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Item 7. Management’s Discussion and Analysis

2020-11-24 compared with 2019-11-25 · 111 added, 168 removed, 108 unchanged (72% of the section changed)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following section discusses management’s view of the financial condition as of September 30, 2019 and 2018, and the results of operations and cash flows for the three fiscal years in the period ended September 30, 2019, of Sally Beauty.

The following section discusses management’s view of Sally Beauty’s financial condition and results of operations for fiscal year 2020 compared to fiscal year 2019.

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of our Annual Report on Form 10-K for the fiscal year ended September 30, 2019, for a discussion of the financial condition and results of operations for fiscal year 2019 compared to fiscal year 2018.

This section should be read in conjunction with the audited consolidated financial statements of Sally Beauty and the related notes included elsewhere in this Annual Report.

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Highlights of the Fiscal Year Ended September 30, 2020:

Consolidated net sales for the fiscal year ended September 30, 2019, decreased $56.2 million, or 1.4%, to $3,876.4 million, compared to the prior fiscal year.

Consolidated net sales for the fiscal year ended September 30, 2019, include a negative impact from changes in foreign currency exchange rates of $31.9 million, or 0.8% of consolidated net sales;

Consolidated same store sales increased 0.3% and consolidated e-commerce sales increased by 29.4% compared to the prior fiscal year;

Consolidated gross profit for the fiscal year ended September 30, 2019, decreased by $33.9 million, or 1.7%, to $1,910.5 million, compared to the prior fiscal year.

Gross margin decreased 10 basis points to 49.3% for the fiscal year ended September 30, 2019, compared to the prior fiscal year;

Consolidated operating earnings for the fiscal year ended September 30, 2019, increased $31.9 million, or 7.5%, to $458.5 million, compared to the prior fiscal year.

Operating margin increased 100 basis points to 11.8% for the fiscal year ended September 30, 2019, compared to the prior fiscal year;

Consolidated net earnings increased $13.6 million, or 5.3%, to $271.6 million, compared to the prior fiscal year;

Diluted earnings per share for the fiscal year ended September 30, 2019, were $2.26 compared to $2.08 for the prior fiscal year;

Cash provided by operations was $320.4 million for the fiscal year ended September 30, 2019, compared to $372.7 million for the prior fiscal year;

During the year, we strategically paid down an additional $115.0 million aggregate principle of our term loan B and repurchased approximately $64.8 million aggregate principal amount of our 2023 and 2025 senior notes;

We repurchased and retired approximately 3.6 million shares of our common stock under the 2017 Share Repurchase Program at an aggregate cost of $46.6 million;

In September 2019, we entered into a multi-year agreement with Alliance Data’s card services business to launch a private label credit card for both SBS and BSG to benefit our retail and professional customers.

Business Strategy Update

We continue to make solid progress against our transformation as we play to win by focusing on hair color and hair care, improve our retail fundamentals, advance our digital commerce capabilities and drive cost out of the business.

As part of this effort, we made progress on our supply chain modernization effort, reduced our debt levels, and rolled out new e-commerce tools such as the Sally Beauty Supply app.

During the year, we began rolling out a new point-of-sale system in both SBS and BSG nationwide, which will allow our store associates to better serve our customers.

In February 2019, we announced our supply chain modernization plans to gain efficiencies and cost savings.

During the fiscal year 2019, we have closed select fulfillment centers, including in the U.S.

and within Europe, and identified a location in Texas and signed a lease agreement for a new approximately 500,000 square foot automated

and concentrated distribution center , which we anticipate opening by March 2020 .

Additionally, we identified a location and signed a lease agreement for a new distribution center that will service operations in Ghent, Belgium.

During the fiscal year, our results of operation were severely impacted by COVID-19 as we temporarily shut down virtually all global customer-facing store operations during parts of our second and third fiscal quarters.

Consolidated net sales for the fiscal year decreased $362.1 million, or 9.3%, to $3,514.3 million and included a negative impact from changes in foreign currency exchange rates of $5.6 million, or 0.1% of consolidated net sales;

Consolidated same store sales for the fiscal year decreased 8.1%, while our consolidated e-commerce sales increased by 102.6% compared to the prior fiscal year;

Consolidated gross profit decreased by $194.9 million, or 10.2%, to $1,715.6 million.

Gross margin decreased 50 basis points to 48.8% compared to the prior fiscal year;

Consolidated operating earnings for the fiscal year decreased $199.7 million, or 43.6%, to $258.8 million.

