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, 2020
-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 24, 2020, there were 112,852,369 shares of the issuer’s common stock outstanding.
TABLE OF CONTENTS
Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
5
Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
29
Item 3. Quantitative And Qualitative Disclosures About Market Risk
36
Item 4. Controls And Procedures
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
38
Item 1A. Risk Factors
Item 6. Exhibits
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. Forward-looking statements may relate to, among other things, the impact on our business, operations and financial results of the novel coronavirus (“COVID-19”) pandemic.
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 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, 2019, and in our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2020, which should be read in conjunction with the forward-looking statements in this report. 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
WHERE YOU CAN FIND MORE INFORMATION
Our quarterly financial results and other important information are available by calling our Investor Relations Department at (940) 297-3877.
We maintain a website at www.sallybeautyholdings.com where investors and other interested parties may obtain, free of charge, press releases and other information as well as gain access to our periodic filings with the Securities and Exchange Commission (“SEC”). The information contained on this website should not be considered to be a part of this or any other report filed with or furnished to the SEC.
4
Item 1. Financial Statements.
The following condensed consolidated balance sheets as of June 30, 2020, and September 30, 2019, the condensed consolidated statements of earnings (loss), condensed consolidated statements of comprehensive income (loss) and the condensed statements of stockholders’ deficit for the three and nine months ended June 30, 2020 and 2019, and the condensed consolidated statements of cash flows for the nine months ended June 30, 2020 and 2019, 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)
June 30,
2020
September 30,
2019
(Unaudited)
Assets
Current assets:
Cash and cash equivalents
$
838,811
71,495
Trade accounts receivable, net
42,818
43,136
Accounts receivable, other
17,485
61,403
Inventory
815,632
952,907
Other current assets
48,596
34,612
Total current assets
1,763,342
1,163,553
Property and equipment, net of accumulated depreciation of $688,798 at
June 30, 2020, and $659,285 at September 30, 2019
311,063
319,628
Operating lease assets
514,415
—
Goodwill
530,681
530,786
Intangible assets, excluding goodwill, net of accumulated amortization of
$65,791 at June 30, 2020, and $64,615 at September 30, 2019
56,859
62,051
Other assets
21,734
22,428
Total assets
3,198,094
2,098,446
Liabilities and Stockholders’ Deficit
Current liabilities:
Current maturities of long-term debt
395,673
1
Accounts payable
239,905
278,688
Accrued liabilities
148,197
169,054
Current operating lease liabilities
152,650
Income taxes payable
1,307
8,336
Total current liabilities
937,732
456,079
Long-term debt
1,845,594
1,594,542
Long-term operating lease liabilities
377,930
Other liabilities
26,433
27,757
Deferred income tax liabilities, net
79,538
80,391
Total liabilities
3,267,227
2,158,769
Stockholders’ deficit:
Common stock, $0.01 par value. Authorized 500,000 shares; 112,848 and
116,986 shares issued and 112,280 and 116,725 shares outstanding at
June 30, 2020, and September 30, 2019, respectively
1,123
1,167
Preferred stock, $0.01 par value. Authorized 50,000 shares; none issued
Additional paid-in capital
2,513
Accumulated earnings
46,399
55,797
Accumulated other comprehensive loss, net of tax
(119,168
)
(117,287
Total stockholders’ deficit
(69,133
(60,323
Total liabilities and stockholders’ deficit
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
Condensed Consolidated Statements of Earnings (Loss)
(In thousands, except per share data)
Three Months Ended
Nine Months Ended
Net sales
705,287
975,169
2,556,518
2,910,474
Cost of goods sold
383,441
492,947
1,330,067
1,479,222
Gross profit
321,846
482,222
1,226,451
1,431,252
Selling, general and administrative expenses
314,599
360,183
1,075,827
1,088,797
Restructuring
5,816
1,908
11,541
74
Operating earnings
1,431
120,131
139,083
342,381
Interest expense
27,298
25,781
70,483
74,092
Earnings (loss) before provision for income taxes
(25,867
94,350
68,600
268,289
Provision (benefit) for income taxes
(2,341
23,186
25,543
65,673
Net earnings (loss)
(23,526
71,164
43,057
202,616
Earnings (loss) per share:
Basic
(0.21
0.59
0.38
1.69
Diluted
0.37
1.68
Weighted-average shares:
112,271
120,119
114,413
120,062
120,977
115,370
120,928
7
Condensed Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
Other comprehensive income (loss):
Foreign currency translation adjustments
5,116
834
(3,707
(9,591
Interest rate caps, net of tax
245
586
274
(4,384
Foreign exchange contracts, net of tax
(286
103
1,552
(65
Other comprehensive income (loss), net of tax
5,075
1,523
(1,881
(14,040
Total comprehensive income (loss)
(18,451
72,687
41,176
188,576
8
Condensed Consolidated Statements of Cash Flows
Nine Months Ended June 30,
Cash Flows from Operating Activities:
Net earnings
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Depreciation and amortization
80,829
80,425
Share-based compensation expense
9,094
7,728
Amortization of deferred financing costs
2,965
2,894
Loss (gain) on early extinguishment of debt
(357
951
Loss (gain) on disposal of equipment and other property
2,910
(6,557
Deferred income taxes
600
12,095
Changes in (exclusive of effects of acquisitions):
Trade accounts receivable
495
3,361
45,888
(10,641
134,824
(28,283
(15,840
4,687
(691
(1,195
Accounts payable and accrued liabilities
(35,572
(59,105
(7,154
(926
13,336
(4,227
Net cash provided by operating activities
274,384
203,823
Cash Flows from Investing Activities:
Payments for property and equipment
(89,740
(66,763
Proceeds from sale of property and equipment
12,021
Acquisitions, net of cash acquired
(1,944
(2,763
Net cash used by investing activities
(91,646
(57,505
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt
1,087,504
394,004
Repayments of long-term debt
(437,391
(561,162
Debt issuance costs
(6,257
Payments for common stock repurchased
(61,357
Proceeds from exercises of stock options
2,722
1,787
Net cash provided (used) by financing activities
585,221
(165,371
Effect of foreign exchange rate changes on cash and cash equivalents
(643
(387
Net increase (decrease) in cash and cash equivalents
767,316
(19,440
Cash and cash equivalents, beginning of period
77,295
Cash and cash equivalents, end of period
57,855
Supplemental Cash Flow Information:
Interest paid
74,046
82,903
Income taxes paid
45,292
62,852
Capital expenditures incurred but not paid
4,469
3,116
9
Condensed Consolidated Statements of Stockholders’ Deficit
Accumulated
Additional
Other
Total
Common Stock
Paid-in
Comprehensive
Stockholders’
Shares
Amount
Capital
Earnings
Loss
Equity (Deficit)
Balance at September 30, 2019
116,725
Cumulative effect of ASC 842 adoption
(445
53,215
Other comprehensive income
14,870
Repurchases and cancellations of
common stock
(766
(7
(6,237
(5,113
(11,357
Share-based compensation
3,473
Stock issued for stock options
206
2,764
2,766
Balance at December 31, 2019
116,165
1,162
103,454
(102,417
2,199
13,368
Other comprehensive loss
(21,826
(3,936
(39
(3,064
(46,897
(50,000
3,059
35
Balance at March 31, 2020
112,264
-
69,925
(124,243
(53,195
Net loss
2,562
16
(49
Balance at June 30, 2020
112,280
(Deficit)
Deficit
Balance at September 30, 2018
119,926
1,199
(179,764
(89,991
(268,556
65,727
(16,705
3,354
115
1,448
1,449
Balance at December 31, 2018
120,041
1,200
4,802
(114,037
(106,696
(214,731
65,725
1,142
2,517
66
271
272
Balance at March 31, 2019
120,107
1,201
7,590
(48,312
(105,554
(145,075
1,857
23
Balance at June 30, 2019
120,130
9,513
22,852
(104,031
(70,465
10
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, 2019. 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, 2020, and September 30, 2019, our consolidated results of operations, consolidated comprehensive income (loss), and consolidated statements of stockholders’ deficit for the three and nine months ended June 30, 2020 and 2019, and our consolidated cash flows for the nine months ended June 30, 2020 and 2019.
