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) March 31, 2022 September 30, 2021 (Unaudited) Assets Current assets: Cash and cash equivalents $ 227,413 $ 400,959 Trade accounts receivable, net 28,615 32,623 Accounts receivable, other 32,100 33,958 Inventory 962,563 871,349 Other current assets 50,990 44,686 Total current assets 1,301,681 1,383,575 Property and equipment, net of accumulated depreciation of $ 800,715 at March 31, 2022, and $ 767,403 at September 30, 2021 287,855 307,377 Operating lease assets 540,801 537,673 Goodwill 539,682 541,209 Intangible assets, excluding goodwill, net of accumulated amortization of $ 40,528 at March 31, 2022, and $ 38,957 at September 30, 2021 52,994 55,532 Other assets 19,990 21,766 Total assets $ 2,743,003 $ 2,847,132 Liabilities and Stockholders’ Equity Current liabilities: Current maturities of long-term debt $ 182 $ 194 Accounts payable 240,594 291,632 Accrued liabilities 170,540 206,155 Current operating lease liabilities 160,549 156,234 Income taxes payable 2,404 10,666 Total current liabilities 574,269 664,881 Long-term debt 1,381,385 1,382,530 Long-term operating lease liabilities 406,658 404,147 Other liabilities 16,547 29,056 Deferred income tax liabilities, net 92,278 85,777 Total liabilities 2,471,137 2,566,391 Stockholders’ equity: Common stock, $ 0.01 par value. Authorized 500,000 shares; 107,003 and 113,138 shares issued and 106,930 and 112,913 shares outstanding at March 31, 2022, and September 30, 2021, respectively 1,069 1,129 Preferred stock, $ 0.01 par value. Authorized 50,000 shares; none issued — — Additional paid-in capital — 17,286 Accumulated earnings 372,265 356,967 Accumulated other comprehensive loss, net of tax ( 101,468 ) ( 94,641 ) Total stockholders’ equity 271,866 280,741 Total liabilities and stockholders’ equity $ 2,743,003 $ 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 Six Months Ended March 31, March 31, 2022 2021 2022 2021 Net sales $ 911,387 $ 926,328 $ 1,891,638 $ 1,862,350 Cost of goods sold 446,055 459,099 926,177 924,397 Gross profit 465,332 467,229 965,461 937,953 Selling, general and administrative expenses 378,871 391,087 765,121 757,257 Restructuring — 631 1,099 863 Operating earnings 86,461 75,511 199,241 179,833 Interest expense 19,896 23,883 40,137 49,861 Earnings before provision for income taxes 66,565 51,628 159,104 129,972 Provision for income taxes 19,757 13,316 43,458 34,469 Net earnings $ 46,808 $ 38,312 $ 115,646 $ 95,503 Earnings per share: Basic $ 0.43 $ 0.34 $ 1.05 $ 0.85 Diluted $ 0.42 $ 0.34 $ 1.03 $ 0.84 Weighted-average shares: Basic 108,743 112,603 110,387 112,538 Diluted 110,540 114,342 112,207 114,028 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 Six Months Ended March 31, March 31, 2022 2021 2022 2021 Net earnings $ 46,808 $ 38,312 $ 115,646 $ 95,503 Other comprehensive (loss) income: Foreign currency translation adjustments ( 2,752 ) ( 7,890 ) ( 7,261 ) 17,117 Interest rate caps, net of tax - - 278 175 Foreign exchange contracts, net of tax ( 324 ) 574 156 ( 1,020 ) Other comprehensive (loss) income, net of tax ( 3,076 ) ( 7,316 ) ( 6,827 ) 16,272 Total comprehensive income $ 43,732 $ 30,996 $ 108,819 $ 111,775 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 loss — — — — ( 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 Net earnings — — — 46,808 — 46,808 Other comprehensive loss — — — — ( 3,076 ) ( 3,076 ) Share-based compensation — — 2,032 — — 2,032 Stock issued for equity awards 111 1 423 — — 424 Employee withholding taxes paid related to net share settlement ( 1 ) — ( 15 ) — — ( 15 ) Repurchases and cancellations of common stock ( 3,157 ) ( 32 ) ( 2,440 ) ( 52,856 ) — ( 