UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended JUNE 30, 2019
-OR-
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 1-33145
SALLY BEAUTY HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware
36-2257936
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
3001 Colorado Boulevard
Denton, Texas
76210
(Address of principal executive offices)
(Zip Code)
(940) 898-7500
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report): N/A
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading SymbolName of each exchange on which registered
Common Stock, $0.01 par valueSBHThe New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes ☐ No ☒
As of July 26, 2019, there were 120,543,133 shares of the issuer’s common stock outstanding.
TABLE OF CONTENTS
Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
4
Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
28
Item 3. Quantitative And Qualitative Disclosures About Market Risk
33
Item 4. Controls And Procedures
34
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
35
Item 1A. Risk Factors
Item 6. Exhibits
36
2
In this Quarterly Report, references to “the Company,” “Sally Beauty,” “our company,” “we,” “our,” “ours” and “us” refer to Sally Beauty Holdings, Inc. and its consolidated subsidiaries unless otherwise indicated or the context otherwise requires.
cautionary notice regarding forward-looking statements
Statements in this Quarterly Report on Form 10-Q and in the documents incorporated by reference herein which are not purely historical facts or which depend upon future events may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which we refer to as the Exchange Act. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” or similar expressions may also identify such forward-looking statements.
Readers are cautioned not to place undue reliance on forward-looking statements, as such statements speak only as of the date they were made and involve risks and uncertainties that could cause actual events or results to differ materially from the events or results described in the forward-looking statements. The most important risks, uncertainties and other factors which could cause our actual results to differ from our forward-looking statements are set forth in our description of risk factors in Item 1A contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2018, which should be read in conjunction with the forward-looking statements in this report. Additional risks and uncertainties may also be discussed in this quarterly report and the other reports we file with the SEC. Forward-looking statements speak only as of the date they are made, and we do not undertake any obligation to update any forward-looking statement.
The events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. As a result, our actual results may differ materially from the results contemplated by these forward-looking statements.
3
Item 1. Financial Statements.
The following condensed consolidated balance sheets as of June 30, 2019 and September 30, 2018, the condensed consolidated statements of earnings, condensed consolidated statements of comprehensive income, and the condensed statements of stockholders’ deficit for the three and nine months ended June 30, 2019 and 2018, and the condensed consolidated statements of cash flows for the nine months ended June 30, 2019 and 2018 are those of Sally Beauty Holdings, Inc. and its subsidiaries.
SALLY BEAUTY HOLDINGS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In thousands, except par value data)
(Unaudited)
June 30,
2019
September 30,
2018
Assets
Current assets:
Cash and cash equivalents
$
57,855
77,295
Trade accounts receivable, net
44,680
48,417
Accounts receivable, other
52,316
42,073
Inventory
967,744
944,338
Other current assets
37,853
42,960
Total current assets
1,160,448
1,155,083
Property and equipment, net of accumulated depreciation of $652,839 at
June 30, 2019 and $611,021 at September 30, 2018
292,371
308,357
Goodwill
533,963
535,925
Intangible assets, excluding goodwill, net of accumulated amortization of
$140,739 at June 30, 2019 and $132,724 at September 30, 2018
65,442
72,698
Other assets
20,047
25,351
Total assets
2,072,271
2,097,414
Liabilities and Stockholders’ Deficit
Current liabilities:
Current maturities of long-term debt
21,002
5,501
Accounts payable
272,629
303,241
Accrued liabilities
146,209
180,287
Income taxes payable
1,214
2,144
Total current liabilities
441,054
491,173
Long-term debt
1,589,663
1,768,808
Other liabilities
25,709
30,022
Deferred income tax liabilities, net
86,310
75,967
Total liabilities
2,142,736
2,365,970
Stockholders’ deficit:
Common stock, $0.01 par value. Authorized 500,000 shares; 120,565 and
120,145 shares issued and 120,130 and 119,926 shares outstanding at
June 30, 2019 and September 30, 2018, respectively
1,201
1,199
Preferred stock, $0.01 par value. Authorized 50,000 shares; none issued
—
Additional paid-in capital
9,513
Accumulated earnings (deficit)
22,852
(179,764
)
Accumulated other comprehensive loss, net of tax
(104,031
(89,991
Total stockholders’ deficit
(70,465
(268,556
Total liabilities and stockholders’ deficit
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
Condensed Consolidated Statements of Earnings
(In thousands, except per share data)
Three Months Ended
Nine Months Ended
Net sales
975,169
996,283
2,910,474
2,966,568
Cost of goods sold
492,947
502,913
1,479,222
1,500,247
Gross profit
482,222
493,370
1,431,252
1,466,321
Selling, general and administrative expenses
360,183
378,598
1,088,797
1,118,345
Restructuring
1,908
12,544
74
24,513
Operating earnings
120,131
102,228
342,381
323,463
Interest expense
25,781
24,501
74,092
73,779
Earnings before provision for income taxes
94,350
77,727
268,289
249,684
Provision for income taxes
23,186
19,501
65,673
46,823
Net earnings
71,164
58,226
202,616
202,861
Earnings per share:
Basic
0.59
0.48
1.69
1.63
Diluted
1.68
1.62
Weighted average shares:
120,119
120,901
120,062
124,331
120,977
121,673
120,928
125,111
6
Condensed Consolidated Statements of Comprehensive Income
(In thousands)
Other comprehensive income (loss):
Foreign currency translation adjustments
834
(22,168
(9,591
(11,986
Interest rate caps, net of tax
586
308
(4,384
1,815
Foreign exchange contracts, net of tax
103
(65
Other comprehensive income (loss), net of tax
1,523
(21,860
(14,040
(10,171
Total comprehensive income
72,687
36,366
188,576
192,690
7
Condensed Consolidated Statements of Cash Flows
Nine Months Ended June 30,
Cash Flows from Operating Activities:
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Depreciation and amortization
80,425
81,428
Share-based compensation expense
7,728
8,237
Amortization of deferred financing costs
2,894
2,842
Loss on extinguishment of debt
951
876
Gain on disposal of equipment and other property
(6,557
Deferred income taxes
12,095
(25,132
Changes in (exclusive of effects of acquisitions):
Trade accounts receivable
3,361
(2,171
(10,641
(914
(28,283
(24,119
4,687
12,973
(1,195
341
Accounts payable and accrued liabilities
(59,105
10,180
(926
801
(4,227
13,727
Net cash provided by operating activities
203,823
281,930
Cash Flows from Investing Activities:
Payments for property and equipment
(66,763
(62,190
Proceeds from sale of property and equipment
12,021
19
Acquisitions, net of cash acquired
(2,763
(9,175
Net cash used by investing activities
(57,505
(71,346
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt
394,004
369,319
Repayments of long-term debt
(561,162
(401,222
Debt issuance costs
(1,151
Payments for common stock repurchased
(164,838
Proceeds from exercises of stock options
1,787
1,317
Net cash used by financing activities
(165,371
(196,575
Effect of foreign exchange rate changes on cash and cash equivalents
(387
(913
Net (decrease) increase in cash and cash equivalents
(19,440
13,096
Cash and cash equivalents, beginning of period
63,759
Cash and cash equivalents, end of period
76,855
Supplemental Cash Flow Information:
Interest paid
82,903
83,344
Income taxes paid
62,852
53,559
Capital expenditures incurred but not paid
3,116
3,264
8
Condensed Consolidated Statements of Stockholders’ Deficit
Accumulated
Additional
Other
Total
Common Stock
Paid-in
Earnings
Treasury
Comprehensive
Stockholders’
Shares
Amount
Capital
(Deficit)
Stock
Loss
Deficit
Balance at September 30, 2018
119,926
65,727
Other comprehensive loss
(16,705
Share-based compensation
3,354
Stock issued for stock options
115
1
1,448
1,449
Balance at December 31, 2018
120,041
1,200
4,802
(114,037
(106,696
(214,731
65,725
Other comprehensive income
1,142
2,517
66
271
272
Balance at March 31, 2019
120,107
7,590
(48,312
(105,554
(145,075
1,857
23
Balance at June 30, 2019
120,130
Balance at September 30, 2017
129,585
1,296
(283,076
(81,836
(363,616
83,264
(1,058
Repurchases and cancellations of
common stock
(3,848
(39
(3,386
(61,187
(64,612
3,111
62
275
276
Balance at December 31, 2017
125,799
1,258
(260,999
(82,894
(342,635
61,371
12,747
(2,899
(29
(3,573
(46,484
(50,086
2,738
102
835
836
Balance at March 31, 2018
123,002
1,230
(246,112
(70,147
(315,029
(3,157
(32
(2,593
(47,515
(50,140
2,387
37
206
207
Balance at June 30, 2018
119,882
(235,401
(92,007
(326,209
9
Sally Beauty Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
1. 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 are adequate to make the information not misleading. 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, 2018. 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 June 30, 2019 and September 30, 2018, our consolidated results of operations, consolidated comprehensive income and consolidated statements of stockholders’ deficit for the three and nine months ended June 30, 2019 and 2018, and our consolidated cash flows for nine months ended June 30, 2019 and 2018.
