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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

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**FORM 10-K**

 

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| ** ****x**                                    | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                               |                                                                                                    |
| **FOR  THE FISCAL YEAR ENDED: SEPTEMBER 30, 2009** |
| ** **                                         |
| **-OR-**                                           |
| ** **                                         | ** **                                                                                              |
| ** ****o**                                    | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition period from                  to                  **

 

**Commission File No. 333-144427**

 

**SALLYHOLDINGS LLC**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                      | ** ** | **36-4472381**                        |
|---------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or |       | (I.R.S. Employer  Identification No.) |
| organization)                                     |       |                                  |
|                                              |       |                                  |
| **3001  Colorado Boulevard**                      | ** ** |                                  |
| **Denton,  Texas**                                |       | **76210**                             |
| (Address of principal  executive offices)         |       | (Zip Code)                            |

 

Registrant’s telephone number, including area code:**(940) 898-7500**

 

Securities registered pursuant to Section 12(b) of the Act: **None**

 

Securities registered pursuant to Section 12(g) of the Act: **None**

 

THEREGISTRANT, AN INDIRECT WHOLLY-OWNED SUBSIDIARY OF SALLY BEAUTYHOLDINGS, INC., MEETS THE CONDITIONS SET FORTH IN GENERALINSTRUCTION I(1) (a) and (b) OF FORM 10-K AND ISTHEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT PURSUANT TOGENERAL INSTRUCTION I(2).

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as definedunder Rule 405 of the Securities Act.  YES o   NO x

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.  YES o   NO x

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. YES x   NO o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Website, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files. YES o   NO o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  x

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company.(See the definitions of “accelerated filer,” “large accelerated filer” and“smaller reporting company” in Rule 12b-2 of the Exchange Act).

 

| Large  accelerated filer o                |   | Accelerated  filer o        |
|------------------------------------------------|--------|----------------------------------|
|                                           |   |                             |
| Non-accelerated  filer x                  |   | Smaller reporting company o |
| (Do  not check if a smaller reporting company) |   |                             |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act.)  YES o   NO x

 

Novoting or non-voting common equity of the registrant was held by non-affiliatesof the registrant as of March 31, 2009. As of November 19, 2009, allmember units were owned by Sally Investment Holdings LLC, a wholly-ownedsubsidiary of Sally Beauty Holdings, Inc.

 

**DOCUMENTSINCORPORATED BY REFERENCE: NONE**

 

 

 

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**TABLEOF CONTENTS**

 
| ** **        | ** **                                                                                       | ** ** | **Page** |
|-------------------|--------------------------------------------------------------------------------------------------|------------|----------|
| **PART I**   |
| ITEM 1.      | BUSINESS                                                                                         |       | 1        |
| ITEM 1A.     | RISK FACTORS                                                                                     |       | 12       |
| ITEM 1B.     | UNRESOLVED  STAFF COMMENTS                                                                       |       | 25       |
| ITEM 2.      | PROPERTIES                                                                                       |       | 25       |
| ITEM 3.      | LEGAL  PROCEEDINGS                                                                               |       | 27       |
| ITEM 4.      | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                             |       | 27       |
|              |                                                                                             |       |     |
| **PART II**  |
| ITEM 5.      | MARKET  FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                      |       | 28       |
| ITEM 6.      | SELECTED  FINANCIAL DATA                                                                         |       | 29       |
| ITEM 7.      | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      |       | 31       |
| ITEM 7A.     | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                      |       | 56       |
| ITEM 8.      | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                     |       | 57       |
| ITEM 9.      | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE            |       | 57       |
| ITEM 9A.     | CONTROLS  AND PROCEDURES                                                                         |       | 57       |
| ITEM 9B.     | OTHER  INFORMATION                                                                               |       | 58       |
|              |                                                                                             |       |     |
| **PART III** |
| ITEM 10.     | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                          |       | 59       |
| ITEM 11.     | EXECUTIVE  COMPENSATION                                                                          |       | 59       |
| ITEM 12.     | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS |       | 59       |
| ITEM 13.     | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                       |       | 59       |
| ITEM 14.     | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                          |       | 59       |
|              |                                                                                             |       |     |
| **PART IV**  |
| ITEM 15.     | EXHIBITS AND  FINANCIAL STATEMENT SCHEDULES                                                 |       | 61       |

 

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Sally Holdings LLC, or Sally Holdings, a limitedliability company organized under the laws of the State of Delaware, has been awholly-owned subsidiary of Sally Investment Holdings LLC, or Sally Investment,a wholly-owned subsidiary of Sally Beauty Holdings, Inc., or Sally Beauty,since November 16, 2006. All of the interests of Sally Holdings arebeneficially owned by Sally Investment, and all of the interests of SallyInvestment are beneficially owned by Sally Beauty.  Prior to November 16, 2006, SallyHoldings was a Delaware corporation named “Sally Holdings, Inc.” and was awholly-owned subsidiary of Alberto-Culver Company, or Alberto-Culver. On November 16,2006, Sally Holdings, Inc. was converted to a Delaware limited liabilitycompany, was renamed “Sally Holdings LLC” and became a wholly-owned subsidiaryof Sally Investment and an indirect subsidiary of Sally Beauty in connectionwith the separation of Sally Holdings’ business from Alberto-Culver. Alloperations of Sally Investment and Sally Beauty are conducted through SallyHoldings and its consolidated subsidiaries. Sally Capital Inc., a Delaware corporation, or Sally Capital, is awholly-owned subsidiary of Sally Holdings and does not have any assets oroperations of any kind.

 

In this Annual Report, references to “Sally Holdings,”“the Company,” “our company,” “we,” “our,” “ours” and “us” refer to SallyHoldings LLC, and its consolidated subsidiaries for periods after theseparation from Alberto-Culver, and to Sally Holdings, Inc. and itsconsolidated subsidiaries for periods prior to the separation fromAlberto-Culver unless otherwise indicated or the context otherwise requires.

 

###### **CAUTIONARY NOTICE REGARDING FORWARD-LOOKINGSTATEMENTS**

 

Statements in this Annual Report on Form 10-K andthe documents incorporated by reference herein which are not purely historicalfacts or which depend upon future events may be forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, asamended, which we refer to as the Exchange Act. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,”“plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would”or similar expressions may also identify such forward-looking statements.

 

Readers are cautioned not to place undue reliance onforward-looking statements as such statements speak only as of the date theywere made. Any forward-looking statements involve risks and uncertainties thatcould cause actual events or results to differ materially from the events orresults described in the forward-looking statements, including, but not limitedto, risks and uncertainties related to:

 

·    the highly competitive nature of, and theincreasing consolidation of, the beauty products distribution industry;

 

·    anticipating changes in consumer preferences andbuying trends and managing our product lines and inventory;

 

·    potential fluctuation in our same store sales andquarterly financial performance;

 

·    our dependence upon manufacturers who may beunwilling or unable to continue to supply products to us;

 

·    the possibility of material interruptions in thesupply of beauty supply products by our manufacturers;

 

·    products sold by us being found to be defective inlabeling or content;

 

·    compliance with laws and regulations or becomingsubject to additional or more stringent laws and regulations;

 

·    product diversion;

 

·    the operational and financial performance of ourArmstrong McCall, L.P. business;

 

·    the success of our new internet-based business;

 

·    successfully identifying acquisition candidates orsuccessfully completing desirable acquisitions;

 

·    integrating businesses acquired in the future;

 

·    opening and operating new stores profitably;

 

·    the impact of a continued downturn in the economyupon our business;

 

·    the success of our cost control plans;

 

·    protecting our intellectual property rights,specifically our trademarks;

 

·    conducting business outside the United States;

 

·    disruption in our information technology systems;

 

·    natural disasters or acts of terrorism;

 

·    the preparedness of our accounting and othermanagement systems to meet financial reporting and other requirements and theupgrade of our existing financial reporting system;

 

·    being a holding company, with no operations of ourown, and depending on our subsidiaries for cash;

 

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·    our substantial indebtedness;

 

·    the possibility that we may incur substantialadditional debt;

 

·    restrictions and limitations in the agreements andinstruments governing our debt;

 

·    generating the significant amount of cash needed toservice all of our debt and refinancing all or a portion of our indebtedness orobtaining additional financing;

 

·    changes in interest rates increasing the cost ofservicing our debt or increasing our interest expense due to our interest rateswap agreements;

 

·    the potential impact on us if the financialinstitutions we deal with become impaired;

 

·    the representativeness of our historicalconsolidated financial information with respect to our future financialposition, results of operations or cash flows;

 

·    our reliance upon Alberto-Culver for the accuracyof certain historical services and information;

 

·    the share distribution of Alberto-Culver commonstock in our separation from Alberto-Culver not constituting a tax-free distribution;

 

·    actions taken by certain large stockholders ofSally Beauty adversely affecting the tax-free nature of the share distributionof Alberto-Culver common stock;

 

·    the voting power of Sally Beauty’s largeststockholder discouraging third party acquisitions of Sally Beauty at a premium;and

 

·    the interests of Sally Beauty’s largest stockholderdiffering from the interests of other holders of Sally Beauty’s common stock.

 

The events described in the forward-looking statementsmight not occur or might occur to a different extent or at a different timethan we have described. As a result, our actual results may differ materiallyfrom the results contemplated by these forward-looking statements. We assume noobligation to publicly update or revise any forward-looking statements.

 

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###### **PART I**

###### ** **

# **ITEM 1. BUSINESS**

 

## **Introduction**

 

We are the largest distributor of professional beautysupplies in the U.S. based on store count. We operate primarily through twobusiness units, Sally Beauty Supply and Beauty Systems Group, or BSG. ThroughSally Beauty Supply and BSG (which operates stores under the CosmoProf servicemark), we operated a multi-channel platform of 3,727 stores and supplied 187franchised stores primarily in North America, South America and selectedEuropean countries, as of September 30, 2009. Within BSG, we also have oneof the largest networks of professional distributor sales consultants in NorthAmerica, with approximately 1,022 professional distributor sales consultantswho sell directly to salons and salon professionals. As of September 30,2009, Sally Beauty Supply had 2,898 company-operated retail stores and supplied25 franchised stores (all outside the U.S.), and BSG had829 company-operated stores and supplied 162 franchised stores. We provideour customers with a wide variety of leading third-party branded andexclusive-label professional beauty supplies, including hair care products,styling appliances, skin and nail care products and other beauty items. SallyBeauty Supply stores target retail consumers and salon professionals, while BSGexclusively targets salons and salon professionals. Approximately 84%, 82% and84% of our consolidated net sales for the fiscal years ended September 30,2009, 2008 and 2007, respectively, were in the U.S. For the year ended September 30,2009, our consolidated net sales were $2,636.6 million.

 

Sally Beauty Supply began operations with a singlestore in New Orleans in 1964 and was acquired in 1969 by our former parentcompany, Alberto-Culver. BSG became a subsidiary of Alberto-Culver in 1995. In November 2006,our business separated from Alberto-Culver and became an indirect wholly-ownedsubsidiary of Sally Beauty. We refer to our separation from Alberto-Culver andits consumer products-focused business as the Separation Transactions. SallyBeauty is a Delaware corporation formed in June 2006 and became theaccounting successor company to Sally Holdings upon the completion of theSeparation Transactions. When we refer to Alberto-Culver, we meanAlberto-Culver Company prior to the Separation Transactions or the company fromwhich we separated, which is currently a separate public company.

 

In connection with the Separation Transactions, CDRSAcquisition LLC, or CDRS and CD&R Parallel Fund VII, L.P., or theParallel Fund, and which we refer to together with CDRS as the CDR Investors,invested an aggregate of $575.0 million in cash equity, representingownership subsequent to the separation of approximately 48% of the outstandingshares of Sally Beauty’s common stock on an undiluted basis. CDRS, which ownedapproximately 47.4% of the outstanding shares of Sally Beauty’s common stock onan undiluted basis as of September 30, 2009, is a Delaware limitedliability company organized by Clayton, Dubilier & Rice Fund VII,L.P., a private investment fund managed by Clayton, Dubilier & Rice, Inc.Also in connection with the Separation Transactions, we incurred approximately$1,850.0 million of indebtedness, as more fully described below. Pleasesee “Risk Factors — Risks Relating toOur Substantial Indebtedness” in Item 1A below.

 

Sally Holdings is a Delaware limited liabilitycompany.  Sally Capital, a Delawarecorporation, is a wholly-owned subsidiary of Sally Holdings and does not haveany assets or operations of any kind.

 

## **Professional BeautySupply Industry Distribution Channels**

 

The professional beauty supply industry servesend-users through four channels: full-service/exclusive distribution, open-linedistribution, direct and mega-salon stores.

 

##### ***Full-Service/Exclusive***

 

This channel exclusively serves salons and salonprofessionals and distributes “professional-only” products for use and resaleto consumers in salons. Many brands are distributed through arrangements withsuppliers by geographic territory. BSG is a leading full-service distributor inthe U.S.

 

##### ***Open-Line***

 

This channel serves retail consumers and salonprofessionals through retail stores and the internet. This channel is served bya large number of localized retailers and distributors, with only a few havinga regional presence and significant channel share. We believe that Sally BeautySupply is the only open-line distributor in the U.S. with a nationalnetwork of retail stores. In addition, Sally Beauty Supply sells some of itsproducts through Sally Beauty’s web site (*www.sallybeauty.com*).

 

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***Direct***

 

This channel focuses on direct sales to salons andsalon professionals by large manufacturers. This is the dominant form ofdistribution in Europe, but represents a small channel in the U.S. due tothe highly fragmented nature of the U.S. marketplace, which tends to makedirect distribution cost prohibitive for manufacturers.

 

##### ***Mega-Salon Stores***

##### *** ***

In this channel, large-format salons are supplieddirectly by manufacturers due to their large scale.

 

## **Key Industry Trends**

 

We operate within the large and growingU.S. professional beauty supply industry. Potential growth in the industryis expected to be driven by increases in consumer demand for hair color, hairloss prevention and hair styling products and services, offset by lower salesof certain electrical products and/or full-service sales during periods ofeconomic slowdown. We believe the following key industry trends andcharacteristics will influence our business going forward:

 

·    *High level of marketplacefragmentation.*  TheU.S. salon channel is highly fragmented with over 250,000salons. Given the fragmented and small-scale nature of the salon industry,we believe that salon operators will continue to depend on full-service/exclusivedistributors and open-line channels for a majority of their beauty supplypurchases.

 

·    *Growth in booth renting andfrequent stocking needs.*  Salonprofessionals primarily rely on just-in-time inventory due to capitalconstraints and a lack of warehouse and shelf space at salons.  In addition, booth renters, who comprise asignificant percentage of total U.S. salon professionals, are often responsiblefor purchasing their own supplies. Historically, booth renters havesignificantly increased as a percentage of total salon professionals, and weexpect this trend to continue. Given their smaller individual purchases andrelative lack of financial resources, booth renters are likely to be dependenton frequent trips to professional beauty supply stores, like BSG and SallyBeauty Supply.  These factors continue todrive demand for conveniently located professional beauty supply stores.

 

·    *Increasing use ofexclusive-label products.*  Weoffer a broad range of private label and control label products, which wegenerally refer to collectively as “exclusive-label products.” Private labelproducts are brands for which we own or license the trademark and, in someinstances, the formula. Control label products are brands that are owned by themanufacturer, but for which we have been granted sole distribution rights.Generally, our exclusive-label products have higher gross margins than theleading third-party branded products, and we believe this area offers potentialgrowth. Please see “Risk Factors - We depend upon manufacturers who may beunable to provide products of adequate quality or who may be unwilling tocontinue to supply products to us” in Item 1A below.

 

·    *Favorable demographic and consumer trends.*  Theaging baby-boomer population is expected to drive future growth in professionalbeauty supply sales through an increase in the usage of hair color and hairloss products. Additionally, continuously changing fashion-related trends thatdrive new hair styles are expected to result in continued demand for hairstyling products. Changes in consumer tastes and fashion trends can impact ourfinancial performance. Our continued success depends in large part on ourability to anticipate, gauge and react in a timely and effective manner tochanges in consumer spending patterns and preferences for beauty products. Wecontinuously adapt our marketing and merchandising initiatives for Sally BeautySupply in an effort to expand our market reach or to respond to changingconsumer preferences.  If we are unableto anticipate and respond to trends in the marketplace for beauty products andchanging consumer demands, our business could suffer.

 

·    *International growthstrategies. *A key element of our growth strategy dependson our ability to capitalize on growth in the international marketplace and togrow our current level of non-U.S. operations. For example, on September 4, 2009, we acquired DistribuidoraIntersalon Limitada (“InterSalon”), a leading distributor of premier beautysupply products with 16 stores located in Chile and, in May of 2008, we acquired Pro-Duo, N.V., a cash and carryretailer of both professional and retail hair products with 40 stores locatedmainly in Belgium, France and Spain. In addition, in February of 2007, weacquired Chapelton 21 Limited, a private company based in Scotland with almost100 stores located in the United Kingdom, Ireland, Germany, and Spain.  These acquisitions provided us with aninitial presence in South America and furthered our expansion plans in Europe,both significant parts of Sally Beauty Supply’s international growthinitiatives.  We intend to continue toidentify and evaluate non-U.S. acquisition targets.  Our ability to grow our non-U.S. operations,integrate our new non-U.S. acquisitions and successfully pursue additionalnon-U.S. acquisitions may be affected by business, legal, regulatory andeconomic risks. Please see “Risk Factors - We may not be able to successfullyidentify acquisition candidates and complete desirable acquisitions,” “If weacquire any businesses in the future they could prove difficult to integrate,disrupt our business or have an adverse effect on our results of operations”and “Our ability to conduct business in international marketplaces may beaffected by legal, regulatory and economic risks” in Item 1A below.

 

·    *Continuing consolidation.*  There is continuing consolidationamong professional beauty product distributors and professional beauty productmanufacturers. We plan to continue to examine ways in which we can benefit fromthis trend, including reviewing opportunities to shift business fromcompetitive distributors to the BSG network as well as seeking opportunistic, 

 

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value-addedacquisitions which complement our long-term growth strategy. We believe thatsuppliers are increasingly likely to focus on larger distributors and retailerswith a broader scale and retail footprint. We also believe that we are wellpositioned to capitalize on this trend as well as participate in the ongoingconsolidation at the distributor/retail level. However, changes often occur inour relationships with suppliers that may materially affect the net sales andoperating earnings of our business segments. Consolidation among supplierscould exacerbate the effects of these relationship changes and could increasepricing pressures. For example, as we announced in December of 2006, ourlargest supplier, L’Oreal, moved a material amount of revenue out of the BSGnationwide distribution network and into competitive regional distributionnetworks. More recently, L’Oreal acquired distributors competing with BSG inthe southeastern and west coast of the U.S. and a supplier that does notcurrently do business with BSG.  As a result, L’Oreal directly competeswith BSG in certain geographic areas. If L’Oreal acquired other distributors orsuppliers that conduct significant business with BSG, we could lose relatedrevenue. There can be no assurance that there will not be further loss ofrevenue over time by BSG (including within its franchise-based business) due topotential losses of additional products (both from L’Oreal and from othersuppliers) as well as from the increased competition from L’Oreal-affiliateddistribution networks. Please see “Risk Factors - The beauty productsdistribution industry is highly competitive and is consolidating” and “Wedepend upon manufacturers who may be unable to provide products of adequatequality or who may be unwilling to continue to supply products to us” in Item1A below.

 

·    *Relationships with suppliers.*  Sally Beauty Supply/BSG and their suppliers are dependent on each other for thedistribution of beauty products. We donot manufacture the brand name or exclusive-label products we sell. We purchaseour products from a limited number of manufacturers. As is typical indistribution businesses, these relationships are subject to change from time totime (including the expansion or loss of distribution rights in variousgeographies and the addition or loss of product lines). Since we purchaseproducts from many manufacturers on an at-will basis, under contracts which cangenerally be terminated without cause upon 90 days’ notice or less orwhich expire without express rights of renewal, such manufacturers coulddiscontinue sales to us at any time or upon the expiration of the distributionperiod. Some of our contracts with manufacturers may be terminated by suchmanufacturers if we fail to meet specified minimum purchase requirements. Insuch cases, we do not have contractual assurances of continued supply, pricingor access to new products and vendors may change the terms upon which theysell. Infrequently, a supplier will seek to terminate a distributionrelationship through legal action. Changes in our relationships with suppliersoccur often and could positively or negatively impact our net sales andoperating profits. Although we focus on developing new revenue and costmanagement initiatives to mitigate the negative effects resulting fromunfavorable changes in our supplier relationships, there can be no assurancethat our efforts will continue to completely offset the loss of these or otherdistribution rights. Please see “Risk Factors*—* We depend upon manufacturers who may be unable to provide productsof adequate quality or who may be unwilling to continue to supply products tous” in Item 1A below.

 

We expect to continue to expand our product line offerings and to gainadditional distribution rights over time through either further negotiationwith suppliers or by strategic acquisitions of existing distributors.  Although we are focused on developing newrevenue and cost management initiatives, there can be no assurance that ourefforts will partially or completely offset any potential loss of distributionrights in the future. Please see “Risk Factors—We depend upon manufacturers whomay be unable to provide products of adequate quality or who may be unwillingto continue to supply products to us” in Item 1A below.

 

·    *High level of competition.*  Sally Beauty Supply competes withother domestic and international beauty product wholesale and retail outlets,including local and regional open-line beauty supply stores, professional-onlybeauty supply stores, salons, mass merchandisers, drug stores and supermarkets,as well as sellers on the internet and salons retailing hair care items. BSGcompetes with other domestic and international beauty product wholesale andretail suppliers and manufacturers selling professional beauty productsdirectly to salons and individual salon professionals. We also face competitionfrom authorized and unauthorized retailers and internet sites offeringprofessional salon-only products. The increasing availability of unauthorizedprofessional salon products in large format retail stores such as drug stores,grocery stores and others could also have a negative impact on our business.Please see “Risk Factors — The beauty products distribution industry ishighly competitive and is consolidating”in Item 1A below.

 

·    *Economic conditions.*  Weappeal to a wide demographic consumer profile and offer a broad selection ofbeauty products sold directly to retail consumers and salons and salonprofessionals. Historically, these factors have provided us with reducedexposure to downturns in economic conditions in the countries in which weoperate.  However, a continued downturnin the economy, especially for an extended period of time, could adverselyimpact consumer demand of discretionary items such as beauty products and salonservices, particularly affecting our electrical products category and ourfull-service sales business. In addition, higher freight costs resulting fromincreases in the cost of fuel, especially for an extended period of time, mayimpact our expenses at levels that we cannot pass through to ourcustomers.  These factors could have amaterial adverse effect on our business, financial condition and results ofoperations. Please see “Risk Factors — A further downturn in the economy may affectconsumer purchases of discretionary items such as beauty products and salonservices, which could have a material adverse effect on our business, financialcondition and results of operations” in Item 1A below.

 

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·    *Controlling expenses*. Another important aspect of our business is our ability to controlcosts, especially in our BSG business segment, by right-sizing the business andmaximizing the efficiency of our structure. During the past three years, weimplemented a $22.0 million capital spending program to consolidate warehousesand reduce administrative expenses related to BSG’s distribution networkoptimization program. We estimate that this program resulted in cost savings ofapproximately $8.0 million in the fiscal year 2009 and believe that annualizedcost savings**from this program could approximate$10.0 million beginning in fiscal year 2010. Please see “Risk Factors — We arenot certain that our ongoing cost control plans will continue to be successful”in Item 1A below.

 

·    *Opening new stores*.  Ourfuture growth strategy depends in part on our ability to open and profitablyoperate new stores in existing and additional geographic areas. The capitalrequirements to open a U.S.-based Sally Beauty Supply or BSG store, excludinginventory, average approximately $70,000 and $80,000, respectively, with thecapital requirements for international stores costing less or substantiallymore depending upon the marketplace. However, in response to economicconditions and to allow flexibility to capitalize on potential real estaterevaluations in key locations, we have slowed our new store openings. We maynot be able to open all of the new stores we plan to open and any new stores weopen may not be profitable, any of which could have a material adverse impacton our financial condition or results of operations. Please see “Risk Factors —If we are unable to profitably open and operate new stores, our business,financial condition and results of operations may be adversely affected” inItem 1A below.

 

·    *Changesto our information technology systems*.  As our operations grow in bothsize and scope, we will continuously need to improve and upgrade ourinformation systems and infrastructure while maintaining the reliability andintegrity of our systems and infrastructure. The expansion of our systems and infrastructure will require us tocommit substantial financial, operational and technical resources in advance ofany increase in the volume of our business, with no assurance that the volumeof business will increase.  For example,in fiscal year 2009, we began upgrading our distribution information systems(in connection with our capital spending program to consolidate warehouses, asdiscussed above), upgrading our AS400 iSeries servers and installing Hyperionsoftware to enhance our financial reporting system. These and any otherrequired upgrades to our information systems and information technology (or newtechnology), now or in the future, will require that our management andresources be diverted from our core business to assist in completion of theseprojects. There can be no assurance that the time and resources our managementwill need to devote to these upgrades, service outages or delays due to theinstallation of any new or upgraded technology (and customer issues therewith),or the impact on the reliability of our data from any new or upgradedtechnology will not have a material adverse effect on our financial reporting,business, financial condition or results of operations.  Please see “Risk Factors — We may beadversely affected by any disruption in our information technology systems” inItem 1A below.

 

## **Business Segments,Geographic Area Information and Seasonality**

 

We operate two business segments: (i) SallyBeauty Supply, an open-line and exclusive-label distributor of professionalbeauty supplies offering professional beauty supplies to both retail consumersand salon professionals primarily in North America, Europe, Puerto Rico andSouth America, and (ii) BSG, a full-service beauty supply distributoroffering professional brands directly to salons and salon professionals throughour own sales force and professional-only stores, many in exclusivegeographical territories in North America. BSG operates stores under theCosmoProf service mark. BSG also franchises beauty supply outlets in thesouthwest portion of the U.S. and Mexico, and supplies sub-distributors inEurope. Sales of Sally Beauty Supply accounted for approximately 64%, 63% and62%; and BSG accounted for approximately 36%, 37% and 38% of the company’sconsolidated net sales for the years ended September 30, 2009, 2008 and2007, respectively.

 

Financial information about business segments andgeographic area information is incorporated herein by reference to the“Business Segments and Geographic Area Information,” Note 17 of the “Notesto Consolidated Financial Statements” in “Item 8—Financial Statements andSupplementary Data” of this Annual Report.

 

Neither the sales nor the product assortment for SallyBeauty Supply or BSG are generally seasonal in nature.

 

## ***SallyBeauty Supply***

##  

We believe Sally Beauty Supply is the largestopen-line distributor of professional beauty supplies in the U.S. based onstore count. As of September 30, 2009, Sally Beauty Supply operated 2,898company-operated retail stores, 2,357 of which are located in the U.S. (withthe remainder in the United Kingdom and certain other countries in Europe,Canada, Puerto Rico, Mexico and Chile), and supplied 25 franchised stores (alloutside the U.S.). Its stores carry an extensive selection of professionalbeauty products, ranging between 4,000 and 8,000 stock keeping units (or SKUs)of beauty products, and includes products for hair care, nail care, beautysundries and small electrical appliances targeting retail consumers and salonprofessionals. Sally Beauty Supply stores carry leading third-party brands suchas Clairol, Revlon and Conair, as well as an extensive selection ofexclusive-label merchandise. We believe that Sally Beauty Supply hasdifferentiated itself from its competitors through its customer valueproposition, attractive pricing, extensive selection of leading third-partybranded and exclusive-label products, broad ethnic product selection, theproduct knowledge of its sales associates and convenient store locations.

 

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### *Store Design andOperations*

 

Sally Beauty Supply stores are designed to create anappealing shopping environment that embraces the retail consumer and salonprofessional and highlights its extensive product offering. Sally Beauty Supplystores average between 1,200 square feet and 1,700 square feet in size andare located primarily in strip shopping centers. Generally, Sally Beauty Supplystores follow a consistent format, allowing customers familiarity between SallyBeauty Supply locations.

 

Sally Beauty Supply stores are segmented intodistinctive areas arranged by product type with signs allowing its customers toeasily navigate through its stores. Sally Beauty Supply seeks to stimulatecross-selling and impulse buying through strategic product placement and use ofthe front of the store to highlight new products and key promotional items.

 

### *Merchandise*

 

Sally Beauty Supply stores carry a broad selection ofbranded and exclusive-label beauty supplies. Sally Beauty Supply manages eachcategory by product and by SKU and uses centrally developed planoguides tomaintain a consistent merchandise presentation across its store base (primarilyin the U.S. and Canada). Through its information systems, Sally Beauty Supplyactively monitors each store’s performance by category, allowing it to maintainconsistently high levels of in-stock merchandise. We believe Sally BeautySupply’s tailored merchandise strategy enables it to meet local demands andhelps drive traffic in its stores. Additionally, its information systems enableit to track and automatically replenish inventory levels, generally on a weeklybasis, primarily in the U.S.

 

Sally Beauty Supply offers a comprehensive ethnicproduct selection with specific appeal to African-American and Hispaniccustomers. Its ethnic product offerings are tailored by store based on marketdemographics and category performance. For example, sales of products targetedfor the African-American marketplace represented approximately 9% of net salesin Sally Beauty Supply’s U.S. stores for fiscal year 2009. We believe thebreadth of selection of ethnic products available in Sally Beauty Supply storesis unique and differentiates its stores from its competition. Sally BeautySupply also aims to position itself to be competitive in price, but not adiscount leader.

 

Sally Beauty Supply’s pricing strategy isdifferentiated by customer segment. Professional salon customers are generallyentitled to a price lower than that received by retail customers. However,Sally Beauty Supply does offer discounts to retail customers through itscustomer loyalty program.

 

### *Leading Third-PartyBranded Products*

 

Sally Beauty Supply offers an extensive selection ofhair care products, nail care products, beauty sundries and appliances fromleading third-party brands such as Clairol, Revlon and Conair, as well as anextensive selection of exclusive-label merchandise. We believe that carrying abroad selection of the latest premier branded merchandise is critical tomaintaining long-term relationships with our customers. The merchandise SallyBeauty Supply carries includes products from one or more of the leadingmanufacturers in each category. Sally Beauty Supply’s objective is not only tocarry leading brands, but also to carry a full range of branded andexclusive-label products within each category. As hair trends continue toevolve, we expect to offer the changing professional beauty product assortmentnecessary to meet the needs of retail consumers and salon professionals.

 

### *Exclusive-LabelProducts*

 

Sally Beauty Supply offers a broad range of privatelabel and controlled label products, which we generally refer to collectivelyas exclusive-label products, unless the context requires otherwise. Privatelabel products are brands manufactured under trademarks we own or license andin some instances we also own the formula. Controlled label products involvebrands that are owned by the manufacturer, but for which we have been grantedsole distribution rights. We believe exclusive-label products provide customerswith an attractive alternative to higher-priced leading third-party brands.Exclusive-label products accounted for approximately 42% of Sally BeautySupply’s product sales in the U.S. during fiscal year 2009. Generally, theexclusive-label brands have higher gross margins than the leading third-partybranded products, and we believe this area offers continued potential growth.Sally Beauty Supply maintains exclusive-label products in a number ofcategories including hair care, small electrical appliances and salon products.Sally Beauty Supply actively promotes its exclusive-label brands throughin-store promotions and monthly flyers. We believe our customers perceive theseexclusive-label products to be comparable in quality and name recognition toleading third-party branded products.

 

The following table sets forth the approximatepercentage of Sally Beauty Supply’s sales by merchandise category:

 
| ** **                        | ** ** | **Year Ended********September 30, 2009** | ** ** |
|-----------------------------------|------------|-----------------------------------------------|------------|
| Hair color                        |       | 22.0                                          | %          |
| Hair care                         |       | 18.8                                          | %          |
| Brushes, cutlery  and accessories |       | 16.9                                          | %          |
| Skin and nail  care               |       | 13.2                                          | %          |
| Electrical  appliances            |       | 11.9                                          | %          |
| Ethnic products                   |       | 8.7                                           | %          |
| Other beauty  items               |       | 8.5                                           | %          |
| Total                             |       | 100.0                                         | %          |

 

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### *Marketing and Advertising*

 

Sally Beauty Supply’s marketing program is designed topromote its extensive selection of brand name products at competitive prices.The program is currently centered on multi-page, color flyers highlightingpromotional products. Separate flyers are created and tailored to Sally BeautySupply’s retail customers and salon professionals. These flyers, which areavailable in Sally Beauty Supply stores, are also mailed to loyalty programcustomers and salon professionals on a monthly basis and are supplemented bye-mail newsletters.

 

We continuously adapt our marketing and merchandisinginitiatives for Sally Beauty Supply in an effort to expand our market reach orto respond to changing consumer preferences.

 

Sally Beauty Supply’s customer loyalty and marketingprograms allow Sally Beauty Supply to collect point-of-sale customer data andincrease our understanding of customers’ needs. The Sally “Beauty Club” is aloyalty program for customers who are not salon professionals. Beauty Clubmembers, after paying a nominal annual fee, receive a special, discounted priceon almost every non-sale item. Members are also eligible for a special BeautyClub e-mail newsletter that contains additional savings, beauty tips, newproduct information and coupons. In addition, the “ProCard” is a marketingprogram for licensed salon professionals. ProCard members receive discounts onall beauty products sold at Sally Beauty Supply stores. We believe theseprograms are effective in developing and maintaining customer relationships.

 

### *Store Locations*

 

Sally Beauty Supply selects geographic areas and storesites on the basis of demographic information, quality and nature ofneighboring tenants, store visibility and location accessibility. Sally BeautySupply seeks to locate stores primarily in strip malls, which are occupied byother high traffic retailers including grocery stores, mass merchants and homecenters.

 

Sally Beauty Supply balances its store expansionbetween new and existing marketplaces. In its existing marketplaces, SallyBeauty Supply adds stores as necessary to provide additional coverage. In newmarketplaces, Sally Beauty Supply generally seeks to expand in geographicallycontiguous areas to leverage its experience. We believe that Sally BeautySupply’s knowledge of local marketplaces is an important part of its success.

 

The following table provides a history of Sally BeautySupply’s store count during the last five fiscal years:

 
| ** **                          | ** ** | **Fiscal Year  Ended September 30,** | ** ** |
|-------------------------------------|------------|-------------------------------------------|------------|
| ** **                          | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Stores open at  beginning of period |       | 2,844                                     |       | 2,694 |   | 2,511 |   | 2,419 |   | 2,355 |   |
| Net store openings  during period   |       | 60                                        |       | 110 |   | 83 |   | 92 |   | 62 |   |
| Stores acquired during  period      |       | 19                                        |       | 40 |   | 100 |   | — |   | 2 |   |
| Stores open at end of  period       |       | 2,923                                     |       | 2,844 |   | 2,694 |   | 2,511 |   | 2,419 |   |

 

## ***BeautySystems Group***

 

We believe that BSG is the largest full-servicedistributor of professional beauty supplies in the U.S. As of September 30,2009, BSG had 829 company-operated stores, supplied 162 franchised storesand had a sales force of approximately 1,022 professional distributor salesconsultants selling exclusively to salons and salon professionals insubstantially every state in the U.S., in Puerto Rico and in portions ofCanada, Mexico and certain European countries.

 

### *Store Design andOperations*

 

BSG stores are designed to create a professionalshopping environment that embraces the salon professional and highlights itsextensive product offering. Company-operated BSG storesaverage approximately 2,700 square feet and are located primarily insecondary strip shopping centers. BSG store layouts are designed to provideoptimal variety and options to the salon professional. Stores are segmentedinto distinctive areas arranged by product type with certain areas dedicated toleading third-party brands; such as Paul Mitchell, Wella, Sebastian, Goldwelland TIGI. The selection of these brands varies by territory.

 

### *ProfessionalDistributor Sales Consultants*

 

BSG has a network of approximately 1,022 professionaldistributor sales consultants, which exclusively serve salons and salonprofessionals. The following table sets forth the number of consultants in theBSG network during the last five fiscal years:

 

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| ** **                                     | ** ** | **Fiscal Year  Ended September 30,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                     | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Professional  distributor sales consultants(a) |       | 1,022                                     |       | 984 |   | 1,002 |   | 1,163 |   | 1,244 |   |

 

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(a)   Includes300, 328, 317, 348 and 355 distributor sales consultants of franchisees at September 30,2009, 2008, 2007, 2006 and 2005, respectively.

 

The number of distributor sales consultants, at September 30,2009, reflects approximately 100 distributor sales consultants previouslyemployed by Schoeneman Beauty Supply, Inc (“Schoeneman”). On September 30,2009, the Company acquired Schoeneman and these distributor sales consultantsbecame part of BSG’s consultant sales team. The decrease in distributor salesconsultants in fiscal year 2007 was in response to the loss of L’Oreal relatedsales discussed below under “Competition.” BSG’s sales force was reduced infiscal year 2007 and the remaining affected distributor sales consultants wereoffered certain compensation related incentives to stay with us as BSG replacedlost L’Oreal sales.

 

In order to provide a knowledgeable consultant team,BSG actively recruits individuals with industry knowledge or sales experience,as we believe that new consultants with either broad knowledge about theproducts or direct sales experience will be more successful.

 

BSG provides training to new consultants beginningwith a one-week training program, followed by a continuing program ofmedia-based training, delivered through audio, video and web-based e-learning.The program is designed to develop product knowledge as well as techniques onhow best to serve salon professionals. In addition to selling professionalbeauty products, these sales consultants offer in-store training forprofessionals and owners in areas such as new styles, techniques and businesspractices.

 

An important component of consultants’ compensation issales commissions. BSG’s commission system is designed to drive sales and focusconsultants on selling products that are best suited to individual salons andsalon professionals. We believe our emphasis on recruitment, training, andsales-based compensation results in a sales force that distinguishes itself fromother full-service/exclusive-channel distributors.

 

The following table sets forth the approximatepercentage of BSG sales attributable by channel:

 
| ** **                                                | ** ** | **Fiscal Year Ended September 30,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| Company-operated  retail stores                           |       | 60.0                                     | %          | 57.0 | % |
| Professional  distributor sales consultants(full-service) |       | 27.9                                     | %          | 29.9 | % |
| Franchise stores                                          |       | 12.1                                     | %          | 13.1 | % |
| Total                                                     |       | 100.0                                    | %          | 100.0 | % |

 

### *Merchandise*

 

BSG stores carry a broad selection of branded beautysupplies and a lesser selection of exclusive-label products, ranging between4,000 and 9,000 SKUs of beauty products, including hair care products, nailcare, small electrical appliances and other beauty items. Some products areavailable in bulk packaging for higher volume salon needs. Through BSG’sinformation systems, each store’s product performance is actively monitored,allowing maintenance of an optimal merchandise mix. Additionally, BSG’sinformation systems track and automatically replenish inventory levels on aweekly basis, enabling BSG to maintain high levels of product in stock.Although BSG positions itself to be competitive on price, its primary focus isto provide a comprehensive selection of branded products to the salonprofessional. Certain BSG products are sold under exclusive arrangements withsuppliers, whereby BSG is designated the sole distributor for a specific brandname within certain geographic territories. We believe that carrying a broadselection of branded merchandise is critical to maintaining relationships withour valued professional customers.

 

The following table sets forth the approximatepercentage of sales attributable by merchandise category:

 
| ** **                        | ** ** | **Fiscal Year Ended********September 30, 2009** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| Hair care                         |       | 38.5                                                 | %          |
| Hair color                        |       | 28.4                                                 | %          |
| Promotional  items(a)             |       | 12.5                                                 | %          |
| Skin and nail  care               |       | 7.7                                                  | %          |
| Electrical  appliances            |       | 4.9                                                  | %          |
| Brushes, cutlery  and accessories |       | 3.2                                                  | %          |
| Other beauty  items               |       | 4.8                                                  | %          |
| Total                             |       | 100.0                                                | %          |

 

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(a)           Promotionalitems consist of sales from other categories that are sold on a value-pricedbasis.

 

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### *Marketing andAdvertising*

 

BSG’s marketing program is designed primarily topromote its extensive selection of brand name products at competitive prices.BSG distributes at its stores and mails to its salon and salon professionalcustomers, multi-page color flyers that highlight promotional products.Some BSG stores also host monthly manufacturer-sponsored classes for customers.These classes are held at BSG stores and led by manufacturer-employededucators. Salon professionals, after paying a small fee to attend, areeducated on new products and beauty trends. We believe these classes increasebrand awareness and drive sales in BSG stores.

 

### *Store Locations*

###  

BSG stores are primarily located in secondary stripshopping centers. Although BSG stores are located in visible and convenientlocations, salon professionals are less sensitive about store location thanSally Beauty Supply customers.

 

The following table provides a history of BSG’s storecount during the last five fiscal years:

 
| ** **                         | ** ** | **Fiscal Year Ended September 30,** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **2009**                            | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Stores open at beginning of period |       | 929                                 |       | 874 |   | 828 |   | 822 |   | 692 |   |
| Net store openings during period   |       | 16                                  |       | 44 |   | 46 |   | 6 |   | 37 |   |
| Stores acquired during period (a)  |       | 46                                  |       | 11 |   | — |   | — |   | 93 |   |
| Stores open at end of  period      |       | 991                                 |       | 929 |   | 874 |   | 828 |   | 822 |   |

 

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(a)           Includes43 stores acquired from Schoeneman on September 30, 2009.

 

## **Our Strategy**

 

We believe there are significant opportunities to increaseour sales and profitability through the further implementation of our operatingstrategy and by growing our store base in existing and contiguous marketplaces,both organically and through strategic acquisitions. Specific elements of ourgrowth strategy include the following:

 

##### ***Increase Sales Productivity of Our Stores***

 

We intend to grow same store sales by focusing onimproving our merchandise mix and introducing new products. In addition, weplan to tailor our marketing, advertising and promotions to attract newcustomers and increase sales with existing customers. We also plan to enhanceour customer loyalty programs, which allow us to collect point-of-sale customerdata and increase our understanding of customers’ needs.

 

##### ***Open New Stores and Exploring NewMarketplaces***

 

In fiscal year 2009, we opened or acquired 79 and62 net new stores for Sally Beauty Supply and BSG, respectively. Becauseof the limited initial capital outlay, rapid payback, and attractive return oncapital, we intend to continue to expand our Sally Beauty Supply and BSG storebase. We believe there are growth opportunities for additional stores in theU.S., Canada, Mexico, Europe and South America. We expect new store openingsand acquisitions in existing and new areas to be an important aspect of ourfuture growth opportunities. Please also see “Pursue Strategic Acquisitions.”

 

##### ***Increase Sales of Exclusive-label Products***

 

We currently intend to grow exclusive-label sales inSally Beauty Supply. We believe our customers view our exclusive-label productsas high-quality, recognizable brands, which are competitive with leadingthird-party branded merchandise. Exclusive-label products are currently soldthrough our Sally Beauty Supply stores with very limited exclusive-labelofferings at BSG. Exclusive-label products account for a substantial amount ofthe Sally Beauty Supply segment net sales and generate a gross margin greaterthan that of the leading third-party brands sold through our stores. Potentialgrowth for such products is believed to be significant. In addition, our broadexclusive-label product offering minimizes our dependence on any one brand orsupplier. We believe exclusive-label products present opportunities to growprofits and increase store loyalty.

 

##### ***Increase Operating Efficiency andProfitability***

 

We believe there are opportunities to increase theprofitability of operations, especially in our BSG business. During the lastcouple of fiscal years, we made certain changes which included right-sizing thebusiness (including some targeted reductions-in-force) and maximizing theefficiency of our structure. We completed a re-branding project at BSG thatrepositioned all of our North American company-operated stores under a commonname and store identity, CosmoProf, which we believe has improved brandconsistency, saved on advertising and promotional costs and allowed for a morefocused marketing strategy. We also implemented a two-year, $22.0 millioncapital spending program to consolidate BSG warehouses and reduce administrativeexpenses related to BSG’s distribution network. Additionally, during fiscalyear 2007 we implemented working capital improvement initiatives focused on themanagement of receivables, inventory and payables to further maximize our freecash flow. Over the past few years, we have also 

 

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undertaken a full review of our procurement strategy.This initiative is intended to identify lower-cost alternative sources ofsupply in certain product categories from countries with lower manufacturingcosts. We also offer between 5,000 and 8,000 SKUs of our Sally Beauty Supplyproducts for sale through Sally Beauty’s website (*www.sallybeauty.com*),which we expect will increasingly lead to additional sales for that businesssegment.

 

##### ***Pursue Strategic Acquisitions***

 

We have completed approximately 32 acquisitions overthe last 10 years. We believe our experience in identifying attractiveacquisition targets; our proven integration process; and our highly scalableinfrastructure have created a strong platform for potential futureacquisitions, subject to restrictions on our ability to finance acquisitions byincurring additional debt or issuing equity under our debt agreements. Forexample, (1) on September 4, 2009, we acquired InterSalon, a leadingdistributor of premier beauty supply products with 16 stores located in Chile; (2) onSeptember 18, 2009, we acquired the assets and business of Belleza ConceptInternational, Inc., a distributor of beauty supply products operating inPuerto Rico; (3) on September 30, 2009, we acquired Schoeneman, a43-store beauty supply chain located in the central northeast United States; 4)in May of 2008 we acquired Pro-Duo, N.V., a cash and carry retailer ofboth professional and retail hair products with 40 stores located mainly inBelgium, France and Spain; and (5) in February of 2007, we acquiredChapelton 21 Limited, a private company based in Scotland with almost 100stores located in the United Kingdom, Ireland, Germany and Spain. We intend tocontinue to identify and evaluate acquisition targets both domestically andinternationally, with a focus on expanding our exclusive BSG territories andallowing Sally Beauty Supply to enter new channels outside the U.S.

