Sally Beauty Holdings, Inc. 10-Q

Item 1. Financial Statements. SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (In thousands, except par value data) December 31, 2022 September 30, 2022 (Unaudited) Assets Current assets: Cash and cash equivalents $ 99,071 $ 70,558 Trade accounts receivable, net 32,671 34,102 Accounts receivable, other 42,741 38,175 Inventory 986,878 936,374 Other current assets 57,840 53,192 Total current assets 1,219,201 1,132,401 Property and equipment, net of accumulated depreciation of $ 849,202 at December 31, 2022, and $ 820,811 at September 30, 2022 288,732 297,876 Operating lease assets 542,806 532,177 Goodwill 532,514 526,066 Intangible assets, excluding goodwill, net of accumulated amortization of $ 28,820 at December 31, 2022, and $ 26,794 at September 30, 2022 50,963 50,315 Other assets 34,330 38,032 Total assets $ 2,668,546 $ 2,576,867 Liabilities and Stockholders’ Equity Current liabilities: Current maturities of long-term debt $ 65,171 $ 68,658 Accounts payable 296,170 275,717 Accrued liabilities 142,785 161,065 Current operating lease liabilities 156,168 157,734 Income taxes payable 16,972 4,740 Total current liabilities 677,266 667,914 Long-term debt 1,082,175 1,083,043 Long-term operating lease liabilities 427,168 424,762 Other liabilities 22,748 22,427 Deferred income tax liabilities, net 85,891 85,085 Total liabilities 2,295,248 2,283,231 Stockholders’ equity: Common stock, $ 0.01 par value. Authorized 500,000 shares; 107,291 and 107,024 shares issued and 107,284 and 106,970 shares outstanding at December 31, 2022, and September 30, 2022, respectively 1,073 1,070 Preferred stock, $ 0.01 par value. Authorized 50,000 shares; none issued — — Additional paid-in capital 8,329 4,241 Accumulated earnings 490,509 440,172 Accumulated other comprehensive loss, net of tax ( 126,613 ) ( 151,847 ) Total stockholders’ equity 373,298 293,636 Total liabilities and stockholders’ equity $ 2,668,546 $ 2,576,867 The accompanying notes are an integral part of these condensed consolidated financial statements. 4 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Earnings (In thousands, except per share data) (Unaudited) Three Months Ended December 31, 2022 2021 Net sales $ 957,055 $ 980,251 Cost of goods sold 468,481 480,122 Gross profit 488,574 500,129 Selling, general and administrative expenses 391,580 386,250 Restructuring 10,406 1,099 Operating earnings 86,588 112,780 Interest expense 17,923 20,241 Earnings before provision for income taxes 68,665 92,539 Provision for income taxes 18,328 23,701 Net earnings $ 50,337 $ 68,838 Earnings per share: Basic $ 0.47 $ 0.61 Diluted $ 0.46 $ 0.60 Weighted-average shares: Basic 107,140 111,995 Diluted 109,460 113,968 The accompanying notes are an integral part of these condensed consolidated financial statements. 5 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Comprehensive Income (In thousands) (Unaudited) Three Months Ended December 31, 2022 2021 Net earnings $ 50,337 $ 68,838 Other comprehensive income (loss): Foreign currency translation adjustments 25,941 ( 4,509 ) Interest rate caps, net of tax 203 278 Foreign exchange contracts, net of tax ( 910 ) 480 Other comprehensive income (loss), net of tax 25,234 ( 3,751 ) Total comprehensive income $ 75,571 $ 65,087 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, 2022 106,970 $ 1,070 $ 4,241 $ 440,172 $ ( 151,847 ) $ 293,636 Net earnings — — — 50,337 — 50,337 Other comprehensive income — — — — 25,234 25,234 Share-based compensation — — 5,135 — — 5,135 Stock issued for equity awards 404 4 78 — — 82 Employee withholding taxes paid related to net share settlement ( 90 ) ( 1 ) ( 1,125 ) — — ( 1,126 ) Balance at December 31, 2022 107,284 $ 1,073 $ 8,329 $ 490,509 $ ( 126,613 ) $ 373,298 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 The accompanying notes are an integral part of these condensed consolidated financial statements. 