Certain amounts for the prior year have been conformed to the current year’s presentation.
2. Significant 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 estimated annual effective income tax rates.
3. Accounting Changes and Recent Accounting Pronouncements
Accounting Changes
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU No. 2014-09”), which introduced new guidance that established how an entity should measure revenue in connection with its sale of goods and services to a customer based on the consideration to which the entity expects to be entitled in exchange for each of those goods and services. On October 1, 2018, we adopted ASU No. 2014-09 using the modified retrospective transition method. Additionally, in connection with the adoption, we designed changes to our internal control procedures and updated processes to ensure appropriate recognition and presentation of financial information. This adoption did not have a material effect on our consolidated financial statements or on our internal controls over financial reporting. We do not believe that the adoption will have a material effect on our consolidated financial statements on an ongoing basis. The comparative periods continue to be presented under the accounting standards in effect during those periods.
In connection with the adoption of ASU No. 2014-09, we now present our sales returns allowance on a gross basis rather than a net liability basis. As such, we recognize a return asset from the right to recover merchandise from customers (included in other current assets) and a return liability from the amount to be returned to the customer (included in accrued liabilities) within our consolidated balance sheets. Additionally, we now recognize revenue for our gift cards not expected to be redeemed (“gift card breakage”) within revenue in our consolidated statements of earnings.
The following tables set forth the impact of adopting this standard on our condensed consolidated balance sheets as of June 30, 2019 and our condensed consolidated statements of earnings for the three and nine months ended June 30, 2019 (in thousands):
Effect of ASU No. 2014-09 Adoption on Condensed Consolidated Balance Sheet
Excluding
ASU No. 2014-09
As reported
Effect
35,214
2,639
143,570
10
Effect of ASU No. 2014-09 Adoption on Condensed Consolidated Statement of Earnings
For the three months ended June 30, 2019
Net Sales
975,099
70
Gross Profit
482,152
360,113
For the nine months ended June 30, 2019
2,910,229
245
1,431,007
1,088,552
See note 4, Revenue Recognition, for additional information related to ASU No. 2014-09.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, Leases, which will require most leases to be reported on the balance sheet as a right-of-use asset and a lease liability. Under the new guidance, the lease liability must be measured initially based on the present value of future lease payments, subject to certain conditions. The right-of-use asset must be measured initially based on the amount of the liability, plus certain initial direct costs. The new guidance further requires that leases be classified at inception as either (a) operating leases or (b) finance leases. For operating leases, periodic expense will generally be flat (straight-line) throughout the life of the lease. For finance leases, periodic expense will decline (similar to capital leases under prior rules) over the life of the lease. The new standard must be adopted using a modified retrospective transition method, but companies can adopt using the effective date method or the comparative method. For public companies, this standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. We will adopt this pronouncement on October 1, 2019 using the effective date method.
We have completed a preliminary assessment of the potential impact of adopting ASU No. 2016-02 on our consolidated financial statements. At June 30, 2019, adoption of ASU No. 2016-02 would have resulted in recognition of a right-of-use asset in the estimated amount of approximately $525.0 million and a lease liability for a similar amount on our consolidated balance sheet. We are currently in the final stages of implementing changes to our processes, controls and systems and expect to be compliant upon required adoption of the new standard. We do not believe adoption of ASU No. 2016-02 will have a material impact on our consolidated results of operations or consolidated cash flows. The amount of the right-of-use asset and the lease liability we ultimately recognize may materially differ from this preliminary estimate, including as a result of future organic growth in our business, changes in interest rates, and potential acquisitions.
4. Revenue Recognition
Substantially all of our revenue is derived through the sale of merchandise. Revenue is recognized net of estimated sales returns and sales taxes. We estimate sales returns based on historical data. Additionally, we have assessed all revenue streams for principal versus agent considerations and have concluded we are the principal for all transactions.
See Note 13, Business Segments, for additional information regarding the disaggregation of our sales revenue.
Merchandise Revenues
The majority of our revenue comes from the sale of products in our company-operated stores. These sales generally have one single performance obligation and the revenue is recognized at the point of sale. However, discounts and incentives issued at the point of sale to entice a customer to a future purchase are treated as a separate performance obligation. As such, we allocate a portion of the revenue generated from the point of sale to each of the additional performance obligations separately using explicitly stated amounts or our best estimate using historical data.
We also sell merchandise on our online platforms, to our franchisees and by using distributor sales consultants. These sales generally have one single performance obligation and revenue is recognized upon the shipment of the merchandise. Any shipping and handling
11
fees charged to the customer are recognized as revenue, while any shipping and handling costs to get the merchandise shipped is recognized in cost of goods sold.
We extend credit to certain customers, primarily salon professionals, which generally have 30 day payment terms. Based on the nature of theses receivables, no significant financing component exists.
Gift Cards
The revenue from the sale of our gift cards is recognized at the time the gift card is used to purchase merchandise, which is generally within one year from the date of purchase. Our gift cards do not carry expiration dates or impose post-sale fees. Based on historical experience, a certain amount of our gift cards will not be redeemed, also referred to as “gift card breakage.” We recognize revenue related to gift card breakage within revenue in our consolidated statements of earnings over time proportionately to historical redemption patterns. The gift cards are issued and represent liabilities of either of our operating entities, Sally Beauty Supply LLC or Beauty Systems Group LLC, which are both limited liability companies formed in the state of Virginia.