 

## **Competition**

 

Although there are a limited number of sizable directcompetitors to our business, the beauty industry is highly competitive. In eacharea in which we operate, we experience competition from domestic andinternational businesses often with more resources, including massmerchandisers, drug stores, supermarkets and other chains offering similar orsubstitute beauty products at comparable prices. Our business also facescompetition from department stores. In addition, our business competes withlocal and regional open-line beauty supply stores and full-service distributorsselling directly to salons and salon professionals through both professionaldistributor sales consultants and outlets open only to salons and salonprofessionals. Our business also faces increasing competition from certainmanufacturers that use their own sales forces to distribute their professionalbeauty products directly or align themselves with our competitors. Some ofthese manufacturers are vertically integrating through the acquisition ofdistributors and stores. In addition, these manufacturers may acquireadditional brands that we currently distribute and attempt to shift theseproducts to their own distribution channels. Our business also facescompetition from authorized and unauthorized retailers and internet sitesoffering professional salon-only products. Please see “Risk Factors—The beautyproducts distribution industry is highly competitive and is consolidating” foradditional information on our competition.

 

## **CompetitiveStrengths**

 

We believe the following competitive strengthsdifferentiate us from our competitors and contribute to our success:

 

##### ***The Largest Professional Beauty SupplyDistributor in the U.S. with Multi-Channel Platform***

 

Sally Beauty Supply and BSG together comprise thelargest distributor of professional beauty products in the U.S. by storecount. Our leading channel positions and multi-channel platform afford usseveral advantages, including strong positioning with suppliers, the ability tobetter service the highly fragmented beauty supply marketplace, economies ofscale and the ability to capitalize on the ongoing consolidation in our sector.Through our multi-channel platform, we are able to generate and grow revenuesacross broad, diversified geographies, and customer segments using varyingproduct assortments. We operate in several countries outside the U.S. andPuerto Rico, offering up to 8,000 and 9,000 SKUs in Sally Beauty Supply (in ourstores and online) and BSG stores, respectively, to a potential customer basethat includes millions of retail consumers, and more than 250,000 salons in theU.S.

 

##### ***Differentiated Customer Value Proposition***

 

We believe that our stores are differentiated fromtheir competitors through convenient location, broad selection of professionalbeauty products (including leading third-party branded and exclusive-labelmerchandise), high levels of in-stock merchandise, knowledgeable salespeopleand competitive pricing. Our merchandise mix includes a comprehensive ethnicproduct selection, which is tailored by store based on market demographics andcategory performance. We believe that the breadth of our selection of theseproducts further differentiates Sally Beauty Supply from its competitors. Inaddition, as discussed above, Sally Beauty Supply also offers a customerloyalty program for Sally Beauty Supply customers, the Beauty Club, wherebymembers receive a special, discounted price on products and are also eligiblefor a special Beauty Club e-mail newsletter with additional promotionalofferings, beauty tips and new product information for a nominal annual fee. Webelieve that our differentiated customer value proposition and strong brandsdrive customer loyalty and high repeat traffic, contributing to our consistenthistorical financial performance. Our BSG professional distributor salesconsultants benefit from their customers having access to the BSG store systemsas customers have the ability to pick up the products they need between salesvisits from professional distributor sales consultants.

 

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##### ***Attractive Store Economics***

 

We believe that our stores generate attractive returnson invested capital. The capital requirements to open a U.S.-based Sally BeautySupply or BSG store, excluding inventory, average approximately $70,000 and$80,000, respectively, with the capital requirements for international storescosting less or substantially more depending upon the marketplace. Sally BeautySupply stores average between 1,200 square feet and 1,700 square feet and BSGstores average approximately 2,700 square feet in size. Domestically, ourstores are typically located within strip shopping centers. Strong averagesales per square foot combined with minimal staffing requirements, low rentexpense and limited initial capital outlay typically result in positivecontribution margins within a few months, and cash payback on investmentwithin approximately two years. Due to such attractive investment returns andrelatively high operating profit contributions per store, during the past fiveyears Sally Beauty Supply and BSG have opened an aggregate of 407 and149 net new stores, respectively, excluding the effect of acquisitions.

 

##### ***Consistent Financial Performance***

 

We have a proven track record of strong growth andconsistent profitability due to superior operating performance, new storeopenings and strategic acquisitions. Over the past five fiscal years, ourconsolidated same store sales growth has been positive in each year and hasaveraged 2.7%, as set forth in the following table:

 
| ** **                      | ** ** | **Year Ended September 30,** | ** ** |
|---------------------------------|------------|-----------------------------------|------------|
| **Same store sales growth (a)** | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Sally Beauty  Supply            |       | 2.1                               | %          | 1.2 | % | 2.7 | % | 2.4 | % | 2.4 | % |
| Beauty Systems  Group           |       | 1.0                               | %          | 6.9 | % | 10.1 | % | 4.1 | % | (0.6 | )% |
| Consolidated                    |       | 1.8                               | %          | 2.6 | % | 4.5 | % | 2.8 | % | 1.8 | % |

 

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(a)    Same stores are defined as company-operated stores thathave been open for at least 14 months as of the last day of a month. Ourinternet site has generated sales for at least 14 months and, accordingly,internet-based sales are included in same store sales for fiscal year 2009.

 

##### ***Experienced Management Team with a ProvenTrack Record***

 

Our management team, which includes the managementteam of Sally Beauty, is led by President and Chief Executive Officer GaryWinterhalter and has a strong record of performance.

 

## **Customer Service**

 

We strive to complement our extensive merchandiseselection and innovative store design with superior customer service. Weactively recruit individuals with cosmetology experience because we believethat such individuals are more knowledgeable about the products they sell.Additionally, Sally Beauty Supply recruits individuals with retail experiencebecause we believe their general retail knowledge can be leveraged in thebeauty supply industry. We believe that employees’ knowledge of the productsand ability to demonstrate and explain the advantages of the products increasessales and that their prompt, knowledgeable service fosters the confidence andloyalty of customers and differentiates our business from other professionalbeauty supply distributors.

 

We emphasize product knowledge during initial trainingas well as during ongoing training sessions, with programs intended to providenew associates and managers with significant training. The training programsencompass operational and product training and are designed to increase employeeand store productivity. Store employees are also required to participate intraining on an ongoing basis to keep up-to-date on products and operationalpractices.

 

Most of our stores are staffed with a store manager,and two or three full-time or part-time associates. BSG stores are generallyalso staffed with an assistant manager. The operations of each store aresupervised by a district manager, who reports to a territory manager. Asignificant number of our store managers and assistant managers are licensed inthe cosmetology field. Additionally, in certain geographic areas in the U.S., asignificant number of our store personnel, including store managers andassistant managers, speak Spanish as a second language. We believe that theseskills enhance our store personnel’s ability to serve our customers.

 

## **Relationships withSuppliers**

 

We purchase our merchandise directly frommanufacturers through supply contracts and by purchase orders. For the fiscalyear 2009, our five largest suppliers, Procter & Gamble, theProfessional Products Division of L’Oreal USA S/D, Inc., or L’Oreal,Conair Corporation, Shiseido Cosmetic (America) Limited, and John Paul MitchellSystems, accounted for approximately 40% of our consolidated merchandisepurchases. Products are purchased from these and many manufacturers on anat-will basis or under contracts which can be terminated without cause upon90 days notice or less or expire without express rights of renewal. Suchmanufacturers could discontinue sales to us at any time or upon short notice.If any of these suppliers discontinued selling or were unable to continueselling to us, there could be a material adverse effect on our consolidatedresults of operations.

 

As is typical in the distribution businesses,relationships with suppliers are subject to change from time to time (includingthe expansion or loss of distribution rights in various geographies and theaddition or loss of products lines). Changes in our relationships 

 

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with suppliers occur often, and could positively ornegatively impact our net sales and operating profits. Please see “RiskFactors—We depend upon manufacturers who may be unable to provide products ofadequate quality or who may be unwilling to continue to supply products to us.”However, we believe that we can be successful in mitigating negative effectsresulting from unfavorable changes in the relationships between us and oursuppliers through, among other things, the development of new or expandedsupplier relationships.

 

**Distribution**

 

As of September 30, 2009, we operated 16distribution centers, seven of which serviced Sally Beauty Supply and nine ofwhich serviced BSG. During the past three years, we implemented a capitalspending program to consolidate warehouses and reduce administrative expensesrelated to BSG’s distribution network optimization program. Total capitalexpenditures were approximately $22.0 million and related expenses wereapproximately $5.0 million for this program. We believe that annual savingsfrom this program could approximate $10.0 million beginning with fiscal year2010.

 

Our purchasing and distribution system is designed tominimize the delivered cost of merchandise and maximize the level ofmerchandise in-stock in stores. This distribution system also allows formonitoring of delivery times and maintenance of appropriate inventory levels.Product deliveries are typically made to our stores on a weekly basis. Eachdistribution center has a quality control department that monitors productsreceived from suppliers. We utilize proprietary software systems to providecomputerized warehouse locator and inventory support.  Pleasesee “Risk Factors —We are not certain that our ongoing cost control plans willcontinue to be successful.”

 

## **ManagementInformation Systems**

 

Our management information systems provide orderprocessing, accounting and management information for the marketing, distributionand store operations functions of our business. A significant portion of thesesystems have been developed internally. The information gathered by themanagement information systems supports automatic replenishment of in-storeinventory and provides support for product purchase decisions. Please see “RiskFactors—We may be adversely affected by any disruption in our informationtechnology systems.”

 

## **Employees**

 

In our domestic and foreign operations, we hadapproximately 22,410 employees as of September 30, 2009; consistingof approximately 6,480 salaried, 4,930 hourly and 11,000 part-timeemployees. We had approximately 21,140 employees as of September 30,2008; consisting of approximately 5,850 salaried, 4,710 hourly and 10,580part-time employees. Part-time employees are used to supplement schedules,particularly in North America. The number of employees at September 30,2009, includes approximately 600 persons employed by Schoeneman andapproximately 100 persons employed by InterSalon.

 

Certain subsidiaries in Mexico have collectivebargaining agreements covering warehouse and store personnel which expire atvarious times over the next several years. We believe that we have goodrelationships with our employees worldwide.

 

**Regulation**

 

We are subject to a wide variety of laws andregulations, 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 methodsof advertising and marketing utilized are regulated by a host of federalagencies, including, in each case, one or more of the following: the Food andDrug Administration, or FDA, the Federal Trade Commission, or FTC, and theConsumer Products Safety Commission. The transportation and disposal of many ofour products are also subject to federal regulation. State and local agenciesregulate many aspects of our business. In marketplaces outside of the U.S.,regulation is also comprehensive and focused upon labeling and safety issues.

 

Sally Beauty Supply supplies 25 and BSG supplies 162franchised stores located in the U.S., Mexico and certain countries in Europe.As a result of these franchisor-franchisee relationships, we are subject toregulation when offering and selling franchises in the applicable countries.The applicable laws and regulations affect our business practices, asfranchisor, in a number of ways, including restrictions placed upon theoffering, renewal, termination and disapproval of assignment of franchises. Todate, these laws and regulations have not had a material effect uponoperations.

 

## **Trademarks and OtherIntellectual Property Rights**

 

Our trademarks, certain of which are material to ourbusiness, are registered or legally protected in the U.S., Canada and othercountries throughout the world in which we operate. Our subsidiaries and we ownover 238 trademark registrations in the U.S., and 800 trademark registrationsoutside the U.S. We also rely upon trade secrets and know-how to develop andmaintain our competitive position. We protect intellectual property rightsthrough a variety of methods, including reliance upon trademark, patent andtrade secret laws and confidentiality agreements with many vendors, employees,consultants and others who have access to our proprietary information. Theduration of our trademark registrations is generally 10 or 15 years,depending on the country in which a mark is registered, and generally theregistrations can be renewed. The scope and duration of intellectual propertyprotection varies by jurisdiction and by individual product.

 

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## **Access to PublicFilings**

 

Our Annual Report on Form 10-K, our QuarterlyReports on Form 10-Q and our Current Reports on Form 8-K, andamendments to such reports are available, without charge, on Sally Beauty’swebsite, *www.sallybeautyholdings.com*, as soon asreasonably possible after they are filed electronically with the Securities andExchange Commission, or SEC, under the Exchange Act. We will provide copies ofsuch reports to any person, without charge, upon written request to ourInvestor Relations Department at 3001 Colorado Blvd, Denton, TX 76210. Theinformation found on Sally Beauty’s website shall not be considered to be partof this or any other report filed with or furnished to the SEC.

 

In addition to Sally Beauty’s website, you may readand copy public reports we file with or furnish to the SEC at the SEC’s PublicReference Room at 100 F Street, NE, Washington, DC 20549. You may obtaininformation on the operation of the Public Reference Room by calling theSEC at 1-800-SEC-0330. The SEC maintains an internet site that contains ourreports, proxy and information statements, and other information that we fileelectronically with the SEC at *www.sec.gov*.

 

# **ITEM 1A. RISK FACTORS**

 

The following describes risks that we believe to bematerial to our business. If any of the following risks or uncertaintiesactually occurs, our business, financial condition and operating results couldbe materially and adversely affected. There may be additional risks of which weare not aware or that we do not believe to be material that could materiallyand adversely affect our business. This report also contains forward-lookingstatements and the following risks could cause our actual results to differmaterially from those anticipated in such forward-looking statements.

 

## **Risks Relating toOur Business**

 

***The beauty products distribution industry is highly competitiveand is consolidating.***

 

The beauty productsdistribution industry is highly fragmented, and there are few significantbarriers to entry into the marketplaces for most of the types of products andservices we sell. Sally Beauty Supply competes with other domestic andinternational beauty product wholesale and retail outlets, including local andregional open line beauty supply stores, professional-only beauty supplystores, salons, mass merchandisers, drug stores and supermarkets. BSG competeswith other domestic and international beauty product wholesale and retailsuppliers and with manufacturers selling professional beauty products directlyto salons and individual salon professionals. We also face competition fromauthorized and unauthorized retailers as well as internet sites offeringprofessional salon-only products. The increasing availability of divertedprofessional salon products in large format retail stores such as drug stores,grocery stores and others could have a negative impact on our business. Theprimary competitive factors in the beauty products distribution industry arethe price at which we purchase products from manufacturers, the quality,perceived value, consumer brand name recognition, packaging and mix of theproducts we sell, customer service, the efficiency of our distribution networkand the availability of desirable store locations. Competitive conditions maylimit our ability to maintain prices or may require us to reduce prices toretain business or marketplace share. Some of our competitors have greaterfinancial and other resources than we do, and are less leveraged than ourbusiness, and may therefore be able to spend more aggressively on advertisingand promotional activities and respond more effectively to changing businessand economic conditions. We expect existing competitors, business partners andnew entrants to the beauty products distribution industry to constantly reviseor improve their business models in response to challenges from competingbusinesses, including ours. If these competitors introduce changes ordevelopments that we cannot address in a timely or cost-effective manner, ourbusiness may be adversely affected.

 

In addition, our industryis consolidating, which may give our competitors increased negotiating leverageand greater marketing resources, thereby providing them correspondingcompetitive advantages over us. For instance, we may lose customers if ourcompetitors that own national chains acquire additional salons that are BSGcustomers or if professional beauty supply manufacturers align themselves withother beauty product wholesale and retail suppliers who compete with BSG. Forexample, BSG’s largest supplier, L’Oreal, has moved a material amount ofrevenue out of the BSG nationwide distribution network and into competitiveregional distribution networks. L’Oreal has also acquired one supplier (thatdoes not currently do business with BSG) and distributors competitive with BSGin the southeastern U.S. as well as the west coast of the U.S. As a result,L’Oreal entered into direct competition with BSG and there can be no assurancethat there will not be further revenue losses over time at BSG, due topotential losses of additional L’Oreal related products as well as from theincreased competition from L’Oreal-affiliated distribution networks. If L’Orealwere to acquire a supplier that conducted business with BSG, we could lose thatrevenue as well. Such consolidation may increase competition from distributionchannels related to suppliers and place more leverage in the hands of thosesuppliers to negotiate better margins on products sold in our stores.

 

If we are unable tocompete effectively in our marketplace or if competitors divert our customersaway from our stores, it would adversely impact our business, financialcondition and results of operations.

 

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***We may be unable to anticipate changes in consumer preferencesand buying trends or manage our product lines and inventory commensurate withconsumer demand.***

 

Our success depends inpart on our ability to anticipate, gauge and react in a timely manner tochanges in consumer spending patterns and preferences for beauty products. Ifwe do not anticipate and respond to trends in the marketplace for beautyproducts and changing consumer demands in a timely manner, our sales maydecline significantly and we may be required to mark down certain products tosell the resulting excess inventory at prices which can be significantly lowerthan the normal retail or wholesale price, which could adversely impact ourbusiness, financial condition and results of operations. In addition, we dependon our inventory management and information technology systems in order toreplenish inventories and deliver products to store locations in response tocustomer demands. Any systems-related problems could result in difficultiessatisfying the demands of customers which, in turn, could adversely affect oursales and profitability.

 

We expect the aging babyboomer population to drive future growth in professional beauty supply salesthrough an increase in the use of hair color and hair loss products.Additionally, we expect continuously changing fashion-related trends that drivenew hair styles to result in continued demand for hair styling products.Changes in consumer tastes and fashion trends can have an impact on ourfinancial performance. If we are unable to anticipate and respond to trends inthe marketplace for beauty products and changing consumer demands, our businesscould suffer.

 

***Our comparable store sales and quarterly financialperformance may fluctuate for a variety of reasons.***

 

Our comparable storesales and quarterly results of operations have fluctuated in the past, and weexpect them to continue to fluctuate in the future. A variety of factors affectour comparable store sales and quarterly financial performance, including:

 

·          changes in our merchandising strategy or mix;

 

·          the performance of our new stores;

 

·          the effectiveness of our inventory management;

 

·          the timing and concentration of new store openings,including additional human resource requirements and related pre-opening andother start-up costs;

 

·          levels of pre-opening expenses associated with newstores;

 

·          a portion of a typical new store’s sales (or sales wemake over the internet channel) coming from customers who previously shopped atother existing stores;

 

·          expenditures on our distribution system;

 

·          the earnings impact of those of our interest rateswaps which do not qualify for hedge accounting treatment;

 

·          the timing and effectiveness of our marketingactivities, particularly our Sally Beauty Club promotions;

 

·          seasonal fluctuations due to weather conditions;

 

·          the level of sales made through our internet channel;

 

·          actions by our existing or new competitors; and

 

·          worldwide economic conditions and, in particular, theretail sales environment in the U.S.

 

Accordingly, our resultsfor any one fiscal quarter are not necessarily indicative of the results to beexpected for any other quarter, and comparable store sales for any particularfuture period may decrease, which could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

***We depend upon manufacturers who may be unable to provideproducts of adequate quality or who may be unwilling to continue to supplyproducts to us.***

 

We do not manufacture thebrand name or exclusive label products we sell, and instead purchase ourproducts from manufacturers and fillers. We depend on a limited number ofmanufacturers for a significant percentage of the products we sell. For fiscalyear 2009, our three largest suppliers were Procter & Gamble Co., orP&G, the Professional Products Division of L’Oreal USA S/D, Inc., orL’Oreal, and John Paul Mitchell Systems. BSG’s largest supplier, L’Oreal,represented approximately 15.1% of BSG’s total net sales in the fiscal year2009.

 

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In addition, since wepurchase products from many manufacturers and fillers on an at-will basis undercontracts which can generally be terminated without cause upon 90 daysnotice or less, or which expire without express rights of renewal, suchmanufacturers and fillers could discontinue sales to us at any time or upon theexpiration of the distribution period. Some of our contracts with manufacturersmay be terminated by such manufacturers if we fail to meet specified minimumpurchase requirements. In such cases, we do not have contractual assurances ofcontinued supply, pricing or access to new products and vendors may change theterms upon which they sell. Infrequently, a supplier will seek to terminate adistribution relationship through legal action. For example, in 2009 L’Orealfiled an action which threatens a long-term distribution agreement withArmstrong McCall. Armstrong McCall is vigorously defending its rights under theagreement. For these and other reasons, we may not be able to acquire desiredmerchandise in sufficient quantities or on acceptable terms in the future.

 

Changes in Sally BeautySupply and BSG’s relationships with suppliers occur often, and could positivelyor negatively impact the net sales and operating profits of both businesssegments.  Some of our suppliers may seekto decrease their reliance on distribution intermediaries, including full-service/exclusiveand open-line distributors like BSG and Sally Beauty Supply, by promoting theirown distribution channels, as discussed above. These suppliers may offeradvantages, such as discounted prices, when their products are purchased fromdistribution channels they control. If our access to supplier-provided productswere to be diminished relative to our competitors or we were not able topurchase products at the same prices as our competitors, our business could bematerially and adversely affected. Also, consolidation among suppliers mayincrease their negotiating leverage, thereby providing them with competitiveadvantages over us that may increase our costs and reduce our revenues,adversely affecting our business, financial condition and results ofoperations.

 

As discussed above,L’Oreal is entering into direct competition with BSG, and there can be noassurance that there will not be further revenue losses over time at BSG, dueto potential losses of additional L’Oreal related products as well as from theincreased competition from L’Oreal-affiliated distribution networks. Forexample, L’Oreal could attempt to terminate our contracts to carry certain oftheir products in BSG stores, which brought in revenues of approximately $99.1million in U.S. sales for the fiscal year 2009 and have expiration dates at theend of 2012. Therefore, there can be no assurance that the impact of thesedevelopments will not adversely impact revenue to a greater degree than wecurrently expect or that our efforts to mitigate the impact of thesedevelopments will be successful. If the impact of these developments is greaterthan we expect or our efforts to mitigate the impact of these developments arenot successful, this could have a material adverse effect on our business,financial condition or results of operations.

 

Although we plan tomitigate the negative effects resulting from unfavorable changes in ourrelationships with suppliers, such as L’Oreal, there can be no assurance thatour efforts will partially or completely offset the loss of these distributionrights.

 

***Any significant interruption in the supply of beauty supplyproducts by manufacturers of our products could disrupt our ability to delivermerchandise to our stores and customers in a timely manner, which could have amaterial adverse effect on our business, financial condition and results ofoperations.***

 

Manufacturers and fillersof beauty supply products are subject to certain risks that could adverselyimpact their ability to provide us with their products on a timely basis,including industrial accidents, environmental events, strikes and other labordisputes, union organizing activity, disruptions in logistics or informationsystems, loss or impairment of key manufacturing sites, product qualitycontrol, safety, and licensing requirements and other regulatory issues, aswell as natural disasters and other external factors over which neither theynor we have control. In addition, our operating results depend to some extenton the orderly operation of our receiving and distribution processes, whichdepend on manufacturers’ adherence to shipping schedules and our effectivemanagement of our distribution facilities and capacity.

 

If a materialinterruption of supply occurs, or a significant supplier ceases to supply us ormaterially decreases its supply to us, we may not be able to acquire productswith similar quality and consumer brand name recognition as the products wecurrently sell or to acquire such products in sufficient quantities to meet ourcustomers’ demands or on favorable terms to our business, any of which couldadversely impact our business, financial condition and results of operations.

 

***If products sold by us are found to be defective in labelingor 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 toliability in excess of our products liability insurance coverage andmanufacturer indemnities.***

 

We do not control theproduction process for the brand name and exclusive label products we sell. Wemay not be able to identify a defect in a product we purchase from amanufacturer or filler before we offer such product for resale.  In many cases, we rely on representations ofmanufacturers and fillers about the products we purchase for resale regardingwhether such products have been manufactured in accordance with applicablegovernmental regulations. Our sale of certain products exposes us topotential product liability claims, recalls or other regulatory or enforcementactions initiated by federal, state or foreign regulatory authorities orthrough 

 

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private causes of action.Such claims, recalls or actions could be based on allegations that, among otherthings, the products sold by us are misbranded, contain contaminants, provideinadequate instructions regarding their use or misuse, or include inadequate warningsconcerning flammability or interactions with other substances. Claims againstus could also arise as a result of the misuse by purchasers of such products oras a result of their use in a manner different than the intended use. We may berequired to pay for losses or injuries actually or allegedly caused by theproducts we sell and to recall any product we sell that is alleged to be or isfound to be defective.

 

Any actual defects orallegations of defects in products sold by us could result in adverse publicityand harm our credibility, which could adversely affect our business, financialcondition and results of operations. Although we may have indemnificationrights against the manufacturers of many of the products we distribute andrights as an “additional insured” under the manufacturer’s insurance policies,it is not certain that any individual manufacturer or insurer will befinancially solvent and capable of making payment to any party suffering lossor injury caused by products sold by us. Further, some types of actions andpenalties, including many actions or penalties imposed by governmental agenciesand punitive damages awards, may not be remediable through reliance onindemnity agreements or insurance. Furthermore, potential product liabilityclaims may exceed the amount of indemnity or insurance coverage or be excludedunder the terms of an indemnity agreement or insurance policy. If we are forcedto pay to satisfy such claims, it could have an adverse effect on our business,financial condition and results of operations.

 

***We could be adversely affected if we do not comply with lawsand regulations or if we become subject to additional or more stringent lawsand regulations.***

 

We are subject to anumber of U.S. federal, state and local laws and regulations, as well as thelaws and regulations applicable in each other marketplace in which we dobusiness. These laws and regulations govern the composition, packaging,labeling and safety of the products we sell, the methods we use to sell these products,and the methods we use to import these products. Non-compliance with applicablelaws and regulations of governmental authorities, including the FDA and similarauthorities in other jurisdictions, by us or the manufacturers of the productssold by us could result in fines, product recalls and enforcement actions orotherwise restrict our ability to market certain products, which couldadversely affect our business, financial condition and results of operations.The laws and regulations applicable to us or manufacturers of the products soldby us may become more stringent. Continued legal compliance could require thereview and possible reformulation or relabeling of certain products, as well asthe possible removal of some products from the marketplace altogether. Legalcompliance could also lead to considerably higher internal regulatory costs.Manufacturers may try to recover some or all of any increased costs ofcompliance by increasing the prices at which we purchase products, and we maynot be able to recover some or all of such increased cost in our own prices toour customers. We are also subject to state and local laws and regulations thataffect our franchisor-franchisee relationships. Increased compliance costs andthe loss of sales of certain products due to more stringent or new laws andregulations could adversely affect our business, financial condition andresults of operations.

 

Laws and regulationsimpact our business in many areas that have no direct relation to the productswe sell. For example, as a reporting company, we are subject to a number oflaws and regulations related to the issuance and sale of our securities.Another area of intense regulation is that of the relationships we have withour employees, including compliance with many different wage/hour andnondiscrimination related regulatory schemes. Violation of any of the laws orregulations governing our business and/or the assertion of individual orclass-wide claims could have an adverse effect on our business, financial conditionand results of operations.

 

***Product diversion could have an adverse impact on ourrevenues.***

 

The majority of theproducts that BSG sells, including those sold by our Armstrong McCallfranchisees, are meant to be used exclusively by salons and individual salonprofessionals or are meant to be sold exclusively by the purchasers, such assalons, to their retail consumers. However, despite our efforts to preventdiversion, incidents of product diversion occur, whereby our products are soldby these purchasers (and possibly by other bulk purchasers such as franchisees)to wholesalers and general merchandise retailers. These retailers, in turn,sell such products to consumers. The diverted product may be old, tainted ordamaged and sold through unapproved outlets, all of which could diminish thevalue of the particular brand. Diversion may result in lower net sales for BSGshould consumers choose to purchase diverted products from retailers ratherthan purchasing from our customers, or choose other products altogether becauseof the perceived loss of brand prestige.

 

Product diversion isgenerally prohibited under our supplier contracts, and we may be under acontractual obligation to stop selling to salons, salon professionals and otherbulk purchasers who engage in product diversion. If we fail to stop diversionas required (including any known diversion of products sold through ourArmstrong McCall franchisees or by BSG), our supplier contracts could beadversely affected or even terminated. In addition, our investigation andenforcement of our anti-diversion policies may result in reduced sales to ourcustomer base, thereby decreasing our revenues and profitability.

 

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***BSG’s financial results are affected by the financialresults of BSG’s franchised-based business (Armstrong McCall).***

 

BSG receives revenue fromproducts purchased by Armstrong McCall franchisees. Accordingly, a portion ofBSG’s financial results is to an extent dependent upon the operational andfinancial success of these franchisees, including their implementation of BSG’sstrategic plans. If sales trends or economic conditions worsen for ArmstrongMcCall’s franchisees, their financial results may worsen. Additionally, ifArmstrong McCall franchisees fail to renew their franchise agreements, or ifArmstrong McCall fails to meet its obligations under its franchise agreementsor vendor distribution agreements or is required to restructure its franchiseagreements in connection with such renewal, it could result in decreasedrevenues for BSG or legal issues with our franchisees or vendors.

 

***Our new Internet-based business may be unsuccessful or maycause internal channel conflict.***

 

We offer many of ourbeauty products for sale through Sally Beauty’s website (*www.sallybeauty.com*). Therefore, weencounter risks and difficulties frequently experienced in internet-based businesses,including risks related to our ability to attract and retain customers on acost-effective basis and our ability to operate, support, expand and developour internet operations, Sally Beauty’s websites, and our software and otherrelated operational systems. In addition, our internet-based business mayconflict with the success of our Sally Beauty Supply stores. For example, ourinternet-based business may compete with our Sally Beauty Supply stores for thesame customers. Although we believe that our participation in bothinternet-based and store-based sales is a distinct advantage for us due tosynergies and the potential for new customers, customer conflicts between theseofferings could create issues that have the potential to adversely affect ourresults of operations. For example, such conflict could cause some of ourcurrent or potential internet customers to consider competing distributors ofbeauty products. These events could have an adverse effect on our business,financial condition and results of operations.

 

***We may not be able to successfully identify acquisitioncandidates or successfully complete desirable acquisitions.***

 

In the past severalyears, we have completed several significant acquisitions. We intend tocontinue to pursue additional acquisitions in the future. Our business has inthe past actively reviewed acquisition prospects that would complement ourexisting lines of business, increase the size and geographic scope of ouroperations or otherwise offer growth and operating efficiency opportunities.There can be no assurance that we will be able to identify suitable acquisitioncandidates.

 

If suitable candidatesare identified, sufficient funds may not be available to make suchacquisitions. We compete against many other companies, some of which are largerand have greater financial and other resources than we do. Increasedcompetition for acquisition candidates could result in fewer acquisitionopportunities and higher acquisition prices. In addition, we are highlyleveraged and the agreements governing our indebtedness contain limits on ourability to incur additional debt to pay for acquisitions.  Additionally, the amount of equity that SallyBeauty can issue to make acquisitions or raise additional capital will beseverely limited. We may be unable to finance acquisitions that would increaseour growth or improve our financial and competitive position. To the extentthat debt financing is available to finance acquisitions, our net indebtednesscould be increased as a result of any acquisitions.

 

***If we acquire any businesses in the future, they could provedifficult to integrate, disrupt our business or have an adverse effect on ourresults of operations.***

 

Any acquisitions that wedo make may be difficult to integrate profitably into our business and mayentail numerous risks, including:

 

·          difficulties in assimilating acquired operations,stores or products, including the loss of key employees from acquiredbusinesses;

 

·          difficulties and costs associated with integrating andevaluating the distribution or information systems and/or internal controlsystems of acquired businesses;

 

·          expenses associated with the amortization ofidentifiable intangible assets;

 

·          problems retaining key technical, operational andadministrative personnel;

 

·          diversion of management’s attention from our corebusiness, including loss of management focus on marketplace developments;

 

·          complying with foreign regulatory requirements,including multi-jurisdictional competition rules;

 

·          enforcement of intellectual property rights in someforeign countries;

 

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·          adverse effects on existing business relationshipswith suppliers and customers, including the potential loss of suppliers of theacquired businesses;

 

·          operating inefficiencies and negative impact onprofitability;

 

·          entering geographic areas or channels in which we havelimited or no prior experience; and

 

·          those related to general economic and politicalconditions, including legal and other barriers to cross-border investment ingeneral, or by U.S. companies in particular.

 

In addition, during theacquisition process, we may fail or be unable to discover some of theliabilities of businesses that we acquire. These liabilities may result from aprior owner’s noncompliance with applicable laws and regulations. Acquiredbusinesses may also not perform as we expect or we may not be able to obtainthe financial improvements in acquired businesses that we expect.

 

***If we are unable to profitably open and operate new stores,our business, financial condition and results of operations may be adverselyaffected.***

 

Our future growthstrategy depends in part on our ability to open and profitably operate newstores in existing and additional geographic areas. The capital requirements toopen a U.S.-based Sally Beauty Supply or BSG store, excluding inventory,average approximately $70,000 and $80,000, respectively, with the capitalrequirements for international stores costing less or substantially moredepending upon the marketplace. Despite these relatively-low per-store openingcosts, we may not be able to open all of the new stores we plan to open and anynew stores we open may not be profitable, either of which could have a materialadverse impact on our financial condition or results of operations. There areseveral factors that could affect our ability to open and profitably operatenew stores, including:

 

·          the inability to identify and acquire suitable sitesor to negotiate acceptable leases for such sites;

 

·          proximity to existing stores that may reduce newstores’ sales or the sales of existing stores;

 

·          difficulties in adapting our distribution and other operationaland management systems to an expanded network of stores;

 

·          the potential inability to obtain adequate financingto fund expansion because of our high leverage and limitations on SallyBeauty’s ability to issue equity under our credit agreements, among otherthings;

 

·          increased (and sometimes unanticipated) costsassociated with opening stores in new international locations;

 

·          difficulties in obtaining any needed governmental andthird-party consents, permits and licenses needed to operate additional stores;and

 

·          potential limitations on capital expenditures whichmay be included in financing documents that we enter into.

 

***A further downturn in the economy may affect consumerpurchases of discretionary items such as beauty products and salon services,which could have a material adverse effect on our business, financial conditionand results of operations.***

 

Our results of operationsmay be materially affected by conditions in the global capital markets and theeconomy generally, both in the U.S. and elsewhere around the world. Thestress experienced by global capital markets that began in the second half of2007 continued and substantially increased during 2008 and 2009.  Concerns over inflation, energy costs,geopolitical issues, the availability and cost of credit, theU.S. mortgage market and a declining real estate market in theU.S. have contributed to increased volatility and diminished expectationsfor the economy.  We appeal to a widedemographic consumer profile and offer a broad selection of beauty productssold directly to retail consumers and salons and salon professionals. Continueduncertainty in the economy could adversely impact consumer purchases ofdiscretionary items such as beauty products and salon services, particularly inour electrical products category and in our professional sales business.Factors that could affect consumers’ willingness to make such discretionarypurchases include general business conditions, levels of employment, interestrates and tax rates, the availability of consumer credit, and consumerconfidence in future economic conditions. In the event of a further orprotracted economic downturn, consumer spending habits could be adverselyaffected, and we could experience lower than expected net sales. In addition, a reduction intraffic to, or the closing of, the other destination retailers in the shoppingareas where our stores are located could significantly reduce our sales andleave us with unsold inventory.  Theeconomic downturn could also adversely affect our vendors which we rely on tosupply the 

 

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products that we sell.  The occurrence of any of these events could have a material adverse effect onour business, financial condition and results of operations.

 

***We are not certain that our ongoing cost control plans willcontinue to be successful.***

 

Our business strategydepends, to a substantial degree, on continuing to control or reduce operatingexpenses. In furtherance of this strategy, we have engaged in ongoingactivities to reduce or control costs. These activities include maximizing theefficiency of our structure, including through the implementation of a capitalspending program in fiscal years 2007 through 2009 to consolidate BSGwarehouses and reduce administrative expenses related to BSG’s distributionnetwork optimization program. We cannot assure you that our efforts will resultin the increased profitability, cost savings or other benefits that we expect,which could have a material adverse effect on our business, financial conditionand results of operations.

 

***If we are unable to protect our intellectual propertyrights, specifically our trademarks and service marks, our ability to competecould be negatively impacted.***

 

The success of ourbusiness depends to a certain extent upon the value associated with ourintellectual property rights. We own certain trademark and service mark rightsused in connection with our business including, but not limited to, “Sally,”“Sally Beauty,” “Sally Beauty Supply,” “Sally Pro Preferred Card,” “SallyBeauty Club Card,” “BSG,” “CosmoProf,” “Proclub,” “Armstrong McCall,” “ion,”“Beyond the Zone,” and “Salon Services.” We protect our intellectual propertyrights through a variety of methods, including, but not limited to, applyingand obtaining trademarks in the U.S., Canada and other countries throughout theworld in which our business operates. We also rely on trade secret laws, inaddition to confidentiality agreements with vendors, employees, consultants,and others who have access to our proprietary information. While we intend tovigorously protect our trademarks against infringement, we may not besuccessful in doing so. In addition, the laws of certain foreign countries maynot protect our intellectual property rights to the same extent as the laws ofthe U.S. The costs required to protect our intellectual property rights andtrademarks are expected to continue to be substantial.

 

***Our ability to conduct business in internationalmarketplaces may be affected by legal, regulatory and economic risks.***

 

Our ability to capitalizeon growth in new international marketplaces and to grow or maintain our currentlevel of operations in our existing international marketplaces is subject torisks associated with our international operations. These risks include:unexpected changes in regulatory requirements; trade barriers to someinternational marketplaces; economic and foreign currency fluctuations inspecific marketplaces; potential difficulties in enforcing contracts,protecting assets, including intellectual property, and collecting receivablesin certain foreign jurisdictions; potential tax liabilities associated withrepatriating funds from foreign operations; and difficulties and costs ofstaffing, managing and accounting for foreign operations.

 

***We may be adversely affected by any disruption in ourinformation technology systems.***

 

Our operations aredependent upon our information technology systems, which encompass all of ourmajor business functions. We rely upon such information technology systems tomanage and replenish inventory, to fill and ship customer orders on a timelybasis, to coordinate our sales activities across all of our products andservices and to coordinate our administrative activities. A substantialdisruption in our information technology systems for any prolonged time period(arising from, for example, system capacity limits from unexpected increases inour volume of business, outages or delays in our service) could result indelays in receiving inventory and supplies or filling customer orders andadversely affect our customer service and relationships. Our systems might bedamaged or interrupted by natural or man-made events or by computer viruses,physical or electronic break-ins and similar disruptions affecting the globalinternet. There can be no assurance that such delays, problems, or costs willnot have a material adverse effect on our financial condition and results ofoperations.

 

As our operations grow inboth size and scope, we will continuously need to improve and upgrade oursystems and infrastructure while maintaining the reliability and integrity ofour systems and infrastructure. The expansion of our systems and infrastructurewill require us to commit substantial financial, operational and technicalresources before the volume of our business increases, with no assurance thatthe volume of business will increase. In particular, we have upgraded ourfinancial reporting system and are currently upgrading our distribution systemsand implementing a new point-of-sale system for tracking customer sales. Theseand any other required upgrades to our systems and information technology, ornew technology, now and in the future, will require that our management andresources be diverted from our core business to assist in compliance with thoserequirements. Since our systems are proprietary, our options are limited inseeking third-party help with the operation and upgrade of these systems. Therecan be no assurance that the time and resources our management will need todevote to these upgrades, service outages or delays due to the installation ofany new or upgraded technology (and customer issues therewith), or the impacton the reliability of our data from any new or upgraded technology will nothave a material adverse effect on our business, financial condition or resultsof operations.

 

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***The occurrence of one or more natural disasters or acts ofterrorism could adversely affect our operations and financial performance.***

 

The occurrence of one ormore natural disasters or acts of terrorism could result in physical damage toone or more of our properties, the temporary closure of stores or distributioncenters, the temporary lack of an adequate work force in an area, the temporaryor long-term disruption in the supply of products (or a substantial increase inthe cost of those products) from some domestic or foreign suppliers, thetemporary disruption in the delivery of goods to our distribution centers (or asubstantial increase in the cost of those deliveries), the temporary reductionin the availability of products in our stores, and/or the temporary reductionin visits to stores by customers.

 

If one or more naturaldisasters or acts of terrorism were to impact our business, we could, amongother things, incur significantly higher costs and longer lead times associatedwith distributing products to stores. Furthermore, insurance costs associatedwith our business may rise significantly in the event of a large scale naturaldisaster or act of terrorism.

 

***The accounting and other management systems, controls andresources of our ultimate parent, Sally Beauty, may not be adequately preparedto meet the financial reporting and other requirements to which Sally Beautyand we are subject.***

 

Sally Beauty, as anindependent, publicly-traded company, is directly subject to reporting andother obligations under the Exchange Act. In addition, as a result of theregistered exchange offers for our senior notes and our senior subordinatednotes completed in July of 2007, which we collectively refer to as theNotes, we are also directly subject to reporting and other obligations underthe Exchange Act. These reporting and other obligations place significantdemands on the management and administrative and operational resources, includingaccounting resources, of Sally Beauty, us and our subsidiaries. As reportingcompanies, Sally Beauty and we incur significant legal, accounting, and otherexpenses. Under the SEC rules and regulations, as well as those of the NewYork Stock Exchange, Sally Beauty and we have significant compliance costs.

 

In addition, as reportingcompanies Sally Beauty and we are subject to rules adopted by the SECpursuant to Section 404 of the Sarbanes-Oxley Act of 2002, which requireus to include in our Annual Report on Form 10-K our management’s reporton, and assessment of, the effectiveness of our internal controls overfinancial reporting. Furthermore, our independent registered public accountingfirm must attest to and report on the effectiveness of such internal controls.If we fail to properly assess and/or achieve and maintain the adequacy of ourinternal controls, there is a risk that we will not comply with all of therequirements imposed by Section 404. Moreover, effective internal controlsare necessary to help prevent financial fraud. Any of these possible outcomescould result in an adverse reaction in the financial marketplace due to a lossof investor confidence in the reliability of our financial statements, whichultimately could harm our business and could negatively impact the market priceof our debt instruments.

 

To comply with theserequirements, Sally Beauty, we and our subsidiaries are continuously upgradingour systems, including information technology, and implementing additionalfinancial and management controls, reporting systems and procedures. These andany other required upgrades to our financial and management controls, reportingsystems, information technology and procedures under the financial reportingrequirements and other rules that apply to reporting companies, now and inthe future, will require that our management and resources be diverted from ourcore business to assist in compliance with those requirements. There can be noassurance that the time and resources our management will need to devote tothese upgrades, service outages or delays due to the installation of upgrades,or the impact on the reliability of our data from these upgrades will not havea material adverse effect on our business, financial condition or results ofoperations.

 

***We are a holding company with no operations of our own, andwe depend on our subsidiaries for cash.***

 

We are a holding companyand do not have any material assets or operations other than ownership ofequity interests of our subsidiaries. Our operations are conducted almostentirely through our subsidiaries, and our ability to generate cash to meet ourobligations or to pay dividends to Sally Beauty is highly dependent on theearnings of, and receipt of funds from, our subsidiaries through dividends orintercompany loans. The ability of our subsidiaries to generate sufficient cashflow from operations to allow us and them to make scheduled payments on ourobligations will depend on their future financial performance, which will beaffected by a range of economic, competitive and business factors, many ofwhich are outside of our control. We cannot assure you that the cash flow andearnings of our operating subsidiaries will be adequate for our subsidiaries toservice our and their debt obligations.  If our subsidiaries do not generate sufficient cash flow from operationsto satisfy their obligations we may have to undertake alternative financingplans, such as refinancing or restructuring our and their debt, selling assets,reducing or delaying capital investments or seeking to raise additionalcapital. We cannot assure you that any such alternative refinancing would bepossible, that any assets could be sold, or, if sold, of the timing of thesales and the amount of proceeds realized from those sales, that additionalfinancing could be obtained on acceptable terms, if at all, or that additionalfinancing would be permitted under the terms of our various debt instrumentsthen in effect. Our inability to generate sufficient cash flow to satisfy ourobligations, or to refinance our obligations on commercially reasonable terms,would have an adverse effect on our business, financial condition and resultsof operations.

 

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Furthermore, we and oursubsidiaries may incur substantial additional indebtedness in the future thatmay severely restrict or prohibit our subsidiaries from making distributions,paying dividends or making loans to us.

 

**RisksRelating to Our Substantial Indebtedness**

 

***We have substantial debt and may incur substantialadditional debt, which could adversely affect our financial health, our abilityto obtain financing in the future and our ability to react to changes in ourbusiness.***

 

In connection with theSeparation Transactions, together with certain of our subsidiaries, we incurredapproximately $1,850.0 million in debt. As of September 30, 2009, wehad an aggregate principal amount of approximately $1,677.5 million, includingcapital lease obligations, of outstanding debt, and a total debt to equityratio of -2.61:1.00.

 

Our substantial debtcould have important consequences to you. For example, it could:

 

·          make it more difficult for us to satisfy ourobligations to our lenders, resulting in possible defaults on and accelerationof such indebtedness;

 

·          limit our ability to obtain additional financing orraise even a small amount of equity capital for working capital, capitalexpenditures, acquisitions, debt service requirements or general corporatepurposes;

 

·          require us to dedicate a substantial portion of ourcash flow from operations to the payment of principal and interest on ourindebtedness, thereby reducing the availability of such cash flows to fundworking capital, capital expenditures and other general corporate purposes;

 

·          restrict the ability of our subsidiaries to paydividends or otherwise transfer assets to us, which could limit our ability tomake required payments on our debt facilities;

 

·          increase our vulnerability to general adverse economicand industry conditions, including interest rate fluctuations because a portionof our borrowings are at variable rates of interest, including borrowings underour senior secured term loan facilities and our asset-backed senior securedloan facility, which we refer to collectively as the senior secured creditfacilities;

 

·          place us at a competitive disadvantage compared to ourcompetitors with proportionately less debt or comparable debt at more favorableinterest rates and that, as a result, may be better positioned to withstandeconomic downturns;

 

·          limit our ability to refinance indebtedness or causethe associated costs of such refinancing to increase; and

 

·          limit our flexibility to adjust to changing marketconditions and ability to withstand competitive pressures, or prevent us fromcarrying out capital spending that is necessary or important to our growthstrategy and efforts to improve operating margins or our business.

