Sally Beauty Holdings, Inc. 10-Q

Item 1. Financial Statements. SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (In thousands, except par value data) December 31, 2021 September 30, 2021 (Unaudited) Assets Current assets: Cash and cash equivalents $ 298,140 $ 400,959 Trade accounts receivable, net 29,588 32,623 Accounts receivable, other 36,568 33,958 Inventory 1,005,838 871,349 Other current assets 45,396 44,686 Total current assets 1,415,530 1,383,575 Property and equipment, net of accumulated depreciation of $ 784,622 at December 31, 2021, and $ 767,403 at September 30, 2021 293,871 307,377 Operating lease assets 531,657 537,673 Goodwill 540,287 541,209 Intangible assets, excluding goodwill, net of accumulated amortization of $ 39,670 at December 31, 2021, and $ 38,957 at September 30, 2021 54,316 55,532 Other assets 20,281 21,766 Total assets $ 2,855,942 $ 2,847,132 Liabilities and Stockholders’ Equity Current liabilities: Current maturities of long-term debt $ 184 $ 194 Accounts payable 346,302 291,632 Accrued liabilities 151,938 206,155 Current operating lease liabilities 154,465 156,234 Income taxes payable 28,863 10,666 Total current liabilities 681,752 664,881 Long-term debt 1,381,926 1,382,530 Long-term operating lease liabilities 406,362 404,147 Other liabilities 17,268 29,056 Deferred income tax liabilities, net 87,613 85,777 Total liabilities 2,574,921 2,566,391 Stockholders’ equity: Common stock, $ 0.01 par value. Authorized 500,000 shares; 110,052 and 113,138 shares issued and 109,977 and 112,913 shares outstanding at December 31, 2021, and September 30, 2021, respectively 1,100 1,129 Preferred stock, $ 0.01 par value. Authorized 50,000 shares; none issued — — Additional paid-in capital — 17,286 Accumulated earnings 378,313 356,967 Accumulated other comprehensive loss, net of tax ( 98,392 ) ( 94,641 ) Total stockholders’ equity 281,021 280,741 Total liabilities and stockholders’ equity $ 2,855,942 $ 2,847,132 The accompanying notes are an integral part of these condensed consolidated financial statements. 4 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Earnings (In thousands, except per share data) (Unaudited) Three Months Ended December 31, 2021 2020 Net sales $ 980,251 $ 936,022 Cost of goods sold 480,122 465,298 Gross profit 500,129 470,724 Selling, general and administrative expenses 386,250 366,170 Restructuring 1,099 232 Operating earnings 112,780 104,322 Interest expense 20,241 25,978 Earnings before provision for income taxes 92,539 78,344 Provision for income taxes 23,701 21,153 Net earnings $ 68,838 $ 57,191 Earnings per share: Basic $ 0.61 $ 0.51 Diluted $ 0.60 $ 0.50 Weighted-average shares: Basic 111,995 112,475 Diluted 113,968 113,828 The accompanying notes are an integral part of these condensed consolidated financial statements. 5 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Comprehensive Income (In thousands) (Unaudited) Three Months Ended December 31, 2021 2020 Net earnings $ 68,838 $ 57,191 Other comprehensive (loss) income: Foreign currency translation adjustments ( 4,509 ) 25,007 Interest rate caps, net of tax 278 175 Foreign exchange contracts, net of tax 480 ( 1,594 ) Other comprehensive (loss) income, net of tax ( 3,751 ) 23,588 Total comprehensive income $ 65,087 $ 80,779 The accompanying notes are an integral part of these condensed consolidated financial statements. 6 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Stockholders’ Equity (In thousands) (Unaudited) Accumulated Additional Other Total Common Stock Paid-in Accumulated Comprehensive Stockholders’ Shares Amount Capital Earnings Loss Equity Balance at September 30, 2021 112,913 $ 1,129 $ 17,286 $ 356,967 $ ( 94,641 ) $ 280,741 Net earnings — — — 68,838 — 68,838 Other comprehensive income — — — — ( 3,751 ) ( 3,751 ) Share-based compensation — — 3,958 — — 3,958 Stock issued for equity awards 795 8 7,364 — — 7,372 Employee withholding taxes paid related to net share settlement ( 56 ) ( 1 ) ( 1,136 ) — — ( 1,137 ) Repurchases and cancellations of common stock ( 3,675 ) ( 36 ) ( 27,472 ) ( 47,492 ) — ( 75,000 ) Balance at December 31, 2021 109,977 $ 1,100 $ — $ 378,313 $ ( 98,392 ) $ 281,021 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 158 2 ( 2 ) Employee withholding taxes paid related to net share settlement ( 25 ) ( 1 ) ( 248 ) — — ( 249 ) Balance at December 31, 2020 112,538 $ 1,125 $ 4,556 $ 174,300 $ ( 81,115 ) $ 98,866 The accompanying notes are an integral part of these condensed consolidated financial statements. 