Sally Beauty Holdings, Inc. 10-Q

Item 1. Financial Statements. The following condensed consolidated balance sheets as of March 31, 2021, and September 30, 2020, the condensed consolidated statements of earnings, condensed consolidated statements of comprehensive income (loss) and the condensed consolidated statements of stockholders’ equity (deficit) for the three and six months ended March 31, 2021 and 2020, and the condensed consolidated statements of cash flows for the six months ended March 31, 2021 and 2020, are those of Sally Beauty Holdings, Inc. and its subsidiaries. 5 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (In thousands, except par value data) March 31, 2021 September 30, 2020 (Unaudited) Assets Current assets: Cash and cash equivalents $ 408,321 $ 514,151 Trade accounts receivable, net 39,294 35,590 Accounts receivable, other 26,862 20,839 Inventory 949,695 814,503 Other current assets 42,278 48,014 Total current assets 1,466,450 1,433,097 Property and equipment, net of accumulated depreciation of $ 741,083 at March 31, 2021, and $ 694,709 at September 30, 2020 289,070 315,029 Operating lease assets 524,955 525,634 Goodwill 544,630 540,038 Intangible assets, excluding goodwill, net of accumulated amortization of $ 69,511 at March 31, 2021, and $ 63,491 at September 30, 2020 56,909 58,283 Other assets 27,558 23,066 Total assets $ 2,909,572 $ 2,895,147 Liabilities and Stockholders’ Equity Current liabilities: Current maturities of long-term debt $ 197,596 $ 180 Accounts payable 310,215 236,333 Accrued liabilities 195,467 170,665 Current operating lease liabilities 155,711 153,267 Income taxes payable 16,062 2,917 Total current liabilities 875,051 563,362 Long-term debt 1,389,545 1,796,897 Long-term operating lease liabilities 388,733 394,375 Other liabilities 30,113 32,976 Deferred income tax liabilities, net 91,297 92,094 Total liabilities 2,774,739 2,879,704 Stockholders’ equity: Common stock, $ 0.01 par value. Authorized 500,000 shares; 112,949 and 112,824 shares issued and 112,679 and 112,405 shares outstanding at March 31, 2021, and September 30, 2020, respectively 1,127 1,124 Preferred stock, $ 0.01 par value. Authorized 50,000 shares; none issued — — Additional paid-in capital 9,525 1,913 Accumulated earnings 212,612 117,109 Accumulated other comprehensive loss, net of tax ( 88,431 ) ( 104,703 ) Total stockholders’ equity 134,833 15,443 Total liabilities and stockholders’ equity $ 2,909,572 $ 2,895,147 The accompanying notes are an integral part of these condensed consolidated financial statements. 6 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Earnings (In thousands, except per share data) (Unaudited) Three Months Ended Six Months Ended March 31, March 31, 2021 2020 2021 2020 Net sales $ 926,328 $ 871,023 $ 1,862,350 $ 1,851,231 Cost of goods sold 459,099 441,266 924,397 946,626 Gross profit 467,229 429,757 937,953 904,605 Selling, general and administrative expenses 391,087 383,299 757,257 761,228 Restructuring 631 3,193 863 5,725 Operating earnings 75,511 43,265 179,833 137,652 Interest expense 23,883 21,644 49,861 43,185 Earnings before provision for income taxes 51,628 21,621 129,972 94,467 Provision for income taxes 13,316 8,253 34,469 27,884 Net earnings $ 38,312 $ 13,368 $ 95,503 $ 66,583 Earnings per share: Basic $ 0.34 $ 0.12 $ 0.85 $ 0.58 Diluted $ 0.34 $ 0.12 $ 0.84 $ 0.57 Weighted-average shares: Basic 112,603 114,823 112,538 115,478 Diluted 114,342 115,795 114,028 116,462 The accompanying notes are an integral part of these condensed consolidated financial statements. 