 

Any of the foregoingimpacts of our substantial indebtedness could have a material adverse effect onour business, financial condition and results of operations.

 

***Despite our current indebtedness levels, we and oursubsidiaries may be able to incur substantially more debt, including secureddebt, which could further exacerbate the risks associated with our substantialindebtedness.***

 

We and our subsidiariesmay incur substantial additional indebtedness in the future. The terms of theinstruments governing our indebtedness do not fully prohibit us or oursubsidiaries from doing so. As of September 30, 2009, our senior creditfacilities provided us commitments for additional borrowings of up toapproximately $325.6 million under the asset-backed senior secured loan(or ABL) facility, subject to borrowing base limitations. If new debt is addedto our current debt levels, the related risks that we face would increase, andwe may not be able to meet all our debt obligations. In addition, theagreements governing our senior credit facilities as well as the indenturesgoverning our senior notes and senior subordinated notes, which we refer tocollectively as the Notes, do not prevent us from incurring obligations that donot constitute indebtedness.

 

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***The agreements and instruments governing our debt containrestrictions and limitations that could significantly impact our ability tooperate our business.***

 

The senior secured termloan facilities, which we refer to as the Term Loans, contain covenants that,among other things, restrict our and our subsidiaries’ ability to:

 

·    dispose of assets;

 

·    incur additional indebtedness (includingguarantees of additional indebtedness);

 

·    pay dividends, repurchase stock or makeother distributions;

 

·    make voluntary prepayments on the Notesor make amendments to the terms thereof;

 

·    prepay certain other debt or amendspecific debt agreements;

 

·    create liens on assets;

 

·    make investments (including jointventures);

 

·    make acquisitions of all of the businessor assets of, or stock representing beneficial ownership of, any person;

 

·    engage in mergers, consolidations orsales of all or substantially all of our assets;

 

·    engage in certain transactions withaffiliates; and

 

·    permit restrictions on our subsidiaries’ability to pay dividends to us.

 

The ABL facility containscovenants that, among other things, restrict our and our subsidiaries’ abilityto:

 

·          change our line of business;

 

·          engage in certain mergers, consolidations andtransfers of all or substantially all of our assets;

 

·          make certain dividends, stock repurchases and otherdistributions;

 

·          make acquisitions of all of the business or assets of,or stock representing beneficial ownership of, any person;

 

·          dispose of certain assets;

 

·          make voluntary prepayments on the Notes or makeamendments to the terms thereof;

 

·          prepay certain other debt or amend specific debtagreements;

 

·          change our or our direct parent’s fiscal year; and

 

·          create or incur negative pledges.

 

The Term Loans contain arequirement that we not exceed a maximum ratio of net senior secured debt toconsolidated EBITDA (as those terms are defined in the relevant creditagreement). In addition, if we fail to maintain a specified minimum level ofborrowing capacity under the ABL facility, we will then be obligated tomaintain a specified fixed-charge coverage ratio. Our ability to comply withthese covenants in future periods will depend on our ongoing financial andoperating performance, which in turn will be subject to economic conditions andto financial, market and competitive factors, many of which are beyond ourcontrol. Our ability to comply with these covenants in future periods will alsodepend substantially on the pricing of our products, our success atimplementing cost reduction initiatives and our ability to successfullyimplement our overall business strategy.

 

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The indentures governingthe Notes also contain restrictive covenants that, among other things, limitSally Beauty’s and our ability and the ability of our restricted subsidiariesto:

 

·          dispose of assets;

 

·          incur additional indebtedness (including guarantees ofadditional indebtedness);

 

·          pay dividends, repurchase stock or make otherdistributions;

 

·          prepay subordinated debt;

 

·          create liens on assets (which, in the case of thesenior subordinated notes, would be limited in applicability to liens securing *pari passu* or subordinated indebtedness);

 

·          make investments (including joint ventures);

 

·          engage in mergers, consolidations or sales of all orsubstantially all of our assets;

 

·          engage in certain transactions with affiliates; and

 

·          permit restrictions on our subsidiaries’ ability topay dividends to us.

 

The restrictions in theindentures governing our Notes and the terms of our senior credit facilitiesmay prevent us from taking actions that we believe would be in the bestinterest of our business and may make it difficult for us to successfullyexecute our business strategy or effectively compete with companies that arenot similarly restricted. We may also incur future debt obligations that mightsubject us to additional restrictive covenants that could affect our financialand operational flexibility. We cannot assure you that we will be grantedwaivers or amendments to these agreements if for any reason we are unable tocomply with these agreements or that we will be able to refinance our debt onterms acceptable to us or at all.

 

Our ability to complywith the covenants and restrictions contained in the senior credit facilitiesand the indentures for the Notes may be affected by economic, financial andindustry conditions beyond our control. The breach of any of these covenants orrestrictions could result in a default under either the senior creditfacilities or the indentures that would permit the applicable lenders or noteholders, as the case may be, to declare all amounts outstanding thereunder tobe due and payable, together with accrued and unpaid interest. If we are unableto repay debt, lenders having secured obligations, such as the lenders underthe senior credit facilities, could proceed against the collateral securing thedebt. In any such case, we may be unable to borrow under the senior creditfacilities and may not be able to repay the amounts due under the Term Loansand the Notes. This could have serious consequences to our financial conditionand results of operations and could cause us to become bankrupt or insolvent.

 

***Our ability to generate the significant amount of cashneeded to service all of our debt and our ability to refinance all or a portionof our indebtedness or obtain additional financing depend on many factorsbeyond our control.***

 

Our ability to makescheduled payments on, or to refinance our obligations under, our debt willdepend on our financial and operating performance, which, in turn, will besubject to prevailing economic and competitive conditions and to the financialand business factors, many of which may be beyond our control, described under“—Risks Relating to Our Business” above.

 

If our cash flow andcapital resources are insufficient to fund our debt service obligations, we maybe forced to reduce or delay capital expenditures, sell assets, seek to obtainadditional equity capital or restructure our debt. In the future, our cash flowand capital resources may not be sufficient for payments of interest on andprincipal of our debt, and such alternative measures may not be successful andmay not permit us to meet our scheduled debt service obligations.

 

We cannot assure you thatwe will be able to refinance any of our indebtedness or obtain additionalfinancing, particularly because of our high levels of debt and the debtincurrence restrictions imposed by the agreements governing our debt, as wellas prevailing market conditions. In the absence of such operating results andresources, we could face substantial liquidity problems and might be requiredto dispose of material assets or operations to meet our debt service and otherobligations. Our senior credit facilities and the indentures governing theNotes restrict our ability to dispose of assets and use the proceeds from anysuch dispositions. We cannot assure you we will be able to consummate thosesales, or if we do, what the timing of the sales will be or whether the proceedsthat we realize will be adequate to meet debt service obligations when due.

 

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***Youshould not expect Sally Capital to participate in making payments on the Notes.***

 

Sally Capital is ourwholly-owned subsidiary, which acts as a co-issuer solely to facilitate theissuance of the Notes.  Sally Capitaldoes not have any operations or assets of any kind and did not receive anyproceeds from the issuance of the Notes. You should not expect Sally Capital to participate in servicing any ofour obligations in the Notes.

 

***An increase in interest rates would increase the cost ofservicing our debt and could reduce our profitability.***

 

A significant portion ofour outstanding debt, including under our senior credit facilities, bearsinterest at variable rates. As a result, an increase in interest rates, whetherbecause of an increase in market interest rates or a decrease in ourcreditworthiness, would increase the cost of servicing our debt and couldmaterially reduce our profitability and cash flows. The impact of such anincrease would be more significant for us than it would be for some othercompanies because of our substantial debt.

 

***The impairment ofother financial institutions could adversely affect us.***

 

We have exposure to different counterparties withregard to our interest rate swaps. These transactions expose us to credit riskin the event of default of our counterparty. We also have exposure to financialinstitutions used as depositories of our corporate cash balances.  If our counterparties and financialinstitutions become impaired or insolvent, this could have serious consequencesto our financial condition and results of operations.

 

**RisksRelating to Our Separation from Alberto-Culver and Relating to Sally Beauty’sLargest Stockholder**

 

***We rely upon Alberto-Culver for the accuracy of certainhistorical services and information.***

 

We sometimes rely uponAlberto-Culver for the accuracy and/or completeness of certain historicalservices and information provided to us when we were part of that company. Forexample, as the successor entity to Alberto-Culver after the separation, werely upon the prior-year federal income tax returns of Alberto-Culver andaccounting methods established therein, for certain calculations that affectour U.S. federal income tax liability. We also rely upon Alberto-Culver forhistorical information related to our insurance programs and other benefits.There can be no assurance that our reliance upon the accuracy or completenessof historical information or services previously provided by them will not havean adverse impact on our business, financial condition and results ofoperations.

 

***If the share distribution of Alberto-Culver common stock inthe transactions separating us from Alberto-Culver did not constitute atax-free distribution under Section 355 of the Internal Revenue Code of1986, as amended, or the Code, or if Sally Beauty became liable for additionaltaxes owed by Alberto-Culver, then we may be responsible for payment ofsignificant U.S. federal income taxes.***

 

The following discussiondescribes the risk that the share distribution of Alberto-Culver common stockin the Separation Transactions may have triggered significant tax liabilitiesfor Sally Beauty, our ultimate parent company, which could result in a materialadverse effect on us.  Since we have beena member of Sally Beauty’s consolidated group of companies for U.S. federalincome tax purposes and certain state tax purposes during the taxable year ofthe share distribution of Alberto-Culver common stock, we (and other SallyBeauty subsidiaries that were also members of such group) will generally beliable for the income tax liability of Sally Beauty’s consolidated group ofcompanies for that tax year.  Therefore,if Sally Beauty incurred significant income tax liability as a result of theshare distribution of Alberto-Culver common stock and was unable to pay thesetaxes, we could be liable for such taxes to the taxing authorities. Inconnection with the share distribution of Alberto-Culver common stock in theseparation, Sally Beauty received (i) a private letter ruling from theInternal Revenue Service, or IRS, and (ii) an opinion of Sidley AustinLLP, counsel to Alberto-Culver, in each case, to the effect that thetransactions qualify as a reorganization under Section 368(a)(1)(D) ofthe Code and a distribution eligible for non-recognition under Sections 355(a) and361(c) of the Code. The private letter ruling and the opinion of counselwere based, in part, on assumptions and representations as to factual mattersmade by, among others, Alberto-Culver, Sally Beauty and representatives of Mrs. CarolL. Bernick, Mr. Leonard H. Lavin and certain of Sally Beauty’s otherstockholders to whom we refer as the Lavin family stockholders, as requested bythe IRS or counsel, which, if incorrect, could jeopardize the conclusionsreached by the IRS and counsel. The private letter ruling also did not addresscertain material legal issues that could affect its conclusions, and reservedthe right of the IRS to raise such issues upon a subsequent audit. Opinions ofcounsel neither bind the IRS or any court, nor preclude the IRS from adopting acontrary position.

 

If the Alberto-Culvershare distribution were not to qualify as a tax-free distribution under Section 355of the Code, Sally Beauty would recognize taxable gain equal to the excess ofthe fair market value of the Alberto-Culver common stock distributed to itsstockholders over Sally Beauty’s tax basis in such Alberto-Culver common stock.

 

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Even if theAlberto-Culver share distribution otherwise qualified as a tax-freedistribution under Section 355 of the Code, it would result in significantU.S. federal income tax liabilities to Sally Beauty if there was an acquisitionof its stock or the stock of Alberto-Culver as part of a plan or series ofrelated transactions that includes the Alberto-Culver share distribution andthat results in an acquisition of 50% or more of Alberto-Culver’s or SallyBeauty’s outstanding common stock.

 

In the event that SallyBeauty recognizes a taxable gain in connection with the Alberto-Culver sharedistribution (either (i) because the Alberto-Culver share distribution didnot qualify as a tax-free distribution under Section 355 of the Code or (ii) becauseof an acquisition by CDR Investors of 50% or more of Alberto-Culver or SallyBeauty’s outstanding common stock as part of a plan or series of relatedtransactions that includes the Alberto-Culver share distribution), the taxablegain recognized by Sally Beauty would result in significant U.S. federal incometax liabilities to Sally Beauty. Under the Code, Sally Beauty would be jointlyand severally liable for these taxes for which Alberto-Culver may be requiredto indemnify Sally Beauty under their tax allocation agreement, and there canbe no assurance that Alberto-Culver would be able to fulfill its obligationsunder the tax allocation agreement if Alberto-Culver was determined to beresponsible for these taxes thereunder.

 

The process fordetermining whether a prohibited change in control has occurred under the rules iscomplex, inherently factual and subject to interpretation of the facts andcircumstances of a particular case. If Alberto-Culver did not carefully monitorits, or Sally Beauty did not carefully monitor its, compliance with theserules, this might inadvertently cause or permit a prohibited change in theownership of Sally Beauty or of Alberto-Culver to occur, thereby triggeringAlberto-Culver’s or Sally Beauty’s respective obligations to indemnify the otherpursuant to the tax allocation agreement, which would have a material adverseeffect on Sally Beauty and us.

 

If any of the aboveevents occur, Sally Beauty will be jointly and severally liable for thesetaxes, and there can be no assurance that Alberto-Culver would be able tofulfill its indemnification obligations to Sally Beauty under the taxallocation agreement if Alberto-Culver was determined to be responsible forthese taxes thereunder. In addition, these mutual indemnity obligations coulddiscourage or prevent a third party from making a proposal to acquire SallyBeauty.

 

***Actions taken by the Lavin family stockholders or by the CDRinvestors could adversely affect the tax-free nature of the share distributionof Alberto-Culver common stock in connection with the transactions separatingus from Alberto-Culver.***

 

Sales and/or acquisitionsby the Lavin family stockholders of Sally Beauty’s common stock orAlberto-Culver’s common stock may adversely affect the tax-free nature of theshare distribution of Alberto-Culver’s common stock in the SeparationTransactions. First, with certain exceptions, sales by the Lavin familystockholders of Sally Beauty’s common stock or Alberto-Culver’s common stock atany time after the Separation Transactions might be considered evidence thatthe share distribution was used principally as a device for the distribution ofearnings and profits, particularly if the selling stockholder was found to havean intent to effect such sale at the time of the share distribution. If the IRSsuccessfully asserted that the share distribution was used principally as sucha device, the share distribution would not qualify as a tax-free distribution,and thus would be taxable to Sally Beauty. Second, with certain exceptions, ifany of the Lavin family stockholders had sold an amount of Sally Beauty’scommon stock that it received in connection with the Separation Transactions(or acquired additional shares of Sally Beauty’s common stock) within the twoyear period following completion of the Alberto-Culver share distribution, andthat amount of stock, if added to the common stock that was acquired by CDRInvestors were to equal or exceed 50% of Sally Beauty’s outstanding commonstock, as determined under the Code and applicable Treasury regulations, adeemed acquisition of control of Sally Beauty in connection with theAlberto-Culver share distribution would be presumed. If this presumption werenot rebutted, Sally Beauty would be subject to significant U.S. federal incometax liabilities, which, if not reimbursed by Alberto-Culver, would have amaterial adverse effect on Sally Beauty and us.

 

***The voting power of Sally Beauty’s largest stockholder maydiscourage third party acquisitions of Sally Beauty at a premium.***

 

CDRS, Sally Beauty’s largeststockholder, owns approximately 47.4% of its outstanding common stock on anundiluted basis. Pursuant to the stockholders agreement entered into by SallyBeauty, the CDR Investors and the Lavin family stockholders, which we refer toas the Stockholders Agreement, CDRS has designated five of Sally Beauty’seleven directors, as well as the Chairman of Sally Beauty’s Board of Directors,and CDRS’ rights to nominate certain numbers of directors will continue so longas it owns specified percentages of Sally Beauty’s common stock. The CDRInvestors’ ownership of Sally Beauty’s common stock may have the effect ofdiscouraging offers to acquire control of Sally Beauty and may preclude holdersof its common stock from receiving any premium above market price for theirshares that may otherwise be offered in connection with any attempt to acquirecontrol of Sally Beauty.

 

***The interests of Sally Beauty’s largest stockholder maydiffer from the interests of other holders of its common stock.***

 

CDRS, Sally Beauty’s largest stockholder, ownsapproximately 47.4% of its outstanding common stock on an undiluted basis.Pursuant to the Stockholders Agreement, CDRS has designated five of Sally’sBeauty’s eleven directors and CDRS’ rights to nominate certain numbers of directorswill continue so long as it owns specified percentages of Sally Beauty’s commonstock, as discussed 

 

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above. In addition, the current Chairman of SallyBeauty’s Board of Directors is affiliated with CDRS. The interests of CDRS maydiffer from those of other holders of Sally Beauty’s common stock in materialrespects. For example, CDRS may have an interest in pursuing acquisitions,divestitures, financings, re-financings, stockholder dividends or othertransactions that, in its judgment, could enhance its overall equity portfolioor the short-term value of their investment in Sally Beauty, even though suchtransactions might involve substantial risks to holders of Sally Beauty’scommon stock. The manager of CDRS’ ultimate parent is in the business of makinginvestments in companies, and may from time to time in the future, acquireinterests in businesses that directly or indirectly compete with certainportions of our business or are suppliers of us or our customers. Additionally,CDRS may determine that the disposition of some or all of its interests inSally Beauty would be beneficial to it at a time when such disposition could bedetrimental to Sally Beauty, us and/or to the other holders of Sally Beauty’scommon stock. Moreover, the ownership by CDRS of approximately 47.4% of SallyBeauty’s outstanding common stock may have the effect of discouraging offers toacquire control of Sally Beauty and may preclude holders of Sally Beauty’scommon stock from receiving any premium above market price for their sharesthat may otherwise be offered in connection with any attempt to acquire controlof Sally Beauty.

 

# **ITEM 1B. UNRESOLVED STAFFCOMMENTS**

 

Not applicable.

 

# **ITEM 2.PROPERTIES**

 

Substantially all of our store and warehouse locationsare leased and our corporate headquarters and four warehouses/distributioncenters are owned. The average store lease is for a term of five years withcustomary renewal options. The following table provides the number of stores inthe U.S. and globally, as of September 30, 2009:

 
| ** **                             | ** ** | **Sally  Beauty Supply** | ** ** | **Beauty  Systems Group** | ** ** |
|----------------------------------------|------------|--------------------------|------------|---------------------------|------------|
| **Location**                           | ** ** | **Company-Operated**     | ** ** | **Franchise**             | ** ** | **Company-Operated** | ** ** | **Franchise** | ** ** |
| United States  (excluding Puerto Rico) |       | 2,357                    |       | —                    |       | 739 |   | 133 |   |
| Puerto Rico                            |       | 34                       |       | —                    |       | 3 |   | — |   |
| International:                         |       |                     |       |                      |       |   |   |   |   |
| United Kingdom                         |       | 254                      |       | 6                         |       | — |   | — |   |
| Belgium                                |       | 28                       |       | 3                         |       | — |   | — |   |
| Canada                                 |       | 45                       |       | —                    |       | 87 |   | — |   |
| Chile                                  |       | 16                       |       | —                    |       | — |   | — |   |
| France                                 |       | 19                       |       | 2                         |       | — |   | — |   |
| Germany                                |       | 30                       |       | —                    |       | — |   | — |   |
| Japan                                  |       | 19                       |       | —                    |       | — |   | — |   |
| Mexico                                 |       | 85                       |       | —                    |       | — |   | 29 |   |
| Other                                  |       | 11                       |       | 14                        |       | — |   | — |   |
| Total International                    |       | 507                      |       | 25                        |       | 87 |   | 29 |   |
| Total Store Count                      |       | 2,898                    |       | 25                        |       | 829 |   | 162 |   |

 

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The following table provides locations for oursignificant offices and warehouses and corporate headquarters, as of September 30,2009:

 
| **Location**                    | ** ** | **Type of  Facility**  | ** ** | **Sq. Feet** | ** ** | **Business  Segment** | ** ** |
|---------------------------------|------------|------------------------|------------|--------------|------------|-----------------------|------------|
| Company-Owned Properties:       |       |                   |       |         |       |                  |       |
| Columbus, Ohio                  |       | Warehouse              |       | 246,000      |       | (1                    | )          |   |
| Denton, Texas                   |       | Corporate Headquarters |       | N/A          |       | (1                    | )(2)       |   |
| Denton, Texas                   |       | Warehouse              |       | 45,000       |       | (2                    | )          |   |
| Jacksonville, Florida           |       | Warehouse              |       | 237,000      |       | (1                    | )          |   |
| Reno, Nevada                    |       | Warehouse              |       | 253,000      |       | (1                    | )          |   |
| Leased Properties:              |       |                   |       |         |       |                  |       |   |
| Benicia, California             |       | Office, Warehouse      |       | 187,000      |       | (2                    | )          |   |
| Clackamas, Oregon               |       | Warehouse              |       | 104,000      |       | (2                    | )          |   |
| Fresno, California              |       | Warehouse              |       | 200,000      |       | (2                    | )          |   |
| Greenville, Ohio                |       | Office, Warehouse      |       | 246,000      |       | (2                    | )          |   |
| Pottsville,  Pennsylvania       |       | Office, Warehouse      |       | 160,000      |       | (2                    | )(3)       |   |
| Spartanburg, South  Carolina    |       | Warehouse              |       | 100,000      |       | (2                    | )          |   |
| Blackburn, Lancashire,  England |       | Warehouse              |       | 107,000      |       | (1                    | )          |   |
| Calgary, Alberta,  Canada       |       | Warehouse              |       | 62,000       |       | (2                    | )          |   |
| Gent, Belgium                   |       | Office, Warehouse      |       | 83,000       |       | (1                    | )          |   |
| Mississauga, Ontario,  Canada   |       | Office, Warehouse      |       | 60,000       |       | (2                    | )          |   |
| Guadalupe, Nuevo Leon,  Mexico  |       | Warehouse              |       | 40,000       |       | (1                    | )          |   |
| Thornliebank, Scotland          |       | Office, Warehouse      |       | 94,000       |       | (1                    | )          |   |

 

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(1)           Sally BeautySupply

(2)           BSG

(3)           Property relatedto the September 30, 2009 acquisition of Schoeneman

 

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# **ITEM 3.LEGAL PROCEEDINGS**

 

There were no material legal proceedings pendingagainst us or our subsidiaries as of September 30, 2009. We are involvedin various claims and lawsuits incidental to the conduct of our business in theordinary course. We carry insurance coverage in such amounts in excess of ourself-insured retention as we believe to be reasonable under the circumstancesand that may or may not cover any or all of our liabilities in respect ofclaims and lawsuits. We do not believe that the ultimate resolution of thesematters will have a material adverse impact on our consolidated financialposition, cash flows or results of operations.

 

We are subject to a number of U.S., federal, state andlocal laws and regulations, as well as the laws and regulations applicable ineach other marketplace in which we do business. These laws and regulationsgovern, among other things, the composition, packaging, labeling and safety ofthe products we sell, the methods we use to sell these products and the methodswe use to import these products.  Webelieve that we are in material compliance with such laws and regulations,although no assurance can be provided that this will remain true going forward.

 

On February 25, 2008,Sally Beauty disclosed in a Current Report on Form 8-K that on February 21,2008, L’Oreal filed a lawsuit in the Superior Court of the State of Californiain and for the County of San Diego — Central Division naming, among others, SDHair, Ltd. and Hair of Nevada, LLC (collectively, “SD Hair”), franchisees ofour subsidiary Armstrong McCall division (“AMLP”) of our BSG business unit, asdefendants.  The suit alleged, among other things, that SD Hair breachedits franchise agreement with AMLP by diverting (selling) Matrix brandedproducts to unauthorized buyers, and that L’Oreal is entitled to make claimsagainst SD Hair under the franchise agreement as a third-party beneficiary ofthat agreement.  On March 24, 2008, SD Hair filed a cross-complaintin the same case naming AMLP and BSG as cross-defendants, seeking, among otherthings, i) declaratory relief from BSG and AMLP in the form of a judicialfinding that SD Hair is not inbreach of its franchise agreement and that L’Oreal has no rights as athird-party beneficiary to SD Hair’s franchise agreement, and ii) injunctiverelief in the form of a judicial order compelling AMLP and BSG to takeappropriate legal action against L’Oreal to enforce SD Hair’s claimed rightsunder AMLP’s Matrix distribution agreement.  We have answered thecross-complaint and the lawsuit has been set for a jury trial in June of2010.

 

On July 30, 2009,Sally Beauty disclosed in a Current Report on Form 8-K that L’Oreal fileda Second Amended Complaint in connection with the previously disclosed lawsuitdescribed above.  The Second AmendedComplaint alleges, among other things, that AMLP, certain ofits employees and others were involved in selling Matrix brandedproducts to unauthorized buyers and that certain of its employees (and others)engaged in improper business transactions for personal benefit during 2005through 2007.  L’Oreal seeks moneydamages, certain injunctive relief and a declaration that L’Oreal is entitledto terminate the 1981 Matrix Distributor Agreement now in effect betweenL’Oreal and AMLP.  None of the employeesinvolved in the allegations are executive officers of Sally Beauty or theCompany.  Substantially all of theseallegations were made known by L’Oreal to the Company prior to the filingof the Second Amended Complaint. L’Oreal also provided the Company withdocuments allegedly supporting the allegations.

 

## **As aresult of these allegations made by L’Oreal, many of which areincorporated into the Second Amended Complaint, the Audit Committee of theBoard of Directors of Sally Beauty engaged independent special counsel toinvestigate whether certain employees engaged in improper business transactionsfor personal benefit.  After extensivereview, the Audit Committee and independent special counsel found insufficientevidence to support a conclusion that Sally Beauty or Company employees enteredinto improper transactions for personal benefit.**

##  

On September 8,2009, AMLP and BSG filed a cross-complaint against L’Oreal.  In thecross-complaint, AMLP and BSG allege that L’Oreal does not have a genuineinterest in stopping diversion, and that L’Oreal’s anti-diversion policies havebeen discriminatorily applied to AMLP and BSG.  AMLP further allegesthat L’Oreal is using diversion as a pretext to attempt to terminate theDistributor Agreement with AMLP.

 

# **ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Omitted pursuant to General Instruction I to Form 10-K

 

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###### **PART II**

###### ** **

# **ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES**

# ** **

## **There is no established public trading market for the member units ofSally Holdings LLC.  Sally InvestmentHoldings LLC, a wholly-owned subsidiary of Sally Beauty Holdings, Inc.,owns all of the member units of Sally Holdings LLC.**

##  

Wedo not expect to pay dividends in the foreseeable future.  The agreements governing our indebtednessrestrict our ability to pay dividends.  Please see “Risk Factors—Risks Relating to OurSubstantial Indebtedness” and Note 11 of the “Notes to Consolidated FinancialStatements” in “Item 8—Financial Statements and Supplementary Data.”

 

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# **ITEM 6.SELECTED FINANCIAL DATA**

 

The following table presents selected financial dataof Sally Holdings LLC and its consolidated subsidiaries for the year ended September 30,2009, 2008 and 2007, and of Sally Holdings, Inc. and its consolidatedsubsidiaries for the years ended September 30, 2006 and 2005 (dollars inthousands). Sally Holdings, Inc. was a wholly owned subsidiary ofAlberto-Culver until November 16, 2006 when it was converted to a Delawarelimited liability company, was renamed “Sally Holdings LLC,” and became anindirect wholly owned subsidiary of Sally Beauty in connection with theSeparation Transactions. Sally Beauty was formed on June 16, 2006 inconnection with the Separation Transactions.

 
| ** **                                                                                   | ** ** | **Year Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                   | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Results of operations information:**                                                       |       |                              |       |   |   |   |   |   |   |   |   |
| Net  sales                                                                                   |       | $                                 | 2,636,600  |   | $ | 2,648,191 |   | $ | 2,513,772 |   | $ | 2,373,100 |   | $ | 2,254,307 |   |
| Cost  of products sold and distribution expenses                                             |       | 1,393,283                         |       | 1,413,597 |   | 1,360,025 |   | 1,286,329 |   | 1,227,307 |   |
| Gross  profit                                                                                |       | 1,243,317                         |       | 1,234,594 |   | 1,153,747 |   | 1,086,771 |   | 1,027,000 |   |
| Selling,  general and administrative expenses(a)                                             |       | 891,056                           |       | 895,632 |   | 850,159 |   | 798,211 |   | 768,847 |   |
| Depreciation  and amortization                                                               |       | 47,066                            |       | 48,533 |   | 42,605 |   | 38,032 |   | 33,906 |   |
| Sales-based  service fee charged by Alberto-Culver                                           |       | —                            |       | — |   | 3,779 |   | 28,852 |   | 27,615 |   |
| Non-cash  charge related to Alberto-Culver’s conversion to one class of common stock(b) |       | —                            |       | — |   | — |   | — |   | 4,051 |   |
| Transaction  expenses(c)                                                                     |       | —                            |       | — |   | 21,502 |   | 41,475 |   | — |   |
| Operating  earnings                                                                          |       | 305,195                           |       | 290,429 |   | 235,702 |   | 180,201 |   | 192,581 |   |
| Interest  expense, net(d)                                                                    |       | 132,043                           |       | 158,897 |   | 145,972 |   | 92 |   | 2,966 |   |
| Earnings  before provision for income taxes                                                  |       | 173,152                           |       | 131,532 |   | 89,730 |   | 180,109 |   | 189,615 |   |
| Provision  for income taxes                                                                  |       | 68,424                            |       | 48,664 |   | 41,169 |   | 69,916 |   | 73,154 |   |
| Net  earnings                                                                                |       | $                                 | 104,728    |   | $ | 82,868 |   | $ | 48,561 |   | $ | 110,193 |   | $ | 116,461 |   |
|                                                                                         |       |                              |       |   |   |   |   |   |   |   |   |
| **Operating data:**                                                                          |       |                              |       |   |   |   |   |   |   |   |   |
| Number  of retail stores (end of period):                                                    |       |                              |       |   |   |   |   |   |   |   |   |
| Sally  Beauty Supply                                                                         |       | 2,923                             |       | 2,844 |   | 2,694 |   | 2,511 |   | 2,419 |   |
| Beauty  Systems Group                                                                        |       | 991                               |       | 929 |   | 874 |   | 828 |   | 822 |   |
| Total                                                                                        |       | 3,914                             |       | 3,773 |   | 3,568 |   | 3,339 |   | 3,241 |   |
| Professional  distributor salesconsultants (end of period)                                   |       | 1,022                             |       | 984 |   | 1,002 |   | 1,163 |   | 1,244 |   |
| Same  store sales growth(e):                                                                 |       |                              |       |   |   |   |   |   |   |   |   |
| Sally  Beauty Supply                                                                         |       | 2.1                               | %          | 1.2 | % | 2.7 | % | 2.4 | % | 2.4 | % |
| Beauty  Systems Group                                                                        |       | 1.0                               | %          | 6.9 | % | 10.1 | % | 4.1 | % | (0.6 | )% |
| Consolidated                                                                                 |       | 1.8                               | %          | 2.6 | % | 4.5 | % | 2.8 | % | 1.8 | % |
| **Financial condition information (at period end):**                                         |       |                              |       |   |   |   |   |   |   |   |   |
| Working  capital                                                                             |       | $                                 | 315,943    |   | $ | 348,560 |   | $ | 341,891 |   | $ | 479,107 |   | $ | 382,482 |   |
| Cash,  cash equivalents and short-terminvestments                                            |       | 54,447                            |       | 99,788 |   | 38,272 |   | 107,571 |   | 38,612 |   |
| Property,  plant and equipment, net                                                          |       | 151,249                           |       | 156,260 |   | 154,068 |   | 142,735 |   | 149,354 |   |
| Total  assets                                                                                |       | 1,490,510                         |       | 1,525,658 |   | 1,404,261 |   | 1,338,841 |   | 1,225,507 |   |
| Long-term  debt, excluding current maturities(d)                                             |       | 1,653,013                         |       | 1,724,684 |   | 1,758,594 |   | 621 |   | 18,828 |   |
| Member’s  (deficit)/stockholder’s equity                                           |       | $                                 | (642,139   | ) | $ | (722,280 | ) | $ | (780,317 | ) | $ | 1,005,967 |   | $ | 900,296 |   |

 

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| (a)    | We  adopted the revised accounting standards for stock-based compensation  (currently the Financial Accounting Standards Board (“FASB”) Accounting  Standards Codification (“ASC”) 718), using the modified  prospective method, effective October 1, 2005. Fiscal years 2009, 2008,  2007 and 2006 include share-based compensation of $8.0 million, $9.6 million,  $12.3 million and $5.2 million, respectively. |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (b)    | During  fiscal year 2004, Alberto-Culver’s board of directors approved the conversion  of all then-outstanding Alberto-Culver shares of Class A common stock  into Class B common stock. Fiscal year 2005 includes non-cash charges  related to this conversion.                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (c)    | Fiscal  year 2007 includes one-time charges associated with the Separation  Transactions. Fiscal year 2006 includes one-time charges associated with the  termination of a merger agreement. Please see Note 3 of the “Notes to  Consolidated Financial Statements” in “Item 8—Financial Statements and Supplementary  Data” for additional information about the Separation Transactions.                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (d)    | After  November 16, 2006, long-term debt primarily represents debt incurred in  connection with the Separation Transactions and interest                                                                                                                                                                                                                                                                                               |

 

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|   | expense  related mainly to such indebtedness. Prior to the Separation Transactions,  interest expense was attributable to notes payable to then-affiliates.                                                                                                                                      |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                             |
| (e)    | Same  stores are defined as company-operated stores that have been open for at  least 14 months as of the last day of a month. Our internet  site has generated sales for at least 14 months and, accordingly,  internet-based sales are included in same store sales for fiscal year 2009. |

 

Prior to November 16, 2006, Alberto-Culver ownedall shares of issued and outstanding common stock of Sally Holdings, Inc.Since November, 16, 2006, all members units of Sally Holdings LLC have beenowned by Sally Investment, a wholly-owned subsidiary of Sally Beauty.

 

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# **ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

The following section discusses management’s view ofthe financial condition, results of operations and cash flows of SallyHoldings, a wholly-owned subsidiary of Sally Investment Holdings LLC, or SallyInvestment, a wholly-owned subsidiary of Sally Beauty Holdings, Inc. orSally Beauty, and its consolidated subsidiaries, as of and for the fiscal yearsended September 30, 2009 and 2008. All of the interests of Sally Holdingsare beneficially owned by Sally Investment, and all of the interests of SallyInvestment are beneficially owned by Sally Beauty. This section should be readin conjunction with the audited consolidated financial statements of SallyHoldings and, for periods prior to the Separation Transactions, the auditedconsolidated financial statements of Sally Holdings, Inc., and the relatednotes included elsewhere in this Annual Report. This Management’s Discussionand Analysis of Financial Condition and Results of Operations section containsforward-looking statements. Please see “Cautionary Notice RegardingForward-Looking Statements” for a discussion of the uncertainties, risks andassumptions associated with these forward-looking statements that could causeresults to differ materially from those reflected in such forward-lookingstatements.

 

## **Highlightsof the Fiscal Year Ended September 30, 2009**

 

·                  Our sales from company-operated storesthat have been open for at least 14 months as of the last day of a month,which we refer to as same store sales, increased 1.8% for the fiscal year endedSeptember 30, 2009;

·                  Our consolidated net sales for the fiscalyear ended September 30, 2009 decreased $11.6 million, or 0.4%, to$2,636.6 million compared to the fiscal year ended September 30, 2008. Netsales for the fiscal year ended September 30, 2009 reflect approximately$86.0 million, or 3.2%, in negative impact from changes in foreign currencyexchange rates;

·                  Our consolidated gross profit for thefiscal year ended September 30, 2009 increased $8.7 million, or 0.7%, to$1,243.3 million compared to $1,234.6 million for the fiscal year ended September 30,2008. As a percentage of net sales, gross profit increased to 47.2% for thefiscal year ended September 30, 2009, compared to 46.6% for the fiscalyear ended September 30, 2008;

·                  Our consolidated operating earnings forthe fiscal year ended September 30, 2009 increased $14.8 million, or 5.1%,to $305.2 million compared to $290.4 million for the fiscal year ended September 30,2008. As a percentage of net sales, operating earnings were 11.6% for thefiscal year ended September 30, 2009, compared to 11.0% for the fiscalyear ended September 30, 2008;

·                  During fiscal year 2009, we completed our2-year program to consolidate warehouses and reduce administrative expenses ofthe BSG segment.  For the fiscal yearended September 30, 2009, unallocated corporate expenses decreased 6.3% to$62.3 million compared to $66.5 million for the fiscal year ended September 30,2008;

·                  Sally Beauty Supply and BSG opened or acquired 79 and 62 net new stores,respectively, during the fiscal year ended September 30, 2009;

·                  On September 30, 2009, we acquiredSchoeneman Beauty Supply, Inc., a 43-store beauty supply chain located inthe central northeast United States, for approximately $71.0 million, subjectto certain adjustments, and on September 4, 2009, we acquired InterSalon,a leading distributor of premier beauty supply products with 16 stores locatedin Chile for approximately $6.4 million; and

·                  During fiscal year 2009, we madescheduled payments of $6.1 million, a mandatory repayment in the amount of$16.7 million and optional repayments in the aggregate amount of $45.0 millionon our senior term loan facilities, and repurchased $5.0 million in par valueof our 10.5% senior subordinated notes (due in November 2016).

 

**Overview**

 

##### ***Description of Business***

 

We are the largest distributor of professional beautysupplies in the U.S. based on store count. We operate primarily through twobusiness units, Sally Beauty Supply and BSG. Through Sally Beauty Supply andBSG (which operates stores under the CosmoProf service mark), we operated amulti-channel platform of 3,727 stores and supplied 187 franchised stores inNorth America, South America and selected European countries, as of September 30,2009. Within BSG, we also have one of the largest networks of professionaldistributor sales consultants in North America, with approximately 1,022professional distributor sales consultants who sell directly to salons andsalon professionals.  We provide ourcustomers with a wide variety of leading third-party branded andexclusive-label professional beauty supplies, including hair care products,styling appliances, skin and nail care products and other beauty items. SallyBeauty Supply stores target retail consumers and salon professionals, while BSGexclusively targets salons and salon professionals. For the year ended September 30,2009, our consolidated net sales and operating earnings were$2,636.6 million and $305.2 million, respectively.

 

We believe Sally Beauty Supply is the largestopen-line distributor of professional beauty supplies in the U.S. based onstore count. As of September 30, 2009, Sally Beauty Supply operated 2,898company-operated retail stores, 2,357 of which are located in the U.S.

 

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(with the remainder in the United Kingdom and certainother countries in Europe, Canada, Puerto Rico, Mexico and Chile) and supplied25 franchised stores (all outside the U.S.). Sally Beauty Supply stores in theU.S. range in size between 1,200 square feet and 1,700 square feetand are primarily located in strip shopping centers. The product selection inSally Beauty Supply stores ranges between 4,000 and 8,000 SKUs of beautyproducts and includes products for hair care, skin and nail care, beautysundries and electrical appliances targeting retail consumers and salonprofessionals. Sally Beauty Supply stores carry leading third-party brands suchas Clairol, Revlon and Conair, as well as an extensive selection ofexclusive-label merchandise. For the year ended September 30, 2009, SallyBeauty Supply’s net sales and segment operating earnings were$1,695.7 million and $283.9 million, respectively, representing 64.3%and 75.6% of our consolidated net sales and operating profit before unallocatedcorporate expenses, respectively.

 

We believe BSG is the largest full-service distributorof professional beauty supplies in the U.S. As of September 30, 2009,BSG had 829 company-operated stores, supplied 162 franchised stores and had asales force of approximately 1,022 professional distributor sales consultantsselling exclusively to salons and salon professionals in substantially allstates in the U.S. and in portions of Canada, Puerto Rico, Mexico andcertain European countries. BSG stores average approximately2,700 square feet and are primarily located in secondary strip shoppingcenters. Through BSG’s large store base and sales force, BSG is able to accessa significant portion of the highly fragmented U.S. salon channel. Theproduct selection in BSG stores, ranging between 4,000 and 9,000 SKUs of beautyproducts, includes hair care and color, skin and nail care, beauty sundries andelectrical appliances; targeting salons and salon professionals. BSG carriesleading professional beauty product brands, intended for use in salons and forresale by the salon to consumers. Certain BSG products are sold under exclusivedistribution agreements with suppliers, whereby BSG is designated as the soledistributor for a product line within certain geographic territories. For theyear ended September 30, 2009, BSG’s net sales and segment operatingprofit were $940.9 million and $91.6 million, respectively,representing 35.7% and 24.4% of our consolidated net sales and operating profitbefore unallocated corporate expenses, respectively.

 

##### ***Industry and Business Trends***

##### *** ***

We operate within the large and growingU.S. professional beauty supply industry. Potential growth in the industryis expected to be driven by increases in hair color, hair loss prevention andhair styling products, offset by lower sales of electrical products duringperiods of prolonged economic slowdown. We believe the following key industryand business trends and characteristics will influence our business and ourfinancial results going forward:

 

·             *High level of marketplace fragmentation.*  The U.S. salon channel ishighly fragmented with over 250,000 salons. Given the fragmented andsmall-scale nature of the salon industry, we believe that salon operators willcontinue to depend on full-service/exclusive distributors and open-linechannels for a majority of their beauty supply purchases.

 

·             *Growth in booth renting and frequent stocking needs.*  Salon professionals primarilyrely on just-in-time inventory due to capital constraints and a lack of warehouseand shelf space at salons.  In addition,booth renters, who comprise a significant percentage of total U.S. salonprofessionals, are often responsible for purchasing their own supplies.Historically, booth renters have significantly increased as a percentage oftotal salon professionals, and we expect this trend to continue. Given theirsmaller individual purchases and relative lack of financial resources, boothrenters are likely to be dependent on frequent trips to professional beautysupply stores, like BSG and Sally Beauty Supply.  These factors continue to drive demand forconveniently located professional beauty supply stores.

 

·             *Increasing use of exclusive-label products.*  We offer a broad range of privatelabel and control label products, which we generally refer to collectively as“exclusive-label products.” Private label products are brands for which we ownor license the trademark and, in some instances, the formula. Control labelproducts are brands that are owned by the manufacturer, but for which we havebeen granted sole distribution rights. Generally, our exclusive-label productshave higher gross margins than the leading third-party branded products, and webelieve this area offers potential growth. Please see “Risk Factors - We dependupon manufacturers who may be unable to provide products of adequate quality orwho may be unwilling to continue to supply products to us.”

 

·             *Favorabledemographic and consumer trends.*  The aging baby-boomerpopulation is expected to drive future growth in professional beauty supplysales through an increase in the usage of hair color and hair loss products.Additionally, continuously changing fashion-related trends that drive new hairstyles are expected to result in continued demand for hair styling products.Changes in consumer tastes and fashion trends can have an impact on ourfinancial performance. Our continued success depends in large part on ourability to anticipate, gauge and react in a timely and effective manner tochanges in consumer spending patterns and preferences for beauty products. Wecontinuously adapt our marketing and merchandising initiatives for Sally BeautySupply in an effort to expand our market reach or to respond to changingconsumer preferences.  If we are unableto anticipate and respond to trends in the marketplace for beauty products andchanging consumer demands, our business could suffer.

 

·             *Internationalgrowth strategies. *A key element of our growth strategy dependson our ability to capitalize on growth in the international marketplace and togrow our current level of non-U.S. operations. For example, on September 4, 2009, we acquired DistribuidoraIntersalon Limitada, a leading distributor of premier beauty supply productswith 16 stores located in

 

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Chile and, in May of 2008, weacquired Pro-Duo, N.V., a cash and carry retailer of both professional andretail hair products with 40 stores located mainly in Belgium, France andSpain. In addition, in February of 2007, we acquired Chapelton 21 Limited,a private company based in Scotland with almost 100 stores located in theUnited Kingdom, Ireland, Germany, and Spain. These acquisitions furthered our expansion plans in Europe, asignificant part of Sally Beauty Supply’s international growth initiative.  We intend to continue to identify andevaluate non-U.S. acquisition targets. Our ability to grow our non-U.S. operations, integrate our new non-U.S.acquisitions and successfully pursue additional non-U.S. acquisitions may beaffected by business, legal, regulatory and economic risks. Please see “RiskFactors - We may not be able to successfully identify acquisition candidatesand complete desirable acquisitions,” “If we acquire any businesses in thefuture they could prove difficult to integrate, disrupt our business or have anadverse effect on our results of operations” and “Our ability to conductbusiness in international marketplaces may be affected by legal, regulatory andeconomic risks.”

 

·             *Continuing consolidation.*  There is continuing consolidation among professional beautyproduct distributors and professional beauty product manufacturers. We plan tocontinue to examine ways in which we can benefit from this trend, includingreviewing opportunities to shift business from competitive distributors to theBSG network as well as seeking opportunistic, value-added acquisitions whichcomplement our long-term growth strategy. We believe that suppliers areincreasingly likely to focus on larger distributors and retailers with abroader scale and retail footprint. We also believe that we are well positionedto capitalize on this trend as well as participate in the ongoing consolidationat the distributor/retail level. However, changes often occur in ourrelationships with suppliers that may materially affect the net sales andoperating earnings of our business segments. Consolidation among supplierscould exacerbate the effects of these relationship changes and could increasepricing pressures. For example, as we announced in December 2006, ourlargest supplier, L’Oreal, moved a material amount of revenue out of the BSGnationwide distribution network and into competitive regional distributionnetworks. More recently, L’Oreal acquired distributors competing with BSG inthe southeastern and west coast of the U.S. and a supplier that does notcurrently do business with BSG.  As a result, L’Oreal directly competeswith BSG in certain geographic areas. If L’Oreal acquired other distributors orsuppliers that conduct significant business with BSG, we could lose relatedrevenue. There can be no assurance that there will not be further loss ofrevenue over time by BSG (including within its franchise-based business) due topotential losses of additional products (both from L’Oreal and from othersuppliers) as well as from the increased competition from L’Oreal-affiliateddistribution networks. Please see “Risk Factors - The beauty productsdistribution industry is highly competitive and is consolidating” and “Wedepend upon manufacturers who may be unable to provide products of adequatequality or who may be unwilling to continue to supply products to us.”