Our operating results for the three months ended June 30, 2020, may not be indicative of the results that may be expected for the full fiscal year ending September 30, 2020, in particular as a result of the effects of the COVID-19 pandemic. As a result of COVID-19, we temporarily shut down virtually all global customer-facing store operations at the end of our second fiscal quarter and the start of our third fiscal quarter, followed by a rapid re-opening process over the course of the third quarter, although there is no certainty that we will not have to reclose certain, even a significant number, of our stores in the future. As of June 30, 2020, we have re-opened substantially all of our customer-facing store operations, except for parts of our operations in Mexico and South America. Due to the uncertainty over the duration and severity of the economic and operational impacts of COVID-19, the material adverse impact of this pandemic will likely continue for the remainder of our fiscal year 2020, and may continue into our fiscal year 2021 and possibly beyond.
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. See Note 3 for more information about the adoption of the new lease accounting standard. 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 Change
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (“ASU No. 2016-02”), which requires most operating leases to be reported on the balance sheet as a right-of-use asset and a lease liability. On October 1, 2019, we adopted ASU No. 2016-02 using a modified retrospective transition method without restating comparative periods. We have elected the package of practical expedients permitted within the transition guidance under the new standard relating to the identification, classification and initial direct costs of leases commencing before the effective date of Topic 842. In addition, we have elected to not recognize a right-of-use asset or lease obligation for short-term leases with an initial term of 12 months or less.
Additionally, the adoption of ASU No. 2016-02, as amended, resulted in the recognition of an operating lease asset of $513.9 million and an operating lease liability of $523.5 million. Existing straight-line rent liability, prepaid rent and accrued rent were reclassified from certain other assets and liabilities into the operating lease asset. Furthermore, the cumulative effect of the adoption of ASU No. 2016-02 resulted in a $0.4 million adjustment to accumulated earnings resulting from the impairment of certain operating lease assets. The impact on our condensed consolidated results of operations or condensed consolidated cash flows was not material.
See Note 8 for additional information in connection with ASU No. 2016-02.
Recent Accounting Pronouncements
In December 2019, the FASB issued ASU No. 2019-12 which simplifies the accounting for income taxes by removing an exception related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period with year to date losses and the recognition of deferred tax liabilities for outside basis differences. Additionally, the update clarifies and simplifies other areas of ASC 740, Income Taxes. For public companies, the amendments in the update are effective for fiscal years, and interim
11
periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted, but all amendments must be adopted at once. The amendments in this update have different adoption methods including prospective basis, retrospective basis, and a modified retrospective basis dependent on the specific change. We are currently evaluating the impact of this update.
4. 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 for the period were as follows (in thousands):
September 30, 2019
12,866
Loyalty points and gift cards issued but not redeemed, net of estimated breakage
9,161
Revenue recognized from beginning liability
(8,703
June 30, 2020
13,324
Private Label Credit Card - In September 2019, we signed a multi-year agreement with a third-party bank to launch a private label credit card (the “Program”). As of June 30, 2020, Program operations had not yet commenced.
See Note 13 for additional information regarding the disaggregation of our sales revenue.
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):
Classification
Fair Value Hierarchy Level
Financial Assets:
Foreign exchange contracts
Level 2
1,367
Interest rate caps
308
344
1,675
Other fair value disclosures
Carrying Value
Fair Value
Long-term debt, excluding capital leases
Senior notes
Level 1
1,177,380
1,177,726
885,296
898,814
Term loan B
685,788
651,498
724,000
709,830
Total long-term debt
1,863,168
1,829,224
1,609,296
1,608,644
The table above excludes amounts related to our ABL facility as the balance approximates fair value due to the short-term nature of our borrowings.
6. Stockholders’ Equity (Deficit)
Share Repurchases
In August 2017, our Board of Directors approved a share repurchase program authorizing the Company to repurchase up to $1.0 billion of its common stock, subject to certain limitations governed by our debt agreements, over an approximate four-year period expiring on September 30, 2021.
12
Information related to our shares repurchased and subsequently retired were as follows (in thousands):
Number of shares repurchased
4,702
Total cost of share repurchased
61,357
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
(113,932
(3,201
(154
Other comprehensive loss (income) before
reclassification, net of tax
(131
(1,115
(4,953
Reclassification to net earnings (loss), net of tax
405
2,667
3,072
(117,639
(2,927
1,398
The tax impact for the changes in other comprehensive loss and the reclassifications to net earnings (loss) were not material.
7. Weighted-Average Shares
The following table sets forth the reconciliation of basic and diluted weighted-average shares (in thousands):
Weighted-average basic shares
Dilutive securities:
Stock option and stock award programs
858
957
866
Weighted-average diluted shares
Anti-dilutive options excluded from our computation of diluted shares
4,976
5,044
4,887
Potentially dilutive stock option and stock award programs excluded from our computation of diluted shares
941
8. Leases
Substantially all of our leases are operating leases and relate primarily to retail stores and warehousing properties with lease terms of five to ten years. Some of our leases include options to extend the agreement by a certain number of years, typically five years. At the lease commencement date, an operating lease liability and related operating lease asset are recognized and include the extended terms to the extent we are reasonably certain that we will exercise the option.
