ITEM 1. BUSINESS
Introduction
Sally Beauty Holdings, Inc. is an international specialty retailer and distributor of professional beauty supplies with operations in North America,
South America and Europe. We believe we are the largest distributor of professional beauty supplies in the U.S. based on store count. At September 30, 2017, we operated through two business
units, Sally Beauty Supply ("SBS") and Beauty Systems Group ("BSG"), and, through SBS and BSG, we had 4,963 company-operated stores and supplied 187 franchised stores. Within BSG, we also have
one of the largest networks of distributor sales consultants for professional beauty products in North America, with 829 sales consultants who train, educate and sell directly to salons and salon
professionals. SBS targets retail consumers and salon professionals, while BSG exclusively targets salons and salon professionals. Through SBS and BSG, we have store locations in the United States
(including Puerto Rico), Canada, Mexico, the United Kingdom, Ireland, Belgium, France, Germany, the Netherlands, Spain, Chile and Peru. We provide our customers with a wide variety of leading
third-party branded and exclusive-label professional beauty supplies, including hair color products, hair care products, styling tools, skin and nail care products and other beauty items. For each of
the fiscal years ended September 30, 2017, 2016 and 2015, over 80% of our consolidated net sales were from customers located in the U.S. For the fiscal year ended September 30, 2017, our
consolidated net sales and operating earnings were $3,938.3 million and $478.6 million, respectively. The information contained in this section should be read in conjunction with the
information contained in Item 1A. "RISK FACTORS" below.
Professional Beauty Supply Industry Distribution Channels
The professional beauty supply industry serves end-users through four distribution channels: full-service/exclusive distribution, open-line distribution,
direct and mega-salon stores.
Full-Service/Exclusive
This channel exclusively serves salons and salon professionals and distributes "professional-only" products for use in salons and resale to consumers in
salons. Many brands are distributed through exclusive arrangements with suppliers by geographic territory. BSG is one of the leading full-service distributors in the U.S. In addition, BSG offers its
products for sale to salons and salon professionals through websites (including
www.cosmoprofbeauty.com
and
www.cosmoprofequipment.com
).
Open-Line
This channel serves retail consumers and salon professionals through retail stores and e-commerce platforms. This channel is served by a large number of
localized retailers and distributors, with only a few having a regional or national presence and significant channel share. We believe that SBS, with its nationwide network or retail stores, is the
largest open-line distributor in the U.S.. In addition, SBS's websites (including
www.sallybeauty.com
) and other e-commerce platforms provide retail
consumers and salon professionals access to product offerings and information beyond our retail stores.
Direct
This channel focuses on direct sales to salons and salon professionals by large manufacturers. This is the dominant form of distribution in Europe, but
represents a smaller channel in the U.S. due to the highly fragmented nature of the U.S. salon industry, which makes direct distribution costs prohibitive for many manufacturers.
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Mega-Salon Stores
In this channel, large-format salons are supplied directly by manufacturers due to their significant purchase requirements.
Key Industry and Business Trends
We operate within the large and growing professional beauty supply industry, primarily in the U.S., but also in 11 other countries across North America, South
America and Europe. We believe the following key industry and business trends and characteristics will influence our business and our financial results going forward:
High level of marketplace fragmentation.
The U.S. salon industry is highly fragmented with approximately 270,000 salons and barbershops. Given the fragmented and
small-scale nature of the salon industry, we believe that salon operators will continue to depend on full-service/exclusive distributors and open-line channels for a majority of their beauty supply
purchases.
Growth in chair renting and frequent stocking needs.
Salon professionals primarily rely on just-in-time inventory due to capital constraints and limited warehouse
and shelf space. In addition, chair renters and suite renters, who now comprise a significant percentage of the total U.S. salon professionals, are often responsible for purchasing their own supplies.
The number of chair renters and suite renters has significantly increased as a percentage of total salon professionals in recent years, and we expect this trend to continue. Chair renters and suite
renters, given their smaller and more frequent purchase pattern, are dependent on frequent trips to professional beauty supply stores, like BSG and SBS. We expect that these factors will continue to
drive demand for conveniently located professional beauty supply stores.
Increasing use of exclusive-label products.
We offer an extensive range of exclusive-label professional beauty products, predominantly in our SBS segment. As our
lines of exclusive-label products have matured and become better known in our retail stores and online, we have seen an increase in sales of
these products. Generally, our exclusive-label products have higher gross margins than leading third-party branded products and, accordingly, we believe that driving growth in sales of these products
would enhance our overall gross margins. Furthermore, we believe that we provide our customers with a unique value proposition by offering compelling exclusive-label brands that we believe to be of
the same quality as leading third-party branded products at more attractive prices.
Favorable consumer trends.
Our industry is characterized by continuously changing fashion-related trends that drive new styles, including hair and nail styles, and
continuing demand for beauty products. In addition, we expect the aging baby-boomer population in the U.S. to continue to drive sales growth in certain professional beauty product categories,
including through an increase in the usage of hair color and hair loss products. We continuously adapt our marketing and merchandising initiatives in an effort to expand our market reach or to respond
to changing consumer preferences.
Business Segments, Geographic Area Information and Seasonality
We operate in two business segments: (i) SBS, an open-line and exclusive-label retailer of professional beauty supplies offering professional beauty
supplies to both retail consumers and salon professionals, primarily in North America, South America and Europe, and (ii) BSG, including its franchise-based business Armstrong McCall, a
full-service beauty supply distributor offering professional brands directly to salons and salon professionals through our own sales force and professional-only stores, many in exclusive geographical
territories, in North America. For each of the fiscal years ended September 30, 2017, 2016 and 2015, SBS accounted for approximately 59.5% and BSG accounted for approximately 40.5% of our
consolidated net sales.
Neither
the sales nor the product assortment for SBS or BSG are generally seasonal in nature.
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Sally Beauty Supply
As of September 30, 2017, SBS had 3,763 company-operated retail stores (generally under the Sally Beauty banner), 2,883 of which are located in the
U.S. (including Puerto Rico), with the remaining 880 company-operated retail stores located in Canada, Mexico, the United Kingdom, Ireland, Belgium, France, Germany, the Netherlands, Spain, Chile and
Peru. SBS also supplied 19 franchised stores located in the United Kingdom, Belgium and certain other European countries. At September 30, 2017, SBS's store count was flat versus the
prior year-end. At September 30, 2016 and 2015, SBS's net store count had increased by 108 and 110 stores (including franchised stores), respectively, compared to the prior year-end. Our SBS
stores and website carry an extensive selection of professional beauty supplies for both retail customers and salon professionals, featuring an average of 8,000 stock keeping units, or SKUs, of beauty
products across a variety of product categories including hair color, hair care, skin and nail care, styling tools and other beauty products. SBS's stores and website carry leading third-party brands
such as OPI®, China Glaze®, Wella®, Clairol®, Conair® and Hot Shot Tools®, as well as an extensive selection of exclusive-label
merchandise. We believe that SBS has differentiated itself from its competitors through its customer value proposition based on delivering an extensive selection of leading third-party branded and
exclusive-label professional beauty products at attractive prices through knowledgeable sales associates and convenient store locations.
Store Design and Operations
SBS stores are designed to create an appealing shopping environment that embraces the retail consumer and salon professional and highlights SBS's extensive
product offering. In the U.S. and Canada, Sally Beauty stores average approximately 1,700 square feet in size, are located primarily in strip shopping centers and generally follow a consistent format,
allowing customers familiarity between Sally Beauty store locations. Store formats, including average size and product selection, outside the U.S. and Canada vary by marketplace.
In
2015, SBS launched a number of store refresh initiatives designed to enhance the consumer experience at its stores, primarily in the U.S, by upgrading the look, feel and "shopability" of its
stores. Sally Beauty initiatives aim to align category displays and footage at the store with customer trends in order to optimize sales per customer, while improving the overall flow and layout of
the store. As part of this initiative, SBS continues to support the nail studio, expansion of hair color education center, expansion of multicultural hair, and greater exposure to cosmetics. In
addition, SBS installed new floors, LED lighting and updated signage at a significant number of its stores in the U.S. These store refresh initiatives were intended to provide our customers with a
brighter and more engaging store that is easier to navigate. As of September 30, 2017, SBS had substantially completed the store refresh initiative launched in 2015. We will continue to assess
the look, feel and "shopability" of our Sally Beauty stores primarily in the U.S., and will upgrade additional stores as necessary to maintain an appealing shopping environment. In addition to these
physical store improvements, we have also
focused our marketing efforts designed to reach our customer through a variety of medium and by leveraging our customer relationship management ("CRM") programs to more effectively communicate with
our customers. See
Marketing and Advertising
below.
Merchandise
Our Sally Beauty stores and website carry an extensive selection of third-party and exclusive-label professional, high-quality beauty products. SBS applies
strong category management processes, including centrally developed guides, to maintain consistent merchandise presentation across its store base. Additionally, SBS's information systems enable it to
track and automatically replenish inventory levels, allowing it to maintain high levels of in-stock merchandise on regular-priced and promotional items, while managing inventory levels from a
centralized location.
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The
following table sets forth SBS's sales mix by major product category:
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Fiscal Year Ended
September 30,
|
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|
|
2017
|
|
2016
|
|
2015
|
|
Hair color
|
|
|
26.1
|
%
|
|
25.3
|
%
|
|
24.7
|
%
|
Hair care
|
|
|
21.4
|
%
|
|
21.5
|
%
|
|
22.1
|
%
|
Skin and nail care
|
|
|
15.6
|
%
|
|
15.5
|
%
|
|
15.8
|
%
|
Styling tools
|
|
|
14.5
|
%
|
|
15.1
|
%
|
|
14.7
|
%
|
Multicultural products
|
|
|
7.8
|
%
|
|
7.6
|
%
|
|
7.0
|
%
|
Salon supplies and accessories
|
|
|
6.9
|
%
|
|
7.1
|
%
|
|
8.0
|
%
|
Other beauty items
|
|
|
7.7
|
%
|
|
7.9
|
%
|
|
7.7
|
%
|
|
|
|
|
|
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Total
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100.0
|
%
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|
100.0
|
%
|
|
100.0
|
%
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Leading Third-Party Branded Products
SBS offers an extensive selection of hair care products, nail care products, beauty sundries and styling tools, featuring leading third-party brands such as
OPI®, China Glaze®, Wella®, Clairol®, Conair® and Hot Shot Tools®. SBS believes that carrying a wide selection of the latest
premier branded
merchandise is critical to building long-term relationships with its customers and attracting new customers. The merchandise SBS carries includes products from one or more of the leading manufacturers
in each category. SBS's objective is to carry not only leading brands, but also a wide range of third-party branded and exclusive-label products within each category. As beauty trends continue to
evolve, SBS will continue to offer the changing professional beauty product assortment necessary to meet the needs of retail consumers and salon professionals.
Exclusive-Label Products
SBS offers an extensive selection of owned-brands and controlled brands, which we refer to as exclusive-label, professional beauty products that are only
available at SBS stores and related websites. We believe that SBS's exclusive-label products offer equal or better quality products as high-priced leading third-party brands, providing the customer
attractive alternatives to those brands at lower prices. During the fiscal year ended September 30, 2017, exclusive-label brand accounted for approximately 47% of SBS's product sales in the
U.S. Generally, SBS's exclusive-label products have higher gross margins than the leading third-party branded products, and we believe that this area offers continued growth potential. SBS intends to
continue to invest in the growth of its exclusive-label brands and to actively promote these products in an effort to strengthen this category of products, with the goal of making these brands more
distinctive and well-known.