 

·             *Relationshipswith suppliers.*   Sally Beauty Supply/BSG and theirsuppliers are dependent on each other for the distribution of beauty products. We do not manufacture the brand name orexclusive-label products we sell. We purchase our products from a limitednumber of manufacturers. As is typical in distribution businesses, theserelationships are subject to change from time to time (including the expansionor loss of distribution rights in various geographies and the addition or lossof product lines). Since we purchase products from many manufacturers on anat-will basis, under contracts which can generally be terminated without causeupon 90 days’ notice or less or which expire without express rights ofrenewal, such manufacturers could discontinue sales to us at any time or uponthe expiration of the distribution period. Some of our contracts withmanufacturers may be terminated by such manufacturers if we fail to meetspecified minimum purchase requirements. In such cases, we do not havecontractual assurances of continued supply, pricing or access to new productsand vendors may change the terms upon which they sell. Infrequently, a supplierwill seek to terminate a distribution relationship through legal action.Changes in our relationships with suppliers occur often and could positively ornegatively impact our net sales and operating profits. Although we focus ondeveloping new revenue and cost management initiatives to mitigate the negativeeffects resulting from unfavorable changes in our supplier relationships, therecan be no assurance that our efforts will continue to completely offset theloss of these or other distribution rights. Please see “Risk Factors*—* We depend upon manufacturers who may beunable to provide products of adequate quality or who may be unwilling tocontinue to supply products to us.”

 

We expect to continue to expand our product line offerings and to gainadditional distribution rights over time through either further negotiationwith suppliers or by strategic acquisitions of existing distributors.  Although we are focused on developing newrevenue and cost management initiatives, there can be no assurance that ourefforts will partially or completely offset any potential loss of distributionrights in the future. Please see “Risk Factors—We depend upon manufacturers whomay be unable to provide products of adequate quality or who may be unwillingto continue to supply products to us.”

 

·             *Highlevel of competition.  *Sally Beauty Supply competes with other domestic and internationalbeauty product wholesale and retail outlets, including local and regionalopen-line beauty supply stores, professional-only beauty supply stores, salons,mass merchandisers, drug stores and supermarkets, as well as sellers on theinternet and salons retailing hair care items. BSG competes with other domesticand international beauty product wholesale and retail suppliers andmanufacturers selling professional beauty products directly to salons andindividual salon professionals. We also face competition from authorized andunauthorized retailers and internet sites offering professional salon-onlyproducts. The increasing availability of unauthorized professional salonproducts in large format retail stores such as drug stores, grocery stores andothers could also have a negative impact on our business. Please see “Risk Factors — The beautyproducts distribution industry is highly competitive and is consolidating.”

 

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·             *Economicconditions.*  We appeal to a wide demographic consumerprofile and offer a broad selection of beauty products sold directly to retailconsumers and salons and salon professionals. Historically, these factors haveprovided us with reduced exposure to downturns in economic conditions in thecountries in which we operate.  However,a continued downturn in the economy, especially for an extended period of time,could adversely impact consumer demand of discretionary items such as beautyproducts and salon services, particularly affecting our electrical productscategory and our full-service sales business. In addition, higher freight costsresulting from increases in the cost of fuel, especially for an extended periodof time, may impact our expenses at levels that we cannot pass through to ourcustomers.  These factors could have amaterial adverse effect on our business, financial condition and results of operations.Please see “Risk Factors — A further downturn in the economy may affect consumer purchases ofdiscretionary items such as beauty products and salon services, which couldhave a material adverse effect on our business, financial condition and resultsof operations.”

 

·             *Controllingexpenses*.  Another important aspect of our business isour ability to control costs, especially in our BSG business segment, byright-sizing the business and maximizing the efficiency of our structure. Inlate fiscal year 2007, we began implementing an approximately $22.0 millioncapital spending program to consolidate warehouses and reduce administrativeexpenses related to BSG’s distribution network optimization program. Weestimate that this program resulted in cost savings of approximately $8.0million in the fiscal year 2009 and believe that annualized cost savings**fromthis program could approximate $10.0 million beginning in fiscal year2010. Please see “Risk Factors — We are not certain that our ongoing costcontrol plans will continue to be successful.”

 

·             *Openingnew stores*.  Our future growth strategy depends in part onour ability to open and profitably operate new stores in existing andadditional geographic areas. The capital requirements to open a U.S. - basedSally Beauty Supply or BSG store, excluding inventory, average approximately$70,000 and $80,000, respectively, with the capital requirements forinternational stores costing less or substantially more depending upon themarketplace. However, in response to economic conditions and to allowflexibility to capitalize on potential real estate revaluations in keylocations, we have slowed our new store openings. We may not be able to openall of the new stores we plan to open and any new stores we open may not beprofitable, any of which could have a material adverse impact on our financialcondition or results of operations. Please see “Risk Factors — If we are unableto profitably open and operate new stores, our business, financial conditionand results of operations may be adversely affected.”

 

·             *Changes toour information technology systems*. As our operations grow in both size and scope, we will continuously needto improve and upgrade our information systems and infrastructure whilemaintaining the reliability and integrity of our systems and infrastructure.  The expansion of our systems andinfrastructure will require us to commit substantial financial, operational andtechnical resources in advance of any increase in the volume of our business,with no assurance that the volume of business will increase.  Forexample, in fiscal year 2009, we began upgrading our distribution informationsystems (in connection with our capital spending program to consolidatewarehouses, as discussed above), upgrading our AS400 iSeries servers andinstalling Hyperion software to enhance our financial reporting system. Theseand any other required upgrades to our information systems and informationtechnology (or new technology), now or in the future, will require that ourmanagement and resources be diverted from our core business to assist incompletion of these projects. There can be no assurance that the time andresources our management will need to devote to these upgrades, service outagesor delays due to the installation of any new or upgraded technology (andcustomer issues therewith), or the impact on the reliability of our data fromany new or upgraded technology will not have a material adverse effect on ourfinancial reporting, business, financial condition or results of operations.  Please see “Risk Factors — We may beadversely affected by any disruption in our information technology systems.”

 

##### ***Significant Recent Acquisitions***

 

During the fiscal year 2009, we acquired SchoenemanBeauty Supply, Inc. (“Schoeneman”) at a cost of approximately $71.0million, subject to certain adjustments, of which a significant portion wasallocated to goodwill. The acquisition of Schoeneman, a 43-store beauty supplychain located in the central northeast United States, was on September 30,2009 and was pursuant to a merger agreement between Schoeneman, the formerstockholders of Schoeneman and a subsidiary of the Company. The Companycurrently expects to realize approximately $10 million of future tax savings asa result of anticipated incremental depreciation and amortization taxdeductions relating to the assets acquired in this transaction. Goodwill ofapproximately $61.0 million was recorded as a result of this acquisition.In addition, during the fiscal year 2009, we completed several otherindividually immaterial acquisitions at an aggregate cost of $11.3 million. Thepurchase prices of all acquisitions completed during the fiscal year 2009 havebeen allocated to assets acquired and liabilities assumed based on theirestimated fair values at the date of acquisition. The final valuation of theassets acquired and liabilities assumed will be completed during fiscal year2010. Generally, we funded these acquisitions with cash from operations.

 

During the fiscal year 2008, we completed severalacquisitions at an aggregate cost of $53.4 million, of which substantially allwas allocated to intangible assets and goodwill.  Generally, we funded these acquisitions withcash from operations as well as borrowings

 

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under our ABL facility.  In May of 2008, we acquired Pro-Duo, a40-store beauty supply chain with stores mainly in Belgium, France and Spain,for €19.3 million (approximately $29.8 million plus incidental acquisitioncosts capitalized) subject to certain adjustments.  This acquisition provided the Sally BeautySupply segment with an expanded geographic footprint in continental Europe andwas funded with cash from operations and borrowings on our subsidiaries’ ABLfacility.  We also assumed €3.0 million(approximately $4.7 million) of pre-acquisition debt of Pro-Duo in connectionwith the acquisition.

 

During the fiscal year 2007, we acquired Chapelton 21Limited, which we refer to as Salon Services, a private company based inScotland. This acquisition provided the Sally Beauty Supply segment a strongEuropean presence. We acquired Salon Services for an aggregate cash purchaseprice of approximately $57.8 million of which $30.0 million was allocatedto goodwill and $17.6 million was allocated to identifiable intangible assets.We financed the purchase price through a draw-down of approximately $57.0million under our ABL facility. In addition, we extinguished approximately $3.9 millionof pre-acquisition debt of Salon Services. Salon Services, through its directand indirect subsidiaries supplies professional hair and beauty productsprimarily to salon and spa operators and independent hair and beautyprofessionals in the United Kingdom, Germany, Ireland and Spain.

 

##### ***Our Separation from Alberto-Culver***

 

Our business historically constituted two operatingsegments within the consolidated financial statements of Alberto-Culver. On November 16,2006, we separated from Alberto-Culver, pursuant to the Investment Agreement.As a result: (i) we became an indirect wholly-owned subsidiary of SallyBeauty; (ii) Sally Beauty, through us, owns and operates the Sally BeautySupply and BSG distribution businesses that were owned and operated by Alberto-Culverprior to the Separation Transactions; (iii) at the closing of theSeparation Transactions, the stockholders of Alberto-Culver prior theretobecame the beneficial owners of approximately 52% of Sally Beauty’s outstandingcommon stock on an undiluted basis and the CDR Investors, who in the aggregateinvested $575.0 million in Sally Beauty, received an equity interestrepresenting approximately 48% of Sally Beauty’s outstanding common stock on anundiluted basis; and (iv) Alberto-Culver continued to own and operate itsconsumer products business. In addition, in connection with the SeparationTransactions, we and certain of our subsidiaries incurred approximately$1,850.0 million of indebtedness. See Note 11 of the “Notes to ConsolidatedFinancial Statements” in “Item 8—Financial Statements and Supplementary Data”of this Annual Report.

 

Prior to November 16, 2006, the Company was asubsidiary of Alberto-Culver and had no share-based compensation plans of itsown; however, certain employees of the Company had been granted stock optionsand stock awards under share-based compensation plans of Alberto-Culver.Alberto-Culver treated the Separation Transactions as though they constituted achange in control for purposes of Alberto-Culver’s stock options and stockawards. As a result, in accordance with the terms of these plans, alloutstanding stock options and restricted shares of Alberto-Culver, includingthose held by our employees, became fully vested upon completion of theSeparation Transactions. Due to the Separation Transactions, during the fiscalyear 2007, we recorded a charge of approximately $5.3 million, whichrepresents the amount of future compensation expense that would have beenrecognized in subsequent periods as the stock options and restricted shares forour employees vested over the original vesting periods. Upon completion of theSeparation Transactions, all outstanding Alberto-Culver stock options held byour employees became options to purchase shares of Sally Beauty’s common stock.

 

##### ***Credit Facilities***

 

The Term Loans and the ABLfacility are secured by substantially all of our assets, those of SallyInvestment, those of our domestic subsidiaries and, in the case of the ABLfacility, those of our Canadian subsidiaries. The Term Loans may be prepaid atour option at any time without premium or penalty. Such facility is subjectto mandatory prepayment in an amount equal to 50% of excess cash flow (asdefined in the agreement governing the Term Loans) for any fiscal year unless aspecified leverage ratio is met. Additionally, the facility is subject to mandatory prepayment in anamount equal to 100% of the proceeds of specified asset sales that are notreinvested in the business or applied to repay borrowings under the ABLfacility.

 

Our Notes are unsecured obligations of us and SallyCapital and are guaranteed on a senior basis (in the case of the senior notes)and on a senior subordinated basis (in the case of the senior subordinatednotes) by each of our material domestic subsidiaries (other than SallyCapital). Our Notes carry optional redemption features whereby we have theoption to redeem the Notes on or before November 15, 2010 and November 15,2011, respectively, at par plus a premium, plus accrued and unpaid interestand, thereafter, at par plus a premium declining ratably to par, plus accruedand unpaid interest.

 

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Details of long-term debt (excluding capitalizedleases) as of September 30, 2009 are as follows (dollars in thousands):

 
| ** **                 | ** ** | **Amount** | ** ** | **Maturity dates** | ** **      | **Interest Rates** | ** **                       |
|----------------------------|------------|------------|------------|--------------------|-----------------|--------------------|----------------------------------|
| ABL facility               |       | $          | —     |               | —          |               | (i)                              | Prime plus up to 0.50%  or; |   |
|                       |       |       |       |               |            | (ii)               | LIBOR plus (1.00% to  1.50%)     |   |
| Term Loan A                |       | 105,000    |       | Nov.  2012    |            | (i)                | Prime plus (1.00% to  1.50%) or; |   |
|                       |       |       |       |               |            | (ii)               | LIBOR plus (2.00% to  2.50%)     |   |
| Term Loan B                |       | 863,856    |       | Nov.  2013    |            | (i)                | Prime plus (1.25% to  1.50%) or; |   |
|                       |       |       |       |               |            | (ii)               | LIBOR plus (2.25% to  2.50%)     |   |
| Other (a)                  |       | 3,135      |       | 2009-2014          |            | 4.05% to 7.0%      |                             |
| Total                      |       | $          | 971,991    |               |            |               |                             |   |
|                       |       |       |       |               |            |               |                             |
| Senior notes               |       | $          | 430,000    |               | Nov.  2014 |               | 9.25%                            |   |
| Senior subordinated  notes |       | 275,000    |       | Nov.  2016    |            | 10.50%             |                             |
| Total                      |       | $          | 705,000    |               |            |               |                             |   |

 

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(a)   Representspre-acquisition debt of Pro-Duo, N.V.

 

##### ***Other Significant Items***

 

*InterestRate Swap Agreements*

 

The Company utilizes interest rate swap agreements tomanage its cash flow risk associated with changing interest rates as it relatesto its Term Loans. We do not currently purchase or hold any derivativeinstruments for trading or speculative purposes. The counterparties are deemedto be of substantial resources and strong creditworthiness. However, thesetransactions do result in exposure to credit risks in the event of default by acounterparty. The recent financial crisis affecting the banking systems andfinancial markets resulted in many well-known financial institutions becomingless creditworthy or having diminished liquidity and, thus, we could be exposedto an increased level of counterparty risk. In the event that a counterparty defaults in its obligation under ourinterest rate swaps, we could incur substantial financial loss. At September 30,2009, the aggregate fair market value of all our interest rate swaps was aliability of $17.7million.

 

In November of 2006, we entered into fourinterest rate swap agreements with an aggregate notional amount of $500million. Interest rate swap agreements with a notional amount of $150 millionexpired in November of 2008 and interest rate swap agreements with anotional amount of $350 million will expire in November of 2009. These interest rate swap agreements do notcurrently qualify as hedges and, therefore, the change in fair value of theseinterest rate swap agreements is recorded in net interest expense in theconsolidated statements of earnings.

 

Additionally, in May of 2008, we entered into twointerest rate swap agreements with an aggregate notional amount of $300million. These interest rate swap agreements are designated as effectivehedges, consistent with the Financial Accounting Standards Board (“FASB”)Accounting Standards Codification (“ASC”) 815. Accordingly, adjustments to reflect the change in the fair values of theseinterest rate swap agreements are recorded in accumulated other comprehensiveincome until the hedged obligation is settled or the swap agreements expire,whichever is earlier.  Anyineffectiveness is recognized in net interest expense in the consolidatedstatements of earnings. Please see “Item 7A—Quantitative and QualitativeDisclosures about Market Risk—Interest rate risk” and Note 12 of the “Notes toConsolidated Financial Statements” in Item 8 - “Financial Statements andSupplementary Data.”

 

*Share-Based Payments*

 

We have no share-based plans of our own. Since theSeparation Transactions, we have been a wholly-owned subsidiary of SallyBeauty, and certain of our employees have been granted stock options and shareawards under its share-based compensation plans. For the fiscal years 2009,2008 and 2007, total share-based compensation cost charged against earnings was$8.0 million, $9.6 million and $12.3 million, respectively, and resulted in anincrease in due to Sally Beauty by the same amounts. Share-based compensationfor the fiscal year 2007 includes $5.3 million of accelerated expense relatedto the Separation Transactions. Share-based compensation for the fiscal year 2009, 2008 and 2007includes $2.0 million, $3.1 million and $2.6 million, respectively, ofaccelerated expense related to certain retirement eligible employees who areeligible to continue vesting awards upon retirement under the terms of SallyBeauty’s 2007 Omnibus Incentive Plan (the “2007 Plan”), which is a share-basedcompensation plan adopted by the stockholders of Sally Beauty during fiscalyear 2007. For the fiscal year 2009, 2008 and 2007, the total income taxbenefit recognized in the consolidated statements of earnings from allshare-based compensation plans in which our employees participate orparticipated was $1.9 million, $2.3 million and $4.8 million, respectively, andresulted in the recognition of deferred tax assets of the same amount. Ourconsolidated statements of cash flows reflect, for the fiscal year 2009, an excesstax shortfall of $0.2 million and, for the fiscal year 2008 and 2007, excesstax benefits of $0.5 million and $0.8 million, respectively, from employeeexercises of stock options as financing cash flows. As of September 30,2009, we had $8.9 million of unrecognized compensation expense related tonon-vested stock option awards that is expected to be charged to expense overthe weighted average period of 2.3 years and $2.0 million of unrecognizedcompensation

 

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expense related to non-vested restricted stock awardsthat is expected to be charged to expense over the weighted average period of3.3 years.

 

Prior to the Separation Transactions, we were asubsidiary of Alberto-Culver and had no share-based compensation plans of ourown; however, certain of our employees had been granted stock options andrestricted stock awards under share-based compensation plans of Alberto-Culver.The Separation Transactions constituted a change in control for purposes ofAlberto-Culver’s stock option and stock award plans. As a result, in accordancewith the terms of these plans, all outstanding stock options and stock awardsof Alberto-Culver, including those held by our employees, became fully vestedupon completion of the Separation Transactions on November 16, 2006. Inaddition, Alberto-Culver’s stock option and stock award plans became SallyBeauty’s plans. Accordingly, in fiscal year 2007, we recorded a charge toexpense equal to the amount of future compensation expense of approximately$5.3 million that would have been recognized in subsequent periods had thesestock options and stock awards for our employees vested over the originalvesting periods. Upon completion of the Separation Transactions, alloutstanding Alberto-Culver stock options held by our employees became optionsto purchase shares of Sally Beauty’s common stock.

 

**Results of Operations**

 

The following table shows the condensed results ofoperations of our business for the fiscal years ended September 30, 2009,2008 and 2007 (in millions):

 
| ** **                                       | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                       | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | $                                 | 2,636.6    |   | $ | 2,648.2 |   | $ | 2,513.8 |   |
| Cost of products sold  and distribution expenses |       | 1,393.3                           |       | 1,413.6 |   | 1,360.0 |   |
| Gross profit                                     |       | 1,243.3                           |       | 1,234.6 |   | 1,153.8 |   |
| Total other operating  costs and expenses        |       | 938.1                             |       | 944.2 |   | 918.1 |   |
| Operating earnings                               |       | 305.2                             |       | 290.4 |   | 235.7 |   |
| Interest expense, net                            |       | 132.0                             |       | 158.9 |   | 146.0 |   |
| Earnings before provision  for income taxes      |       | 173.2                             |       | 131.5 |   | 89.7 |   |
| Provision for income  taxes                      |       | 68.5                              |       | 48.6 |   | 41.2 |   |
| Net earnings                                     |       | $                                 | 104.7      |   | $ | 82.9 |   | $ | 48.5 |   |

 

The following table shows the condensed results ofoperations of our business for the fiscal years ended September 30, 2009,2008 and 2007, expressed as a percentage of net sales for the respectiveperiods:

 
| ** **                                       | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                       | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | 100.0                             | %          | 100.0 | % | 100.0 | % |
| Cost of products sold  and distribution expenses |       | 52.8                              | %          | 53.4 | % | 54.1 | % |
| Gross profit                                     |       | 47.2                              | %          | 46.6 | % | 45.9 | % |
| Total other costs and  expenses                  |       | 35.6                              | %          | 35.6 | % | 36.5 | % |
| Operating earnings                               |       | 11.6                              | %          | 11.0 | % | 9.4 | % |
| Interest expense, net                            |       | 5.0                               | %          | 6.0 | % | 5.8 | % |
| Earnings before  provision for income taxes      |       | 6.6                               | %          | 5.0 | % | 3.6 | % |
| Provision for income  taxes                      |       | 2.6                               | %          | 1.9 | % | 1.7 | % |
| Net earnings                                     |       | 4.0                               | %          | 3.1 | % | 1.9 | % |

 

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##### ***Key Operating Metrics***

 

The following table sets forth, for the periodsindicated, information concerning key measures we rely on to gauge ouroperating performance (dollars in thousands):

 
| ** **                                                 | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                 | ** ** | **2009**                          | ** ** | **2008(a)** | ** ** | **2007(a)** | ** ** |
| Net sales:                                                 |       |                              |       |   |   |   |   |
| Sally Beauty Supply                                        |       | $                                 | 1,695,652  |   | $ | 1,672,897 |   | $ | 1,569,088 |   |
| BSG                                                        |       | 940,948                           |       | 975,294 |   | 944,684 |   |
|                                                       |       | $                                 | 2,636,600  |   | $ | 2,648,191 |   | $ | 2,513,772 |   |
| Gross Profit                                               |       | $                                 | 1,243,317  |   | $ | 1,234,594 |   | $ | 1,153,747 |   |
| Gross profit margin                                        |       | 47.2                              | %          | 46.6 | % | 45.9 | % |
|                                                       |       |                              |       |   |   |   |   |
| Selling, general and  administrative expenses              |       | $                                 | 891,056    |   | $ | 895,632 |   | $ | 850,159 |   |
| Depreciation and  amortization                             |       | $                                 | 47,066     |   | $ | 48,533 |   | $ | 42,605 |   |
|                                                       |       |                              |       |   |   |   |   |
| Earnings before  provision for income taxes:               |       |                              |       |   |   |   |   |
| Segment operating  profit:                                 |       |                              |       |   |   |   |   |
| Sally Beauty Supply                                        |       | $                                 | 283,872    |   | $ | 285,615 |   | $ | 272,364 |   |
| BSG                                                        |       | 91,604                            |       | 80,927 |   | 63,456 |   |
| Segment operating  profit                                  |       | 375,476                           |       | 366,542 |   | 335,820 |   |
| Unallocated expenses                                       |       | (62,289                           | )          | (66,499 | ) | (62,570 | ) |
| Share-based  compensation expense                          |       | (7,992                            | )          | (9,614 | ) | (12,267 | ) |
| Sales-based service fee  charged by Alberto-Culver         |       | —                            |       | — |   | (3,779 | ) |
| Transaction expenses                                       |       | —                            |       | — |   | (21,502 | ) |
| Operating earnings                                         |       | 305,195                           |       | 290,429 |   | 235,702 |   |
| Interest expense, net  of interest income                  |       | (132,043                          | )          | (158,897 | ) | (145,972 | ) |
| Earnings before  provision for income taxes                |       | $                                 | 173,152    |   | $ | 131,532 |   | $ | 89,730 |   |
|                                                       |       |                              |       |   |   |   |   |
| Segment operating  profit margin:                          |       |                              |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 16.7                              | %          | 17.1 | % | 17.4 | % |
| BSG                                                        |       | 9.7                               | %          | 8.3 | % | 6.7 | % |
| Consolidated operating  profit margin                      |       | 11.6                              | %          | 11.0 | % | 9.4 | % |
| Number of stores at  end-of-period (including franchises): |       |                              |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 2,923                             |       | 2,844 |   | 2,694 |   |
| BSG                                                        |       | 991                               |       | 929 |   | 874 |   |
|                                                       |       | 3,914                             |       | 3,773 |   | 3,568 |   |
| Same store sales  growth(b)                                |       |                              |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 2.1                               | %          | 1.2 | % | 2.7 | % |
| BSG                                                        |       | 1.0                               | %          | 6.9 | % | 10.1 | % |
| Consolidated                                               |       | 1.8                               | %          | 2.6 | % | 4.5 | % |

 

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(a)               Certain amountsfor prior fiscal years have been reclassified to conform to the current year’spresentation.

(b)              Same stores aredefined as company-operated stores that have been open for at least14 months as of the last day of a month. Sally Beauty’s internet site hasgenerated sales for at least 14 months and, accordingly, internet-based salesare included in same store sales for the fiscal year 2009.

 

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##### ***Description of Sales and Expenses***

##### *** ***

*Net Sales.*  Ournet sales consist primarily of the following:

 

·             *Sally Beauty Supply.*  SallyBeauty Supply generates net sales primarily by selling products through itsstores to both professional and retail customers. Sally Beauty Supply sellshair care, hair color, skin and nail care products, electrical appliances andother beauty related accessories. Because approximately 42% of our Sally BeautySupply product sales come from exclusive or control label brands, most of thesesame products are generally not available in most other retail stores or in ourBSG business segment. Various factors influence Sally Beauty Supply’s net salesincluding local competition, product assortment and availability, price, hoursof operation and marketing and promotional activity. Sally Beauty Supply’sproduct assortment and sales are generally not seasonal in nature.

 

·             *Beauty Systems Group.*  BSGgenerates net sales by selling products to salon professionals and independentstylists through company-operated and franchised stores as well as through itsnetwork of professional distributor sales consultants. BSG sells hair care,hair color products, skin and nail care products, electrical appliances andother beauty related accessories. These products are not sold directly to thegeneral public and are generally not the same products as those sold in ourSally Beauty Supply stores. Various factors influence BSG’s net sales,including product breadth and availability, competitive activity, relationshipswith suppliers, new product introductions and price. BSG’s product assortmentand sales are generally not seasonal in nature.

 

*Cost of Products Sold andDistribution Expenses.*Cost of products sold and distributionexpenses consist of the cost to purchase merchandise from suppliers, lessrebates and allowances, and certain overhead expenses including purchasingcosts, freight from distribution centers to stores and handling costs in thedistribution centers. Cost of products sold and distribution expenses are alsoaffected by store inventory shrinkage, which represents products that are lost,stolen or damaged at the store level.

 

*Selling, General and AdministrativeExpenses.*  Selling, general and administrativeexpenses consist primarily of personnel costs, commissions paid to professionaldistributor sales consultants, benefits, utilities, property maintenance,advertising, rent, insurance, freight and distribution expenses for delivery tocustomers, administrative costs and costs associated with our corporate supportcenter.

 

*Sales-based Service Fee.*Priorto the Separation Transactions, we were charged a sales-based service fee underthe consulting, business development and advisory services agreement betweencertain of our subsidiaries and Alberto-Culver. In conjunction with the SeparationTransactions, the arrangements giving rise to this fee from Alberto-Culver wereterminated and the related charges have ceased. We believe that had we been astand-alone company, we would have not incurred a comparable expense.

 

*Transaction Expenses*.  For fiscal year 2007, transaction expensesare costs associated with the Separation Transactions and are primarilypayments to Alberto-Culver pursuant to the separation agreements. In addition,we recognized severance costs for two executives and certain professional feesrelated to the Separation Transactions.

 

*Net Interest Expense*.  Net interest expense includes theamortization of deferred debt issuance costs and is stated net of interestincome. Net interest expense is primarily associated with debt incurred inconnection with the Separation Transactions.

 

***The Fiscal Year Ended September 30,2009 compared to the Fiscal Year Ended September 30, 2008***

 

The table below presents net sales, gross profit andgross profit margin data for each reportable segment (dollars in thousands).

 
| ** **                       | ** ** | **Fiscal Year Ended September 30,** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|
| ** **                       | ** ** | **2009**                                 | ** ** | **2008** | ** ** | **Increase (Decrease)** | ** ** |
| Net sales:                       |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                        | 1,695,652  |   | $ | 1,672,897 |   | $ | 22,755 |   | 1.4 | % |
| BSG                              |       | 940,948                                  |       | 975,294 |   | (34,346 | ) | (3.5 | )% |
| Consolidated net sales           |       | $                                        | 2,636,600  |   | $ | 2,648,191 |   | $ | (11,591 | ) | (0.4 | )% |
|                             |       |                                     |       |   |   |   |   |   |   |
| Gross profit:                    |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                        | 878,738    |   | $ | 858,375 |   | $ | 20,363 |   | 2.4 | % |
| BSG                              |       | 364,579                                  |       | 376,219 |   | (11,640 | ) | (3.1 | )% |
| Consolidated gross profit        |       | $                                        | 1,243,317  |   | $ | 1,234,594 |   | $ | 8,723 |   | 0.7 | % |
|                             |       |                                     |       |   |   |   |   |   |   |
| Gross profit margin:             |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | 51.8                                     | %          | 51.3 | % | 0.5 | % |   |   |
| BSG                              |       | 38.7                                     | %          | 38.6 | % | 0.1 | % |   |   |
| Consolidated gross profit margin |       | 47.2                                     | %          | 46.6 | % | 0.6 | % |   |   |

 

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### *NetSales*

###  

Consolidated netsales decreased by $11.6 million, or 0.4%, for the fiscal year ended September 30,2009 compared to the fiscal year ended September 30, 2008.Company-operated stores that have been open for at least 14 months contributedan increase of approximately $70.5 million, or 2.7%, and sales through certainnon-store sales channels contributed an increase of approximately $3.9 million,or 0.1%, to consolidated net sales. Other sales channels experienced declinescompared to the fiscal year ended September 30, 2008. Sales through BSG’sfranchise-based businesses declined by approximately $12.0 million, or 0.5%,sales through our BSG distributor sales consultants declined approximately $29.2million, or 1.1%, and sales through new stores (not including acquisitions)declined approximately $19.6 million, or 0.7%, due to fewer store openingsthrough the twelve-month period ended September 30, 2009 compared to thetwelve-month period ended September 30, 2008. In addition, incrementalsales from businesses acquired in the preceding 12 months contributed $25.2million, or 1.0%, less to our consolidated net sales for the fiscal year ended September 30,2009 compared to the fiscal year ended September 30, 2008. Consolidatednet sales for the fiscal year ended September 30, 2009, are inclusive ofapproximately $86.0 million in negative impact from changes in foreign currencyexchange rates.

 

*SallyBeauty Supply*.  Netsales for Sally Beauty Supply increased by $22.8 million, or 1.4%, for thefiscal year ended September 30, 2009 compared to the fiscal year ended September 30,2008.  In the Sally Beauty Supplysegment, company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $52.4 million, or 3.1%, while ournon-store sales channels contributed an increase of approximately $3.9 million,or 0.2%. Sales of businesses acquired in the preceding 12 months contributed$28.3 million less to the Sally Beauty Supply segment’s net sales for thefiscal year ended September 30, 2009 compared to the fiscal year ended September 30,2008 and sales through new stores (not including acquisitions) declinedapproximately $5.3 million, or 0.3%. Net sales for Sally Beauty Supply for thefiscal year ended September 30, 2009, are inclusive of approximately $64.1million in negative impact from changes in foreign currency exchange rates.

 

*Beauty Systems Group*. Net sales for BSG decreased by $34.3 million, or 3.5%, for the fiscalyear ended September 30, 2009 compared to the fiscal year ended September 30,2008. While company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $18.1 million, or 1.9%, and sales frombusinesses acquired in the preceding 12 months contributed $3.1 million more tothe BSG segment’s net sales, other sales channels experienced declines comparedto the fiscal year ended September 30, 2008. Sales through BSG’sfranchise-based businesses declined by approximately $12.0 million, or 1.2%,sales through distributor sales consultants declined approximately $29.2million, or 3.0%, and sales through new stores (not including acquisitions)declined approximately $14.3 million, or 1.5%. Net sales for BSG for the fiscalyear ended September 30, 2009, are inclusive of approximately $21.9million in negative impact from changes in foreign currency exchange rates.

 

#### *Gross Profit*

####  

Consolidated grossprofit increased by $8.7 million, or 0.7%, for the fiscal year ended September 30,2009 compared to the fiscal year ended September 30, 2008, principally dueto higher sales volume for the Sally Beauty Supply segment and improved grossmargin percentages for both business segments. This increase was partiallyoffset by lower sales volume for the BSG segment, as more fully describedbelow.

 

*SallyBeauty Supply*. Sally Beauty Supply’s gross profit increasedby $20.4 million, or 2.4%, for the fiscal year ended September 30, 2009compared to the fiscal year ended September 30, 2008, principally as aresult of increased unit sales volume and improved margins.  Sally Beauty Supply’s gross profit as apercentage of net sales increased to 51.8% for the fiscal year ended September 30,2009 compared to 51.3% for the fiscal year ended September 30, 2008. Thisincrease was the result of recent marketing efforts, low-cost sourcinginitiatives and a shift in product mix (including an increase in sales ofexclusive-label products and other higher-margin products).

 

*Beauty Systems Group*.  BSG’s gross profit decreased by $11.6million, or 3.1%, for the fiscalyear ended September 30, 2009 compared to the fiscal year ended September 30, 2008, principallyas a result of lower unit sales volume. BSG’s gross profit as a percentage ofnet sales increased slightly to 38.7% for the fiscal year ended September 30, 2009 comparedto 38.6% for thefiscal year ended September 30, 2008, principally as a result of afavorable change in sales mix towards higher company-operatedstore sales volume (with higher gross profit margins as opposed to bothfranchise store and distributor sales consultants’ sales).

 

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#### *Selling, General andAdministrative Expenses*

####  

Consolidatedselling, general and administrative expenses decreased by $4.6 million, or0.5%, to $891.1 million for the fiscal year ended September 30, 2009compared to $895.6 million for the fiscal year ended September 30, 2008.   Selling, general and administrativeexpenses, as a percentage of net sales, were 33.8% for both the fiscal yearended September 30, 2009 and the fiscal year ended September 30,2008. The decrease in selling, general and administrative expenses reflects lowershare-based compensation of $1.6 million, lower sales commissions of $4.7million and a decrease in other unallocated corporate expenses as a result ofcost-saving initiatives as well as favorable foreign currency transactions of$3.9 million resulting from intercompany notes not permanently invested,partially offset by the incremental expenses related to businesses acquired inthe last twelve months as well as to an increase in advertising expenses ofapproximately $4.5 million. Selling, general and administrative expense for thefiscal year ended September 30, 2008 included approximately $3.0 millionfor BSG retention incentives for distributor sales consultants (resulting fromthe L’Oreal contractual changes reported during fiscal year 2007) and warehouseoptimization expenses of approximately $2.4 million, with no similar expensesin the fiscal year ended September 30, 2009.

 

#### *Depreciation andAmortization*

####  

Consolidateddepreciation and amortization decreased to $47.1 million for the fiscal yearended September 30, 2009 compared to $48.5 million for the fiscal yearended September 30, 2008, due to a favorable impact from changes inforeign currency exchange rates, partially offset by the expenses associatedwith businesses acquired in the fiscal years 2008 and 2009.

 

*Operating Earnings*

 

The following table sets forth, for the periodsindicated, information concerning our operating earnings for each reportablesegment (dollars in thousands):

 
| ** **                        | ** ** | **Fiscal Year Ended September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                 | ** ** | **2008(a)** | ** ** | **Increase (Decrease)** | ** ** |
| Operating Earnings:               |       |                                     |       |   |   |   |   |   |   |
| Segment operating  profit:        |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply               |       | $                                        | 283,872    |   | $ | 285,615 |   | $ | (1,743 | ) | (0.6 | )% |
| BSG                               |       | 91,604                                   |       | 80,927 |   | 10,677 |   | 13.2 | % |
| Segment operating  profit         |       | 375,476                                  |       | 366,542 |   | 8,934 |   | 2.4 | % |
| Unallocated expenses              |       | (62,289                                  | )          | (66,499 | ) | (4,210 | ) | (6.3 | )% |
| Share-based  compensation expense |       | (7,992                                   | )          | (9,614 | ) | (1,622 | ) | (16.9 | )% |
| Operating earnings                |       | $                                        | 305,195    |   | $ | 290,429 |   | $ | 14,766 |   | 5.1 | % |

 

----

(a) Certain amounts for prior fiscal years have been reclassifiedto conform to the current year’s presentation.

 

Consolidatedoperating earnings increased by $14.8 million, or 5.1%, to $305.2 million forthe fiscal year ended September 30, 2009 compared to $290.4 million forthe fiscal year ended September 30, 2008. Operating earnings, as apercentage of net sales, were 11.6% for the fiscal year ended September 30,2009 compared to 11.0% for the fiscal year ended September 30, 2008. Theincrease in consolidated operating earnings was due primarily to an increase inBSG operating earnings and declines in unallocated expenses and share-basedcompensation expense, offset in part by a decline in the Sally Beauty Supply’soperating profits, as discussed below. Consolidated operating earnings for the fiscal year ended September 30,2009, are inclusive of approximately $1.4 million in negative impact fromchanges in foreign currency exchange rates.

 

*SallyBeauty Supply*.  SallyBeauty Supply’s segment operating earnings decreased $1.7 million, or 0.6%, to$283.9 million for the fiscal year ended September 30, 2009 compared to$285.6 million for the fiscal year ended September 30, 2008.  The decrease in Sally Beauty Supply’s segmentoperating earnings was primarily a result of higher advertising costs ofapproximately $6.4 million and the incremental costs related to approximately78 additional company-operated stores (stores opened or acquired during thepast twelve months) operating during the fiscal year ended September 30,2009, partially offset by declines in other segment operating expensesresulting from cost-saving initiatives. Segment operating earnings, as a percentage of net sales, were 16.7% forthe fiscal year ended September 30, 2009 compared to 17.1% for the fiscalyear ended September 30, 2008. The decrease in Sally Beauty Supply’ssegment operating earnings as a percentage of segment net sales was primarily aresult of higher advertising costs as a percentage of segment net sales andcontinued softer sales in some of the segment’s international operations.

 

*BeautySystems Group*.  BSG’ssegment operating earnings increased $10.7 million, or 13.2%, to $91.6 millionfor the fiscal year ended September 30, 2009 compared to $80.9 million forthe fiscal year ended September 30, 2008. Segment operating earnings, as apercentage of net sales, were 9.7% for the fiscal year ended September 30,2009 compared to 8.3% for the fiscal year ended

 

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September 30,2008. This increase was due primarily to a decline in segment operatingexpenses resulting from cost-saving initiatives and slightly higher segmentgross profit, as discussed above. BSG’s segment operating earnings alsoreflect, for the fiscal year ended September 30, 2008, approximately $3.0million for retention incentives for distributor sales consultants (resultingfrom the L’Oreal contractual changes reported during fiscal year 2007). Segmentoperating earnings for the fiscal year ended September 30, 2009, areinclusive of approximately $2.0 million in negative impact from changes inforeign currency exchange rates.

 

*Unallocated expenses.*Unallocated expenses, which representcorporate costs (such as payroll, employee benefits and travel expenses forcorporate staff, certain professional fees and corporate governance expenses)that have not been charged to our operating segments decreased by $4.2 million,or 6.3%, to $62.3 million for the fiscal year ended September 30, 2009compared to $66.5 million for the fiscal year ended September 30, 2008.This decrease was due primarily to favorable foreign currency transactions of$5.1 million resulting from intercompany notes not permanently invested,partially offset by an increase in corporate expenses mainly in connection withrecent upgrades to our information technology systems.

 

#### *Share-based Compensation Expense.* For the fiscal year ended September 30, 2009, totalcompensation cost charged against income for share-based compensationarrangements was $8.0 million compared to $9.6 million for the fiscal year ended September 30, 2008. Thisdecrease was due to a decline in the fair value per share of options awarded inthe period ended September 30, 2009 compared to options awarded in theperiod ended September 30, 2008.  During the fiscal year ended September 30,2009 and 2008, the Sally Beauty granted to the Company’s employees andconsultants approximately 2.7 million and 2.8 million stock options,respectively, and approximately 123,000 and 136,000 restricted share awards,respectively, under the 2007 Plan.

####  

#### *Net Interest Expense*

####  

Interest expense, net ofinterest income of $0.3 million, was $132.0 million for the fiscal year ended September 30,2009 compared to $159.0 million, net of interest income of $0.7 million, forthe fiscal year ended September 30, 2008. The decrease in interest expense was primarily attributable to a $9.9million favorable change in the fair value of certain interest rate swaps(please see Note 12 of the “Notes to Consolidated Financial Statements” in Item8 - “Financial Statements and Supplementary Data”) and to lower prevailinginterest rates on our ABL and senior term loan facilities and lower outstandingprincipal balances on our senior term loans.

 

#### *Provision for Income Taxes*

####  

Provision for incometaxes was $68.4 million during the fiscal year ended September 30, 2009compared to $48.7 million for the fiscal year ended September 30,2008.  The effective tax rate is 39.5%for fiscal year 2009 compared to 37.0% for fiscal year 2008.  The increase in the effective tax rateprimarily relates to a reduction in earnings in low tax jurisdictions and areduction in favorable permanent items triggered by lower foreign earnings.

 

#### *Net Earnings*

####  

As a result of the foregoing, consolidated net earningsincreased by $21.9 million, or 26.3%, to $104.7 million for the fiscal yearended September 30, 2009 compared to $82.9 million for the fiscal yearended September 30, 2008. Net earnings, as a percentage of net sales, were4.0% for the fiscal year ended September 30, 2009 compared to 3.1% for thefiscal year ended September 30, 2008.

 

***The Fiscal Year Ended September 30,2008 compared to the Fiscal Year Ended September 30, 2007***

 

The table below presentsnet sales, gross profit and gross profit margin data for each reportablesegment (dollars in thousands).

 
| ** **                       | ** ** | **Fiscal Year Ended September 30,** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                 | ** ** | **2007(a)** | ** ** | **Increase (Decrease)** | ** ** |
| Net sales:                       |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                        | 1,672,897  |   | $ | 1,569,088 |   | $ | 103,809 |   | 6.6 | % |
| BSG                              |       | 975,294                                  |       | 944,684 |   | 30,610 |   | 3.2 | % |
| Consolidated net sales           |       | $                                        | 2,648,191  |   | $ | 2,513,772 |   | $ | 134,419 |   | 5.3 | % |
|                             |       |                                     |       |   |   |   |   |   |   |
| Gross profit:                    |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                        | 858,375    |   | $ | 798,656 |   | $ | 59,719 |   | 7.5 | % |
| BSG                              |       | 376,219                                  |       | 355,091 |   | 21,128 |   | 6.0 | % |
| Consolidated gross profit        |       | $                                        | 1,234,594  |   | $ | 1,153,747 |   | $ | 80,847 |   | 7.0 | % |
|                             |       |                                     |       |   |   |   |   |   |   |
| Gross profit margin:             |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | 51.3                                     | %          | 50.9 | % | 0.4 | % |   |   |
| BSG                              |       | 38.6                                     | %          | 37.6 | % | 1.0 | % |   |   |
| Consolidated gross profit margin |       | 46.6                                     | %          | 45.9 | % | 0.7 | % |   |   |

 

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(a)           Certain amounts for prior fiscal years have beenreclassified to conform to the current year’s presentation.

###  

### *Net Sales*

###  

Consolidated netsales increased $134.4 million, or 5.3% for the fiscal year ended September 30,2008 compared to the fiscal year ended September 30, 2007.  The significant factors causing the net salesincrease were same store sales growth of 2.6%, which contributed approximately$51.5 million, or 2.0%; net sales from new stores (not including acquisitions)of approximately $45.0 million, or 1.8%; and $56.3 million, or 2.2%, inadditional sales from acquired businesses; partially offset by a decrease infranchise store sales of approximately $15.7 million, or 0.6%, and indistributor sales consultant revenue of approximately $12.0 million, or 0.5%.These amounts are inclusive of approximately $18.4 million, or 0.7%, inpositive impact from foreign currency exchange rates. Current period net saleswere positively impacted by the introduction of new product lines during thefiscal year 2008 but negatively impacted by lower L’Oreal product sales ofapproximately $36.2 million due to the previously-disclosed contractual changesoccurring during fiscal year 2007.

 

*SallyBeauty Supply*.  Netsales for Sally Beauty Supply increased $103.8 million, or 6.6%, for the fiscalyear ended September 30, 2008 compared to the fiscal year ended September 30,2007.  The significant factors causingthe net sales increase were same stores sales growth of 1.2%, which contributedapproximately $17.7 million, or 1.1%; net sales from 110 new stores (notincluding acquisitions) of approximately $26.6 million, or 1.7%; and $56.3million, or 3.6%, in additional sales from acquired businesses. These sales areinclusive of approximately $8.0 million, or 0.5%, in positive impact fromforeign currency exchange rates.  Samestore sales were positively impacted by continued growth of exclusive-labelproduct sales and certain merchandise categories as well as an increase inpromotional sales.

 

*BeautySystems Group*.  Netsales for BSG increased $30.6 million, or 3.2% for the fiscal year ended September 30,2008 compared to the fiscal year ended September 30, 2007.  The significant factors causing the net salesincrease were same store sales growth of 6.9%, which contributed approximately$33.8 million, or 3.6%; and net sales from 44 new stores of approximately $18.4million, or 1.9%; partially offset by a decrease in franchise sales ofapproximately $15.7 million, or 1.7%, and in distributor sales consultantrevenue of approximately $12.0 million, or 1.3%. These sales are inclusive ofapproximately $10.4 million, or 1.1%, in positive impact from foreign currencyexchange rates.  BSG net sales were positivelyimpacted by the introduction of new product lines during the fiscal year 2008but negatively impacted by lower L’Oreal product sales of approximately $36.2million due to the previously-disclosed contractual changes during fiscal year2007.

 

#### *Gross Profit*

####  

Consolidated grossprofit increased $80.8 million for the fiscal year ended September 30,2008 as compared to the fiscal year ended September 30, 2007, principallydue to increased sales volume resulting from acquisitions for Sally BeautySupply and improved gross margins in both operating segments.

