Sally Beauty Holdings, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations This 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 information contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2020, and our other filings with the Securities and Exchange Commission, including the Risk Factors sections therein, and information contained elsewhere in this Quarterly Report, including the condensed consolidated interim financial statements and notes to those financial statements. The results of operations for any interim period may not necessarily be indicative of the results that may be expected for any future interim period or the entire fiscal year, in particular as a result of the uncertainty of the continued effects of the COVID-19 pandemic on future periods. Highlights for the Three Months Ended June 30, 2021 • Consolidated net sales for the three months ended June 30, 2021, increased $317.1 million, or 45.0%, to $1,022.4 million, compared to the three months ended June 30, 2020; • Consolidated same store sales increased 44.7% for the three months ended June 30, 2021, compared to the three months ended June 30, 2020; • Consolidated gross profit for the three months ended June 30, 2021, increased $192.6 million, or 59.8%, to $514.4 million, compared to the three months ended June 30, 2020. Gross margin increased 470 basis points to 50.3% for the three months ended June 30, 2021, compared to the three months ended June 30, 2020; • Consolidated operating earnings for the three months ended June 30, 2021, increased $126.0 million, or 8,804.1%, to $127.4 million, compared to the three months ended June 30, 2020. Operating margin increased 1,230 basis points to 12.5% for the three months ended June 30, 2021, compared to the three months ended June 30, 2020; • For the three months ended June 30, 2021, we had consolidated net earnings of $76.2 million compared to consolidated net loss of $23.5 million for the three months ended June 30, 2020; • For the three months ended June 30, 2021, we had diluted earnings per share of $0.66, compared to diluted loss per share of $0.21 for the three months ended June 30, 2020; and • Cash provided by operations was $86.2 million for the three months ended June 30, 2021, compared to $198.3 million for the three months ended June 30, 2020. Impact of COVID-19 on Our Business and Business Strategy Update COVID-19 restrictions on our global store operations continued to ease in the current quarter. However, due to the continued 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. Furthermore, we continue to make progress against our key business initiatives, which includes leveraging and optimizing our elevated digital capabilities, growing our customer engagement and loyalty, and implementing the final steps in our successful transformation journey, which remains on track to be substantially completed by the end of the year. 17 Overview Key Operating Metrics The following table sets forth, for the periods indicated, information concerning key measures we rely on to evaluate our operating performance (dollars in thousands): Three Months Ended June 30, Nine Months Ended June 30, 2021 2020 Increase (Decrease) 2021 2020 Increase (Decrease) Net sales: SBS $ 602,681 $ 415,468 $ 187,213 45.1 % $ 1,693,015 $ 1,504,125 $ 188,890 12.6 % BSG 419,706 289,819 129,887 44.8 % 1,191,722 1,052,393 139,329 13.2 % Consolidated $ 1,022,387 $ 705,287 $ 317,100 45.0 % $ 2,884,737 $ 2,556,518 $ 328,219 12.8 % Gross profit: SBS $ 349,167 $ 202,460 $ 146,707 72.5 % $ 982,139 $ 800,517 $ 181,622 22.7 % BSG 165,239 119,386 45,853 38.4 % 470,220 425,934 44,286 10.4 % Consolidated $ 514,406 $ 321,846 $ 192,560 59.8 % $ 1,452,359 $ 1,226,451 $ 225,908 18.4 % Segment gross margin: SBS 57.9 % 48.7 % 920 bps 58.0 % 53.2 % 480 bps BSG 39.4 % 41.2 % (180) bps 39.5 % 40.5 % (100) bps Consolidated 50.3 % 45.6 % 470 bps 50.3 % 48.0 % 230 bps Net earnings (loss): Segment operating earnings: SBS $ 116,784 $ 3,087 $ 113,697 3683.1 % $ 311,975 $ 133,684 $ 178,291 133.4 % BSG 55,265 40,084 15,181 37.9 % 151,680 143,557 8,123 5.7 % Segment operating earnings 172,049 43,171 128,878 298.5 % 463,655 277,241 186,414 67.2 % Unallocated expenses and restructuring (a) 44,632 41,740 2,892 6.9 % 156,405 138,158 18,247 13.2 % Consolidated operating earnings 127,417 1,431 125,986 8804.1 % 307,250 139,083 168,167 120.9 % Interest expense 23,452 27,298 (3,846 ) (14.1 )% 73,313 70,483 2,830 4.0 % Earnings (loss) before provision for income taxes 103,965 (25,867 ) 129,832 (501.9 )% 233,937 68,600 165,337 241.0 % Provision (benefit) for income taxes 27,759 (2,341 ) 30,100 (1285.8 )% 62,228 25,543 36,685 143.6 % Net earnings (loss) $ 76,206 $ (23,526 ) $ 99,732 (423.9 )% $ 171,709 $ 43,057 $ 128,652 298.8 % . Number of stores at end-of-period (including franchises): SBS 3,611 3,691 (80 ) (2.2 )% BSG 1,367 1,371 (4 ) (0.3 )% Consolidated 4,978 5,062 (84 ) (1.7 )% Same store sales growth (decline) (b) : SBS 43.3 % (25.9 )% 6,920 bps 12.6 % (11.3 )% 2,390 bps BSG 47.8 % (27.9 )% 7,570 bps 14.5 % (11.2 )% 2,570 bps Consolidated 44.7 % (26.6 )% 7,130 bps 13.2 % (11.3 )% 2,450 bps (a) Unallocated expenses consist of corporate and shared costs and are included in selling, general and administrative expenses in our consolidated statements of earnings. (b) For the purpose of calculating our same store sales metrics, we compare the current period sales for stores open for 14 months or longer as of the last day of a month with the sales for these stores for the comparable period in the prior fiscal year. Our same store sales are calculated in constant dollars and include e-commerce sales from certain digital platforms, but do not generally include the sales from stores relocated until 14 months after the relocation. The sales from stores acquired are excluded from our same store sales calculation until 14 months after the acquisition. 