Operating margin decreased 440 basis points to 7.4% compared to the prior fiscal year;

Consolidated net earnings for the fiscal year decreased $158.4 million, or 58.3%, to $113.2 million;

Diluted earnings per share for the fiscal year were $0.99 compared to $2.26 for the prior fiscal year;

Cash provided by operations was $426.9 million for the fiscal year compared to $320.4 million for the prior fiscal year;

In the first half of our fiscal year, we repurchased and retired approximately 4.7 million shares of our common stock at an aggregate cost of $61.4 million;

During the fiscal year, we launched two new private label rewards credit cards branded for SBS and BSG to benefit our retail and professional customer by providing elevated loyalty perks and unique benefits;

Impact of COVID-19 on Our Business and Business Strategy Update

Our results of operations for the fiscal year 2020 were significantly impacted by the effects of COVID-19 as we experienced a rolling shut down of customer-facing operations at all global stores starting in mid-March through mid-April, followed by the rolling restart of store operations from mid-April until the end of June, when almost all stores were re-opened.

Store re-openings were triggered by local regulation;

the adoption of our new COVID-19 related safety protocols involving store cleaning, masks, and gloves;

limiting the number of customers in stores at one time;

in-store social distancing guidelines;

and the recall from furlough of sufficient store staff.

By the end of our third fiscal quarter, we had re-opened substantially all global customer-facing store operations and saw strong consumer and professional demand in our re-opened stores.

However, this demand was below pre-COVID-19 levels as market disruptions, including but not limited to salon closures, customer occupancy restrictions and consumer concerns over safety, persisted due to COVID-19.

The impact of COVID-19 led us to reprioritize our transformation plans to accelerate key digital and supply chain initiatives, and pivot to cash management and expense reduction.

As such, during our third fiscal quarter, we amended our ABL facility to increase the revolving commitment thereunder from $500.0 million to $600.0 million.

Also in our third fiscal quarter, to further strengthen our liquidity, we sold $300.0 million of 8.75% senior secured second-lien notes due 2025 (“Senior Secured Notes”).

During our fourth fiscal quarter, we made significan t progress in the implementation of our new merchandising system and began operations within our new North Texas distribution node.

Additionally, due to the evolving COVID-19 pandemic and the related business uncertainty, we continue to defer non-digital c apital investments and address our short-term cost structure.

The effects of the COVID-19 pandemic and related responses had a material impact on our fiscal year 2020 results of operations, cash flows and financial position.

Furthermore, due to the uncertainty over the duration and severity of the economic and operational impacts of COVID-19, the material adverse impact of the pandemic may continue into our fiscal year 2021 and possibly beyond.

Results of Operations

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Unallocated expenses represent certain corporate costs (such as payroll, share-based compensation, employee benefits and travel expense for corporate staff, certain professional fees and corporate governance expenses) that have not been charged to our segments and are included in selling, general and administrative expenses in our consolidated statements of earnings.

For the fiscal year 2018, unallocated expenses reflect expenses of $7.9 million in connection with the data security incidents.

Restructuring charges relate to the supply chain modernization plan, 2018 Restructuring Plan and the 2017 Restructuring Plan.

Restructuring relates to Project Surge and our Transformation Plan.

See Note 19 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about our restructuring plans.

The Fiscal Year Ended September 30, 2020 compared to the Fiscal Year Ended September 30, 2019

The decrease in net sales for SBS was primarily driven by the following (in thousands):

Foreign currency exchange

Stores outside same store sales

Same store sales

Stores outside same store sales

Foreign currency exchange

Other consists of non-store sales, which include catalog and internet sales of our Sinelco Group subsidiaries.

SBS experienced lower unit volume, including lower customer traffic and the impact of fewer company-operated stores, partially offset by a positive impact from increase in average unit prices, resulting from price increases and a promotional efficiency effort (which reduced promotions that provided ‘free’ units, such as Buy One, Get One offers).

The decrease in SBS net sales was a result of lower unit volume caused primarily by the impact of the temporary closure of all our customer-facing store operations due to the effects of COVID-19 during our second and third fiscal quarters, partially offset by strong demand upon re-opening.

The challenges faced by lower unit volume were partially offset by an increase in average unit prices, resulting from the cancellation of most promotional activity.

The decrease in net sales for BSG was driven by the following (in thousands):

Same store sales

Distributor sales consultants

Foreign currency exchange

Same store sales

Other consists of stores outside same store sales and sales to our franchisees.

BSG experienced a decrease in unit volume, including from the impact of fewer company-operated stores, partially offset by an increase in average unit prices (resulting primarily from the introduction of certain third-party brands with higher average unit prices in the preceding 12 months).

SBS’s gross profit decreased as a result of lower sales, partially offset by a higher gross margin.

The higher gross margin reflects improved gross margins in our U.S.

and Canadian operations, from price increases and promotional efficiency efforts, partially offset by weaker gross margins in our European operations.

BSG’s gross profit decreased as a result of lower sales and a lower gross margin.

The decrease in the gross margin was primarily a result of challenges related to the ongoing merchandising transformation.

Selling, General and Administrative Expenses

Consolidated.

Consolidated selling, general and administrative expenses decreased primarily as a result of lower compensation and compensation-related expenses, lower advertising expenses, no expenses related to the data security incidents and the positive impact from changes in foreign currency exchange rates.

This decrease was partially offset by higher facility expenses and expenses related to our information technology systems.