Marketing and Advertising
SBS's marketing programs are designed to drive customer traffic by differentiating SBS as a source of professional advice, solutions and salon-quality
products at competitive prices, and to back it with our "Love It or Return It" guarantee.
We
continuously adapt our marketing initiatives and adjust our media and messaging mix to achieve a high return on our marketing and advertising dollars. We target existing and potential customers
through an integrated marketing approach designed to reach the customer through a variety of medium with which he or she engages, including digital advertising, email, social media, text messaging,
direct mail, and print advertising.
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We
continue to refine the strategy for our
sallybeauty.com
and other websites, shifting from largely transactional-based to a more content-rich
experience that enables customers to learn about the latest trends and techniques from influencers, engage in our latest product launches and research products. We frequently update our home page to
enhance its appeal to our existing and prospective customers. In addition, we continue to refine our internal processes and partnerships to increase traffic to the website. We currently offer
approximately 9,500 SKUs of our SBS products for sale through our website (
sallybeauty.com
). Many of our customers research products on our mobile or
desktop site before visiting a store, and we believe that our website enhances our other efforts intended to promote consumer awareness of SBS's products. Beyond generating e-commerce sales, we
believe our website is an important vehicle to reach consumers researching beauty products online who could potentially visit our stores as a result of their experience on our website.
SBS's
customer loyalty and CRM programs, primarily in the U.S. and Canada, allow SBS the opportunity to collect valuable point-of-sale customer data as a means of increasing its understanding of
customers' needs and enhancing its ability to market to them in more personalized, relevant ways. The Sally "Beauty Club" is a loyalty program for customers who are not salon professionals. Beauty
Club members, after paying a nominal annual fee, are eligible to receive a discounted price on almost every non-sale item. Members are eligible to receive direct mail, text messages and e-mail
communications that contain special offers, beauty tips and new product information. We recently improved our CRM capabilities to better respond to our customers' behavior, drive the customer
experience, and increase sales.
In
addition, SBS's "ProCard" is a loyalty program for licensed salon professionals. ProCard members are eligible to receive discounts on all beauty products sold at SBS stores and sallybeauty.com, as
well as special offerings available only to salon professionals. Outside the U.S. and Canada, our customer loyalty and marketing programs vary by marketplace.
We
will continue to assess and update our SBS customer loyalty and CRM programs in an effort to further enhance the customer experience and promote repeat sales from both retail customers and salon
professionals.
Store Locations
SBS selects geographic areas and store sites on the basis of demographic information, the quality and nature of neighboring tenants, store visibility and
location accessibility. SBS seeks to locate stores primarily in strip malls, which are occupied by other high traffic retailers such as grocery stores, mass merchants and home improvement centers.
SBS
balances its store expansion between new and existing geographies, with future store growth expected primarily in non-U.S. geographies. In its existing marketplaces, SBS adds stores as necessary
to provide additional coverage. In new marketplaces, SBS generally seeks to expand in geographically contiguous areas to leverage its experience. We believe that SBS's knowledge of local marketplaces
will continue to be an important part of its success.
Beauty Systems Group
As of September 30, 2017, BSG operated 1,200 company-operated stores (generally under the CosmoProf banner) with 1,099 located in the U.S. (including
Puerto Rico) and the remaining 101 company-operated retail stores located in Canada. In addition, as of September 30, 2017, BSG supplied 168 franchised stores and had a sales force of
approximately 829 distributor sales consultants in the U.S., Canada and Mexico. During the fiscal years ended September 30, 2017, 2016 and 2015, BSG added 30, 29 and 29 stores (including
franchised stores, but excluding 15 stores acquired in 2016), respectively. We believe BSG is the largest full-service distributor of professional beauty supplies in North America exclusively
targeting salons and salon professionals. Through BSG's large store base, websites and sales force, including its franchise-based business, Armstrong McCall, BSG is able to access a significant
portion of the highly fragmented U.S. professional beauty salon products industry.
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Table of Contents
Store Design and Operations
BSG stores, including its franchise-based Armstrong McCall stores, are designed to create a professional shopping environment that highlights its extensive
product offering and embraces the salon professional. Company-operated BSG stores, average approximately 2,600 square feet and are located primarily in secondary strip shopping centers. BSG store
layouts are designed to provide variety and options to the salon professional. Stores are segmented into distinctive areas arranged by product type, with certain areas dedicated to leading third-party
brands; such as Paul Mitchell®, Wella®, Schwarzkopf®, Kenra®, Goldwell®, Joico® and Aquage®. The selection of these
and other brands varies by territory.
Distributor Sales Consultants
As of September 30, 2017, BSG had a network of approximately 829 distributor sales consultants ("DSC" or "DSCs"), which exclusively train, educate and
sell directly to salons and salon professionals.
In
order to provide a knowledgeable sales consultant team, BSG actively recruits individuals with industry knowledge or sales experience. We believe that DSCs with broad product knowledge and direct
sales experience are more successful in driving sales. In addition, new DSCs are enrolled in a targeted training program intended to reduce the time it takes a trainee to become effective in his or
her role. The training program includes field-based onboarding, classroom-based advanced sales training, and continuing web-based learning and development. The goal of the program is to equip new DSCs
with knowledge of our products and of our customers' needs, and the sales techniques necessary to deliver the best possible service and support to salon professionals. In addition to selling
professional beauty products, our DSCs offer in-salon training for professionals and salon owners in areas such as new styles, techniques and business practices. Our sales commission program is an
important component of our DSCs compensation, which is designed to drive sales and to focus DSCs on selling products that are best suited to individual salons and salon professionals.
We
believe that our emphasis on recruitment, training, and sales-based compensation results in a sales force that distinguishes itself from other full-service/exclusive-channel distributors and the
employment of DSCs is an effective way to serve salons and salon professionals.
The
following table sets forth the percentage of BSG sales attributable to each major distribution channel:
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Fiscal Year Ended September 30,
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2017
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2016
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2015
|
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Company-operated stores
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68.8
|
%
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68.0
|
%
|
|
67.4
|
%
|
Distributor sales consultants
|
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|
23.5
|
%
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24.0
|
%
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24.0
|
%
|
Franchise stores
|
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7.7
|
%
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8.0
|
%
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8.6
|
%
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Total
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|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
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Prior
fiscal year percentages have been adjusted in connection with the realignment of a business component from BSG to SBS in fiscal year 2017.
Merchandise
BSG stores carry an extensive selection of third-party branded products, featuring an average of 10,500 SKUs of beauty products, including hair color and
care, skin and nail care, styling tools and other beauty items. Some products are available in bulk packaging for higher volume salon needs. Through BSG's information systems, each store's product
sales performance is actively monitored, allowing an optimal merchandise mix. Additionally, BSG's information systems track and automatically replenish inventory levels on a weekly basis, enabling BSG
to maintain sufficient levels of product in stock. BSG's primary
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focus
is to provide a comprehensive selection of branded products to the salon professional at competitive prices. BSG is also the exclusive source for certain well-known third-party branded products
pursuant to BSG's exclusive arrangements with certain suppliers within specified geographic
territories. Increasing our exclusive distribution of well-known brands is an important aspect of our growth strategy for BSG, and in recent years BSG has acquired distribution rights for additional
well-known brands in new geographies and extended contracts with several key existing vendors. We believe that carrying an extensive selection of branded merchandise is critical to maintaining
relationships with our professional customers.
The
following table sets forth BSG's sales mix by major product category:
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Fiscal Year Ended
September 30,
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|
2017
|
|
2016
|
|
2015
|
|
Hair color
|
|
|
37.0
|
%
|
|
35.4
|
%
|
|
32.7
|
%
|
Hair care
|
|
|
34.4
|
%
|
|
34.3
|
%
|
|
34.5
|
%
|
Skin and nail care
|
|
|
9.0
|
%
|
|
8.9
|
%
|
|
9.5
|
%
|
Styling tools
|
|
|
4.2
|
%
|
|
4.5
|
%
|
|
5.0
|
%
|
Promotional items(a)
|
|
|
8.5
|
%
|
|
10.1
|
%
|
|
10.7
|
%
|
Other beauty items
|
|
|
6.9
|
%
|
|
6.8
|
%
|
|
7.6
|
%
|
|
|
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|
|
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|
Total
|
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
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-
(1)
-
Promotional
items consist of sales from other categories that are sold on a value-priced basis.
Marketing and Advertising
BSG's marketing programs are designed primarily to promote its extensive selection of brand name products at competitive prices and to educate, motivate and
empower its customers to grow professionally. BSG communicates on a frequent basis with its customers and potential customers, and distributes promotional material through multiple communication
channels, including trade shows, educational events, store personnel, distributor sales consultants, print mail, e-mail, text and social media. In addition, BSG offers up to 17,000 SKUs (primarily in
the U.S.) of professional beauty products for sale through its websites (
www.cosmoprofequipment.com and www.cosmoprofbeauty.com
). We believe that BSG's
websites enhance its other efforts intended to promote awareness of BSG's products by salons, salon professionals and retail customers.
Competitive Strengths
We believe the following competitive strengths differentiate us from our competitors and will help drive our future growth:
The Largest Professional Beauty Supply Distributor in the U.S. with Multi-Channel Platform
We believe that SBS and BSG together comprise the largest distributor of professional beauty products in the U.S. by store count. Our leading channel
positions and multi-channel platform afford us several advantages, including strong positioning with suppliers, the ability to better service the highly fragmented beauty supply marketplace, economies
of scale and the ability to capitalize on the ongoing consolidation in our sector. Through our multi-channel platform, we are able to generate and grow revenues across broad, diversified geographies,
and customer segments using varying product assortments.
Differentiated Customer Value Proposition
We believe that we offer our customers a strong and differentiated value proposition by providing salon-quality products and solutions at attractive prices.
Our stores are conveniently located and offer a wide
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selection
of competitively priced professional beauty products (including leading third-party branded and exclusive-label merchandise), high levels of in-stock merchandise, beauty solutions and
expertise delivered by our knowledgeable salespeople. We also offer a comprehensive selection of ethnic products we believe further differentiates SBS from its competitors.
We
believe that our DSC programs distinguish ourselves from other full-service/exclusive-channel distributors by better understanding our customers' needs and we believe the employment of DSCs is an
effective way to serve salons and salon professionals. In addition to placing orders through our DSCs, our customers have the ability to order and pick up the products they need between visits from
our DSCs by visiting a nearby BSG store. We believe that our differentiated customer value proposition and strong brands drive customer loyalty and high repeat traffic, contributing to our success and
growth.
Diverse Customer Base
We appeal to a wide demographic consumer profile and offer an extensive selection of professional beauty products sold directly to retail consumers, salons
and salon professionals. Historically, these factors have provided us with reduced exposure to downturns in economic conditions in the countries in which we operate.
Attractive Store Economics
We believe that our stores generate attractive returns on invested capital. In the U.S. and Canada, the capital requirements to open a SBS or BSG store,
excluding inventory, average less than $100,000. Strong average sales per square foot combined with minimal staffing requirements, low rent and other occupancy costs and expenses and limited initial
capital outlay typically result in positive contribution margins within a year of opening, and attractive returns on investment. Due to such attractive investment returns and relatively high operating
profit contributions per store, SBS and BSG have opened an aggregate of 467 and 148 net new stores, respectively, excluding the effect of acquisitions, over the past five fiscal years. In addition,
each SBS and BSG store (in the U.S. and Canada) contains an average of $70,000 and $150,000, respectively, of merchandise inventory. Outside the U.S. and Canada, our store format, sizes, inventory
levels and capital requirements vary by marketplace, but we believe these stores also generate compelling unit economics. In addition, over the past two years, SBS completed a number of store refresh
initiatives designed to enhance the consumer experience, primarily in the U.S, by upgrading the look, feel and "shopability" of its stores. We believe our stores are well-positioned to continue to
benefit from these recent improvements.