7 SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (In thousands) (Unaudited) Three Months Ended December 31, 2022 2021 Cash Flows from Operating Activities: Net earnings $ 50,337 $ 68,838 Adjustments to reconcile net earnings to net cash provided (used) by operating activities: Depreciation and amortization 25,285 24,421 Share-based compensation expense 5,135 3,958 Amortization of deferred financing costs 648 932 Impairment of long-lived assets, including operating lease assets 2,103 — Loss on disposal of equipment and other property 77 3 Deferred income taxes 889 1,867 Changes in (exclusive of effects of acquisitions): Trade accounts receivable 2,270 2,841 Accounts receivable, other ( 3,817 ) ( 1,724 ) Inventory ( 38,019 ) ( 137,326 ) Other current assets ( 4,018 ) ( 446 ) Other assets 4,074 1,371 Operating leases, net ( 10,392 ) 6,475 Accounts payable and accrued liabilities 7,606 16,729 Income taxes payable 12,460 18,166 Other liabilities 313 ( 11,790 ) Net cash provided (used) by operating activities 54,951 ( 5,685 ) Cash Flows from Investing Activities: Payments for property and equipment, net of proceeds ( 25,007 ) ( 26,390 ) Acquisitions, net of cash acquired — ( 319 ) Net cash used by investing activities ( 25,007 ) ( 26,709 ) Cash Flows from Financing Activities: Proceeds from issuance of long-term debt 229,000 — Repayments of long-term debt, including prepayment costs ( 233,927 ) ( 1,421 ) Payments for common stock repurchased — ( 75,000 ) Proceeds from equity awards 60 7,372 Employee withholding taxes paid related to net share settlement of equity awards ( 1,125 ) ( 1,136 ) Net cash used by financing activities ( 5,992 ) ( 70,185 ) Effect of foreign exchange rate changes on cash and cash equivalents 4,561 ( 240 ) Net increase (decrease) in cash and cash equivalents 28,513 ( 102,819 ) Cash and cash equivalents, beginning of period 70,558 400,959 Cash and cash equivalents, end of period $ 99,071 $ 298,140 Supplemental Cash Flow Information: Interest paid $ 26,758 $ 35,034 Income taxes paid $ 3,081 $ 3,978 Capital expenditures incurred but not paid $ 5,542 $ 3,594 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 Basis of Presentation The unaudited condensed consolidated interim financial statements of Sally Beauty Holdings, Inc. and its subsidiaries 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, 2022. In the opinion of management, these unaudited condensed consolidated interim financial statements reflect all adjustments that are of a normal recurring nature and which are necessary to present fairly our consolidated financial position as of December 31, 2022, and September 30, 2022, and our consolidated results of operations, consolidated comprehensive income, consolidated cash flows and consolidated statements of stockholders’ equity for the three months ended December 31, 2022 and 2021. Principles of Consolidation The unaudited 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. 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. 9 2. Revenue Recognition Substantially all of our revenue is derived through the sale of merchandise at the point-of-sale. Revenue is recognized net of estimated sales returns and sales taxes. We estimate sales returns based on historical data. Changes to our contract liabilities, which are included in accrued liabilities in our condensed consolidated balance sheets, for the periods were as follows (in thousands): Three Months Ended December 31, 2022 2021 Beginning Balance $ 13,460 $ 16,744 Loyalty points and gift cards issued but not redeemed, net of estimated breakage 6,291 5,842 Revenue recognized from beginning liability ( 4,489 ) ( 3,509 ) Ending Balance $ 15,262 $ 19,077 See Note 10, Segment Reporting , for additional information regarding the disaggregation of our sales revenue. 3. Fair Value Measurements We measure on a recurring basis and disclose the fair value of our financial instruments under the provisions of ASC Topic 820, Fair Value Measurement, as amended (“ASC 820”). We define “fair value” as the price that would be received to sell an asset or paid to transfer a liability (i.e., the exit price) in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level hierarchy for measuring fair value and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. This valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date. The three levels of that hierarchy are defined as follows: Level 1 - Quoted prices are available in active markets for identical assets or liabilities; Level 2 - Pricing inputs are other than quoted prices in active markets, included