Sally Beauty Holdings, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 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, 2021. Executive Overview Our financial results in the first quarter of 2022 reflect strong performance across our core categories of color and care as well as our ability to mitigate the current macro environment’s challenges and respond to them effectively. Our company and team of talented associates remain focused on providing first-rate experiences for our customers. We believe that this, coupled with our healthy levels of inventory, position us to meet customer demand and continue executing on our strategic initiatives. To that end, during the quarter we continued making progress on four strategic pillars; leveraging our digital platform, driving loyalty and personalization, delivering product innovation and advancing our supply chain. Highlights for the Three Months Ended December 31, 2021 • Consolidated net sales for the three months ended December 31, 2021, increased $44.2 million, or 4.7%, to $980.3 million, compared to the three months ended December 31, 2020; • Consolidated comparable sales increased 6.1% for the three months ended December 31, 2021, compared to the three months ended December 31, 2020; • Consolidated gross profit for the three months ended December 31, 2021, increased $29.4 million, or 6.2%, to $500.1 million, compared to the three months ended December 31, 2020. Gross margin increased 70 basis points to 51.0% for the three months ended December 31, 2021, compared to the three months ended December 31, 2020; • Consolidated operating earnings for the three months ended December 31, 2021, increased $8.5 million, or 8.1%, to $112.8 million, compared to the three months ended December 31, 2020. Operating margin increased 40 bps to 11.5% for the three months ended December 31, 2021, compared to the three months ended December 31, 2020; • For the three months ended December 31, 2021, our consolidated net earnings increased $11.6 million, or 20.4%, to $68.8 million, compared to the three months ended December 31, 2020; • For the three months ended December 31, 2021, our diluted earnings per share was $0.60 compared to $0.50 for the three months ended December 31, 2020; and • Cash used by operations was $5.7 million for the three months ended December 31, 2021, compared to cash provided by operations of $39.0 million for the three months ended December 31, 2020. Impact of COVID-19 on Our Business During the current quarter, the COVID-19 Omicron variant started to spread globally. Meanwhile, we continued to stay vigilant to developments in compliance and guidance from local and federal authorities, as well as geographical impacts of the virus and its variants. We continue to take decisive actions to protect our customers and associates. As such, we incurred additional costs around COVID-19, including testing in our distribution centers and COVID-19 cleanings during the quarter. While trends in business have been improving, we cannot reasonably predict the effects of new variants or expect these positive trends to continue. Therefore, our future performance may partially depend on impacts of COVID-19 such as widespread infections, labor shortages, global supply chain disruptions, variants of the virus, changes in governmental compliance and availability of vaccines and testing. Refer Item 1A. “Risk Factors” in Part I of our Annual Report on Form 10-K for the fiscal year ended September 30, 2021, for further discussion of the risks and uncertainties pertaining to COVID-19. 15 Global Supply Chain and Inflationary Impact There continues to be volatility in the global supply chain as strong U.S. customer demand, COVID-19 restrictions, and labor shortages in many U.S. ports have caused logistical and delivery challenges specifically with inbound container volume. Shifts in demand have led to longer lead times and delays, and carriers have been faced with increased costs associated with capacity imbalances between Chinese and U.S ports, causing the freight market to increase as well. Due to these events, we have seen an increase in our inbound freight costs and the number of out-of-stock products. Furthermore, the increase in customer demand, along with COVID-19, have created labor shortages in the U.S and caused an increase in labor costs. As a result, we may experience an increase in our compensation costs in order to attract and retain associates. Comparable Sales We have recently launched many digital initiatives to support our omni-channel strategies to provide customers an enhanced shopping experience. As such, we believe that comparable sales is an appropriate performance indicator to measure our sales growth compared to the prior period. O ur comparable sales include sales from stores that have been operating for 14 months or longer as of the last day of a month and e-commerce revenue. Additionally, our comparable sales include sales to franchisees and full service sales. Our comparable sales excludes the effect of changes in foreign exchange rates and sales from stores relocated until 14 months after the relocation. Revenue from acquisitions are excluded from our comparable sales calculation until 14 months after the acquisition. Our calculation of comparable sales might not be the same as other retailers as the calculation varies across the retail industry. 