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 results in the second quarter of 2022 delivered a solid financial performance with increases in gross margin, net earnings and diluted earnings per share, compared to the same period last year. We achieved all of this despite the ongoing macro-environment challenges surrounding the COVID-19 Omicron variant, supply chain, and inflationary pressures, which have impacted customer behavior and purchasing power. However, by continuing to focus on our four strategic pillars; leveraging our digital platform, driving loyalty and personalization, delivering product innovation and optimizing our supply chain, we believe we are well-positioned to navigate these macro headwinds and continue to drive growth in both of our businesses, retail and professional. Highlights for the Three Months Ended March 31, 2022 • Consolidated net sales for the three months ended March 31, 2022, decreased $14.9 million, or 1.6%, to $911.4 million, compared to the three months ended March 31, 2021; • Consolidated comparable sales increased 0.2% for the three months ended March 31, 2022, compared to the three months ended March 31, 2021; • Consolidated gross profit for the three months ended March 31, 2022, decreased $1.9 million, or 0.4%, to $465.3 million, compared to the three months ended March 31, 2021. Gross margin increased 70 basis points to 51.1% for the three months ended March 31, 2022, compared to the three months ended March 31, 2021; • Consolidated operating earnings for the three months ended March 31, 2022, increased $11.0 million, or 14.5%, to $86.5 million, compared to the three months ended March 31, 2021. Operating margin increased 130 bps to 9.5% for the three months ended March 31, 2022, compared to the three months ended March 31, 2021; • For the three months ended March 31, 2022, our consolidated net earnings increased $8.5 million, or 22.2%, to $46.8 million, compared to the three months ended March 31, 2021; • For the three months ended March 31, 2022, our diluted earnings per share was $0.42 compared to $0.34 for the three months ended March 31, 2021; and • Cash provided by operations was $2.8 million for the three months ended March 31, 2022, compared to cash provided by operations of $92.6 million for the three months ended March 31, 2021. Impact of COVID-19 on Our Business Throughout the current quarter and year we continued to experience disruptions to our business as a result of the COVID-19 pandemic and continued to take certain actions in order to protect our customers and associates. In particular, our store operations were disrupted by the Omicron variant due to employee illnesses primarily in December and January and we continued to incur additional costs associated with testing and vaccinations, disinfectant cleanings in connection with positive cases in stores and support centers, and the write-down of obsolete personal-protective equipment inventory . Due to general labor shortages in the U.S., especially among retail and hourly employees, we have also experienced staffing shortages at our U.S. stores and an increase in our compensation costs in order to attract and retain associates. While the situation has 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 decreased customer in-store traffic, new waves of infection, labor and supply chain disruptions, developing variants, changes in guidance from international and domestic authorities, and availability and timing of vaccines. Refer to Item 1A. “Risk Factors” in our Form 10-K for the fiscal year ended September 30, 2021, for further discussion on the risks and uncertainties created by COVID-19. 15 Global Supply Chain and Inflationary Impact There continues to be volatility in the global supply chain as shipment delays continue to impact ports, inflationary pressures are exacerbated by global political instability, and consumer demand continues to evolve as a lingering effect from the COVID-19 pandemic. In the current quarter we continued to experience elevated distribution costs as these shifts in demand and supply have led to longer lead times and delays, and carriers are faced with increased costs associated with capacity imbalances between ports as well as overall prolonged transportation challenges. Moreover, the war in Ukraine has created additional uncertainty in the global markets, which have seen a rise in fuel prices, and is another factor impacting distribution costs. Due to these events, we have seen an increase in our inbound freight costs and extended inventory in transit times. Inflationary pressures also impacted customer behavior which resulted in lower traffic and conversion in the current quarter. 