7 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Comprehensive Income (Loss) (In thousands) (Unaudited) Three Months Ended Six Months Ended March 31, March 31, 2021 2020 2021 2020 Net earnings $ 38,312 $ 13,368 $ 95,503 $ 66,583 Other comprehensive income (loss): Foreign currency translation adjustments ( 7,890 ) ( 23,784 ) 17,117 ( 8,823 ) Interest rate caps, net of tax - ( 80 ) 175 29 Foreign exchange contracts, net of tax 574 2,038 ( 1,020 ) 1,838 Other comprehensive income (loss), net of tax ( 7,316 ) ( 21,826 ) 16,272 ( 6,956 ) Total comprehensive income (loss) $ 30,996 $ ( 8,458 ) $ 111,775 $ 59,627 The accompanying notes are an integral part of these condensed consolidated financial statements. 8 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Stockholders’ Equity (Deficit) (In thousands) (Unaudited) Accumulated Additional Other Total Common Stock Paid-in Accumulated Comprehensive Stockholders’ Shares Amount Capital Earnings Loss Equity Balance at September 30, 2020 112,405 $ 1,124 $ 1,913 $ 117,109 $ ( 104,703 ) $ 15,443 Net earnings — — — 57,191 — 57,191 Other comprehensive income — — — — 23,588 23,588 Share-based compensation — — 2,893 — — 2,893 Stock issued for equity awards 133 1 ( 250 ) — — ( 249 ) Balance at December 31, 2020 112,538 $ 1,125 $ 4,556 $ 174,300 $ ( 81,115 ) $ 98,866 Net earnings — — — 38,312 — 38,312 Other comprehensive loss — — — — ( 7,316 ) ( 7,316 ) Share-based compensation — — 2,648 — — 2,648 Stock issued for equity awards 141 2 2,321 — — 2,323 Balance at March 31, 2021 112,679 $ 1,127 $ 9,525 $ 212,612 $ ( 88,431 ) $ 134,833 Accumulated Additional Other Total Common Stock Paid-in Accumulated Comprehensive Stockholders’ Shares Amount Capital Earnings Loss Equity (Deficit) Balance at September 30, 2019 116,725 $ 1,167 $ — $ 55,797 $ ( 117,287 ) $ ( 60,323 ) Cumulative effect of ASC 842 adoption — — — ( 445 ) — ( 445 ) Net earnings — — — 53,215 — 53,215 Other comprehensive income — — — — 14,870 14,870 Repurchases and cancellations of common stock ( 766 ) ( 7 ) ( 6,237 ) ( 5,113 ) — ( 11,357 ) Share-based compensation — — 3,473 — — 3,473 Stock issued for equity awards 206 2 2,764 — — 2,766 Balance at December 31, 2019 116,165 $ 1,162 $ — $ 103,454 $ ( 102,417 ) $ 2,199 Net earnings — — — 13,368 — 13,368 Other comprehensive loss — — — — ( 21,826 ) ( 21,826 ) Repurchases and cancellations of common stock ( 3,936 ) ( 39 ) ( 3,064 ) ( 46,897 ) — ( 50,000 ) Share-based compensation — — 3,059 — — 3,059 Stock issued for equity awards 35 — 5 — — 5 Balance at March 31, 2020 112,264 $ 1,123 $ — $ 69,925 $ ( 124,243 ) $ ( 53,195 ) The accompanying notes are an integral part of these condensed consolidated financial statements. 9 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (In thousands) (Unaudited) Six Months Ended March 31, 2021 2020 Cash Flows from Operating Activities: Net earnings $ 95,503 $ 66,583 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 52,945 53,997 Share-based compensation expense 5,541 6,532 Amortization of deferred financing costs 2,326 1,767 Loss (gain) on early extinguishment of debt 1,390 ( 357 ) Loss (gain) on disposal of equipment and other property 1,741 ( 18 ) Deferred income taxes ( 365 ) 5,547 Changes in (exclusive of effects of acquisitions): Trade accounts receivable ( 3,437 ) 158 Accounts receivable, other ( 5,544 ) 19,199 Inventory ( 127,324 ) 1,365 Other current assets 3,588 ( 17,692 ) Other assets ( 4,307 ) 575 Operating leases, net ( 2,420 ) — Accounts payable and accrued liabilities 101,331 ( 55,679 ) Income taxes payable 13,447 ( 7,199 ) Other liabilities ( 2,859 ) 1,353 Net cash provided by operating activities 131,556 76,131 Cash Flows from Investing Activities: Payments for property and equipment, net of proceeds ( 27,095 ) ( 71,960 ) Acquisitions, net of cash acquired ( 2,245 ) ( 1,944 ) Net cash used by investing activities ( 29,340 ) ( 73,904 ) Cash Flows from Financing Activities: Proceeds from issuance of long-term debt — 787,500 Repayments of long-term debt ( 213,271 ) ( 437,385 ) Payments for common stock repurchased — ( 61,357 ) Proceeds from equity awards 2,073 2,771 Net cash (used) provided by financing activities ( 211,198 ) 291,529 Effect of foreign exchange rate changes on cash and cash equivalents 3,152 ( 837 ) Net (decrease) increase in cash and cash equivalents ( 105,830 ) 292,919 Cash and cash equivalents, beginning of period 514,151 71,495 Cash and cash equivalents, end of period $ 408,321 $ 364,414 Supplemental Cash Flow Information: Interest paid $ 46,445 $ 41,366 Income taxes paid $ 20,791 $ 45,521 Capital expenditures incurred but not paid $ 3,255 $ 5,090 The accompanying notes are an integral part of these condensed consolidated financial statements. 