Our Strategy
We believe there are significant opportunities to increase our sales and profitability through the further implementation of our operating strategy and by
growing our store base in existing and additional geographic areas, both organically and through strategic acquisitions. Key elements of our growth strategy are to:
Increase Overall Traffic and Sales Productivity at Our Existing Stores
Over the past year, we have implemented a number of initiatives designed to significantly improve the customer experience at SBS and BSG in an effort to
attract new customers to our stores and improve sales productivity at our existing stores. For example, we upgraded key merchandising sections across our U.S. Sally Beauty stores, including installing
interactive "nail studio" displays and hair color education centers. At our SBS stores in the U.S., we have recently reset key merchandising sections, including the brushes, cutlery and accessories
category, in order to improve the visibility of these products, and have recently installed new hardwood floors, LED lighting and updated signage at a number of those stores. In addition to these
physical store improvements, we also focused our marketing efforts on a consistent marketing
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campaign
designed to communicate with our customers through a variety of medium with which they engage, including tailoring our marketing efforts to reach a wider selection of prospective customers
and otherwise promoting recognition of the "Sally" brand among consumers. We believe that these initiatives will help drive increased customer traffic to our stores and increase their sales
productivity.
In
addition to these strategic initiatives, we also plan to grow same store sales by improving our merchandise mix, introducing new products (including third-party brands and exclusive-label
products), growing our sales of exclusive-label products and enhancing our customer loyalty programs. To grow sales and increase customer loyalty in SBS, we intend to continue to develop and introduce
exclusive-label products through product innovation, to continue to introduce new third-party products and to promote our wide selection of product offerings at a value. We believe enhancements to our
customer loyalty programs at SBS and BSG will allow us to further collect valuable point-of-sale customer data and increase our understanding of customers' needs, all in an effort to grow sales to
existing customers.
Expand and Optimize Our Store Base
The success of our growth strategy in the future depends in part on our ability to open and profitably operate new stores in existing and additional
geographic areas. Because of the limited initial capital outlay and attractive return on capital, we intend to continue to selectively expand and optimize our store base. We believe there are
opportunities for us to open or acquire additional stores in North America, Europe, and Central and South America. We expect new store openings in existing and new areas to be a component of our
future growth.
In
addition to opening new stores, we must effectively optimize our store base to maximize profitability. As a result, we anticipate closing a small number of underperforming SBS and BSG stores in the
U.S. in the next couple of years due in part to the challenging retail environment and the impact of recent natural disasters. During fiscal year 2017, we closed approximately 135 SBS and BSG stores
in the U.S. Selectively closing underperforming stores will allow us to focus on our more profitable stores and open stores in new geographies that we believe offer attractive opportunities for
growth.
Pursue Strategic Acquisitions and New Territories for Organic Growth
We have completed more than 35 acquisitions during our last ten full fiscal years. We believe that our experience in identifying attractive acquisition
targets, our proven acquisition integration process and our highly scalable infrastructure have created a strong platform for potential future acquisitions.
There
is continuing consolidation among professional beauty product distributors and professional beauty product manufacturers. We plan to continue to examine ways in which we can benefit from this
trend, including the evaluation of opportunities to shift business from competing distributors to the BSG network as well as seeking opportunistic, value-added acquisitions which complement our
long-term growth strategy. We believe that suppliers are increasingly likely to focus on larger distributors and retailers with a broader scale and retail footprint and that we are well positioned to
capitalize on this trend and participate in the ongoing consolidation at the distributor/retail level.
We
intend to continue to identify and evaluate acquisition targets and organic growth opportunities both domestically and internationally, with a focus on expanding our exclusive BSG territories and
allowing SBS to enter new geographic areas, principally outside the U.S.
Grow Internationally
A key element of our growth strategy is to capitalize on international growth opportunities and to grow and optimize our current level of non-U.S. operations.
For example, our number of international company-operated stores increased from 742 stores to 981 stores in the last five years. We intend to continue to identify and evaluate international growth
opportunities, including potential acquisitions. International
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sales
represent approximately 25% of SBS's net sales and we believe our platform provides us with the foundation to continue to expand internationally. We are also focused on improving our business in
each of our non-U.S. geographies, and, in recent years, have made a series of leadership changes in these countries to improve our operating discipline and growth strategy.
Increase Operating Efficiency and Profitability
We believe there are opportunities to increase the profitability of our operations by growing our exclusive-label brands, improving sourcing, shifting
customer mix, continuing our cost-cutting initiatives and further expanding our e-commerce capabilities. We continue to develop and promote our higher margin exclusive-label products and increase
exclusive-label product sales, which we believe will enhance our overall gross margins and operating results. In addition, we have undertaken a full review of our merchandise procurement strategy and
continue to focus on our procurement practices. This initiative has helped identify lower-cost alternative sources of supply in certain product categories from countries with lower manufacturing
costs. We continue to focus on changing our customer mix by increasing the percentage of retail customers (versus professional customers) within our SBS stores.
We
are also focused on growing our online sales. We currently offer a significant number of our SBS products for sale through our website
(
www.sallybeauty.com
) and offer a significant number of our BSG products for sale principally through BSG's websites for beauty professionals
(
www.cosmoprofbeauty.com
and
www.cosmoprofequipment.com
). We have upgraded our e-commerce platforms over
the past few years to transform these platforms from largely transactional-based sites to more content-rich sites to drive traffic to and improve sales from these sites.
Competition
Although there are a limited number of direct competitors to our business, the global beauty industry is highly competitive. For example, SBS competes with
other domestic and international beauty product wholesale and retail outlets, including local and regional open-line beauty supply stores, professional-only beauty supply stores, mass merchandisers,
on-line retailers, drug stores, department stores and supermarkets, as well as salons that retail hair care items. BSG competes primarily with domestic and international beauty product wholesale and
retail suppliers and with manufacturers selling professional beauty products directly to salons and individual salon professionals. The primary competitive factors in the beauty products distribution
industry are the price at which branded and exclusive-label products are sold to customers; the quality, perceived value, consumer brand name recognition, packaging and variety of the products sold;
customer service; the efficiency of distribution networks; and the availability of desirable store locations. Although SBS positions itself to be competitive on price, its primary focus is to be a
source of professional advice, solutions and salon-quality products. While BSG positions itself to be competitive on price, its primary focus is to provide a comprehensive selection of branded
products to the salon professional.
We
face increasing competition from certain manufacturers that use their own sales forces to distribute their professional beauty products directly or that align themselves with our competitors. Some
of these manufacturers are vertically integrating through the acquisition of distributors and stores. We also face competition from authorized and unauthorized retailers and internet sites offering
professional salon-only products.
Customer Service
We strive to complement our extensive merchandise selection and innovative store design with superior customer service. We actively recruit individuals with
cosmetology experience that are not only knowledgeable about the products we sell, but are able to deliver practical beauty advice and solutions to our customers, which we believe strengthens customer
loyalty. Additionally, SBS recruits individuals with
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retail
experience because we believe their general retail knowledge can be leveraged in the beauty supply industry. We believe that employees' product knowledge and ability to demonstrate and explain
the advantages of the products increases sales, and that their prompt, knowledgeable service fosters confidence in and loyalty from customers, thus differentiating our business from other professional
beauty supply distributors.
Most
of our stores are staffed with a store manager and two or three full-time or part-time sales associates. BSG stores are generally also staffed with an assistant manager. The operations of each
store are supervised by a district manager, who reports to a territory director. A significant number of our store managers and assistant store managers are licensed in the cosmetology field.
Additionally, in certain geographic areas in the U.S., a significant number of our store personnel, including store managers and assistant store managers, speak fluent Spanish. We believe that these
skills enhance our store personnel's ability to serve our customers.
Relationships with Suppliers
We purchase our merchandise directly from manufacturers through supply contracts and by purchase orders. For the fiscal year 2017, our five largest suppliers,
Coty, Inc. (including certain business units formerly owned by The Procter & Gamble Company), the Professional Products Division of L'Oreal USA S/D, Inc., or
L'Oreal, John Paul Mitchell Systems, Conair Corporation and Shiseido Cosmetics (America) Limited, accounted for approximately 39% of our consolidated merchandise purchases. Products are
purchased from these and many other manufacturers on an at-will basis or under contracts which can generally be terminated without cause upon 90 days' notice or less or expire without express
rights of renewal.
SBS
and BSG, and their respective suppliers are dependent on each other for the distribution of beauty products. We purchase all the products we sell, including our exclusive-label products, from a
limited number of manufacturers. As is typical in the distribution businesses, relationships with suppliers are subject to change from time to time (including the expansion or loss of distribution
rights in various geographies and the addition or loss of product lines), and such changes could positively or negatively impact our net sales and operating earnings. However, we believe that we can
be successful in mitigating negative effects resulting from unfavorable changes in the relationships between us and our suppliers through, among other things, the development of new or expanded
supplier relationships. We believe we have excellent relationships with our suppliers.
Distribution
Our distribution system is designed to minimize the delivered cost of merchandise and maximize the level of merchandise in-stock in stores. This distribution
system also allows us to monitor delivery times and inventory levels. Product deliveries are typically made to our stores on a weekly basis, primarily in the U.S. and Canada. Each distribution center
has a quality control department that monitors products received from suppliers.
Information Technology Systems
Our information technology systems are essential to our efforts to process customer sales transactions, manage inventory levels, conduct business with our
suppliers and other business partners, and record, summarize and analyze the results of our operations. These systems
contain, among other things, material operational, financial and administrative information related to the marketing, distribution and store operations functions of our business. The information
contained in our information technology systems supports, among other things, the processing of customer payments and automatic replenishment of in-store inventory, and provides support for product
purchase decisions.
11
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A
significant portion of our systems has been developed internally and, as a result, our options are limited in seeking third-party assistance with the operation and upgrade of these systems. The
expansion of our systems and infrastructure will require us to commit substantial financial, operational and technical resources in advance of any increase in the volume of our business, with no
assurance that the volume of business will increase. For example, we have substantially completed implementing enterprise resource planning ("ERP") systems for both our domestic and international
operations, which will integrate local systems and provide enhanced functionality. In addition, in recent years we implemented a point-of-sale system upgrade in our SBS operations in the U.S. and are
in the process of introducing a new point-of-sale system in our BSG operations in the U.S. which we believe will provide significant benefits, including enhanced tracking of customer sales and store
inventory activity. Further, following the previously disclosed data security incidents, we have taken and are continuing to take actions to further strengthen the security of our information
technology systems, including a recently completed initiative to adopt payment terminals with end-to-end encryption technology, in order to enhance the security of our credit card payment systems. We
have also taken steps to upgrade our e-commerce platforms and improve the sophistication of our CRM technology. These and any other required upgrades to our information systems and information
technology (or new technology), now or in the future, may require significant costs and divert management's attention and other resources from our core business in order to assist in the completion of
these projects.