Customer Loyalty Rewards
We launched our new Sally Beauty Rewards Loyalty Program nationwide during the first quarter of fiscal year 2019 to the U.S. and Canada, which enables customers to earn points based on their status for every dollar spent on merchandise purchased in our Sally Beauty Supply (“SBS”) stores and through our sallybeauty.com website, including on our new SBS mobile commerce-based app. When a specific tier has been reached, a customer will receive a certificate which can be used at any of our U.S. and Canadian SBS stores or through our sallybeauty.com website on their next purchase. Based on the rewards loyalty program policies, points expire after twelve months of inactivity and certificates will expire after a specific time period from the date of issuance. Certificates generated from our rewards loyalty program provide a material right to customers and represent a separate performance obligation. Rewards loyalty points are accrued at the standalone value per point, net of estimated breakage, and are included within accrued liabilities on our consolidated balance sheets. We recognize the revenue when the customer redeems the certificate. Points and certificates are issued by and represent liabilities of Sally Beauty Supply LLC.
The following table shows the amount of our gift card and rewards loyalty program liabilities included in accrued liabilities on our condensed consolidated balance sheets as of June 30, 2019 and September 30, 2018 (in thousands):
Gift cards
4,354
4,144
Rewards loyalty program
8,646
1,165
Total liability
13,000
5,309
5. Fair Value Measurements
Fair value 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):
As of June 30, 2019
As of September 30, 2018
Financial assets
Interest rate caps
Level 2
697
8,367
Foreign exchange contracts
423
Total financial assets
1,120
Financial liabilities
121
Other fair value disclosures
Carrying Value
Fair Value
Senior notes
Level 1
885,296
873,513
950,000
911,490
Other long-term debt
741,741
713,353
845,383
824,951
Total debt
1,627,037
1,586,866
1,795,383
1,736,441
12
6. 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
(91,356
1,365
Other comprehensive loss before reclassification, net of tax
(5,904
(478
(15,973
Reclassification to net earnings, net of tax
1,520
413
1,933
(100,947
(3,019
The tax impact for the changes in other comprehensive loss and the reclassifications to net earnings were not material.
7. Weighted-Average Shares
The following table sets forth the computations of basic and diluted weighted-average shares (in thousands):
Weighted-average basic shares
Dilutive securities:
Stock option and stock award programs
858
772
866
780
Weighted-average diluted shares
For the three and nine months ended June 30, 2019, options to purchase 5.0 million shares of our common stock were outstanding but not included in our computations of diluted earnings per share, since these options were anti-dilutive. For the three and nine months ended June 30, 2018, options to purchase 5.2 million shares of our common stock were outstanding but not included in the computations of diluted earnings per share, since these options were anti-dilutive.
8. Share-Based Payments
Performance-Based Awards
The following table presents a summary of the activity for our performance unit awards assuming 100% payout:
Performance Unit Awards
Number
of Shares
(in Thousands)
Weighted
Average Fair
Value Per
Share
Average
Remaining
Vesting Term
(in Years)
Unvested at September 30, 2018
349
20.88
1.3
Granted
230
17.22
Vested
(23
23.45
Forfeited
(113
21.29
Unvested at June 30, 2019
443
18.75
1.6
13
Service-Based Awards
The following table presents a summary of the activity for our stock option awards:
Number of
Outstanding
Options
Exercise
Price
Contractual
Term
Aggregate
Intrinsic
Value
Outstanding at September 30, 2018
5,405
23.04
5.4
3,161
948
18.14
Exercised
(137
15.02
Forfeited or expired
(989
24.77
Outstanding at June 30, 2019
5,227
22.03
6.0
486
Exercisable at June 30, 2019
3,402
23.62
4.6
The following table presents a summary of the activity for our Restricted Stock Awards:
Restricted Stock Awards
219
16.98
2.1
287
(28
16.85
(43
17.73
435
17.71
1.9
The following table presents a summary of the activity for our Restricted Stock Units:
Restricted Stock Units
88
(8
80
0.3
9. Goodwill and Intangible Assets
During the three months ended March 31, 2019 we completed our annual assessment for impairment of goodwill and other intangible assets. No material impairment losses were recognized in the current or prior periods presented in connection with our goodwill and other intangible assets.
For the three months ended June 30, 2019 and 2018, amortization expense related to other intangible assets was $2.8 million and $3.2 million, respectively, and, for the nine months ended June 30, 2019 and 2018, amortization expense was $8.5 million and $8.8 million, respectively.
During the nine months ended June 30, 2019, we recorded approximately $1.9 million in other intangible assets related to immaterial asset acquisitions. Additionally, goodwill and other intangible assets were negatively impacted from changes in foreign currency exchange rates of approximately $2.2 million and $0.7 million, respectively.
14
10. Short-term Borrowings and Long-term Debt
At June 30, 2019, we had $[466.5] million available for borrowing under our asset-based senior secured loan facility (the “ABL facility”), including the Canadian sub-facility. At June 30, 2019, we were in compliance with the agreements and instruments governing our debt, including our financial covenants.
During the three months ended June 30, 2019, we paid down $115.0 million aggregate principal amount of our term loan B. Additionally, we repurchased approximately $4.7 million aggregate principal amount of our 5.625% Senior Notes due 2025 (the “2025 Notes”) at a weighted-average price of 99.3% of face value, excluding accrued interest. In connection with debt repayment, we recognized a $1.4 million loss on the extinguishment of debt from the write-off of unamortized deferred financing costs.
During the three months ended March 31, 2019, we commenced a tender offer for up to $100.0 million in aggregate purchase price of our 2025 Notes with a sublimit of $25.0 million for purchase of our 5.500% Senior Notes due 2023 (the “2023 Notes”), in each case issued by our indirect wholly-owned subsidiaries Sally Holdings LLC and Sally Capital Inc. (“Tender Offer”). As a result of the Tender Offer, we repurchased approximately $57.5 million aggregate principal amount of the 2025 Notes and approximately $2.6 million aggregate principal amount of the 2023 Notes at a total tender offer price of 98.0% and 100.0%, respectively, excluding accrued interest. In connection with the Tender Offer, we recognized a $0.5 million gain on the extinguishment of debt, including a gain of approximately $1.2 million from the discount paid under the face value of the accepted 2025 Notes and the write-off of $0.7 million in unamortized deferred financing costs.
11. Derivative Instruments and Hedging Activities
During the nine months ended June 30, 2019, we did not purchase or hold any derivative instruments for trading or speculative purposes.
Designated Cash Flow Hedges
Foreign Currency Forwards
In December 2018, we entered into foreign currency forwards to mitigate the exposure to exchange rate changes on inventory purchases in USD by our foreign subsidiaries. At June 30, 2019, the notional amount we held through these forwards, based upon exchange rates at June 30, 2019, was as follows (in thousands):
Notional Currency
Notional Amount
MXP
7,337
EUR
5,561
CAD
3,824
GBP
2,086
18,808
We record quarterly, net of income tax, the changes in fair value related to the foreign currency forwards into AOCL. As the forwards are exercised, the realized value will be recognized into cost of goods sold based on inventory turns. Based on June 30, 2019 valuations and exchange rates, we expect to reclassify approximately $0.7 million into cost of goods sold over the next 12 months.
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 increasing interest rates in connection with our term loan B variable tranche. The interest rate caps are comprised of individual caplets that expire ratably through June 30, 2023 and are designated as cash flow hedges.
