Sally Beauty Holdings, Inc. (SBH) FY 2024 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following section discusses management’s view of Sally Beauty’s financial condition and results of operations for fiscal year 2024 compared to fiscal year 2023. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of our Annual Report on Form 10-K for the fiscal year ended September 30, 2023, for a discussion of the financial condition and results of operations for fiscal year 2023 compared to fiscal year 2022. This section should be read in conjunction with the audited consolidated financial statements of Sally Beauty and the related notes included elsewhere in this Annual Report. This Management’s Discussion and Analysis of Financial Condition and Results of Operations section may contain forward-looking statements. See “Cautionary Notice Regarding Forward-Looking Statements” and “Risk Factors” for a discussion of the uncertainties, risks and assumptions associated with these forward-looking statements that could cause results to differ materially from those reflected in such forward-looking statements.

Financial Results Summary of the Fiscal Year Ended September 30, 2024:

•
Consolidated net sales for the fiscal year decreased $11.1 million, or 0.3%, to $3,717.0 million and included a positive impact from changes in foreign currency exchange rates of $9.3 million, or 0.2% of consolidated net sales;

•
Global e-commerce sales represented 9.8% of our consolidated net sales;

•
Consolidated comparable sales for the fiscal year increased 0.3% compared to the prior fiscal year;

•
Consolidated gross profit decreased by $7.8 million, or 0.4%, to $1,890.3 million. Gross margin was unchanged at 50.9% compared to the prior fiscal year;

•
Consolidated operating earnings for the fiscal year decreased $42.3 million, or 13.0%, to $282.7 million. Operating margin decreased 110 basis points to 7.6% compared to the prior fiscal year;

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Consolidated net earnings for the fiscal year decreased $31.2 million, or 16.9%, to $153.4 million;

•
Diluted earnings per share for the fiscal year were $1.43 compared to $1.69 for the prior fiscal year; and

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Cash provided by operations was $246.5 million for the fiscal year compared to $249.3 million for the prior fiscal year.

Trends Impacting Our Business

Recent global inflationary pressures have slowed from the highs experienced in the past few years, but they continue to influence consumer and stylist shopping behavior as well as the cost for products and services. While inflation eased, our customers have inflation fatigue and remain price sensitive. Inflationary pressures have also impacted wages, especially among retail and hourly employees, as we have experienced an increase in our labor costs in order to attract and retain associates Within our SBS business, we adapted our promotional strategy to be more focused on the promotions that matter to the customer, and we saw improvements in customer frequency. Within our BSG business, we saw our stylists respond to big promotional events, but also to newness and innovation in the assortment.

We continue to monitor inflationary challenges and implement measures to help mitigate their impacts, including managing our inventory levels to reduce out-of-stock items, adjusting our promotional activities, optimizing our store base and expanding our partnerships with delivery service providers, including with DoorDash and Instacart marketplaces. Although these initiatives have helped mitigate ongoing macro-headwinds, we cannot reasonably predict the long-term effects of inflation.

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 amounts exclude the effect of changes in foreign exchange rates and sales from stores relocated until 14 months after the relocation. Revenue from acquired stores is 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.

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Results of Operations

Key Operating Metrics

The following table sets forth, for the periods indicated, information concerning key measures on which we rely to assess our operating performance (dollars in thousands):

(a)
Unallocated expenses represent certain corporate costs, including share-based compensation expense, that have not been charged to our segments and are included in SG&A expenses in our consolidated statements of earnings. Additionally, unallocated includes costs related to our Fuel for Growth initiative.

(b)
Restructuring expenses primarily relate to the Plan, as discussed in Note 17 in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report.

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The Fiscal Year Ended September 30, 2024, compared to the Fiscal Year Ended September 30, 2023

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 lower comparable sales and the impact of store closures pursuant to the Plan. Comparable sales decreased $23.8 million resulting from store closures under the Plan; however, a significant portion of those lost sales were recaptured at other SBS locations. These decreases were partially offset by a favorable impact 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.

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

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

BSG's net sales increase was primarily driven by an increase in comparable sales, reflecting expanded distribution, new brand innovation and improving salon demand trends, partially offset by the impact of store closures and the unfavorable impact from foreign currency exchange rates.

Gross Profit

SBS. SBS’s gross profit decrease was driven by lower net sales, partially offset by a higher gross margin. SBS’s gross margin improvement was primarily due to lower distribution and freight costs from supply chain efficiencies and higher product margins, partially offset by unfavorable fixed cost absorption.