7 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (In thousands) (Unaudited) Three Months Ended December 31, 2021 2020 Cash Flows from Operating Activities: Net earnings $ 68,838 $ 57,191 Adjustments to reconcile net earnings to net cash (used) provided by operating activities: Depreciation and amortization 24,421 26,386 Share-based compensation expense 3,958 2,893 Amortization of deferred financing costs 932 1,496 Loss on disposal of equipment and other property 3 1,589 Deferred income taxes 1,867 229 Changes in (exclusive of effects of acquisitions): Trade accounts receivable 2,841 ( 3,502 ) Accounts receivable, other ( 1,724 ) ( 8,643 ) Inventory ( 137,326 ) ( 67,764 ) Other current assets ( 446 ) 3,220 Other assets 1,371 ( 240 ) Operating leases, net 6,475 2,996 Accounts payable and accrued liabilities 16,729 12,401 Income taxes payable 18,166 14,307 Other liabilities ( 11,790 ) ( 3,573 ) Net cash (used) provided by operating activities ( 5,685 ) 38,986 Cash Flows from Investing Activities: Payments for property and equipment, net of proceeds ( 26,390 ) ( 15,483 ) Acquisitions, net of cash acquired ( 319 ) ( 2,025 ) Net cash used by investing activities ( 26,709 ) ( 17,508 ) Cash Flows from Financing Activities: Repayments of long-term debt ( 1,421 ) ( 63 ) Payments for common stock repurchased ( 75,000 ) — Proceeds from equity awards 7,372 — Employee withholding taxes paid related to net share settlement of equity awards ( 1,136 ) ( 249 ) Net cash used by financing activities ( 70,185 ) ( 312 ) Effect of foreign exchange rate changes on cash and cash equivalents ( 240 ) 2,327 Net (decrease) increase in cash and cash equivalents ( 102,819 ) 23,493 Cash and cash equivalents, beginning of period 400,959 514,151 Cash and cash equivalents, end of period $ 298,140 $ 537,644 Supplemental Cash Flow Information: Interest paid $ 35,034 $ 43,439 Income taxes paid $ 3,978 $ 2,609 Capital expenditures incurred but not paid $ 3,594 $ 6,707 The accompanying notes are an integral part of these condensed consolidated financial statements. 8 Sally Beauty Holdings, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) 1. Significant Accounting Policies Business Operations Sally Beauty Holdings is an international specialty retailer and distributor of professional beauty supplies with operations in North America, South America and Europe. We are one of the largest distributers of professional beauty supplies in the U.S. based on store count, operating under two segments, Sally Beauty Supply (“SBS”) and Beauty Systems Group (“BSG”). Our operations consist of company-operated stores, franchise stores and several e-commerce platforms. Within BSG, we also have one of the largest networks of distributor sales consultants (“DSCs”) for professional beauty products in North America, who sell directly to salons and salon professionals. SBS targets retail consumers, salons and salon professionals, while BSG targets salons and salons professionals. 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 for the interim period presented. 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, 2021. 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 December 31, 2021 and September 30, 2021, and our consolidated results of operations, consolidated comprehensive income, consolidated statements of stockholders’ equity and our consolidated cash flows for the for the three months ended December 31, 2021 and 2020. Principles of Consolidation The condensed consolidated interim financial statements include all accounts of Sally Beauty Holdings, Inc. and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. All amounts are in U.S. Dollars. 