Sally Beauty Holdings, Inc.: Form 10-Q for the period ended Dec 31, 2023

This section discusses management’s view of the financial condition, results of operations and cash flows of Sally Beauty for the periods covered by this Quarterly Report. 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, 2023, 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.

Financial Summary for the Three Months Ended December 31, 2023

• Consolidated net sales for the three months ended December 31, 2023 decreased $25.8 million, or 2.7%, to $931.3 million, compared to the three months ended December 31, 2022. Consolidated net sales included a net positive impact from changes in foreign currency exchange rates of $8.6 million;
• Consolidated comparable sales decreased 0.8% for the three months ended December 31, 2023;
• Consolidated gross profit for the three months ended December 31, 2023 decreased $21.4 million, or 4.4%, to $467.2 million, compared to the three months ended December 31, 2022. Consolidated gross margin decreased 80 bps to 50.2% for the three months ended December 31, 2023, compared to the three months ended December 31, 2022;
• Consolidated operating earnings for the three months ended December 31, 2023 decreased $17.5 million, or 20.2%, to $69.1 million, compared to the three months ended December 31, 2022. Operating margin decreased 160 bps to 7.4% for the three months ended December 31, 2023, compared to the three months ended December 31, 2022;
• For the three months ended December 31, 2023, our consolidated net earnings decreased $11.9 million, or 23.7%, to $38.4 million, compared to the three months ended December 31, 2022;
• For the three months ended December 31, 2023, our diluted earnings per share was $0.35 compared to $0.46 for the three months ended December 31, 2022; and
• Cash provided by operations was $51.0 million for the three months ended December 31, 2023, compared to $55.0 million for the three months ended December 31, 2022.

Comparable Sales

We believe that comparable sales is an appropriate performance indicator to measure our sales growth compared to the prior period. Our comparable sales include sales from stores that have been operating for 14 months or longer as of the last day of a month and from e-commerce revenue. Additionally, comparable sales include sales to franchisees and full service sales. Our comparable sales excludes the effect of changes in foreign exchange rates and sales from stores relocated until 14 months after the relocation. Revenue from acquired stores are excluded from our comparable sales calculation until 14 months after the acquisition. Our calculation of comparable sales might not be the same as other retailers as the calculation varies across the retail industry.

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):

(a) Unallocated expenses consist of corporate and shared costs and are included in selling, general and administrative expenses in our condensed consolidated statements of earnings.

Results of Operations

The Three Months Ended December 31, 2023, compared to the Three Months Ended December 31, 2022

Net Sales

SBS. The decrease in net sales for SBS was primarily driven by the following (in thousands):

(a) Includes closed stores, including stores closed under the Plan, net of stores opened for less than 14 months.

SBS's net sales decrease was primarily driven by the impact of store closures in connection with the Plan in an amount of approximately $23.3 million, partially offset by a significant portion of these sales being recaptured in other locations included within comparable sales and favorable impacts from foreign currency exchange rates. SBS’s comparable sales decline was a result of fewer transactions, partially offset by growth in our average unit retail, driven by inflationary impacts and pricing leverage, and the sales recaptured from closed stores.

BSG. The increase in net sales for BSG was primarily driven by the following (in thousands):

(a) Includes closed stores, including stores closed under the Plan, net of stores opened for less than 14 months and sales from acquired stores.

BSG's net sales were slightly higher due to an increase in comparable sales, reflecting expanded distribution, new brand innovation and improving salon demand trends, partially offset by the impact of store closures.

Gross Profit

SBS. SBS’s gross profit decreased for the three months ended December 31, 2023, as a result of a decrease in net sales and from lower gross margin on the units sold. SBS’s gross margin decline was driven primarily by an unfavorable sales mix shift from lower sales of higher margin Sally Beauty domestic sales and unfavorable fixed cost absorption partially offset by lower distribution and freight costs from supply chain efficiencies.

BSG. BSG’s gross profit decreased for the three months ended December 31, 2023, primarily as a result of a lower gross margin on the units sold. BSG’s gross margin decline was driven by unfavorable fixed cost absorption and shrink expense, partially offset by lower distribution and freight costs from supply chain efficiencies and higher product margin.

Selling, General and Administrative Expenses

SBS. SBS’s selling, general and administrative expenses increased $4.6 million, or 2.1%, for the three months ended December 31, 2023, and included an unfavorable impact from foreign exchange rates of $3.3 million. As a percentage of SBS net sales, selling, general and administrative expense for the three months ended December 31, 2023, was 43.8% compared to 40.8% for the three months ended December 31, 2022. The increase as a percentage of sales was due to higher labor costs, rent costs, and advertising expenses, partially offset by cost savings from store closures in connection with the Plan.

BSG. BSG’s selling, general and administrative expenses increased $0.5 million, or 0.5%, for the three months ended December 31, 2023. As a percentage of BSG net sales, selling, general and administrative expense for the three months ended December 31, 2023, was 28.4% compared to 28.3% for the three months ended December 31, 2022. The slight increase as a percentage of sales was driven primarily by higher wage and bonus expense, and higher depreciation and amortization expense, partially offset by lower delivery expense and cost savings from store closures in connection with the Plan.

Unallocated. Unallocated selling, general and administrative expenses, which represent certain corporate costs that have not been charged to our reporting segments, increased $1.4 million, or 2.7%, for the three months ended December 31, 2023, primarily due to higher consulting fees in connection with our Fuel for Growth initiative, partially offset by lower health insurance costs due to fewer claims.