During the three months ended June 30, 2019, concurrent with the repayment of $115.0 million of the term loan B variable tranche, we dedesignated one interest rate cap and terminated $115.0 million in notional amount. Subsequently, we redesignated the remaining notional amounts of the interest rate cap. Once we determined the hedge transaction related to $115.0 million of the term loan B variable tranche principal would not occur, we reclassified a loss of $1.2 million from AOCL into interest expense. Furthermore, changes in fair value of the remaining hedged interest rate caps are recorded quarterly, net of income tax, and are included in AOCL. Over the next 12 months, we expect to reclassify approximately $0.5 million into interest expense, which represents the original value of the expiring caplets.
15
The table below presents the fair value of our derivative financial instruments (in thousands):
Asset Derivatives
Liability Derivatives
Classification
Derivatives designated as hedging
instruments:
N/A
Other current
assets
Accrued
liabilities
The effects of our derivative financial instruments on our condensed consolidated statements of earnings were not material for the three and nine months ended June 30, 2019 and 2018, except for the loss recorded related to the interest rate cap as a described above.
12. Income Taxes
Our effective tax rate for the three months ended June 30, 2019 and 2018 was 24.6% and 25.1%, respectively. For the three months ended June 30, 2019, our effective tax rate was favorably impacted by a lower federal statutory rate when compared to the prior year as a result of the Tax Cut and Jobs Act (“U.S. Tax Reform”), as well as improving operations in companies for which a valuation allowance is recorded. For the fiscal year 2019, our U.S. federal statutory rate will be 21.0% compared to 24.5% for the prior fiscal year.
Our effective tax rate for the nine months ended June 30, 2019 and 2018 was 24.5% and 18.8%, respectively. For the nine months ended June 30, 2018, our effective tax rate was favorably impacted by a net income tax benefit of $22.0 million related to U.S. Tax Reform when compared to the current period. This benefit was partially offset by the lower federal statutory rates recorded in the current period as compared to the prior period.
In December 2017, the SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”) which provided guidance allowing registrants to record provisional amounts, during a specified measurement period, when the necessary information is not available, prepared or analyzed in reasonable detail to account for the impact of U.S. Tax Reform. As of December 31, 2018, we have completed our analysis on our provisional calculations within the measurement period provided by SAB 118. As a result, during the nine months ended June 30, 2019, we identified certain immaterial adjustments to our provisional calculations, including a benefit of $3.0 million related to the transition tax on unremitted earnings of our foreign operations.
The U.S. Treasury Department has issued final regulations covering the one-time transition tax on unrepatriated foreign earnings, which was enacted as part of U.S Tax Reform. Certain guidance included in these final regulations is inconsistent with our interpretation of the enacted tax law that led to the recognition of a $2.5 million benefit in the first quarter of the current fiscal year. Notwithstanding this inconsistency, we remain confident in our interpretation of the Internal Revenue Code and intend to defend this position through litigation, if necessary. However, if we are ultimately unsuccessful in defending our position, we may be required to reverse the benefit.
Beginning in our first quarter of fiscal year 2019, we are subject to taxation on global intangible low-taxed income (“GILTI”) earned by certain foreign subsidiaries. We have made the policy election to record this tax as a period cost at the time it is incurred. The impact from GILTI was immaterial for the nine months ended June 30, 2019 and is expected to be immaterial for the full fiscal year 2019.
16
13. Business Segments
Segment data for the three and nine months ended June 30, 2019 and 2018 is as follows (in thousands):
Net sales:
SBS
575,025
591,583
1,721,238
1,757,272
Beauty Systems Group ("BSG")
400,144
404,700
1,189,236
1,209,296
Earnings before provision for income taxes:
Segment operating earnings:
95,763
94,912
272,470
271,834
BSG
61,552
62,039
180,401
186,553
Segment operating earnings
157,315
156,951
452,871
458,387
Unallocated expenses
(35,276
(42,179
(110,416
(110,411
(1,908
(12,544
(74
(24,513
Consolidated operating earnings
(25,781
(24,501
(74,092
(73,779
Sales between segments, which are eliminated in consolidation, were not material during the three and nine months ended June 30, 2019 and 2018.
Disaggregation of net sales by segment
Hair color
30.2
%
27.3
28.9
26.8
Hair care
20.3
21.7
20.5
21.4
Skin and nail care
15.5
16.3
14.9
15.2
Styling tools
12.4
12.9
13.9
14.1
Salon supplies and accessories
7.1
7.3
7.2
Multicultural products
6.6
6.7
6.5
6.8
Other Beauty items
7.9
7.8
8.1
8.4
100.0
40.5
39.2
39.5
38.2
36.1
34.9
34.6
34.2
8.5
8.2
8.7
3.4
3.5
4.0
Other beauty items
6.4
6.3
6.2
Promotional items
5.3
7.5
17
14. Parent, Issuers, Guarantor and Non-Guarantor Condensed Consolidating Financial Statements
Condensed Consolidating Balance Sheet
June 30, 2019
Parent
Sally
Holdings LLC
and Sally
Capital Inc.
Guarantor
Subsidiaries
Non-
Consolidating
Eliminations
Sally Beauty
Holdings,
Inc. and
31,254
26,591
Trade and other accounts receivable, net
60,003
36,993
96,996
Due from affiliates
2,818,602
(2,818,602
721,063
246,681
2,755
21,034
13,976
Property and equipment, net
227,845
64,520
Investment in subsidiaries
1,563,789
4,299,448
390,061
(6,253,298
Goodwill and other intangible assets, net
454,443
144,962
599,405
1,325
2,258
(1,654
18,118
1,567,875
4,301,804
4,722,651
551,841
(9,071,900
Liabilities and Stockholders’ (Deficit) Equity
20
219,508
53,101
Due to affiliates
1,631,574
1,118,896
68,132
190
9,027
105,554
31,438
97
1,519
(402
1,609,799
864
1,610,665
6,729
15,096
3,884
(270
(1,226
83,043
4,763
1,638,340
2,738,015
423,203
161,780
Total stockholders’ (deficit) equity
Total liabilities and stockholders’ (deficit) equity
18
September 30, 2018
29,050
48,235
53,295
37,191
90,490
2,598,681
(2,598,681
714,000
230,338
2,010
111
27,422
13,417
232,941
75,408
1,368,927
4,044,669
380,166
(5,793,762
459,348
149,275
608,623
10,242
(4,797
18,581
1,372,274
4,055,032
4,490,106
572,445
(8,392,443
38
-
233,936
69,267
1,629,411
888,141
81,129
234
23,019
125,179
31,855
585
40
1,773,426
882
1,774,309
10,562
15,250
4,210
71,071
4,896
1,640,830
2,686,105
445,437
192,279
Condensed Consolidating Statement of Earnings and Comprehensive Income
Three Months Ended June 30, 2019
Holdings, Inc.