16 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 December 31, 2021 2020 Increase (Decrease) Net sales: SBS $ 561,530 $ 547,670 $ 13,860 2.5 % BSG 418,721 388,352 30,369 7.8 % Consolidated $ 980,251 $ 936,022 $ 44,229 4.7 % Gross profit: SBS $ 328,172 $ 315,811 $ 12,361 3.9 % BSG 171,957 154,913 17,044 11.0 % Consolidated $ 500,129 $ 470,724 $ 29,405 6.2 % Segment gross margin: SBS 58.4 % 57.7 % 70 bps BSG 41.1 % 39.9 % 120 bps Consolidated 51.0 % 50.3 % 70 bps Net earnings: Segment operating earnings: SBS $ 100,623 $ 95,128 $ 5,495 5.8 % BSG 58,546 48,572 9,974 20.5 % Segment operating earnings 159,169 143,700 15,469 10.8 % Unallocated expenses and restructuring (a) 46,389 39,378 7,011 17.8 % Consolidated operating earnings 112,780 104,322 8,458 8.1 % Interest expense 20,241 25,978 (5,737 ) (22.1 )% Earnings before provision for income taxes 92,539 78,344 14,195 18.1 % Provision for income taxes 23,701 21,153 2,548 12.0 % Net earnings $ 68,838 $ 57,191 $ 11,647 20.4 % . Number of stores at end-of-period (including franchises): SBS 3,529 3,645 (116 ) (3.2 )% BSG 1,364 1,384 (20 ) (1.4 )% Consolidated 4,893 5,029 (136 ) (2.7 )% Comparable sales growth (decline) (b) : SBS 4.4 % (3.9 )% 830 bps BSG 8.6 % (6.4 )% 1,500 bps Consolidated 6.1 % (4.9 )% 1,100 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) Our comparable sales include sales from stores that have been operating for 14 months or longer as of the last day of a month and e-commerce revenue. Additionally, our comparable sales include sales to franchisees and full service sales. Our comparable sales excludes the effect of changes in foreign exchange rates and sales from stores relocated until 14 months after the relocation. Revenue from acquisitions are excluded from our comparable sales calculation until 14 months after the acquisition. Prior to fiscal year 2022, we reported Same Store Sales. For fiscal year 2022, we are reporting Comparable Sales, which includes sales to franchisees and full service sales. We have recast prior year amounts to conform to the change. See “Comparable Sales” discussion above for further information. 17 Results of Operations The Three Months Ended December 31, 2021, compared to the Three Months Ended December 31, 2020 Net Sales SBS . The increase in net sales for SBS was primarily driven by the following (in thousands): Comparable sales $ 23,155 Sales outside comparable sales (a) (7,932 ) Foreign currency exchange (1,363 ) Total $ 13,860 (a) Includes stores opened for less than 14 months, net of stores closures The increase in net sales was driven by an increase in comparable sales, reflecting strong customer demand. While store traffic and conversion remained consistent with recent trends, average unit price increased this quarter, led by our color categories. These increases were offset by a decrease in unit volume due to operating fewer stores compared to the same quarter last year. BSG . The increase in net sales for BSG was primarily driven by the following (in thousands): Comparable sales $ 32,268 Sales outside comparable sales (a) (3,144 ) Foreign currency exchange 1,245 Total $ 30,369 (a) Includes stores opened for less than 14 months, net of stores closures The increase in net sales was driven by an increase in comparable sales, primarily due to an increase in average unit prices, salons operating at full capacity during the quarter, as well as strong e-commerce growth. These increases were offset by a decrease in overall unit volume due to operating fewer stores in the current quarter compared to the same quarter last year. Gross Profit SBS . SBS’s gross profit increased for the three months ended December 31, 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 pricing leverage, partially offset by higher distribution and freight costs. BSG . BSG’s gross profit increased for the three months ended December 31, 2021, as a result of an increase in net sales and a higher gross margin. BSG’s gross margin increased primarily as a result of increased pricing leverage and an increase in sales volume from e-commerce customers. Selling, General and Administrative Expenses SBS . SBS’s selling, general and administrative expenses increased $6.9 million, or 3.1%, for the three months ended December 31, 2021. The increase was driven primarily by higher compensation and compensation-related expenses of $11.2 million, driven by general economic inflationary conditions and to international markets re-opening, partially offset by lower delivery expense of $2.4 million, as a result of a change in fulfillment strategy, and lower depreciation and amortization expenses of $2.1 million. BSG . BSG’s selling, general and administrative expenses increased $7.1 million, or 6.6%, for the three months ended December 31, 2021. The increase was driven primarily by higher compensation and compensation-related expenses of $3.0 million, an increase in variable-sales related expense of $1.8 million, higher advertising expenses of $1.0 million and an increase in other operating expenses of $0.8 million. Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, increased $6.1 million, or 15.7%, for the three months ended December 31, 2021, primarily due to higher COVID-19 related expenses and compensation and compensation-related expenses. Restructuring For the three months ended December 31, 2021, restructuring charges in connection with our previously communicated Transformation Plan increased $0.9 million to $1.1 million. 18 Interest Expense The decrease in interest expense is primarily due to the lower outstanding debt principal for the three months ended December 31, 2021 compared to the three months ended December 31, 2020, as a result of the paydown of our senior notes due 2023 and our term loan B fixed tranche during fiscal year 2021. See “Liquidity and Capital Resources” below for additional information. Provision for Income Taxes The effective tax rates were 25.6% and 27.0%, for the three months ended December 31, 2021, and 2020, respectively. The decrease in the effective tax rate was primarily due to the tax impact of share-based compensation which was beneficial in the current year quarter, but detrimental in the prior year quarter. Liquidity and Capital Resources Overview 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) increased $15.1 million, to $733.8 million at December 31, 2021, compared to $718.7 million at September 30, 2021, primarily from increased inventory as a result of restocking to new levels of demand and our risk mitigation strategy to protect against potential, continued supply chain disruptions, partially offset by a decrease in cash and cash equivalents. At December 31, 2021, cash and cash equivalents were $298.1 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 twelve months. We have continued to focus on reducing our debt levels and shares outstanding through repurchases, 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 share repurchases. During the three months ended December 31, 2021, we did not draw funds under our ABL facility. As of December 31, 2021, we had $481.1 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. Share Repurchase Programs During the three months ended December 31, 2021, we repurchased 3.7 million shares of our common stock for $75.0 million. As of December 31, 2021, we had authorization of approximately $651.1 million of additional potential share repurchases remaining under the 2017 Share Repurchase Program. Cash Flows Historically, our primary source of cash has been net funds provided by operating activities and, when necessary, borrowings under our ABL facility. Historically, the primary uses of cash have been for share repurchases, capital expenditures, repayments and servicing of long-term debt and acquisitions. Net Cash (Used) Provided by Operating Activities The $44.7 million decrease in net cash (used) provided by operating activities was driven by an increase in inventory purchases as we increased stocking levels to new demand and our risk mitigation strategy to protect against potential, continued supply chain disruptions, partially offset by an increase in net earnings and the timing of our receivable collections. Net Cash Used by Investing Activities Net cash used by investing activities during the three months ended December 31, 2021, increased $9.2 million to $26.7 million, compared to the three months ended December 31, 2020. This change was primarily a result of additional investments in information technology and store improvements. Net Cash Used by Financing Activities Net cash used by financing activities for the three months ended December 31, 2021, increased $69.9 million to $70.2 million, as a result of share repurchases, partially offset by an increase in stock options exercised. 19 Debt and Guarantor Financial Information At December 31, 2021, we had $1,391.6 million in debt, not including capital leases, unamortized debt issuance costs and debt discounts, in the aggregate, of $9.5 million. Our debt consisted of $980.0 million of senior notes outstanding and a term loan with an outstanding principal balance of $411.6 million. As of December 31, 2021, there were no outstanding borrowings under our ABL facility. We are currently in compliance with the agreements and instruments governing our debt, including our financial covenants. Guarantor Financial Information 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 December 31, 2021 and September 30, 2021 (in thousands): December 31, 2021 September 30, 2021 Inventory $ 782,320 $ 662,802 Intercompany receivable $ - $ 67,337 Current assets $ 1,082,672 $ 1,069,266 Total assets $ 2,199,462 $ 2,198,990 Intercompany payable $ 16,248 $ - Current liabilities $ 432,598 $ 422,137 Total liabilities $ 2,348,793 $ 2,343,946 The following table presents the summarized statement of income information for three months ended December 31, 2021 (in thousands): Net sales $ 788,081 Gross profit $ 405,136 Earnings before provision for income taxes $ 74,557 Net Earnings $ 56,315 Contractual Obligations There have been no material changes outside the ordinary course of our business in any of our contractual obligations since September 30, 2021. Off-Balance Sheet Financing Arrangements At December 31, 2021, and September 30, 2021, 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, 2021. Recent Accounting Pronouncements There have been no recent accounting pronouncements issued that will have a material impact to our business.