10 Sally Beauty Holdings, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) 1. Basis of Presentation The condensed consolidated interim financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and pursuant to the rules and regulations of the SEC. Accordingly, certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC, although we believe that the disclosures included herein are adequate to make the information not misleading. These condensed consolidated interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2020. In the opinion of management, these condensed consolidated interim financial statements reflect all adjustments that are of a normal recurring nature and which are necessary to present fairly our consolidated financial position as of March 31, 2021 and September 30, 2020, and our consolidated results of operations, consolidated comprehensive income, and consolidated statements of stockholders’ equity for the three and six months ended March 31, 2021 and 2020, our consolidated cash flows for the six months ended March 31, 2021 and 2020. Our operating results for the three and six months ended March 31, 2021, may not be indicative of the results that may be expected for the full fiscal year ending September 30, 2021, in particular as a result of the uncertainty around the continuing effects of the COVID-19 pandemic on future periods. Due to the uncertainty over the duration and severity of the economic and operational impacts of COVID-19, the adverse impact of the pandemic may continue further into our fiscal year 2021 and possibly beyond, and it may be material. 2. Significant Accounting Policies We adhere to the same accounting policies in the preparation of our condensed consolidated interim financial statements as we do in the preparation of our full year consolidated financial statements. As permitted under GAAP, interim accounting for certain expenses, including income taxes, is based on full-year assumptions. For interim financial reporting purposes, income taxes are recorded based upon estimated annual effective income tax rates. 3. Recent Accounting Pronouncements In December 2019, the FASB issued ASU No. 2019-12 which simplifies the accounting for income taxes by removing an exception related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period with year to date losses and the recognition of deferred tax liabilities for outside basis differences. Additionally, the update clarifies and simplifies other areas of ASC 740, Income Taxes . For public companies, the amendments in the update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted, but all amendments must be adopted at once. The amendments in this update have different adoption methods including prospective basis, retrospective basis, and a modified retrospective basis dependent on the specific change. We are currently evaluating the impact of this update, but based on our preliminary assessment we do not believe that adoption of this update will have a material impact on our results of operations or financial position. 