 

*SallyBeauty Supply*. Sally Beauty Supply’s gross profit increased$59.7 million for the fiscal year ended September 30, 2008 compared to thefiscal year ended September 30, 2007, principally as a result of increasedunit sales volume and gross profit margin improvements across nearly allgeographic areas.  Sally Beauty Supply’sgross profit as a percent of net sales increased to 51.3% for the fiscal yearended September 30, 2008 compared to 50.9% for the fiscal year ended September 30,2007. This increase was principally the result of a shift in product mixincluding an increase in sales of exclusive-label products and otherhigher-margin products.  This increasewas partially offset by an increase in promotional initiatives in the U.S. andhigher freight costs.

 

*Beauty Systems Group*.  BSG’s gross profit increased $21.1 millionfor the fiscal year ended September 30, 2008 compared to the fiscal year ended September 30,2007. This increase was principally as a result of increased unit sales volumeoffset in part by approximately $1.7 million of warehouse optimization costs,included in cost of products sold and distribution expenses.  BSG’s gross profit as a percentage of netsales increased to 38.6% for the fiscal year ended September 30, 2008compared to 37.6% for the fiscal year ended September 30, 2007. Thisincrease was due primarily to margin pressure from lower-margin products in ourfranchise-based business during the fiscal year ended September 30, 2007that was not repeated during the fiscal year ended September 30, 2008

 

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as well as a shift in salesmix during the fiscal year ended September 30, 2008, towards highercompany-operated store sales volume (with higher gross profit margins asopposed to both franchise store and distributor sales consultants’ sales), aswell as the introduction of new product lines during the fiscal year 2008.

 

#### *Selling, General andAdministrative Expenses*

####  

Consolidatedselling, general and administrative expenses increased $45.5 million to $895.6million for the fiscal year ended September 30, 2008 compared to $850.2million for the fiscal year ended September 30, 2007. This increase wasattributable principally to expenses directly associated with the increase inunit sales volume, increased expenses related to the opening of new stores andto acquired businesses. Selling, general and administrative expenses includeapproximately $2.4 million of warehouse optimization costs for the fiscal yearended September 30, 2008 and approximately $3.0 million and $5.2 millionof BSG retention incentives for distributor sales consultants due to theL’Oreal contractual changes reported during fiscal year 2007 for the fiscalyear ended September 30, 2008 and 2007, respectively. Most of theretention incentives related to the L’Oreal contractual changes have beenexpensed during 2007 and 2008. Fiscal 2008 results also include professionalfees incurred for a corporate reorganization project related to therationalization of our various foreign subsidiaries.  Selling, general and administrative expenses,as a percentage of net sales, were 33.8% for the fiscal years ended September 30,2008 and 2007.  The expense increaseswere partially offset by a $1.0 million decrease in expenses from the inclusionin the results, for the fiscal year ended September 30, 2007, of allocatedoverhead charges from Alberto-Culver prior to the Separation Transactions.There were no comparable charges during the fiscal year ended September 30,2008.

 

#### *Depreciation andAmortization*

####  

Consolidateddepreciation and amortization increased $5.9 million to $48.5 million forfiscal year ended September 30, 2008 compared to $42.6 million for thefiscal year ended September 30, 2007. The increase was due primarily to the amortization of intangible assetsassociated with acquisitions and capital expenditures made to support unitgrowth of both operating segments.

 

#### *Sales-based Service Fee Charged byAlberto-Culver*

####  

The sales-basedservice fee charged by Alberto-Culver was $3.8 million for the fiscal yearended September 30, 2007.  Thefiscal year ended September 30, 2008 had no comparable expenses as aresult of the cancellation of this agreement in connection with the SeparationTransactions.

 

#### *Transaction Expenses*

####  

We recorded $21.5million in expenses related to the Separation Transactions for the fiscal yearended September 30, 2007.  Theseexpenses were for fees allocated to us by Alberto-Culver for severance paymentsto certain former officers and for other professional fees related to theSeparation Transactions.  We did notincur any comparable expenses related to the Separation Transactions in thefiscal year ended September 30, 2008.

 

*Operating Earnings*

 

The following table sets forth, for the periodsindicated, information concerning our operating earnings for each reportablesegment (in thousands):

 
| ** **                                         | ** ** | **Fiscal Year Ended September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                         | ** ** | **2008(a)**                              | ** ** | **2007(a)** | ** ** | **Increase (Decrease)** | ** ** |
| Operating Earnings:                                |       |                                     |       |   |   |   |   |   |   |
| Segment operating  profit:                         |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply                                |       | $                                        | 285,615    |   | $ | 272,364 |   | $ | 13,251 |   | 4.9 | % |
| BSG                                                |       | 80,927                                   |       | 63,456 |   | 17,471 |   | 27.5 | % |
| Segment operating  profit                          |       | 366,542                                  |       | 335,820 |   | 30,722 |   | 9.1 | % |
| Unallocated expenses                               |       | (66,499                                  | )          | (62,570 | ) | 3,929 |   | 6.3 | % |
| Share-based  compensation expense                  |       | (9,614                                   | )          | (12,267 | ) | (2,653 | ) | (21.6 | )% |
| Sales-based service fee  charged by Alberto-Culver |       | —                                   |       | (3,779 | ) | (3,779 | ) | (100.0 | )% |
| Transaction expenses                               |       | —                                   |       | (21,502 | ) | (21,502 | ) | (100.0 | )% |
| Operating earnings                                 |       | $                                        | 290,429    |   | $ | 235,702 |   | $ | 54,727 |   | 23.2 | % |

 

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(a) Certain amounts for prior fiscal years have been reclassifiedto conform to the current year’s presentation.

 

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Consolidatedoperating earnings increased $54.7 million, or 23.2%, to $290.4 million for thefiscal year ended September 30, 2008 compared to $235.7 million for the fiscalyear ended September 30, 2007. Operating earnings, as a percentage of netsales, were 11.0% for the fiscal year ended September 30, 2008 compared to9.4% for the fiscal year ended September 30, 2007.  The increase in consolidated operatingearnings was due primarily to increased gross profit by both operating segmentsas well as the non-recurrence of both $21.5 million of expenses related to theSeparation Transactions and a sales-based service fee of $3.8 million chargedby Alberto-Culver in the fiscal year ended September 30, 2007.

 

*SallyBeauty Supply*.  SallyBeauty Supply’s segment operating earnings increased $13.3 million, or 4.9%, to$285.6 million for the fiscal year ended September 30, 2008 compared to$272.4 million for the fiscal year ended September 30, 2007. Segmentoperating earnings, as a percentage of net sales, were 17.1% for the fiscalyear ended September 30, 2008 compared to 17.4% for the fiscal year ended September 30,2007.  The decrease in Sally BeautySupply’s segment operating earnings as a percentage of net sales was primarilya result of higher advertising costs of approximately $3.6 million.

 

*BeautySystems Group*.  BSG’ssegment operating earnings increased $17.5 million, or 27.5%, to $80.9 millionfor the fiscal year ended September 30, 2008 compared to $63.4 million forthe fiscal year ended September 30, 2007. Segment operating earnings, as apercentage of net sales, were 8.3% for the fiscal year ended September 30,2008 compared to 6.7% for the fiscal year ended September 30, 2007.  BSG’s segment operating earnings werepositively impacted by improvement in gross profit margins due to sales mix aswell as a lower growth rate in selling, general and administrative expenses.  In addition, operating earnings were improvedfrom the non-recurrence of certain consulting fees and expenses related to theL’Oreal contractual changes incurred for the fiscal year ended September 30,2007.  These improvements were offset, inpart, by the operating expenses attributable to stores opened and businessesacquired as well as by warehouse optimization project expenses of $4.7 million(including depreciation) in the fiscal year ended September 30, 2008.

 

*Unallocated expenses.*Unallocated expenses, which representcorporate costs that have not been charged to the operating segments, increasedto $66.5 million, or by approximately $3.9 million, for the year ended September 30,2008 compared to the year ended September 30, 2007.  The increase was due primarily to higherpayroll related costs to provide support for the growth in segment operations.

 

#### *Share-based Compensation Expense.* For thefiscal year ended September 30, 2008, total compensation cost chargedagainst income for share-based compensation arrangements was $9.6 millioncompared to $12.3 million for the year ended September 30, 2007.  The amounts for the fiscal year 2008 included$3.1 million of accelerated expense related to certain retirement eligibleemployees who are eligible to continue vesting awards upon retirement and, forthe fiscal year 2007, $5.3 million of accelerated expense related to theSeparation Transactions and $2.6 million of accelerated expense related tocertain retirement eligible employees who are eligible to continue vestingawards upon retirement.

####  

During the yearsended September 30, 2008 and 2007, Sally Beauty granted to the Company’semployees approximately 2.8 million and 5.1 million stock options,respectively.

 

#### *Sales-based Service Fee Charged byAlberto-Culver.*The sales-based service fee charged byAlberto-Culver was $3.8 million for the fiscal year ended September 30,2007.  The fiscal year ended September 30,2008 had no comparable expenses as a result of the cancellation of thisagreement in connection with the Separation Transactions.

####  

#### *Transaction Expenses.*Werecorded $21.5 million in expenses related to the Separation Transactions forthe fiscal year ended September 30, 2007. These expenses were for fees allocated to us by Alberto-Culver forseverance payments to certain former officers and for other professional feesrelated to the Separation Transactions. We did not incur any comparable expenses related to the SeparationTransactions in the fiscal year ended September 30, 2008.

####  

#### *Interest Expense, net*

####  

Interest expense, net ofinterest income of $0.7 million, was $159.0 million for the fiscal year ended September 30,2008 compared to $146.0 million, net of interest income of $1.7 million, forthe fiscal year ended September 30, 2007. The increase in interest expense was primarily attributable to the impactof interest associated with the debt incurred on November 16, 2006 whichwas outstanding for 47 less days in fiscal year 2007 than in fiscal year2008.  Net interest expense also reflectsnon-cash expense of $4.6 million and $3.0 million for the fiscal year ended September 30,2008 and 2007, respectively, resulting from marked-to-market adjustments forcertain interest rate swaps, as described in Note 12 of the “Notes toConsolidated Financial Statements” in Item 8 - “Financial Statements andSupplementary Data.”

 

#### *Provision for Income Taxes*

####  

Provision for income taxes was $48.7 million duringthe fiscal year ended September 30, 2008 compared to $41.2 million for thefiscal year ended September 30, 2007. The effective tax rate is 37.0% forfiscal year 2008 compared to 45.9% for fiscal year 2007.  The reduction in the estimated annualeffective tax rate primarily relates to non-deductible costs related to theSeparation Transactions

 

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included in the tax rate for the fiscal year 2007 andthe reduced impact of permanent items on higher earnings and a reduction inforeign statutory tax rates for fiscal year 2008.

 

#### *Net Earnings*

####  

As a result of the foregoing, consolidated netearnings increased $34.3 million to $82.9 million for the fiscal year ended September 30,2008 compared to $48.6 million for the fiscal year ended September 30,2007. Net earnings, as a percentage of net sales, were 3.1% for the fiscal yearended September 30, 2008 compared to 1.9% for the fiscal year ended September 30,2007.

 

## **FinancialCondition**

 

##### ***September 30, 2009 Compared to September 30,2008***

 

Working capital (currentassets less current liabilities) at September 30, 2009 was $315.9 millioncompared to $348.6 million at September 30, 2008, representing a decreaseof $32.6 million. The ratio of current assets to current liabilities was 1.79to 1.00 at September 30, 2009 compared to 1.76 to 1.00 at September 30,2008. The decrease in working capital reflects an $88.5 million decrease incurrent assets and a decrease of $55.9 million in current liabilities.  The decrease in current assets as of September 30,2009 includes a $45.3 million decrease in cash and cash equivalents and a $38.5million reduction in inventory levels. The decrease in current liabilities as of September 30, 2009 wasprimarily the result of a decrease in current maturities of long-term debt of$76.1 million partially offset by an increase of $21.6 million in accountspayable.

 

Cash and cash equivalentsdecreased by $45.3 million to $54.4 million at September 30, 2009 comparedto $99.8 million at September 30, 2008 due primarily to cash used inconnection with acquisitions and to repay debt during the fiscal year ended September 30,2009 (please see *Liquidity and Capital Resources*below).

 

Inventories decreased by$38.5 million to $559.7 million at September 30, 2009 compared to $598.2million at September 30, 2008 due primarily to efforts to right-sizeinventory levels (including through lower purchases by us) during the fiscalyear ended September 30, 2009 in response to the current economicslowdown, and to the effect of foreign currency translation adjustments ofapproximately $7.3 million, partially offset by the inventories of businessesacquired in the 2009 fiscal year.

 

Current maturities of long-term debt decreased by$76.1 million to $24.5 million at September 30, 2009 compared to $100.6million at September 30, 2008 due primarily to the repayment of $75.0million of borrowings under our ABL facilities (please see *Liquidityand Capital Resources* below).

 

Accounts payableincreased by $21.6 million to $193.6 million at September 30, 2009 from$172.0 million at September 30, 2008 due primarily to changes in thetiming of payments to vendors in connection with purchases of inventory andproperty plant and equipment in the ordinary course of business, and to theassumption of the accounts payable of businesses acquired in the 2009 fiscalyear.

 

Net property and equipment decreased $5.0 million to$151.2 million at September 30, 2009 compared to $156.3 millionat September 30, 2008, primarily due to current fiscal year depreciationexpense and the effect of foreign currency translation adjustments, partiallyoffset by the net property and equipment of businesses acquired in the 2009fiscal year.

 

Goodwill increased $69.2 million to$494.1 million at September 30, 2009 compared to $425.0 millionat September 30, 2008, primarily due to acquisitions (please see Note 17of the “Notes to Consolidated Financial Statements” in Item 8 - “FinancialStatements and Supplementary Data”), partially offset by the effect of foreigncurrency translation adjustments.

 

Intangible assets decreased $6.7 million to$78.7 million at September 30, 2009 compared to $85.4 million atSeptember 30, 2008, primarily due to current fiscal year amortizationexpense and the effect of foreign currency translation adjustments, partiallyoffset by the effect of businesses acquired in the 2009 fiscal year.

 

Other assets decreased $4.0 million to $50.7 millionat September 30, 2009 compared to $54.7 million at September 30,2008, primarily due to amortization of the costs associated with the fiscalyear 2007 issuance of debt, which are being amortized as interest expense overthe term of the debt.

 

Long-term debt (excluding current maturities)decreased by $71.7 million to $1,653.0 million at September 30, 2009compared to $1,724.7 million at September 30, 2008 due primarily torepayments of principal under our senior term loan facilities made during thefiscal year ended September 30, 2009 (please see *Liquidityand Capital Resources* below).

 

Deferred income tax liabilities, net, decreased $3.5million to $34.4 million at September 30, 2009 compared to $37.9 millionat September 30, 2008. This decrease was primarily due to differencesbetween depreciation included for tax purposes versus depreciation included inour consolidated statements of earnings, and the tax effect of deferred(losses) gains on certain interest rate swaps.

 

Stock options subject to redemption decreased $4.1million to $1.8 million at September 30, 2009 compared to$5.9 million as of September 30, 2008, primarily due to exercises,cancellations and other adjustments in connections with these options.

 

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Total member’s deficit decreased by $80.1 million to$642.1 million at September 30, 2009, as a result of net earnings of$104.7 million; partially offset by cumulative translation adjustments anddeferred losses on interest rate swaps, as described below.

 

Accumulated other comprehensive (loss) income changedby $24.6 million, to a loss of $15.9 million at September 30, 2009, due toforeign currency translation adjustments of $14.4 million and deferred losseson hedged interest rate swaps of $10.2 million, net of income tax.

 

## **Liquidityand Capital Resources**

 

We broadly define liquidity as our ability to generatesufficient cash flow from operating activities to meet our obligations andcommitments. In addition, liquidity includes the ability to obtain appropriatedebt and equity financing and to convert into cash those assets that are nolonger required to meet existing strategic and financial objectives. Therefore,liquidity cannot be considered separately from capital resources that consistof current or potentially available funds for use in achieving long-rangebusiness objectives and meeting debt service commitments.

 

We are highly leveraged and a substantial portion ofour liquidity needs will arise from debt service on indebtedness incurredprimarily in connection with the Separation Transactions and from funding thecosts of operations, working capital and capital expenditures. As a holdingcompany, we depend on our subsidiaries to distribute funds to us so that we maypay our obligations and expenses. The ability of our subsidiaries to make suchdistributions will be subject to their operating results, cash requirements andfinancial condition and their compliance with covenants and financial ratiosrelated to their existing or future indebtedness. In addition, under Delawarelaw, the ability of each of our subsidiaries to make distributions to us willbe limited to the extent: (i) of its surplus, or if there is no surplus,of its net earnings for the fiscal year in which the distribution is declaredand/or the preceding fiscal year, if such subsidiary is a corporation; or (ii) thefair value of its assets exceeds its liabilities, in the case of a subsidiarythat is a limited liability company. If, as a consequence of these limitations,we cannot receive sufficient distributions from our subsidiaries, we may not beable to meet our obligations to fund general corporate expenses. Please see“Risk Factors—Risks Relating to Our Business,” and “—Risks Relating to OurSubstantial Indebtedness.”

 

We may from time to time repurchase or otherwiseretire our debt (through our subsidiaries) and take other steps to reduce ourdebt or otherwise improve our balance sheet. These actions may include openmarket repurchases of our notes, prepayments of our term loans or otherretirements of outstanding debt. The amount of debt that may be repurchased orotherwise retired, if any, would be decided upon at the sole discretion of SallyBeauty’s Board of Directors and will depend on market conditions, tradinglevels of the Company’s debt from time to time, the Company’s cash position andother considerations.

 

During the fiscal year ended September 30, 2009,the Company made scheduled payments in the aggregate amount of $6.1 million onits senior term loans. The senior term loan facilities may be prepaid at theoption of Sally Holdings at any time without premium or penalty and are subjectto mandatory repayment in an amount equal to 50% of excess cash flow (asdefined in the agreement governing the term loan facilities) for any fiscalyear unless a specified leverage ratio is met. In January 2009, theCompany made a mandatory repayment on the senior term loan facilities in theamount of $16.7 million and expects to make a mandatory repayment in the amountof $22.3 million in January of 2010. Amounts paid pursuant to saidprovision may be applied, at the option of the Company, against minimum loanrepayments otherwise required of it over the twelve-month period following anysuch payment under the terms of the loan agreement. During the fiscal yearended September 30, 2009, the Company also made optional repayments in theaggregate amount of $45.0 million on its senior term loans. In addition, in May 2009,the Company repurchased $5.0 million in par value of its 10.5% seniorsubordinated notes (due in November 2016) for approximately $5.0 million,plus accrued interest. In connection with the mandatory and optional repaymentsmade during the fiscal year ended September 30, 2009, the Company recordedlosses on extinguishment of debt in the aggregate amount of $1.0 million, whichare included in net interest expense in the Company’s consolidated statementsof earnings.

 

Based upon the current level of operations andanticipated growth, we anticipate that existing cash balances, funds expectedto be generated by operations, and funds available under the ABL facility willbe sufficient to meet our working capital requirements and to finance anticipatedcapital expenditures over the next 12 months.

 

There can be no assurance that our business willgenerate sufficient cash flows from operations, that anticipated net sales andoperating improvements will be realized, or that future borrowings will beavailable under our ABL facility in an amount sufficient to enable us toservice our indebtedness or to fund our other liquidity needs. In addition, ourability to meet our debt service obligations and liquidity needs are subject tocertain risks, which include, but are not limited to, increases in competitiveactivity, the loss of key suppliers, rising interest rates, the loss of keypersonnel, the ability to execute our business strategy and general economicconditions. Please see “Risk Factors.”

 

We utilize our ABL facilityfor the issuance of letters of credit as well as to manage normal fluctuationsin operational cash flow. In that regard, we may from time to time draw fundsunder the revolving credit facility for general corporate purposes including acquisitionsand interest payments due on our indebtedness.  The funds drawn onindividual occasions during the fiscal year ended September 30, 2009have varied in amounts of up to $20.0**million,with total amounts outstanding ranging from zero up to $120.0 million. Theamounts drawn are generally paid down with cash provided by our operatingactivities.

 

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As of September 30,2009, we had $325.6 million available for additional borrowings under our ABLfacility, subject to borrowing base limitations, as reduced by outstandingletters of credit.

 

We are a holding companyand do not have any material assets or operations other than ownership ofequity interests of our subsidiaries. The agreements and instruments governingthe debt of us and our subsidiaries contain material limitations on our abilityto pay dividends and other restricted payments to Sally Beauty.

 

Under the agreements andindentures governing the term loan facilities and the notes, we may not makecertain restricted payments to Sally Beauty if a default then exists under thecredit agreement or the indentures or if our consolidated interest coverage ratiois less than 2.0 to 1.0 at the time of the making of such restrictedpayment.  As of September 30, 2009,our consolidated interest coverage ratio exceeded 2.0 to 1.0.  Further, the aggregate amount of restrictedpayments we are able to make is limited pursuant to various baskets ascalculated pursuant to the credit agreement and indentures.

 

The agreements governing our ABL facility generallypermit the making of distributions and certain other restricted payments solong as borrowing availability under the facility equals or exceeds $60million.  If borrowing availability fallsbelow this amount, we may nevertheless make restricted payments to Sally Beautyin the aggregate since the date of the Separation Transactions, together withthe aggregate cash amount paid in acquisitions since said date, of not greaterthan $50 million, together with certain other exceptions.  As of September 30, 2009, borrowingavailability under the ABL facility exceeded $60 million. As of September 30,2009, the net assets of our consolidated subsidiaries that were unrestrictedfrom transfer under our credit arrangements totaled $225.3 million, subject tocertain adjustments**.**

 

During the fiscal year ended September 30, 2009,we completed several acquisitions at an aggregate cost of $82.3 million. Ingeneral, we funded these acquisitions with cash from operations. For example,on September 4, 2009, we acquired Distribuidora Intersalon Limitada, aleading distributor of premier beauty supply products with 16 stores located inChile for approximately $6.4 million and, on September 30, 2009, weacquired Schoeneman Beauty Supply, Inc. (“Schoeneman”), a 43-store beautysupply chain located in the central northeast United States, for approximately$71.0 million, subject to certain adjustments.

 

During the fiscal year ended September 30, 2008,we completed several acquisitions at an aggregate cost of $53.4 million. Ingeneral, we funded these acquisitions with cash from operations and, whennecessary, with borrowings under our ABL facility. For example, in May of2008, we acquired Pro-Duo, a 40-store beauty supply chain located in Belgium,France and Spain, for €19.3 million (approximately $29.8 million plusincidental costs capitalized) subject to certain adjustments.  We also assumed €3.0 million (approximately$4.7 million) of pre-acquisition debt of Pro-Duo in connection with theacquisition.

 

##### ***Historical Cash Flows***

 

### *Ourprimary source of cash has been from funds provided by operating activitiesand, for fiscal years 2009, 2008 and 2007, from borrowings. The primary uses ofcash during the past three years were for acquisitions and capital expendituresand, for fiscal year 2007, for the cash distribution paid in connection withthe Separation Transactions. The following table shows our sources and uses offunds for the fiscal years ended September 30, 2009, 2008 and 2007 (inthousands):*

 
| ** **                                                                     | ** ** | **Fiscal Year Ended September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                     | ** ** | **2009**                                 | ** ** | **2008** | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| Cash provided by  operating activities                                         |       | $                                        | 223,984    |   | $ | 111,415 |   | $ | 112,569 |   | $ | 111,415 |   | $ | 194,267 |   | $ | (82,852 | ) |
| Cash used by investing  activities                                             |       | (118,559                                 | )          | (98,162 | ) | (20,397 | ) | (98,162 | ) | (121,364 | ) | 23,202 |   |
| Cash (used) provided by  financing activities                                  |       | (149,916                                 | )          | 47,134 |   | (197,050 | ) | 47,134 |   | (143,814 | ) | 190,948 |   |
| Effect of foreign  currency exchange rate changes on cash and cash equivalents |       | (850                                     | )          | 1,129 |   | (1,979 | ) | 1,129 |   | 1,612 |   | (483 | ) |
| Net (decrease) increase  in cash and cash equivalents                          |       | $                                        | (45,341    | ) | $ | 61,516 |   | $ | (106,857 | ) | $ | 61,516 |   | $ | (69,299 | ) | $ | 130,815 |   |

 

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### *Cash Provided by Operating Activities*

 

Net cash provided by operating activities, whichexcludes cash used for acquisitions completed during the period, during the fiscalyear ended September 30, 2009 increased by $112.6 million to$224.0 million compared to $111.4 million during the fiscal yearended September 30, 2008. The increase was primarily due to a reduction ofapproximately $75.7 million in inventory levels, an increase in accountspayable and accrued expenses of approximately $29.0 million, and an improvementof approximately $21.9 million in earnings, partially offset by a change inother liabilities of $12.4 million for the fiscal year ended September 30,2009 compared to the fiscal year ended September 30, 2008.

 

Net cash provided by operating activities, whichexcludes the effects of acquisitions, during the fiscal year ended September 30,2008 decreased by $82.9 million to $111.4 million compared to $194.3 millionduring the fiscal year ended September 30, 2007. The decrease was dueprimarily to an increase in cash used to purchase inventory of approximately$69.6 million as our inventory levels increased and a reduction in accountspayable and accrued expenses of $35.6 million. This decrease was offset, in part, by improved earnings for the fiscalyear ended September 30, 2008 of approximately $34.3 million.

 

### *Cash Used by Investing Activities*

###  

Net cash used by investing activities during thefiscal year ended September 30, 2009 increased by $20.4 million to$118.6 million compared to $98.2 million during the fiscal year endedSeptember 30, 2008.  This increasewas primarily due to $28.6 million more in cash used for acquisitions,partially offset by lower capital expenditures (primarily as a result of fewerstore openings) for the fiscal year ended September 30, 2009 compared tothe fiscal year ended September 30, 2008.

 

Net cash used by investing activities during thefiscal year ended September 30, 2008 decreased by $23.2 million to$98.2 million compared to $121.4 million during the fiscal year endedSeptember 30, 2007.   This decreasewas due primarily to a reduction in cash used for acquisitions of $23.5 million(including approximately $29.8 million in connection with the acquisition ofPro-Duo in 2008 and approximately $57.7 million in connection with theacquisition of Salon Services in 2007) partially offset by proceeds from thesale of property and equipment in 2007 of $8.4 million.

 

### *Cash (Used) Provided by Financing Activities*

###  

Net cash (used) provided by financing activitiesduring the fiscal year ended September 30, 2009 changed by $197.1 millionto cash used of $149.9 million compared to cash provided of$47.1 million during the fiscal year ended September 30, 2008.  The change was primarily due to netborrowings of $63.6 million under our ABL facility during the fiscal year endedSeptember 30, 2008 compared to net repayments of $75.0 million during thefiscal year ended September 30, 2009. In addition, during the fiscal yearended September 30, 2009, the Company made scheduled payments in theaggregate amount of $6.1 million, a mandatory repayment in the amount of $16.7million and optional repayments in the aggregate amount of $45.0 million on itsterm loan facilities and the Company repurchased $5.0 million in par value ofits senior subordinated notes (please see *Liquidity and CapitalResources* above).

 

Net cash provided by financing activities during thefiscal year ended September 30, 2008 increased by $190.9 million to$47.1 million compared to cash used of $143.8 million during thefiscal year ended September 30, 2007. The increase was due primarily to the absence, during the fiscal yearended September 30, 2008, of distributions to Sally Beauty andAlberto-Culver and costs associated with the Separation Transactions (includingdebt issuance costs and the special cash distribution paid to Sally Beauty)during the fiscal year ended September 30, 2007. These increases wereoffset, in part, by the absence, during the fiscal year ended September 30,2008, of proceeds from the issuance of debt in connection with the SeparationTransactions during the fiscal year ended September 30, 2007.

 

##### ***Credit Facilities***

 

In connection with the Separation Transactions, we: (i) enteredinto the Term Loans in an aggregate amount of $1,070.0 million; (ii) issuedsenior notes in an aggregate amount of $430.0 million and senior subordinatednotes in an aggregate amount of $280.0 million (the Notes); and (iii) enteredinto the $400.0 million ABL facility, subject to borrowing base limitations, ofwhich approximately $70.0 million was drawn at closing, which resulted in theincurrence of aggregate indebtedness in connection with the SeparationTransactions of approximately $1,850.0 million. Proceeds from this new debt andthe $575.0 million equity investment in Sally Beauty by the CDR Investorswere used to pay a $25.00 per share cash dividend to holders of record ofAlberto-Culver shares as of the record date for the Separation Transactions.Please see “Risk Factors—Risks Relating to Our Substantial Indebtedness.”

 

As of September 30, 2009, there were outstandingborrowings of $968.9 million under the Term Loans, at a weighted averageinterest rate of 2.52%, and outstanding borrowings of $705.0 million under theNotes, at a weighted average interest rate of 9.75%. As of September 30,2009, we had $325.6 million available for additional borrowings under our ABLfacility, subject to borrowing base limitations, as reduced by outstandingletters of credit.

 

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The agreements and instruments governing our debtcontain restrictions and limitations that could significantly impact ourability to operate our business. These restrictions and limitations relate to:

 

·                  disposal of assets

·                  incurrence of additional indebtedness (includingguarantees of additional indebtedness)

·                  dividends and distributions

 

·                  certain debt prepayments and modifications

·                  liens on assets

·                  making investments (including joint ventures)

·                  mergers, consolidations or sales of our assets

 

·                  ability of subsidiaries to pay dividends

·                  making acquisitions of all of the business or assetsof or stock representing beneficial ownership of, any person

 

In addition, the ABL facility contains restrictionsand limitations related to: (i) changing our line of business; (ii) changingour fiscal year; and (iii) creating or incurring negative pledges.

 

The Term Loans and the ABLfacility are secured by substantially all of our assets, those of SallyInvestment, those of our domestic subsidiaries and, in the case of the ABLfacility, those of our Canadian subsidiaries. The Term Loans may be prepaid atour option at any time without premium or penalty and are subject tomandatory prepayment in an amount equal to 50% of excess cash flow (as definedin the agreement governing the Term Loans) for any fiscal year unless aspecified leverage ratio is met. Additionally, the Term Loans are subject tomandatory prepayment in an amount equal to 100% of the proceeds of specifiedasset sales that are not reinvested in the business or applied to repayborrowings under the ABL facility.

 

The Term Loans contain a covenant requiring us and oursubsidiaries to meet certain maximum consolidated secured leverage ratiolevels, which decline over time. The consolidated secured leverage ratio is aratio of (A) net consolidated secured debt to (B) Consolidated EBITDAas defined in the agreement underlying the Term Loans. Compliance with theconsolidated secured leverage ratio is tested quarterly, with a maximum ratioof 4.50 as of September 30, 2009. Failure to comply with the consolidatedsecured leverage ratio covenant under the Term Loans would result in a defaultunder such facilities.

 

The ABL facility contains a covenant requiring us andour subsidiaries to maintain a fixed-charge coverage ratio of at least 1.0 to1.0 in the event that availability under the ABL facility falls below $40.0million. The fixed-charge coverage ratio is defined as the ratio of (A) EBITDA(as defined in the agreement underlying the ABL facility, or Credit AgreementEBITDA) less unfinanced capital expenditures to (B) fixed charges (as includedin the definition of the fixed-charge coverage ratio in the agreement governingthe ABL facility).

 

For purposes of calculating either the consolidatedsecured leverage ratio or the fixed-charge coverage ratio, Consolidated EBITDAand Credit Agreement EBITDA are measured on a last-four-quarters basis.Accordingly, the calculation can be disproportionately affected by aparticularly strong or weak quarter and may not be comparable to the measurefor any previous or subsequent four-quarter period.

 

Failure to comply with the fixed-charge coverage ratiocovenant (if and when applicable) under the ABL facility would result in adefault under such facility. A default could also result in a default under theother facility or facilities, as the case may be, and the Notes. Absent awaiver or an amendment from our lenders and note holders, such defaults couldpermit the acceleration of all indebtedness under the ABL facility, the TermLoans and the Notes, which would have a material adverse effect on our resultsof operations, financial position and cash flows.

 

Consolidated EBITDA and Credit Agreement EBITDA arenot recognized measurements under accounting principles generally accepted inthe United States of America, or GAAP, and should not be considered as asubstitute for financial performance and liquidity measures determined inaccordance with GAAP, such as net earnings, operating income or operating cashflow. In addition, because other companies may calculate EBITDA differently,Consolidated EBITDA and Credit Agreement EBITDA likely will not be comparableto EBITDA or similarly titled measures reported by other companies or reportedby us in our quarterly earnings releases.

 

We believe that we are currently in compliance withthe agreements and instruments governing our debt, including our financialcovenants. Our ability to comply with these covenants in future periods willdepend on our ongoing financial and operating performance, which in turn willbe subject to economic conditions and to financial, market and competitivefactors, many of which are beyond our control. Our ability to comply with thesecovenants in future periods will also depend substantially on the pricing ofour products, our success at implementing cost reduction initiatives and our abilityto successfully implement our overall business strategy. Please see “RiskFactors—Risks Relating to Our Substantial Indebtedness.”

 

##### ***Capital Requirements***

 

During the fiscal year 2009, we had total capitalexpenditures of approximately $37.3 million which were primarily to fund theaddition of new stores; the remodel, expansion or relocation of existing storesin the ordinary course of our business; and corporate projects. For the fiscalyear 2010, we anticipate capital expenditures in the range of approximately$45.0 million to $50.0 million,

 

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excluding acquisitions. Capital expenditures will beprimarily for the addition of new stores; the remodel, expansion or relocationof existing stores in the ordinary course of our business; and corporateprojects.

 

## **ContractualObligations**

 

The following table is a summary of our contractualcash obligations and commitments outstanding by future payment dates at September 30,2009 (in thousands):

 
| ** **                                                     | ** ** | **Payments Due by Period**  | ** ** |
|----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                     | ** ** | **Less than 1********year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5 years** | ** ** | **Total** | ** ** |
| Long-term debt  obligations, including interest obligations(a) |       | $                           | 117,310    |   | $ | 268,187 |   | $ | 1,026,306 |   | $ | 771,331 |   | $ | 2,183,134 |   |
| Operating leases  obligations(b)                               |       | 128,417                     |       | 197,876 |   | 99,332 |   | 63,351 |   | 488,976 |   |
| Purchase obligations(c)                                        |       | 66,176                      |       | 55,169 |   | — |   | — |   | 121,345 |   |
| Other long-term  obligations(d)                                |       | 12,300                      |       | 30,343 |   | 8,340 |   | 4,930 |   | 55,913 |   |
| Total                                                          |       | $                           | 324,203    |   | $ | 551,575 |   | $ | 1,133,978 |   | $ | 839,612 |   | $ | 2,849,368 |   |

 

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(a)                                  Long-term debtincludes capital leases and future interest payments on debt facilities, basedupon outstanding principal amounts and interest rates as of September 30,2009.

 

(b)                                 In accordancewith GAAP, these obligations are not reflected in the accompanying consolidatedbalance sheets. The operating leases do not include executory costs.

 

(c)                                  Purchaseobligations reflect legally binding agreements entered into by us to purchasegoods that specify minimum quantities to be purchased with variable priceprovisions. In accordance with GAAP, these obligations are not reflected in theaccompanying consolidated balance sheets.

 

(d)                                 Other long-termobligations principally represent commitments under various acquisition-relatedagreements including non-compete, consulting and severance agreements anddeferred compensation arrangements. These obligations are included in accruedexpenses and other liabilities in the accompanying consolidated balance sheets.

 

The table above excludes amounts included in currentliabilities, other than the current portion of long-term debt, as these itemswill be paid within one year, and long-term liabilities not requiring cashpayments, such as deferred lease incentives.

 

Our assumptions with respect to the interest ratesapplicable to the Term Loans and the ABL facility are subject to changes thatmay be material. In addition, other future events could cause actual paymentsto differ materially from these amounts. Please see Note 12 of the “Notes toConsolidated Financial Statements” in “Item 8—Financial Statements andSupplementary Data” of this Annual Report and “Item 7A—Quantitative andQualitative Disclosures about Market Risk—Interest rate risk” for a discussionof interest rate swap agreements.

 

The majority of our operating leases are for SallyBeauty Supply and BSG stores, which typically are located in strip shoppingcenters. The use of operating leases allows us to expand our business to newlocations without making significant up-front cash outlays for the purchase ofland and buildings.

 

## **Off-BalanceSheet Financing Arrangements**

 

At September 30, 2009 and 2008, we had nooff-balance sheet financing arrangements other than operating leases incurredin the ordinary course of business, as well as outstanding letters of creditrelated to inventory purchases and self insurance programs, which totaled $13.4million and $12.1 million, respectively.

 

## **Inflation**

 

We believe that inflation currently does not have amaterial effect on our results of operations.

 

## **CriticalAccounting Policies and Estimates**

 

The preparation of financial statements in conformitywith GAAP requires us to make estimates and assumptions that affect thereported amounts of assets, liabilities, revenues and expenses and disclosureof contingent assets and liabilities in the financial statements. Actualresults may differ from these estimates. We believe these estimates andassumptions are reasonable. We consider accounting policies to be critical whenthey require us to make assumptions about matters that are highly uncertain atthe time the accounting estimate is made and when different estimates that ourmanagement reasonably could have used have a material effect on thepresentation of our financial condition, changes in financial condition orresults of operations.

 

Our critical accounting policies include but are notlimited to the valuation of inventories, vendor concessions, retention of risk,income taxes, long-lived assets impairment assessment, share-based payments andrelated party transactions.

 

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##### ***Valuation of Inventories***

 

When necessary, we adjust the carrying value ofinventories to the lower of cost or market, including costs to sell or dispose,and for estimated inventory shrinkage. Inventories are stated at the lower ofcost (first in, first out method) or market (net realizable value). Estimatesof the future demand for our products, age of the inventory and changes instock-keeping units are some of the key factors used by our management inassessing the net realizable value of inventories. We estimate inventoryshrinkage based upon our historical experience. Actual results differing fromthese estimates could significantly affect our inventories and cost of productssold and distribution expenses. Inventory shrinkage averaged approximately 1.0%of consolidated net sales in fiscal years 2009, 2008 and 2007. A 10% increaseor decrease in our estimate of inventory shrinkage at September 30, 2009,would impact net earnings by approximately $1.5 million, net of income tax.

 

##### ***Vendor Rebates and Concessions***

 

We account for cash consideration received from vendorsunder ACS 605-50, *Customer Payments and Incentives*.This standard states that cash consideration received by a customer ispresumed to be a reduction of the cost of sales unless it is for an asset orservice or a reimbursement of a specific, incremental, identifiable costincurred by the customer in selling the vendor’s products. The majority of cashconsideration we receive is considered to be a reduction of the cost of salesand is allocated to cost of products sold and distribution expenses as the relatedinventory is sold. We consider the facts and circumstances of the variouscontractual agreements with vendors in order to determine the appropriateclassification of amounts received in the consolidated statements of earnings.We record cash consideration expected to be received from vendors in otherreceivables. These receivables are recorded at the amount we believe will becollected based on the provisions of the programs in place and are computed byestimating the point in time that we have completed our performance under theagreements and the amounts earned. These receivables could be significantlyaffected if actual results differ from management’s expectations. A 10%increase or decrease in these receivables at September 30, 2009, wouldimpact net earnings by approximately $1.4 million, net of income tax.

 

##### ***Retention of Risk***

 

### *Employee Health Insurance Liability*

 

We maintain a largely self-funded program forhealthcare benefits for employees who work for us on a full-time basis. Wecover the majority of expenses associated with these benefits, other thanpayroll deductions and out-of pocket expenses paid by the employees. Paymentsfor healthcare benefits below specified amounts (currently $350,000 perindividual per year and $1,000,000 per individual for a lifetime maximum) areself-insured by us. We base our estimate of ultimate liability on trends inclaim payment history, historical trends in claims incurred but not yetreported, and other components such as expected increases in medical costs, projectedpremium costs and the number of plan participants. We review our liability on aregular basis and adjust our accruals accordingly. As of September 30,2009 and 2008, we accrued an estimated liability relating to employee healthinsurance of $5.6 million and $7.1 million, respectively.  Prior to the Separation Transactions, ouremployees were covered by healthcare plans provided by Alberto-Culver.

 

Changes in facts and circumstances may lead to achange in the estimated liability due to revisions of the estimated ultimatecosts of our employee healthcare benefits. Estimates of medical costs andtrends in claims are some of the key factors used by our management indetermining our employee health insurance liability. This liability could besignificantly affected if actual results differ from management’s expectations.A 10% increase or decrease in our employee health insurance liability at September 30,2009 would impact net earnings by approximately $0.3 million, net of incometax.

 

### *Workers’ Compensation Liability, GeneralLiability and Automobile and Property Liability*

###  

We maintain a large deductible insurance plan forworkers’ compensation liability, general liability and automobile and propertyliability loss exposures. We base our estimates of the ultimate liability on anactuarial analysis performed by an independent third-party actuary. We reviewour liability on a regular basis and adjust our accruals accordingly. As of September 30,2009 and 2008, our balance sheet included an estimated liability related to thedeductible and retention limits of approximately $19.7 million and $16.5million, respectively. Prior to the Separation Transactions, we were covered bythe workers’ compensation, general liability and automobile and propertyliability plans provided by Alberto-Culver.

 

Changes in facts and circumstances may lead to achange in the estimated liability due to revisions of the estimated ultimatecosts that affect our workers’ compensation, general liability and automobileand property liability insurance coverage. Changes in estimates occur over timedue to such factors as claims incidence and severity of injury or damages. Ourliabilities could be significantly affected if actual results differ frommanagement’s expectations or actuarial analyses. A 10% increase or decrease inour workers’ compensation liability, general liability and automobile andproperty liability at September 30, 2009 would impact net earnings byapproximately $1.2 million, net of income tax.

 

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The change in the self-insurance liability was asfollows (in thousands):

 
| ** **                                       | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                       | ** ** | **2009**                          | ** ** | **2008** | ** ** |
| Balance at beginning of  period                  |       | $                                 | 25,415     |   | $ | 18,663 |   |
| Self-insurance expense                           |       | 54,566                            |       | 46,511 |   |
| Self-insurance  liability of businesses acquired |       | 214                               |       | — |   |
| Payments, net of  employee contributions         |       | (53,275                           | )          | (39,759 | ) |
| Balance at end of  period                        |       | $                                 | 26,920     |   | $ | 25,415 |   |

 

##### ***Income Taxes***

 

We record tax provisions in our consolidated financialstatements based on an estimation of current income tax liabilities. Thedevelopment of these provisions requires judgments about tax issues, potentialoutcomes and timing. If we prevail in tax matters for which provisions havebeen established or are required to settle matters in excess of establishedprovisions, our effective tax rate for a particular period could besignificantly affected.

 

Deferred income taxes are recognized for the futuretax consequences attributable to differences between the financial statementcarrying amounts of assets and liabilities and their respective tax bases.Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which temporary differencesare estimated to be recovered or settled. We believe that it is more likelythan not that our results of operations in the future will generate sufficienttaxable income to realize our deferred tax assets, net of the valuationallowance currently recorded. In the future, if we determine that certaindeferred tax assets will not be realizable, the related adjustments couldsignificantly affect our effective tax rate at that time.  The estimated tax benefit of an uncertain taxposition is recorded in our financial statements only after determining amore-likely-than-not probability that the uncertain tax position will withstandchallenge, if any, from applicable taxing authorities.

 

***Long-Lived Assets ImpairmentAssessment***

 

Long-lived assets, such as property and equipment,including store equipment, and purchased intangibles subject to depreciation oramortization, are reviewed for impairment annually, and whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. Recoverability of long-lived assets is measured by a comparisonof the carrying amount of an asset to estimated future cash flows expected tobe generated by the asset. If the carrying amount of an asset exceeds itsestimated future cash flows, an impairment charge is recognized by the amountby which the carrying amount of the asset exceeds the fair value of the asset.There were no significant impairments in the current or prior fiscal yearspresented in the accompanying financial statements.

 

##### ***Share-Based Payments***

 

We account for stock-based compensation under ASC 718.We recognize compensation expense on a straight-line basis over the vestingperiod or to the date a participant becomes eligible for retirement, ifearlier. For fiscal years 2009, 2008 and 2007, total compensation cost chargedagainst income and included in selling, general and administrative expenses forshare-based compensation arrangements was $8.0 million, $9.6 million and $12.3million, respectively.

 

The amount of stock option expense is determined basedon the fair value of each stock option grant, which is estimated on the date ofgrant using the Black-Scholes option pricing model with the followingassumptions: expected life, volatility, risk-free interest rate and dividendyield. The expected life of Sally Beauty’s stock options represents the periodof time that the stock options granted are expected to be outstanding. Weestimate the expected life based on historical exercise trends. We estimateexpected volatility by using an industry group that Sally Beauty belongs tosince it is not practicable to estimate the expected volatility due to our lackof trading history. The risk-free interest rate is based on the zero-couponU.S. Treasury issue at the date of the grant for the expected life of the stockoptions. The dividend yield represents Sally Beauty’s anticipated cash dividendover the expected life of the stock options. The amount of stock option expenserecorded is significantly affected by these estimates. In addition, we recordstock option expense based on an estimate of the total number of stock optionsexpected to vest, which requires us to estimate future forfeitures. We usehistorical forfeiture experience as a basis for this estimate. Actualforfeitures differing from these estimates could significantly affect thetiming of the recognition of stock option expense. We have based all theseestimates on our assumptions as of September 30, 2009. Our estimates forfuture periods may be based on different assumptions and accordingly maydiffer.

 

We believe that our stock-based compensation expenseis based on reasonable estimates and assumptions. However, if actual resultsare not consistent with our estimate or assumptions, we may be exposed tochanges in stock-based compensation expense that could be material. A 10%change in our stock based compensation expense for the year ended September 30,2009 would affect earnings by approximately $0.5 million, net of income tax.