SBS’s selling, general and administrative expenses decreased $24.0 million, or 2.6% for the fiscal year ended September 30, 2019.

This decrease was primarily as a result of the impact of the 2018 Restructuring Plan, our recently implemented field structure realignment and store labor hour optimization initiatives (net of labor rate inflation), the positive impact from changes in the foreign currency exchange rate of approximately $11.3 million and lower advertising expense of $6.7 million.

This decrease was partially offset by higher facility costs of $2.3 million and the impact of the reduction of an estimated casualty loss related to hurricanes of $2.4 million during fiscal year 2018 .

BSG’s selling, general and administrative expenses decreased $12.8 million, or 3.1% for the fiscal year ended September 30, 2019.

This decrease was primarily as a result of as a result of the impact of the 2018 Restructuring

Plan, lower sales commissions of $3.

5 million, lower advertising expenses of $2.

9 million and a positive impact from changes in foreign currency exchange rate of approximately $1.

Unallocated selling, general and administrative expenses increased $5.3 million, or 3.7%, for the fiscal year ended September 30, 2019.

This increase is primarily a result of higher expenses related to our information technology systems and no comparable positive adjustments related to our actuarially determined insurance liabilities in the current year compared to $6.9 million in the prior year.

These increases were partially offset by no expenses related to the data security incidents compared to $7.9 million in the prior year.

Restructuring

For the fiscal year ended September 30, 2019, we recognized a $8.4 million gain resulting from the sale of our secondary headquarters and fulfillment center in Denton, Texas, and our Marinette, Wisconsin, fulfillment center in connection with the supply chain modernization plan, partially offset by charges of $7.7 million in connection with our supply chain modernization plan and the 2018 Restructuring Plan.

For the fiscal year ended September 30, 2018, we incurred restructuring charges of approximately $33.6 million in connection with the 2018 Restructuring Plan.

See Note 18 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about our restructuring plans.

Interest Expense

Interest expense decreased as a result of fewer borrowings under the ABL facility during the current fiscal year and lower outstanding principal balances on our senior notes and term loan B.

This decrease was partially offset by a higher interest rate on our term loan B variable tranche.

Provision for Income Taxes

For the fiscal year ended September 30, 2019 and 2018, our effective tax rate was 25.0% and 21.4%, respectively.

The increase in the effective tax rate was due primarily to the impact of U.S.

Tax Reform in the prior year, partially offset by a decrease in our federal statutory tax rate this year to 21.0% compared to 24.5% in the prior year.

See Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about the impact of the U.S.

Tax Reform on our consolidated financial statements.

The Fiscal Year Ended September 30, 2018 compared to the Fiscal Year Ended September 30, 2017

The decrease in net sales for SBS was primarily driven by a decrease in same store sales of approximately $23.7 million and lower net sales from new company-operated stores of approximately $17.9 million, partially offset by the positive impact from changes in foreign currency exchange rates of approximately $30.1 million.

SBS experienced lower unit volume, including lower customer traffic, partially offset by a positive impact from an increase in average unit prices, resulting primarily from select price increases in certain geographical areas of the U.S.

and a change in product mix (to higher-priced products) resulting from shifts in customer preferences.

The increase in net sales for BSG was driven by the impact of the Chalut acquisition, net of the impact of Peerless sales in the prior year now included in same store sales, of approximately $10.1 million, the positive impact from changes in foreign currency exchange rates of approximately $3.0 million and higher net sales from other sales channels of approximately $7.2 million, partially offset by decreases in sales by our DSCs of approximately $11.1 million and same store sales of approximately $3.8 million.

Net sales from other sales channels include sales from new company-operated stores, sales to our franchisees and sales by our DSCs.

BSG experienced an increase in average unit prices (resulting primarily from the introduction of certain third-party brands with higher average unit prices in the preceding 12 months), partially offset by a decrease in unit volume (notwithstanding the impact of incremental sales from 28 company-operated stores opened or acquired during the last 12 months).

In addition, we were impacted by vendor supply chain issues that negatively affected BSG’s net sales by approximately $13 million.

The decrease in BSG net sales was a result of lower unit volume primarily as a result of the temporary closure of all of our customer-facing store operations in the U.S.

and Canada due to the effects of COVID-19 during our second and third fiscal quarters .

The negative impact of the temporary closures were partially offset by an increase in average unit prices resulting primarily from lower promotional activity.

SBS’s gross profit decreased as a result of lower sales and a lower gross margin.

This decrease reflects a change in geographic sales mix, as a result of lower-margin non-U.S.

sales making up a greater portion of total segment sales, and higher coupon redemption, compared to the prior fiscal year.

BSG’s gross profit decreased as a result of a lower gross margin, partially offset by higher sales.

BSG’s gross margin decrease was driven by opportunistic purchases that were not repeated from the prior year and lower vendor allowances.

SBS’s gross margin decreased primarily as a result of aggressive inventory clearance actions in the third quarter and lower vendor allowances, partially offset by the positive impact from fewer promotions and favorable product mix.