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 March 31, Six Months Ended March 31, 2022 2021 Increase (Decrease) 2022 2021 Increase (Decrease) Net sales: SBS $ 525,785 $ 542,664 $ (16,879 ) (3.1 )% $ 1,087,315 $ 1,090,334 $ (3,019 ) (0.3 )% BSG 385,602 383,664 1,938 0.5 % 804,323 772,016 32,307 4.2 % Consolidated $ 911,387 $ 926,328 $ (14,941 ) (1.6 )% $ 1,891,638 $ 1,862,350 $ 29,288 1.6 % Gross profit: SBS $ 309,262 $ 317,161 $ (7,899 ) (2.5 )% $ 637,434 $ 632,973 $ 4,461 0.7 % BSG 156,070 150,068 6,002 4.0 % 328,027 304,980 23,047 7.6 % Consolidated $ 465,332 $ 467,229 $ (1,897 ) (0.4 )% $ 965,461 $ 937,953 $ 27,508 2.9 % Segment gross margin: SBS 58.8 % 58.4 % 40 bps 58.6 % 58.1 % 50 bps BSG 40.5 % 39.1 % 140 bps 40.8 % 39.5 % 130 bps Consolidated 51.1 % 50.4 % 70 bps 51.0 % 50.4 % 60 bps Net earnings: Segment operating earnings: SBS $ 80,940 $ 100,063 $ (19,123 ) (19.1 )% $ 181,563 $ 195,191 $ (13,628 ) (7.0 )% BSG 46,008 47,843 (1,835 ) (3.8 )% 104,554 96,415 8,139 8.4 % Segment operating earnings 126,948 147,906 (20,958 ) (14.2 )% 286,117 291,606 (5,489 ) (1.9 )% Unallocated expenses and restructuring (a) 40,487 72,395 (31,908 ) (44.1 )% 86,876 111,773 (24,897 ) (22.3 )% Consolidated operating earnings 86,461 75,511 10,950 14.5 % 199,241 179,833 19,408 10.8 % Interest expense 19,896 23,883 (3,987 ) (16.7 )% 40,137 49,861 (9,724 ) (19.5 )% Earnings before provision for income taxes 66,565 51,628 14,937 28.9 % 159,104 129,972 29,132 22.4 % Provision for income taxes 19,757 13,316 6,441 48.4 % 43,458 34,469 8,989 26.1 % Net earnings $ 46,808 $ 38,312 $ 8,496 22.2 % $ 115,646 $ 95,503 $ 20,143 21.1 % . Number of stores at end-of-period (including franchises): SBS 3,499 3,625 (126 ) (3.5 )% BSG 1,363 1,379 (16 ) (1.2 )% Consolidated 4,862 5,004 (142 ) (2.8 )% Comparable sales growth (decline) (b) : SBS (0.5 )% 3.7 % (420) bps 2.0 % (0.2 )% 220 bps BSG 1.3 % 8.0 % (670) bps 4.9 % 0.2 % 470 bps Consolidated 0.2 % 5.4 % (520) bps 3.2 % (0.1 )% 330 bps (a) Unallocated expenses consist of corporate and shared costs and are included in selling, general and administrative expenses in our condensed 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 March 31, 2022, compared to the Three Months Ended March 31, 2021 Net Sales SBS . The decrease in net sales for SBS was primarily driven by the following (in thousands): Comparable sales $ (2,580 ) Sales outside comparable sales (a) (10,409 ) Foreign currency exchange (3,890 ) Total $ (16,879 ) (a) Includes stores opened for less than 14 months, net of stores closures The decrease in net sales was driven by lower unit volume, primarily due to operating fewer stores compared to the same period last year, lower traffic and conversion due to the impact of COVID-19, supply chain disruptions, the lapping of stimulus gains in the prior year, and inflationary pressures impacting consumer behavior, along with the negative impact of foreign exchange rates. This decrease was partially offset by an increase in average unit prices, led by our color and care categories. BSG . The increase in net sales for BSG was primarily driven by the following (in thousands): Comparable sales $ 4,737 Sales outside comparable sales (a) (2,741 ) Foreign currency exchange (58 ) Total $ 1,938 (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 and from strong e-commerce growth. These increases were offset by a decrease in overall unit volume due to operating fewer stores compared to the same period last year. Gross Profit SBS . SBS’s gross profit decreased for the three months ended March 31, 2022, as a result of a decrease in net sales, partially offset by a higher gross margin. SBS’s gross margin increased primarily as a result of pricing leverage and a decrease in write-downs of obsolete personal-protective equipment, partially offset by higher distribution and freight costs and an unfavorable sales mix shift between the U.S. and international markets. BSG . BSG’s gross profit increased for the three months ended March 31, 2022, driven by an improvement in pricing leverage and a decrease in write-downs of obsolete personal-protective equipment, partially offset by higher distribution and freight costs. Selling, General and Administrative Expenses SBS . SBS’s selling, general and administrative expenses increased $11.2 million, or 5.2%, for the three months ended March 31, 2022. The increase was driven primarily by higher compensation and compensation-related expenses of $8.9 million, driven by general economic inflationary conditions and to store re-openings in certain international markets, as well as higher store facility costs associated with those re-openings. BSG . BSG’s selling, general and administrative expenses increased $7.8 million, or 7.7%, for the three months ended March 31, 2022. The increase was driven primarily by higher delivery expense of $1.9 million as a result of supply chain disruptions and the cost of fuel. Additionally, there were increases in depreciation expense of $1.0 million, credit card fees of $0.9 million and other increases in variable operating expenses. Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, decreased $31.3 million, or 43.6%, for the three months ended March 31, 2022, primarily due to the recognition of $31.2 million donation expense related to personal-protective equipment inventory in the prior period. Interest Expense The decrease in interest expense is primarily due to the lower outstanding debt principal for the three months ended March 31, 2022, as a result of the pay-down of our senior notes due 2023 and our term loan B fixed tranche during fiscal year 2021. Additionally, we recognized $1.4 million of loss on debt extinguishment in connection with the pay-down of our term loan B fixed tranche in the prior period with no comparable amounts in the current period. See “Liquidity and Capital Resources” below for additional information. 18 Provision for Income Taxes The effective tax rates were 29.7% and 25.8%, for the three months ended March 31, 2022, and 2021, respectively. The increase in the effective tax rate was primarily due to the impact of the write-off of deferred tax assets related to share-based compensation in connection with expired stock options. The Six Months Ended March 31, 2022, compared to the Six Months Ended March 31, 2021 Net Sales SBS . The decrease in net sales for SBS was primarily driven by the following (in thousands): Comparable sales $ 20,704 Sales outside comparable sales (a) (18,791 ) Foreign currency exchange (4,932 ) Total $ (3,019 ) (a) Includes stores opened for less than 14 months, net of stores closures The decrease in net sales was driven by lower unit volume, primarily due to operating fewer stores compared to the same period last year, and the negative impact of foreign exchange rates. This decrease was partially offset by an increase in comparable sales, reflecting stronger customer demand in the first fiscal quarter, and higher average unit prices, led by our color and care categories. BSG . The increase in net sales for BSG was primarily driven by the following (in thousands): Comparable sales $ 36,394 Sales outside comparable sales (a) (5,283 ) Foreign currency exchange 1,196 Total $ 32,307 (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 and from strong e-commerce growth. These increases were offset by a decrease in overall unit volume due to operating fewer stores compared to the same period last year. Gross Profit SBS . SBS’s gross profit increased for the six months ended March 31, 2022, as a result of a higher gross margin, primarily due to pricing leverage and a decrease in obsolete personal-protective equipment write-downs, partially offset by higher distribution and freight costs. BSG . BSG’s gross profit increased for the six months ended March 31, 2022, driven by an increase in sales, and improvement of pricing leverage, coupled with a decrease in personal-protective equipment write-downs. Selling, General and Administrative Expenses SBS . SBS’s selling, general and administrative expenses increased $18.1 million, or 4.1%, for the six months ended March 31, 2022. The increase was driven primarily by higher compensation and compensation-related expenses of $18.6 million, as a result of general economic inflationary conditions and store re-openings in certain international markets. BSG . BSG’s selling, general and administrative expenses increased $14.9 million, or 7.1%, for the six months ended March 31, 2022. The increase was driven primarily by an increase in delivery expense of $2.5 million, compensation and compensation-related expenses of $2.3 million, depreciation expense of $1.9 million, advertising expense of $1.6 million, technology expense of $1.1 million and other increases in variable operating expenses. Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, decreased $25.1 million, or 22.7%, for the six months ended March 31, 2022, driven by the recognition of $31.2 million donation expense related to personal-protective equipment inventory in the prior period, partially offset by an increase in information technology expense of $2.7 million. Restructuring For the six months ended March 31, 2022, restructuring charges in connection with our previously communicated Transformation Plan increased $0.2 million, to $1.1 million for the current year. 19 Interest Expense The decrease in interest expense is primarily due to the lower outstanding debt principal for the six months ended March 31, 2022, as a result of the pay-down of our senior notes due 2023 and our term loan B fixed tranche during fiscal year 2021. Additionally, we recognized $1.4 million of loss on debt extinguishment in connection with the pay-down of our term loan B fixed tranche in the prior period with no comparable amounts in the current period. See “Liquidity and Capital Resources” below for additional information. Provision for Income Taxes The effective tax rates were 27.3% and 26.5%, for the six months ended March 31, 2022 and 2021, respectively. The increase in the effective tax rate was primarily due to an increase in foreign losses, for which we do not receive a tax benefit, and the write-off of deferred tax assets related to share-based compensation in connection with expired stock option awards. 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 $8.7 million, to $727.4 million at March 31, 2022, compared to $718.7 million at September 30, 2021, primarily from increased inventory as a result of restocking to normal levels of demand following prior year shipping delays, and our risk mitigation strategy to protect against potential, continued supply chain disruptions, and the reduction in accounts payable and accrued liabilities, due to the timing of payments. These increases were partially offset by a decrease in cash and cash equivalents. At March 31, 2022, cash and cash equivalents were $227.4 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), cash 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 six months ended March 31, 2022, we did not draw funds under our ABL facility. As of March 31, 2022, 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 six months ended March 31, 2022, we repurchased 6.8 million shares of our common stock for $130.3 million with existing cash balances. As of March 31, 2022, we had authorization of approximately $595.8 million of additional potential share repurchases remaining under our 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 $134.3 million decrease in operating activities was driven by the reduction in accounts payable and accrued liabilities primarily due to the timing of payments, partially offset by lower inventory purchases compared to the six months ended March 31, 2021 and an increase in net earnings. Net Cash Used by Investing Activities Net cash used by investing activities during the six months ended March 31, 2022, increased $15.1 million to $44.4 million, compared to the six months ended March 31, 2021. This change was primarily a result of additional investments in information technology and store improvements. 20 Net Cash Used by Financing Activities Net cash used by financing activities for the six months ended March 31, 2022, decreased $84.7 million to $126.5 million, as a result of the debt pay-down during the six months ended March 31, 2021 and an increase in stock options exercised, partially offset by share repurchases during the six months ended March 31, 2022. Debt and Guarantor Financial Information At March 31, 2022, we had $1,390.2 million in debt, not including capital leases, unamortized debt issuance costs and debt discounts, in the aggregate, of $8.6 million. Our debt consisted of $980.0 million of senior notes outstanding and a term loan with an outstanding principal balance of $410.3 million. As of March 31, 2022, 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 We currently have 5.625% Senior Notes due 2025 outstanding . These notes were issued by our wholly-owned subsidiaries, Sally Holdings LLC and Sally Capital Inc. (the “Issuers”), and registered with the Securities and Exchange Commission 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 March 31, 2022 and September 30, 2021 (in thousands): March 31, 2022 September 30, 2021 Inventory $ 735,272 $ 662,802 Intercompany receivable $ - $ 67,337 Current assets $ 976,855 $ 1,069,266 Total assets $ 2,098,588 $ 2,198,990 Intercompany payable $ 13,531 $ - Current liabilities $ 331,459 $ 422,137 Total liabilities $ 2,258,947 $ 2,343,946 The following table presents the summarized statement of income information for six months ended March 31, 2022 (in thousands): Net sales $ 1,532,316 Gross profit $ 787,970 Earnings before provision for income taxes $ 132,691 Net Earnings $ 98,176 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 March 31, 2022, 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.