55,328 ) Balance at March 31, 2022 106,930 $ 1,069 $ — $ 372,265 $ ( 101,468 ) $ 271,866 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 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 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) Six Months Ended March 31, 2022 2021 Cash Flows from Operating Activities: Net earnings $ 115,646 $ 95,503 Adjustments to reconcile net earnings to net cash (used) provided by operating activities: Depreciation and amortization 48,471 52,945 Share-based compensation expense 5,990 5,541 Amortization of deferred financing costs 1,865 2,326 Loss on early extinguishment of debt — 1,390 Loss on disposal of equipment and other property 80 1,741 Deferred income taxes 6,507 ( 365 ) Changes in (exclusive of effects of acquisitions): Trade accounts receivable 3,800 ( 3,437 ) Accounts receivable, other 2,108 ( 5,544 ) Inventory ( 95,468 ) ( 127,324 ) Other current assets ( 6,273 ) 3,588 Other assets 1,979 ( 4,307 ) Operating leases, net 3,657 ( 2,420 ) Accounts payable and accrued liabilities ( 70,217 ) 101,331 Income taxes payable ( 8,393 ) 13,447 Other liabilities ( 12,525 ) ( 2,859 ) Net cash (used) provided by operating activities ( 2,773 ) 131,556 Cash Flows from Investing Activities: Payments for property and equipment, net of proceeds ( 44,109 ) ( 27,095 ) Acquisitions, net of cash acquired ( 318 ) ( 2,245 ) Net cash used by investing activities ( 44,427 ) ( 29,340 ) Cash Flows from Financing Activities: Repayments of long-term debt ( 2,841 ) ( 213,271 ) Payments for common stock repurchased ( 130,328 ) — Proceeds from equity awards 7,796 2,322 Employee withholding taxes paid related to net share settlement of equity awards ( 1,151 ) ( 249 ) Net cash used by financing activities ( 126,524 ) ( 211,198 ) Effect of foreign exchange rate changes on cash and cash equivalents 178 3,152 Net decrease in cash and cash equivalents ( 173,546 ) ( 105,830 ) Cash and cash equivalents, beginning of period 400,959 514,151 Cash and cash equivalents, end of period $ 227,413 $ 408,321 Supplemental Cash Flow Information: Interest paid $ 37,809 $ 46,445 Income taxes paid $ 56,701 $ 20,791 Capital expenditures incurred but not paid $ 3,205 $ 3,255 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 March 31, 2022 and September 30, 2021, and our consolidated results of operations, consolidated comprehensive income, consolidated statements of stockholders’ equity for the three and six months ended March 31, 2022 and 2021 and our consolidated cash flows for the for the six months ended March 31, 2022 and 2021. 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 and six months ended March 31, 2022, were adversely impacted by the COVID-19 pandemic and its continuing effects on the economy, including inflationary pressures, continued supply chain disruptions, increased freight costs, labor shortages and increased labor costs. Given the uncertainty around the continuing effects of the COVID-19 pandemic and its economic impact we cannot reasonably predict the effect they will have on future periods. If we become materially and adversely impacted, we may have to consider adjustments to our strategic plans, inventory, liquidity, operational and capital expenditure plans. 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. 