18 Results of Operations The Three Months Ended June 30, 2021, compared to the Three Months Ended June 30, 2020 Net Sales Consolidated . Consolidated net sales include a positive impact from changes in foreign currency exchange rates of $18.7 million, or 2.6% of consolidated net sales. SBS . The increase in net sales for SBS was primarily driven by the following (in thousands): Same store sales $ 173,984 Other (a) (1,986 ) Foreign currency exchange 15,215 Total $ 187,213 (a) Other consists of stores outside same store sales and non-store sales, including catalog and internet sales of our Sinelco Group subsidiaries. SBS experienced higher unit volume primarily due to the reopening of all of our customer-facing store operations in the U.S. and Canada, improving consumer confidence in the U.S. and the easing of COVID-19 restrictions across international territories. For the three months ended June 30, 2021, there was minimal impact from temporary closures of certain customer-facing store operations as a result of COVID-19. Additionally, SBS experienced an increase in average unit prices, resulting from a change in product mix to higher-priced products. BSG . The increase in net sales for BSG was primarily driven by the following (in thousands): Same store sales $ 91,644 Distributor sales consultants 16,230 Sales to franchisees 10,133 Other (a) 8,419 Foreign currency exchange 3,461 Total $ 129,887 (a) Other consists of stores outside same store sales, included recently acquired businesses. BSG experienced higher unit volume primarily due to reopening of all of our customer-facing store operations in the U.S. and Canada and higher operating capacities in salons from the easing of COVID-19 restrictions. This was partially offset by a decrease in average unit price primarily due to increased promotions and customer discounts. Gross Profit Consolidated . Consolidated gross profit increased for the three months ended June 30, 2021, due to higher net sales in both segments and a higher gross margin in SBS, partially offset by a lower gross margin in BSG. SBS . SBS’s gross profit increased for the three months ended June 30, 2021, as a result of an increase in net sales and a higher gross margin. SBS’s gross margin increased primarily as a result of the impact of the prior year’s non-cash inventory write down and inventory clearance efforts, partially offset by higher sales volume from the lower margin European operations as a percentage of total segment sales compared to the prior year. BSG . BSG’s gross profit increased for the three months ended June 30, 2021, as a result of an increase in net sales, partially offset by a lower gross margin. BSG’s gross margin decreased primarily as a result of higher sales volume from large volume/lower margin full service customers that rebounded from the COVID-19 impact in the prior year. Selling, General and Administrative Expenses Consolidated . Consolidated selling, general and administrative expenses increased primarily as a result of higher compensation and compensation-related expenses, rent expense and advertising expenses. These increases were driven by the impact of COVID-19 in the prior year. Consolidated selling, general and administrative expenses, as a percentage of net sales, decreased 680 basis points to 37.8% for the three months ended June 30, 2021, due to the increase in sales. SBS . SBS’s selling, general and administrative expenses increased $33.0 million, or 16.6%, for the three months ended June 30, 2021. The increase was driven primarily by higher compensation and compensation-related expenses of $49.7 million, resulting from furloughs due to COVID-19 in the prior year. Additionally, rent expense increased $6.9 million, due to rent abatements in the prior year. These expenses were partially offset by lower delivery expense of $21.5 million due to lower e-commerce volume compared to the three months ended June 30, 2020. 19 BSG . BSG’s selling, general and administrative expenses increased $ 30.7 million , or 38.7% , for the three months ended June 30, 2021 . The increase was driven primarily by higher compensation and compensation-related expenses of $23.3 million, resulting from furloughs due to COVID-19 in the prior year. Additionally, rent expense increased $3.9 million, due to rent abatements in the prior year, and advertising expenses increased $1.7 million. Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, increased $8.2 million, or 22.8%, for the three months ended June 30, 2021, primarily due to higher compensation and compensation-related expenses of $14.9 million as a result of employees furloughed in the prior year. This increase was partially offset by lower COVID-19 expense in the current period. Restructuring For the three months ended June 30, 2021, restructuring charges in connection with our previously communicated Project Surge and the Transformation Plan decreased $5.3 million to $0.5 million as we have substantially completed these restructuring plans. Interest Expense The decrease in interest expense is primarily due to the lower outstanding debt principal for the three months ended June 30, 2021 compared to the three months ended June 30, 2020. We recognized lower interest expense as a result of the repayments of our term loan B fixed tranche of $3.0 million and senior notes due 2023 of $2.7 million. Additionally, the lower outstanding principal balance on our ABL facility resulted in lower interest expense of $2.6 million. These decreases were partially offset by debt extinguishment costs of $2.9 million and incremental interest on the senior notes issued in April 2020 of $1.7 million. See “Liquidity and Capital Resources” below for additional information. Provision for Income Taxes The effective tax rates were 26.7% and 9.1%, for the three months ended June 30, 2021, and 2020, respectively. The effective tax rate for the three months ended June 30, 2020 was negatively impacted by foreign losses which cannot be tax benefitted. For the three months ended June 30, 2020, the impact of these and certain other tax impacting items is opposite the customary relationship due to the loss before the provision for income taxes that was incurred. A lower effective tax rate is not beneficial in situations where a pre-tax book loss has been incurred. See Note 12, Income Tax , for more information on our effective tax rate. The Nine Months Ended June 30, 2021, compared to the Nine Months Ended June 30, 2020 Net Sales Consolidated . Consolidated net sales include a positive impact from changes in foreign currency exchange rates of $29.6 million, or 1.2% of consolidated net sales. SBS . The increase in net sales for SBS was primarily driven by the following (in thousands): Same store sales $ 180,779 Other (a) (15,803 ) Foreign currency exchange 23,914 Total $ 188,890 (a) Other consists of stores outside same store sales, which were negatively impacted by net store closures, and non-store sales, including catalog and internet sales of our Sinelco Group subsidiaries. SBS experienced an increase in average unit prices as a result of a reduction in promotional activity and increased sales of higher-priced products. Additionally, SBS experienced higher unit volume primarily due to the reopening of all of our customer-facing store operations in the U.S. and Canada , improving consumer confidence in the U.S. and the easing of COVID-19 restrictions across international territories. BSG . The increase in net sales for BSG was primarily driven by the following (in thousands): Same store sales $ 102,694 Sales to franchisees 11,094 Distributor sales consultants 6,372 Other (a) 13,452 Foreign currency exchange 5,717 Total $ 139,329 (a) Other consists of stores outside same store sales, included recently acquired businesses. 20 BSG experienced higher unit volume and an increase in average unit prices. The higher unit volume was primarily due to the impact of reopening of customer-facing store operations in the U.S. and Canada. For the nine months ended June 30, 2021, we experienced additional temporary closures and restricted capacity of certain customer-facing store operations in various markets in the U.S. and Canada, as well as salon closures in parts of California and Canada due to the effects of COVID-19 during the fiscal year. The increase in the average unit price was primarily driven by lower promotional activity. Gross Profit Consolidated . Consolidated gross profit increased for the nine months ended June 30, 2021, due to higher net sales in both segments and a higher gross margin in SBS, partially offset by a lower gross margin in BSG. SBS . SBS’s gross profit increased for the nine months ended June 30, 2021, as a result of increased net sales and a higher gross margin. SBS’s gross margin increased primarily as a result of fewer promotions, partially offset by the write-down of personal-protective equipment inventory. BSG . BSG’s gross profit decreased for the nine months ended June 30, 2021, as a result of a lower gross margin, partially offset by increased net sales. BSG’s gross margin decreased primarily as a result of the write-down of personal-protective equipment inventory, partially offset by fewer promotions. Selling, General and Administrative Expenses Consolidated . Consolidated selling, general and administrative expenses increased primarily as a result of the impact of prior year cost saving initiatives in response to COVID-19, including furloughs and the suspension or elimination of all non-critical projects and non-essential spend. Additionally, the increase was due to higher COVID-19 expenses, primarily from donation expense related to personal-protective equipment inventory, rent expense and incremental costs from businesses acquired in the past 12 months. Consolidated selling, general and administrative expenses, as a percentage of net sales, decreased 250 basis points to 39.6% for the nine months ended June 30, 2021, due to the increase in sales. SBS . SBS’s selling, general and administrative expenses increased $3.3 million, or 