In
addition, as part of our operations, we receive and maintain information about our customers, employees and other third parties. We have physical, technical and procedural safeguards in place that
are designed to protect information and protect against security and data breaches, fraudulent transactions and other activities. Despite these safeguards and our other security processes and
protections, we have been a victim of cyber-attacks and data security breaches, including breaches that resulted in the unauthorized installation of malware on our information technology systems that
may have placed at risk certain payment card data. Furthermore, there can be no assurances that we will not suffer another cyber-attack or data security breach in the future and, if we do, whether our
physical, technical and procedural safeguards will adequately protect us against such attacks and breaches.
Employees
The following table sets forth certain information about the Company's employees:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
September 30,
|
|
|
|
2017
|
|
2016
|
|
2015
|
|
Salaried
|
|
|
7,660
|
|
|
7,945
|
|
|
7,760
|
|
Hourly
|
|
|
6,375
|
|
|
6,465
|
|
|
5,975
|
|
Part-time(a)
|
|
|
15,440
|
|
|
15,255
|
|
|
14,595
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
|
29,475
|
|
|
29,665
|
|
|
28,330
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
(a)
-
Part-time
employees enable us to supplement store staffing schedules, particularly in North America.
Certain
of our international subsidiaries have collective bargaining agreements covering warehouse and store personnel that expire at various times over the next several years. We believe that we have
excellent relationships with our employees worldwide.
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Regulation
We are subject to a wide variety of laws and regulations, which historically have not had a material effect on our business. For example, in the U.S., most of
the products sold and the content and methods of advertising and marketing utilized are subject to both federal and state regulations administered by a host of federal and state agencies, including,
in each case, one or more of the following: the Food and Drug Administration, or FDA, the Federal Trade Commission and the Consumer Products Safety Commission. The transportation and disposal of many
of our products are also subject to federal and state regulation. State and local agencies regulate many aspects of our business. We also face comprehensive regulation outside the U.S., focused
primarily on product labeling and safety issues.
As
of September 30, 2017, SBS and BSG supplied franchised stores located in the U.S., Mexico and certain countries in Europe. As a result of these franchisor-franchisee relationships, we are
subject to regulation when offering and selling franchises in the applicable countries. The applicable laws and regulations affect our business practices, as franchisor, in a number of ways, including
restrictions placed upon the offering, renewal, termination and disapproval of assignment of franchises. To date, these laws and regulations have not had a material effect upon our operations.
Access to Public Filings
Our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K, and amendments to such reports
are available, without charge, on our website,
www.sallybeautyholdings.com
, as soon as reasonably possible after they are filed electronically with the
Securities and Exchange Commission, or SEC, under the Exchange Act. We will provide copies of such reports to any person, without charge, upon written request to our Investor Relations Department at
3001 Colorado Blvd, Denton, TX 76210. The information found on our website shall not be considered to be part of this or any other report filed with or furnished to the SEC.
In
addition to our website, you may read and copy public reports we file with or furnish to the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain
information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains our reports, proxy and information statements, and
other information that we file electronically with the SEC at
www.sec.gov
.
ITEM 1A. RISK FACTORS
The following describes risks that we believe to be material to our business. If any of the following risks or uncertainties actually occurs, our business,
financial condition and operating results could be materially and adversely affected. This report also contains forward-looking statements and the following risks could cause our actual results to
differ materially from those anticipated in such forward-looking statements.
Risks Relating to Our Business
The beauty products distribution industry is highly competitive and is consolidating.
The beauty products distribution industry is highly fragmented and competitive, and there are few significant barriers to entry into the marketplaces for most
of the types of products and services we sell. SBS competes with other domestic and international beauty product wholesale and retail outlets, including local and regional open line beauty supply
stores, professional-only beauty supply stores, salons, mass merchandisers, on-line retailers, drug stores and supermarkets. BSG competes with other domestic and international beauty product wholesale
and retail suppliers and with manufacturers selling professional beauty products directly to salons and individual salon professionals. We also face competition from authorized and unauthorized
retailers as well as e-commerce retailers offering professional salon-only and other products. The availability of diverted professional salon products in unauthorized large format retail
13
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stores
such as drug stores, grocery stores and others could also have a negative impact on our business. The primary competitive factors in the beauty products distribution industry are the price at
which we purchase branded and exclusive-label products from manufacturers and the price at which we resell them to our customers, the quality, perceived value, consumer brand name recognition,
packaging and variety of the products we sell, customer service, the efficiency of our distribution network, and the availability of desirable store locations. Competitive conditions may limit our
ability to maintain prices or may require us to reduce prices in efforts to retain business or channel share, particularly because customers are able to quickly and conveniently comparison shop and
determine real-time product availability using digital tools, which can lead to decisions driven solely by price, the functionality of the digital tools, or a combination of these and other factors.
We must compete by offering a consistent and convenient shopping experience for our customers regardless of the ultimate sales channel. Some of our competitors have greater financial and other
resources than we do and are less leveraged than our business, and may therefore be able to spend more aggressively on advertising and promotional activities and respond more effectively to changing
business and economic conditions. We expect existing competitors, business partners and new entrants to the beauty products distribution industry to constantly revise or improve their business models
in response to challenges from competing businesses, including ours. If these competitors introduce changes or developments that we cannot address in a timely or cost-effective manner, our business
may be adversely affected.
In
addition, our industry is consolidating, which may give our competitors increased negotiating leverage with suppliers and greater marketing resources, resulting in a more effective ability to
compete with us. For instance, we may lose customers if those competitors which have broad geographic reach attract additional salons (individual and chain) that are currently BSG customers, or if
professional beauty supply manufacturers align themselves with our competitors. For example, one of BSG's largest suppliers, L'Oreal, has been able to shift a material amount of revenue
out of the BSG nationwide distribution network and into its own regional distribution networks that compete with us. L'Oreal directly competes with BSG and there can be no assurance
that there will not be further revenue losses over time at BSG, due to potential losses of additional L'Oreal related products as well as from the increased competition from
L'Oreal-affiliated distribution networks. If L'Oreal (or another direct competitor) were to acquire or otherwise merge with another manufacturer which conducts business
with BSG, and L'Oreal (or such other direct competitor) decided to distribute products from that manufacturer using its own distribution network, we could lose revenue from the sale of
these products as well. Not only does consolidation in distribution pose risks from competing distributors, but it may also place more leverage in the hands of those manufacturers, resulting in
smaller margins on products sold through our network.
If
we are unable to compete effectively in our marketplace or if competitors divert our customers away from our networks, it would adversely impact our business, financial condition and results of
operations.
We may be unable to anticipate and effectively respond to changes in consumer preferences and buying trends
in a timely manner.
Our success depends in part on our ability to anticipate, gauge and react in a timely manner to changes in consumer spending patterns and preferences for
specific beauty products. If we do not timely identify and properly respond to evolving trends and changing consumer demands for beauty products in the geographies in which we compete, our sales may
decline significantly. Furthermore, we may accumulate additional inventory and be required to mark down unsold inventory to prices that are significantly lower than normal prices, which would
adversely impact our margins and could further adversely impact our business, financial condition and results of operations. Additionally, approximately 47% of our SBS product sales come from our
exclusive-label brands. The development and promotion of these exclusive-label brands and products often occur well before these products are sold in our stores. As a result, the success of these
exclusive-label brands and products is largely dependent on our ability to develop brands and products that meet future consumer preferences at prices that are acceptable to our customers.
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Furthermore,
we may have to spend a significant amount on the advertising and marketing of our exclusive-label brands to drive customer awareness of these brands. There can be no assurance that any
new exclusive-label brand or product will meet consumer preferences, gain acceptance among our customer base or generate sales to become profitable or to cover the costs of its development and
promotion, which would also adversely impact our margins and could adversely impact our business, financial condition and results of operations.
In
addition, we depend on our inventory management and information technology systems in order to replenish inventories and deliver products to store locations in response to customer demands. Any
systems-related problems could result in difficulties satisfying the demands of customers that, in turn, could adversely affect our sales and profitability. In addition, our failure to manage
inventory levels appropriately during any period could adversely affect our results of operations and profitability. We also rely on vendor relationships to provide us with access to the latest beauty
products that meet the changing demands of our customers. If we are unable to maintain these relationships, our ability to meet these demands will be impaired. See below
"
We depend upon manufacturers who may be unable to provide products of adequate quality or who may be unwilling to continue to supply products to
us.
"
We
expect continuously changing fashion-related trends and consumer tastes to influence future demand for beauty products. Changes in consumer tastes and fashion trends can have an impact on our
financial performance. If we are unable to anticipate and respond to trends in the marketplace for beauty products and changing consumer demands, our business could suffer.
Our future success depends in part on our ability to successfully implement our strategic initiatives to
improve the customer experience, attract new customers and improve the sales productivity of our stores.
In fiscal year 2015, we began the implementation of a number of strategic initiatives designed to improve the customer experience at SBS and BSG in an effort
to attract new customers to our stores, improve sales productivity at our existing stores and effectively compete with our competitors. For example, we are testing alternatives to its existing loyalty
club card program and will continue to assess the look, feel and "shopability" of its Sally Beauty stores primarily in the U.S., and will upgrade additional stores on a case by case basis as necessary
to maintain an appealing shopping environment. There can be no assurance that these strategic initiatives will attract new customers to our stores or improve sales productivity at our existing stores.
Furthermore, we are investing significant resources in these initiatives and the costs of the initiatives may outweigh their benefits. If these strategic initiatives are not successful, our same store
sales will suffer and our growth prospects, financial results, profitability and cash flows will also be adversely impacted.
We are not certain that our ongoing cost control plans will continue to be successful.
Our ability to grow profitably depends in large part on our ability to successfully control or reduce our operating expenses. In furtherance of this strategy,
we have engaged in ongoing activities to reduce or control costs, some of which are complicated and require us to expend significant resources to implement. For example, in January 2017, the Company's
Board of Directors approved a comprehensive restructuring plan for the Company's businesses that included a wide range of organizational efficiency initiatives and other cost reduction opportunities.
Despite these cost control plans, we anticipate that our labor and rental costs will continue to increase for the foreseeable future as we compete for talent and attractive retail locations with other
retailers. Furthermore, we have also made significant investments in our strategic initiatives, including our store refresh initiatives and various marketing initiatives, which have resulted in cost
increases in recent periods. While we expect these costs to diminish in future periods, such costs may continue at elevated levels for future periods. We cannot assure you that our strategic
initiatives and cost control efforts will result in the increased profitability, cost savings or other benefits that we expect, which could have a material adverse effect on our business, financial
condition and results of operations.
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Our comparable store sales and quarterly financial performance may fluctuate for a variety of reasons.
Our comparable store sales, which we refer to as same store sales, and quarterly results of operations have fluctuated in the past and we expect them to
continue to fluctuate in the future. A variety of factors affect our comparable store sales and quarterly financial performance, including:
-
-
the success of our strategic initiatives to improve the customer experience at our existing stores and attract new customers to our stores;
-
-
changes in our merchandising strategy or mix;
-
-
the performance of our new stores;
-
-
our ability to increase sales and meet forecasted levels of profitability at our existing stores;
-
-
our ability to anticipate and effectively respond to changing consumer preferences and buying trends in the geographies that our stores serve;
-
-
the effectiveness of our inventory management processes and systems;
-
-
the timing and concentration of new store openings, including additional human resource requirements and related pre-opening and other start-up
costs;
-
-
costs and disruptions associated with our store refresh program;
-
-
the effect of our integration of acquired businesses and stores over time;
-
-
the varying cost and profitability of new stores opened in the U.S. and in other countries;
-
-
a portion of a typical new store's sales (or sales we make over our e-commerce channels) coming from customers who previously shopped at other
existing stores;
-
-
expenditures on our distribution system;
-
-
the timing and effectiveness of our marketing activities, particularly our ability to drive new retail traffic into our stores and our Sally
Beauty Club and ProCard promotions at an acceptable cost;
-
-
seasonal fluctuations due to weather conditions, including severe weather events or other natural disasters;
-
-
our e-commerce channels diverting sales from our stores;
-
-
actions by our existing or new competitors;
-
-
fluctuations over time in the cost to us of products we sell; and
-
-
worldwide economic conditions and, in particular, the retail sales environment in the U.S.