9 Changes to our contract liabilities, which are included in accrued liabilities in our condensed balance sheets, for the periods were as follows (in thousands): Six Months Ended March 31, 2022 2021 Beginning Balance $ 16,744 $ 13,947 Loyalty points and gift cards issued but not redeemed, net of estimated breakage 6,214 7,998 Revenue recognized from beginning liability ( 6,316 ) ( 6,729 ) Ending Balance $ 16,642 $ 15,216 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 March 31, 2022 September 30, 2021 Financial Assets: Foreign exchange contracts Other current assets Level 2 $ 329 $ — Interest rate caps Other assets Level 2 133 35 Total assets $ 462 $ 35 . Financial Liabilities: Foreign exchange contracts Accrued liabilities Level 2 $ 612 $ — 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: March 31, 2022 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 $ 1,000,636 $ 979,961 $ 1,019,635 Term loan B Level 2 410,250 405,122 413,000 411,451 Total long-term debt $ 1,390,211 $ 1,405,758 $ 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. 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 . As of March 31, 2022, we had authorization of approximately $ 595.8 million of additional potential share repurchases remaining under our share repurchase program. Information related to our shares repurchased and subsequently retired were as follows (in thousands): Three Months Ended March 31, Six Months Ended March 31, 2022 2021 2022 2021 Number of shares repurchased 3,157 — 6,832 — Total cost of share repurchased $ 55,328 $ — $ 130,328 $ — 10 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 loss before reclassification, net of tax ( 7,261 ) ( 114 ) ( 212 ) ( 7,587 ) Reclassification to net earnings, net of tax — 392 368 760 Balance at March 31, 2022 $ ( 99,415 ) $ ( 1,807 ) $ ( 246 ) $ ( 101,468 ) The tax impact for the changes in other comprehensive loss 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 March 31, Six Months Ended March 31, 2022 2021 2022 2021 Weighted-average basic shares 108,743 112,603 110,387 112,538 Dilutive securities: Stock option and stock award programs 1,797 1,739 1,820 1,490 Weighted-average diluted shares 110,540 114,342 112,207 114,028 Anti-dilutive options excluded from our computation of diluted shares 2,534 4,197 2,169 4,222 6. Goodwill and Intangible Assets During the three months ended March 31, 2022, 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. Three Months Ended March 31, Six Months Ended March 31, (in thousands) 2022 2021 2022 2021 Intangible assets amortization expense $ 999 $ 1,609 $ 2,070 $ 3,307 Additionally, during the six months ended March 31, 2022, the decrease in goodwill was primarily from the effects of foreign currency exchange rates of $ 1.5 million. 7. Accrued Liabilities Accrued liabilities consist of the following (in thousands): March 31, 2022 September 30, 2021 Compensation and benefits $ 55,300 $ 73,344 Interest payable 24,103 24,101 Deferred revenue 18,410 18,543 Rental obligations 10,754 10,501 Insurance reserves 5,962 5,934 Property and other taxes 2,293 3,853 Operating accruals and other 53,718 69,879 Total accrued liabilities $ 170,540 $ 206,155 11 8. Derivative Instruments and Hedging Activities During the six months ended March 31, 2022, 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 March 31, 2022, we held forwards, which expire ratably through September 30, 2022 , with a notional amount, based upon exchange rates at March 31, 2022, as follows (in thousands): Notional Currency Notional Amount Mexican Peso $ 13,013 Euro 8,551 Canadian Dollar 5,804 Total $ 27,368 Quarterly, the changes in fair value related to the foreign currency forwards are recorded into AOCL. As the forwards are exercised, the realized value is recognized into cost of goods sold, based on inventory turns, in our condensed consolidated statements of earnings. For the six months ended March 31, 2022 and 2021, we recognized a loss of $ 0.4 million and a gain of $ 0.4 million, respectively. The effects of our foreign currency