BSG’s gross profit decreased as a result of lower sales, partially offset by a higher gross margin.

BSG’s gross margin increased primarily from fewer promotions, partially offset by lower vendor allowances.

Selling, General and Administrative Expenses

Consolidated.

Consolidated selling, general and administrative expenses increased primarily as a result of the negative impact from changes in foreign currency exchange rates, the impact from the Chalut acquisition, higher expenses related to the data security incidents and higher facility expenses.

These increases were partially offset by a reduction of estimated casualty loss and no comparable casualty loss this fiscal year, positive impact from gift card breakage, positive adjustments to actuarially determined insurance liabilities and cost reduction initiatives, related to our restructuring plans.

Consolidated selling, general and administrative expenses, as a percentage of net sales, increased 50 basis points to 37.7% for the fiscal year ended September 30, 2018.

SBS’s selling, general and administrative expenses increased primarily as a result of the negative impact from changes in the foreign currency exchange rate of approximately $13.2 million, higher facility expense of $5.0 million and higher advertising expense of $2.0 million.

These increases were partially offset by the impact of the reduction of prior year’s estimated casualty loss, in connection with natural disasters that occurred in the fourth quarter of our fiscal year 2017, and no comparable casualty losses this fiscal year, in the aggregate, of $6.5 million and by positive impact from gift card breakage of $2.1 million in the current fiscal year.

BSG’s selling, general and administrative expenses increased primarily as a result of the incremental operating expenses associated with Chalut of $8.6 million and higher facility expenses of $3.3 million.

These increases were partially offset by lower commission expense of $3.0 million, advertising expense of $1.5 million and intangible asset amortization expense of $1.3 million, resulting from the impact of intangible assets that became fully amortized in the preceding 12 months.

Unallocated selling, general and administrative expenses increased $4.1 million, or 2.9%, for the fiscal year ended September 30, 2018.

This increase includes expenses related to the previously disclosed data security incidents of $7.9 million and higher professional fees of $1.7 million.

See Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about the data security incidents.

This increase was partially offset by lower compensation and compensation-related expenses of $4.3 million primarily due to the results of the 2018 Restructuring Plan.

In addition, for our actuarially determined insurance liabilities, we recorded net positive adjustments of $6.9 million in fiscal year 2018 as a result of a decrease in our estimated future payments, compared to positive adjustments of $5.7 million in fiscal year 2017.

Restructuring Charges

Restructuring charges increased $10.9 million for the fiscal year ended September 30, 2018.

During the fiscal year ended September 30, 2018, we incurred restructuring charges of approximately $33.6 million in connection with the 2018 Restructuring Plan, including severance and related expenses of approximately $15.6 million, consulting expenses of $10.9 million and other costs of $7.1 million.

During the fiscal year ended September 30, 2017, we incurred restructuring charges of approximately $22.7 million in connection with the 2017 Restructuring Plan, including severance and related expenses of $12.1 million, facility closure expenses of $6.7 million and other expenses of $3.9 million.

SBS’s selling, general and administrative expenses decreased $11.0 million, or 1.2%.

This decrease was driven by lower compensation and compensation-related expense of $51.5 million, primarily as a result of previously announced furloughs related to COVID-19.

This decrease was partially offset by an increase in shipping costs of $34.5 million, resulting primarily from the increase in e-commerce sales volume, and incremental store expense for personal protective equipment.

BSG’s selling, general and administrative expenses decreased $9.8 million, or 2.4%.

This decrease reflects lower compensation and compensation-related expense of $18.2 million, primarily as a result of previously announced furloughs related to COVID-19.

This decrease was partially offset by an increase in shipping costs of $7.9 million, resulting primarily from increased e-commerce volume.

Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, increased $10.8 million, or 7.3%.

This increase was primarily from costs associated with specific expert capability builds in areas like marketing, merchandising, e-commerce and digital product, and costs associated with disaster payments in response to COVID-19, partially offset by lower compensation expenses, as a result of previously announced furloughs related to COVID-19.

Restructuring

For fiscal year 2020, we incurred restructuring charges of $14.0 million in connection with Project Surge and the Transformation Plan.

For fiscal year 2019, restructuring represents gains of $8.4 million in connection with the sale of our secondary headquarters and fulfillment center and our Marinette, Wisconsin fulfillment center, partially offset by expenses incurred in connection with the 2018 Restructuring Plan of $7.7 million.

See Note 19 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about our restructuring plans.

Interest Expense

Interest expense decreased as a result of a loss on extinguishment of debt of $28.0 million in the prior fiscal year, compared to $0.9 million in the current fiscal year.

These losses were the result of our redemption of certain senior notes in July 2017 with the proceeds from the term loan B with lower interest rates in the prior fiscal year and from the repricing of the variable-rate tranche of the term loan B in the current fiscal year.

The lower interest rate on the

term loan B reduced interest expense by $8.8 million.