Accordingly,
our results for any one fiscal quarter are not necessarily indicative of the results to be expected for any other quarter, and comparable store sales for any particular future period may
not continue to increase at the same rates as we have recently experienced and may even decrease, which could have a material adverse effect on our business, financial condition and results of
operations.
We depend upon manufacturers who may be unable to provide products of adequate quality or who may be
unwilling to continue to supply products to us.
We do not manufacture any products we sell, and instead purchase our products from recognized brand manufacturers and private label fillers. We depend on a
limited number of manufacturers for a significant percentage of the products we sell. During the fiscal year 2017, our five largest suppliers were Coty Inc., or Coty (including certain business
units formerly owned by The Procter & Gamble Company, or P&G), the Professional Products Division of L'Oreal USA S/D, Inc., or L'Oreal, John Paul Mitchell
Systems, Conair
16
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Corporation,
and Shiseido Cosmetics (America) Limited. Together, these suppliers accounted for approximately 39% of our consolidated merchandise purchases and approximately 44% of BSG's merchandise
purchases. For example, in 2016, Coty, a leading supplier of fragrances, color cosmetics, and skin and body products, acquired the fragrances, color cosmetics, and hair color divisions of P&G and
thereby became our largest supplier. In the fiscal year 2015, P&G was our largest supplier. There can be no assurances as to the impact, if any, that Coty's acquisition of the fragrances, color
cosmetics, and hair color divisions of P&G will have on our ability to continue to source products from these divisions at current prices and volumes.
Since
we purchase products from many manufacturers and fillers under at-will contracts and contracts which can be terminated without cause upon 90 days' notice or less, or which expire without
express rights of renewal, manufacturers and fillers could discontinue sales to us immediately or upon short notice. Some of our contracts with manufacturers may be terminated if we fail to meet
specified minimum purchase requirements. If minimum purchase requirements are not met, we do not have
contractual assurances of continued supply. In lieu of termination, a manufacturer may also change the terms upon which it sells, for example, by raising prices or broadening distribution to third
parties. Infrequently, a supplier will seek to terminate a distribution relationship through legal action. For these and other reasons, we may not be able to acquire desired merchandise in sufficient
quantities or on acceptable terms in the future.
Changes
in SBS's and BSG's relationships with suppliers occur often, and could positively or negatively impact the net sales and operating earnings of both business segments. Some of our suppliers may
seek to decrease their reliance on distribution intermediaries, including full-service/exclusive and open-line distributors like BSG and SBS, by promoting their own distribution channels, as discussed
above. These suppliers may offer advantages, such as lower prices, when their products are purchased from distribution channels they control. If our access to supplier-provided products were to
diminish relative to our competitors or we were not able to purchase products at the same prices as our competitors, our business could be materially and adversely affected. Also, consolidation among
suppliers may increase their negotiating leverage, thereby providing them with competitive advantages that may increase our costs and reduce our revenues, adversely affecting our business, financial
condition and results of operations. Therefore, there can be no assurance that the impact of these developments, if they were to occur, will not adversely impact revenue to a greater degree than we
currently expect or that our efforts to mitigate the impact of these developments will be successful. If the impact of these developments is greater than we expect or our efforts to mitigate the
impact of these developments are not successful, this could have a material adverse effect on our business, financial condition or results of operations.
Although
we plan to mitigate the negative effects resulting from potential unfavorable changes in our relationships with suppliers, there can be no assurance that our efforts will partially or
completely offset the loss of these distribution rights.
Any significant interruption in the supply of products by manufacturers and fillers could disrupt our ability
to deliver merchandise to our stores and customers in a timely manner, which could have a material adverse effect on our business, financial condition and results of operations.
Manufacturers and exclusive-label fillers of beauty supply products are subject to certain risks that could adversely impact their ability to provide us with
their products on a timely basis, including inability to procure ingredients, industrial accidents, environmental events, strikes and other labor disputes, union organizing activity, disruptions in
logistics or information systems, loss or impairment of key manufacturing sites, product quality control, safety, licensing requirements and other regulatory issues, as well as natural disasters and
other external factors over which neither they nor we have control. In addition, we directly source many of our exclusive-label products, including, but not limited to, styling tools, salon equipment,
sundries and other promotional products, from foreign third-party manufacturers and many of our vendors also use overseas sourcing to manufacture some or all of their products. Any event causing a
sudden disruption of manufacturing or imports from such foreign countries, including the imposition of additional
17
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or
increased import restrictions, duties or tariffs, political instability, labor disputes, local business practices, legal or economic restrictions on overseas suppliers' ability to produce and
deliver products or acts of war or terrorism, could materially harm our operations to the extent they affect the production, shipment or receipt of merchandise. Our operating results depend to some
extent on the orderly operation of our receiving and distribution processes, which depend on manufacturers' adherence to shipping schedules and our effective management of our distribution facilities
and capacity.
If
a material interruption of supply occurs, or a significant manufacturer or filler ceases to supply us or materially decreases its supply to us, we may not be able to acquire products with similar
quality and consumer brand name recognition as the products we currently sell or to acquire such products in sufficient quantities to meet our customers' demands or on favorable terms to our business,
any of which could adversely impact our business, financial condition and results of operations.
Fluctuations in the price, availability and quality of inventory may result in higher cost of goods, which we
may not be able to pass on to the customers.
Our suppliers are increasingly passing on higher production costs, which may impact our ability to maintain or grow our margins. The price and availability of
raw materials may be impacted by demand, regulation, weather and other factors. Additionally, manufacturers have and may continue to have increases in other manufacturing costs, such as
transportation, labor and benefit costs. These increases in production costs result in higher merchandise costs to us. We may not always be able to pass on those cost increases to our customers, which
could have a material adverse effect on our results of operations and financial condition.
If products sold by us are found to be defective in labeling or content, our credibility and that of the
brands we sell may be harmed, marketplace acceptance of our products may decrease, and we may be exposed to liability in excess of our products liability insurance coverage and manufacturer
indemnities.
We do not control the production process for the products we sell. We may not be able to identify a defect in a product we purchase from a manufacturer or
exclusive-label filler before we offer such product for resale. In many cases, we rely on representations of manufacturers and fillers about the products we purchase for resale regarding the
composition, manufacture and
safety of the products, as well as the compliance of our product labels with government regulations. Our sale of certain products exposes us to potential product liability claims, recalls or other
regulatory or enforcement actions initiated by federal, state or foreign regulatory authorities or through private causes of action. Such claims, recalls or actions could be based on allegations that,
among other things, the products sold by us are misbranded, contain contaminants or impermissible ingredients, provide inadequate instructions regarding their use or misuse, or include inadequate
warnings concerning flammability or interactions with other substances. Claims against us could also arise as a result of the misuse by purchasers of such products or as a result of their use in a
manner different than the intended use. We may be required to pay for losses or injuries actually or allegedly caused by the products we sell and to recall any product we sell that is alleged to be or
is found to be defective.
Any
actual defects or allegations of defects in products sold by us could result in adverse publicity and harm our credibility or the credibility of the manufacturer, which could adversely affect our
business, financial condition and results of operations. Although we may have indemnification rights against the manufacturers of many of the products we distribute and rights as an "additional
insured" under the manufacturers' insurance policies, it is not certain that any manufacturer or insurer will be financially solvent and capable of making payment to any party suffering loss or injury
caused by products sold by us. Further, some types of actions and penalties, including many actions or penalties imposed by governmental agencies and punitive damages awards, may not be remediable
through reliance on indemnity agreements or insurance. Furthermore, potential product liability claims may exceed the amount of indemnity or insurance coverage or be excluded under the terms of an
indemnity agreement or insurance policy and claims for indemnity or reimbursement by us may require us to expend significant resources and may take years to resolve. If we are forced to expend
significant resources and time to resolve such claims or to pay material amounts to satisfy such claims, it could have an adverse effect on our business, financial condition and results of operations.
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We could be adversely affected if we do not comply with current laws and regulations or if we become subject
to additional or more stringent laws and regulations.
We are subject to a number of federal, state and local laws and regulations in the U.S., as well as applicable laws and regulations in each foreign
marketplace in which we do business. These laws and regulations govern the composition, packaging, labeling and safety of the products we sell, as well as the methods we use to sell and import these
products. Non-compliance with applicable laws and regulations of governmental authorities, including the FDA and similar authorities in other jurisdictions, by us or the manufacturers and fillers of
the products sold by us could result in fines, product recalls and enforcement actions, and otherwise restrict our ability to market certain products, which could adversely affect our business,
financial condition and results of operations.
In
addition, the laws and regulations applicable to us or manufacturers of the products sold by us may become more stringent. For example, the State of California, where we operate a number of stores,
currently enforces legislation commonly referred to as "Proposition 65" that requires that "clear and reasonable" warnings be given to consumers who are exposed to chemicals known to the State of
California to cause cancer or reproductive toxicity. Although we have sought to comply with Proposition 65 requirements, there can be no assurance that we will not be adversely affected by litigation
or other actions relating to Proposition 65 or future legislation that is similar or related thereto. Continued legal compliance with new and existing regulations, such as Proposition 65 and other
federal or state-level safe consumer product regulations, could require the review and possible reformulation or relabeling of certain products, as well as the possible removal of some products from
the marketplace. Failure to comply with these new and existing regulations could result in significant fines or damages, in addition to costs and expenses to defend claims related thereto. Legal
compliance could also lead to considerably higher internal regulatory costs. Manufacturers may try to recover some or all of any increased costs of compliance by increasing the prices at which we
purchase products, and we may not be able to recover some or all of such increased cost in our own prices to our customers. We are also subject to state and local laws and regulations that affect our
franchisor-franchisee relationships. Increased compliance costs and the loss of sales of certain products due to more stringent or new laws and regulations could adversely affect our business,
financial condition and results of operations.
Laws
and regulations impact our business in many areas that have no direct relation to the products we sell. For example, as a public company, we are subject to a number of laws and regulations
related to the disclosure of financial and other information about us, as well as the issuance and sale of our securities. Another area of intense regulation is that of the relationships we have with
our employees, including, for example, compliance with many different wage and hour and nondiscrimination related regulatory schemes and, in the U.S., compliance with the 2010 Patient Protection and
Affordable Care Act. Violation of any of the laws or regulations governing our business or the assertion of individual or class-wide claims could have an adverse effect on our business, financial
condition and results of operations.
Our e-commerce businesses may be unsuccessful or, if successful, may divert sales from our stores.