4. Revenue Recognition Substantially all of our revenue is derived through the sale of merchandise at the point-of-sale. Revenue is recognized net of estimated sales returns and sales taxes. We estimate sales returns based on historical data. Changes to our contract liabilities for the period were as follows (in thousands): September 30, 2020 $ 13,947 Loyalty points and gift cards issued but not redeemed, net of estimated breakage 7,998 Revenue recognized from beginning liability ( 6,729 ) March 31, 2021 $ 15,216 See Note 11, Business Segments , for additional information regarding the disaggregation of our sales revenue. 11 5. Fair Value Measurements Fair value on recurring basis Consistent with the three-level hierarchy defined in ASC Topic 820, Fair Value Measurement , as amended, we categorize our financial assets and liabilities as follows (in thousands): Classification Fair Value Hierarchy Level March 31, 2021 September 30, 2020 Financial Assets: Cash equivalents Cash and cash equivalents Level 1 $ — $ 194,612 Foreign exchange contracts Other current assets Level 2 20 — Interest rate caps Other assets Level 2 18 27 Total assets $ 38 $ 194,639 . Financial Liabilities: Foreign exchange contracts Accrued liabilities Level 2 $ 516 $ — Other fair value disclosures March 31, 2021 September 30, 2020 Fair Value Hierarchy Level Carrying Value Fair Value Carrying Value Fair Value Long-term debt, excluding capital leases Senior notes Level 1 $ 1,177,380 $ 1,234,481 $ 1,177,380 $ 1,217,707 Term loan B Level 2 422,625 421,040 635,788 619,397 Total long-term debt $ 1,600,005 $ 1,655,521 $ 1,813,168 $ 1,837,104 The table above excludes amounts, if any, related to our ABL facility as the balance approximates fair value due to the short-term nature of our borrowings. 6. Stockholders’ Equity Share Repurchases In August 2017, our Board of Directors approved a share repurchase program authorizing the Company to repurchase up to $ 1.0 billion of its common stock, subject to certain limitations governed by our debt agreements, over an approximate four-year period expiring on September 30, 2021 . Information related to our shares repurchased and subsequently retired were as follows (in thousands): Three Months Ended March 31, Six Months Ended March 31, 2021 2020 2021 2020 Number of shares repurchased — 3,936 — 4,702 Total cost of share repurchased $ — $ 50,000 $ — $ 61,357 Accumulated Other Comprehensive Loss The change in accumulated other comprehensive loss (“AOCL”) was as follows (in thousands): Foreign Currency Translation Adjustments Interest Rate Caps Foreign Exchange Contracts Total Balance at September 30, 2020 $ ( 102,111 ) $ ( 3,003 ) $ 411 $ ( 104,703 ) Other comprehensive income (loss) before reclassification, net of tax 17,117 ( 69 ) ( 601 ) 16,447 Reclassification to net earnings, net of tax — 244 ( 419 ) ( 175 ) Balance at March 31, 2021 $ ( 84,994 ) $ ( 2,828 ) $ ( 609 ) $ ( 88,431 ) The tax impact for the changes in other comprehensive loss and the reclassifications to net earnings was not material. 12 7. Weighted-Average Shares The following table sets forth the reconciliation of basic and diluted weighted-average shares (in thousands): Three Months Ended March 31, Six Months Ended March 31, 2021 2020 2021 2020 Weighted-average basic shares 112,603 114,823 112,538 115,478 Dilutive securities: Stock option and stock award programs 1,739 972 1,490 984 Weighted-average diluted shares 114,342 115,795 114,028 116,462 Anti-dilutive options excluded from our computation of diluted shares 4,197 5,076 4,222 5,076 8. Goodwill and Intangible Assets During the three months ended March 31, 2021, we completed our annual assessment for impairment of goodwill and other intangible assets. For goodwill, we used a qualitative analysis and our actual and forecasted results are exceeding the estimates from the last quantitative test . No material impairment losses were recognized in the current or prior periods presented in connection with our goodwill and other intangible assets. For the three months ended March 31, 2021 and 2020, amortization expense related to other intangible assets was $ 1.6 million and $ 2.2 million, respectively, and for the six months ended March 31, 2021 and 2020, amortization expense was $ 3.3 million and $ 4.6 million, respectively. Additionally during the six months ended March 31, 2021, goodwill increased $ 4.6 million primarily from the effects of foreign currency exchange rates. 