The decrease was offset in part by incremental interest expense of $1.3 million in connection with borrowings under the ABL facility.

Interest expense was slightly higher as a result of a higher average outstanding balance on our ABL during the second-half of fiscal year 2020 and the incremental interest expense from the issuance of our Senior Secured Notes, partially offset by a lower outstanding principal balances on our term loan B and a lower average interest rate on our term loan B variable tranche.

Provision for Income Taxes

The provision for income taxes was $70.4 million and $130.6 million, resulting in an effective tax rate of 21.4% and 37.8%, for the fiscal year ended September 30, 2018 and 2017, respectively.

The decrease in the effective tax rate was due primarily to the impact of the U.S.

More specifically, we recognized a provisional income tax benefit of $37.7 million in connection with the revaluation of our deferred income tax assets and liabilities, including a benefit related to the adoption of income tax method changes of $2.7 million, and a provisional income tax charge of $11.7 million for federal and state income taxes applicable to accumulated but undistributed earnings of our foreign operations.

See Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about the impact of the U.S.

Tax Reform on our consolidated financial statements.

For fiscal year 2020 and 2019, our effective tax rate was 29.2% and 25.0%, respectively.

The increase in the effective tax rate was primarily driven by the establishment of a valuation allowance in a foreign subsidiary and increased foreign losses, as compared to the prior period, which cannot be tax benefitted.

Our effective tax rate may fluctuate on a quarterly and/or annual basis due to various factors, including but not limited to, total earnings and the mix of earnings by jurisdiction, new tax laws, as well as changes in valuation allowances and uncertain tax positions.

Liquidity and Capital Resources

We are highly leveraged and a substantial portion of our liquidity needs will arise from debt service on our outstanding indebtedness and from funding the costs of operations, working capital, capital expenditures and opportunistic share repurchases.

Working capital (current assets less current liabilities) increased $43.6 million to $707.5 million at September 30, 2019, compared to $663.9 million at September 30, 2018, resulting primarily from the reduction in accounts payable and accrued liabilities and the increase in vendor receivables included in accounts receivable, other.

The ratio of current assets to current liabilities was 2.55 to 1.00 at September 30, 2019, compared to 2.35 to 1.00 at September 30, 2018.

At September 30, 2020, cash and cash equivalents were $514.2 million.

Based upon the current level of operations and anticipated growth, we anticipate that existing cash balances (excluding certain amounts permanently invested in connection with foreign operations), funds expected to be generated by operations and funds available under the ABL facility will be sufficient to meet our working capital requirements, potential acquisitions, finance anticipated capital expenditures, including information technology upgrades and store remodels, debt repayment and opportunistic share repurchases over the next 12 months.

For the foreseeable future, we will prioritize needed investments in our business that we believe will deliver value for shareholders, and will consider measured debt repayment within our ratings guidance as well as opportunistic share repurchases.

Based upon the current level of operations and anticipated growth, we anticipate that existing cash balances (excluding certain amounts permanently invested in connection with foreign operations), funds expected to be generated by operations and funds available under the ABL facility will be sufficient to fund working capital requirements, potential acquisitions, finance anticipated capital expenditures, including information technology upgrades and store remodels and debt repayments over the next 12 months.

Due to the impact of COVID-19, we have shifted our focus to being proactive in maintaining our financial flexibility.

Working capital (current assets less current liabilities) increased $162.2 million to $869.7 million at September 30, 2020, compared to $707.5 million at September 30, 2019, resulting primarily from the increase in our cash and cash equivalents, partially offset by the reduction in our inventory, as a result of the impact of COVID-19 and aggressive inventory clearance actions during the year, and the impact of the adoption of the new lease standard.

The ratio of current assets to current liabilities was 2.54 to 1.00 at September 30, 2020, compared to 2.55 to 1.00 at September 30, 2019.

We utilize our ABL facility for the issuance of letters of credit, for certain working capital and liquidity needs and to manage normal fluctuations in our operational cash flow.

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The amounts drawn are generally paid down with cash provided by our operating activities.

As of September 30, 2019, 2018, Sally Holdings had $482.0 million available for borrowings under the ABL facility, subject to borrowing base limitations, as reduced by $18.0 million in outstanding letters of credit.

As of September 30, 2020, Sally Holdings had $435.0 million available for borrowings under the ABL facility, subject to borrowing base limitations and outstanding letters of credit of $18.6 million.

Share Repurchase Programs

During the fiscal years ended September 30, 2019, 2018 and 2017, we repurchased and subsequently retired approximately 3.6 million shares, 10.0 million shares and 16.1 million shares, respectively, of our common stock under the 2017 Share Repurchase Program or the 2014 Share Repurchase Program at a cost of $46.6 million, $165.9 million and $346.1 million, respectively.

During the fiscal years 2020, 2019 and 2018, we repurchased and subsequently retired approximately 4.7 million shares, 3.6 million shares and 10.0 million shares, respectively, of our common stock under the 2017 Share Repurchase Program or the 2014 Share Repurchase Program at a cost of $61.4 million, $46.6 million and $165.9 million, respectively.