Restructuring

The decrease in restructuring was primarily due to the lapping of expenses incurred in connection with our Distribution Center Consolidation and Store Optimization Plan in the prior year for $10.4 million. See Note 11, Restructuring, in Item 1 of this quarterly report for more information on the Plan.

Interest Expense

The decrease in interest expense is primarily due to lower borrowings on our ABL facility, partially offset by higher interest rates on our variable rate debt. See Note 9, Derivative Instruments and Hedging Activities, in Item 1 of the quarterly report for more information on our interest rate swap that has helped mitigate some of the additional interest costs resulting from higher interest rates.

Provision for Income Taxes

The effective tax rates were 25.9% and 26.7%, for the three months ended December 31, 2023, and 2022, respectively. The decrease in the effective tax rate was primarily due to foreign operations.

Liquidity and Capital Resources

Overview

Our principal sources of liquidity are cash from operations, cash and cash equivalents and borrowings under our ABL facility. A substantial portion of our liquidity needs arise from funding the costs of our operations, working capital, capital expenditures, debt interest and principal payments. Additionally, under our share repurchase program, see below for more details, we will from time-to-time repurchase shares of our common stock on the open market to return value to our shareholders. At December 31, 2023, we had $603.6 million in our liquidity pool, which includes $482.6 million available for borrowing under our ABL facility and cash and cash equivalents of $121.0 million.

Our working capital (current assets less current liabilities) increased $41.1 million, to $689.8 million at December 31, 2023, compared to $648.7 million at September 30, 2023, driven by higher inventory, resulting from timing of purchases and $8.1 million from the impact of foreign exchange rates, and lower accrued liabilities, driven by the timing of interest and payroll payments. The increase was partially offset by the timing of income tax payments.

We anticipate that existing cash balances (excluding certain amounts permanently invested in connection with foreign operations), cash expected to be generated by operations, and funds available under our ABL facility will be sufficient to fund our working capital and capital expenditure requirements over the next twelve months.

Cash Flows

(in thousands)

Net Cash Provided by Operating Activities

The decrease in cash provided by operating activities was driven by lower revenues, partially offset by the timing in inventory purchases.

Net Cash Used by Investing Activities

The increase in cash used by investing activities was driven by higher capital expenditures related to store improvements.

Net Cash Used by Financing Activities

The increase in cash used by financing activities was primarily due to shares repurchased in the current year under our share repurchases program and from lower net debt principal repayments in the current year.

Debt and Guarantor Financial Information

At December 31, 2023, we had $1.1 billion in outstanding debt principal, excluding finance lease obligations, unamortized debt issuance costs and debt discounts, in the aggregate, of $7.5 million. Our debt consists of $680.0 million in 2025 Senior Notes outstanding and $397.0 million remaining on our term loan. There were no outstanding borrowings under our ABL facility.

We utilize our ABL facility for the issuance of letters of credit, certain working capital and liquidity needs, and to manage normal fluctuations in our operational cash flow. In that regard, we may from time to time draw funds under the ABL facility for general corporate purposes including funding of capital expenditures, acquisitions, paying down other debt and share repurchases. Amounts drawn on our ABL facility are generally paid down with cash provided by our operating activities. During the three months ended December 31, 2023, the weighted average interest rate on our borrowings under the ABL facility was 8.75%.

We are currently in compliance with the agreements and instruments governing our debt, including our financial covenants.

Guarantor Financial Information

Our 2025 Senior Notes were issued by our wholly-owned subsidiaries, Sally Holdings LLC and Sally Capital Inc. (the “Issuers”). The notes are unsecured debt instruments guaranteed by us and certain of our wholly-owned domestic subsidiaries (together, the “Guarantors”) and have certain restrictions on the ability of our subsidiaries to make certain restrictive payments to Sally Beauty. The guarantees are joint and several, and full and unconditional. Certain other subsidiaries, including our foreign subsidiaries, do not serve as guarantors.

The following summarized consolidating financial information represents financial information for the Issuers and the Guarantors on a combined basis. All transactions and intercompany balances between these combined entities has been eliminated.

The following table presents the summarized balance sheets information for the Issuers and the Guarantors as of December 31, 2023, and September 30, 2023:

(in thousands)

The following table presents the summarized statement of earnings information for the Issuers and the Guarantors for three months ended December 31, 2023 (in thousands):

Share Repurchase Programs

Under our current share repurchase program, we may from time-to-time repurchase our common stock on the open market. During the three months ended December 31, 2023, we repurchased 1.9 million shares of our common stock for $20.0 million under our share repurchase program, excluding the impact of excise taxes. During the three months ended December 31, 2022, no shares were repurchased in connection with our share repurchase program. See Note 5, Stockholders’ Equity, for more information about our share repurchase program.

Contractual Obligations

Other than our debt, as discussed above, there have been no material changes outside the ordinary course of our business to our contractual obligations since September 30, 2023.

Off-Balance Sheet Financing Arrangements

At December 31, 2023, and September 30, 2023, 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, 2023.

Recent Accounting Pronouncements

See Note 2 of the Notes to Condensed Consolidated Financial Statements in Item 1 – “Financial Statements” in Part I – Financial Information.

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, 2023. 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, 2023.

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 December 31, 2023. 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 December 31, 2023, 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.

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, 2023, 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.