forwards were not material for the three months ended March 31, 2022 and 2021. Based on March 31, 2022 valuations and exchange rates, we expect to reclassify losses of approximately $ 0.1 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. For the six months ended March 31, 2022 and 2021, we recognized expense of $ 0.4 million and $ 0.2 million, respectively, 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 March 31, 2022 and 2021. Over the next 12 months, we expect to reclassify approximately $ 1.9 million into interest expense, which represents the original value of the expiring caplets. 12 9. Segment Reporting Segment data for the three and six months ended March 31, 2022 and 2021, is as follows (in thousands): Three Months Ended March 31, Six Months Ended March 31, 2022 2021 2022 2021 Net sales: Sally Beauty Supply ("SBS") $ 525,785 $ 542,664 $ 1,087,315 $ 1,090,334 Beauty Systems Group ("BSG") 385,602 383,664 804,323 772,016 Total $ 911,387 $ 926,328 $ 1,891,638 $ 1,862,350 Earnings before provision for income taxes: Segment operating earnings: SBS $ 80,940 $ 100,063 $ 181,563 $ 195,191 BSG 46,008 47,843 104,554 96,415 Segment operating earnings 126,948 147,906 286,117 291,606 Unallocated expenses 40,487 71,764 85,777 110,910 Restructuring — 631 1,099 863 Consolidated operating earnings 86,461 75,511 199,241 179,833 Interest expense 19,896 23,883 40,137 49,861 Earnings before provision for income taxes $ 66,565 $ 51,628 $ 159,104 $ 129,972 Sales between segments, which are eliminated in consolidation, were not material during the three and six months ended March 31, 2022 and 2021. 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 March 31, Six Months Ended March 31, SBS 2022 2021 2022 2021 Hair color 38.1 % 35.8 % 37.4 % 35.9 % Hair care 24.1 % 21.7 % 24.0 % 21.4 % Styling tools and supplies 19.2 % 22.8 % 19.7 % 22.9 % Nail 10.6 % 10.7 % 10.5 % 10.8 % Skin and cosmetics 7.4 % 8.3 % 7.7 % 8.3 % Other beauty items 0.6 % 0.7 % 0.7 % 0.7 % Total 100.0 % 100.0 % 100.0 % 100.0 % Three Months Ended March 31, Six Months Ended March 31, BSG 2022 2021 2022 2021 Hair color 42.7 % 42.6 % 42.4 % 41.4 % Hair care 39.9 % 38.8 % 39.9 % 39.0 % Styling tools and supplies 11.2 % 11.2 % 11.3 % 11.8 % Skin and cosmetics 3.5 % 4.0 % 4.0 % 4.3 % Nail 2.3 % 2.9 % 2.1 % 3.1 % Other beauty items 0.4 % 0.5 % 0.3 % 0.4 % Total 100.0 % 100.0 % 100.0 % 100.0 % 13 The following tables disaggregate our segment revenue by sales channels: Three Months Ended March 31, Six Months Ended March 31, SBS 2022 2021 2022 2021 Company-operated stores 93.7 % 93.0 % 94.0 % 93.5 % E-commerce 6.3 % 6.9 % 6.0 % 6.5 % Franchise stores 0.0 % 0.1 % 0.0 % 0.0 % Total 100.0 % 100.0 % 100.0 % 100.0 % Three Months Ended March 31, Six Months Ended March 31, BSG 2022 2021 2022 2021 Company-operated stores 66.6 % 70.2 % 67.1 % 69.9 % Distributor sales consultants 14.0 % 13.7 % 13.8 % 14.0 % E-commerce 12.4 % 9.1 % 12.0 % 8.8 % Franchise stores 7.0 % 7.0 % 7.1 % 7.3 % Total 100.0 % 100.0 % 100.0 % 100.0 % 10. Subsequent Event On April 29, 2022, we announced that our wholly-owned subsidiaries, Sally Holdings LLC (“Holdings”) and Sally Capital Inc. (together with Holdings, the “Issuers”), issued a notice of redemption (the “Redemption Notice”), to redeem on May 31, 2022, the entire $ 300.00 million aggregate principal amount of the 8.750 % Senior Secured Second Lien Notes due 2025 (“Notes”) which remain outstanding. The redemption is being made pursuant to the terms of the Indenture dated April 24, 2020, at a redemption price equal to 104.375 % of the principal amount of the Notes plus accrued but unpaid interest to, but not including, the redemption date. 14