All the fiscal year 2020 shares repurchases occurred during the first half of the fiscal year.

We funded these share repurchases with cash from operations and borrowings under the ABL facility.

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Net cash used by investing activities

Net cash used by financing activities

Effect of foreign currency exchange rate

changes on cash and cash equivalents

Net increase (decrease) in cash

and cash equivalents

Net cash provided (used) by financing activities

Effect of foreign currency exchange rate changes on cash and cash equivalents

Net increase (decrease) in cash and cash equivalents

Net Cash Provided by Operating Activities

Net cash provided by operating activities decreased for the fiscal year ended September 30, 2019, compared to the fiscal year ended September 30, 2018, primarily due to a focused reduction of accounts payable and the timing of vendor receivables.

Net cash provided by operating activities increased for the fiscal year ended September 30, 2018, compared to the fiscal year ended September 30, 2017, primarily due to favorable cash impact of improved net earnings and accrued liabilities, partially offset by the unfavorable impact by deferred taxes and merchandise purchases.

Net cash provided by operating activities increased for fiscal year 2020, compared to fiscal year 2019, primarily due to a reduction in our inventory balance, driven by fewer inventory purchases due to the impact of COVID-19 and a concerted merchandising effort to rationalize our assortment during the third and fourth quarters.

Additionally, we experienced a reduction in vendor receivables resulting from fewer vendor co-op arrangements due to the impact of COVID-19 and a concerted effort to reduce the collection time.

Net Cash Used by Investing Activities

Net cash used by investing activities increased slightly for the fiscal year ended September 30, 2019, compared to the fiscal year ended September 30, 2018, due to an increase in capital expenditures primarily from investments in our information technology systems, partially offset by proceeds received from the sale our secondary headquarters and fulfillment center in Denton, Texas and our fulfillment center in Marinette, Wisconsin, and as a result of not having any significant acquisitions in the current year.

Net cash used by investing activities increased for the fiscal year ended September 30, 2018, compared to the fiscal year ended September 30, 2017, primarily due to the acquisition of Chalut.

Net Cash Used by Financing Activities

Net cash used by financing activities decreased for the fiscal year ended September 30, 2019, compared to the fiscal year ended September 30, 2018, driven by fewer shares repurchased, partially offset by additional debt reduction.

Net cash used by financing activities decreased for the fiscal year ended September 30, 2018, compared to the fiscal year ended September 30, 2017, primarily due to a decrease in share repurchases of $180.2 million.

This decrease was partially offset by lower net debt proceeds, primarily from repayments on the ABL facility and term loan B.

Net cash used by investing activities was higher for fiscal year 2020, compared to fiscal year 2019, primarily due to cash proceeds in the prior year from the sale our secondary headquarters and fulfillment center in Denton, Texas and our fulfillment center in Marinette, Wisconsin, an increase in capital expenditures primarily from investments in our information technology systems and the acquisition of La Maison Ami-Co (1981) Inc.

Net Cash provided (Used) by Financing Activities

We had net cash provided by financing activity for fiscal year 2020, compared to net cash used in fiscal year 2019, primarily as a result of the issuance of our Senior Secured Notes during our third fiscal quarter.

Long-Term Debt

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Capital Requirements

During the fiscal year ended September 30, 2019, we had total capital expenditures of approximately $118.7 million, including amounts incurred but not paid of approximately $26.2 million, primarily in connection with information technology projects and store remodels and maintenance.

During fiscal year ended 2020, we had total capital expenditures of approximately $94.4 million, excluding amounts paid in connection with the prior year, primarily in connection with information technology projects, new store openings, store maintenance and the build out of our new North Texas distribution node.

Contractual Obligations

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Amounts shown do not reflect open purchase orders, mainly for merchandise, to be fulfilled within one year, which are generally cancellable or contracts that tend to be reoccurring in nature and similar in amount year over year.

Other long-term obligations, including current portion, principally represent obligations under insurance and self-insurance programs.

Other long-term obligations, including current portion, principally represent obligations under insurance and self-insurance programs and deferral of social security taxes in connection with the Coronavirus Aid, Relief, and Economic Security Act.

These obligations are included in accrued liabilities and other liabilities, as appropriate, in our consolidated balance sheets.

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Off-Balance Sheet Financing Arrangements

At September 30, 2019, we did not have any off-balance sheet financing arrangements other than obligations under operating leases and letters of credit, as discussed above.

We believe inflation did not have a material effect on our results of operations during each of the three fiscal years in the period ended September 30, 2019.

However, during the past few years, in the U.S., we have experienced an increase in labor and real estate costs (including store rent and other occupancy expenses).

Employee compensation and real estate expenses represent our two most significant operating expense categories.

A material increase in labor and real estate costs in the future, particularly for an extended period of time, could have a material adverse effect on our results of operations.