BSG. BSG’s gross profit decreased slightly as a result of lower gross margin, partially offset by higher net sales. BSG's gross margin decline was driven primarily by lower product margins and favorable adjustments to our expected obsolescence reserve related to the Plan in the prior year.

Selling, General and Administrative Expenses

SBS. SBS’s SG&A expenses increased $16.4 million, or 1.8%, to $923.6 million for fiscal year 2024, which includes the unfavorable impact from foreign exchange rates of $3.8 million due to the weakening of the U.S. Dollar compared to currencies in our foreign operations. As a percentage of SBS net sales, SG&A for fiscal year 2024 was 43.8% compared to 42.4% for fiscal year 2023. This increase as a percentage of sales was primarily due to higher labor and other compensation-related expenses, rent expense, depreciation expense and advertising expense.

BSG. BSG’s SG&A expenses increased $2.8 million, or 0.6%, to $454.0 million for fiscal year 2024 and includes a favorable impact from foreign exchange rates of $2.5 million. As a percentage of BSG net sales, SG&A for fiscal year 2024 was 28.2% compared to 28.4% for fiscal year 2023. This decrease was driven primarily by higher net sales and lower delivery expense.

Unallocated. Unallocated SG&A expenses, which represent certain corporate costs that have not been charged to our reporting segments, increased $32.6 million, or 16.5%, to $230.1 million, primarily due to expenses in connection with our Fuel for Growth initiative in the current year.

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Restructuring

The decrease in restructuring expenses was primarily due to the lapping of expenses that were incurred in connection with the Plan in the prior year totaling $17.2 million. See Note 17 in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information on our restructuring plans.

Interest Expense

The increase in interest expense was primarily due to the impacts of higher interest rates and debt extinguishment costs, partially offset by lower average outstanding borrowings on our ABL facility during the current year. Additionally, our interest rate swap helped mitigate some of the impacts from higher interest rates on a portion of our term loan B.

Provision for Income Taxes

For fiscal years 2024 and 2023, our effective tax rate was 25.6% and 26.8%, respectively. The decrease in our effective tax rate was primarily due to additional taxes and interest recorded in the prior fiscal year in connection with the one-time transition tax on unrepatriated foreign earnings ("Repatriation Tax") related to fiscal year 2018. See Note 15, Income Taxes, for more information on our effective tax rate.

Our effective tax rate may fluctuate on a quarterly and/or annual basis due to various factors, including, but not limited to, total earnings and the mix of earnings by jurisdiction, new tax laws, as well as changes in valuation allowances and uncertain tax positions.

Liquidity and Capital Resources

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 and debt-servicing. 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 September 30, 2024, we had $590.5 million in our liquidity pool, which includes amounts available for borrowings under our ABL facility of $482.5 million and cash and cash equivalents of $108.0 million. Based upon the current level of operations and anticipated growth, we anticipate existing cash balances (excluding certain amounts permanently invested in connection with foreign operations), as well as cash expected to be generated by operations and funds available under the ABL facility, will be sufficient to fund working capital requirements, potential acquisitions, anticipated capital expenditures (including information technology investments and store projects) and service our debt obligations over the next 12 months and beyond.

Our working capital (current assets less current liabilities) increased $63.9 million to $712.6 million at September 30, 2024, compared to $648.7 million at September 30, 2023. The increase in our working capital was driven by higher inventory balances, as a result of expanded distribution rights in BSG and vendor price increases, the impacts of assets held for sale, and the timing of account payables, income tax payables, and vendor receivables, included in accounts receivable, other. These impacts were partially offset by a decrease in cash and cash equivalents and timing of lease renewals. The ratio of current assets to current liabilities was 2.20 to 1.00 at September 30, 2024, compared to 2.12 to 1.00 at September 30, 2023.

Share Repurchase Programs

During the fiscal years 2024 and 2023, we repurchased and subsequently retired approximately 5.1 million shares and 1.5 million shares of our common stock under our share repurchase program at a cost of $60.0 million and $15.0 million, respectively, excluding the impact of excise taxes on share repurchases. Share repurchases are funded primarily with cash from operations and, occasionally, with borrowings under the ABL facility. As of September 30, 2024, we had approximately $520.8 million of additional share repurchase authorization remaining under our Share Repurchase Program, which expires September 30, 2025.

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Historical Cash Flows

The following table shows our sources and uses of cash for the periods presented (in thousands):

Operating Activities

The slight decrease in net cash provided by operating activities for fiscal year 2024, compared to fiscal year 2023, was primarily driven by higher inventory purchases, fewer cash receipts from customers, and the timing of vendor and manufacturing allowances, partially offset by the timing of tax and interest payments and the impact of lease contract termination and severance payments in connection with the Plan in the prior year.