in Level 1, that are either directly or indirectly observable; and Level 3 - Unobservable pricing inputs in which little or no market activity exists, therefore requiring an entity to develop its own model with estimates and assumptions. Financial instruments measured at fair value on recurring basis Consistent with the fair value hierarchy, we categorized our financial assets and liabilities as follow: (in thousands) Classification Fair Value Hierarchy Level December 31, 2022 September 30, 2022 Financial Assets: Foreign exchange contracts Non-designated cash flow hedges Other current assets Level 2 $ 4,463 $ 294 Interest rate caps Other current assets Level 2 3,627 3,860 Total assets $ 8,090 $ 4,154 . Financial Liabilities: Foreign exchange contracts Designated cash flow hedges Accrued liabilities Level 2 $ 1,930 $ — Non-designated cash flow hedges Accrued liabilities Level 2 4,045 79 Total liabilities $ 5,975 $ 79 The fair value for interest rate caps and foreign exchange contracts were measured using widely accepted valuation techniques, such as discounted cash flow analyses and observable inputs, such as market interest rates and foreign exchange rates. 10 Other fair value disclosures The carrying amounts of cash equivalents, trade and other accounts receivable and accounts payable and borrowing under our ABL facility approximate their respective fair values due to the short-term nature of these financial instruments. Carrying amounts and the related estimated fair value of our long-term debt, excluding capital lease obligations and debt issuance costs, are as follows: December 31, 2022 September 30, 2022 (in thousands) Fair Value Hierarchy Level Carrying Value Fair Value Carrying Value Fair Value Long-term debt, excluding capital leases Senior notes Level 1 $ 679,961 $ 652,763 $ 679,961 $ 639,163 Term loan B Level 2 406,125 403,587 407,500 398,331 Total long-term debt $ 1,086,086 $ 1,056,350 $ 1,087,461 $ 1,037,494 The fair value of term loan B 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 (“Board”) approved a share repurchase program authorizing us 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 approved a term extension of the share repurchase program for the four-year period ending September 30, 2025 . As of December 31, 2022, we had authorization of approximately $ 595.8 million of additional potential share repurchases remaining under our share repurchase program. For the three months ended December 31, 2022, we did no t repurchase shares under our share repurchase program. For the three months ended December 31, 2021, we repurchased 3.7 million shares of common stock at a total cost of $ 75.0 million. Accumulated Other Comprehensive Income (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, 2022 $ ( 153,128 ) $ 1,960 $ ( 679 ) $ ( 151,847 ) Other comprehensive income (loss) before reclassification, net of tax 25,941 155 ( 608 ) 25,488 Reclassification to net earnings, net of tax — 48 ( 302 ) ( 254 ) Balance at December 31, 2022 $ ( 127,187 ) $ 2,163 $ ( 1,589 ) $ ( 126,613 ) 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 December 31, 2022 2021 Weighted-average basic shares 107,140 111,995 Dilutive securities: Stock option and stock award programs 2,320 1,973 Weighted-average diluted shares 109,460 113,968 Anti-dilutive options excluded from our computation of diluted shares 2,123 2,775 6. Goodwill and Intangible Assets W e considered potential triggering events and determined there were none for the three months ended December 31, 2022. No material impairment losses were recognized in the current or prior periods presented in connection with our goodwill and other intangible assets. 11 Three Months Ended December 31, (in thousands) 2022 2021 Intangible assets amortization expense $ 1,008 $ 1,071 Additionally, during the three months ended December 31, 2022, the changes in goodwill and other intangibles were primarily from the effects of foreign currency exchange rates of $ 6.4 million and $ 1.7 million, respectively. During the three months ended December 31, 2021, the changes in goodwill were primarily from the effects of foreign currency exchange rates of $ 0.9 million. 