At September 30, 2020, we did not have any off-balance sheet financing arrangements other than obligations under letters of credit, as discussed above.

Critical Accounting Estimates

The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at each balance sheet date, reported amount of revenues and expenses for each reporting period presented, and related disclosures of contingent liabilities.

Actual results may differ from these estimates.

We believe these estimates and assumptions are reasonable.

We consider accounting policies to be

critical when they require us to make assumptions about matters that are highly uncertain at the time the accounting estimate is made and when different estimates that we reasonably could have used have a material effect on the presentation of our consolidated financial condition, changes in consolidated financial condition or consolidated results of operations.

Our critical accounting estimates relate to the valuation of inventory, vendor rebates and concessions, retention of risk, income taxes, assessment of long-lived assets and intangible assets for impairment and share-based payments.

The preparation of our consolidated financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”) requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosure.

Actual results could differ from the estimates and assumptions used, which could have a material impact to financial statements.

We believe the following are our most critical accounting estimates that require subjective judgement, estimates and assumptions:

Valuation of Inventory

Inventory is stated at the lower of cost, determined using the first-in, first-out (“FIFO”) method, or net realizable value.

In assessing the net realizable value of inventory, we consider several key factors including estimates of the future demand for our products, historical turn-over rates, the age and sales history of the inventory, and historic as well as anticipated changes in SKUs.

When necessary, we adjust the carrying value of inventory for estimated inventory shrinkage and damage.

During fiscal year 2020, we changed how we value our inventory.

See Note 3 of the Notes to Consolidated Financial Statements in Item 8 contained in this Annual Report for more information related to the change in our valuation method.

At September 30, 2020, inventory is stated at the lower of weighted average cost or net realizable value.

At September 30, 2019, inventory was stated at the lower of cost using first-in first-out (“FIFO”) or net realizable value.

In assessing the net realizable value of inventory, we will adjust the carrying value of inventory for estimated shrinkage, damage and obsolescence using consider several key factors including estimates of the future demand for our products, historical turn-over rates, the age and sales history of the inventory, and historic as well as anticipated changes in SKUs.

We estimate inventory shrinkage between physical counts and product damage based upon our historical experience.

Actual results differing from these estimates could significantly affect our inventory and cost of goods sold.

Inventory shrinkage and damage expense, in the aggregate, averaged less than 1.0% of consolidated net sales in fiscal years 2019, 2018 and 2017.

A 10% increase or decrease in our estimate of inventory shrinkage and damage at September 30, 2019, would impact net earnings by approximately $2.2 million.

Actual results differing from these estimates could significantly affect our carrying value of inventory and cost of goods sold.

Inventory shrinkage, in the aggregate, averaged less than 1.0% of consolidated net sales in fiscal years 2020, 2019 and 2018.

A 10% increase or decrease in our estimate of inventory shrinkage and obsolescence reserves at September 30, 2020, would impact net earnings by approximately $1.6 million.

Vendor Rebates and Concessions

We deem cash consideration received from a supplier to be a reduction of the cost of goods sold unless it is in exchange for an asset or service or a reimbursement of a specific, incremental, identifiable cost incurred by us in selling the vendor’s products.

We deem cash consideration received from a vendor to be a reduction of the cost of goods sold unless it is in exchange for an asset or service or a reimbursement of a specific, incremental, identifiable cost incurred by us in selling the vendor’s products.

The majority of cash consideration we receive is considered to be a reduction of inventory and a subsequent reduction in cost of goods sold as the related products are sold.

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These receivables could be significantly affected if the actual amounts subsequently collected differ from our expectations.

A 10% increase or decrease in these receivables at September 30, 2019, would impact net earnings by approximately $3.9 million.

We retain a substantial portion of the risk related to employee health (primarily in the U.S.), workers’ compensation, general and product liability.

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If we prevail in tax matters for which provisions have been established or are required to settle matters in excess of established provisions, our effective tax rate for a particular period could be significantly affected.

Additionally, deferred income taxes are recognized for the future tax consequences attributable to differences between our financial statement carrying amounts of assets and liabilities and their respective tax bases.

Additionally, deferred in come taxes are recognized for the future tax consequences attributable to differences between our financial statement carrying amounts of assets and liabilities and their respective tax bases.

Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are estimated to be recovered or settled.

We believe that it is more-likely-than-not that our results of operations in the future will generate sufficient taxable income to realize our deferred tax assets, net of the valuation allowance currently recorded.

We believe that it is more-likely-than-not that our results of operations in the future will generate sufficient taxable inc ome to realize our deferred tax assets, net of the valuation allowance currently recorded.

We have recorded a valuation allowance to account for uncertainties regarding the recoverability of certain deferred tax assets, primarily foreign loss carryforwards .

In the future, if we determine that certain deferred tax assets will not be realizable, the related adjustments could significantly affect our effective tax rate at that time.

An estimated tax benefit related to an uncertain tax position is recorded in our consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax position will withstand challenge, if any, from applicable taxing authorities.

