increased by $2.5 million, or 3.6%, to $70.4 million for three months ended March 31, 2009, compared to $67.9 million for the three months ended March 31, 2008.  The increase in Sally Beauty Supply’s segment operating earnings was primarily a result of increased same store sales volume and improved gross margins, partially offset by higher advertising costs of approximately $1.2 million and incremental costs related to approximately 131 additional company-operated stores operating during the three months ended March 31, 2009.  Segment operating earnings, as a percentage of net sales, were 17.1% for the three months ended March 31, 2009, compared to 16.7% for the three months ended March 31, 2008. The increase in Sally Beauty Supply’s operating earnings as a percentage of segment net sales was primarily a result of gross margin improvements, partially offset by an increase in advertising costs as a percentage of segment sales and continued softer sales in some of the segment’s international operations.

 

Beauty Systems Group.  BSG’s segment operating earnings increased by $2.4 million, or 13.5%, to $20.4 million for the three months ended March 31, 2009, compared to $17.9 million for the three months ended March 31, 2008. Segment operating earnings, as a percentage of net sales, increased to 8.9% for the three months ended March 31, 2009, compared to 7.6% for the three months ended March 31, 2008. This increase was due to lower segment selling and administrative costs, partially offset by the decline in segment sales and gross profit, as discussed above.

 

Unallocated expenses. Unallocated expenses, which represent corporate costs (such as payroll, employee benefits and travel expenses for corporate staff, certain professional fees and corporate governance expenses) that have not been charged to our operating segments decreased by $1.8 million, or 9.6%, to $16.9 million for the three months ended March 31, 2009, compared to $18.7 million for the three months ended March 31, 2008. This decrease was due primarily to lower corporate expenses resulting from cost-saving initiatives as well as to lower currency translation losses resulting from intercompany notes not permanently invested.

 

Share-based Compensation Expense. Total compensation cost charged against income for share-based compensation arrangements was $1.6 million for the three months ended March 31, 2009 and 2008.

 

Net Interest Expense

 

Interest expense, net of interest income of $0.1 million, was $32.0 million for the three months ended March 31, 2009, compared to $47.6 million, net of interest income of $0.2 million, for the three months ended March 31, 2008.  The decrease in interest expense was primarily attributable to a $10.8 million change in the fair value of certain interest rate swaps (please see Note 8 of the Condensed Notes to Consolidated Financial Statements) and to lower prevailing interest rates on our ABL and senior term loan facilities and lower outstanding principal balances on our senior term loans, partially offset by higher outstanding borrowings under our ABL facility as discussed in “Liquidity and Capital Resources” below.

 

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Table of Contents

 

Provision for Income Taxes

 

Provision for income taxes was $15.7 million during the three months ended March 31, 2009, compared to $5.5 million for the three months ended March 31, 2008.  Income taxes for the interim periods ended March 31, 2009 and March 31, 2008 have been included in the accompanying financial statements on the basis of an estimated annual effective rate.  The estimated annual effective tax rate (excluding discrete items) is 37.9% for fiscal year 2009, compared to 35.5% for fiscal year 2008.  The increase in the estimated annual effective tax rate primarily relates to a reduction in earnings in low tax jurisdictions and a reduction in favorable permanent items triggered by lower foreign earnings.

 

For the three months ended March 31, 2009, the actual tax rate exceeds the estimated annual effective tax rate because of losses recorded in the three months ended March 31, 2009 for entities for which a valuation allowance is required.

 

Net Earnings

 

As a result of the foregoing, consolidated net earnings increased by $12.2 million, or 98.4%, to $24.6 million for the three months ended March 31, 2009, compared to $12.4 million for the three months ended March 31, 2008. Net earnings, as a percentage of net sales, were 3.8% for the three months ended March 31, 2009, compared to 1.9% for the three months ended March 31, 2008.

 

The Six Months Ended March 31, 2009 compared to the Six Months Ended March 31, 2008

 

The table below presents net sales, gross profit and gross profit margin data for each reportable segment (dollars in thousands).

 

 

 

Six Months Ended March 31,

 

 

 

2009

 

2008

 

Increase (Decrease)

 

Net sales:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

$

822,875

 

$

815,629

 

$

7,246

 

0.9

%

BSG

 

464,212

 

483,504

 

(19,292

)

(4.0

)%

Consolidated net sales

 

$

1,287,087

 

$

1,299,133

 

$

(12,046

)

(0.9

)%

 

 

 

 

 

 

 

 

 

 

Gross profit:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

$

427,693

 

$

418,876

 

$

8,817

 

2.1

%

BSG

 

177,963

 

185,717

 

(7,754

)

(4.2

)%

Consolidated gross profit

 

$

605,656

 

$

604,593

 

$

1,063

 

0.2

%

 

 

 

 

 

 

 

 

 

 

Gross profit margin:

 

 

 

 

 

 

 

 

 

Sally Beauty Supply

 

52.0

%

51.4

%

0.6

%

 

 

BSG

 

38.3

%

38.4

%

(0.1

)%

 

 

Consolidated gross profit margin