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 our estimated annual effective income tax. Use of Estimates In order to present our financial statements in conformity with GAAP, we are required to make certain estimates and assumptions that impact our interim financial statements and supplementary disclosures. These estimates may use forecasted financial information based on reasonable information available, however are subject to change in the future. Additionally, unknown future impacts of COVID-19 may impact those estimates and assumptions as well. Significant estimates and assumptions are part of our accounting for sales allowances, deferred revenue, valuation of inventory, amortization and depreciation, intangibles and goodwill, and other reserves. We believe these estimates and assumptions are reasonable however they are based on management’s current knowledge of events and actions and changes in facts and circumstances may result in revised estimates, and impact actual results. Impact of COVID-19 Our operating results for the three months ended December 31, 2021, may not be indicative of the results that may be expected for the full fiscal year ending September 30, 2022, in particular as a result of the uncertainty around the continuing effects of the COVID-19 pandemic and its variants on future periods. While trends have been improving, we cannot reasonably predict the effects of the pandemic or expect these positive trends to continue. If we become negatively impacted, we may have to consider adjustments to our strategic plans, inventory, liquidity, operational and capital expenditure plans. Additionally, as the uncertainty of the economy as a result of COVID-19 continues to be prolonged, it may have an impact on our net sales and operations, and may require changes to our reserves including adjustments, write-downs and restructuring charges. 9 2. 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, which are included in accrued liabilities in our condensed balance sheets, for the periods were as follows (in thousands): Three Months Ended December 31, 2021 2020 Beginning Balance $ 16,744 $ 13,947 Loyalty points and gift cards issued but not redeemed, net of estimated breakage 5,842 5,709 Revenue recognized from beginning liability ( 3,509 ) ( 3,476 ) Ending Balance $ 19,077 $ 16,180 See Note 9, Segment Reporting , for additional information regarding the disaggregation of our sales revenue. 3. Fair Value Measurements Financial instruments measured 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 December 31, 2021 September 30, 2021 Financial Assets: Foreign exchange contracts Other current assets Level 2 $ 439 $ — Interest rate caps Other assets Level 2 133 35 Total assets $ 572 $ 35 . Financial Liabilities: Foreign exchange contracts Accrued liabilities Level 2 $ 51 $ — Financial instruments not measured at fair value Carrying amounts and the related estimated fair value of our long-term debt, excluding capital lease obligations and debt issuance costs, are as follows: December 31, 2021 September 30, 2021 (in thousands) Fair Value Hierarchy Level Carrying Value Fair Value Carrying Value Fair Value Long-term debt, excluding capital leases Senior notes Level 1 $ 979,961 $ 1,012,310 $ 979,961 $ 1,019,635 Term loan B Level 2 411,625 410,700 413,000 411,451 Total long-term debt $ 1,391,586 $ 1,423,010 $ 1,392,961 $ 1,431,086 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. The fair value of the senior notes was measured using unadjusted quoted market prices. The fair value of other long-term debt was measured using quoted market prices for similar debt securities in active markets or widely accepted valuation techniques, such as discounted cash flow analyses, using observable inputs, such as market interest rates. 10 4. 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. In July 2021, our Board of Directors approved a term extension of the share repurchase program for the four-year period ending September 30, 2025 . Information related to our shares repurchased and subsequently retired were as follows (in thousands): Three Months Ended December 31, 2021 2020 Number of shares repurchased 3,675 — Total cost of share repurchased $ 75,000 $ — 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, 2021 $ ( 92,154 ) $ ( 2,085 ) $ ( 402 ) $ ( 94,641 ) Other comprehensive income (loss) before reclassification, net of tax ( 4,509 ) ( 114 ) 171 ( 4,452 ) Reclassification to net earnings, net of tax — 392 309 701 Balance at December 31, 2021 $ ( 96,663 ) $ ( 1,807 ) $ 78 $ ( 98,392 ) The tax impact for the changes in other comprehensive (loss) income and the reclassifications to net earnings was not material. 