The operating lease liabilities are calculated using the present value of lease payments. The discount rate used is either the rate implicit in the lease, when known, or our estimated incremental borrowing rate. Our incremental borrowing rate for a lease is the rate of interest we would have to pay on a collateralized basis to borrow an amount equal to the lease payments under similar terms. Because we do not generally borrow on a collateralized basis, we derive an appropriate incremental borrowing rate using the interest rate we pay on our non-collateralized borrowings, adjusted for the amount of the lease payments, the lease term and the effect of designating specific collateral with a value equal to the unpaid lease payments for that lease. We apply the incremental borrowing rate on a portfolio basis given the impact of applying it on a lease by lease basis would be immaterial.
Operating lease assets are valued based on the initial operating lease liabilities plus any prepaid rent and direct costs from executing the leases, reduced by tenant improvement allowances and any rent abatement. Operating lease assets are tested for impairment in the same manner as our long-lived assets. During the three months ended June 30, 2020, we recognized impairment on our certain operating lease asset and immaterial amounts for lease hold improvements of $0.9 million within selling, general and administrative expenses. See Note 15 for additional information related to impairments in connection with our restructuring activity.
13
Our operating and finance leases consisted of the following (in thousands):
Balance Sheet Classification
Assets:
Operating lease
Finance lease
Property and equipment, net
2,839
Total lease assets
517,254
Liabilities:
Current:
173
Long-term:
683
Total lease liabilities
531,436
Our lease costs, net of immaterial sublease income, consisted of the following (in thousands):
Statement of Earnings (Loss) Classification
Operating lease costs (a)
Cost of goods sold and
selling, general and administrative expenses (b)
48,785
143,472
Finance lease costs:
Amortization of leased assets
224
Interest on lease liabilities
33
Variable lease costs (c)
5,276
34,240
Total lease costs
54,146
177,969
(a)
Includes costs related to short-term leases, which are immaterial.
(b)
Certain supply chain-related amounts are included in cost of goods sold.
(c)
Includes common area maintenance, real estate taxes and insurance related to leases.
In response to COVID-19, the FASB issued interpretive guidance that provides an option for entities to make a policy election for lease concessions as a result of COVID-19, provided that the modified contracts result in total cash flows that are substantially the same or less than the original contracts. This policy election allows for lease concessions to be treated as though enforceable rights and obligations for those concessions existed (regardless of whether those enforceable rights and obligations for the concessions explicitly exist in the contracts). We have elected to apply this policy election and have included rent abatements related to COVID-19 into variable lease costs. For the three and nine months ended June 30, 2020, we have recognized a benefit of $8.1 million for rent abatements.
As of June 30, 2020, the approximate future lease payments under our leases are as follows (in thousands):
Fiscal Year
Operating leases
Finance leases
Remainder of 2020
45,867
45
2021
161,902
171
2022
122,267
2023
86,973
2024
58,007
Thereafter
101,561
127
Total undiscounted lease payments
576,577
856
Less: imputed interest
45,997
Present value of lease liabilities
530,580
The table above does not include operating leases we have entered into of approximately $11.6 million that have not commenced, primarily related to future retail stores.
14
As of September 30, 2019, our future minimum lease payments under non-cancelable operating leases as reported under the previous accounting standard were as follows (in thousands):
174,578
136,900
95,918
61,944
33,803
40,545
543,688
Other lease information is as follows (dollars in thousands):
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows – operating leases
147,959
Operating cash flows – finance leases
Financing cash flows – finance leases
Supplemental non-cash information on lease liabilities:
Lease assets obtained in exchange for new operating lease liabilities
151,528
Lease assets obtained in exchange for new finance lease liabilities
Weighted-average remaining lease term (in years):
4.9
4.0
Weighted-average discount rate:
4.3
%
5.0
9. Goodwill and Intangible Assets
We performed our annual assessment for impairment of goodwill and other intangible assets during our fiscal second quarter prior to the impacts of COVID-19. As a result of COVID-19, we performed an interim assessment for impairment of goodwill and other intangibles as of March 31, 2020, which updated our assumptions around the growth, timing and discount rate applied to future cash flows in connection with our business restart. Due to the uncertainty around COVID-19, our projected future cash flows may differ materially from actual results. Furthermore, we considered potential triggering events and determined there were none during the three months ended June 30, 2020, as our assumptions relative to future cash flows had improved during the quarter, and our market capitalization had increased significantly since March 31, 2020. 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, 2020 and 2019, amortization expense related to other intangible assets was $2.2 million and $2.8 million, respectively, and, for the nine months ended June 30, 2020 and 2019, amortization expense was $6.8 million and $8.5 million, respectively.
During the nine months ended June 30, 2020, we recorded approximately $1.4 million in other intangible assets related to immaterial acquisitions. Additionally, goodwill was negatively impacted by approximately $0.1 million from changes in foreign currency exchange rates during the nine months ended June 30, 2020.
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10. Short-term Borrowings and Long-term Debt
During the nine months ended June 30, 2020, we preemptively drew on our ABL facility as a result of COVID-19. At June 30, 2020, we had $395.5 million outstanding, including the FILO (first-in, last-out) tranche, and $81.0 million available for borrowing under our ABL facility, including the Canadian sub-facility, subject to the conditions contained therein. Our ABL facility matures on July 6, 2022.
During the three months ended December 31, 2019, we paid down $14.8 million aggregate principal amount of our term loan B fixed tranche at a weighted-average price of 97.875% of face value, excluding accrued interest. Additionally, during the three months ended March 31, 2020, we paid down $22.0 million aggregate principal amount of our term loan B fixed tranche at a weighted-average price of 99.0% of face value, excluding accrued interest. In connection with the debt repayment, for the nine months ended June 30, 2020, we recognized a $0.4 million gain on the extinguishment of debt, including a gain of approximately $0.4 million from the discount paid under the face value and the write-off of $0.1 million in unamortized deferred financing costs.
During the three months ended March, 31, 2020, we paid down $7.9 million aggregate principal amount of our senior notes due 2025 at a weighted-average price of 98.7% of face value, excluding accrued interest.
On April 15, 2020, we entered into an amendment to our ABL facility to, among other things, increased the revolving commitment thereunder from $500.0 million to $600.0 million, established a FILO (first-in, last-out) tranche of indebtedness in the amount of $20.0 million, increased pricing on the revolving loans and modified certain covenant and reporting terms. The ABL facility continues to be secured by a first-priority lien in and upon the accounts and inventory (and the proceeds thereof) of the Company and its guarantor subsidiaries. The ABL facility is also secured by a second-priority lien in and upon the remaining assets of the Company and its guarantor subsidiaries.
On April 24, 2020, we completed a private offering of $300.0 million aggregate principal amount of senior secured second lien notes due 2025 (the “Senior Secured Notes”) and received $295.5 million in net proceeds from the Senior Secured Notes offering. The Notes bear interest at a rate of 8.75% and were issued at par. The Senior Secured Notes are guaranteed on a senior secured basis by the guarantors who have guaranteed obligations under our senior secured credit facilities and our existing notes. We currently intend to hold the net proceeds from this offering to maintain cash reserves on our balance sheet. If necessary, we will use the cash for working capital and general corporate purposes.
Covenants
The agreements governing our ABL facility, term loan B and the senior notes contain a customary covenant package that places restrictions on the disposition of assets, the granting of liens and security interests, the prepayment of certain indebtedness, and other matters with customary events of default, including customary cross-default and/or cross-acceleration provisions. As of June 30, 2020, we were in compliance with all debt covenants and all the net assets of our consolidated subsidiaries were unrestricted from transfer.
11. Derivative Instruments and Hedging Activities
During the nine months ended June 30, 2020, we did not purchase or hold any derivative instruments for trading or speculative purposes. See Note 5 for the classification and fair value of our derivative instruments.
Designated Cash Flow Hedges
Foreign Currency Forwards
We regularly enter into foreign currency forwards to mitigate our exposure to exchange rate changes on inventory purchases in U.S. dollars by our foreign subsidiaries. At June 30, 2020, the notional amount we held through these forwards, based upon exchange rates at June 30, 2020, was as follows (in thousands):
Notional Currency
Notional Amount
Mexican Peso
6,529
Canadian Dollar
2,340
8,869
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 is recognized into cost of goods sold based on inventory turns. For the nine months ended June 30, 2020, we recognized $1.4 million into cost of goods sold on our condensed consolidated statements of earnings (loss). Based on June 30, 2020, valuations and exchange rates, we expect to reclassify gains of approximately $1.8 million into cost of goods sold over the next 12 months.
Additionally during the nine months ended June 30, 2020, we de-designated certain foreign currency forwards as it became probable that the forecasted transaction would not occur as a result of the recent COVID-19 pandemic. As a result, we reclassified $1.3 million in gains from AOCL into selling, general and administration expenses. These contracts expired ratably through June 30, 2020.
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. Over the next 12 months, we expect to reclassify approximately $1.0 million into interest expense, which represents the original value of the expiring caplets.
The effects of our interest rate caps on our condensed consolidated statements of earnings (loss) were not material for the nine months ended June 30, 2020.
12. Income Tax
The effective tax rates were 9.1% and 24.6%, for the three months ended June 30, 2020 and 2019, respectively. The effective tax rate for the third quarter of the current year was negatively impacted by foreign losses which cannot be tax benefitted. The effective tax rates were 37.2% and 24.5%, for the nine months ended June 30, 2020 and 2019, respectively. The increase in the effective tax rate was primarily driven by the establishment of a valuation allowance in a foreign subsidiary and increased foreign losses, as compared to the prior period, the tax benefit of which cannot be recognized. Additionally, for the nine months ended June 30, 2019, the provision for income taxes included an income tax benefit due to an adjustment to our previously recorded transition tax on unrepatriated foreign earnings as a result of the Tax Cuts and Jobs Act.
The difference between the U.S. statutory federal income tax rate and the effective income tax rate is summarized below:
U.S. federal statutory income tax rate
21.0
State income taxes, net of federal tax benefit
2.9
3.3
3.9
3.4
Effect of foreign operations (1)
4.6
0.2
(0.5
0.1
Foreign valuation allowances (1)
(13.0
(0.3
10.2
Deemed repatriation tax (1)
(1.1
0.4
Other, net (1)
(5.3
2.2
0.9
Effective tax rate
9.1
24.6
37.2
24.5
(1)
For the three months ended June 30, 2020, the impact of these items is opposite the customary relationship due to the loss before the provision for income taxes that was incurred.
In response to the global pandemic related to COVID-19, President Donald Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) on March 27, 2020. The CARES Act provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of net operating losses, temporary changes to the prior and future limitations on interest deductions, technical corrections from prior tax legislation for tax depreciation of certain qualified improvement property, temporary suspension of certain payment requirements for the employer portion of social security taxes, and the creation of certain refundable employee retention credits. There was not a material impact on our income tax expense for the three or nine months ended June 30, 2020. We will continue to monitor legislative developments related to COVID-19 and will record the associated income tax impacts in the periods that guidance is finalized or when we are able to reasonably estimate an impact.
17
13. Business Segments
Segment data for the three and nine months ended June 30, 2020 and 2019, is as follows (in thousands):
Net sales:
Sally Beauty Supply ("SBS")
415,468
575,025
1,504,125
1,721,238
Beauty Systems Group ("BSG")
289,819
400,144
1,052,393
1,189,236
Earnings (loss) before provision for income taxes:
Segment operating earnings:
SBS
3,087
95,763
133,684
272,470
BSG
40,084
61,552
143,557
180,401
Segment operating earnings
43,171
157,315
277,241
452,871
Unallocated expenses
35,924
35,276
126,617
110,416
Consolidated operating earnings
Sales between segments, which are eliminated in consolidation, were not material during the three and nine months ended June 30, 2020 and 2019.
Disaggregation of net sales by segment
Hair color
36.6
30.2
33.8
28.9
Hair care
16.3
20.3
19.0
20.5
Styling tools
13.6
12.4
13.0
13.9
Skin and nail care
13.3
15.5
13.8
14.9
Salon supplies and accessories
7.1
7.5
7.2
Textured hair products
4.7
6.6
5.1
6.5
Other beauty items
6.4
7.9
7.8
8.1
100.0
42.2
40.5
39.7
39.5
32.5
36.1
34.2
34.6
8.2
6.2
3.5
7.0
6.3
Promotional items
5.3
7.6
The following tables disaggregate our segment revenue by sales channels:
Company-operated stores
79.1
96.9
90.9
96.8
E-commerce
20.8
2.8
8.9
Franchise stores
0.3
18
63.9
68.8
68.2
69.4
Distributor sales consultants
10.8
18.3
18.2
17.4
4.8
8.0
7.4
14. Parent, Issuers, Guarantor and Non-Guarantor Condensed Consolidating Financial Statements
Certain 100% wholly owned domestic subsidiaries (“guarantor subsidiaries”), as defined in our credit agreements, of Sally Beauty serve as guarantors to the ABL facility, term loan B and senior notes due 2023 and 2025. The guarantees related to these debt instruments are full and unconditional, joint and several and have certain restrictions on the ability to pay restricted payments to Sally Beauty Holdings, Inc. (“parent”). Certain other subsidiaries, including our foreign subsidiaries, do not serve as guarantors (“non-guarantor subsidiaries”).
The following condensed consolidating financial information represents financial information for (i) parent, (ii) Sally Holdings LLC and Sally Capital Inc., (iii) the guarantor subsidiaries; (iv) the non-guarantor subsidiaries, (v) elimination entries necessary for consolidation purposes, and (vi) Sally Beauty on a consolidated basis.
19
Condensed Consolidating Balance Sheet
Parent
Sally
Holdings LLC
and Sally
Capital Inc.
Guarantor
Subsidiaries
Non-
Consolidating
Eliminations
Sally Beauty
Holdings,
Inc. and
771,131
67,670
Trade and other accounts receivable, net
33,856
26,447
60,303
Due from affiliates
2,378,638
(2,378,638
608,147
207,485
14,375
23,417
10,598
259,521
51,535
381,907
132,508
Investment in subsidiaries
1,668,707
4,473,741
361,944
(6,504,392
Goodwill and other intangible assets, net
448,869
138,671
587,540
1,447
3,701
4,589
11,997
1,684,536
4,477,658
5,272,019
646,911
(8,883,030
Liabilities and Stockholders’ Equity (Deficit)
68
197,442
42,380
Due to affiliates
1,747,406
554,908
76,324
164
11,567
107,574
28,892
2,162
(855
2,240,411
854
2,241,267
397,477
133,103
6,441
19,930
62
(165
75,853
4,207
1,753,669
2,808,951
798,278
284,967
Total stockholders’ equity (deficit)
Total liabilities and stockholders’ equity (deficit)
20
41,009
30,476
65,746
38,793
104,539
2,878,072
(2,878,072
722,830
230,077
1,436
132
22,480
10,564
258,132
61,490
1,621,843
4,374,334
385,629
(6,381,806
452,645
140,192
592,837
1,446
3,499
(581
18,064
1,624,731
4,377,975
4,825,962
529,656
(9,259,878
48
235,940
42,700
1,672,322
1,142,324
63,426
188
17,937
121,375
29,554
6,055
2,161
119
1,593,710
832
1,594,543
17,639
3,677
76,672
3,719
1,685,054
2,756,132
451,628
144,027
21
Condensed Consolidating Statement of Earnings (Loss) and Comprehensive Income
Three Months Ended June 30, 2020
Holdings, Inc.
and Subsidiaries
604,881
100,406
Related party sales
236
(236
319,527
64,150
285,590
36,256
2,763
255,841
55,863
Operating earnings (loss)
(132
23,933
(19,607
Interest expense (income)
27,377
(1
(78
(27,509
23,934
(19,529
(709
(7,061
7,208
(1,779
Equity in earnings (loss) of subsidiaries, net of tax
(21,472
(1,024
(17,750
40,246
Other comprehensive income, net of tax
4,830
Total comprehensive loss
(21,227
(12,920
22
Condensed Consolidating Statement of Earnings and Comprehensive Income
Three Months Ended June 30, 2019
789,534
185,635
545
(545
393,875
99,617
396,204
86,018
2,564
123
281,520
75,976
(2,564
(123
112,776
10,042
25,824
(3
(40
(25,947
112,779
10,082
(659
(6,659
28,193
2,311
Equity in earnings of subsidiaries, net of tax
73,069
92,357
7,771
(173,197
937
Total comprehensive income
73,655
8,708
Nine Months Ended June 30, 2020
2,105,368
451,150
1,231
(1,231
1,075,180
256,118
1,031,419
195,032
8,250
467
858,490
208,620
(8,250
(467
161,388
(13,588
70,590
(111
(71,057
161,384
(13,477
(2,117
(18,239
41,488
4,411
49,190
102,008
(17,888
(133,310
(2,155
49,464
(20,043
24
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
(2,171
(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
25
Condensed Consolidating Statement of Cash Flows
Net cash (used) provided by operating activities
(16,444
(56,439
313,209
34,058
(80,854
(8,881
(1,691
(253
499,434
(499,434
Net cash (used) provided by investing activities
416,912
(9,119
1,087,500
(437,388
Repurchases of common stock
75,084
(587,416
12,898
Net cash provided by financing activities
16,449
56,439
Effect of foreign exchange rate changes on cash and
cash equivalents
Net increase in cash and cash equivalents
730,122
37,194
26
(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
2,163
230,755
(12,997
Net cash (used) provided by financing activities
3,950
63,597
(12,998
2,204
(21,644
29,050
48,235
31,254
26,591
27
15. Restructuring
Restructuring expense for the three and nine months ended June 30, 2020 and 2019, are as follows (in thousands):
Project Surge
70
1,430
Transformation Plan
5,746
10,111
Total expense
In November 2019, we announced that we were launching Project Surge, which takes the successful elements of the North American Sally Beauty transformation and integrates them into our European operations, with the support and participation of several key leaders from the corporate headquarters. As part of this plan, we are focusing on several operating elements, including a review of our talent and operating structure.
The liability related to Project Surge, which is included in accrued liabilities on our condensed consolidated balance sheets, is as follows (in thousands):
Liability at
Expenses
Expenses Paid or Otherwise Settled
Adjustments
Workforce reductions
1,068
362
Expenses incurred during the nine months ended June 30, 2020, represent costs incurred by SBS of $1.3 million and corporate of $0.1 million.
We previously disclosed a plan to focus on certain core business strategies. In addition to optimizing our supply chain network with changes to our transportation model and network of nodes, we are improving our marketing and digital commerce capabilities, and advancing our merchandising transformation efforts. In addition, we expanded our plan and announced a reduction in workforce within our field and headquarters. All these together, make up our Transformation Plan.
The liability related to the Transformation Plan, which is included in accrued liabilities on our condensed consolidated balance sheets, is as follows (in thousands):
654
5,562
4,660
1,556
Consulting
204
1,426
1,630
3,123
3,193
928
9,483
Expenses incurred during the nine months ended June 30, 2020, represent costs incurred by SBS of $5.1 million, BSG of $1.8 million and corporate of $3.2 million. Additionally, other expenses in the table above includes a non-cash asset impairment of $1.8 million related to the re-measurement of certain long-lived assets and operating lease assets. These assets had a carrying value of $5.4 million and were adjusted down to their estimated fair values. The fair value measurements for these purposes were based on unobservable inputs (Level 3).
28
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, 2019, and our other filings with the Securities and Exchange Commission, including the Risk Factors sections therein, and information contained elsewhere in this Quarterly Report, including the condensed consolidated interim 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, in particular as a result of the effects of the COVID-19 pandemic.