0.5%, for the nine months ended June 30, 2021. The increase was driven primarily by higher compensation and compensation-related expenses of $33.5 million, resulting from furloughs due to COVID-19 in the prior year. The increase was partially offset by lower delivery expense of $17.3 million due to lower e-commerce volume compared to the nine months ended June 30, 2020, advertising expenses of $7.0 million and incremental store expense for personal protective equipment in the prior year . BSG . BSG’s selling, general and administrative expenses increased $36.2 million, or 12.8%, for the nine months ended June 30, 2021. The increase was driven primarily by higher compensation and compensation-related expenses of $20.5 million, resulting from furloughs due to COVID-19 in the prior year. Additionally, the increase was due to higher rent expense of $5.6 million, primarily due to rent abatements in the prior year, shipping costs and incremental costs from businesses acquired in the past 12 months. Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, increased $28.4 million, or 22.4%, for the nine months ended June 30, 2021, primarily due to higher compensation and compensation-related expenses of $24.9 million as a result of employees furloughed in the prior year, and higher COVID-19 expense in the current period primarily from donation expense related to personal-protective equipment inventory of $29.8 million, compared to COVID-19 expense of $23.4 million in the prior year. Restructuring For the nine months ended June 30, 2021, restructuring charges in connection with our previously communicated Project Surge and the Transformation Plan decreased $10.2 million to $1.4 million as we have substantially completed these restructuring plans. Interest Expense The increase in interest expense is primarily due to incremental interest on the senior notes issued in April 2020 of $14.8 million and debt extinguishment costs of $4.5 million, partially offset by the impact of the repayments of our term loan B fixed tranche in January 2021 of $7.0 million and the senior notes due 2023 in April 2021 of $2.7 million. Additionally, the lower outstanding principal balance on our ABL facility resulted in lower interest expense of $3.3 million and the lower interest rates on our term loan B variable tranche of $4.0 million. See “Liquidity and Capital Resources” below for additional information. Provision for Income Taxes The effective tax rates were 26.6% and 37.2%, for the nine months ended June 30, 2021, and 2020, respectively. The decrease in the effective tax rate was primarily due to greater losses in the prior year from foreign subsidiaries for which a tax benefit could not be recognized and the establishment of a valuation allowance in a foreign subsidiary in the prior year. See Note 12, Income Tax , for more information on our effective tax rate. 21 Liquidity and Capital Resources We are highly leveraged and a substantial portion of our liquidity needs arise from debt service on our outstanding indebtedness and from funding the costs of our operations, working capital, capital expenditures, debt repayment and share repurchases. Working capital (current assets less current liabilities) decreased $190.8 million, to $678.9 million at June 30, 2021, compared to $869.7 million at September 30, 2020, resulting primarily from a decrease in cash and cash equivalents from the repayments of outstanding long-term debt and increased inventory as a result of improving COVID-19 conditions. At June 30, 2021, cash and cash equivalents were $270.3 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 our ABL facility will be sufficient to fund working capital requirements, potential acquisitions, anticipated capital expenditures, including information technology upgrades and store remodels, and debt repayments over the next 12 months. Due to the improving COVID-19 conditions, we have shifted our focus to reducing our debt levels while also being proactive in maintaining our financial flexibility. We utilize our ABL facility for the issuance of letters of credit, certain working capital and liquidity needs, and to manage normal fluctuations in our operational cash flow. In that regard, we may from time to time draw funds under the ABL facility for general corporate purposes including funding of capital expenditures, acquisitions, interest payments due on our indebtedness, paying down other debt and opportunistic share repurchases. During the nine months ended June 30, 2021, we did not borrow under our ABL facility. As of June 30, 2021, we had $481.7 million available for borrowings under our ABL facility, subject to borrowing base limitations, as reduced by outstanding letters of credit. Amounts drawn on our ABL facility are generally paid down with cash provided by our operating activities. During the three months ended June 30, 2021, we entered into a third amendment to our ABL facility which extended the maturity date to May 11, 2026. Share Repurchase Programs During the nine months ended June 30, 2021, we did not repurchase any common stock. As of June 30, 2021, we had authorization of approximately $726.1 million of additional potential share repurchases remaining under the 2017 Share Repurchase Program. See Note 13, Subsequent Event , for additional information