Investing Activities

The increase in net cash used by investing activities for fiscal year 2024, compared to fiscal year 2023, was primarily due to higher capital expenditures, partially offset by lower cash used for acquisitions. During fiscal year 2024, we had total capital expenditures of approximately $94.7 million, excluding amounts paid in connection with the prior year, primarily in connection with investments in technology and store leasehold improvements.

Financing Activities

Net cash used by financing activities increased as a result of increased shares repurchased under our share repurchase program and higher costs related to the issuance of debt compared to the prior year.

Debt and Guarantor Financial Information

During the current fiscal year, we issued $600.0 million in 2032 Senior Notes and used the proceeds, together with cash on hand and borrowings under our ABL facility, to redeem in full our 2025 Senior Notes.

At September 30, 2024, we had $994.0 million in outstanding debt, excluding finance lease obligations, unamortized debt issuance costs and discounts, in the aggregate, of $8.7 million. Our debt consists of $600.0 million in 2032 Senior Notes outstanding and $394.0 million remaining on our term loan B. At September 30, 2024, 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, debt servicing and, occasionally, share repurchases. Amounts drawn on our ABL facility are generally paid down with cash provided by our operating activities. During fiscal year 2024, the weighted average interest rate on our borrowings under the ABL facility was 7.25%.

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

See Note 11 of the Notes to Consolidated Financial Statements in Item 8 contained in this Annual Report for additional information about our debt.

Guarantor Financial Information

Our 2032 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.

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

The following table presents the summarized balance sheets information for the Issuers and the Guarantors as of September 30, 2024 and 2023 (in thousands):

The following table presents the summarized statement of earnings information for fiscal year 2024 (in thousands):

Contractual Obligations

The following table summarizes our contractual obligations at September 30, 2024 (in thousands):

(a)
Long-term debt obligations include future interest payments on our debt outstanding as of September 30, 2024. The amounts shown above do not include deferred debt issuance costs reflected in our consolidated balance sheets, nor do they include the impact of any interest received from the impact of our interest rate swap.

(b)
The amounts reported for operating leases do not include common area maintenance (CAM), property taxes or other executory costs. The amounts shown above do not include immaterial contingent liabilities for operating leases for which we are liable in the event of default by a franchisee.

(c)
Purchase obligations reflect legally binding agreements that are entered into by us to purchase goods or services, that specify minimum quantities to be purchased and with fixed or variable price provisions. Amounts shown do not reflect open purchase orders, mainly for merchandise, to be fulfilled within one year, which are generally cancellable or contracts that tend to be reoccurring in nature and similar in amount year over year.

(d)
Other long-term obligations, including current portion, principally represent obligations under our insurance and self-insurance programs. These obligations are included in accrued liabilities and other liabilities, as appropriate, in our consolidated balance sheets.

(e)
The table above does not include an estimated $8.4 million of unrecognized tax benefits due to uncertainty regarding the realization and timing of the related future cash flows, if any.

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The information contained in the table above with regards to our long-term debt obligations is based on the current terms of such debt obligations and does not reflect any assumptions about our ability or intent to refinance any of our debt either on or before their maturity. In the event we refinance some or all of the debt either on or before maturity, actual payments for some of the periods shown may differ materially from the amounts reported herein. In addition, other future events, including potential increases in interest rates, could cause actual payments to differ materially from these amounts.

Off-Balance Sheet Financing Arrangements

At September 30, 2024, we did not have any off-balance sheet financing arrangements other than obligations under letters of credit, as discussed above.

Critical Accounting Estimates

The preparation of our consolidated financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”) requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosures. Actual results could differ from the estimates and assumptions used, which could have a material impact on financial statements. We believe the following are our most critical accounting estimates that require subjective judgments, estimates and assumptions:

Vendor Rebates and Concessions

We deem cash consideration received from a vendor to be a reduction of the cost of goods sold unless it is in exchange for an asset or service, or a reimbursement of a specific, incremental, identifiable cost incurred by us in selling the vendor’s products. The majority of cash consideration we receive is considered to be a reduction of the cost of inventory and a subsequent reduction in cost of goods sold as the related products are sold. We consider the facts and circumstances of the various contractual agreements with vendors in order to determine the appropriate classification of amounts received in our consolidated statements of earnings. We record cash consideration expected to be received from vendors in accounts receivables, other when earned and at the amount we believe will be collected. These receivables could be significantly affected if the actual amounts subsequently collected differ from our expectations. Historically, adjustments between the amount recorded and the amount collected have not had a material impact on our results of operations.