9. Short-term Borrowings and Long-term Debt At March 31, 2021, there were no outstanding borrowings and we had $ 496.9 million available for borrowing under our ABL facility, including the Canadian sub-facility, subject to the conditions contained therein. Our ABL facility matures on July 6, 2022 . During the three months ended March 31, 2021, we paid the remaining $ 213.2 million of aggregate outstanding principal on our term loan B fixed tranche at par, excluding accrued interest. In connection with the debt repayment, we recognized a $ 1.4 million loss on the extinguishment of debt from the write-off of unamortized deferred financing costs . Please see Note 13, Subsequent Event , for further information about our debt. Covenants The agreements governing our ABL facility, term loan B and the senior notes contain a customary covenant package that places restrictions on the disposition of assets, the granting of liens and security interests, the prepayment of certain indebtedness, and other matters with customary events of default, including customary cross-default and/or cross-acceleration provisions. As of March 31, 2021, we were in compliance with all debt covenants and all the net assets of our consolidated subsidiaries were unrestricted from transfer. 13 10. Derivative Instruments and Hedging Activities During the six months ended March 31, 2021, we did no t purchase or hold any derivative instruments for trading or speculative purposes. See Note 5, Fair Value Measurements , for the classification and fair value of our derivative instruments. Designated Cash Flow Hedges Foreign Currency Forwards We regularly enter into foreign currency forwards to mitigate our exposure to exchange rate changes on inventory purchases in U.S. dollars by our foreign subsidiaries. At March 31, 2021, the notional amount we held through these forwards, based upon exchange rates at March 31, 2021, was as follows (in thousands): Notional Currency Notional Amount Euro $ 8,717 Mexican Peso 7,235 Canadian Dollar 2,659 Total $ 18,611 We record quarterly, net of income tax, the changes in fair value related to the foreign currency forwards into AOCL. As the forwards are exercised, the realized value is recognized into cost of goods sold based on inventory turns. For the three and six months ended March 31, 2021, we recognized gains of $ 0.1 million and $ 0.4 million, respectively, into cost of goods sold on our condensed consolidated statements of earnings. Based on March 31, 2021, valuations and exchange rates, we expect to reclassify losses of approximately $ 0.7 million into cost of goods sold over the next 12 months. Interest Rate Caps In July 2017, we purchased two interest rate caps with an initial aggregate notional amount of $ 550 million (the “interest rate caps”) to mitigate the exposure to higher interest rates in connection with our term loan B. The interest rate caps are comprised of individual caplets that expire ratably through June 30, 2023 , and are designated as cash flow hedges. Accordingly, changes in fair value of the interest rate caps are recorded quarterly, net of income tax, and are included in AOCL. Over the next 12 months, we expect to reclassify approximately $ 1.5 million into interest expense, which represents the original value of the expiring caplets. The effects of our interest rate caps on our condensed consolidated statements of earnings were not material for the three and six months ended March 31, 2021. 