on our share repurchase program. Historical Cash Flows Historically, our primary source of cash has been net funds provided by operating activities and, when necessary, borrowings under our ABL facility. While historically, the primary uses of cash have been for share repurchases, capital expenditures, repayments and servicing of long-term debt and acquisitions, we have shifted our focus in the short-term to reduce cash expenditures. Net Cash Provided by Operating Activities Net cash provided by operating activities during the nine months ended June 30, 2021, decreased $56.7 million to $217.7 million, compared to the nine months ended June 30, 2020, mainly due to increases in vendor receivables and inventory, partially offset by increased net income and higher accounts payable. The increase in inventory and accounts payable was driven by the timing of inventory purchases and payments as we restock to new levels of demand. Additionally, the increase in vendor receivables was driven by higher sales in the three months ended June 30, 2021. Net Cash Used by Investing Activities Net cash used by investing activities during the nine months ended June 30, 2021, decreased $44.4 million to $47.2 million, compared to the nine months ended June 30, 2020. This change was primarily a result of our focus on reduced capital expenditures. Net Cash (Used) Provided by Financing Activities Net cash used by financing activities during the nine months ended June 30, 2021 resulted primarily from the repayments on our term loan B fixed tranche, the senior notes due 2023 and term loan B variable tranche. During the nine months ended June 30, 2020, we had a source of cash from financing activities primarily from the borrowings on our ABL and the issuance of senior notes as a response to COVID-19, partially offset by share repurchases. Long-Term Debt and Guarantor Financial Information At June 30, 2021, we had $1,394.3 million in debt, not including capital leases, unamortized debt issuance costs and debt discounts, in the aggregate, of $11.7 million. Our debt consisted of $980.0 million of senior notes outstanding and a term loan with an outstanding principal balance of $414.4 million. As of June 30, 2021, there were no outstanding borrowings under our ABL facility. During the fiscal year, we paid the remaining $213.2 million of aggregate outstanding principal on our term loan B fixed tranche, the $197.4 million outstanding on our senior notes due 2023 and $8.3 million on our term loan B variable tranche. We are currently in compliance with the agreements and instruments governing our debt, including our financial covenants. 22 See Note 9, Short-term Borrowings and Long-term Debt , for more information on our debt. Guarantor Financial Information We are providing the following information in compliance with Rule 13-01 of Regulation S-X for guaranteed issued securities that have been registered under such regulation. Currently, our issued securities consist of the 5.625% Senior Notes due 2025 . This debt instrument was issued by our wholly-owned subsidiaries, Sally Holdings LLC and Sally Capital Inc. (the “Issuers”), under a shelf registration statement. The notes are unsecured debt instruments guaranteed by us and certain of our wholly-owned domestic subsidiaries (together, the “Guarantors”) and have certain restrictions on the ability to pay restrictive payments to Sally Beauty. The guarantees are joint and several, and full and unconditional. Certain other subsidiaries, including our foreign subsidiaries, do not serve as guarantors. The following summarized consolidating financial information represents financial information for the Issuers and the Guarantors on a combined basis. All transactions and intercompany balances between these combined entities has been eliminated. The following table presents the summarized balance sheets information for the Issuers and the Guarantors as of June 30, 2021 and September 30, 2020 (in thousands): June 30, 2021 September 30, 2020 Inventory $ 711,847 $ 615,092 Intercompany receivable $ 80,114 $ 75,892 Current assets $ 995,974 $ 1,166,250 Total assets $ 2,101,376 $ 2,281,896 Current liabilities $ 384,423 $ 325,380 Total liabilities $ 2,311,335 $ 2,657,033 The following table presents the summarized statement of income information for nine months ended June 30, 2021 (in thousands): Net sales $ 2,391,586 Gross profit $ 1,212,180 Earnings before provision for income taxes $ 201,462 Net Earnings $ 149,269 Contractual Obligations There have been no material changes outside the ordinary course of our business in any of our contractual obligations since September 30, 2020, other than the extinguishment of our term loan B fixed tranche, as discussed above. Off-Balance Sheet Financing Arrangements At June 30, 2021, and September 30, 2020, we had no off-balance sheet financing arrangements other than outstanding letters of credit related to inventory purchases and self-insurance programs. Critical Accounting Estimates There have been no material changes to our critical accounting estimates or assumptions since September 30, 2020. Recent Accounting Pronouncements See Note 3, Recent Accounting Pronouncements , of the Notes to Condensed Consolidated Financial Statements in Item 1 – “Financial Statements” in Part I – Financial Information.