5. Weighted-Average Shares The following table sets forth the reconciliation of basic and diluted weighted-average shares (in thousands): Three Months Ended December 31, 2021 2020 Weighted-average basic shares 111,995 112,475 Dilutive securities: Stock option and stock award programs 1,973 1,353 Weighted-average diluted shares 113,968 113,828 Anti-dilutive options excluded from our computation of diluted shares 2,775 6,009 6. Goodwill and Intangible Assets We considered potential triggering events and determined there were none during the three months ended December 31, 2021. No material impairment losses were recognized in the current or prior periods presented in connection with our goodwill and other intangible assets. Three Months Ended December 31, (in thousands) 2021 2020 Intangible assets amortization expense $ 1,071 $ 1,698 Additionally, during the three months ended December 31, 2021, the decrease in goodwill was primarily from the effects of foreign currency exchange rates of $ 0.9 million. 11 7. Accrued Liabilities Accrued liabilities consist of the following (in thousands): December 31, 2021 September 30, 2021 Compensation and benefits $ 44,946 $ 73,344 Deferred revenue 20,373 18,543 Rental obligations 11,524 10,501 Interest payable 7,978 24,101 Insurance reserves 6,408 5,934 Property and other taxes 2,976 3,853 Operating accruals and other 57,733 69,879 Total accrued liabilities $ 151,938 $ 206,155 8. Derivative Instruments and Hedging Activities During the three months ended December 31, 2021, we did no t purchase or hold any derivative instruments for trading or speculative purposes. See Note 3, 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 December 31, 2021, the notional amount we held through these forwards, based upon exchange rates at December 31, 2021, was as follows (in thousands): Notional Currency Notional Amount Mexican Peso $ 17,759 Euro 12,364 Canadian Dollar 8,090 Total $ 38,213 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 months ended December 31, 2021 and 2020, we recognized a loss of $ 0.3 million and a gain of $ 0.4 million, respectively, into cost of goods sold on our condensed consolidated statements of earnings. Based on December 31, 2021 valuations and exchange rates, we expect to reclassify losses of approximately $ 0.6 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 $ 1.8 million into interest expense, which represents the original value of the expiring caplets. For the three months ended December 31, 2021, we recognized expense of approximately $ 0.4 million into interest expense on our condensed consolidated statements of earnings. The effects of our interest rate caps on our condensed consolidated statements of earnings were not material for the three months ended December 31, 2020. 12 9. Segment Reporting Segment data for the three months ended December 31, 2021 and 2020, is as follows (in thousands): Three Months Ended December 31, 2021 2020 Net sales: Sally Beauty Supply ("SBS") $ 561,530 $ 547,670 Beauty Systems Group ("BSG") 418,721 388,352 Total $ 980,251 $ 936,022 Earnings before provision for income taxes: Segment operating earnings: SBS $ 100,623 $ 95,128 BSG 58,546 48,572 Segment operating earnings 159,169 143,700 Unallocated expenses 45,290 39,146 Restructuring 1,099 232 Consolidated operating earnings 112,780 104,322 Interest expense 20,241 25,978 Earnings before provision for income taxes $ 92,539 $ 78,344 Sales between segments, which are eliminated in consolidation, were not material during the three months ended December 31, 2021 and 2020. Disaggregation of net sales by segment The following tables disaggregate our segment revenues by merchandise category. We have reclassified certain prior year amounts to conform to current year presentation. Three Months Ended December 31, SBS 2021 2020 Hair color 36.8 % 36.0 % Hair care 23.8 % 20.9 % Styling tools and supplies 20.2 % 23.1 % Nail 10.4 % 10.8 % Skin and cosmetics 7.9 % 8.4 % Other beauty items 0.9 % 0.8 % Total 100.0 % 100.0 % Three Months Ended December 31, BSG 2021 2020 Hair color 41.9 % 40.2 % Hair care 39.9 % 39.1 % Styling tools and supplies 10.8 % 12.6 % Skin and cosmetics 3.6 % 3.7 % Nail 3.5 % 4.0 % Other beauty items 0.3 % 0.4 % Total 100.0 % 100.0 % 13 The following tables disaggregate our segment revenue by sales channels: Three Months Ended December 31, SBS 2021 2020 Company-operated stores 94.2 % 93.9 % E-commerce 5.8 % 6.0 % Franchise stores 0.0 % 0.1 % Total 100.0 % 100.0 % Three Months Ended December 31, BSG 2021 2020 Company-operated stores 67.5 % 69.6 % Distributor sales consultants 13.6 % 14.3 % E-commerce 11.7 % 8.5 % Franchise stores 7.2 % 7.6 % Total 100.0 % 100.0 % 14