Income Taxes

We record income tax provisions in our consolidated financial statements based on an estimate of current income tax liabilities. The development of these provisions requires judgments about tax positions, potential outcomes and timing. If we prevail in tax matters for which provisions have been established or are required to settle matters in excess of established provisions, our effective tax rate for a particular period could be significantly affected.

Additionally, deferred income taxes are recognized for the future tax consequences attributable to differences between our financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are estimated to be recovered or settled. We believe it is more-likely-than-not that our results of operations in the future will generate sufficient taxable income to realize our deferred tax assets, net of the valuation allowance currently recorded. We have recorded a valuation allowance to account for uncertainties regarding the recoverability of certain deferred tax assets, primarily foreign loss carryforwards and tax credit carryforwards. In the future, if we determine certain deferred tax assets will not be realizable, the related adjustments could significantly affect our effective tax rate at that time. An estimated tax benefit related to an uncertain tax position is recorded in our consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax position will withstand challenge, if any, from applicable taxing authorities.

Assessment of Long-Lived Assets for Impairment and Restructuring

We review long-lived assets, including operating lease assets, for impairment whenever events or circumstances indicate the carrying amount of an asset may not be fully recoverable based on estimated undiscounted future cash flows. Long-lived assets are reviewed at the lowest level of identifiable cash flows, which typically is at the store level. In assessing for impairment, we determine the fair value of each individual store by discounting projected future cash flows. There are certain estimates and assumptions used to arrive at estimated future cash flows, including projected earnings and growth rates. The carrying amount of a long-lived asset or asset group is considered impaired

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when the carrying value of the asset or asset group exceeds the expected future cash flows from the asset or asset group. The impairment loss recognized is the excess of the carrying value of the asset or asset group over its fair value.

When we commit to an exit plan of scale that we believe will result in the disposal of long-lived assets prior to the end of their useful lives, the approval of such plan may be considered a triggering event and therefore require a reassessment of asset carrying values for recoverability, based on projected cash flows. If the carrying values are not recoverable, write-downs or impairment charges may be required to bring carrying values of certain long-lived assets, including operating lease asset, to fair value. In connection with facility and store closures, we typically will also incur charges for employee severance, disposal costs and other expenses incurred with closures. These charges are accrued and estimated based on facts and circumstances at the time. Actual cash flows and expected payments could be significantly different from our estimates.

For fiscal years 2024 and 2023, no material impairment losses were recognized. For fiscal year 2022, we recognized an impairment loss of $24.8 million within restructuring in connection with the Plan.

Assessment of Goodwill and Intangible Assets for Impairment

We review goodwill and intangible assets for impairment annually, or when events or circumstances indicate it is more-likely-than-not that the value of the asset may be impaired. In assessing these types of assets for impairment, there are significant estimates and assumptions used to determine the fair value, including relevant market and economic conditions, anticipated future revenues and cash flows, royalty rates and discount rates.

When assessing goodwill for impairment, we may perform a qualitative assessment which evaluates macro-economic conditions, current and projected cash flows, and other events or changes in circumstances to determine if a quantitative assessment is necessary. During quantitative assessment, we use a discounted cash flow model to determine an estimated fair value. If it is determined that the fair value of a reporting unit is less than its carrying value, an impairment charge will be recorded to bring the carrying value down to its fair value.

During fiscal year 2024, we determined that no triggering events had occurred, as both internal and external facts and circumstances, including revenues in fiscal year 2024 versus prior projections and prior weighted-average cost of capital, continued to see improvement from the end of September 2023. At the end of September 2023, we determined that a triggering event had occurred, due to the decline in the Company's share price and market capitalization at the end of fiscal year 2023, among other factors. As a result, we conducted a quantitative assessment at September 30, 2023 and determined that no impairment existed for our SBS or BSG reporting units.

Like goodwill, our indefinite-lived intangible assets are tested for impairment by comparing the fair value of each asset to its carrying value, but only if a triggering event exists. As of September 30, 2024, our indefinite-lived assets were comprised of only trade names. To determine the fair value of each trade name, we use the relief-from-royalty method, which estimates what a third-party would be willing to pay in royalties to receive a benefit from the use of the asset. If it is determined the asset’s fair value is less than its carrying value, then an impairment charge is recorded to reduce the carrying value down to its fair value. No impairment losses were recognized in fiscal years 2024, 2023, or 2022.

Recent Accounting Pronouncements

See Note 3 of the Notes to Consolidated Financial Statements in Item 8 — “Financial Statements and Supplementary Data” contained elsewhere in this Annual Report for information about recent accounting pronouncements.