7. Accrued Liabilities Accrued liabilities consist of the following (in thousands): December 31, 2022 September 30, 2022 Compensation and benefits $ 46,027 $ 58,693 Deferred revenue 20,384 18,810 Rental obligations 14,353 10,701 Insurance reserves 6,104 5,742 Property and other taxes 4,266 4,161 Interest payable 3,865 13,445 Operating accruals and other 47,786 49,513 Total accrued liabilities $ 142,785 $ 161,065 8. Short-term Borrowings and Long-term Debt At December 31, 2022, our ABL facility had $ 65.0 million in outstanding borrowings and $ 417.7 million available for borrowing, including the Canadian sub-facility, subject to the conditions contained therein. 9. Derivative Instruments and Hedging Activities During the three months ended December 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 forecasted inventory purchases in U.S. dollars by our foreign subsidiaries. At December 31, 2022, we held forwards, which expire ratably through September 30, 2023 , with a notional amount, based upon exchange rates at December 31, 2022, as follows (in thousands): Notional Currency Notional Amount Mexican Peso $ 17,629 Euro 11,549 Canadian Dollar 8,921 Total $ 38,099 Quarterly, the changes in fair value related to these 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 three months ended December 31, 2022 and 2021, we recognized a gain of $ 0.3 million and a loss of $ 0.3 million, respectively. Based on December 31, 2022, valuations and exchange rates, we expect to reclassify losses of approximately $ 1.6 million into cost of goods sold over the next 12 months. Interest Rate Caps In July 2017, we purchased two interest rate caps with an initial aggregate notional amount of $ 550 million (the “interest rate caps”) to mitigate the exposure to higher interest rates in connection with our term loan B. The interest rate caps are comprised of individual caplets that expire ratably through June 30, 2023 , and are designated as cash flow hedges. Accordingly, changes in fair value of the interest rate caps are recorded quarterly, net of income tax, and are included in AOCL. For the three months ended December 31, 2022 and 2021, we recognized expense of $ 0.1 million and $ 0.4 million, respectively, into interest expense on our condensed consolidated statements of earnings. Over the next 12 months, we expect to reclassify gains of 12 approximately $ 2.6 million into interest expense, which represents estimated interest rate settlements less the original value of the expiring caplets. Non-Designated Derivative Instruments We also use foreign exchange contracts to mitigate our exposure to exchange rate changes in connection with certain intercompany balances not permanently invested. At December 31, 2022, we held forwards, which expire on various dates in the first month of both the second and third fiscal quarters of fiscal year 2023, with a notional amount, based upon exchange rates at December 31, 2022, as follows (in thousands): Notional Currency Notional Amount British Pound $ 87,321 Canadian Dollar 56,329 Euro 56,269 Mexican Peso 23,865 Total $ 223,784 We record changes in fair value and realized gains or losses related to these foreign currency forwards into selling, general and administrative expenses. For the three months ended December 31, 2022 and 2021, the effects of these foreign exchange contracts on our condensed consolidated financial statements were gains of $ 0.4 million in both years. 10. Segment Reporting Segment data for the three months ended December 31, 2022 and 2021, is as follows (in thousands): Three Months Ended December 31, 2022 2021 Net sales: Sally Beauty Supply ("SBS") $ 549,472 $ 561,530 Beauty Systems Group ("BSG") 407,583 418,721 Total $ 957,055 $ 980,251 Earnings before provision for income taxes: Segment operating earnings: SBS $ 99,174 $ 100,623 BSG 49,647 58,546 Segment operating earnings 148,821 159,169 Unallocated expenses 51,827 45,290 Restructuring 10,406 1,099 Consolidated operating earnings 86,588 112,780 Interest expense 17,923 20,241 Earnings before provision for income taxes $ 68,665 $ 92,539 Sales between segments, which are eliminated in consolidation, were not material during the three months ended December 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 within BSG to conform to current year presentation. Three Months