Assessment of Long-Lived Assets and Intangible Assets for Impairment

Long-lived assets, such as property and equipment, including store equipment, and purchased intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.

The recoverability of long-lived assets and intangible assets subject to amortization is assessed by comparing the net carrying amount of each asset to its total estimated undiscounted future cash flows expected to be generated by the asset.

If the carrying amount of an asset exceeds the sum of its undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset.

Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in a business combination.

G oodwill and intangible assets with indefinite lives are not amortized;

rather, they are reviewed for impairment at least annually, and whenever events or changes in circumstances indicate it is more-likely-than-not that the value of the asset may be impaired.

For the purpose of reviewing goodwill for impairment, we aggregate components of our operating segments with similar economic characteristics into a reporting unit.

When assessing goodwill and intangible assets with indefinite lives for potential impairment, we compare the carrying amount of the asset to its fair value.

In addition, we consider whether the value of an asset has been impaired by evaluating if various factors (including current operating results, anticipated future results and cash flows, and relevant market and economic conditions) indicate a possible impairment.

Based on our assessments and after considering potential triggering events, we recognized impairment losses of $4.4 million in the fiscal year ended September 30, 2017, in connection with our long-lived assets and intangible assets.

An estimated tax benefit related to an uncertain tax position is recorded in o ur consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax position will withstand challenge, if any, from applicable taxing authorities.

Assessment of Long-Lived Assets for Impairment

We review long-lived assets for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be fully recoverable based on estimated undiscounted future cash flows.

Long-lived assets are reviewed at the lowest level of identifiable cash flows, which is at the store level.

In assessing for impairment, we determine the fair value of each individual store by discounting projected future cash flows over the remaining lease term.

There are significant estimates and assumptions used to arrive at estimated future cash flows, including local market conditions and growth rates.

If the carrying amount of the store, which includes the operating lease asset, asset exceeds the sum of its undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the estimated fair value of the store.

Based on our assessments and after considering potential triggering events, including COVID-19, we recognized an impairment loss of $4.1 million in the fiscal year ended September 30, 2020, in connection with our long-lived assets.

No material impairment losses were recognized in fiscal years 2019 or 2018.

Share-Based Payments

The amount of share-based compensation expense related to stock option awards is determined based on the fair value of each stock option award on the date of grant.

The fair value of each stock option is estimated using the Black-Scholes option pricing model.

The amount of expense recognized in connection with stock option awards is significantly affected by our estimates.

The amount of share-based compensation expense related to performance-based restricted stock awards is determined based on the fair value of each award on the date of grant, which is based on the closing market price of our common stock on the date of grant.

In addition, we record periodic expense (which is estimated quarterly) in connection with performance-based awards based on our estimate of the number of awards actually expected to vest.

This requires that we estimate our future performance over the performance period (generally three years) associated with each award.

Actual performance could differ from these estimates and could significantly affect the amount and timing of recognition of our share-based compensation expense related to performance-based awards.

If actual results are not consistent with our estimate or assumptions, we may be exposed to changes in share-based compensation expense that could be material.

A 10% change in our share-based compensation expense for the year ended September 30, 2019 , would affect net earnings by approximately $ 0.7 million.

Assessment of Goodwill and Intangible Assets for Impairment

We review goodwill and intangible assets for impairment annually, or when events or circumstances indicate it is more-likely-than-not that the value of the asset may be impaired.

In assessing these types of assets for impairment, there are significant estimates and assumptions used to determine the fair value, including relevant market and economic conditions, anticipated future revenues and cash flows, royalty rates and discount rates .

Goodwill is tested for impairment by comparing the fair value of each reporting unit to its carrying value.

In determining the fair value of a reporting unit, we use a discounted cash flow model.

If it is determined that the fair value of a reporting unit is less than its carrying value, an impairment charge will be recorded to bring the carrying value down to its fair value.

At March 31, 2020, the date of our annual impairment test, a 10% decrease in either reporting unit’s fair value would not have resulted in an impairment.

Like goodwill, our indefinite-lived intangible assets are tested for impairment by comparing the fair value of each asset to its carrying value.

As of September 30, 2020, our indefinite-lived assets comprised of only tradenames.

To determine the fair value of each tradename, we use the relief-from-royalty method, which estimates what a third-party would be willing to pay in royalties to receive a benefit from the use of the asset.

It if is determined that the asset’s fair value is less than its carrying value, then an impairment charge is recorded to reduce the carrying value down to its fair value.

No impairment losses were recognized in fiscal years 2020, 2019 or 2018.

Recent Accounting Pronouncements

See Note 3 of the Notes to Consolidated Financial Statements in Item 8 — “Financial Statements and Supplementary Data” contained in this Annual Report for information about recent accounting pronouncements.

See Note 3 of the Notes to Consolidated Financial Statements in Item 8 contained in this Annual Report for information about recent accounting pronouncements.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis