Item 2. Management’s Discussion and Analysis
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
In the third quarter of fiscal year 2022, we delivered solid gross margin growth in both segments compared to the same period last year. Additionally during the quarter, we repaid the entire $300 million dollar balance on our 8.75% Senior Notes and continued to invest for growth through many of our initiatives, despite volatile market conditions and its impact on our topline performance. With a healthy balance sheet, a strong operating infrastructure and the loyalty of our core customers, we believe we are well positioned to continue navigating the macro-environment and remain focused on our four strategic pillars: leveraging our digital platform, driving loyalty and personalization, delivering product innovation and optimizing our supply chain.
Financial Summary for the Three Months Ended June 30, 2022
•
Consolidated net sales for the three months ended June 30, 2022, decreased $60.9 million, or 6.0%, to $961.5 million, compared to the three months ended June 30, 2021. Consolidated net sales included a negative impact from changes in foreign currency exchange rates of $13.0 million;
•
Consolidated comparable sales decreased 3.6% for the three months ended June 30, 2022, compared to the three months ended June 30, 2021;
•
Consolidated gross profit for the three months ended June 30, 2022, decreased $24.2 million, or 4.7%, to $490.2 million, compared to the three months ended June 30, 2021. Gross margin increased 70 basis points to 51.0% for the three months ended June 30, 2022, compared to the three months ended June 30, 2021;
•
Consolidated operating earnings for the three months ended June 30, 2022, decreased $28.2 million, or 22.1%, to $99.2 million, compared to the three months ended June 30, 2021. Operating margin decreased 220 bps to 10.3% for the three months ended June 30, 2022, compared to the three months ended June 30, 2021;
•
For the three months ended June 30, 2022, our consolidated net earnings decreased $29.6 million, or 38.9%, to $46.6 million, compared to the three months ended June 30, 2021;
•
For the three months ended June 30, 2022, our diluted earnings per share was $0.43 compared to $0.66 for the three months ended June 30, 2021;
•
Cash provided by operations was $52.0 million for the three months ended June 30, 2022, compared to $86.2 million for the three months ended June 30, 2021; and
•
During the period, we redeemed the entire outstanding principal amount of our 8.75% Senior Notes at a redemption price equal to 104.375%. As a result, we recorded a loss on debt extinguishment of $16.4 million within interest expense on our condensed consolidated statements of earnings.
15
Trends Impacting Our Business
Global inflationary pressures continue to impact consumer spending behavior and the cost for products and services. Moreover, there is still volatility in the global supply chain, while freight carriers are faced with higher fuel prices. During the current quarter and fiscal year, these headwinds have resulted in lower traffic and conversion in our business and increases in certain operating costs, including inbound freight and delivery expenses. Additionally, due to general labor shortages in the U.S. during the year, especially among retail and hourly employees, we have experienced an increase in our compensation costs in order to attract and retain associates. We continue to monitor these challenges and implement measures to help mitigate their impacts, including managing our inventory levels to reduce out-of-stock items, adjusting our promotional activities, optimizing our store base and expanding our partnerships with delivery service providers. Although these initiatives have helped mitigate ongoing macro-headwinds we cannot reasonably predict the long-term effects of inflation and supply chain disruptions.
In a measure to curb inflation, the U.S. Federal Reserve has continued to increase the federal funds effective rate. In turn, these increases have raised the cost of debt borrowings. We currently have approximately $575.9 million in variable rate debt, with $408.9 million hedged with interest rate caps to help mitigate the impact of raising rates. Future increases in the federal funds effective rate could have a material adverse impact to our cost of debt, including any future changes in our debt structure.
Impact of COVID-19 on Our Business
During the fiscal year, we experienced disruptions to our business as a result of the COVID-19 pandemic and we continue to take certain actions in order to protect our customers and associates. In particular, our store operations continue to face challenges and disruptions related to COVID-19 surges and spikes in infection levels. While the situation has shown signs of stabilization, we cannot reasonably predict the effects of new variants or expect improving trends to continue. Therefore, our future performance may partially depend on impacts of COVID-19 such as decreased customer in-store traffic, temporary store closures, and continued labor and supply chain disruptions.
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.