 

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##### ***Related Party Transactions***

 

In January of 2007, we entered into an agreementwith Sally Beauty under which we agreed to provide certain general andadministrative services to Sally Beauty including accounting, finance, payroll,legal and tax sharing services. The cost of these services is based on apercentage of certain key employees’ salaries and benefits, and may not necessarilybe indicative of the costs which would be incurred by Sally Beauty as anindependent stand alone entity.

 

In addition, we have entered into a tax sharingagreement and we file consolidated tax returns with our parent, SallyBeauty.  See Note 16 of the “Notes toConsolidated Financial Statements” in “Item 8—Financial Statements andSupplementary Data” of this report for further information.

 

## **RecentAccounting Pronouncements**

 

In June 2009, theFASB issued a new accounting standard named *The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples*. This pronouncement, among other things, identified thepreviously issued accounting standards that were considered authoritativegenerally accepted accounting principles in the U.S. and replaced allpreviously issued accounting pronouncements of the FASB, and its predecessorrule-making bodies, with the ASC. This standard was effective prospectively forreporting periods ended after September 15, 2009 and, accordingly, theCompany adopted it during the fourth quarter of the fiscal year 2009. Theadoption of this standard did not have an effect on the Company’s consolidatedfinancial position, results of operations or cash flows. As a result ofadopting this standard, the Company’s references to GAAP standards have beenchanged to refer to topics, subtopics, sections or subsections of the ASC, asappropriate.

 

In May 2009, theFASB issued ASC 855, *Subsequent Events*(“ASC855”). ASC 855 establishes standards of accounting for and disclosure oftransactions and events that occur after the balance sheet date but before thefinancial statements are issued. This accounting standard requires thedisclosure, among other things, of the date through which an entity has evaluatedsubsequent events and whether that date is the date the financial statementswere issued or the date the financial statements were available to be issued.This accounting standard must be applied prospectively for interim and annualperiods ended after June 15, 2009 and, accordingly, the Company adoptedits provisions effective for the quarter ended June 30, 2009. Inconnection therewith, the Company has evaluated all material transactions andevents through November 19, 2009, the last full business day before thisAnnual Report was filed with the SEC.

 

Effective on January 1,2009, the Company adopted the amendment to ASC 815 contained in ASC 815-10-65,*Derivatives and Hedging, Transition*(“ASC 815-10-65”). ASC815-10-65 established, among other things, the disclosure requirements forderivative instruments and for hedging activities. This standard amended andexpanded those disclosures to also require qualitative disclosures about theobjectives and strategies for using derivative instruments, quantitativedisclosures about the fair value of and gains and losses on derivativeinstruments and disclosures about credit-risk-related contingent featurescontained in the derivative instruments. This standard also requires companies to disclose information about howderivatives and related hedges are accounted for and how the hedges affect theentity’s financial position, financial performance and cash flows, includingthe location and amounts of derivative instruments in the entity’s financialstatements.

 

As required by ASC 815,the Company records all derivative instruments on its balance sheet at fairvalue.  The accounting for changes in the fair value of derivativeinstruments depends on the intended use of the derivative, whether the Companyhas elected to designate a derivative instrument in a hedging relationship andapply hedge accounting and whether the hedging relationship has satisfied thecriteria necessary to apply hedge accounting. Derivative instruments designatedand qualifying as a hedge of the exposure to variability in expected futurecash flows or other types of forecasted transactions are considered cash flowhedges. Hedge accounting generally provides for the matching of the timing ofgain or loss recognition on the hedging instrument with the recognition of theimpact on earnings of the hedged transaction or transactions. The Company mayfrom time to time enter into derivative contracts that are intended to hedgecertain economic risks even though hedge accounting does not apply or the Companyelects not to apply hedge accounting to such derivative contracts. Please seeNote 12 of the “Notes to Consolidated Financial Statements” in Item 8 -“Financial Statements and Supplementary Data” for more details about theCompany’s derivative instruments and hedging activities as of September 30,2009.

 

The Company adopted theprovisions of ASC 820, *Fair Value Measurementsand Disclosures*(“ASC 820”), as it relates to its financialinstruments, effective on October 1, 2008. ASC 820 defines fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements. This standarddefines “fair value” as the price that would be received to sell an asset orpaid to transfer a liability in the principal or most advantageous market in anorderly transaction between market participants on the measurement date.  This standard establishes a three-levelhierarchy for measuring fair value and requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value.

 

This valuation hierarchyis based upon the transparency of inputs to the valuation of an asset orliability on the measurement date.  Thethree levels of that hierarchy are defined as follows:

 

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Level 1 - Unadjusted quoted prices in activemarkets for identical assets or liabilities

 

Level 2 - Unadjusted quoted prices in activemarkets for similar assets or liabilities; or unadjusted quoted prices foridentical or similar assets or liabilities in markets that are not active; orinputs other than quoted prices that are observable for the asset or liability;or inputs that are derived principally from or corroborated by observablemarket data

 

Level 3 - Unobservable inputs for the asset orliability

 

The Company measurescertain financial assets and liabilities at fair value on a recurring basis,including interest rate swaps. The Company has determined that the majority ofthe inputs used to value its interest rate swaps fall within Level 2 of thevaluation hierarchy. In accordance with ASC 820, the Company categorizedcertain of its financial assets and liabilities based on priority of the inputsto the valuation technique for the instruments, as follows (in thousands):

 
| ** **                          | ** ** | **As of September 30, 2009** | ** ** |
|-------------------------------------|------------|-----------------------------------|------------|
| ** **                          | ** ** | **Total**                         | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Liabilities                         |       |                              |       |   |   |   |   |   |   |
| Long-term  debt (1)                 |       | $                                 | 1,655,076  |   | $ | 727,719 |   | $ | 927,357 |   |   |   |
| Hedged  interest rate swaps (2)     |       | 15,365                            |       |   |   | 15,365 |   |   |   |
| Non-hedged  interest rate swaps (2) |       | 2,356                             |       |   |   | 2,356 |   |   |   |
| Total                               |       | $                                 | 1,672,797  |   | $ | 727,719 |   | $ | 945,078 |   |   |   |

 

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(1) Long-termdebt, which is carried at amortized cost in the Company’s financial statements,is valued using internal models based on market observable inputs, except forthe senior and senior subordinated notes. The senior and senior subordinatednotes are valued using quoted market prices for such debt securities.

(2) Interestrate swaps are valued using internal models based on market observable inputs,including market interest rates.

 

In April 2009, theFASB amended ASC 825, *Financial Instruments*.This amendment, currently contained in ASC 825-10-50, extended to interimperiods certain disclosures about fair value of financial instruments forpublicly traded companies and amended prior accounting standards to requirethose disclosures in summarized financial information at interim reportingperiods. This amendment was effective for interim reporting periods endingafter June 15, 2009 and its adoption, during the third quarter of thefiscal year 2009, did not have a material effect on the Company’s consolidatedfinancial position, results of operations or cash flows.

 

We have not yet adoptedand are currently assessing any potential effect of the followingpronouncements on our consolidated financial statements:

 

In August 2009, theFASB issued Accounting Standards Update 2009-05 which amended ASC 820, *Fair Value Measurements and Disclosures*(“ASC 820”), as itrelates to the measurement of liabilities at fair value, effective for interimreporting periods beginning after August 26, 2009. This update providesclarification for liabilities in which a quoted price in an active market foran identical liability is not available.

 

In April 2008, theFASB amended ASC 350, *Intangibles and Other*.This new accounting standard, currently contained in ASC 350-30-35,specifically amends the factors that should be considered in developing renewalor extension assumptions used to determine the useful life of a recognizedintangible asset. The objective of this amendment is to improve the consistencybetween the useful life of a recognized intangible asset and the period ofexpected cash flows used to measure the fair value of the asset. This newstandard is effective for fiscal years beginning after December 15, 2008.Early application is not permitted.

 

In December 2007, the FASB revised the accountingstandards for business combinations. This new standard, currently contained inASC 805, *Business Combinations*(“ASC 805”), amongother things, generally requires that an acquirer recognize the assets acquiredand liabilities assumed measured at their “full fair values” on the acquisitiondate. This practice replaces the practice, under predecessor accountingstandards, of allocating the cost of an acquisition to the individual assetsacquired and liabilities assumed based on their relative estimated fairvalues.  This new standard further requiresthat acquisition-related costs be recognized separately from the relatedacquisition and must be applied prospectively to business combinationsconsummated on or after the first annual reporting period beginning on or afterDecember 15, 2008.  Earlyapplication is not permitted.

 

In April 2009, the FASBissued ASC 805-20 *Business Combinations — Identifiable Assetsand Liabilities and Any Non-controlling Interest*. This newaccounting standard amends and clarifies ASC 805 and applies to assets acquiredand liabilities assumed that arise from contingencies in a businesscombination.  This amendment mustalso be applied prospectively to business combinations consummated on or afterthe first annual reporting period beginning on or after December 15,2008.  Early application is notpermitted.

 

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# **ITEM 7A. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

As a multinational corporation, we are subject tocertain market risks including foreign currency fluctuations, interest ratesand credit risk. We consider a variety of practices to manage these marketrisks, including, when deemed appropriate, the occasional use of derivativefinancial instruments.

 

## **Foreigncurrency exchange rate risk**

 

We are exposed to potential gains or losses fromforeign currency fluctuations affecting net investments and earningsdenominated in foreign currencies. Our primary exposures are to changes inexchange rates for the U.S. dollar versus the British pound sterling,Canadian dollar, Euro and Mexican peso. Our various foreign currency exposuresat times offset each other providing a natural hedge against foreign currencyrisk. For fiscal year 2009, 2008 and 2007, approximately 16%, 18% and 16%,respectively, of our sales were made in currencies other than the U.S. dollar.Consolidated net sales for the fiscal year ended September 30, 2009, areinclusive of approximately $86.0 million in negative impact from changes inforeign currency exchange rates. In addition, for the fiscal year ended September 30,2009, other comprehensive income reflects $14.4 million in foreign currencytranslation adjustments. Fluctuations in the U.S. dollar exchange ratesfor the fiscal years 2009, 2008 and 2007 did not otherwise have a materialeffect on our consolidated financial condition and consolidated results ofoperations.

 

We currently have no derivative financial instrumentsintended to manage foreign currency exchange rate risk. A 10% increase ordecrease in the exchange rates for the U.S. dollar versus the foreigncurrencies to which we have exposure, would have impacted consolidated netsales by approximately 1.6% in the fiscal year 2009, and would have impactedconsolidated net assets by 2.3% at September 30, 2009.

 

## **Interestrate risk**

 

As a result of the debt financing incurred inconnection with the Separation Transactions, we are subject to interest ratemarket risk in connection with our long-term debt. The principal interest rateexposure relates to amounts borrowed under the Term Loans and the ABL facility.Based on the approximately $968.9 million of borrowings under the Term Loansand the ABL facility as of September 30, 2009, a change in the estimatedapplicable interest rate up or down by 1/8% will increase or decrease earningsbefore provision for income taxes by approximately $1.2 million on an annualbasis, without considering the effect of any interest rate swap agreements wemay have from time to time.

 

We are sensitive to interest rate fluctuations. Inorder to enhance our ability to manage risk relating to cash flow and interestrate exposure, we and/or our other subsidiaries who are borrowers under the ABLfacility may from time to time enter into and maintain derivative instruments,such as interest rate swap agreements, for periods consistent with the relatedunderlying exposures. In addition, pursuant to the agreement underlying ourTerm Loans we hedge a portion of our floating interest rate exposure for aspecified period as more fully described below. We do not purchase or hold anyderivative instruments for speculative or trading purposes.

 

In November of 2006, we entered into fourinterest rate swap agreements with an aggregate notional amount of $500million. Interest rate swap agreements with an aggregate notional amount of$150 million expired in November 2008 and interest rate swap agreementswith a notional amount of $350 million expire in November 2009. Theagreements outstanding at September 30, 2009 enable us to convert aportion of our variable interest rate obligations to fixed rate obligationswith interest rates ranging from 7.19% to 7.44%. Theseinterest rate swap agreements do not currently qualify as hedges and,therefore, the change in the fair value of these interest rate swap agreements,which are adjusted quarterly, are recorded in net interest expense in theCompany’s results of operations. As discussed in Item 1A“Risk Factors,” changes in the fair value of these interest rate swapagreements are mainly driven by interest rate changes and will increase ordecrease our net interest expense and may therefore affect our earnings.

 

In May of 2008, we entered into two additionalinterest rate swap agreements with an aggregatenotional amount of $300 million (each agreement with anotional amount of $150 million).  Theseagreements expire on May 31, 2012 and enable us to convert a portion ofour variable interest rate obligations to fixed rate obligations with interestranging from 5.818% to 6.090%.  Theseagreements are designated as effective hedges consistent with ASC 815.  Adjustments to reflect the change in the fairvalues of these interest rate swap agreements, which areadjusted quarterly, are recorded in accumulated othercomprehensive (loss) income until the hedged obligation is settled or the swapagreements expire, whichever is earlier. Any ineffectiveness of these interest rate swaps is recognized inearnings.

 

## **Creditrisk**

 

We are exposed to credit risk on certain assets,primarily cash equivalents, short-term investments and accounts receivable. Webelieve that the credit risk associated with cash equivalents and short-terminvestments, if any, is largely mitigated by our policy of investing in adiversified portfolio of securities with high credit ratings.

 

We provide credit to customers in the ordinary courseof business and perform ongoing credit evaluations. We believe that ourexposure to concentrations of credit risk with respect to trade receivables islargely mitigated by our broad customer base. We believe our allowance fordoubtful accounts is sufficient to cover customer credit risks.

 

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# **ITEM 8. FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

Please see “Index to Financial Statements” which islocated on page 67 of this Annual Report.

 

# **ITEM 9. CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

# **ITEM 9A. CONTROLSAND PROCEDURES**

 

*Background.*  Attached as exhibits to this Annual Report onForm 10-K are certifications of our Chief Executive Officer (“CEO”) andChief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14of the Exchange Act. This “Controls and Procedures” section includesinformation concerning the controls and controls evaluation referred to in thecertifications. Part II, Item 8—Financial Statements and SupplementaryData of this Annual Report on Form 10-K sets forth the attestation reportof KPMG LLP, our independent registered public accounting firm, regarding itsaudit of our internal control over financial reporting. This section should beread in conjunction with the certifications and the KPMG attestation report fora more complete understanding of the topics presented.

 

*Controls Evaluation and Related CEOand CFO Certifications.*  Our management, with theparticipation of our CEO and CFO, conducted an evaluation of the effectivenessof the design and operation of our disclosure controls and procedures as of theend of the period covered by this Annual Report. The controls evaluation wasconducted by our Disclosure Committee, comprised of senior representatives fromour finance, accounting, internal audit, and legal departments under thesupervision of our CEO and CFO.

 

Certifications of our CEO and our CFO, which arerequired in accordance with Rule 13a-14 of the Exchange Act, are attachedas exhibits to this Annual Report. This “Controls and Procedures” sectionincludes the information concerning the controls evaluation referred to in thecertifications, and it should be read in conjunction with the certificationsfor a more complete understanding of the topics presented.

 

*Limitations on the Effectiveness ofControls.*  We do not expect that our disclosurecontrols and procedures will prevent all errors and all fraud. A system ofcontrols and procedures, no matter how well conceived and operated, can provideonly reasonable, not absolute, assurance that the objectives of the system aremet. Because of the limitations in all such systems, no evaluation can provideabsolute assurance that all control issues and instances of fraud, if any,within the Company have been detected. Furthermore, the design of any system ofcontrols and procedures is based in part upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions,regardless of how unlikely. Because of these inherent limitations in acost-effective system of controls and procedures, misstatements or omissionsdue to error or fraud may occur and not be detected.

 

*Scope of the Controls Evaluation.*  Theevaluation of our disclosure controls and procedures included a review of theirobjectives and design, our implementation of the controls and procedures andthe effect of the controls and procedures on the information generated for usein this Annual Report. In the course of the evaluation, we sought to identifywhether we had any data errors, control problems or acts of fraud and toconfirm that appropriate corrective action, including process improvements, wasbeing undertaken if needed. This type of evaluation is performed on a quarterlybasis so that conclusions concerning the effectiveness of our disclosurecontrols and procedures can be reported in our Quarterly Reports on Form 10-Qand our Annual Reports on Form 10-K. Many of the components of ourdisclosure controls and procedures are also evaluated by our internal auditdepartment, by our legal department and by personnel in our financeorganization. The overall goals of these various evaluation activities are tomonitor our disclosure controls and procedures on an ongoing basis, and tomaintain them as dynamic systems that change as conditions warrant.

 

*Conclusions regarding DisclosureControls.*  Based on the required evaluation of ourdisclosure controls and procedures, our CEO and CFO have concluded that, as of September 30,2009, we maintain disclosure controls and procedures that are effective inproviding reasonable assurance that information required to be disclosed by usin the reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSEC’s rules and forms, and that such information is accumulated andcommunicated to our management, including our CEO and CFO, as appropriate toallow timely decisions regarding required disclosure.

 

*Management’s Annual Reporton Internal Control over Financial Reporting.*

 

Management of the Company, including the CEO and CFO,is responsible for establishing and maintaining adequate internal control overfinancial reporting as defined in Rule 13a-15(f) under the ExchangeAct. Our internal control system was designed to provide reasonable assuranceto management and our Board of Directors regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles.

 

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All internal control systems, no matter how welldesigned, have inherent limitations. A system of internal controls may becomeinadequate over time because of changes in conditions or deterioration in thedegree of compliance with the policies or procedures. Therefore, even thosesystems determined to be effective can provide only reasonable assurance withrespect to financial statement preparation and presentation.

 

Management assessed the effectiveness of our internalcontrol over financial reporting as of September 30, 2009 using thecriteria set forth by the Committee of Sponsoring Organizations of the TreadwayCommission (“COSO”) in *InternalControl-Integrated Framework.* Based on this assessment, management has concluded that, as of September 30,2009 our internal control over financial reporting was effective to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles based on such criteria.

 

*Report of IndependentRegistered Public Accounting Firm***. **Please refer toKPMG’s Report of Independent Registered Public Accounting Firm on InternalControl over Financial Reporting on page F-1 of the financial statements,which begin on page 67 of this Annual Report.

 

*Changes in Internal Control overFinancial Reporting.*  During our last fiscalquarter, there have been no changes in our internal control over financialreporting identified in connection with the evaluation described above thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

**ITEM 9B. OTHERINFORMATION**

 

None.

 

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# **PART III**

 

# **ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATEGOVERNANCE**

 

## **Omitted pursuant to General Instruction I to Form 10-K**

 

# **ITEM 11.   EXECUTIVE COMPENSATION**

 

## **Omitted pursuant to General Instruction I to Form 10-K**

 

# **ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

## **Omitted pursuant to General Instruction I to Form 10-K**

 

# **ITEM 13.   CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

## **Omitted pursuant to General Instruction I to Form 10-K**

 

# **ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

## ***Pre-ApprovalPolicies and Procedures***

 

## **The Audit Committee of the Board of Directors of Sally Beauty (the“Audit Committee”) is responsible for the appointment, compensation andoversight of the work of our independent public accountant. The Audit Committeeof Sally Beauty has reviewed the non-audit services provided by KPMG anddetermined that the provision of these services during fiscal year 2009 wascompatible with maintaining KPMG’s independence.**

 

## ***Pre-Approval Policy.*** The Audit Committee (or its designee, asdescribed below) approved all audit and permissible non-audit fees duringfiscal year 2009.  The Audit Committeehas the sole and direct authority to engage, appoint and replace ourindependent auditors. In addition, the Audit Committee has established an Auditand Non-Audit Services Pre-Approval Policy, whereby every engagement of KPMG toperform audit or permissible non-audit services on behalf of us or any of oursubsidiaries requires pre-approval from the Audit Committee or its designeebefore KPMG is engaged to provide those services. Pursuant to that policy, weexpect that on an annual basis, the Audit Committee will review and providepre-approval for certain types of services that may be rendered by theindependent auditors, together with a budget for the applicable fiscal year.The pre-approval policy also requires the pre-approval of any fees that are inexcess of the amount budgeted by the Audit Committee. The pre-approval policycontains a provision delegating limited pre-approval authority to the chairmanof the Audit Committee in instances when pre-approval is needed prior to a scheduledAudit Committee meeting. The chairman of the Audit Committee would be requiredto report on such pre-approvals at the next scheduled Audit Committee meeting.As a result, the Audit Committee or its designee has approved 100% of allservices performed by KPMG on behalf of us or any of our subsidiariessubsequent to November 16, 2006, the date we became a reporting company.

 

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## ***Fees Paid to KPMG***

 

## **The fees billed by KPMG for benefit of the Company with respect to theyears ended September 30, 2008 and 2007 were as follows:**

 
| ** **            | ** ** | **Fiscal Years Ended  September 30,** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|
| ** **            | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
|                  |       |                                       |       |   |   |
| Audit Fees(1)         |       | $                                          | 2,196,908  |   | $ | 2,293,496 |   |
|                  |       |                                       |       |   |   |
| Audit-Related Fees(2) |       | 59,500                                     |       | 57,000 |   |
|                  |       |                                       |       |   |   |
| Tax Fees (3)          |       | 72,037                                     |       | 33,750 |   |
|                  |       |                                       |       |   |   |
| All Other Fees        | ** ** | **—**                                 | ** ** | **—** | ** ** |
|                  | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Total Fees(4)         |       | $                                          | 2,328,445  |   | $ | 2,384,246 |   |

 

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## **(1)**                                  Aggregate fees billed forprofessional services for the audit of annual financial statements as well asaccounting and reporting advisory services related to regulatory filings andacquisition activities.

 

## **(2)           Audit-related feesconsist of fees for audits of Sally Beauty’s employee benefit plans.**

 

## **(3)           Tax fees consist offees for tax consultation and tax compliance services.**

 

## **(4)           The Audit Committeeof Sally Beauty’s Board of Directors pre-approved all fees.**

 

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###### **PART IV**

 

# **ITEM 15. EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**

 

Documents filed as part of this Annual Report:

 

## **(a)  Financial Statements and Financial Statement Schedules**

 

Please see “Index to Financial Statements” which islocated on page 67 of this Annual Report.

 

**(b)  ****Exhibits Requiredby Securities and Exchange Commission****Regulation S-K**

 

The following exhibits are filed as part of thisAnnual Report or are incorporated herein by reference:

 

**Exhibits**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                  |       | Investment  Agreement, dated as of June 19, 2006, among Alberto-Culver Company, New  Aristotle Company, Sally Holdings, Inc., New Sally Holdings, Inc.  and CDRS Acquisition LLC, which is incorporated herein by reference from  Exhibit 2.1 to Amendment No. 3 to the Registration Statement on  Form S-4 of New Sally Holdings, Inc. (File No. 333-136259)  filed on October 10, 2006                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.2                  |       | First  Amendment to the Investment Agreement, dated as of October 3, 2006,  among Alberto-Culver Company, New Aristotle Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and CDRS Acquisition LLC,  which is incorporated herein by reference from Exhibit 2.2 to Amendment  No. 3 to the Registration Statement on Form S-4 of New Sally  Holdings, Inc. (File No. 333-136259) filed on October 10, 2006         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.3                  |       | Second  Amendment to the Investment Agreement, dated as of October 26, 2006,  among Alberto-Culver Company, New Aristotle Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and CDRS Acquisition LLC,  which is incorporated herein by reference from Exhibit 2.02 to the  Current Report on Form 8-K of New Sally Holdings, Inc. (File  No. 333-136259) filed on October 30, 2006                                      |
| ** **           | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 2.4                  |       | Separation  Agreement, dated as of June 19, 2006, among Alberto-Culver Company,  Sally Holdings, Inc., New Sally Holdings, Inc. and New Aristotle  Holdings, Inc., which is incorporated herein by reference from  Exhibit 2.3 to Amendment No. 3 to the Registration Statement on  Form S-4 of New Sally Holdings, Inc. (File No. 333-136259) filed  on October 10, 2006                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.5                  |       | First  Amendment to the Separation Agreement, dated as of October 3, 2006,  among Alberto-Culver Company, Sally Holdings, Inc., New Sally  Holdings, Inc. and New Aristotle Holdings, Inc., which is  incorporated herein by reference from Exhibit 2.4 to Amendment No. 3  to the Registration Statement on Form S-4 of New Sally  Holdings, Inc. (File No. 333-136259) filed on October 10, 2006                   |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.6                  |       | Second  Amendment to the Separation Agreement, dated as of October 26, 2006,  among Alberto-Culver Company, Sally Holdings, Inc., New Sally  Holdings, Inc. and New Aristotle Holdings, Inc., which is  incorporated herein by reference from Exhibit 2.01 to the Current Report  on Form 8-K of New Sally Holdings, Inc. (File No. 333-136259)  filed on October 30, 2006                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 3.1                  |       | Certificate  of Formation of Sally Holdings LLC, which is incorporated herein by reference  to Exhibit 3.1 to the Registration Statement on Form S-4 (File  No. 333-144427) of Sally Holdings LLC and Sally Capital Inc. filed on  July 9, 2007                                                                                                                                                                                                    |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 3.2                  |       | Limited  Liability Company Agreement of Sally Holdings LLC, which is incorporated  herein by reference to Exhibit 3.2 to the Registration Statement on  Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally  Capital Inc. filed on July 9, 2007                                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.1                  |       | Stockholders  Agreement, dated as of November 16, 2006, by and among the Company, CDRS  Acquisition LLC, CD&R Parallel Fund VII, L.P. and the other stockholders  party thereto, which is incorporated herein by reference from  Exhibit 4.8 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.2                  |       | First  Amendment to the Stockholders Agreement, dated as of December 13, 2006,  between the Company and CDRS Acquisition LLC and Carol L. Bernick, as  representative of the other stockholders, which is incorporated herein by  reference from Exhibit 4.2 to the Annual Report on Form 10-K of  Sally Beauty Holdings, Inc. filed on December 22, 2006                                                                                     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.3                  |       | Indenture,  dated as of November 16, 2006, by and among Sally Holdings LLC and Sally  Capital Inc., as Co-Issuers, the Subsidiary Guarantors from time to time  parties thereto, and Wells Fargo Bank, National Association, as Trustee,  governing the 9.25% Senior Notes due 2014, which is incorporated herein by  reference from Exhibit 4.1 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on November 22, 2006 |

 

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| 4.4    |   | First  Supplemental Indenture, dated as of May 30, 2007, by and among Sally  Holdings LLC and Sally Capital Inc., as co-Issuers, the Subsidiary Guarantors  named therein, and Wells Fargo Bank, National Association, as trustee,  governing the 9.25% Senior Notes due 2014, which is incorporated herein by  reference from Exhibit 4.2 from the Registration Statement on  Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally  Capital Inc. filed on July 9, 2007                                                                                                                                                                                                                                                                                   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.5    |   | Indenture,  dated as of November 16, 2006, by and among Sally Holdings LLC and Sally  Capital Inc., as Co-Issuers, the Subsidiary Guarantors from time to time  parties thereto, and Wells Fargo Bank, National Association, as Trustee,  governing the 10.5% Senior Subordinated Notes due 2016, which is incorporated  herein by reference from Exhibit 4.2 to the Current Report on  Form 8-K of Sally Beauty Holdings, Inc. filed on November 22,  2006                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.6    |   | First  Supplemental Indenture, dated as of May 30, 2007, by and among Sally  Holdings LLC and Sally Capital Inc., as co-Issuers, the Subsidiary Guarantors  named therein, and Wells Fargo Bank, National Association, as trustee,  governing the 10.5% Senior Subordinated Notes due 2016, which is incorporated  herein by reference from Exhibit 4.4 from the Registration Statement on  Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally  Capital Inc. filed on July 9, 2007                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.7    |   | Exchange  and Registration Rights Agreement, dated as of November 16, 2006, by and  among Sally Holdings LLC, Sally Capital Inc., the Subsidiary Guarantors  parties thereto, Merrill Lynch, Pierce, Fenner & Smith, Incorporated  and the other financial institutions named therein, relating to the 9.25%  Senior Notes due 2014, which is incorporated herein by reference from  Exhibit 4.3 to the Current Report on Form 8-K of Sally Beauty Holdings, Inc.  filed on November 22, 2006                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.8    |   | Exchange  and Registration Rights Agreement, dated as of November 16, 2006, by and  among Sally Holdings LLC, Sally Capital Inc., the Subsidiary Guarantors  parties thereto, Merrill Lynch, Pierce, Fenner & Smith, Incorporated  and the other financial institutions named therein, relating to the 10.5%  Senior Subordinated Notes due 2016, which is incorporated herein by reference  from Exhibit 4.4 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.9    |   | Credit  Agreement, dated November 16, 2006, with respect to a Term Loan  Facility, by and among Sally Holdings LLC, the several lenders from time to  time parties thereto, and Merrill Lynch Capital Corporation, as  Administrative Agent and Collateral Agent, which is incorporated herein by  reference from Exhibit 4.5.1 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.10   |   | Guarantee  and Collateral Agreement, dated as of November 16, 2006, made by Sally  Investment Holdings LLC, Sally Holdings LLC and certain subsidiaries of Sally  Holdings LLC in favor of Merrill Lynch Capital Corporation, as Administrative  Agent and Collateral Agent, which is incorporated herein by reference from  Exhibit 4.5.2 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.11   |   | Credit  Agreement, dated November 16, 2006, with respect to an Asset-Based Loan  Facility, among Sally Holdings LLC, Beauty Systems Group LLC, Sally Beauty  Supply LLC, any Canadian Borrower from time to time party thereto, certain  subsidiaries of Sally Holdings LLC, the several lenders from time to time  parties thereto, Merrill Lynch Capital, a division of Merrill Lynch Business  Financial Services Inc., as Administrative Agent and Collateral Agent, and  Merrill Lynch Capital Canada Inc., as Canadian Agent and Canadian Collateral  Agent, which is incorporated herein by reference from Exhibit 4.6.1 to  the Current Report on Form 8-K of Sally Beauty Holdings, Inc. filed  on November 22, 2006                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.12   |   | U.S.  Guarantee and Collateral Agreement, dated as of November 16, 2006, made  by Sally Investment Holdings LLC, Sally Holdings LLC and certain subsidiaries  of Sally Holdings LLC in favor of Merrill Lynch Capital, a division of  Merrill Lynch Business Financial Services Inc., as Administrative Agent and  Collateral Agent, which is incorporated herein by reference from  Exhibit 4.6.2 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.13   |   | Canadian  Guarantee and Collateral Agreement, dated as of November 16, 2006, made  by Sally Beauty (Canada) Corporation, Beauty Systems Group  (Canada), Inc., Sally Beauty Canada Holdings Inc. and certain of their  respective subsidiaries in favor of Merrill Lynch Capital Canada Inc., as  Canadian Agent and Canadian Collateral Agent, which is incorporated herein by  reference from Exhibit 4.6.3 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.14   |   | Intercreditor  Agreement, dated as of November 16, 2006, by and between Merrill Lynch  Capital Corporation, as Administrative Agent and Collateral Agent under the  Term Loan Facility, and Merrill Lynch Capital, a division of Merrill Lynch  Business Financial Services Inc., as Administrative Agent and Collateral  Agent under the Asset-Based Loan Facility, which is incorporated herein by  reference from Exhibit 4.7 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.15   |   | Assignment  and Acceptance of that certain Credit Agreement, dated as of  November 16, 2006, among Sally Holdings LLC, Beauty Systems Group LLC,  Sally Beauty Supply LLC, the Canadian Borrowers (as defined in the Credit  Agreement), the several banks and other financial institutions from time to  time parties thereto, Merrill Lynch Capital, a division of’ Merrill Lynch  Business Financial Services Inc., as administrative agent and collateral  agent for the Lenders and Merrill Lynch Capital Canada, Inc., as Canadian  agent and Canadian collateral agent for the Lenders, which is incorporated  herein by reference from Exhibit 4.15 to the Annual Report on  Form 10-K of Sally Beauty Holdings, Inc. filed on November 19,  2009 |

 

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| 10.1   |   | Tax  Allocation Agreement, dated as of June 19, 2006, among Alberto-Culver  Company, New Aristotle Holdings, Inc., New Sally Holdings, Inc. and  Sally Holdings, Inc., which is incorporated herein by reference from  Exhibit 10.1 to Amendment No. 3 to the Registration Statement on  Form S-4 of New Sally Holdings, Inc. (File No. 333-136259)  filed on October 10, 2006                          |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.2   |   | First  Amendment to the Tax Allocation Agreement, dated as of October 3, 2006,  among Alberto-Culver Company, New Aristotle Holdings, Inc., New Sally  Holdings, Inc. and Sally Holdings, Inc., which is incorporated  herein by reference from Exhibit 10.2 to Amendment No. 3 to the  Registration Statement on Form S-4 of New Sally Holdings, Inc.  (File No. 333-136259) filed on October 10, 2006 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.3   |   | Second  Amendment to the Tax Allocation Agreement, dated as of October 26, 2006,  among Alberto-Culver Company, New Aristotle Holdings, Inc., New Sally Holdings, Inc.  and Sally Holdings, Inc., which is incorporated herein by reference from  Exhibit 10.01 to the Current Report on Form 8-K of New Sally  Holdings, Inc. filed on October 30, 2006                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.4   |   | Employee  Matters Agreement, dated as of June 19, 2006, among Alberto-Culver  Company, New Aristotle Holdings, Inc., New Sally Holdings, Inc. and  Sally Holdings, Inc., which is incorporated herein by reference from  Exhibit 10.3 to Amendment No. 3 to the Registration Statement on  Form S-4 of New Sally Holdings, Inc. (File No. 333-136259)  filed on October 10, 2006                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.5   |   | First  Amendment to the Employee Matters Agreement, dated October 3, 2006,  among Alberto-Culver Company, New Aristotle Holdings, Inc., New Sally  Holdings, Inc. and Sally Holdings, Inc., which is incorporated  herein by reference from Exhibit 10.4 to Amendment No. 3 to the  Registration Statement on Form S-4 of New Sally Holdings, Inc.  (File No. 333-136259) filed on October 10, 2006     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.6   |   | Second  Amendment to the Employee Matters Agreement, dated as of October 26,  2006, among Alberto-Culver Company, New Aristotle Holdings, Inc., New  Sally Holdings, Inc. and Sally Holdings, Inc., which is  incorporated herein by reference from Exhibit 10.02 to the Current  Report on Form 8-K of New Sally Holdings, Inc. filed on  October 30, 2006                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.7   |   | Support  Agreement, dated as of June 19, 2006, among CDRS Acquisition LLC,  Alberto-Culver Company, New Sally Holdings, Inc. and the stockholders  party thereto, which is incorporated herein by reference from Exhibit 10.10  to the Current Report on Form 8-K filed by Alberto-Culver Company on  June 22, 2006                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.8   |   | Support  Agreement, dated as of June 19, 2006, among CDRS Acquisition LLC,  Alberto-Culver Company, New Sally Holdings, Inc. and Howard B. Bernick,  which is incorporated herein by reference from Exhibit 10.11 to the  Current Report on Form 8-K filed by Alberto-Culver Company on  June 22, 2006                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.9   |   | Termination  Agreement, dated as of June 18, 2006, among Alberto-Culver Company,  Sally Holdings, Inc. and Gary G. Winterhalter, which is incorporated  herein by reference from Exhibit 10.9 to the Current Report on  Form 8-K filed by Alberto-Culver Company on June 22, 2006                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.10  |   | Form of  First Amendment to the Termination Agreement with Gary G. Winterhalter, which  is incorporated herein by reference from Exhibit 10.1 to the Current  Report on Form 8-K of Sally Beauty Holdings, Inc. filed on  January 29, 2007                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.11  |   | Form of  Amended and Restated Severance Agreement for Executive Officers (Gary G.  Winterhalter, Michael G. Spinozzi, John R. Golliher, W. Richard Dowd, Bennie  L. Lowery, Raal H. Roos) effective as of October 3, 2008, which is  incorporated herein by reference from Exhibit 10.1 to the Current Report  on Form 8-K of Sally Beauty Holdings, Inc. filed on October 6,  2008                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.12  |   | Sally  Beauty Holdings, Inc. Independent Director Compensation Policy, which is  incorporated herein by reference from Exhibit 10.12 to the Annual Report  on Form 10-K of Sally Beauty Holdings, Inc. filed on  November 19, 2009                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.13  |   | Alberto-Culver  Company 2003 Stock Option Plan for Non-Employee Directors, which is  incorporated herein by reference from Exhibit 10.17 to the Registration  Statement on Form S-4 (File No. 333-144427) of Sally Holdings LLC  and Sally Capital Inc. filed on July 9, 2007                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.14  |   | Alberto-Culver  Company 2003 Restricted Stock Plan, which is incorporated herein by reference  from Exhibit 10.18 to the Registration Statement on Form S-4 (File  No. 333-144427) of Sally Holdings LLC and Sally Capital Inc. filed on July 9,  2007                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.15  |   | Sally  Beauty Holdings, Inc. Annual Incentive Plan, which is incorporated  herein by reference from Exhibit 10.1 to the Quarterly Report on  Form 10-Q of Sally Beauty Holdings, Inc. filed on May 8, 2008                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.16  |   | Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  herein by reference from Exhibit 4.4 to the Registration Statement on  Form S-8 of Sally Beauty Holdings, Inc. filed on May 3, 2007                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.17  |   | Form of  Stock Option Agreement for Independent Directors pursuant to the Sally Beauty  Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated herein  by reference form Exhibit 10.1 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on April 27, 2007                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.18  |   | 2007  Form of Stock Option Agreement for Employees pursuant to the Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  herein by reference from Exhibit 10.2 to the Current Report on  Form 8-K of Sally Beauty Holdings, Inc. filed April 27, 2007                                                                                                                                            |

 

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| 10.19  |   | 2007  Form of Restricted Stock Unit Agreement for Independent Directors  pursuant to the Sally Beauty Holdings, Inc. 2007 Omnibus Incentive Plan,  which is incorporated herein by reference from Exhibit 10.3 to the  Current Report on Form 8-K of Sally Beauty Holdings, Inc. filed on  April 27, 2007                                                              |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.20  |   | 2007  Form of Restricted Stock Agreement for Employees pursuant to the Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  herein by reference form Exhibit 10.4 to the Current Report on  Form 8-K of Sally Beauty Holdings, Inc. filed on April 27,  2007                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.21  |   | 2009  Form of Stock Option Agreement for Employees pursuant to the Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  herein by reference from Exhibit 10.23 to the Annual Report on  Form 10-K of Sally Beauty Holdings, Inc. filed on November 20,  2008                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.22  |   | 2009  Form of Restricted Stock Unit Agreement for Independent Directors  pursuant to the Sally Beauty Holdings, Inc. 2007 Omnibus Incentive Plan,  which is incorporated herein by reference from Exhibit 10.24 to the  Annual Report on Form 10-K of Sally Beauty Holdings, Inc. filed on  November 20, 2008                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.23  |   | 2009  Form of Restricted Stock Agreement for Employees pursuant to the Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  herein by reference from Exhibit 10.25 to the Annual Report on  Form 10-K of Sally Beauty Holdings, Inc. filed on November 20,  2008                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.24  |   | Tax  Sharing Agreement, dated as of November 16, 2006, made and entered into  by and among Sally Beauty Holdings, Inc., Sally Investment Holdings LLC  and Sally Holdings LLC, which is incorporated herein by reference from  Exhibit 10.14 of the Quarterly Report on Form 10-Q of Sally  Holdings LLC and Sally Capital Inc. filed on August 29, 2007                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.25  |   | Release  and Separation Agreement by and between Sally Beauty Holdings, Inc. and  Walter Richard Dowd, which is incorporated herein by reference from  Exhibit 10.2 to the Quarterly Report on Form 10-Q of Sally Beauty  Holdings, Inc. filed on May 6, 2009                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.26  |   | Form of  Option Exercise Period Extension Agreement for Retired Executives, which is  incorporated herein by reference from Exhibit 10.3 to the Quarterly  Report on Form 10-Q of Sally Beauty Holdings, Inc. filed on  May 6, 2009                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.27  |   | Agreement  and Plan of Merger by and among Beauty Systems Group LLC, Lady Lynn Enterprises, Inc.,  Schoeneman Beauty Supply, Inc., the Shareholders and F. Dale Schoeneman,  dated September 30, 2009, which is incorporated herein by reference from  Exhibit 10.27 to the Annual Report on Form 10-K of Sally Beauty Holdings, Inc.  filed on November 19, 2009 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.28  |   | Amendment  and Restated Alberto-Culver Company Employee Stock Option Plan of 2003, which  is incorporated herein by reference from Exhibit 10.28 to the Annual  Report on Form 10-K of Sally Beauty Holdings, Inc. filed on  November 19, 2009                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.29  |   | 2010  Form of Restricted Stock Unit Agreement for Independent Directors  pursuant to the Sally Beauty Holdings, Inc. 2007 Omnibus Incentive Plan,  which is incorporated herein by reference from Exhibit 10.29 to the  Annual Report on Form 10-K of Sally Beauty Holdings, Inc. filed on  November 19, 2009                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.30  |   | 2010  Form of Restricted Stock Agreement for Employees pursuant to the Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  herein by reference from Exhibit 10.30 to the Annual Report on  Form 10-K of Sally Beauty Holdings, Inc. filed on November 19,  2009                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.31  |   | 2010  Form of Stock Option Agreement for Employees pursuant to the Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  herein by reference from Exhibit 10.31 to the Annual Report on  Form 10-K of Sally Beauty Holdings, Inc. filed on November 19,  2009                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.32  |   | 2010  Form of Stock Option Agreement for Employees pursuant to the  Alberto-Culver Company Employee Stock Option Plan of 2003, which is  incorporated herein by reference from Exhibit 10.32 to the Annual Report  on Form 10-K of Sally Beauty Holdings, Inc. filed on  November 19, 2009                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.33  |   | Form of  Amended and Restated Indemnification Agreement with Directors, which is  incorporated herein by reference from Exhibit 10.33 to the Annual Report  on Form 10-K of Sally Beauty Holdings, Inc. filed on  November 19, 2009                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 23.1   |   | Consent  of KPMG*                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 31.1   |   | Rule 13(a)-14(a)/15(d)-14(a) Certification  of Gary G. Winterhalter*                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 31.2   |   | Rule 13(a)-14(a)/15(d)-14(a) Certification  of Mark J. Flaherty*                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 32.1   |   | Section 1350  Certification of Gary G. Winterhalter*                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 32.2   |   | Section 1350  Certification of Mark J. Flaherty *                                                                                                                                                                                                                                                                                                                                               |

 

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*Included herewith

 

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PLEASE NOTE: In reviewingthe agreements included as exhibits to this Annual Report, please remember theyare included to provide you with information regarding their terms and are notintended to provide any other factual or disclosure information about theCompany or the other parties to the agreements. The agreements containrepresentations and warranties by each of the parties to the applicableagreement. These representations and warranties have been made solely for thebenefit of the other parties to the applicable agreement and:

 

·     should not in all instances be treated ascategorical statements of fact, but rather as a way of allocating the risk toone of the parties if those statements prove to be inaccurate;

·     have been qualified by disclosures thatwere made to the other party in connection with the negotiation of theapplicable agreement, which disclosures are not necessarily reflected in theagreement;

·     may apply standards of materiality in away that is different from what may be viewed as material to you or otherinvestors; and

·     were made only as of the date of theapplicable agreement or such other date or dates as may be specified in theagreement and are subject to more recent developments.

 

Accordingly, these representations and warranties maynot describe the actual state of affairs as of the date they were made or atany other time. Additional information about the Company may be found elsewherein this filing and in the Company’s other public filings, which are availablewithout charge through the SEC’s website at http://www.sec.gov. Please see“Where You Can Find More Information.”