and Subsidiaries
789,534
185,635
Related party sales
545
(545
Cost of products sold and distribution expenses
393,875
99,617
396,204
86,018
2,564
123
281,520
75,976
Operating earnings (loss)
(2,564
(123
112,776
10,042
Interest expense (income)
25,824
(3
(40
Earnings (loss) before provision for income taxes
(25,947
112,779
10,082
Provision (benefit) for income taxes
(659
(6,659
28,193
2,311
Equity in earnings of subsidiaries, net of tax
73,069
92,357
7,771
(173,197
Other comprehensive income, net of tax
937
73,655
8,708
Three Months Ended June 30, 2018
798,185
198,098
639
(639
399,482
104,070
399,342
94,028
2,777
367
292,178
83,276
(2,777
(367
94,620
10,752
24,510
(11
(24,877
94,618
10,763
(804
(7,206
23,823
3,688
60,199
77,870
7,075
(145,144
Total comprehensive income (loss)
60,507
(15,093
21
Nine Months Ended June 30, 2019
2,352,348
558,126
1,694
(1,694
1,181,062
299,854
1,172,980
258,272
8,457
489
849,140
230,711
(8,457
(489
323,766
27,561
74,248
(5
(151
(74,737
323,771
27,712
(19,184
82,671
4,357
208,902
264,455
23,355
(496,712
Other comprehensive loss, net of tax
(9,656
204,518
13,699
22
Nine Months Ended June 30, 2018
2,381,460
585,108
1,716
(1,716
1,194,183
307,780
1,188,993
277,328
8,242
1,148
856,080
252,875
(8,242
(1,148
308,400
24,453
73,817
(1
(37
(74,965
308,401
24,490
(1,883
(21,630
46,666
23,670
209,220
262,555
820
(472,595
211,035
(11,166
Condensed Consolidating Statement of Cash Flows
Net cash provided (used) by operating activities
(3,949
(63,597
270,637
732
(58,607
(8,155
12,017
(1,923
(840
(219,921
219,921
(268,434
(8,991
394,000
(561,158
Repurchases of common stock
2,163
230,755
(12,997
Net cash provided (used) by financing activities
3,950
63,597
(12,998
Effect of foreign exchange rate changes on cash and
cash equivalents
Net increase (decrease) in cash and cash equivalents
2,204
(21,644
24
23,213
(62,729
309,242
12,204
(51,138
(11,052
(252,809
252,809
(303,947
(20,208
369,314
(400,624
(4
(594
140,308
95,190
17,311
(23,213
62,729
16,717
5,296
7,800
22,090
41,659
27,386
49,459
25
15. Restructuring
Restructuring expense and gain for the three and nine months ended June 30, 2019 and 2018, are as follows (in thousands):
Supply Chain Modernization
(3,906
2018 Restructuring Plan
3,980
Total expense (gain)
In February 2019, we announced that we were assessing our supply chain in an effort to minimize out-of-stocks, optimize inventory levels, reduce costs and explore new replenishment and fulfillment options. As part of our supply chain modernization plans, we sold our secondary headquarters and fulfillment center in Denton, Texas, and will be closing select distribution centers, including our Marinette, Wisconsin facility, and upgrading our e-commerce capabilities. Additionally, we will be opening a new automated and concentrated distribution center which will service Sally Beauty Supply stores and e-commerce sales, as well as Beauty Systems Group stores, full service sales and e-commerce sales.
The liability related to the supply chain modernization, which is included in accrued liabilities on our condensed consolidated balance sheets, is as follows (in thousands):
Liability at
Expenses
Cash Payments
Adjustments
Workforce reductions
1,743
661
1,082
Facility closures
884
551
333
114
2,741
1,326
1,415
Expenses incurred in the nine months ended June 30, 2019, represent costs incurred by SBS of $1.1 million, BSG of $1.0 million and corporate of $0.6 million. The above table does not include a gain from selling our secondary headquarters and fulfillment center in Denton, Texas of $6.6 million.
In November 2017, our Board of Directors approved a restructuring plan (the “2018 Restructuring Plan”) focused primarily on significantly improving the profitability of our international businesses, with particular focus on our European operations.
In April 2018, we announced an expansion of the 2018 Restructuring Plan that contained cost reduction initiatives designed to help fund important long-term growth initiatives. The expansion to the 2018 Restructuring Plan included headcount reductions primarily at our corporate headquarters in Denton, Texas. As of December 31, 2018, the 2018 Restructuring Plan was substantially complete and we do not anticipate any additional material costs for the 2018 Restructuring Plan.
The liability related to the 2018 Restructuring Plan, which is included in accrued liabilities on our condensed consolidated balance sheets, is as follows (in thousands):
3,444
643
4,087
Consulting
3,087
2,502
5,589
2,266
2,977
124
8,797
12,653
Expenses incurred in the nine months ended June 30, 2019, represent costs incurred by SBS of $1.1 million and corporate of $2.8 million.
16. Commitments and Contingencies
We are involved, from time to time, in various claims and lawsuits incidental to the conduct of our business in the ordinary course. We carry insurance coverage in such amounts in excess of our self-insured retention as we believe to be reasonable under the
26
circumstances and that may or may not cover any or all of our liabilities in respect of these matters. We do not believe that the ultimate resolution of these matters will have a material adverse impact on our consolidated financial position, cash flows or results of operations.
Data Security Incidents
As previously disclosed, we experienced data security incidents during the fiscal years 2014 and 2015 (together, the “data security incidents”). The data security incidents involved the unauthorized installation of malicious software (“malware”) on our information technology systems, including our point-of-sale systems that may have placed at risk certain payment card data for some transactions. The costs that we have incurred to date in connection with the data security incidents include assessments by payment card networks, professional advisory fees and legal fees relating to investigating and remediating the data security incidents.
During the fiscal year ended September 30, 2018, we received an assessment from a payment card network in connection with the data security incidents. The assessment is based on the network’s claims against the Company’s acquiring banks for costs that it asserts its issuing banks incurred in connection with the data security incidents, including incremental counterfeit fraud losses and non-ordinary course operating expenses, such as card reissuance costs. In the second quarter of fiscal year 2019, we paid the full amount of the assessment and have no remaining liability related to the data security incidents at June 30, 2019.
27
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section discusses management’s view of the financial condition, results of operations and cash flows of Sally Beauty. 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, 2018, including the Risk Factors section, and information contained elsewhere in this Quarterly Report, including the condensed consolidated financial statements and notes to those financial statements. The results of operations for any interim period may not necessarily be indicative of the results that may be expected for any future interim period or the entire fiscal year.
Highlights for the Three Months Ended June 30, 2019:
•
Consolidated net sales for the three months ended June 30, 2019, decreased $21.1 million, or 2.1%, to $975.2 million, compared to the three months ended June 30, 2018;
Our global e-commerce sales increased 25.9% compared to the three months ended June 30, 2018;
Consolidated same store sales increased 0.1% for the three months ended June 30, 2019. SBS same store sales decreased 0.6% and BSG same store sales increased 1.4%;
Consolidated gross profit for the three months ended June 30, 2019, decreased $11.1 million, or 2.3%, to $482.2 million, compared to the three months ended June 30, 2018. Consolidated gross margin was unchanged at 49.5%;
Consolidated operating earnings for the three months ended June 30, 2019, increased $17.9 million, or 17.5%, to $120.1 million, compared to the three months ended June 30, 2018. Consolidated operating margin increased 200 basis points to 12.3% for the three months ended June 30, 2019, compared to the three months ended June 30, 2018;
Consolidated net earnings increased $12.9 million, or 22.2%, to $71.2 million for the three months ended June 30, 2019, compared to the three months ended June 30, 2018. As a percentage of net sales, net earnings increased 150 basis points to 7.3% for the three months ended June 30, 2019, compared to the three months ended June 30, 2018;
Diluted earnings per share for the three months ended June 30, 2019, were $0.59, compared to $0.48 for the three months ended June 30, 2018;
Cash provided by operations was $93.7 million for the three months ended June 30, 2019, compared to $102.5 million for the three months ended June 30, 2018;
During the three months ended June 30, 2019, we paid down $115.0 million aggregate principle of our term loan B and repurchased approximately $4.7 million aggregate principal amount of our 2025 Notes and recognized a net loss of approximately $1.4 million.
Business Strategy Update
We continue to make solid progress against our transformation as we (a) play to win by focusing on hair color and hair care, (b) reintroduce retail fundamentals into our business, (c) advance our digital commerce capabilities, and (d) drive cost out of the business. As part of this effort, we made progress on our supply chain modernization effort, reduced our debt levels, and rolled out new e-commerce tools such as the Sally Beauty Supply app.
During the quarter, we continued to roll-out nationwide a new point-of-sale system in both SBS and BSG, which will allow our store associates to better serve our customers.
In February 2019, we announced our supply chain modernization plans to gain efficiencies and cost savings. During the three months ended June 30, 2019, we identified a location in Texas for the construction of a new 500,000 square foot automated and concentrated distribution center. We continue to explore locations within Europe for a new distribution center that will service operations in Ghent, Belgium.
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):
Increase (Decrease)
(16,558
(2.8
)%
(36,034
(2.1
(4,556
(1.1
(20,060
(1.7
Consolidated
(21,114
(56,094
(1.9
Gross profit:
320,998
328,014
(7,016
952,958
970,365
(17,407
(1.8
161,224
165,356
(4,132
(2.5
478,294
495,956
(17,662
(3.6
(11,148
(2.3
(35,069
(2.4
Segment gross margin:
55.8
55.4
bps
55.2
40.3
40.9
(60)
40.2
41.0
(80)
49.5
49.2
49.4
(20)
(18,415
(4.9
(29,548
(2.6
(10,636
(84.8
(24,439
(99.7
Net earnings:
851
0.9
636
0.2
(487
(0.8
(6,152
(3.3
364
(5,516
(1.2
Unallocated expenses and
restructuring (a)
(37,184
(54,723
(17,539
(32.1
(110,490
(134,924
(24,434
(18.1
17,903
17.5
18,918
5.8
1,280
5.2
313
0.4
16,623
18,605
3,685
18.9
18,850
12,938
22.2
(245
(0.1
.
Number of stores at end-of-period (including franchises):
3,705
3,775
(70
1,384
1,395
5,089
5,170
(81
(1.6
Same store sales growth (decline) (b)
(0.6
100
180
1.4
(2.9
430
0.1
(2.0
210
(a)
Unallocated expenses consist of corporate and shared costs and are included in selling, general and administrative expenses in our consolidated statements of earnings. Restructuring charges relate to the supply chain modernization plan and the 2018 Restructuring Plan.
(b)
For the purpose of calculating our same store sales metrics, we compare the current period sales for stores open for 14 months or longer as of the last day of a month with the sales for these stores for the comparable period in the prior fiscal year. Our same store sales are calculated in constant dollars and include e-commerce sales, but do not generally include the sales from stores that have been relocated until 14 months after the relocation. The sales from stores acquired are excluded from our same store sales calculation until 14 months after the acquisition.
29
Results of Operations
The Three Months Ended June 30, 2019 compared to the Three Months Ended June 30, 2018
Consolidated. Consolidated net sales include a negative impact from changes in foreign currency exchange rates of $8.1 million, or 0.8% of consolidated net sales.
SBS. The decrease in net sales for SBS for the three months ended June 30, 2019 was primarily driven by the negative impact from changes in foreign currency exchange rates of approximately $6.9 million, lower sales from the net decline in the number of company-operated stores of $5.2 million and lower same store sales of approximately $3.2 million. Same store sales for SBS decreased by 0.6% for the three months ended June 30, 2019. Same store sales in the US and Canada were down 0.2%.
SBS experienced lower unit volume resulting from lower customer traffic and the reduction in the number of company-operated stores during the last 12 months. This was partially offset by an increase in average unit prices, resulting from price increases and a promotional efficiency effort (which reduced promotions that provided ‘free’ units, such as Buy One, Get One offers).
BSG. The decrease in BSG’s net sales for the three months ended June 30, 2019 was primarily driven by lower sales by our distributor sales consultants of $6.5 million, the negative impact from changes in foreign currency exchange rates of approximately $1.2 million and lower sales from the net decline in the number of company-operated stores of $0.5 million, partially offset by an increase in same store sales of $3.7 million.
BSG experienced a decrease in unit volume, notwithstanding the impact of incremental sales from the number of company-operated stores opened. This was partially offset by an increase in average unit prices resulting primarily from the introduction of certain third-party brands with higher average unit prices in the preceding 12 months.
Consolidated. Consolidated gross profit decreased due to lower net sales in both reportable segments and a lower gross margin in BSG, offset by a higher gross margin in SBS. Consolidated gross profit margin was unchanged for the three months ended June 30, 2019.
SBS. SBS’s gross profit decreased for the three months ended June 30, 2019, primarily as a result of lower net sales and a negative impact from changes in foreign currency exchange rates. SBS’s gross margin improved as a result of significantly higher gross margins in our U.S. and Canadian operations of 80 bps, partially offset by weaker gross margins in our European operations.
BSG. BSG’s gross profit decreased for the three months ended June 30, 2019, primarily as a result of lower net sales and lower gross margin. BSG’s gross margin decreased primarily as a result of continued challenges related to the ongoing merchandising transformation.
Selling, General and Administrative Expenses
Consolidated. Consolidated selling, general and administrative expenses, as a percentage of net sales, decreased 110 basis points to 36.9% for the three months ended June 30, 2019. Consolidated selling, general and administrative expenses decreased primarily as a result of no comparable expenses related to the data security incidents in the current year, lower compensation and compensation-related expenses and a positive impact from changes in foreign currency exchange rates.
SBS. SBS’s selling, general and administrative expenses decreased $7.9 million, or 3.4%, for the three months ended June 30, 2019. This decrease reflects the impact of the 2018 Restructuring Plan, our recently implemented field structure realignment and store labor hour optimization initiatives, a positive impact from changes in foreign currency exchange rate of approximately $2.8 million and a decrease in professional fees of $0.9 million.
BSG. BSG’s selling, general and administrative expenses decreased $3.6 million, or 3.5%, for the three months ended June 30, 2019, primarily as a result of the impact of the 2018 Restructuring Plan and our recently implemented field structure realignment, lower sales commission of $1.0 million, lower advertising expenses of $0.4 million and a positive impact from changes in foreign currency exchange rate of approximately $0.4 million.
Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, decreased $6.9 million, or 16.4%, for the three months ended June 30, 2019. This decrease is primarily a result of no comparable expenses related to the data security incidents in the current year compared to $7.9 million for the three months ended June 30, 2018.
For the three months ended June 30, 2019, we incurred restructuring charges of $1.9 million in connection with the supply chain modernization plan. For the three months ended June 30, 2018, we incurred restructuring charges of $12.5 million in connection with
30
the 2018 Restructuring Plan. See Note 15 of the Notes to Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report for more information about our restructuring plans.
Interest Expense
The increase in interest expense is primarily from a loss on extinguishment of debt of $1.4 million in connection with the partial repayment on our term loan B and repurchase of our 2025 Notes during the three months ended June 30, 2019. In addition, we realized a loss relating to an interest rate cap derivative of $1.2 million in connection with the partial repayment of our term loan B during the three months ended June 30, 2019. See Note 11 of the Notes to Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report for more information about our derivative instruments and hedging activities. See “Liquidity and Capital Resources” below for additional information.
Provision for Income Taxes
The provision for income taxes was $23.2 million and $19.5 million, resulting in an effective tax rate of 24.6% and 25.1% for the three months ended June 30, 2019 and 2018, respectively.
The Nine Months Ended June 30, 2019 compared to the Nine Months Ended June 30, 2018
Consolidated. Consolidated net sales include a negative impact from changes in foreign currency exchange rates of $25.5 million, or 0.9% of consolidated net sales.
SBS. The decrease in net sales for SBS for the nine months ended June 30, 2019 was driven primarily by the negative impact from changes in foreign currency exchange rates of approximately $21.3 million, lower net sales from the net decline in the number of company-operated stores of approximately $12.3 million and lower same store sales of approximately $1.1 million. Same store sales for SBS decreased by 0.1% for the nine months ended June 30, 2019. Same store sales in the US and Canada were up 0.4%.
SBS experienced lower unit volume resulting from lower customer traffic and the reduction in the number of company-operated stores during the last 12 months. This was partially offset by an increase in average unit prices, resulting from price increases and a promotional efficiency effort.
BSG. The decrease in BSG’s net sales for the nine months ended June 30, 2019 was primarily driven by lower sales by our distributor sales consultants of $16.1 million, the negative impact from changes in foreign currency exchange rates of approximately $4.2 million and lower sales to our franchisees of $2.2 million. This decrease was partially offset by the positive impact from net new company-operated stores of $2.7 million.
Consolidated. Consolidated gross profit decreased for the nine months ended June 30, 2019, primarily due to lower net sales in both reportable segments and a lower gross margin in BSG, partially offset by a higher gross margin in SBS.
SBS. SBS’s gross profit decreased for the nine months ended June 30, 2019, primarily as a result of lower net sales and a negative impact from changes in foreign currency exchange rates. SBS’s gross margin increased due to significantly higher gross margins in our U.S. and Canadian operations of 50 bps, offset by weaker gross margins in our European operations.
BSG. BSG’s gross profit decreased for the nine months ended June 30, 2019, primarily as a result of lower net sales and a lower gross margin. BSG’s gross margin decreased primarily as a result of continued challenges related to the ongoing merchandising transformation.
Consolidated. Consolidated selling, general and administrative expenses, as a percentage of net sales, decreased 30 basis points to 37.4% for the nine months ended June 30, 2019. Consolidated selling, general and administrative expenses decreased primarily as a result of lower compensation and compensation-related expenses, lower advertising expenses and a positive impact from changes in foreign currency exchange rates. This decrease was partially offset by increases in facility expenses and recent upgrades to our information technology systems.
SBS. SBS’s selling, general and administrative expenses decreased $18.0 million, or 2.6%, for the nine months ended June 30, 2019. This decrease reflects the impact of the 2018 Restructuring Plan, our recently implemented field structure realignment and store labor hour optimization initiatives, lower advertising expenses of $2.4 million and a positive impact from changes in foreign currency
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exchange rate of approximately $8.9 million. This decrease was partially offset by higher facility expenses of $2.9 million and the impact of the reduction of an estimated casualty loss related to hurricanes of $2.4 million during the nine months ended June 30, 2018.
BSG. BSG’s selling, general and administrative expenses decreased $11.5 million, or 3.7%, for the nine months ended June 30, 2019, primarily as a result of the impact of the 2018 Restructuring Plan, lower sales commissions of $3.4 million, lower advertising expenses of $2.2 million and a positive impact from changes in foreign currency exchange rate of approximately $1.3 million.
For the nine months ended June 30, 2019, we recognized charges of $6.7 million in connection with the supply chain modernization plan and the 2018 Restructuring Plan, partially offset by a $6.6 million gain from selling our secondary headquarters and fulfillment center in Denton, Texas in connection with the supply chain modernization plan. For the nine months ended June 30, 2018, we incurred restructuring charges of $24.5 million in connection with the 2018 Restructuring Plan. See Note 15 of the Notes to Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report for more information about our restructuring plans.
The increase in interest expense is primarily from a loss on extinguishment of debt of $1.0 million in connection with the debt tender offer, the repayment of a portion of our term loan B and the partial repurchase of our 2025 Notes during the nine months ended June 30, 2019, compared to a loss on extinguishment of debt of $0.9 million in connection with the repricing of the term loan B variable-rate tranche during the nine months ended June 30, 2018. In addition, we realized a loss relating to an interest rate cap derivative of $1.2 million in connection with the partial repayment of our term loan B during the three months ended June 30, 2019. Interest expense also increased to higher interest rates on our term loan B variable tranche. See Note 11 of the Notes to Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report for more information about our derivative instruments and hedging activities. See “Liquidity and Capital Resources” below for additional information.
The provision for income taxes was $65.7 million and $46.8 million resulting in an effective tax rate of 24.5% and 18.8%, for the nine months ended June 30, 2019 and 2018, respectively. The increase in our effective tax rate was due primarily to the impact of the U.S. Tax Reform during the nine months ended June 30, 2018. See Note 12 of the Notes to Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report for more information about the impact of U.S. Tax Reform on our condensed consolidated financial statements.
Liquidity and Capital Resources
We are highly leveraged and a substantial portion of our liquidity needs will arise from debt service on our outstanding indebtedness and from funding the costs of operations, working capital, capital expenditures, debt repayment and share repurchases. Working capital (current assets minus current liabilities) increased $55.5 million, to $719.4 million at June 30, 2019, compared to $663.9 million at September 30, 2018, resulting primarily from decreases in accounts payable and accrued liabilities and an increase in inventory, partially offset by a decrease in cash and cash equivalents and an increase in the outstanding principal on our ABL facility.
At June 30, 2019, cash and cash equivalents were $57.9 million. Based upon the current level of operations and anticipated growth, we anticipate that existing cash balances (excluding certain amounts permanently invested in connection with foreign operations), funds expected to be generated by operations and funds available under the ABL facility will be sufficient to meet working capital requirements, potential acquisitions, finance anticipated capital expenditures, including information technology upgrades and store remodels, debt repayments and opportunistic share repurchases over the next 12 months. For the foreseeable future, we will prioritize needed investments in our business that we believe will deliver value for stockholders, and will consider measured debt repayment within our ratings guidance as well as opportunistic share repurchases.
We utilize our ABL facility for the issuance of letters of credit, for 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 opportunistic share repurchases. During the nine months ended June 30, 2019, the weighted average interest rate on our borrowings under the ABL facility was 4.68%. The amounts drawn are generally paid down with cash provided by our operating activities. As of June 30, 2019, Sally Holdings had $466.5 million available for borrowings under the ABL facility, subject to borrowing base limitations, as reduced by outstanding letters of credit.
Share Repurchase Programs
We did not repurchase any shares of our common stock during the nine months ended June 30, 2019. As of June 30, 2019, we had authorization of approximately $834.1 million of additional potential share repurchases remaining under the 2017 Share Repurchase
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Program. During the nine months ended June 30, 2018, we repurchased and subsequently retired approximately 9.9 million shares of our common stock under Board approved share repurchase programs at an aggregate cost of $164.6 million. We funded these share repurchases with existing cash balances, cash from operations and borrowings under the ABL facility.
Historical Cash Flows
Historically, our primary source of cash has been net funds provided by operating activities and, when necessary, borrowings under our ABL facility. 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, 2019, decreased $78.1 million to $203.8 million, compared to the nine months ended June 30, 2018, mainly due to a focused reduction of accounts payable and an increase in inventory as a result of the launch of new product lines.
Net Cash Used by Investing Activities
Net cash used by investing activities during the nine months ended June 30, 2019, decreased $13.8 million to $57.5 million, compared to the nine months ended June 30, 2018. This change was primarily driven by cash proceeds received from selling our secondary headquarters and fulfillment center in Denton, Texas, and as a result of not having any significant acquisitions in the nine months ended June 30, 2019, partially offset by the additional capital expenditures primarily from investments in our information technology systems.
Net Cash Used by Financing Activities
Net cash used by financing activities during the nine months ended June 30, 2019, decreased $31.2 million to $165.4 million, compared to the nine months ended June 30, 2018. This decrease was driven by a focus on debt reduction rather than share repurchases.
Long-Term Debt
At June 30, 2019, we had $1,626.2 million in debt, not including capital leases, unamortized debt issuance costs or debt discounts, in the aggregate, of $15.5 million. Our debt consisted of outstanding senior notes of $885.3 million and a term loan B with an outstanding principal balance of $725.4 million. There was $15.5 million in borrowings outstanding under our ABL facility as of June 30, 2019.
During the nine months ended June 30, 2019, we repurchased approximately $63.5 million aggregate principal amount of our 2025 Notes and our 2023 Notes. In addition, we repaid $115.0 million aggregate principal of our term loan B above our normal quarterly payments.
We are currently in compliance with the agreements and instruments governing our debt, including our financial covenants.
Contractual Obligations
Other than the debt repayments described above, there have been no material changes outside the ordinary course of our business in any of our contractual obligations since September 30, 2018.
Off-Balance Sheet Financing Arrangements
At June 30, 2019 and September 30, 2018, we had no off-balance sheet financing arrangements other than operating leases incurred in the ordinary course of our business, and 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, 2018.
Accounting Changes and Recent Accounting Pronouncements
See Note 3 of the Notes to Condensed Consolidated Financial Statements in Item 1 – “Financial Statements” in Part I – Financial Information.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As a multinational corporation, we are subject to certain market risks including foreign currency fluctuations, interest rates and government actions. There have been no material changes to our market risks from September 30, 2018. See our disclosures about
market risks contained in Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” in Part II of our Annual Report on Form 10-K for the fiscal year ended September 30, 2018.
Item 4. Controls and Procedures
Controls Evaluation and Related CEO and CFO Certifications. Our management, with the participation of our principal executive officer (“CEO”) and principal financial officer (“CFO”), conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2019. The controls evaluation was conducted by our Disclosure Committee, comprised of senior representatives from our finance, accounting, internal audit, and legal departments under the supervision of our CEO and CFO.
Certifications of our CEO and our CFO, which are required in accordance with Rule 13a-14 of the Exchange Act, are attached as exhibits to this Quarterly Report. This “Controls and Procedures” section includes the information concerning the controls evaluation referred to in the certifications and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.
Limitations on the Effectiveness of Controls. We do not expect that our disclosure controls and procedures will prevent all errors and all fraud. A system of controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the system are met. Because of the limitations in all such systems, no evaluation can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Furthermore, the design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how unlikely. Because of these inherent limitations in a cost-effective system of controls and procedures, misstatements or omissions due to error or fraud may occur and not be detected.
Scope of the Controls Evaluation. The evaluation of our disclosure controls and procedures included a review of their objectives and design, our implementation of the controls and procedures and the effect of the controls and procedures on the information generated for use in this Quarterly Report. In the course of the evaluation, we sought to identify whether we had any data errors, control problems or acts of fraud and to confirm that appropriate corrective action, including process improvements, was being undertaken if needed. This type of evaluation is performed on a quarterly basis so that conclusions concerning the effectiveness of our disclosure controls and procedures can be reported in our Quarterly Reports on Form 10-Q and our Annual Reports on Form 10-K. Many of the components of our disclosure controls and procedures are also evaluated by our internal audit department, by our legal department and by personnel in our finance organization. The overall goals of these various evaluation activities are to monitor our disclosure controls and procedures on an ongoing basis and to maintain them as dynamic systems that change as conditions warrant.
Conclusions regarding Disclosure Controls. Based on the required evaluation of our disclosure controls and procedures, our CEO and CFO have concluded that, as of June 30, 2019, we maintain disclosure controls and procedures that are effective in providing reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting. During our most recent fiscal quarter, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
We are involved, from time to time, in various claims and lawsuits incidental to the conduct of our business in the ordinary course. We carry insurance coverage in such amounts in excess of our self-insured retention as we believe to be reasonable under the circumstances and that may or may not cover any or all of our liabilities in respect of these matters. We do not believe that the ultimate resolution of these matters will have a material adverse impact on our consolidated financial position, cash flows or results of operations.
We are subject to a number of U.S., federal, state and local laws and regulations, as well as the laws and regulations applicable in each foreign country or jurisdiction in which we do business. These laws and regulations govern, among other things, the composition, packaging, labeling and safety of the products we sell, the methods we use to sell these products and the methods we use to import these products. We believe that we are in material compliance with such laws and regulations, although no assurance can be provided that this will remain true going forward.
See also Note 16 of the Notes to Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report.
In addition to the other information set forth in this Quarterly Report, you should carefully consider the factors contained in Item 1A. “Risk Factors” in Part I of our Annual Report on Form 10-K for the fiscal year ended September 30, 2018, which could materially affect our business, financial condition or future results. There have been no material changes from the risk factors disclosed in such Annual Report. The risks described in such Annual Report and herein are not the only risks facing our company.
Exhibit No.
Description
3.1
Third Restated Certificate of Incorporation of Sally Beauty Holdings, Inc., dated January 30, 2014, which is incorporated herein by reference from Exhibit 3.3 to the Company’s Current Report on Form 8-K filed on January 30, 2014
3.2
Amended and Restated Bylaws of Sally Beauty Holdings, Inc., dated April 26, 2017, which is incorporated herein by reference from Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on April 28, 2017
31.1
Rule 13a-14(a)/15d-14(a) Certification of Christian A. Brickman*
31.2
Rule 13a-14(a)/15d-14(a) Certification of Aaron E. Alt*
32.1
Section 1350 Certification of Christian A. Brickman*
32.2
Section 1350 Certification of Aaron E. Alt*
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The following financial information from our Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2019, formatted in iXBRL (Inline Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets; (ii) the Condensed Consolidated Statements of Earnings; (iii) the Condensed Consolidated Statements of Comprehensive Income; (iv) the Condensed Consolidated Statements of Cash Flows; (v) the Condensed Consolidated Statements of Stockholders’ Deficits; and (vi) the Notes to Condensed Consolidated Financial Statements.
* Included herewith
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date: July 31, 2019
By:
/s/ Aaron E. Alt
Aaron E. Alt
Senior Vice President, Chief Financial Officer
and President – Sally Beauty Supply
For the Registrant and as its Principal Financial Officer