Comparable Sales
The Company’s initiative to invest in our digital platforms 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, 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
June 30,
Nine Months Ended
June 30,
2022
2021
Increase (Decrease)
2022
2021
Increase (Decrease)
Net sales:
SBS
$
551,725
$
602,681
$
(50,956
)
(8.5
)%
$
1,639,040
$
1,693,015
$
(53,975
)
(3.2
)%
BSG
409,742
419,706
(9,964
)
(2.4
)%
1,214,065
1,191,722
22,343
1.9
%
Consolidated
$
961,467
$
1,022,387
$
(60,920
)
(6.0
)%
$
2,853,105
$
2,884,737
$
(31,632
)
(1.1
)%
Gross profit:
SBS
$
322,815
$
349,167
$
(26,352
)
(7.5
)%
$
960,249
$
982,139
$
(21,890
)
(2.2
)%
BSG
167,393
165,239
2,154
1.3
%
495,420
470,220
25,200
5.4
%
Consolidated
$
490,208
$
514,406
$
(24,198
)
(4.7
)%
$
1,455,669
$
1,452,359
$
3,310
0.2
%
Segment gross margin:
SBS
58.5
%
57.9
%
60
bps
58.6
%
58.0
%
60
bps
BSG
40.9
%
39.4
%
150
bps
40.8
%
39.5
%
130
bps
Consolidated
51.0
%
50.3
%
70
bps
51.0
%
50.3
%
70
bps
Net earnings:
Segment operating earnings:
SBS
$
88,792
$
116,784
$
(27,992
)
(24.0
)%
$
270,355
$
311,975
$
(41,620
)
(13.3
)%
BSG
56,067
55,265
802
1.5
%
160,621
151,680
8,941
5.9
%
Segment operating earnings
144,859
172,049
(27,190
)
(15.8
)%
430,976
463,655
(32,679
)
(7.0
)%
Unallocated expenses and restructuring (a)
45,656
44,632
1,024
2.3
%
132,532
156,405
(23,873
)
(15.3
)%
Consolidated operating earnings
99,203
127,417
(28,214
)
(22.1
)%
298,444
307,250
(8,806
)
(2.9
)%
Interest expense
35,977
23,452
12,525
53.4
%
76,113
73,313
2,800
3.8
%
Earnings before provision for income taxes
63,226
103,965
(40,739
)
(39.2
)%
222,331
233,937
(11,606
)
(5.0
)%
Provision for income taxes
16,659
27,759
(11,100
)
(40.0
)%
60,117
62,228
(2,111
)
(3.4
)%
Net earnings
$
46,567
$
76,206
$
(29,639
)
(38.9
)%
$
162,214
$
171,709
$
(9,495
)
(5.5
)%
.
Number of stores at end-of-period (including franchises):
SBS
3,468
3,611
(143
)
(4.0
)%
BSG
1,361
1,367
(6
)
(0.4
)%
Consolidated
4,829
4,978
(149
)
(3.0
)%
Comparable sales growth (decline) (b) :
SBS
(5.0
)%
43.1
%
(4,810)
bps
(0.5
)%
11.8
%
(1,235)
bps
BSG
(1.6
)%
43.0
%
(4,460)
bps
2.6
%
12.0
%
(941)
bps
Consolidated
(3.6
)%
43.1
%
(4,670)
bps
0.8
%
11.9
%
(1,110)
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 June 30, 2022, compared to the Three Months Ended June 30, 2021
Net Sales
SBS . The decrease in net sales for SBS was primarily driven by the following (in thousands):
Comparable sales
$
(28,522
)
Sales outside comparable sales (a)
(10,568
)
Foreign currency exchange
(11,866
)
Total
$
(50,956
)
(a)
Includes stores opened for less than 14 months, net of stores closures
The decrease in SBS’s net sales was driven by lower comparable sales, the negative impact from foreign exchange rates and the impact of closed stores. SBS’s comparable sales decrease was driven by fewer transactions as a result of lower store traffic, while the average ticket was relatively unchanged, resulting from lower average unit volume offset by higher average unit retail prices, led by our color and care categories.
BSG . The decrease in net sales for BSG was primarily driven by the following (in thousands):
Comparable sales
$
(6,597
)
Sales outside comparable sales (a)
(2,185
)
Foreign currency exchange
(1,182
)
Total
$
(9,964
)
(a)
Includes stores opened for less than 14 months, net of stores closures
The decrease in BSG’s net sales was primarily due to lower comparable sales, the impact of closed stores and the negative impact from the Canadian foreign exchange rate. BSG’s comparable sales was driven by fewer transactions as a result of lower store traffic, partially offset by an increase in average ticket, resulting from higher average unit retail prices, led by color, care and styling tools categories, partially offset by lower unit volume.
Gross Profit
SBS . SBS’s gross profit decreased for the three months ended June 30, 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 an improvement in pricing leverage, partially offset by higher distribution and freight costs.
BSG . BSG’s gross profit increased for the three months ended June 30, 2022, driven by an improvement in pricing leverage, partially offset by higher distribution and freight costs.
Selling, General and Administrative Expenses
SBS . SBS’s selling, general and administrative expenses increased $1.6 million, or 0.7%, for the three months ended June 30, 2022. The increase was driven by higher compensation and compensation-related expenses of $5.4 million, resulting from higher wages within general labor markets, and higher information technology expenses of $1.2 million, partially offset by the favorable impact of foreign exchange rates of $4.6 million.
BSG . BSG’s selling, general and administrative expenses increased $1.4 million, or 1.2%, for the three months ended June 30, 2022. The increase was driven primarily by higher delivery expense of $1.3 million as a result of increased fuel prices
Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, increased $1.5 million, or 3.4%, for the three months ended June 30, 2022, primarily due to higher information technology expense.
Interest Expense
The increase in interest expense is primarily due to the repayment of our 8.75% Senior Notes, which resulted in a loss from debt extinguishment of $16.4 million from an early call premium of $13.1 million and the write-off of unamortized debt issuance costs of $3.3 million in the current quarter. This increase was partially offset by the interest savings of $2.3 million from the repayment of the 8.75% Senior Notes. See “Liquidity and Capital Resources” below for additional information.
Provision for Income Taxes
The effective tax rates were 26.3% and 26.7%, for the three months ended June 30, 2022, and 2021, respectively.
18
The Nine Months Ended June 30, 2022, compared to the Nine Months Ended June 30, 2021
Net Sales
SBS . The decrease in net sales for SBS was primarily driven by the following (in thousands):
Comparable sales
$
(7,818
)
Sales outside comparable sales (a)
(29,027
)
Foreign currency exchange
(17,130
)
Total
$
(53,975
)
(a)
Includes stores opened for less than 14 months, net of stores closures
The decrease in SBS’s net sales was driven by the impact of store closures, the negative impact of foreign exchange rates and lower comparable sales. SBS’s comparable sales were lower due to fewer transactions, impacted by lower traffic, and a lower average ticket, resulting from lower average unit volume, partially offset by higher average unit retail 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
$
29,797
Sales outside comparable sales (a)
(7,468
)
Foreign currency exchange
14
Total
$
22,343
(a)
Includes stores opened or acquired for less than 14 months, net of stores closures
The increase in BSG’s net sales was driven by higher comparable sales, partially offset by the impact of closed stores. BSG’s comparable sales increase was driven by a higher average ticket, resulting from higher average unit retail prices, led by color, care and styling tools categories, partially offset by lower average unit volume.
Gross Profit
SBS . SBS’s gross profit decreased for the nine months ended June 30, 2022, driven by a decrease in sales, partially offset by a higher gross margin. SBS’s gross margin increase was driven by improvement of pricing leverage and fewer 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, resulting from the closing of certain international operations in the prior year due to COVID-19.
BSG . BSG’s gross profit increased for the nine months ended June 30, 2022, driven by an increase in sales and a higher gross margin. BSG’s gross margin increase was driven by improvement of pricing leverage and fewer write-downs of personal-protective equipment during the current year, partially offset by higher distribution and freight costs.
Selling, General and Administrative Expenses
SBS . SBS’s selling, general and administrative expenses increased $19.7 million, or 2.9%, for the nine months ended June 30, 2022. The increase was driven by higher compensation and compensation-related expenses of $17.5 million, as a result of higher wages within general labor markets and store re-openings in certain international markets, and the unfavorable impact from foreign exchange rates of $7.1 million. These headwinds were partially offset by lower delivery expenses of $2.9 million, as a result of lower e-commerce sales, and lower facility costs of $2.2 million, as a result of operating fewer stores.
BSG . BSG’s selling, general and administrative expenses increased $16.3 million, or 5.1%, for the nine months ended June 30, 2022. The increase was driven by higher delivery expense of $3.8 million, depreciation and amortization of $3.5 million, advertising expense of $2.1 million, credit card fees of $1.4 million, utility expenses of $1.0 million and compensation and compensation-related expenses of $0.9 million.
Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, decreased $23.6 million, or 15.3%, for the nine months ended June 30, 2022, as a result of lower COVID-19 expenses of $26.4 million, including the impact of $31.2 million in donation expense in the prior year, partially offset by higher information technology expense of $3.4 million.
Interest Expense
The increase in interest expense is primarily due to the repayment of our 8.75% Senior Notes, which resulted in a loss from debt extinguishment of $16.4 million during the nine months ended June 30, 2022, compared to loss from debt extinguishment of $4.3 million related to our repayment of our senior notes due 2023 and our term loan B fixed tranche during the prior period. This was partially offset by the interest savings in connection with these repayments for $10.2 million during the fiscal year. See “Liquidity and Capital Resources” below for additional information.
19
Provision for Income Taxes
The effective tax rates were 27.0% and 26.6%, for the nine months ended June 30, 2022 and 2021, respectively.
Liquidity and Capital Resources
Overview
Our capital structure contains a mix of debt and equity, and a substantial portion of our liquidity needs arise from 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 $250.5 million, to $468.2 million at June 30, 2022, compared to $718.7 million at September 30, 2021. This decrease was driven by the repayment of our 8.75% Senior Notes through the use of excess cash and additional borrowing on our ABL facility. Additionally, cash was further reduced by stock repurchases during the fiscal year. The decrease to working capital was partially offset by higher inventory as a result of the inflationary cost increases on our purchases and additional inventory relating to BSG's distribution partnership with Regis to service their salons account.
At June 30, 2022, cash and cash equivalents were $101.3 million. 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 nine months ended June 30, 2022, the weighted average interest rate on our borrowings under the ABL facility was 2.9%. As of June 30, 2022, we had $167.0 million outstanding and $314.2 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 nine months ended June 30, 2022, we repurchased 6.8 million shares of our common stock for $130.3 million with existing cash balances. As of June 30, 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 Provided by Operating Activities
Net cash provided by operating activities during the nine months ended June 30, 2022, decreased $168.5 million to $49.2 million, compared to the nine months ended June 30, 2021. This decrease was driven by the reduction in our accrued liabilities, primarily due to the timing of personal-protective equipment donations and a lower bonus accrual, as well as higher inventory purchases compared to the nine months ended June 30, 2021.
Net Cash Used by Investing Activities
Net cash used by investing activities during the nine months ended June 30, 2022, increased $20.7 million to $67.9 million, compared to the nine months ended June 30, 2021. This was driven by additional investments in technology and store leasehold improvements.
Net Cash Used by Financing Activities
Net cash used by financing activities for the nine months ended June 30, 2022, decreased $142.7 million to $273.8 million, as a result of lower net debt repayments during the fiscal year, compared to prior fiscal year, partially offset by share repurchases during the nine months ended June 30, 2022.
Debt and Guarantor Financial Information
At June 30, 2022, we had $1,255.8 million in debt, not including capital leases, unamortized debt issuance costs and debt discounts, in the aggregate, of $4.7 million. Our debt consisted of $680.0 million in senior notes outstanding, $408.9 million remaining on our term loan and $167.0 million in outstanding borrowings under our ABL facility. During the fiscal year, we called and redeemed our 8.75%
20
Senior Notes, at a redemption price equal to 104.375% of the principal amount , through a combination of excess cash and 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 June 30, 2022, and September 30, 2021 (in thousands):
June 30, 2022
September 30, 2021
Inventory
$
790,561
$
662,802
Intercompany receivable
$
—
$
67,337
Current assets
$
920,021
$
1,069,266
Total assets
$
2,061,778
$
2,198,990
Intercompany payable
$
15,168
$
—
Current liabilities
$
653,989
$
422,137
Total liabilities
$
2,178,657
$
2,343,946
The following table presents the summarized statement of income information for nine months ended June 30, 2022 (in thousands):
Net sales
$
2,317,150
Gross profit
$
1,193,543
Earnings before provision for income taxes
$
184,505
Net Earnings
$
137,808
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, except for the repayment of our 8.75% Senior Notes and the additional ABL borrowings. In connection with these events, our contractual obligations contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021, should be adjusted as follows (in thousands):
Payments Due by Period
Less than 1 year
1-3 years
3 - 5 years
More than 5 years
Total
Long-term debt obligations, including interest
$
122,186
$
(20,540
)
$
(339,375
)
$
—
$
(237,729
)
Off-Balance Sheet Financing Arrangements
At June 30, 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.
21
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.