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized, onthe 20th day of November, 2009.

 
|   | SALLY HOLDINGS LLC                                                                                                                    |
|--------|---------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                  |
|   | By:                                                                                                                                   | /s/ GARY G. WINTERHALTER |
|   | Gary G. Winterhalter                                                                                                                  |
|   | President, Chief Executive Officer ( PrincipalExecutive Officer of the registrant)  and Director of Sally Beauty Holdings, Inc.* |
|   |                                                                                                                                  |
|   | By:                                                                                                                                   | /s/ MARK J. FLAHERTY |
|   | Mark J. Flaherty                                                                                                                      |
|   | Senior Vice President and Chief Financial Officer                                                                                     |
|   | (Principal Financial Officer of the registrant)                                                                                       |
|   |                                                                                                                                  |
|   | By:                                                                                                                                   | /s/ JANNA S. MINTON |
|   | Janna S. Minton                                                                                                                       |
|   | Vice President, Chief Accounting Officer and  Controller                                                                              |
|   | (Principal Accounting Officer of the registrant)                                                                                      |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.

 
| **Signature**                | ** ** | **Title**                                                                | ** ** | **Date**               |
|------------------------------|------------|--------------------------------------------------------------------------|------------|------------------------|
| /s/ JAMES G. BERGES          |       | Chairman of the Board and Director of Sally Beauty  Holdings, Inc.* |       | November 20, 2009 |
| James G. Berges              |       |                                                                     |       |                   |
|                         |       |                                                                     |       |                   |
| /s/ KATHLEEN J. AFFELDT      |       | Director of Sally Beauty Holdings, Inc.*                            |       | November 20, 2009 |
| Kathleen J. Affeldt          |       |                                                                     |       |                   |
|                         |       |                                                                     |       |                   |
| /s/ MARSHALL E. EISENBERG    |       | Director of Sally Beauty Holdings, Inc.*                            |       | November 20, 2009 |
| Marshall E. Eisenberg        |       |                                                                     |       |                   |
|                         |       |                                                                     |       |                   |
| /s/ KENNETH A. GIURICEO      |       | Director of Sally Beauty Holdings, Inc.*                            |       | November 20, 2009 |
| Kenneth A. Giuriceo          |       |                                                                     |       |                   |
|                         |       |                                                                     |       |                   |
| /s/ ROBERT R. McMASTER       |       | Director of Sally Beauty Holdings, Inc.*                            |       | November 20, 2009 |
| Robert R. McMaster           |       |                                                                     |       |                   |
|                         |       |                                                                     |       |                   |
| /s/ WALTER METCALFE          |       | Director of Sally Beauty Holdings, Inc.*                            |       | November 20, 2009 |
| Walter Metcalfe              |       |                                                                     |       |                   |
|                         |       |                                                                     |       |                   |
| /s/ JOHN A. MILLER           |       | Director of Sally Beauty Holdings, Inc.*                            |       | November 20, 2009 |
| John A. Miller               |       |                                                                     |       |                   |
|                         |       |                                                                     |       |                   |
| /s/ MARTHA MILLER de LOMBERA |       | Director of Sally Beauty Holdings, Inc.*                            |       | November 20, 2009 |
| Martha Miller de Lombera     |       |                                                                     |       |                   |
|                         |       |                                                                     |       |                   |
| /s/ EDWARD W. RABIN          |       | Director of Sally Beauty Holdings, Inc.*                            |       | November 20, 2009 |
| Edward W. Rabin              |       |                                                                     |       |                   |
|                         |       |                                                                     |       |                   |
| /s/ RICHARD J. SCHNALL       |       | Director of Sally Beauty Holdings, Inc.*                            |       | November 20, 2009 |
| Richard J. Schnall           |       |                                                                     |       |                   |

 

----

## *** Director of Sally BeautyHoldings, Inc., sole member of Sally Investment Holdings LLC, sole memberof Sally Holdings LLC.**

 

66

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###### **SALLY HOLDINGS LLC AND SUBSIDIARIES**

 

Financial Statements

Years ended September 30,2009, 2008 and 2007

 

###### **INDEX TO FINANCIAL STATEMENTS**

 
| ** **                                                                                                                                | **Page** |
|-------------------------------------------------------------------------------------------------------------------------------------------|----------|
| Report of Independent Registered Public Accounting  Firm                                                                                  | F-1      |
|                                                                                                                                      |     |
| Consolidated Financial Statements:                                                                                                        | F-3      |
| Consolidated  Balance Sheets as of September 30, 2009 and 2008                                                                       | F-4      |
| Consolidated  Statements of Earnings for the years ended September 30, 2009, 2008 and  2007                                          | F-5      |
| Consolidated  Statements of Cash Flows for the years ended September 30, 2009, 2008  and 2007                                        | F-6      |
| Consolidated  Statements of Member’s (Deficit)/Stockholder’s Equity for the years ended  September 30, 2009, 2008 and 2007 | F-7      |
| Notes to Consolidated Financial Statements for the  years ended September 30, 2009, 2008 and 2007                                    | F-8      |

 

67

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## **Report of Independent Registered PublicAccounting Firm**

 

The Board of Directors

Sally Beauty Holdings, Inc.:

 

We have audited SallyHoldings LLC’s (the Company) internal control over financial reporting as of September 30,2009, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).  The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting,included in the accompanying Management’s Annual Report on Internal Controlover Financial Reporting.  Ourresponsibility is to express an opinion on the Company’s internal control overfinancial reporting based on our audit.

 

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States).  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects.  Our audit includedobtaining an understanding of internal control over financial reporting,assessing the risk that a material weakness exists, and testing and evaluatingthe design and operating effectiveness of internal control based on theassessed risk.  Our audit also includedperforming such other procedures as we considered necessary in thecircumstances.  We believe that our auditprovides a reasonable basis for our opinion.

 

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with U.S. generallyaccepted accounting principles.  Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with U.S. generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

In our opinion, SallyHoldings LLC maintained, in all material respects, effective internal controlover financial reporting as of September 30, 2009, based on criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of Sally Holdings LLC (priorto November 16, 2006, Sally Holdings, Inc.) and subsidiaries as of September 30,2009 and 2008, and the related consolidated statements of earnings, cash flowsand member’s (deficit)/stockholder’s equity for each of the years in thethree-year period ended September 30, 2009, and our report dated November 19,2009 expressed an unqualified opinion on those consolidated financialstatements.

 

 

/s/ KPMG LLP

 

KPMG LLP

Dallas, Texas

November 19, 2009

 

F-1

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## **Report of Independent Registered PublicAccounting Firm**

 

The Board of Directors

Sally Beauty Holdings, Inc.:

 

We have audited theaccompanying consolidated balance sheets of Sally Holdings LLC (prior to November 16,2006, Sally Holdings, Inc.) and subsidiaries as of September 30, 2009and 2008, and the related consolidated statements of earnings, cash flows andmember’s (deficit)/stockholder’s equity for each of the years in the three-yearperiod ended September 30, 2009. These consolidated financial statements are the responsibility of theCompany’s management.  Our responsibilityis to express an opinion on these consolidated financial statements based onour audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Sally Holdings LLC andsubsidiaries as of September 30, 2009 and 2008, and the results of theiroperations and their cash flows for each of the years in the three-year periodended September 30, 2009, in conformity with U.S. generally acceptedaccounting principles.

 

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), Sally Holdings LLC’s internal control over financial reportingas of September 30, 2009, based on criteria established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO), andour report dated November 19, 2009 expressed an unqualified opinion on theeffectiveness of the Company’s internal control over financial reporting.

 

 

/s/ KPMG LLP

 

KPMG LLP

Dallas, Texas

November 19, 2009

 

F-2

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Table ofContents

 

## **ConsolidatedFinancial Statements**

 

The following consolidated balance sheets as of September 30,2009 and 2008 and the related consolidated statements of earnings, cash flowsand member’s (deficit)/stockholder’s equity for each of the fiscal years in thethree-year period ended September 30, 2009 are those of Sally Holdings LLC(prior to November 16, 2006, Sally Holdings, Inc.) and itsconsolidated subsidiaries (hereafter “Sally Holdings” or the “Company”). In November of2006, Sally Holdings, Inc. was converted to a Delaware limited liabilitycompany, was renamed “Sally Holdings LLC” and became an indirect wholly-ownedsubsidiary of Sally Beauty Holdings, Inc. (“Sally Beauty”) in connectionwith the separation of our business from Alberto-Culver. In these financialstatements and elsewhere in this Annual Report on Form 10-K, we refer tothese transactions as the Separation Transactions. Sally Beauty was formed on June 16,2006 in connection with the separation of our business from Alberto-Culver.

 

F-3

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Table of Contents

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

#### Consolidated Balance Sheets

September 30, 2009and 2008

(In thousands)

 
| ** **                                                                                                                               | ** ** | **2009**  | ** ** | **2008**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|------------|------------|
| **Assets**                                                                                                                               | ** ** |      | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                          |       |      |       |       |       |
| Cash and cash equivalents                                                                                                                |       | $         | 54,447     |       | $          | 99,788 |   |
| Trade accounts receivable, less allowance for  doubtful accounts of $2,266 and $2,702 at September 30, 2009 and 2008,  respectively |       | 43,649    |       | 44,481     |       |
| Other receivables                                                                                                                        |       | 24,090    |       | 21,596     |       |
| Inventories                                                                                                                              |       | 559,689   |       | 598,195    |       |
| Prepaid expenses                                                                                                                         |       | 18,261    |       | 19,449     |       |
| Deferred income tax assets, net                                                                                                          |       | 15,629    |       | 20,772     |       |
| Total current assets                                                                                                                     |       | 715,765   |       | 804,281    |       |
| Property and equipment, net of accumulated  depreciation of $265,329 and $243,185 at September 30, 2009 and 2008,  respectively     |       | 151,249   |       | 156,260    |       |
| Goodwill                                                                                                                                 |       | 494,135   |       | 424,963    |       |
| Intangible assets, net of accumulated amortization  of $24,357 and $18,203 at September 30, 2009 and 2008, respectively             |       | 78,685    |       | 85,434     |       |
| Other assets                                                                                                                             |       | 50,676    |       | 54,720     |       |
| Total assets                                                                                                                             |       | $         | 1,490,510  |       | $          | 1,525,658 |   |
| **Liabilities and Member’s Deficit**                                                                                                |       |      |       |       |       |
| Current liabilities:                                                                                                                     |       |      |       |       |       |
| Current maturities of long-term debt                                                                                                     |       | $         | 24,517     |       | $          | 100,601 |   |
| Accounts payable                                                                                                                         |       | 193,592   |       | 171,962    |       |
| Accrued expenses                                                                                                                         |       | 153,842   |       | 154,529    |       |
| Income taxes                                                                                                                             |       | 5,829     |       | 11,386     |       |
| Due to Sally Beauty                                                                                                                      |       | 22,042    |       | 17,243     |       |
| Total current liabilities                                                                                                                |       | 399,822   |       | 455,721    |       |
| Long-term debt                                                                                                                           |       | 1,653,013 |       | 1,724,684  |       |
| Other liabilities                                                                                                                        |       | 43,586    |       | 23,708     |       |
| Deferred income tax liabilities, net                                                                                                     |       | 34,428    |       | 37,941     |       |
| Total liabilities                                                                                                                        |       | 2,130,849 |       | 2,242,054  |       |
| Stock options subject to redemption                                                                                                      |       | 1,800     |       | 5,884      |       |
| Member’s deficit:                                                                                                                   |       |      |       |       |       |
| Member’s deficit                                                                                                                    |       | (626,241  | )          | (730,969   | )          |
| Accumulated other comprehensive income                                                                                                   |       | (15,898   | )          | 8,689      |       |
| Total member’s deficit                                                                                                              |       | (642,139  | )          | (722,280   | )          |
| Total liabilities and member’s deficit                                                                                              |       | $         | 1,490,510  |       | $          | 1,525,658 |   |

 

The accompanying notes toconsolidated financial statements are an integral part of these financialstatements.

 

F-4

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Table of Contents

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

#### ConsolidatedStatements of Earnings

Fiscal Years ended September 30,2009, 2008 and 2007

(In thousands)

 
| ** **                                         | ** ** | **2009**  | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|----------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Net sales                                          |       | $         | 2,636,600  |      | $          | 2,648,191 |       | $ | 2,513,772 |   |
| Cost of products sold  and distribution expenses   |       | 1,393,283 |       | 1,413,597 |       | 1,360,025 |       |
| Gross profit                                       |       | 1,243,317 |       | 1,234,594 |       | 1,153,747 |       |
| Selling, general and  administrative expenses      |       | 891,056   |       | 895,632   |       | 850,159   |       |
| Depreciation and  amortization                     |       | 47,066    |       | 48,533    |       | 42,605    |       |
| Sales-based service fee  charged by Alberto-Culver |       | —    |       | —    |       | 3,779     |       |
| Transaction expenses                               |       | —    |       | —    |       | 21,502    |       |
| Operating earnings                                 |       | 305,195   |       | 290,429   |       | 235,702   |       |
| Interest expense, net  (a)                         |       | 132,043   |       | 158,897   |       | 145,972   |       |
| Earnings before  provision for income taxes        |       | 173,152   |       | 131,532   |       | 89,730    |       |
| Provision for income  taxes                        |       | 68,424    |       | 48,664    |       | 41,169    |       |
| Net earnings                                       |       | $         | 104,728    |      | $          | 82,868    |       | $ | 48,561 |   |

 

----

(a)          Interest expenseis net of interest income of $0.3 million, $0.7 million and $1.7 million forthe fiscal years ended September 30, 2009, 2008 and 2007, respectively.

 

The accompanying notes toconsolidated financial statements are an integral part of these financialstatements.

 

F-5

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Table of Contents

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

#### ConsolidatedStatements of Cash Flows

Fiscal Years ended September 30,2009, 2008 and 2007

(In thousands)

 
| ** **                                                                                                                         | ** ** | **2009** | ** ** | **2008** | ** ** | **2007**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| **Cash Flows from Operating Activities:**                                                                                          |       |     |       |     |       |       |       |
| Net  earnings                                                                                                                      |       | $        | 104,728    |     | $          | 82,868     |       | $ | 48,561 |   |
| Adjustments  to reconcile net earnings to net cash provided by operating activities:                                               |       |     |       |     |       |       |       |
| Depreciation  and amortization                                                                                                     |       | 47,066   |       | 48,533   |       | 42,605     |       |
| Share-based  compensation expense (net of deferred tax benefit of $1,897, $2,268 and  $4,794 in 2009, 2008 and 2007, respectively) |       | 6,095    |       | 7,346    |       | 7,473      |       |
| Amortization  of deferred financing costs                                                                                          |       | 8,319    |       | 8,469    |       | 7,407      |       |
| Excess  tax shortfall (benefit) from share-based compensation                                                                      |       | 194      |       | (451     | )          | (780       | )          |
| Net  (gain) loss on disposal of leaseholds and other property                                                                      |       | (56      | )          | 116      |       | 1,820      |       |
| Net  loss on extinguishment of debt                                                                                                |       | 1,017    |       | —   |       | —     |       |
| Deferred  income taxes                                                                                                             |       | 10,524   |       | 3,013    |       | 3,718      |       |
| Changes  in (exclusive of effects of acquisitions):                                                                                |       |     |       |     |       |       |       |
| Trade  accounts receivable                                                                                                         |       | 3,708    |       | 7,629    |       | 2,297      |       |
| Other  receivables                                                                                                                 |       | (1,087   | )          | (58      | )          | 359        |       |
| Inventories                                                                                                                        |       | 46,208   |       | (29,527  | )          | 40,035     |       |
| Prepaid  expenses                                                                                                                  |       | 764      |       | (4,599   | )          | (2,153     | )          |
| Other  assets                                                                                                                      |       | 625      |       | 61       |       | (1,005     | )          |
| Accounts  payable and accrued expenses                                                                                             |       | 17,805   |       | (11,200  | )          | 24,427     |       |
| Income  taxes                                                                                                                      |       | (7,923   | )          | 5,394    |       | 2,136      |       |
| Due  to Sally Beauty                                                                                                               |       | (7,299   | )          | (11,900  | )          | 5,619      |       |
| Other  liabilities                                                                                                                 |       | (6,704   | )          | 5,721    |       | 11,748     |       |
| Net  cash provided by operating activities                                                                                         |       | 223,984  |       | 111,415  |       | 194,267    |       |
| ** **                                                                                                                         |       |     |       |     |       |       |       |
| **Cash Flows from Investing Activities:**                                                                                          |       |     |       |     |       |       |       |
| Capital  expenditures                                                                                                              |       | (37,317  | )          | (45,576  | )          | (53,345    | )          |
| Proceeds  from sale of property and equipment                                                                                      |       | 217      |       | 288      |       | 8,395      |       |
| Acquisitions,  net of cash acquired                                                                                                |       | (81,459  | )          | (52,874  | )          | (76,414    | )          |
| Net  cash used by investing activities                                                                                             |       | (118,559 | )          | (98,162  | )          | (121,364   | )          |
| ** **                                                                                                                         |       |     |       |     |       |       |       |
| **Cash Flows from Financing Activities:**                                                                                          |       |     |       |     |       |       |       |
| Change  in book cash overdraft                                                                                                     |       | (1,633   | )          | 1,633    |       | (6,515     | )          |
| Proceeds  from issuance of long-term debt                                                                                          |       | 95,577   |       | 527,735  |       | 2,204,625  |       |
| Repayments  of long-term debt                                                                                                      |       | (243,666 | )          | (482,685 | )          | (430,012   | )          |
| Debt  issuance costs                                                                                                               |       | —   |       | —   |       | (58,541    | )          |
| Excess  tax (shortfall) benefit from share-based compensation                                                                      |       | (194     | )          | 451      |       | 780        |       |
| Distributions  to Sally Beauty                                                                                                     |       | —   |       | —   |       | (1,809,740 | )          |
| Distributions  to Alberto-Culver                                                                                                   |       | —   |       | —   |       | (44,411    | )          |
| Net  cash (used) provided by financing activities                                                                                  |       | (149,916 | )          | 47,134   |       | (143,814   | )          |
| Effect  of foreign currency exchange rate changes on cash and cash equivalents                                                     |       | (850     | )          | 1,129    |       | 1,612      |       |
| Net  (decrease) increase in cash and cash equivalents                                                                              |       | (45,341  | )          | 61,516   |       | (69,299    | )          |
| Cash  and cash equivalents, beginning of year                                                                                      |       | 99,788   |       | 38,272   |       | 107,571    |       |
| Cash  and cash equivalents, end of year                                                                                            |       | $        | 54,447     |     | $          | 99,788     |       | $ | 38,272 |   |
| ** **                                                                                                                         |       |     |       |     |       |       |       |
| **Supplemental Cash Flow Information:**                                                                                            |       |     |       |     |       |       |       |
| Cash  paid for:                                                                                                                    |       |     |       |     |       |       |       |
| Interest                                                                                                                           |       | $        | 130,204    |     | $          | 149,842    |       | $ | 111,336 |   |
| Income  taxes                                                                                                                      |       | $        | 7,814      |     | $          | 6,432      |       | $ | 5,197 |   |

 

The accompanying notes toconsolidated financial statements are an integral part of these financialstatements.

 

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Table of Contents

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

#### ConsolidatedStatements of Member’s (Deficit)/Stockholder’s Equity

Fiscal Years ended September 30,2009, 2008 and 2007

(In thousands)

 
| ** **                                                            | ** ** | **Common********Stock********Outstanding  (Shares)** | ** ** | **Additional********Paid-in********Capital** | ** ** | **Retained********Earnings** | ** ** | **Member’s********Deficit** | ** ** | **Accumulated********Other********Comprehensive********(Loss) Income** | ** ** | **Total  Member’s  (Deficit)/  Stockholder’s  Equity** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| Balance at  September 30, 2006                                   |       | 1                                                    |       | $                                            | 62,172     |                         | $          | 927,512                          |       | $                                                                      | —     |                                                             | $          | 16,283 |   | $ | 1,005,967 |   |
| Net earnings                                                          |       | —                                               |       | —                                       |       | —                       |       | 48,561                           |       | —                                                                 |       | 48,561                                                           |       |
| Foreign currency  translation                                         |       | —                                               |       | —                                       |       | —                       |       | —                           |       | 18,239                                                                 |       | 18,239                                                           |       |
| Total comprehensive  income                                           |       |                                                 |       |                                         |       |                         |       |                             |       |                                                                   |       | 66,800                                                           |       |
| Adjustment to  stockholder contribution                               |       | —                                               |       | —                                       |       | —                       |       | 1,067                            |       | —                                                                 |       | 1,067                                                            |       |
| Retirement of common  stock                                           |       | (1                                                   | )          | (1                                           | )          | —                       |       | 1                                |       | —                                                                 |       | —                                                           |       |
| Distributions to  Alberto-Culver                                      |       | —                                               |       | —                                       |       | —                       |       | (44,411                          | )          | —                                                                 |       | (44,411                                                          | )          |
|                                                                  |       |                                                 |       |                                         |       |                         |       |                             |       |                                                                   |       |                                                             |       |
| Conversion to member’s  equity                                   |       | —                                               |       | (62,171                                      | )          | (927,512                     | )          | 989,683                          |       | —                                                                 |       | —                                                           |       |
| Distributions to Sally  Beauty                                        |       | —                                               |       | —                                       |       | —                       |       | (1,809,740                       | )          | —                                                                 |       | (1,809,740                                                       | )          |
|                                                                  |       |                                                 |       |                                         |       |                         |       |                             |       |                                                                   |       |                                                             |       |
| Balance at  September 30, 2007                                   |       | —                                               |       | —                                       |       | —                       |       | (814,839                         | )          | 34,522                                                                 |       | (780,317                                                         | )          |
| Net earnings                                                          |       | —                                               |       | —                                       |       | —                       |       | 82,868                           |       | —                                                                 |       | 82,868                                                           |       |
| Deferred gains on  interest rate swaps, net of income taxes of $509   |       | —                                               |       | —                                       |       | —                       |       | —                           |       | 793                                                                    |       | 793                                                              |       |
| Foreign currency  translation                                         |       | —                                               |       | —                                       |       | —                       |       | —                           |       | (26,626                                                                | )          | (26,626                                                          | )          |
| Total comprehensive  income                                           |       |                                                 |       |                                         |       |                         |       |                             |       |                                                                   |       | 57,035                                                           |       |
| Adjustment to  distributions to Alberto-Culver                        |       | —                                               |       | —                                       |       | —                       |       | 1,002                            |       | —                                                                 |       | 1,002                                                            |       |
|                                                                  |       |                                                 |       |                                         |       |                         |       |                             |       |                                                                   |       |                                                             |       |
| Balance at  September 30, 2008                                   |       | —                                               |       | —                                       |       | —                       |       | (730,969                         | )          | 8,689                                                                  |       | (722,280                                                         | )          |
| Net earnings                                                          |       | —                                               |       | —                                       |       | —                       |       | 104,728                          |       | —                                                                 |       | 104,728                                                          |       |
| Deferred losses on  interest rate swaps, net of income taxes of 6,471 |       | —                                               |       | —                                       |       | —                       |       | —                           |       | (10,196                                                                | )          | (10,196                                                          | )          |
| Foreign currency  translation                                         |       | —                                               |       | —                                       |       | —                       |       | —                           |       | (14,391                                                                | )          | (14,391                                                          | )          |
| Total comprehensive  income                                           |       |                                                 |       |                                         |       |                         |       |                             |       |                                                                   |       | 80,141                                                           |       |
|                                                                  |       |                                                 |       |                                         |       |                         |       |                             |       |                                                                   |       |                                                             |       |
| Balance at  September 30, 2009                                   |       | —                                               |       | $                                            | —     |                         | $          | —                           |       | $                                                                      | (626,241   | )                                                                | $          | (15,898 | ) | $ | (642,139 | ) |

 

Prior to November 16,2006, Alberto-Culver owned all shares of issued and outstanding common stock ofSally Holdings, Inc. Since November 16, 2006, all member units ofSally Holdings LLC have been owned by Sally Investment, a wholly-ownedsubsidiary of Sally Beauty.

 

The accompanying notes toconsolidated financial statements are an integral part of these financialstatements.

 

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Sally Holdings LLCand Subsidiaries

Notes to Consolidated Financial Statements

 

## **1.  Description of Business and Basis of Presentation**

 

## **Descriptionof Business**

 

Sally Holdings LLC is a wholly-owned subsidiary ofSally Investment Holdings LLC (“Sally Investment”), a wholly-owned subsidiaryof Sally Beauty.  All of the interests ofSally Holdings are beneficially owned by Sally Investment, and all of theinterests of Sally Investment are beneficially owned by Sally Beauty.  The Company was a wholly-owned subsidiary ofAlberto-Culver until November 16, 2006 when it was converted to a Delawarelimited liability company, was renamed “Sally Holdings LLC” and became a wholly-ownedsubsidiary of Sally Investment and an indirect subsidiary of Sally Beauty inconnection with the separation of its business from Alberto-Culver.  The Company and its consolidated subsidiariessell professional beauty supplies, primarily through its Sally Beauty Supplyretail stores, in the U.S., Puerto Rico, Belgium, Canada, Chile, Mexico, theUnited Kingdom and certain other countries in Europe. Additionally, the Companydistributes professional beauty products to salons and professional cosmetologiststhrough its Beauty Systems Group (“BSG”) store operations and a commissioneddirect sales force that calls on salons primarily in the U.S., Puerto Rico,Canada, the United Kingdom and certain other countries in Europe, and tofranchises in the southern and southwestern U.S. and in Mexico through theoperations of its subsidiary Armstrong McCall, L.P. (“Armstrong McCall”).Certain beauty products sold by BSG and Armstrong McCall are sold throughexclusive territory agreements with the manufacturers of the products.

 

In November 2006, the stockholders ofAlberto-Culver approved a plan to separate its consumer products business andits Sally Beauty Supply/BSG distribution business into two separate,publicly-traded companies. As more fully discussed in Note 3, theseparation was completed on November 16, 2006 (the “SeparationTransactions”) and was effected pursuant to an investment agreement dated as ofJune 19, 2006 (the “Investment Agreement”) among Alberto-Culver andcertain of its subsidiaries, including Sally Holdings, Inc. and CDRSAcquisition LLC (“CDRS”). Sally Beauty was formed on June 16, 2006, andbecame the accounting successor company to Sally Holdings, Inc. upon thecompletion of the Separation Transactions.

 

In the ordinary course of business, the Companyperforms certain administrative services on behalf of Sally Beauty. Theseservices are charged to Sally Beauty and netted against the amount due to SallyBeauty.  Please see Note 16 for furtherinformation.

 

## **Basisof Presentation**

 

The consolidated financial statements included hereinhave been prepared in accordance with accounting principles generally acceptedin the United States of America (“GAAP”). The consolidated financial statementsof our business prior to November 16, 2006 have been prepared fromfinancial statements and accounting records maintained by Alberto-Culver andreflect assumptions and allocations made by Alberto-Culver. The historicalconsolidated financial statements may not necessarily be indicative of thefinancial position that would have existed or the results of operations or cashflows that would have resulted if the Company had been operated as anunaffiliated entity.

 

All references in these notes to “management” are tothe management of Sally Holdings LLC. All references in these notes to “theCompany” are to Sally Holdings LLC and, prior to November 16, 2006, toSally Holdings, Inc.

 

## **2.  Significant Accounting Policies**

 

## **The preparation of financialstatements in conformity with GAAP requires us to interpret and applyaccounting standards and to develop and follow accounting policies consistentwith such standards. The following is a summary of the significant accountingpolicies used in preparing the Company’s consolidated financial statements.**

 

### *Principlesof Consolidation*

 

These consolidatedfinancial statements include the Company and its subsidiaries. All significantintercompany accounts and transactions have been eliminated in the consolidatedfinancial statements.

 

### *Reclassifications*

 

Certain amounts for priorperiods have been reclassified to conform to the current year’s presentation.

 

### *Use of Estimates*

 

The preparation of financial statements in conformitywith GAAP requires management to make estimates and assumptions that affect thereported amounts of assets, liabilities, revenues and expenses and disclosureof contingent assets and liabilities in the financial statements. The level ofuncertainty in estimates and assumptions increases with the length of timeuntil the underlying transactions are completed. Actual results may differ fromthese estimates in amounts that may be material to the financial statements.Management believes that the estimates and assumptions used are reasonable.

 

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Table ofContents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

### *Cash and Cash Equivalents*

 

All highly liquid investments purchased by the Companyfrom time to time which have an original maturity of three months or less areconsidered to be cash equivalents. These investments are stated at cost, whichapproximates market value. Also included in cash equivalents are proceeds duefrom customer credit and debit card transactions, which generally settle withintwo to five days, and were approximately $7.2 million and $6.8 million at September 30,2009 and 2008, respectively.

 

### *Fair Value of Financial Instruments*

###  

The Company’s financial instruments consist of cashand cash equivalents, trade and other accounts receivable, accounts payable,interest rate swap agreements and long-term borrowings.

 

The carrying amounts of cash and cash equivalents,trade and other accounts receivable and accounts payable approximate fair valuedue to the short-term nature of these financial instruments.

 

Theaggregate fair value of all interest rate swap agreements held at September 30,2009 was a liability of $17.7 million, consisting of $2.3 million included inaccrued expenses and $15.4 million included in other liabilities. Theaggregate fair value of all interest rate swap agreements held at September 30,2008 was a net liability of $6.4 million, consisting of $0.5 million includedin accrued expenses, $7.2 million included in other liabilities and $1.3million included in other assets. Fair value amounts reported for the swap agreements are based onthird-party information and were determined using proprietary models based uponwell-recognized financial principles and reasonable estimates about relevantfuture market conditions. Please see *Recent AccountingPronouncements* below.

 

The fair value of the Company’s long-term borrowingswas approximately $1,655.1 million and $1,676.1 million at September 30,2009 and 2008. The fair values of the Company’s long-term borrowings are basedon quoted market prices where available or, if not available, based ondiscounted future cash flows using current market interest rates.

 

*Derivative Instruments and Hedging Activities*

 

The Company utilizes interest rate swap agreements tomanage its cash flow exposure associated with changing interest rates inconnection with its term loan obligations and accounts for them in accordancewith the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification(“ASC”) 815, *Derivatives and Hedging* (“ASC815”). The Company does not purchase or hold any derivative instruments forspeculative or trading purposes. Certain interestrate swap agreements owned by the Company at September 30,2009 are designated as effective cash flow hedges and adjustments to reflectthe change in their fair values, which areadjusted quarterly, are recorded, net of income tax, inaccumulated other comprehensive income until the hedged obligation is settledor the swap agreements expire, whichever is earlier.  Any hedge ineffectiveness, as this term isused in ASC 815, is recognized in net interest expense in the consolidatedstatements of earnings. Certain other interestrate swap agreements owned by the Company at September 30,2009 are not designated as hedges and, accordingly, adjustments to reflectchanges in their fair values, which areadjusted quarterly, are recorded in net interest expense.

 

### *Concentration of Credit Risk*

###  

Financial instruments that potentially expose the Companyto concentration of credit risk consist primarily of investments in cashequivalents and accounts receivable. The Company invests from time to time insecurities of financial institutions with high-credit quality. Accountsreceivable are generally diversified due to the high number of entitiescomprising the Company’s customer base and their dispersion across diversegeographical regions. The Company believes no significant concentration ofcredit risk exists with respect to its investments in cash equivalents and itsaccounts receivable.

 

### *Trade Accounts Receivable and Allowance forDoubtful Accounts*

###  

Trade accounts receivable are recorded at the valuesinvoiced to customers and do not bear interest. Trade accounts receivable arestated net of the allowance for doubtful accounts. The allowance for doubtfulaccounts requires management to estimate future amounts of receivables to becollected. Management records allowances for doubtful accounts based on historicalcollection data and current customer information. Account balances are chargedagainst the allowance after all means of collection have been exhausted and thepotential for recovery is considered remote.

 

In the consolidated statements of earnings, bad debtexpense is included in selling, general and administrative expenses. TheCompany’s exposure to credit risk with respect to trade receivables ismitigated by the Company’s broad customer base and their dispersion acrossdiverse geographical regions.

 

### *Other Receivables*

###  

Other receivables consist primarily of amountsexpected to be received from vendors under various contractual agreements.Other receivables are recorded at the amount management estimates will becollected.

 

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Sally Holdings LLCand Subsidiaries

Notes to Consolidated Financial Statements

 

### *Inventories*

###  

Inventories consist primarily of beauty supplies andrelated accessories and salon equipment for sale in the normal course of ourbusiness and are stated at the lower of cost, determined using the first-in,first-out (FIFO) method, or market (net realizable value). When necessary, theCompany adjusts the carrying value of inventories to the lower of cost ormarket, including costs to sell or dispose, and for estimated inventoryshrinkage. Estimates of the future demand for the Company’s products, age ofthe inventory and changes in stock keeping units (“SKUs”) are some of the keyfactors used by management in assessing the net realizable value ofinventories. The Company estimates inventory shrinkage based on historicalexperience. Inventory shrinkage averaged approximately 1.0% of consolidated netsales in fiscal years 2009, 2008 and 2007.

 

### *Property and Equipment*

###  

Property and equipment are stated at cost lessaccumulated depreciation. Depreciation is calculated using the straight-linemethod based on estimated useful lives of the respective classes of assets andis reflected in depreciation and amortization expense in the consolidatedstatements of earnings. Buildings and building improvements are depreciatedover periods ranging from five to 40 years. Leasehold improvements areamortized over the lesser of the estimated useful lives of the assets or theterm of the related lease, including renewals determined to be reasonablyassured. Furniture, fixtures and equipment are depreciated over periods rangingfrom three to ten years. Expenditures for maintenance and repairs are expensedas incurred while expenditures for major renewals and improvements arecapitalized. Upon the disposition of property and equipment, the cost andrelated accumulated depreciation are removed from the accounts.

 

### *Lease Accounting*

###  

The Company’s lease agreements for office space,retail stores and warehouse/distribution facilities are accounted for asoperating leases. Rent expense (including any rent abatements or escalationcharges) is recognized on a straight-line basis from the date the Company takespossession of the property to begin preparation of the site for occupancy tothe end of the lease term, including renewal options determined to bereasonably assured. Certain leases provide for contingent rents that aredetermined as a percentage of revenues in excess of specified levels. TheCompany records a contingent rent liability along with the corresponding rentexpense when specified levels have been achieved or when management determinesthat achieving the specified levels during the fiscal year is probable.

 

Certain lease agreements to which the Company is aparty provide for tenant improvement allowances. Such allowances are recordedas deferred lease credits, included in accrued expenses and other liabilities,as appropriate, on the balance sheet and amortized on a straight-line basisover the lease term (including renewal options determined to be reasonablyassured) as a reduction of rent expense; which is generally consistent with theamortization period used for the constructed leasehold improvement asset.

 

### *Valuation of Long-Lived Assets*

###  

Long-lived assets, such as property and equipment andpurchased intangibles subject to depreciation or amortization, are reviewed forimpairment annually, and whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. Recoverability oflong-lived assets is measured by a comparison of the carrying amount of anasset to estimated future cash flows expected to be generated by the asset. Ifthe carrying amount of an asset exceeds its estimated future cash flows, animpairment charge is recognized by the amount by which the carrying amount ofthe asset exceeds the fair value of the asset. There were no significantimpairments in the current or prior fiscal years presented in the accompanyingfinancial statements.

 

### *Goodwill and Other Intangibles*

###  

Goodwill is the cost of an acquisition less the fairvalue of the net assets of the acquired business. Goodwill is reviewed forimpairment at least annually, and whenever events or changes in circumstancesindicate it is more likely than not that the fair value of a reporting unit isless than its carrying amount, in accordance with ASC 350. Management considerswhether there has been a permanent impairment to the value of goodwill and otherintangibles by evaluating if various factors, including current operatingresults, anticipated future results and cash flows, and market and economicconditions, indicate possible impairment. Based on the annual reviewsperformed, after taking into account the recent economic downturn in certaingeographies in which we operate, there was no impairment in the current orprior fiscal years presented.

 

Other intangibles with indefinite lives include tradenames and certain distribution rights. Other intangible assets subject toamortization include customer relationships, certain distribution rights andnon-competition agreements, and are amortized over periods of one totwelve years. The weighted average amortization period is approximatelysix years.

 

### *Deferred Financing Costs*

###  

Expenses incurred with the issuance of long-term debtare capitalized and amortized over the life of the related debt agreements on astraight line-basis or by using the effective interest method. Thesecapitalized expenses are recorded on the consolidated balance sheet as otherassets.

 

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Table ofContents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

### *Insurance/Self-Insurance Programs*

 

The Company retains a substantial portion of the riskrelated to certain of its workers’ compensation, general and auto liability andproperty damage insurable loss exposure. Predetermined loss limits have beenarranged with insurance companies to limit the Company’s exposure peroccurrence and aggregate cash outlay. Certain of our employees and theirdependents are also covered by a self-insurance program for healthcare benefitpurposes, up to a certain maximum lifetime limit. Currently theseself-insurance costs, less amounts recovered through payroll deductions andcertain out-of-pocket amounts in connection with the employee healthcareprogram, are funded by the Company. The Company maintains an annual stop-lossinsurance policy for the healthcare benefits plan.

 

The Company records an estimated liability for theultimate cost of claims incurred and unpaid as of the balance sheet date, whichincludes both claims filed and estimated losses incurred but not yet reported.The Company estimates the ultimate cost based on an analysis of historical dataand actuarial estimates. Workers’ compensation, general and auto liability andproperty damage insurable loss liabilities are recorded at the estimate of theirnet present value, while healthcare plan liabilities are not discounted. Theseestimates are reviewed on a regular basis to ensure that the recorded liabilityis adequate. The Company believes the amounts accrued at September 30,2009 and 2008 are adequate, although actual losses may differ from the amountsprovided.

 

### *Advertising Costs*

###  

Advertising costs relate mainly to print, radio andtelevision advertisements and trade shows. Advertising costs incurred inconnection with print, radio and television advertisements are expensed thefirst time the advertisement is run. Other advertising costs are expensed whenincurred. Advertising costs were approximately $55.2 million; $50.6 million and$49.2 million in the fiscal years ended September 30, 2009, 2008 and 2007,respectively, and are included in selling, general and administrative expensesin the Company’s consolidated statements of earnings.

 

### *Vendor Rebates and Concessions*

###  

The Company accounts for cash consideration receivedfrom vendors under ASC 605-50,*CustomerPayments and Incentives.*This accounting standard states that cashconsideration received by a customer is presumed to be a reduction of the costof sales unless it is for an asset or service or a reimbursement of a specific,incremental, identifiable cost incurred by the customer in selling the vendor’sproducts. The majority of cash consideration received by the Company isconsidered to be a reduction of the cost of sales and is allocated to cost ofproducts sold and distribution expenses as the related inventory is sold.

 

### *Income Taxes*

###  

The Company accounts for income taxes in accordancewith ASC 740, *Income Taxes* (“ASC 740”). Under ASC 740, deferredincome taxes are recognized for the estimated future tax consequencesattributable to temporary differences between the financial statement carryingamounts of existing assets and liabilities and their respective tax bases.Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which temporary differencesare estimated to be recovered or settled. The effect on deferred taxes of achange in tax rates is recognized in the consolidated statements of earnings inthe period of enactment. A valuation allowance is recorded to reduce thecarrying amounts of deferred tax assets to the amount expected to be realizedunless it is more-likely-than-not that such assets will be realized infull.  The estimated tax benefit of anuncertain tax position is recorded in our financial statements only afterdetermining a more-likely-than-not probability that the uncertain tax positionwill withstand challenge, if any, from applicable taxing authorities.

 

Effective October 1, 2007, the Company adoptedthe provisions of ASC 740-10-25,*IncomeTaxes - Recognition,* an interpretative amendment of ASC 740. Theadoption of this amendment did not require a change to the Company’s liabilityfor unrecognized tax benefits and had no impact on the Company’s openingbalance of accumulated deficit.  Pleasesee Note 14 for additional information.

 

### *Foreign Currency*

###  

The functional currency of each of the Company’sforeign operations is generally the respective local currency. Balance sheetaccounts are translated into U.S. dollars at the rates of exchange ineffect at the balance sheet date, while the results of operations aretranslated using the average exchange rates during the period presented. Theresulting translation adjustments are recorded as a component of accumulatedother comprehensive income within member’s (deficit) equity. Foreign currencytransaction gains or losses are included in the consolidated statements ofearnings when incurred and were not significant in any of the periods presentedin the accompanying financial statements.

 

### *Revenue Recognition*

###  

The Company recognizes revenue when a customerconsummates a point of sale transaction in a store. The cost of sales incentiveprograms, such as customer and consumer coupons, are recognized as a reductionof revenue at the time of sale. Taxes collected from customers and remitted togovernmental authorities are recorded on a net basis and are excluded fromrevenue. The Company also recognizes revenue on merchandise shipped tocustomers when title and risk of loss pass to the customer. Appropriateprovisions for

 

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Table ofContents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

sales returns and cash discounts are made at the timethe sales are recorded. Sales returns and allowances averaged approximately2.2% of net sales over each of the past three fiscal years.

 

*Cost of Products Sold and Distribution Expenses*

 

Cost of products sold and distribution expensesinclude actual product costs, the cost of transportation to the Company’sdistribution centers and certain shipping and handling costs, such as freightfrom the distribution centers to the stores and handling costs incurred at thedistribution centers. All other shipping and handling costs are included inselling, general and administrative expenses.

 

### *Shipping and Handling*

###  

Shipping and handling costs related to freight anddistribution expenses for delivery to customers are included in selling, generaland administrative expenses in the consolidated statements of earnings andamounted to $30.3 million, $35.8 million and $38.3 million for the fiscal years2009, 2008 and 2007, respectively.

 

### *Share-BasedCompensation*

###  

The Company accounts for stock option and stockawards, which include share-based payment plans of Sally Beauty in accordancewith ASC 718, *Compensation — Stock Compensation.*Accordingly, the Company measures the cost of employee services received inexchange for an award of equity instruments based on the grant-date fair valueof the award and recognizes compensation expense on a straight-line basis overthe vesting period or to the date a participant becomes eligible forretirement, if earlier.

 

Securities and Exchange Commission (“SEC”) StaffAccounting Bulletin No. 107, *Share-Based Payment*,requires public companies to apply the rules of Accounting Series ReleaseNo. 268 (“ASR 268”), *Presentation inFinancial**Statements ofRedeemable Preferred Stocks*, to stock options with contingent cashsettlement provisions. ASR 268 requires securities with contingent cashsettlement provisions, which are not solely in the control of the issuer,without regard to probability of occurrence, to be classified outside ofstockholders’ equity. Prior to November 16, 2006, the Company was asubsidiary of Alberto-Culver and had no share-based compensation plans of itsown. Prior to the Company’s separation from Alberto-Culver, Alberto-Culvergranted stock options to Company employees with a contingent cash settlementprovision upon the occurrence of certain change in control events, pursuant toits stock option plans. As such, the contingent cash settlement of the stockoptions as a result of such event would not be solely in the control of theCompany. In accordance with ASR 268, the Company reported $1.8 million and$5.9 million in “Stock options subject to redemption” outside of member’s(deficit) equity on its consolidated balance sheet as of September 30,2009 and 2008, respectively.

 

##### ***Comprehensive Income***

 

##### ***Comprehensive income reflects changes inmember’s (deficit) equity from sources other than transactions with member and,as such, includes net earnings and certain other specified components. TheCompany’s only components of comprehensive income, other than net earnings, arethe cumulative foreign currency translation adjustments and deferred gains(losses) on certain interest rate swap agreements, net of income tax.***

 

##### ***Accumulated Other Comprehensive (Loss) Income***

 

##### ***The components of accumulated other comprehensive(loss) income at September 30, 2009 and 2008, are as follows (inthousands):***

 
| ** **                                          | ** ** | **As of September 30,** | ** **    |
|-----------------------------------------------------|------------|------------------------------|---------------|
| ** **                                          | ** ** | **2009**                     | ** **    | **2008** | ** ** |
| ** **                                          | ** ** | **Amount  Before Tax**       | ** **    | **Deferred********Tax** | ** ** | **Net********Amount** | ** ** | **Amount  Before Tax** | ** ** | **Deferred********Tax** | ** ** | **Net********Amount** | ** ** |
| Cumulative foreign currency translation adjustments |       | $                            |  (6,495  | ) | — |   | $ |  (6,495 | ) | $ |  7,896 |   | — |   | $ |  7,896 |   |
| Deferred  (losses) gains on interest rate swaps (a) |       | (15,365                      | )             | 5,962 |   | (9,403 | ) | 1,302 |   | (509 | ) | 793 |   |
| Accumulated  other comprehensive (loss) income      |       | $                            |  (21,860 | ) | $ |  5,962 |   | $ |  (15,898 | ) | $ |  9,198 |   | $ |  (509 | ) | $ |  8,689 |   |
|                                                     |            |                              |               |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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## **(a)**          See Note 12 for more information about our interest rate swaps.

 

## ***Recent Accounting Pronouncements***

 

In June 2009, theFASB issued a new accounting standard named *The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples*. This pronouncement, among other things, identified thepreviously issued accounting standards that were considered authoritativegenerally accepted accounting principles in the U.S. and replaced allpreviously issued accounting pronouncements of the FASB, and its predecessorrule-making bodies, with the ASC. This standard was effective prospectively forreporting periods ended after September 15, 2009 and, accordingly, theCompany adopted it during the fourth quarter of the fiscal year 2009. Theadoption of this standard did not have an effect on the Company’s consolidatedfinancial position,

 

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Table ofContents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

results of operations orcash flows. As a result of adopting this standard, the Company’s references toGAAP standards have been changed to refer to topics, subtopics, sections orsubsections of the ASC, as appropriate.

 

In May 2009, theFASB issued ASC 855, *Subsequent Events*(“ASC855”). ASC 855 establishes standards of accounting for and disclosure oftransactions and events that occur after the balance sheet date but before thefinancial statements are issued. This accounting standard requires thedisclosure, among other things, of the date through which an entity hasevaluated subsequent events and whether that date is the date the financialstatements were issued or the date the financial statements were available tobe issued. This accounting standard must be applied prospectively for interimand annual periods ended after June 15, 2009 and, accordingly, the Companyadopted its provisions effective for the quarter ended June 30, 2009. Inconnection therewith, the Company has evaluated all material transactions andevents through November 19, 2009, the last full business day before thisAnnual Report was filed with the SEC.

 

Effective on January 1,2009, the Company adopted the amendment to ASC 815 contained in ASC 815-10-65,*Derivatives and Hedging, Transition*(“ASC 815-10-65”). ASC815-10-65 established, among other things, the disclosure requirements forderivative instruments and for hedging activities. This standard amended andexpanded those disclosures to also require qualitative disclosures about theobjectives and strategies for using derivative instruments, quantitativedisclosures about the fair value of and gains and losses on derivativeinstruments and disclosures about credit-risk-related contingent featurescontained in the derivative instruments. This standard also requires companies to disclose information about howderivatives and related hedges are accounted for and how the hedges affect the entity’sfinancial position, financial performance and cash flows, including thelocation and amounts of derivative instruments in the entity’s financialstatements.

 

As required by ASC 815,the Company records all derivative instruments on its balance sheet at fairvalue.  The accounting for changes in the fair value of derivativeinstruments depends on the intended use of the derivative, whether the Companyhas elected to designate a derivative instrument in a hedging relationship andapply hedge accounting and whether the hedging relationship has satisfied thecriteria necessary to apply hedge accounting. Derivative instruments designatedand qualifying as a hedge of the exposure to variability in expected futurecash flows, or other types of forecasted transactions, are considered cash flowhedges. Hedge accounting generally provides for the matching of the timing ofgain or loss recognition on the hedging instrument with the recognition of theimpact on earnings of the hedged transaction or transactions. The Company mayfrom time to time enter into derivative contracts that are intended to hedgecertain economic risks even though hedge accounting does not apply or theCompany elects not to apply hedge accounting to such derivative contracts.Please see Note 12 for more details about the Company’s derivative instrumentsand hedging activities as of September 30, 2009.