Ended December 31, SBS 2022 2021 Hair color 38.7 % 36.8 % Hair care 23.4 % 23.8 % Styling tools and supplies 19.5 % 20.2 % Nail 10.3 % 10.4 % Skin and cosmetics 7.4 % 7.9 % Other beauty items 0.7 % 0.9 % Total 100.0 % 100.0 % 13 Three Months Ended December 31, BSG 2022 2021 Hair care 43.5 % 43.5 % Hair color 38.3 % 38.4 % Styling tools and supplies 10.8 % 11.4 % Skin and cosmetics 4.4 % 4.4 % Nail 2.7 % 2.0 % Other beauty items 0.3 % 0.3 % Total 100.0 % 100.0 % The following tables disaggregate our segment revenue by sales channels: Three Months Ended December 31, SBS 2022 2021 Company-operated stores 93.6 % 94.2 % E-commerce 6.4 % 5.8 % Total 100.0 % 100.0 % Three Months Ended December 31, BSG 2022 2021 Company-operated stores 66.3 % 67.5 % E-commerce 13.6 % 11.7 % Distributor sales consultants 12.6 % 13.6 % Franchise stores 7.5 % 7.2 % Total 100.0 % 100.0 % 11. Restructuring Restructuring expenses, included in Cost of Goods Sold (“COGS”) and Restructuring for the three months ended December 31, 2022 and 2021 are as follows (in thousands): Three Months Ended December 31, 2022 2021 Included in COGS Distribution Center Consolidation and Store Optimization Plan $ ( 2,680 ) (a) $ — Included in Restructuring Distribution Center Consolidation and Store Optimization Plan $ 10,406 (b) $ — Transformation Plan — 1,099 Total in Restructuring 10,406 1,099 Total Restructuring Expenses $ 7,726 $ 1,099 (a) Amounts included within COGS are related to adjustments to our expected obsolescence reserve related to the Plan (as defined below). (b) Amounts included within Restructuring (SG&A) are related to stores and distribution centers closed during the quarter in accordance with the Plan (as defined below). Distribution Center Consolidation and Store Optimization Plan In the fourth quarter of fiscal year 2022, our Board approved the Distribution Center Consolidation and Store Optimization Plan authorizing the closure of 330 SBS stores and 35 BSG stores, and the closure of two BSG distribution centers in Clackamas, Oregon and Pottsville, Pennsylvania (“the Plan”). During the three months ended December 31, 2022, we completed the closure of the two BSG distributions centers. We believe that consolidating the operation of these two distribution centers into our larger distribution centers will increase product availability, shorten delivery times and reduce overall costs. 14 As of December 31, 2022, we have closed 327 SBS stores and 14 BSG stores as part of the Plan. Stores identified for early closure were part of a strategic evaluation which included a market analysis of certain locations where we believe we will be able to recapture demand at other nearby store locations and improve overall profitability. By optimizing our store base, we are further focusing on our customers’ shopping experience and our product offerings. The Plan will continue to be executed throughout fiscal year 2023 and into the first half of fiscal year 2024, and therefore it may include future charges related to store closures such as exit costs, lease negotiation penalties, termination benefits and adjustments to estimates. The liability related to the Plan, which is included in accrued liabilities on our consolidated balance sheets, is as follows: (in thousands) Liability at September 30, 2022 SBS Expense BSG Expense Cash Payments Non-Cash Amounts Liability at December 31, 2022 Closing costs - leases (a) $ — $ 4,738 $ 132 $ — $ ( 868 ) $ 4,002 Closing costs - payroll expenses (b) — 988 961 — — 1,949 Impairment - property and equipment (c) — 1,069 610 — ( 1,679 ) — Inventory transfer costs — 1,128 204 ( 294 ) — 1,038 Impairment - operating lease assets (c) — 345 83 — ( 428 ) — Other 1,291 102 46 ( 1,351 ) — 88 Total $ 1,291 $ 8,370 $ 2,036 $ ( 1,645 ) $ ( 2,975 ) $ 7,077 (a) Lease-related closing costs include contract terminations costs as well as other rental obligations associated with closing stores. (b) Payroll-related closing costs include one-time termination benefits related to the closure of our distribution centers as well as other payroll expenses associated with closing stores. (c) Remaining carrying value for the long-lived assets, including operating lease assets, were not material and approximate their fair value. 15