We offer many of our beauty products for sale through our websites in the U.S. (such as
www.sallybeauty.com,
www.cosmoprofbeauty.com
and
www.cosmoprofequipment.com
) and abroad. As a result, we encounter risks and difficulties frequently
experienced by internet-based businesses, including risks related to our ability to attract and retain customers on a cost-effective basis and our ability to operate, support, expand and develop our
e-commerce operations, websites and software and other related operational systems. Although we believe that our participation in both e-commerce and physical store sales is a distinct advantage for
us due to synergies and the potential for new customers, supporting product offerings through both of these channels could create issues that have the potential to adversely affect our results of
operations. For example, if our e-commerce businesses successfully grow, they may do so in part by attracting existing customers, rather than new customers, who choose to purchase products from us
online rather than from our physical stores, thereby reducing the financial performance of our
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stores.
In addition, offering different products through each channel could cause conflicts and cause some of our current or potential internet customers to consider competing distributors of beauty
products. In addition, offering products through our e-commerce channels (particularly directly to consumers through our professional business) could cause some of our current or potential vendors to
consider competing internet offerings of their products either directly or through competing distributors. As we continue to grow our e-commerce businesses, the impact of attracting existing rather
than new customers, of conflicts between product offerings online and through our stores, and of opening up our channels to increased internet competition could have a material adverse impact on our
business, financial condition and results of operations, including future growth and same store sales. Furthermore, our recent initiatives to upgrade our e-commerce platforms may not be successful in
driving traffic to our websites and increasing our online sales in the long term, which could adversely impact our net sales.
Diversion of professional products sold by BSG could have an adverse impact on our revenues.
The majority of the products that BSG sells, including those sold by our Armstrong McCall franchisees, are meant to be used exclusively by salons and
individual salon professionals or sold exclusively to their retail consumers. However, despite our efforts to prevent diversion, incidents of product diversion occur, whereby our products are sold by
these purchasers (and possibly by other bulk purchasers such as franchisees) to wholesalers and ultimately to general merchandise retailers, among others. These retailers, in turn, sell such products
to consumers. The diverted product may be old, tainted or damaged and sold through unapproved outlets, all of which could diminish the value of the particular brand. In addition, such diversion may
result in lower net sales for BSG should consumers choose to purchase diverted products from retailers rather than purchasing from our customers, or choose other products altogether because of the
perceived loss of brand prestige.
In
the BSG arena, product diversion is generally prohibited under our manufacturers' contracts, and we are often under a contractual obligation to stop selling to salons, salon professionals and other
bulk purchasers which engage in product diversion. If we fail to comply with our anti-diversion obligations under these manufacturers' contracts, including any known diversion of products sold through
our Armstrong McCall franchisees, these contracts could be adversely affected or even terminated. In addition, our investigation and enforcement of our anti-diversion obligations may result in reduced
sales to our customer base, thereby decreasing our revenues and profitability.
BSG's financial results are affected by the financial results of BSG's franchised-based business (Armstrong
McCall).
BSG receives revenue from its sale of products to Armstrong McCall franchisees. Accordingly, a portion of BSG's financial results is to an extent dependent
upon the operational and financial success of these franchisees, including their implementation of BSG's strategic plans. If sales trends or economic conditions worsen for Armstrong McCall's
franchisees, their financial results may worsen. Additionally, the failure of Armstrong McCall franchisees to renew their franchise agreements, any requirement that Armstrong McCall restructure its
franchise agreements in connection with such renewals, or any failure of Armstrong McCall to meet its obligations under its franchise agreements, could result in decreased revenues for BSG or create
legal issues with our franchisees or with manufacturers.
If our franchisees do not run their stores and sales teams according to our standards, our brand reputation
could be negatively impacted.
We work to ensure that our franchisees maintain and protect our brand; however, we are exposed to risks through these franchise relationships. Our franchisees
may not run the stores and sales teams according to our standards, which could have a material adverse effect on our brand reputation and our business.
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We may not be able to successfully identify acquisition candidates or successfully complete desirable
acquisitions.
In the past several years, we have completed multiple acquisitions and we intend to pursue additional acquisitions in the future. We actively review
acquisition prospects that we believe would complement our existing lines of business, increase the size and geographic scope of our operations or otherwise offer profitable growth and operating
efficiency opportunities. There can be no assurance that we will continue to identify suitable acquisition candidates.
If
suitable candidates are identified, we may be unable to reach agreeable acquisition terms with such candidates or may not have access to sufficient funds to fund such acquisitions. We compete
against many other companies, some of which are larger and have greater financial and other resources than we do. Increased competition for acquisition candidates could result in fewer acquisition
opportunities and higher acquisition prices. In addition, we are highly leveraged and the agreements governing our indebtedness contain limits on our ability to incur additional debt to pay for
acquisitions. We may be unable to finance acquisitions that would increase our growth or improve our financial and competitive position. To the extent that debt financing is available to finance
acquisitions, our net indebtedness could increase as a result of any acquisitions. Internationally, regulatory requirements, trade barriers and due diligence difficulties, among other considerations,
make acquiring suitable foreign candidates more difficult, time-consuming and expensive. See below "
Our ability to conduct business outside the United States may
be affected by legal, regulatory and economic risks
."
If we acquire any businesses in the future, they could prove difficult to integrate, disrupt our business or
have an adverse effect on our results of operations.
Any acquisitions that we do make may be difficult to integrate profitably into our business and may entail numerous risks,
including:
-
-
difficulties in assimilating acquired operations, stores or products, including the loss of key employees from acquired businesses;
-
-
difficulties and costs associated with integrating and evaluating the distribution or information systems and/or internal control systems of
acquired businesses;
-
-
difficulties in competing with existing stores or business or diverting sales from our existing stores or business;
-
-
expenses associated with the amortization of identifiable intangible assets;
-
-
problems retaining key technical, operational and administrative personnel;
-
-
diversion of management's attention from our core business, including loss of management focus on marketplace developments;
-
-
complying with foreign regulatory requirements, including multi-jurisdictional competition rules and restrictions on trade/imports;
-
-
enforcement of intellectual property rights in foreign countries;
-
-
adverse effects on existing business relationships with suppliers and customers, including the potential loss of suppliers of the acquired
businesses;
-
-
operating inefficiencies and negative impact on profitability;
-
-
entering geographic areas or channels in which we have limited or no prior experience; and
-
-
those related to general economic and political conditions, including legal and other barriers to cross-border investment in general, or by
U.S. companies in particular.
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In
addition, during the acquisition process, we may fail or be unable to discover some of the liabilities of businesses that we acquire. These liabilities may result from a prior owner's noncompliance
with applicable laws and regulations. Acquired businesses may also not perform as we expect or we may not be able to obtain the expected financial improvements in the acquired businesses.
If we are unable to optimize our store base by profitably opening and operating new stores and closing less
profitable stores, our business, financial condition and results of operations may be adversely affected.
Our future growth strategy depends in part on our ability to optimize and profitably operate our stores in existing and additional geographic areas, including
in international geographies. While the capital requirements to open a SBS or BSG store, excluding inventory, vary from geography to geography, such capital requirements have historically been
relatively low in the U.S. and Canada. Despite these relatively low opening costs, we may not be able to open all the new stores we plan to open and we may be unable to optimize our store base by
closing stores that are unprofitable or open stores that are profitable, any of which could have a material adverse impact on our financial condition or results of operations. There are several
factors that could affect our ability to open and profitably operate new stores, including:
-
-
the inability to identify and acquire suitable sites or to negotiate acceptable leases for such sites;
-
-
proximity to existing stores that may reduce the new store's sales or the sales of existing stores;
-
-
difficulties in adapting our distribution and other operational and management systems to an expanded network of stores;
-
-
the level of sales made through our e-commerce channels and the potential that sales through our e-commerce channels will divert sales from our
stores;
-
-
the potential inability to obtain adequate financing to fund expansion because of our high leverage and limitations on our ability to issue
equity under our credit agreements, among other things;
-
-
increased (and sometimes unanticipated) costs associated with opening stores in international locations;
-
-
difficulties in obtaining any governmental and third-party consents, permits and licenses;
-
-
limitations on capital expenditures which may be included in financing documents that we enter into; and
-
-
difficulties in adapting existing operational and management systems to the requirements of national or regional laws and local ordinances.
In
addition, as we continue to open new stores, our management, as well as our financial, distribution and information systems, and other resources will be subject to greater demands. If our personnel
and systems are unable to successfully manage this increased burden, our results of operations may be materially affected.
Our ability to conduct business outside the United States may be affected by legal, regulatory and economic
risks.
Our ability to enter and capitalize on growth in new international marketplaces and to grow or maintain our current level of operations in our existing
international marketplaces is subject to risks associated with our international operations. These risks include: unexpected changes in regulatory requirements, trade barriers to some international
marketplaces, economic and foreign currency fluctuations, potential difficulties in enforcing contracts, difficulty in identifying manufacturers or sourcing quality products, increasing levels of
violence or terrorism, an inability to properly protect assets (including intellectual property), an inability to collect receivables, potential tax liabilities associated with repatriating funds from
foreign operations and difficulties and costs of staffing, managing and accounting for foreign operations.
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The potential impact of Britain's decision to leave the European Union and any related or other disruptive
events affecting the U.K., the European Union or other geographies in which we conduct business.
Our results of operations may be materially affected by any adverse impact resulting from Britain's decision to leave the European Union (commonly referred to
as "Brexit"). Brexit may result in increased uncertainty throughout the region and could adversely affect business activity, political stability and adverse economic conditions throughout Europe. The
uncertainty concerning the timing and terms of the separation could also have a negative impact on future growth for the UK and/or other European economies and cause further strengthening of the U.S.
dollar against foreign currencies in which we conduct business. The strengthening of the U.S. dollar relative to the British pound and the euro may adversely affect our results of operations as we
translate sales and other results denominated in foreign currency into U.S. dollars for financial reporting purposes. During periods of a strengthening dollar, our reported international sales and
earnings could be reduced because foreign currencies may translate into fewer U.S. dollars.
The economic conditions in the geographies we serve may affect consumer purchases of discretionary items such
as beauty products and salon services, which could have a material adverse effect on our business, financial condition and results of operations.
Our results of operations may be materially affected by conditions in the global capital markets and the economy generally, both in the U.S. and
internationally. Concerns over inflation, employment, tax laws, energy costs, geopolitical issues, terrorism, the availability and cost of credit, the mortgage market, sovereign and private banking
systems, sovereign deficits and increasing debt burdens and the real estate and other financial markets in the U.S. and Europe have contributed to increased volatility and diminished expectations for
the U.S. and certain foreign economies. We appeal to a wide demographic consumer profile and offer an extensive selection of beauty products sold directly to retail consumers and salons and salon
professionals. Continued uncertainty in the economy could adversely impact consumer purchases of discretionary items such as beauty products, as well as adversely impact the frequency of salon
services performed by professionals using products purchased from us. Factors that could affect consumers' willingness to make such discretionary purchases include: general business conditions, levels
of employment, interest rates, tax rates, the availability of consumer credit and consumer confidence in future economic conditions. In the event of a prolonged economic downturn or acute recession,
consumer spending habits could be adversely affected and we could experience lower than expected net sales. The economic climate could also adversely affect our vendors. The occurrence of any of these
events could have a material adverse effect on our business, financial condition and results of operations.
Our net sales depend on a volume of traffic to our stores, and a reduction in traffic to, or the closing of,
the other destination retailers in the shopping areas where our stores are located could significantly reduce our sales and leave us with excess inventory, which could have a material adverse effect
on our business, financial condition, profitability and cash flows.
Most of our stores are located in strip malls, which are occupied by other high traffic retailers including grocery stores, mass merchants and home centers.
Sales at these stores are derived, in part, from the volume of traffic generated by the other destination retailers and the anchor stores in these shopping areas where our stores are located. Customer
traffic to these shopping areas may be adversely affected by the closing of such destination retailers or anchor stores, or by a reduction in traffic to such stores resulting from a regional or global
economic downturn, a general downturn in the local area where our store is located, or a decline in the desirability of the shopping environment of a particular strip mall. Such a reduction in
customer traffic would reduce our sales and leave us with excess inventory, which could have a material adverse effect on our business, financial condition and results of operations. We may respond by
increasing markdowns, initiating marketing promotions, or transferring product to other stores to reduce excess inventory, which would further decrease our gross profits and net income.
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Use of social media may adversely impact our reputation.
There has been a substantial increase in the use of social media platforms, including blogs, social media websites and other forms of internet-based
communications, which allows access to a broad audience of consumers and other interested persons. Negative commentary regarding us or the products we sell may be posted on social media platforms and
similar devices at any time and may be adverse to our reputation or business. Customers value readily available information and often act on such information without further investigation and without
regard to its accuracy. The harm may be immediate without affording us an opportunity for redress or correction.
We
also use social media platforms as marketing tools. For example, we maintain Facebook, Twitter, Instagram and Pinterest accounts. As laws and regulations rapidly evolve to govern the use of these
platforms and devices, the failure by us, our employees or third parties acting at our direction to abide by applicable laws and regulations in the use of these platforms and devices could adversely
impact our business, financial condition, and results of operations.
In
addition, we have agreements with a variety of industry influencers, and we feature industry influencers on our advertising and marketing efforts and may include them in some of our branding.
Further, many industry influencers use our products and feature our products through their own platforms. Actions taken by these individuals could harm our brand image, net revenues and profitability.
If we are unable to protect our intellectual property rights, specifically our trademarks and service marks,
our ability to compete could be negatively impacted.
We rely upon trade secrets and know-how to develop and maintain our competitive position. Our trademarks, certain of which are material to our business, are
registered or legally protected in the U.S., Canada and other countries in which we operate. The success of our business depends to a certain extent upon the value associated with our intellectual
property rights. We own certain trademark and service mark rights used in connection with our business including, but not limited to, "Sally," "Sally Beauty," "Sally Beauty Supply," "Sally Beauty Club
Card," "BSG," "CosmoProf," "Proclub," "Armstrong McCall," "ion," "Beyond the Zone" and "Salon Services." We
protect our intellectual property rights through a variety of methods, including, but not limited to, applying for and obtaining trademark protection in the U.S., Canada and other countries throughout
the world in which our business operates. We also rely on trade secret laws, in addition to confidentiality agreements with vendors, employees, consultants and others who have access to our
proprietary information. While we intend to vigorously protect our trademarks against infringement, we may not be successful. In addition, the laws of certain foreign countries may not protect our
intellectual property rights to the same extent as the laws of the U.S. The costs required to protect our intellectual property rights and trademarks are expected to continue to be substantial.
We may have to defend our rights in intellectual property that we use in certain of our products, and we
could be found to infringe the intellectual property rights of others, which could be disruptive and expensive to our business.
The industry in which we operate is characterized by the need for a large number of copyrights, trade secrets and trademarks and by frequent litigation based
on allegations of infringement or other violations of intellectual property rights. A third party may at any time assert that our products violate such party's intellectual property rights. Successful
intellectual property claims against us could result in significant financial liabilities and/or prevent us from selling certain of our products. In addition, the resolution of infringement claims may
require us to redesign our products, to obtain licenses to use intellectual property belonging to third parties, which may not be attainable on reasonable terms, or to cease using the intellectual
property altogether. Moreover, any intellectual property claim, regardless of its merits, could be expensive and time-consuming to defend against and could divert the attention of management. As a
result, claims based on allegations of infringement or other violations of intellectual property rights,
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regardless
of outcome, could have a material adverse effect on our business, financial condition and results of operations.
We may be adversely affected by any disruption in our information technology systems.
Our operations are dependent upon our information technology systems, which encompass all of our major business functions. We rely upon such information
technology systems to manage and replenish inventory, to fill and ship customer orders on a timely basis, to coordinate our sales activities across all of our products and services, to coordinate our
administrative activities and to
protect confidential information that we receive and maintain about our customers, employees and other third parties. A substantial disruption in our information technology systems for any prolonged
time period (arising from, for example, system capacity limits from unexpected increases in our volume of business, outages or delays in our service) could result in delays in receiving inventory and
supplies or filling customer orders and adversely affect our customer service and relationships. Our systems might be damaged or interrupted by natural or man-made events (caused by us, by our service
providers or others) or by computer viruses, physical or electronic break-ins and similar disruptions affecting the internet. Such delays, problems or costs may have a material adverse effect on our
business, financial condition and results of operations.
As
our operations grow in both size and scope, we continuously need to improve and upgrade our systems and infrastructure while maintaining their reliability and integrity. The expansion of our
systems and infrastructure will require us to commit substantial financial, operational and technical resources before the volume of our business increases, with no assurance that the volume of
business will increase. For example, we are currently implementing new point-of-sale systems in a number of our divisions, which we anticipate will provide significant benefits, including enhanced
tracking of customer sales. The development and implementation of the new point-of-sale systems and any other future upgrades to our systems and information technology may require significant costs
and divert our management's attention and other resources from our core business. There are also no assurances that these new systems and upgrades will provide us with the anticipated benefits and
efficiencies. Many of our systems are proprietary, and as a result our options are limited in seeking third-party help with the operation and upgrade of those systems. There can be no assurance that
the time and resources our management will need to devote to operations and upgrades, any delays due to the installation of any upgrade (and customer issues therewith), any resulting service outages,
or the impact on the reliability of our data from any upgrade or any legacy system, will not have a material adverse effect on our business, financial condition or results of operations.
Unauthorized access to confidential information and data on our information technology systems and security
and data breaches could materially adversely affect our business, financial condition and operating results.
As part of our operations, we receive and maintain information about our customers, employees and other third parties. We have physical, technical and
procedural safeguards in place that are designed to protect information and protect against security and data breaches as well as fraudulent transactions and other activities. Despite these safeguards
and our other security processes and protections, we cannot be assured that all of our systems and processes are free from vulnerability to security breaches (through cyber-attacks, which are evolving
and becoming increasingly sophisticated, physical breach or other means) or inadvertent data disclosure by third parties or us. A significant data security breach, including misappropriation of our
customers' or employees' confidential information, could result in significant costs to us, which may include, among others, potential liabilities to payment card networks for reimbursements of credit
card fraud and card reissuance costs, including fines and penalties, potential liabilities from governmental or third party investigations, proceedings or litigation, legal, forensic and consulting
fees and expenses, costs and diversion of management attention required for investigation and remediation actions, and the negative impact on our reputation and loss of confidence of our customers,
suppliers and others,
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any
of which could have a material adverse impact on our business, financial condition and operating results.
In
response to the data security incidents, we have taken and are continuing to take actions to further strengthen the security of our information technology systems, including a recent initiative to
adopt payment terminals with end-to-end encryption technology in order to enhance the security of our credit card payment systems. Nevertheless, there can be no assurance that our security upgrades
will be effective, that we will not suffer a similar criminal attack in the future, that unauthorized parties will not gain access to confidential information, or that any such incident will be
discovered promptly. In particular, we understand that the techniques used by criminals to obtain unauthorized access to sensitive data change frequently and often are not recognized until launched
against a target; accordingly, we may be unable to anticipate these techniques or implement adequate preventative measures. The failure to promptly detect, determine the extent of and appropriately
respond to a significant data security breach could have a material adverse impact on our business, financial condition and operating results.
We have experienced data security incidents and are not yet able to determine the full extent or scope of the
potential liabilities relating to these data security incidents.
In the fiscal year 2014, we disclosed that we had experienced a data security incident (the "2014 data security incident"). In the fiscal year 2015, we
disclosed that we had experienced a second data security incident (the "2015 data security incident" and together with the 2014 data security incident, the "data security incidents"). The data
security incidents involved the unauthorized installation of malicious software (malware) on our information technology systems, including our point-of-sale systems that, we believe, may have placed
at risk certain payment card data for some transactions. The costs that the Company has incurred to date in connection with the data security incidents include assessments from payment card networks,
professional advisory fees, legal costs and expenses relating to investigating and remediating the data security incidents. We may have also suffered reputational harm due to multiple data security
incidents and may incur additional costs and expenses related to the data security incidents in the future. As detailed above, these costs may result from potential additional liabilities to payment
card networks, governmental or third party investigations, proceedings or litigation, legal and other fees necessary to defend against any potential liabilities or claims, and further investigatory
and remediation costs. The potential liabilities or other remedies against us related to the data security incidents may have a material adverse impact on our business, financial condition and
operating results.
If we fail to attract and retain highly skilled management and other personnel, our business, financial
condition and results of operations may be harmed.
Our success has depended, and will continue to depend, in large part on our ability to attract and retain senior executives who possess extensive knowledge,
experience and managerial skill applicable to our business. Significant leadership changes or executive management transitions involve inherent risk and any failure to ensure the effective transfer of
knowledge and a smooth transition could hinder our strategic planning, execution and future performance. In addition, from time to time, key executive personnel leave our Company and we may not be
successful in attracting, integrating and retaining the personnel required to grow and operate our business profitably. While we strive to mitigate the negative impact associated with the loss of a
key executive employee, an unsuccessful transition or loss could significantly disrupt our operations and have a material adverse effect on our business, financial condition or results of operations.
We
are also dependent on training, motivating and managing our store employees that interact with our customers on a daily basis. Competition for these types of qualified employees is intense and the
failure to attract, retain and properly train qualified and motivated employees could result in decreased customer satisfaction, loss of customers, and lower sales.
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The occurrence of natural disasters or acts of violence or terrorism could adversely affect our operations
and financial performance.
The occurrence of natural disasters or acts of violence or terrorism could result in physical damage to our properties, the temporary closure of stores or
distribution centers, the temporary lack of an adequate work force, the temporary or long-term disruption in the supply of products (or a substantial increase in the cost of those products) from
domestic or foreign suppliers, the temporary disruption in the delivery of goods to our distribution centers (or a substantial increase in the cost of those deliveries), the temporary reduction in the
availability of products in our stores, and/or the temporary reduction in visits to stores by customers. If one or more natural disasters or acts of violence or terrorism were to impact our business,
we could, among other things, incur significantly higher costs and longer lead times associated with distributing products. Furthermore, insurance costs associated with our business may rise
significantly in the event of a large scale natural disaster or act of violence or terrorism.
Any significant interruption in the operations of our distribution facilities could disrupt our ability to
deliver merchandise to our stores in a timely manner, which could have a material adverse effect on our business, financial condition, profitability and cash flows.
We distribute products to our stores without supplementing such deliveries with direct-to-store arrangements from vendors or wholesalers. We are a retailer
carrying up to 17,000 beauty products that change on a regular basis in response to beauty trends, which makes the success of our operations particularly vulnerable to disruptions in our distribution
infrastructure. Any significant interruption in the operation of our supply chain infrastructure, such as disruptions in our information systems, disruptions in operations due to fire or other
catastrophic events, labor disagreements or shipping and transportation problems, could drastically reduce our ability to receive and process orders and provide products and services to our stores,
which could have a material adverse effect on our business, financial condition, profitability and cash flows.
We are a holding company with no operations of our own, and we depend on our subsidiaries for cash.