11. Business Segments Segment data for the three and six months ended March 31, 2021 and 2020, is as follows (in thousands): Three Months Ended March 31, Six Months Ended March 31, 2021 2020 2021 2020 Net sales: Sally Beauty Supply ("SBS") $ 542,664 $ 519,509 $ 1,090,334 $ 1,088,657 Beauty Systems Group ("BSG") 383,664 351,514 772,016 762,574 Total $ 926,328 $ 871,023 $ 1,862,350 $ 1,851,231 Earnings before provision for income taxes: Segment operating earnings: SBS $ 100,063 $ 56,373 $ 195,191 $ 130,598 BSG 47,843 41,039 96,415 103,473 Segment operating earnings 147,906 97,412 291,606 234,071 Unallocated expenses 71,764 50,954 110,910 90,694 Restructuring 631 3,193 863 5,725 Consolidated operating earnings 75,511 43,265 179,833 137,652 Interest expense 23,883 21,644 49,861 43,185 Earnings before provision for income taxes $ 51,628 $ 21,621 $ 129,972 $ 94,467 Sales between segments, which are eliminated in consolidation, were not material during the three and six months ended March 31, 2021 and 2020. 14 Disaggregation of net sales by segment Three Months Ended March 31, Six Months Ended March 31, SBS 2021 2020 2021 2020 Hair color 35.1 % 32.8 % 35.3 % 31.9 % Hair care 18.6 % 19.5 % 18.6 % 19.7 % Skin and nail care 14.0 % 12.8 % 12.3 % 13.5 % Styling tools 12.2 % 12.7 % 14.4 % 13.4 % Salon supplies and accessories 8.2 % 7.6 % 7.8 % 7.2 % Textured hair products 6.4 % 6.1 % 6.0 % 5.7 % Other beauty items 5.5 % 8.5 % 5.6 % 8.6 % Total 100.0 % 100.0 % 100.0 % 100.0 % Three Months Ended March 31, Six Months Ended March 31, BSG 2021 2020 2021 2020 Hair color 43.5 % 40.1 % 42.1 % 38.8 % Hair care 37.6 % 35.1 % 36.3 % 34.8 % Skin and nail care 7.2 % 8.2 % 7.7 % 8.2 % Styling tools 6.2 % 6.2 % 6.6 % 6.5 % Other beauty items 2.4 % 3.0 % 2.6 % 2.8 % Promotional items 3.1 % 7.4 % 4.7 % 8.9 % Total 100.0 % 100.0 % 100.0 % 100.0 % The following tables disaggregate our segment revenue by sales channels: Three Months Ended March 31, Six Months Ended March 31, SBS 2021 2020 2021 2020 Company-operated stores 93.0 % 94.9 % 93.5 % 95.4 % E-commerce 6.9 % 4.9 % 6.5 % 4.4 % Franchise stores 0.1 % 0.2 % 0.0 % 0.2 % Total 100.0 % 100.0 % 100.0 % 100.0 % Three Months Ended March 31, Six Months Ended March 31, BSG 2021 2020 2021 2020 Company-operated stores 70.2 % 70.4 % 69.9 % 69.8 % Distributor sales consultants 13.7 % 16.6 % 14.0 % 17.3 % E-commerce 9.1 % 5.9 % 8.8 % 5.7 % Franchise stores 7.0 % 7.1 % 7.3 % 7.2 % Total 100.0 % 100.0 % 100.0 % 100.0 % 12. Income Tax For the three months ended March 31, 2021 and 2020, our effective tax rates were 25.8 % and 38.2 %, respectively, and for the six months ended March 31, 2021 and 2020, our effective tax rates were 26.5 % and 29.5 %, respectively. The decrease in the effective tax rates was primarily a result of the establishment of a valuation allowance in a foreign subsidiary in the prior year. Additionally, we had greater losses in the prior year from foreign subsidiaries for which a tax benefit could not be recognized. 15 Refer to the following rate reconciliation for more details relating to the period over period differences in the effective tax rate: Three Months Ended Six Months Ended March 31, March 31, 2021 2020 2021 2020 U.S. federal statutory income tax rate 21.0 % 21.0 % 21.0 % 21.0 % State income taxes, net of federal tax benefit 3.7 4.4 3.4 3.6 Effect of foreign operations ( 0.1 ) 0.1 0.8 0.9 Foreign valuation allowances 1.2 15.9 0.3 3.9 Other, net — ( 3.2 ) 1.0 0.1 Effective tax rate 25.8 % 38.2 % 26.5 % 29.5 % 13. Subsequent Event On April 1, 2021, we called the entire outstanding balance of $ 197.4 million on our 5.50 % senior notes due 2023 at par plus a premium. In connection with the repayment, we recognized losses on extinguishment of debt in the aggregate amount of $ 2.8 million, which included a $ 1.8 million call premium and $ 1.0 million from the write-off of unamortized debt issuance costs. 16