Highlights for the Three Months Ended June 30, 2020:
•
During the three months ended June 30, 2020, we re-opened substantially all global customer-facing store operations, except for parts of our operations in Mexico and South America, on a rolling basis;
Consolidated net sales for the three months ended June 30, 2020, decreased $269.9 million, or 27.7%, to $705.3 million, compared to the three months ended June 30, 2019;
Our global e-commerce sales increased 278.0% compared to the three months ended June 30, 2019;
Consolidated same store sales decreased 26.6% for the three months ended June 30, 2020. SBS same store sales decreased 25.9% and BSG same store sales decreased 27.9%;
Consolidated gross profit for the three months ended June 30, 2020, decreased $160.4 million, or 33.3%, to $321.8 million compared to the three months ended June 30, 2019. Gross margin decreased 390 basis points to 45.6% for the three months ended June 30, 2020, compared to the three months ended June 30, 2019;
Consolidated operating earnings for the three months ended June 30, 2020, decreased $118.7 million, or 98.8%, to $1.4 million compared to the three months ended June 30, 2019. Operating margin decreased 1,210 basis points to 0.2% for the three months ended June 30, 2020, compared to the three months ended June 30, 2019;
For the three months ended June 30, 2020, we had a net loss of $23.5 million compared to net earnings of $71.2 million for the three months ended June 30, 2019;
For the three months ended June 30, 2020, we had diluted loss per share of $0.21, compared to diluted earnings per share of $0.59 for the three months ended June 30, 2019. This was driven primarily due to COVID-19 impact, aggressive tactical inventory clearance actions and restructuring;
Cash provided by operations was $198.3 million for the three months ended June 30, 2020, compared to $93.7 million for the three months ended June 30, 2019; and
As a result of COVID-19, we issued $300 million of Senior Secured Notes.
Impact of COVID-19 on Our Business and Business Strategy Update
Our results of operations for the three months ended June 30, 2020, were significantly impacted by the effects of COVID-19 as we experienced a rolling shut down of customer-facing operations at all global stores starting in mid-March through mid-April, followed by the rolling restart of store operations from mid-April until the end of June. Store re-openings were triggered by local regulation; the adoption of our new COVID-19 related safety protocols involving store cleaning, masks, and gloves; limiting the number of customers in stores at one time; in-store social distancing guidelines; and the recall from furlough of sufficient store staff. As of June 30, 2020, we have re-opened substantially all global customer-facing store operations, other than parts of our network in Mexico and South America, and saw strong consumer and professional demand in our re-opened stores.
As part of our re-opening, we also announced that we recalled all furloughed associates in the field and at the headquarters in the U.S. and Canada, effective as of June 8, 2020, except for associates working in the limited number of stores which remained closed at that time. Additional associates in Europe and Latin America will return in our fourth quarter.
As a result of COVID-19, we reprioritized our transformation plans to accelerate key digital and supply chain initiatives, and pivoted to cash management and expense reduction. We have resumed our work on the implementation of a new merchandising system and the start-up of the new North Texas distribution node, but continue to pause on efforts such as our national brand relaunch. Additionally, due to the evolving COVID-19 pandemic and the related business uncertainty, we continue to defer non-digital capital investments and address our short-term cost structure.
On April 15, 2020, we amended our ABL facility to increase the revolving commitment thereunder from $500.0 million to $600.0 million, establish a FILO (first-in, last-out) tranche of indebtedness in the amount of $20.0 million, increase pricing on the revolving loans and modify certain covenant and reporting terms. To further strengthen our liquidity, on April 24, 2020, we closed on $300.0 million of 8.75% senior secured second-lien notes due 2025.
The effects of the COVID-19 pandemic and related responses had a material impact on the entirety of our fiscal 2020 third quarter results of operations, cash flows and financial position. Furthermore, due to the uncertainty over the duration and severity of the economic and operational impacts of COVID-19, the material adverse impact of the pandemic will likely continue for the remainder of our fiscal 2020 year and may continue into our fiscal 2021 year and possibly beyond.
30
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)
(159,557
(27.7
)%
(217,113
(12.6
(110,325
(27.6
(136,843
(11.5
Consolidated
(269,882
(353,956
(12.2
Gross profit:
202,460
320,998
(118,538
(36.9
800,517
952,958
(152,441
(16.0
119,386
161,224
(41,838
(26.0
425,934
478,294
(52,360
(10.9
(160,376
(33.3
(204,801
(14.3
Segment gross margin:
48.7
55.8
(710)
bps
53.2
55.4
(220)
41.2
40.3
90
40.2
45.6
49.5
(390)
48.0
49.2
(120)
Net earnings (loss):
(92,676
(96.8
(138,786
(50.9
(21,468
(34.9
(36,844
(20.4
(114,144
(72.6
(175,630
(38.8
Unallocated expenses and restructuring (a)
41,740
37,184
4,556
12.3
138,158
110,490
27,668
25.0
(118,700
(98.8
(203,298
(59.4
1,517
5.9
(3,609
(4.9
(120,217
(127.4
(199,689
(74.4
(25,527
(110.1
(40,130
(61.1
(94,690
(133.1
(159,559
(78.7
.
Number of stores at end-of-period (including franchises):
3,691
3,705
(14
(0.4
1,371
1,384
(13
(0.9
5,062
5,089
(27
Same store sales growth (decline) (b):
(25.9
(0.6
(2,530)
(11.3
(0.1
(1,120)
(27.9
1.4
(2,930)
(11.2
(26.6
(2,670)
Unallocated expenses consist of corporate and shared costs and are included in selling, general and administrative expenses in our consolidated statements of earnings (loss). See Note 15 of the Notes to Condensed Consolidated Financial Statements for details on our restructuring charges.
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 from certain digital platforms, but do not generally include the sales from stores 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.
31
Results of Operations
The Three Months Ended June 30, 2020, compared to the Three Months Ended June 30, 2019
Net Sales
Consolidated. Consolidated net sales include a negative impact from changes in foreign currency exchange rates of $3.2 million, or 0.5% of consolidated net sales.
SBS. The decrease in net sales for SBS was primarily driven by the following (in thousands):
Same store sales
(139,836
Sales outside same store sales
(17,171
Foreign currency exchange
(2,550
SBS experienced lower unit volume caused primarily by the impact of the temporary closure of all our customer-facing store operations due to the effects of COVID-19, partially offset by strong demand upon re-opening. The challenges faced by lower unit volume were partially offset by an increase in average unit prices, resulting from a change in product mix to higher-priced products and the cancellation of most promotional activity.
BSG. The decrease in net sales for BSG was primarily driven by the following (in thousands):
(75,464
(34,258
(603
BSG experienced lower unit volume primarily as a result of the temporary closure of all of our customer-facing store operations in the U.S. and Canada due to the effects of COVID-19. The negative impact of the temporary closures were partially offset by an increase in average unit prices resulting primarily from lower promotional activity.