We are a holding company and do not have any material assets or operations other than ownership of equity interests of our subsidiaries. Our operations are
conducted almost entirely through our subsidiaries, and our ability to generate cash to meet our obligations or to pay dividends is highly dependent on the earnings of, and receipt of funds from, our
subsidiaries through dividends or intercompany loans. The ability of our subsidiaries to generate sufficient cash flow from operations to allow us and them to make scheduled payments on our
obligations will depend on their future financial performance, which will be affected by a range of economic, competitive and business factors, many of which are outside of our control. We cannot
assure you that the cash flow and earnings of our operating subsidiaries will be adequate for our subsidiaries to service their debt obligations. If our subsidiaries do not generate sufficient cash
flow from operations to satisfy corporate obligations, we may have to: undertake alternative financing plans (such as refinancing), restructure debt, sell assets, reduce or delay capital investments,
or seek to raise additional capital. We cannot assure you that any such alternative refinancing would be possible, that any assets could be sold, or, if sold, of the timing of the sales and the amount
of proceeds realized from those sales, that additional financing could be obtained on acceptable terms, if at all, or that additional financing would be permitted under the terms of our various debt
instruments then in effect. Our inability to generate sufficient cash flow to satisfy our obligations, or to refinance our obligations on commercially reasonable terms, would have an adverse effect on
our business, financial condition and results of operations.
Furthermore,
we and our subsidiaries may incur substantial additional indebtedness in the future that may severely restrict or prohibit our subsidiaries from making distributions, paying dividends or
making loans to us.
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Litigation costs and the outcome of litigation could have a material adverse effect on our business and any
loss contingency accruals may not be adequate to cover actual losses.
From time to time, we are subject to litigation claims through the ordinary course of our business operations regarding, but not limited to, employment
matters, security of consumer and employee personal information, contractual relations with suppliers, marketing and infringement of trademarks and other intellectual property rights. Litigation to
defend ourselves against these patent infringement claims and other claims by third parties, or to enforce any rights that we may have against third parties, may be necessary, which could result in
substantial costs and diversion of our resources, causing a material adverse effect on our business, financial condition, profitability and cash flows. We establish accruals for potential liability
arising from legal proceedings when potential liability is probable and the amount of the loss can be reasonably estimated based on currently available information. We may still incur legal costs for
a matter even if we have not accrued a liability. In addition, actual losses may be higher than the amount accrued for a certain matter, or in the aggregate. An unfavorable resolution of a legal
proceeding or claim could materially adversely impact our business, financial condition, profitability and cash flows. There can be no assurance that any pending or future litigation will not have a
material adverse effect on our business, financial condition, and results of operations.
Our previously announced share repurchase program could affect the price of our common stock and increase
volatility and may be suspended or terminated at any time, which may result in a decrease in the trading price of our common stock.
Repurchases pursuant to our share repurchase program could affect our stock price and increase its volatility. The existence of a share repurchase program
could also cause our stock price to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for our stock. There can be no assurance that any
share repurchases will enhance stockholder value because the market price of our common stock may decline below the levels at which we repurchased shares of common stock. Although our share repurchase
program is intended to enhance long-term stockholder value, short-term stock price fluctuations could reduce the program's effectiveness. Furthermore, the program does not obligate the Company to
repurchase any dollar amount or number of shares of common stock, and may be suspended or discontinued at any time and any suspension or discontinuation could cause the market price of our stock to
decline.
Risks Relating to Our Substantial Indebtedness
We have substantial debt and may incur substantial additional debt, which could adversely affect our
financial health, our ability to obtain financing in the future and our ability to react to changes in our business.
As of September 30, 2017, certain of our subsidiaries, including Sally Holdings LLC, which we refer to as Sally Holdings, had an aggregate
principal amount of approximately $1,867.9 million of outstanding debt, including capital lease obligations, and a total debt to equity ratio of 5.14:1.00.
Our
substantial debt could have important consequences. For example, it could:
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make it more difficult for us to satisfy our obligations to our lenders, resulting in possible defaults on and acceleration of such
indebtedness;
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limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions, debt service requirements or general
corporate purposes;
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require us to dedicate a substantial portion of our cash flow from operations to the payment of principal and interest on our indebtedness,
thereby reducing the availability of such cash flows to fund working capital, capital expenditures, share repurchases and other general corporate purposes;
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restrict the ability of our subsidiaries to pay dividends or otherwise transfer assets to us, which could limit our ability to conduct
repurchases of our own equity securities or pay dividends to our stockholders, thereby limiting our ability to enhance stockholder value through such transactions;
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increase our vulnerability to general adverse economic and industry conditions, including interest rate fluctuations (because a portion of our
borrowings are at variable rates of interest), including borrowings under our $500 million asset-based senior secured loan facility, which we refer to as the "ABL facility";
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place us at a competitive disadvantage compared to our competitors with proportionately less debt or comparable debt at more favorable interest
rates and that, as a result, may be better positioned to withstand economic downturns;
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limit our ability to refinance indebtedness or cause the associated costs of such refinancing to increase; and
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limit our flexibility to adjust to changing market conditions and ability to withstand competitive pressures, or prevent us from carrying out
capital spending that is necessary or important to our growth strategy and efforts to improve operating margins or our business.
Any
of the foregoing impacts of our substantial indebtedness could have a material adverse effect on our business, financial condition and results of operations.
Despite our current indebtedness levels, we and our subsidiaries may be able to incur substantially more
debt, including secured debt, which could further exacerbate the risks associated with our substantial indebtedness.
We and our subsidiaries may incur substantial additional indebtedness in the future. The terms of the instruments governing our indebtedness do not fully
prohibit us or our subsidiaries from doing so. As of September 30, 2017, our ABL facility provided us commitments for additional borrowings of up to approximately $389.6 million, subject
to borrowing base limitations. If new debt is added to our current debt levels, the related risks that we face would increase, and we may not be able to meet all our debt obligations. In addition, the
agreements governing our ABL facility and our institutional term loan as well as the indentures governing our senior notes due 2023 and senior notes due 2025, which we refer to as the senior notes, do
not prevent us from incurring obligations that do not constitute indebtedness.
The agreements and instruments governing our debt contain restrictions and limitations that could
significantly impact our ability to operate our business.
The agreement governing our ABL facility contains covenants that, among other things, restrict Sally Holdings and its subsidiaries' ability
to:
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change their line of business;
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engage in certain mergers, consolidations and transfers of all or substantially all of their assets;
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make certain dividends, share repurchases and other distributions;
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make acquisitions of all of the business or assets of, or stock representing beneficial ownership of, any person;
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dispose of certain assets;
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make voluntary prepayments on the senior notes or make amendments to the terms thereof;
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prepay certain other debt or amend specific debt agreements;
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change the fiscal year of Sally Holdings or its direct parent; and
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create or incur negative pledges.
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In
addition, if Sally Holdings fails to maintain a specified minimum level of borrowing capacity under the ABL facility, it will then be obligated to maintain a specified fixed-charge coverage ratio.
Our ability to comply with these covenants in future periods will depend on our ongoing financial and operating performance, which in turn will be subject to economic conditions and to financial,
market and competitive factors, many of which are beyond our control. Our ability to comply with these covenants in future periods will also depend substantially on the pricing of our products, our
success at implementing cost reduction initiatives and our ability to successfully implement our overall business strategy.
The
indentures governing the senior notes and our institutional term loan also contain restrictive covenants that, among other things, limit our ability and the ability of Sally Holdings and its
restricted subsidiaries to:
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dispose of assets;
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incur additional indebtedness (including guarantees of additional indebtedness);
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pay dividends, repurchase stock or make other distributions;
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prepay subordinated debt;
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create liens on assets;
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make investments (including joint ventures);
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engage in mergers, consolidations or sales of all or substantially all of Sally Holdings' assets;
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engage in certain transactions with affiliates; and
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permit restrictions on Sally Holdings' subsidiaries' ability to pay dividends.
The
restrictions in the indentures governing our senior notes and the covenants in our institutional term loan, and the terms of our ABL facility and the institutional term loan may prevent us from
taking actions that we believe would be in the best interest of our business and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that
are not similarly restricted. We may also incur future debt obligations that might subject us to additional restrictive covenants that could affect our financial and operational flexibility. We cannot
assure you that our subsidiaries, which are borrowers under these agreements, will be granted waivers or amendments to these agreements if they are unable to comply with these agreements, or that we
will be able to refinance our debt on terms acceptable to us, or at all.
Our
ability to comply with the covenants and restrictions contained in the senior notes and the institutional term loan, and the terms of our ABL facility may be affected by economic, financial and
industry conditions beyond our control. The breach of any of these covenants and restrictions could result in a default under either the ABL facility, the institutional term loan or the indentures
that would permit the applicable lenders or senior note holders, as the case may be, to declare all amounts outstanding thereunder to be due and payable, together with accrued and unpaid interest. If
we are unable to repay debt, lenders having secured obligations, such as the lenders under the ABL facility, could proceed against the collateral securing the debt. In any such case, our subsidiaries
may be unable to borrow under the ABL facility and may not be able to repay the amounts due under the senior notes and the institutional term loan. This could have serious consequences to our
financial condition and results of operations and could cause us to become bankrupt or insolvent.
Our ability to generate the significant amount of cash needed to service all of our debt and our ability to
refinance all or a portion of our indebtedness or obtain additional financing depends on many factors beyond our control.
Our ability to make scheduled payments on, or to refinance our obligations under, our debt will depend on our financial and operating performance, which, in
turn, will be subject to prevailing economic and
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competitive
conditions and to the financial and business factors, many of which may be beyond our control, described under "Risks Relating to Our Business" above.
If
our cash flow and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek to obtain additional equity
capital or restructure our debt. In the future, our cash flow and capital resources may not be sufficient for payments of interest on and principal of our debt, and such alternative measures may not
be successful and may not permit us to meet our scheduled debt service obligations.
We
cannot assure you that we will be able to refinance any of our indebtedness or obtain additional financing, particularly because of our high levels of debt and the debt incurrence restrictions
imposed by the agreements governing our debt, as well as prevailing market conditions. In the absence of such operating results and resources, we could face substantial liquidity problems and might be
required to dispose of material assets or operations to meet our debt service and other obligations. Our ABL facility, the institutional term loan and the indentures governing the senior notes
restrict our ability to dispose of assets and use the proceeds from any such dispositions. We cannot assure you we will be able to consummate those sales, or if we do, what the timing of the sales
will be or whether the proceeds that we realize will be adequate to meet debt service obligations when due.
The impairment of certain financial institutions could adversely affect us.
We have exposure to different financial institutions in their capacities as lenders in our ABL facility and the institutional term loan, depositories of our
corporate cash balances and counterparties on our foreign currency and interest rate hedging transactions. All of these transactions expose us to credit risk in the event of default of the financial
institution(s). If these financial institutions become impaired or insolvent, this could have serious consequences to our financial condition and results of operations.
Currency exchange rate fluctuations could result in higher costs and decreased margins and earnings.
Many of our products are sold outside of the United States. As a result, we conduct transactions in various currencies, which increase our exposure to
fluctuations in foreign currency exchange rates relative to the U.S. dollar. Our international revenues and expenses generally
are derived from sales and operations in foreign currencies, and these revenues and expenses could be affected by currency fluctuations, including amounts recorded in foreign currencies and translated
into U.S. dollars for consolidated financial reporting. Currency exchange rate fluctuations could also disrupt the business of the independent manufacturers that produce our products by making their
purchases of raw materials more expensive and more difficult to finance. Foreign currency fluctuations could have an adverse effect on our results of operations and financial condition.