Gross Profit
Consolidated. Consolidated gross profit decreased for the three months ended June 30, 2020, primarily due to lower net sales in both segments and a lower gross margin in SBS, partially offset by a higher gross margin in BSG. While point-of-sale margin was stronger across both segments versus the prior year, driven by fewer promotions and favorable shift in product mix, it was more than offset by on-shelf inventory clearance efforts related to slow moving inventory plus a non-cash write down of inventory of $27.1 million and a reduction in vendor allowances from fewer promotions and reduced inventory purchases.
SBS. SBS’s gross profit decreased for the three months ended June 30, 2020, as a result of a lower net sales and a lower gross margin. SBS’s gross margin decreased primarily as a result of the combination of lower vendor allowances and from aggressive inventory clearance efforts at the end of the quarter, partially offset by the positive impact from fewer promotions and favorable product mix.
BSG. BSG’s gross profit decreased for the three months ended June 30, 2020, primarily as a result of a lower net sales, partially offset by a higher gross margin. BSG’s gross margin increased primarily as a result of fewer promotions and higher margin product mix, partially offset by lower vendor allowances from fewer promotions and reduced inventory purchases and inventory clearance actions.
Selling, General and Administrative Expenses
Consolidated. Consolidated selling, general and administrative expenses decreased primarily as a result of cost saving initiatives in response to COVID-19, including savings associated with furloughed employees, lower advertising and promotional expenses, rent abatements and the suspension or elimination of all non-critical projects and non-essential spend. These decreases were partially offset by increased shipping costs resulting from increased e-commerce volume and incremental store expenses for personal protective equipment. Consolidated selling, general and administrative expenses, as a percentage of net sales, increased 770 basis points to 44.6% for the three months ended June 30, 2020. This deleveraging was driven by lost sales as a result of the impact of COVID-19.
SBS. SBS’s selling, general and administrative expenses decreased $25.9 million, or 11.5%, for the three months ended June 30, 2020, primarily due to our response to COVID-19. The decrease was driven by lower compensation and compensation-related expenses of $45.5 million (primarily as a result of previously announced furloughs), lower rent expense of $6.3 million (driven by rent abatements) and lower advertising expenses of $5.0 million. These decreases were partially offset by an increase in shipping costs of $23.3 million, resulting primarily from increased e-commerce volume, and incremental store expense for personal protective equipment.
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BSG. BSG’s selling, general and administrative expenses decreased $20.4 million, or 20.4%, for the three months ended June 30, 2020, primarily due to our response to COVID-19. The decrease was driven by lower compensation and compensation-related expenses of $21.5 million, primarily as a result of previously announced furloughs, and lower advertising expenses of $3.9 million. These decreases were partially offset by an increase in shipping costs of $4.7 million, resulting primarily from increased e-commerce volume.
Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, increased $0.6 million, or 1.8%, for the three months ended June 30, 2020, primarily from costs associated with disaster payments and other costs incurred in response to COVID-19, partially offset by lower compensation expenses resulting from furloughed employees.
For the three months ended June 30, 2020, we incurred restructuring charges of $5.8 million primarily in connection with the Transformation Plan. For the three months ended June 30, 2019, we recognized charges of $1.9 million in connection with the supply chain modernization 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 higher outstanding principal balance on our ABL facility and the newly issued Senior Secured Notes. See “Liquidity and Capital Resources” below for additional information.
Provision (Benefit) for Income Taxes
The effective tax rates were 9.1% and 24.6%, for the three months ended June 30, 2020, and 2019, respectively. The effective tax rate for the third quarter of the current year was negatively impacted by foreign losses which cannot be tax benefitted.
The Nine Months Ended June 30, 2020, compared to the Nine Months Ended June 30, 2019
Consolidated. Consolidated net sales include a negative impact from changes in foreign currency exchange rates of $7.3 million, or 0.3% of consolidated net sales.
(183,005
(27,498
(6,610
SBS experienced lower unit volume caused by the temporary closure of all of our customer-facing store operations due to the effects of COVID-19, lower customer traffic and the reduction in company-operated stores during the last 12 months. The segment also experienced a lapped non-recurring benefit from the prior year. These headwinds were partially offset by increased e-commerce sales and an increase in average unit prices. The increase in the average unit prices was a result of targeted price increases earlier in the year, a change in product mix to higher-priced products and a promotional efficiency effort, partially offset by implementation related technology disruptions in the first fiscal quarter which led to incorrect POS pricing, elevated promotional discounts and higher loyalty program redemptions.
(91,544
(44,614
(685
BSG experienced lower unit volume primarily as a result of the temporary closure of all of our customer-facing store operations in the U.S. and Canada due to the effects of COVID-19. The negative effects of these temporary closures were partially offset by increased e-commerce sales and an increase in average unit prices resulting primarily from lower promotional activity and the introduction of certain third-party brands with higher average unit prices in the preceding 12 months.
Consolidated. Consolidated gross profit decreased for the nine months ended June 30, 2020, primarily due to lower net sales in both segments and a lower gross margin in SBS, partially offset by a higher gross margin in BSG.
SBS. SBS’s gross profit decreased for the nine months ended June 30, 2020, primarily as a result of a lower net sales and a lower gross margin. SBS’s gross margin decreased primarily as a result of aggressive inventory clearance actions in the current quarter, the implementation related technology disruptions in the first quarter and non-recurring benefits that we lapped from the prior year, partially offset by fewer promotions.
BSG. BSG’s gross profit decreased for the nine months ended June 30, 2020, primarily as a result of lower net sales, partially offset by a higher gross margin. BSG’s gross margin increased primarily from a shift in the purchased product mix and fewer promotions, partially offset by aggressive inventory clearance actions in the current quarter.
Consolidated. Consolidated selling, general and administrative expenses decreased primarily as a result of lower compensation and compensation-related expenses, partially offset by costs associated with disaster payments and in response to COVID-19 and higher shipping costs. Consolidated selling, general and administrative expenses, as a percentage of net sales, increased 470 basis points to 42.1% for the nine months ended June 30, 2020. This deleveraging was driven by lost sales as a result of the impact of COVID-19.
SBS. SBS’s selling, general and administrative expenses decreased $13.7 million, or 2.0%, for the nine months ended June 30, 2020. This increase reflects lower compensation and compensation-related expense of $43.1 million, primarily as a result of previously announced furloughs. This decrease was partially offset by an increase in shipping costs of $27.6 million, resulting primarily from increased e-commerce volume.
BSG. BSG’s selling, general and administrative expenses decreased $15.5 million, or 5.2%, for the nine months ended June 30, 2020. This increase reflects lower compensation and compensation-related expense of $21.3 million, primarily as a result of previously announced furloughs. This decrease was partially offset by an increase in shipping costs of $5.9 million, resulting primarily from increased e-commerce volume.
Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, increased $16.2 million, or 14.7%, for the nine months ended June 30, 2020, primarily from costs associated with disaster payments in response to COVID-19, partially offset by lower compensation expenses resulting from furloughed employees.
For the nine months ended June 30, 2020, we incurred restructuring charges of $11.5 million in connection with Project Surge and the Transformation Plan. For the nine months ended June 30, 2019, we recognized charges of $6.7 million in connection with the supply chain modernization plan, partially offset by a $6.6 million gain from selling our secondary headquarters and fulfillment center in Denton, Texas, and 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 decrease in interest expense is primarily from lower outstanding principal balances on our term loan B and our senior notes during the first and second quarters, partially offset by a higher average outstanding ABL balance during the nine months ended June 30, 2020 and the newly issued Senior Secured Notes. See “Liquidity and Capital Resources” below for additional information.
The effective tax rates were 37.2% and 24.5%, for the nine months ended June 30, 2020, and 2019, respectively. The increase in the effective tax rate was primarily driven by the establishment of a valuation allowance in a foreign subsidiary and increased foreign losses, as compared to the prior period, which cannot be tax benefitted. Additionally, for the nine months ended June 30, 2019, the provision for income taxes included an income tax benefit due to an adjustment to our previously recorded transition tax on unrepatriated foreign earnings as a result of the Tax Cuts and Jobs Act.
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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 less current liabilities) increased $118.1 million, to $825.6 million at June 30, 2020, compared to $707.5 million at September 30, 2019, resulting primarily from the impact of the adoption of the new lease standard.
At June 30, 2020, cash and cash equivalents were $838.8 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 fund working capital requirements, potential acquisitions, finance anticipated capital expenditures, including information technology upgrades and store remodels and debt repayments over the next 12 months. Due to the impact of COVID-19, we have shifted our focus to being proactive in maintaining our financial flexibility.
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, 2020, the weighted-average interest rate on our borrowings under the ABL facility was 2.85%. During late March, in support of our operations and out of an abundance of caution, we preemptively drew on our ABL facility as a result of COVID-19. The amounts drawn are generally paid down with cash provided by our operating activities. As of June 30, 2020, we had $81.0 million available for borrowings under our ABL facility, subject to borrowing base limitations, as reduced by outstanding letters of credit.
During the nine months ended June 30, 2020, we entered into an amendment to our ABL facility to, among other things, increase the revolving commitment thereunder from $500.0 million to $600.0 million, establish a FILO (first-in, last-out) tranche of indebtedness in the amount of $20.0 million, increase pricing on the revolving loans and modify certain covenant and reporting terms. We also issued $300.0 million of Senior Secured Notes in a private offering in reliance upon an exemption from the registration requirements of the Securities Act of 1933, as amended.
Share Repurchase Programs
During the three months ended June 30, 2020, we did not repurchase any common stock. During the nine months ended June 30, 2020, we repurchased and subsequently retired approximately 4.7 million shares of our common stock at an aggregate cost of $61.4 million. We funded these share repurchases with existing cash balances, cash from operations and borrowings under the ABL facility. As of June 30, 2020, we had authorization of approximately $726.1 million of additional potential share repurchases remaining under the 2017 Share Repurchase Program.
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. While historically, the primary uses of cash have been for share repurchases, capital expenditures, repayments and servicing of long-term debt and acquisitions, we have shifted our focus in the short-term to reduce non-essential cash expenditures and preserve our cash balances.
Net Cash Provided by Operating Activities
Net cash provided by operating activities during the nine months ended June 30, 2020, increased $70.6 million to $274.4 million, compared to the nine months ended June 30, 2019, mainly due to the reduction in inventory purchases as a result of COVID-19 and the timing of our vendor receivables, partially offset by the decrease in net earnings.
Net Cash Used by Investing Activities
Net cash used by investing activities during the nine months ended June 30, 2020, increased $34.1 million to $91.6 million, compared to the nine months ended June 30, 2019. This change was primarily a result of higher capital expenditures, related to our investments in information technology, and the sale of our secondary headquarters and fulfillment center in the prior year with no comparable sale in this year.
Net Cash Provided (Used) by Financing Activities
The change in financing activities cash flows was primarily a result of additional borrowings, out of an abundance of caution in connection with COVID-19, under our ABL facility and the issuance of $300.0 million in new Senior Secured Notes and partially offset by the repurchase of $61.4 million of our common stock.
Long-Term Debt
At June 30, 2020, we had $2,258.7 million in debt, not including capital leases, unamortized debt issuance costs and debt discounts, in the aggregate, of $17.4 million. Our debt consisted of $1,177.4 million of senior notes outstanding, a term loan B with an outstanding principal balance of $685.8 million and $395.5 million of principal borrowings outstanding under our ABL facility.
See Note 10, Short-term Borrowings and Long-term Debt, for more information on our debt.
We are currently in compliance with the agreements and instruments governing our debt, including our financial covenants.
Contractual Obligations
There have been no material changes outside the ordinary course of our business in any of our contractual obligations since September 30, 2019.
Off-Balance Sheet Financing Arrangements
At June 30, 2020, and September 30, 2019, we had no off-balance sheet financing arrangements other than outstanding letters of credit related to inventory purchases and self-insurance programs.
Critical Accounting Estimates
There have been no material changes to our critical accounting estimates or assumptions since September 30, 2019.
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, 2019. 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, 2019.
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, 2020. 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, 2020, 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.
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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.
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, 2019, and in our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2020, 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 and such Quarterly Report. The risks described in such Annual Report and Quarterly 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
4.1
First Amendment to Amended and Restated Credit Agreement dated April 15, 2020 among the Borrowers, the Parent Guarantors, the Administrative Agent, the Syndication Agent, the Documentation Agent, and the Lenders party thereto (as such terms are defined therein), which is incorporated herein by reference from Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on April 16, 2020
4.2
Indenture, dated as of April 24, 2020, by and among Sally Holdings LLC, Sally Capital Inc., the guarantors listed therein and Wells Fargo, National Association, which is incorporated herein by reference from Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on April 27, 2020
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*
101
The following financial information from our Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2020, formatted in iXBRL (Inline Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets; (ii) the Condensed Consolidated Statements of Earnings (Loss); (iii) the Condensed Consolidated Statements of Comprehensive Income (Loss); (iv) the Condensed Consolidated Statements of Cash Flows; (v) the Condensed Consolidated Statements of Stockholders’ Equity (Deficit); and (vi) the Notes to Condensed Consolidated Financial Statements.
104
The cover page from our Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2020, formatted in Inline XBRL (contained in Exhibit 101).
* 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 30, 2020
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
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