 

The Company adopted theprovisions of ASC 820, *Fair Value Measurementsand Disclosures*(“ASC 820”), as it relates to its financialinstruments, effective on October 1, 2008. ASC 820 defines fair value, establishes a framework for measuring fairvalue, and expands disclosures about fair value measurements. This standarddefines “fair value” as the price that would be received to sell an asset orpaid to transfer a liability in the principal or most advantageous market in anorderly transaction between market participants on the measurement date.  This standard establishes a three-levelhierarchy for measuring fair value and requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value.

 

This valuation hierarchyis based upon the transparency of inputs to the valuation of an asset orliability on the measurement date.  Thethree levels of that hierarchy are defined as follows:

 

Level 1 - Unadjusted quoted prices in activemarkets for identical assets or liabilities

 

Level 2 - Unadjusted quoted prices in activemarkets for similar assets or liabilities; or unadjusted quoted prices foridentical or similar assets or liabilities in markets that are not active; orinputs other than quoted prices that are observable for the asset or liability;or inputs that are derived principally from or corroborated by observablemarket data

 

Level 3 - Unobservable inputs for the asset orliability

 

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Table ofContents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

The Company measurescertain financial assets and liabilities at fair value on a recurring basis,including interest rate swaps. The Company has determined that the majority ofthe inputs used to value its interest rate swaps fall within Level 2 of thevaluation hierarchy. In accordance with ASC 820, the Company categorizedcertain of its financial assets and liabilities based on priority of the inputsto the valuation technique for the instruments, as follows (in thousands):

 
| ** **                          | ** ** | **As of September 30, 2009** | ** ** |
|-------------------------------------|------------|-----------------------------------|------------|
| ** **                          | ** ** | **Total**                         | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Liabilities                         |       |                              |       |   |   |   |   |   |   |
| Long-term  debt (1)                 |       | $                                 | 1,655,076  |   | $ | 727,719 |   | $ | 927,357 |   |   |   |
| Hedged  interest rate swaps (2)     |       | 15,365                            |       |   |   | 15,365 |   |   |   |
| Non-hedged  interest rate swaps (2) |       | 2,356                             |       |   |   | 2,356 |   |   |   |
| Total                               |       | $                                 | 1,672,797  |   | $ | 727,719 |   | $ | 945,078 |   |   |   |

 

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(1) Long-termdebt, which is carried at amortized cost in the Company’s financial statements,is valued using internal models based on market observable inputs, except forthe senior and senior subordinated notes. The senior and senior subordinatednotes are valued using quoted market prices for such debt securities.

(2) Interestrate swaps are valued using internal models based on market observable inputs,including market interest rates.

 

In April 2009, theFASB amended ASC 825, *Financial Instruments*.This amendment, currently contained in ASC 825-10-50, extended to interimperiods certain disclosures about fair value of financial instruments forpublicly traded companies and amended prior accounting standards to requirethose disclosures in summarized financial information at interim reportingperiods. This amendment was effective for interim reporting periods endingafter June 15, 2009 and its adoption, during the third quarter of thefiscal year 2009, did not have a material effect on the Company’s consolidatedfinancial position, results of operations or cash flows.

 

We have not yet adoptedand are currently assessing any potential effect of the followingpronouncements on our consolidated financial statements:

 

In August 2009, theFASB issued Accounting Standards Update 2009-05 which amended ASC 820, *Fair Value Measurements and Disclosures*(“ASC 820”), as itrelates to the measurement of liabilities at fair value, effective for interimreporting periods beginning after August 26, 2009. This update providesclarification for liabilities in which a quoted price in an active market foran identical liability is not available.

 

In April 2008, theFASB amended ASC 350, *Intangibles and Other*.This new accounting standard, currently contained in ASC 350-30-35,specifically amends the factors that should be considered in developing renewalor extension assumptions used to determine the useful life of a recognizedintangible asset. The objective of this amendment is to improve the consistencybetween the useful life of a recognized intangible asset and the period ofexpected cash flows used to measure the fair value of the asset. This newstandard is effective for fiscal years beginning after December 15, 2008.Early application is not permitted.

 

In December 2007, the FASB revised the accountingstandards for business combinations. This new standard (currently contained inASC 805, *Business Combinations*(“ASC 805”)),among other things, generally requires that an acquirer recognize the assetsacquired and liabilities assumed measured at their “full fair values” on theacquisition date. This practice replaces the practice, under predecessoraccounting standards, of allocating the cost of an acquisition to theindividual assets acquired and liabilities assumed based on their relativeestimated fair values.  This new standardfurther requires that acquisition-related costs be recognized separately fromthe related acquisition and must be applied prospectively to businesscombinations consummated on or after the first annual reporting periodbeginning on or after December 15, 2008. Early application is not permitted.

 

InApril 2009, the FASB issued ASC 805-20 *Business Combinations —Identifiable Assets and Liabilities and Any Non-controlling Interest*.This new accounting standard amends and clarifies ASC 805 and applies to assetsacquired and liabilities assumed that arise from contingencies in a businesscombination.  This amendment must also be applied prospectively tobusiness combinations consummated on or after the first annual reporting periodbeginning on or after December 15, 2008. Early application is not permitted.

 

## **3.  The Separation Transactions**

 

On November 16, 2006, the Company separated fromAlberto-Culver, pursuant to the Investment Agreement. As a result, Sally Beautyowns and operates, through the Company, the Sally Beauty Supply and BSGdistribution businesses that were previously owned and operated byAlberto-Culver, and Alberto-Culver continues to own and operate its consumerproducts business. The Company and certain subsidiaries incurred approximately$1,850 million of debt in connection with the Separation Transactions. Inaddition, pursuant to the Investment Agreement: (i) the Company became anindirect wholly-owned subsidiary of Sally Beauty;

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

(ii) the stockholders of Alberto-Culverimmediately prior to the Separation Transactions became the beneficial ownersof approximately 52% of the outstanding common stock of Sally Beauty on anundiluted basis; and (iii) CDRS, a limited liability company organized byClayton, Dubilier & Rice Fund VII, L.P., invested$575.0 million to obtain an equity ownership of approximately 48% of theoutstanding common stock of Sally Beauty.

 

Pursuant to the Investment Agreement, Sally Beauty andthe Company paid approximately $1.1 million to CDRS in merger and approximately$20.4 million to Alberto-Culver for expenses incurred in connection with theSeparation Transactions. The Company also paid approximately $58.5 million infees for the debt financing incurred in connection with the separation, whichwere recorded on the consolidated balance sheet as other assets. Most expensesrelated to the Separation Transactions are not expected to be deductible fortax purposes.

 

In connection with the Separation Transactions, SallyBeauty became the parent company for all U.S. tax returns filed under theemployer identification number of Alberto-Culver prior to the completion of theSeparation Transactions. All intercompany receivables, payables and loans(other than trade payables and the Company’s portion of the transactionexpenses described above) between the Company or any of its subsidiaries, onthe one hand, and Alberto-Culver or any of its subsidiaries (other than theCompany and its subsidiaries), on the other hand, were canceled prior tocompletion of the Separation Transactions. In addition, prior thereto, allintercompany agreements between the Company or any of its subsidiaries andAlberto-Culver or any of its subsidiaries were terminated, other than certain agreementsspecifically designated in the Separation Agreement to survive following thetransactions.

 

Alberto-Culver treated the transactions as though theyconstituted a change in control for purposes of Alberto-Culver’s stock optionand restricted stock plans. As a result, in accordance with the terms of theseplans, all outstanding stock options and restricted shares of Alberto-Culver,including those held by the Company’s employees, became fully vested uponcompletion of the Separation Transactions. Due to the Separation Transactions,the Company recorded a charge at that time equal to the amount of futurecompensation expense of approximately $5.3 million that would have beenrecognized in subsequent periods as the stock options and restricted shares forthe Company’s employees vested over the original vesting periods. Uponcompletion of the Separation Transactions all outstanding Alberto-Culver stockoptions held by employees of the Company became options to purchase shares ofSally Beauty common stock.

 

## **4.  Member’s (Deficit)/Stockholder’s Equity**

 

Since November 16, 2006, all member units of theCompany have been owned by Sally Investment.

 

At September 30, 2007, the Company had a member’sdeficit as a result of distributions to Sally Beauty and Alberto-Culver.  In connection with the separation fromAlberto-Culver, the Company received the proceeds from the issuance of the debtand contributed cash of approximately $1,809.7 million to Sally Beauty toenable it to make the dividend payments to existing stockholders in accordancewith the separation agreements entered into in connection with the SeparationTransactions.  The distribution toAlberto-Culver was the result of settlement of the inter-company agreement withAlberto-Culver, thereby decreasing member’s equity by $44.4 million.

 

Prior to November 16, 2006, the additionalpaid-in capital and the retained earnings were part of the stockholder’s equityof Sally Holdings, Inc. and its subsidiaries.  On November 16, 2006, in connection withthe Separation Transactions and the Limited Liability Company Agreement ofSally Holdings LLC entered into by Alberto-Culver and Sally Holdings, Inc.,Sally Holdings, Inc. contributed its stockholder’s equity to SallyHoldings LLC, thereby converting stockholder’s equity into member’s equity.

 

## **5.  Share-Based Payments**

 

Since November 16, 2006, the Company has been anindirect wholly-owned subsidiary of Sally Beauty and has no share based plansof its own; however, certain employees and consultants of the Company have beengranted stock options and share awards under the plans of Sally Beauty.

 

During fiscal year 2007, Sally Beauty adopted the 2007Omnibus Incentive Plan (the “2007 Plan”), which allows for the issuance of upto 10.0 million shares of Sally Beauty’s common stock. During fiscal years2009, 2008 and 2007, Sally Beauty granted to the Company’s employees andconsultants approximately 2.7 million, 2.8 million and 2.4 million stockoptions, respectively, and approximately 123,000, 136,000 and 350,000 restrictedshare awards, respectively, under the 2007 Plan or the 2003 Restricted StockPlan (the “RSP”).

 

For the fiscal years 2009, 2008 and 2007, totalcompensation cost charged against income and included in selling, general andadministrative expenses, for share-based compensation arrangements was $8.0million, $9.6 million and $12.3 million, respectively. These amounts included,for the fiscal years 2009 and 2008, $2.0 million and $3.1 million, respectively, of accelerated expenserelated to certain retirement eligible employees who are eligible tocontinue vesting awards upon retirement and, for fiscal year 2007, $5.3 million of accelerated expense relatedto the Separation Transactions and $2.6 million of accelerated expense relatedto certain retirement eligible employees who are eligible to continuevesting awards upon retirement, under the terms of the 2007 Plan. For fiscal

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

years 2009, 2008 and 2007, the total income taxbenefit recognized in the consolidated statements of earnings from these planswas $1.9 million, $2.3 million and $4.8 million, respectively.

 

Prior to November 16, 2006, the Company was asubsidiary of Alberto-Culver and had no share-based compensation plans of itsown. However, certain employees of the Company had been granted stock optionsand stock awards under share-based compensation plans of Alberto-Culver.Alberto-Culver treated the Separation Transactions as though they constituted achange in control for purposes of Alberto-Culver’s stock options and stockawards. As a result, in accordance with the terms of these plans, alloutstanding stock options and stock awards of Alberto-Culver, including thoseheld by the Company’s employees, became fully vested upon completion of theSeparation Transactions on November 16, 2006. Due to the SeparationTransactions, the Company recorded a charge at that time equal to the amount offuture compensation expense of approximately $5.3 million that would have beenrecognized in subsequent periods as the stock options and stock awards for theCompany’s employees vested over the original vesting periods. Upon completionof the Separation Transactions, all outstanding Alberto-Culver stock optionsand stock awards held by employees of the Company became options to purchaseshares of Sally Beauty’s common stock.

 

As a result of the Separation Transactions, theEmployee Stock Option Plan of 2003 and the 2003 Restricted Stock Plan that werepreviously plans of Alberto-Culver became plans of Sally Beauty. During fiscalyear 2007, Sally Beauty granted approximately 2.7 million stock options to theCompany’s employees and granted approximately 350,000 restricted share awardsto the Company’s employees under these plans. Sally Beauty from time to timemay grant stock option awards to the Company’s employees and consultants underthe Employee Stock Option Plan of 2003, the 2003 Stock Option Plan forNon-Employee Directors and under the 2007 Plan.

 

## **StockOptions**

 

Each option has an exercise price which equals 100% ofthe market price of Sally Beauty’s common stock on the date of grant andgenerally has a maximum term of 10 years. Options generally vest ratably over afour-year period and are subject to forfeiture until the four-year vestingperiod is complete.

 

The following table presents a summary of the activityfor the Sally Beauty’s stock option plans for the fiscal year ended September 30,2009:

 
| ** **                        | ** ** | **Number of  Outstanding  Options (in  Thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  Years)** | ** ** | **Aggregate  Intrinsic  Value (in  Thousands)** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------------------|------------|
| Outstanding at September 30, 2008 |       | 8,138                                               |       | $                                      | 7.99       |                                                            | 8.1        |                                            | $          | 9,680 |   |
| Granted                           |       | 2,707                                               |       | 5.23                                   |       |                                                            |       |                                            |       |
| Exercised                         |       | (273                                                | )          | 2.00                                   |       |                                                            |       |                                            |       |
| Forfeited or expired              |       | (547                                                | )          | 8.19                                   |       |                                                            |       |                                            |       |
| Outstanding at September 30, 2009 |       | 10,025                                              |       | $                                      | 7.40       |                                                            | 7.7        |                                            | $          | 10,678 |   |
|                              |       |                                                |       |                                   |       |                                                            |       |                                            |       |
| Exercisable at September 30, 2009 |       | 4,239                                               |       | $                                      | 7.41       |                                                            | 6.8        |                                            | $          | 5,847 |   |

 

The following table summarizes information about stockoptions under Sally Beauty’s option plans at September 30, 2009 (shares inthousands):

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 
| ** **                   | ** ** | **Options Outstanding**                              | ** ** | **Options Exercisable**                                         | ** ** |
|------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number  Outstanding at  September 30,  2009** | ** ** | **Weighted  Average  Remaining  Contractual  Term (In  Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable at  September 30,  2009** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $2.00                        |       | 1,144                                                |       | 4.8                                                             |       | $ | 2.00 |   | 1,144 |   | $ | 2.00 |   |
| $5.24 – 9.66            |       | 8,881                                                |       | 8.1                                                             |       | 8.09 |   | 3,095 |   | 9.41 |   |
| Total                        |       | 10,025                                               |       | 7.7                                                             |       | $ | 7.40 |   | 4,239 |   | $ | 7.41 |   |

 

The Company uses the Black-Scholes option pricingmodel to value Sally Beauty’s stock options for each stock option award. Usingthis option pricing model, the fair value of each stock option award isestimated on the date of grant. The fair value of Sally Beauty’s stock optionawards, which generally vest ratably over a four year period, is expensed on astraight-line basis over the vesting period of the stock options or to the datea participant becomes eligible for retirement, if earlier.

 

The weighted average assumptions relating to thevaluation of Sally Beauty’s stock options are as follows:

 
| ** **              | ** ** | **Year Ended September 30,** | ** ** |
|-------------------------|------------|-----------------------------------|------------|
| ** **              | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Expected lives (years)  |       | 5.0                               |       | 5.0 |   | 5.0 |   |
| Expected volatility     |       | 47.9                              | %          | 37.5%-41.3 | % | 41.2% - 41.9 | % |
| Risk-free interest rate |       | 2.6                               | %          | 3.5%-4.0 | % | 4.4% - 4.6 | % |
| Dividend yield          |       | 0.0                               | %          | 0.0 | % | 0.0 | % |

 

The expected life of options represents the period oftime that the options granted are expected to be outstanding and is based onhistorical experience of employees of the Company that have been granted stockoptions under stock option plans of Alberto-Culver. Expected volatility isderived by using the average volatility of similar companies since it is notpracticable to estimate Sally Beauty’s expected volatility due to a lack oftrading history. The risk-free interest rate is based on the zero-coupon U.S.Treasury issue as of the date of the grant. Since Sally Beauty does notcurrently expect to pay dividends, the dividend yield is 0%.

 

The weighted average fair value per option at the dateof grant for all stock options issued to Company employees in fiscal years2009, 2008 and 2007 was $2.33, $3.73 and $4.11, respectively.

 

The total intrinsic value of options exercised duringthe fiscal years 2009, 2008 and 2007 was $1.0 million, $3.3 million and $5.9million, respectively; and the tax benefit realized for the tax deductions fromthese option exercises was $0.4 million, $1.3 million and $2.3 million,respectively. The total cash received from these option exercises was $0.7million, $1.1 million and $1.7 million during the fiscal years 2009, 2008 and2007, respectively. The total fair value of stock options issued to Companyemployees that vested during the fiscal years 2009, 2008 and 2007 was $6.2million, $4.7 million and $7.3 million, respectively.

 

At September 30, 2009, unrecognized compensationcost related to non-vested stock option awards of approximately $8.9 million isexpected to be recognized over the weighted average period of 2.3 years.

 

## **StockAwards**

 

##### ***Restricted Stock Awards***

 

As a subsidiary of Sally Beauty, the Company has noemployee stock award plans; however, certain employees and consultants of theCompany have been granted restricted stock awards under the 2003 RestrictedStock Plan of Sally Beauty (the “RSP”) or under the 2007 Plan. A restrictedstock award is an award of shares of Sally Beauty’s common stock (which havefull voting rights but are restricted with regard to sale or transfer), therestrictions over which lapse ratably over a specified period of time(generally five years). Restricted stock awards are independent of stock optiongrants and are generally subject to forfeiture if employment terminates priorto these restrictions lapsing, subject to certain retirement provisions of the2007 Plan. Participants have full voting and dividend rights with respect tounvested shares from restricted stock awards.

 

The Company expenses the cost of the restricted stockawards, which is determined to be the fair value of the restricted stock awardat the date of grant, on a straight-line basis over the period (the “vestingperiod”) in which the restrictions on these stock awards lapse (“vesting”). Forthese purposes, the fair value of the restricted stock award is determinedbased on the closing price of the Sally Beauty’s common stock on the grantdate.

 

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SallyHoldings LLC and Subsidiaries

Notesto Consolidated Financial Statements

 

The following table presents a summary of the activityfor Sally Beauty’s restricted stock awards for the fiscal year ended September 30,2009:

 
| **Restricted Stock Awards**           | ** ** | **Number of  Shares (In  Thousands)** | ** ** | **Weighted  Average Fair  Value Per Share** | ** ** | **Weighted  Average  Remaining  Vesting Term (In  Years)** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------------|------------|
| Non-vested at September 30, 2008 |       | 296                                   |       | $                                           | 8.44       |                                                       | 3.8        |   |
| Granted                               |       | 123                                   |       | 5.17                                        |       |                                                       |       |
| Vested                                |       | (68                                   | )          | 8.44                                        |       |                                                       |       |
| Forfeited or expired                  |       | (20                                   | )          | 4.79                                        |       |                                                       |       |
| Non-vested at September 30, 2009 |       | 331                                   |       | $                                           | 7.45       |                                                       | 3.3        |   |

 

At September 30, 2009, unrecognized compensationexpense related to non-vested restricted stock awards of approximately $2.0million is expected to be recognized over the weighted average period of 3.3years.

 

## **6.  Allowance for Doubtful Accounts**

##  

The change in the allowance for doubtful accounts wasas follows (in thousands):

 
| ** **                                             | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                             | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Balance at beginning of  period                        |       | $                                 | 2,702      |   | $ | 2,564 |   | $ | 2,246 |   |
| Bad debt expense                                       |       | 1,859                             |       | 2,353 |   | 2,632 |   |
| Uncollected accounts  written off, net of recoveries   |       | (2,648                            | )          | (2,218 | ) | (2,568 | ) |
| Allowance for doubtful  accounts of acquired companies |       | 353                               |       | 3 |   | 254 |   |
| Balance at end of  period                              |       | $                                 | 2,266      |   | $ | 2,702 |   | $ | 2,564 |   |

##  

## **7.  Propertyand Equipment, Net**

##  

Property and equipment, net consists of the following(in thousands):

 
| ** **                                      | ** ** | **September 30,** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Land                                            |       | $                      | 9,672      |   | $ | 9,774 |   |
| Buildings and building  improvements            |       | 49,608                 |       | 49,139 |   |
| Leasehold improvements                          |       | 139,642                |       | 130,945 |   |
| Furniture, fixtures and  equipment              |       | 217,656                |       | 209,587 |   |
| Total property and  equipment, gross            |       | 416,578                |       | 399,445 |   |
| Less accumulated  depreciation and amortization |       | (265,329               | )          | (243,185 | ) |
| Total property and  equipment, net              |       | $                      | 151,249    |   | $ | 156,260 |   |

 

Depreciation expense forfiscal years 2009, 2008 and 2007 was $40.9 million, $42.2 million and $38.9million, respectively. As further described in Note 11, the term loan facilities and the ABLfacility are secured by substantially all of our assets, those of SallyInvestment Holdings LLC, a wholly-owned subsidiary of Sally Beauty and thedirect parent of Sally Holdings, those of our domestic subsidiaries and, in thecase of the ABL facility, those of our Canadian subsidiaries.

 

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SallyHoldings LLC and Subsidiaries

Notesto Consolidated Financial Statements

 

## **8.  Goodwill and Other Intangibles**

##  

The changes in the carrying amounts of goodwill byoperating segment for the fiscal years 2009 and 2008 are as follows (inthousands):

 
| ** **                                    | ** ** | **Sally Beauty********Supply** | ** ** | **Beauty Systems********Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|---------------------------------|------------|-----------|------------|
| Balance at  September 30, 2007           |       | $                              | 44,548     |                            | $          | 362,075   |       | $ | 406,623 |   |
| Additions, net  of purchase price adjustments |       | 27,000                         |       | 1,876                           |       | 28,876    |       |
| Foreign currency  translation                 |       | (6,360                         | )          | (4,176                          | )          | (10,536   | )          |
| Balance at  September 30, 2008           |       | 65,188                         |       | 359,775                         |       | 424,963   |       |
| Additions, net  of purchase price adjustments |       | 10,264                         |       | 62,388                          |       | 72,652    |       |
| Foreign currency  translation                 |       | (2,244                         | )          | (1,236                          | )          | (3,480    | )          |
| Balance at  September 30, 2009           |       | $                              | 73,208     |                            | $          | 420,927   |       | $ | 494,135 |   |

 

As described in Note 15, during the fiscal year2009, $61.0 million of the increase in BSG’s goodwill was attributable to theacquisition of Schoeneman Beauty Supply, Inc. on September 30, 2009,and the remaining $1.4 million was attributable to other acquisitions notindividually material.  Further, duringthe fiscal year 2009, the increase in Sally Beauty Supply’s goodwill wasattributable to certain acquisitions which were not individually material. Asfurther described in Note 15, during the fiscal year 2008, $23.9 millionof the increase in Sally Beauty Supply’s goodwill was attributable to the acquisitionof Pro-Duo in May of 2008, net of purchase price adjustments, and theremaining $3.1 million was attributable to other acquisitions not individuallymaterial. Additionally, the increase in BSG’s goodwill, during the fiscal year2008, was attributable to certain acquisitions which were not individuallymaterial.

 

The following table provides the carrying value forintangible assets with indefinite lives and the gross carrying value andaccumulated amortization for intangible assets subject to amortization byoperating segment at September 30, 2009 and 2008 (in thousands):

 
| ** **                                  | ** ** | **Sally Beauty********Supply** | ** ** | **Beauty Systems********Group** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|--------------------------------|------------|---------------------------------|------------|-----------|------------|
| Balance at  September 30, 2009:        |       |                           |       |                            |       |      |       |
| Intangible assets with  indefinite lives:   |       |                           |       |                            |       |      |       |
| Trade names                                 |       | $                              | 20,183     |                            | $          | 33,815    |       | $ | 53,998 |   |
| Other intangibles                           |       | —                         |       | 5,700                           |       | 5,700     |       |
| Total                                       |       | 20,183                         |       | 39,515                          |       | 59,698    |       |
| Intangible assets  subject to amortization: |       |                           |       |                            |       |      |       |
| Gross carrying amount                       |       | 6,933                          |       | 36,411                          |       | 43,344    |       |
| Accumulated  amortization                   |       | (2,299                         | )          | (22,058                         | )          | (24,357   | )          |
| Net value                                   |       | 4,634                          |       | 14,353                          |       | 18,987    |       |
| Total intangible  assets, net               |       | $                              | 24,817     |                            | $          | 53,868    |       | $ | 78,685 |   |
|                                        |       |                           |       |                            |       |      |       |
| Balance at  September 30, 2008:        |       |                           |       |                            |       |      |       |
| Intangible assets with  indefinite lives:   |       |                           |       |                            |       |      |       |
| Trade names                                 |       | $                              | 21,182     |                            | $          | 34,246    |       | $ | 55,428 |   |
| Other intangibles                           |       | —                         |       | 6,053                           |       | 6,053     |       |
| Total                                       |       | 21,182                         |       | 40,299                          |       | 61,481    |       |
| Intangible assets  subject to amortization: |       |                           |       |                            |       |      |       |
| Gross carrying amount                       |       | 7,070                          |       | 35,086                          |       | 42,156    |       |
| Accumulated  amortization                   |       | (1,247                         | )          | (16,956                         | )          | (18,203   | )          |
| Net value                                   |       | 5,823                          |       | 18,130                          |       | 23,953    |       |
| Total intangible  assets, net               |       | $                              | 27,005     |                            | $          | 58,429    |       | $ | 85,434 |   |

 

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SallyHoldings LLC and Subsidiaries

Notesto Consolidated Financial Statements

 

Amortization expense totaled $6.2 million, $6.3million and $3.7 million in fiscal years 2009, 2008 and 2007, respectively. Asof September 30, 2009, future amortization expense related to intangibleassets subject to amortization is estimated to be as follows (in thousands):

 

| **Fiscal Year:** | ** ** | ** ** | ** **   |
|------------------|------------|------------|--------------|
| 2010             |       | $          | 4,795        |   |
| 2011             |       | 3,752      |         |
| 2012             |       | 2,242      |         |
| 2013             |       | 1,642      |         |
| 2014             |       | 1,550      |         |
| Thereafter       |       | 5,006      |         |
|             |       | $          |  18,987 |   |

 

The weighted average amortization period forintangible assets subject to amortization is approximately 6.0 years.

 

## **9.   Accounts Payable and Accrued Expenses**

##  

Accounts payable at September 30,2009 and 2008 include book cash overdrafts of $0.0 million and $1.6 million,respectively.

 

Accrued expenses consist of the following (inthousands):

 

| ** **                    | ** ** | **September 30,** | ** ** |
|-------------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Compensation and  benefits    |       | $                      | 60,811     |   | $ | 58,873 |   |
| Interest payable              |       | 28,612                 |       | 31,013 |   |
| Deferred revenue              |       | 12,392                 |       | 11,003 |   |
| Rental obligations            |       | 10,708                 |       | 10,139 |   |
| Property and other  taxes     |       | 4,355                  |       | 7,012 |   |
| Insurance reserves            |       | 6,805                  |       | 5,973 |   |
| Acquisition related  payables |       | 1,950                  |       | 3,121 |   |
| Operating accruals and  other |       | 28,209                 |       | 27,395 |   |
| Total accrued expenses        |       | $                      | 153,842    |   | $ | 154,529 |   |

##  

## **10.  Lease Commitments and Contingencies**

##  

## **LeaseCommitments**

##  

The Company’s principal leases relate to retail storesand warehousing properties. At September 30, 2009, future minimum paymentsunder non-cancelable operating leases, net of sublease income, are as follows(in thousands):

 

| **Fiscal Year:** | ** ** | ** ** | ** **    |
|------------------|------------|------------|---------------|
| 2010             |       | $          | 128,417       |   |
| 2011             |       | 110,298    |          |
| 2012             |       | 87,578     |          |
| 2013             |       | 62,808     |          |
| 2014             |       | 36,524     |          |
| Thereafter       |       | 63,351     |          |
|             |       | $          |  488,976 |   |

 

Certain leases require the Company to pay itsrespective portion of real estate taxes, insurance, maintenance and specialassessments. Also, certain of the Company’s leases include renewal options andescalation clauses.

 

Total rental expense for operating leases amounted toapproximately $166.3 million, $163.7 million and $147.3 million in the fiscalyears 2009, 2008 and 2007, respectively, and is included in selling, generaland administrative expenses in the consolidated statements of earnings.Included in this amount is $0.4 million, $0.8 million and $0.8 million forcontingent rents for the fiscal years ended September 30, 2009, 2008 and2007, respectively.

 

## **Contingencies**

##  

##### ***Legal Proceedings***

##### *** ***

There were no material legal proceedings pendingagainst the Company or its subsidiaries, as of September 30, 2009. TheCompany is involved in various claims and lawsuits incidental to the conduct ofits business in the ordinary course. The Company does not believe 

 

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SallyHoldings LLC and Subsidiaries

Notesto Consolidated Financial Statements

 

that the ultimate resolution of these matters willhave a material adverse impact on its consolidated financial position,statements of earnings or cash flows.

 

On February 25, 2008,Sally Beauty disclosed in a Current Report on Form 8-K that on February 21,2008, L’Oreal filed a lawsuit in the Superior Court of the State of Californiain and for the County of San Diego — Central Division naming, among others, SDHair, Ltd. and Hair of Nevada, LLC (collectively, “SD Hair”), franchisees ofour subsidiary Armstrong McCall division (“AMLP”) of our BSG business unit, asdefendants.  The suit alleged, among other things, that SD Hair breachedits franchise agreement with AMLP by diverting (selling) Matrix brandedproducts to unauthorized buyers, and that L’Oreal is entitled to make claimsagainst SD Hair under the franchise agreement as a third-party beneficiary ofthat agreement.  On March 24, 2008, SD Hair filed a cross-complaintin the same case naming AMLP and BSG as cross-defendants, seeking, among otherthings, i) declaratory relief from BSG and AMLP in the form of a judicialfinding that SD Hair is not in breach of its franchise agreement and thatL’Oreal has no rights as a third-party beneficiary to SD Hair’s franchiseagreement, and ii) injunctive relief in the form of a judicial order compellingAMLP and BSG to take appropriate legal action against L’Oreal to enforce SDHair’s claimed rights under AMLP’s Matrix distribution agreement.  We have answered the cross-complaint and thelawsuit has been set for a jury trial in June of 2010.

 

On July 30, 2009,Sally Beauty disclosed in a Current Report on Form 8-K that L’Oreal fileda Second Amended Complaint in connection with the previously disclosed lawsuitdescribed above.  The Second AmendedComplaint alleges, among other things, that AMLP, certain ofits employees and others were involved in selling Matrix brandedproducts to unauthorized buyers and that certain of its employees (and others)engaged in improper business transactions for personal benefit during 2005through 2007.  L’Oreal seeks moneydamages, certain injunctive relief and a declaration that L’Oreal is entitledto terminate the 1981 Matrix Distributor Agreement now in effect between L’Orealand AMLP.  None of the employees involvedin the allegations are executive officers of the Company.  Substantially all of these allegations weremade known by L’Oreal to the Company prior to the filing of the SecondAmended Complaint.   L’Oreal alsoprovided the Company with documents allegedly supporting the allegations.

 

## **As aresult of these allegations made by L’Oreal, many of which areincorporated into the Second Amended Complaint, the Audit Committee of theBoard of Directors of Sally Beauty engaged independent special counsel toinvestigate whether certain employees engaged in improper business transactionsfor personal benefit.  After extensivereview, the Audit Committee and independent special counsel found insufficientevidence to support a conclusion that Sally Beauty or Company employees enteredinto improper transactions for personal benefit.**

##  

## **On September 8, 2009, AMLPand BSG filed a cross-complaint against L’Oreal.  In the cross-complaint,AMLP and BSG allege that L’Oreal does not have a genuine interest in stoppingdiversion, and that L’Oreal’s anti-diversion policies have beendiscriminatorily applied to AMLP and BSG.  AMLP further alleges thatL’Oreal is using diversion as a pretext to attempt to terminate the DistributorAgreement with AMLP.**

##  

***Other Contingencies***

 

The Company provides healthcare benefits toessentially all of its full-time employees. The Company is largely self-fundedfor the cost of the healthcare plan, other than certain fees and out-of-pocketamounts paid by the employees. In addition, the Company retains a substantialportion of the risk related to certain workers’ compensation, general liabilityand automobile and property insurance. The Company records an estimatedliability for the ultimate cost of claims incurred and unpaid as of the balancesheet date. The estimated liability is included in accrued expenses (currentportion) and other liabilities (long-term portion) in our consolidated balancesheets. The Company carries insurance coverage in such amounts in excess of itsself-insured retention which management believes to be reasonable.

 

Liabilities for loss contingencies, arising fromclaims, assessments, litigation, fines, penalties and other sources arerecorded when it is probable that a liability has been incurred and the amountof the assessment can be reasonably estimated. The Company has no significantliabilities for loss contingencies at September 30, 2009 and 2008.

 

F-21

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Table of Contents

 

SallyHoldings LLC and Subsidiaries

Notesto Consolidated Financial Statements

 

## **11.  Long-Term Debt**

 

Details of long-term debt are as follows (inthousands):

 
| ** **                   | ** ** | **September 30,  2009** | ** ** | **Maturity dates** | ** **      | **Interest Rates**                              | ** **                           |
|------------------------------|------------|------------------------------|------------|--------------------|-----------------|-------------------------------------------------|--------------------------------------|
| ABL facility                 |       | $                            | —     |               | —          |                                            | (i)   Prime and up to 0.50% or; |   |
|                         |       |                         |       |               |            | (ii) LIBOR  (a) plus (1.00% to 1.50%) |                                 |
| Term Loan A                  |       | 105,000                      |       | Nov.  2012    |            | (i)   Prime plus (1.00% to 1.50%) or;      |                                 |
|                         |       |                         |       |               |            | (ii) LIBOR  plus (2.00% to 2.50%)          |                                 |
| Term Loan B                  |       | 863,856                      |       | Nov.  2013    |            | (i)   Prime plus (1.25% to 1.50%) or;      |                                 |
|                         |       |                         |       |               |            | (ii) LIBOR  plus (2.25% to 2.50%)          |                                 |
| Other (b)                    |       | 3,135                        |       | 2010-2014          |            | 4.05% to 7.00%                                  |                                 |
| Total                        |       | $                            | 971,991    |               |            |                                            |                                 |   |
|                         |       |                         |       |               |            |                                            |                                 |
| Senior notes                 |       | $                            | 430,000    |               | Nov.  2014 |                                            | 9.25%                                |   |
| Senior subordinated notes    |       | 275,000                      |       | Nov.  2016    |            | 10.50%                                          |                                 |
| Total                        |       | $                            | 705,000    |               |            |                                            |                                 |   |
|                         |       |                         |       |               |            |                                            |                                 |
| Capitalized leases and other |       | $                            | 539        |               |            |                                            |                                 |   |
| Less: current portion        |       | (24,517                      | )          |               |            |                                            |                                 |
| Total long-term debt         |       | $                            | 1,653,013  |               |            |                                            |                                 |   |

 

----

(a) London Interbank Offered Rate (“LIBOR”)

(b) Represents pre-acquisition debt of Pro-Duo, N.V.

 

In connection with the Separation Transactions on November 16,2006, the Company and certain of its subsidiaries incurred $1,850.0 million ofindebtedness by: (i) drawing on a $400.0 million revolving (asset-basedlending (“ABL”)) facility in an amount equal to $70.0 million; (ii) enteringinto two term loan facilities (term loans A and B) in an aggregate amount of$1,070.0 million; and (iii) together (jointly and severally) with anotherof the Company’s subsidiaries, Sally Capital Inc., issuing senior notes in anaggregate amount of $430.0 million and senior subordinated notes in anaggregate amount of $280.0 million. The Company incurred approximately $58.5million in costs related to the issuance of the debt, which was capitalized andis being amortized to interest expense over the life of the related debtinstruments. Proceeds from the initial debt were used primarily to pay the$1,809.7 million distribution to Sally Beauty and for certain expensesassociated with the Separation Transactions.

 

The ABL facility provides for senior secured revolvingloans up to a maximum aggregate principal amount of $400.0 million, subject toborrowing base limitations. The availability of funds under the ABL facility issubject to a borrowing base calculation, which is based on specifiedpercentages of the value of eligible inventory and eligible accountsreceivables, subject to certain reserves and other adjustments and reduced bycertain outstanding letters of credit. At September 30, 2009, the Companyhad $325.6 million available for borrowing under the ABL facility.Additionally, the Company is required to pay a commitment fee ranging from0.20% to 0.35% on the unused portion of the ABL facility. At September 30,2009, the commitment fee rate was 0.20%.

 

The ABL facility contains a covenant requiring us andour subsidiaries to maintain a fixed-charge coverage ratio of at least 1.0 to1.0 when availability under the ABL facility falls below $40.0 million. Thefixed-charge coverage ratio is defined as the ratio of EBITDA (as defined inthe agreement underlying the ABL facility, or Credit Agreement EBITDA) lessunfinanced capital expenditures to fixed charges (as included in the definitionof the fixed-charge coverage ratio in the agreement governing the ABLfacility).

 

The senior term loan facilities consist of (i) a$150.0 million senior term loan A facility and (ii) a $920.0 millionsenior term loan B facility. Principal and interest is payable on a quarterlybasis.

 

The Term Loans contain a covenant requiring theCompany and its subsidiaries to meet certain maximum consolidated securedleverage ratio levels, which decline over time. The consolidated securedleverage ratio is a ratio of (A) net consolidated secured debt to (B) ConsolidatedEBITDA as defined in the agreement underlying the Term Loans. Compliance withthe consolidated secured leverage ratio is tested quarterly, with a maximumratio of 4.50 as of September 30, 2009. Failure to comply with theconsolidated secured leverage ratio covenant under the Term Loans would resultin a default under such facilities.

 

The senior term loanfacilities and the ABL facility are secured by substantially all of our assets,those of Sally Investment, those of our domestic subsidiaries and, in the caseof the ABL facility, those of our Canadian subsidiaries. During the fiscal yearended September 30, 2009, the Company made scheduled payments in the aggregateamount of $6.1 million on its senior term loans. The borrowings under thesenior term loan facilities may be prepaid at the option of the Company at anytime without premium or penalty and are subject to mandatory repayment in an amountequal to 50% of excess cash flow (as defined in the agreement governing the

 

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Table of Contents

 

SallyHoldings LLC and Subsidiaries

Notesto Consolidated Financial Statements

 

senior term loan facilities) for any fiscal year,unless a specified leverage ratio is met. In January of 2009, the Companymade a mandatory repayment on the senior term loans in the aggregate amount of$16.7 million and expects to make a mandatory repayment in the amount of $22.3million in January of 2010. Amounts paid pursuant to said provision may beapplied, at the option of the Company, against minimum loan repaymentsotherwise required of us over the twelve-month period following any suchrepayment under the terms of the loan agreement. Additionally, borrowings underthe term loan facility would be subject to mandatory repayment in an amountequal to 100% of the proceeds of specified asset sales that are not reinvestedin the business or applied to repay borrowings under the ABL facility. Webelieve that the Company is currently in compliance with the agreements andinstruments governing our debt, including our financial covenants.

 

During the fiscal year ended September 30, 2009,the Company also made optional repayments in the aggregate amount of $45.0million on its senior term loans. In addition, in May 2009, the Companyrepurchased $5.0 million in par value of its 10.5% senior subordinated notes (duein November of 2016) for approximately $5.0 million, plus accruedinterest. In connection with the mandatory and optional repayments made duringthe fiscal year ended September 30, 2009, the Company recorded losses onextinguishment of debt in the aggregate amount of $1.0 million, which areincluded in net interest expense in the Company’s consolidated statements ofearnings.

 

The senior notes and seniorsubordinated notes are unsecured obligations of the issuers and are guaranteedon a senior basis (in the case of the senior notes) and on a seniorsubordinated basis (in the case of the senior subordinated notes) by eachmaterial domestic subsidiary of the Company (other than Sally Capital). Thesenior notes and the senior subordinated notes carry optional redemptionfeatures whereby the Company has the option to redeem the notes on or before November 15,2010 and November 15, 2011, respectively, at par plus a premium, plusaccrued and unpaid interest, and on or after November 15, 2010 and November 15,2011, respectively, at par plus a premium declining ratably to par, plusaccrued and unpaid interest. Interest on the senior notes and seniorsubordinated notes is payable semi-annually. Furthermore, the agreementsunderlying the Company’s credit facilities contain terms, which significantlyrestrict the ability of us and our subsidiaries to pay dividends or otherwisetransfer assets to Sally Beauty.

 

In November of 2006, the Company entered intofour interest rate swap agreements with an aggregate notional amount of $500.0million in connection with its cash flow risk associated with changing interestrates related to its Term Loans. In May of 2008, the Company entered intotwo additional interest rate swap agreements with an aggregate notional amountof $300.0 million. Please see Note 12 for further information on the interestrate swap agreements.

 

Maturities of the Company’s long-term debt are asfollows at September 30, 2009 (in thousands):

 

| **Fiscal Year:**          | ** ** | ** ** | ** ** |
|---------------------------|------------|------------|------------|
| 2010                      |       | $          | 24,241     |   |
| 2011                      |       | 8,188      |       |
| 2012                      |       | 75,347     |       |
| 2013                      |       | 8,454      |       |
| 2014                      |       | 855,761    |       |
| Thereafter                |       | 705,000    |       |
|                      |       | $          | 1,676,991  |   |
| Capital leases  and other |       | 539        |       |
| Less: current  portion    |       | (24,517    | )          |
| Total                     |       | $          | 1,653,013  |   |

 

We are a holding companyand do not have any material assets or operations other than ownership of equityinterests of our subsidiaries.  Theagreements and instruments governing the debt of the Company and itssubsidiaries contain material limitations on our ability to pay dividends andother restricted payments to Sally Beauty.

 

Under the agreements andindentures governing the term loan facilities and the notes, the Company maynot make certain restricted payments to Sally Beauty if a default then existsunder the credit agreement or the indentures or if its consolidated interestcoverage ratio is less than 2.0 to 1.0 at the time of the making of suchrestricted payment.  As of September 30,2009, its consolidated interest coverage ratio exceeded 2.0 to 1.0.  Further, the aggregate amount of restrictedpayments it is able to make is limited pursuant to various baskets ascalculated pursuant to the credit agreement and indentures.

 

The agreements governing our ABL facility generallypermit the making of distributions and certain other restricted payments solong as borrowing availability under the facility equals or exceeds $60.0million. If borrowing availability falls below this amount, the Company maynevertheless make restricted payments to Sally Beauty in the aggregate sincethe date of the Separation Transactions, together with the aggregate cash amountpaid in acquisitions since said date, of not greater than $50.0 million,together with certain other exceptions. As of September 30, 2009, borrowing availability under the ABLfacility exceeded $60.0 million.  As of September

 

F-23

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Table of Contents

 

SallyHoldings LLC and Subsidiaries

Notesto Consolidated Financial Statements

 

30, 2009, the net assets of our consolidatedsubsidiaries that were unrestricted from transfer under our credit arrangementstotaled $225.3 million, subject to certain adjustments.

 

At September 30, 2009 and 2008, the Company hadno off balance sheet financing arrangements other than operating leasesincurred in the ordinary course of business as disclosed in Note 10, andoutstanding letters of credit related to inventory purchases and self-insuranceprograms which totaled $13.4 million and $12.1 million at September 30,2009 and 2008, respectively.

 

## **12.  Interest Rate Swaps**

##  

The Company is exposed toa wide variety of risks, including risks arising from changing economicconditions. The Company manages its exposure to certain economic risks(including liquidity, credit risk and changes in interest rates) primarily (a) byclosely managing its cash flows from operating and investing activities and theamounts and sources of its debt obligations; (b) by assessing periodicallythe creditworthiness of its business partners; and (c) through the use ofinterest rate swaps by the Company.  TheCompany uses interest rate swaps, as part of its overall economic riskmanagement strategy to add stability to the interest payments due in connectionwith its term loan obligations. Interest payments related to the term loans areimpacted by changes in LIBOR. Interest rate swap agreements involve theperiodic receipt by the Company of amounts based on a variable rate in exchangefor the Company making payments based on a fixed rate over the term of theinterest rate swap agreements, without exchange of the underlying notionalamount. At September 30, 2009, the Company did not hold any otherderivative instruments or hold any derivative instruments for trading orspeculative purposes.

 

**DesignatedCash Flow Hedges of Interest Rate Risk**

 

In May of 2008, theCompany entered into two interest rate swap agreements with an aggregate notional amount of $300 million. These interest rate swap agreements expire in May of 2012 andare designated and qualify as effective cash flow hedges, in accordance withASC 815.  Accordingly, changes in thefair value of derivatives designated and qualifying as cash flow hedges arerecorded quarterly, net of income tax, in accumulated other comprehensive(loss) income (“OCI”) until the hedged obligation is settled or the swapagreements expire, whichever is earlier. Any hedge ineffectiveness, as thisterm is used in ASC 815, is recognized in net interest expense in ourconsolidated statements of earnings. No hedge ineffectiveness on cash flowhedges was recognized during the fiscal years ended September 30, 2009 and2008.

 

Amounts reported in OCI related to interest rate swapsare reclassified into net interest expense, as a yield adjustment, in the sameperiod in which interest on the Company’s variable-rate debt obligations affectearnings. During the fiscal years ended September 30, 2009 and 2008, netinterest expense of $7.9 million and $1.2 million, respectively, resulted fromsuch reclassifications.  During thetwelve months ending September 30, 2010, the Company estimates that anadditional $8.9 million of the amount reported in OCI will be reclassified intointerest expense.

 

**Non-designatedCash Flow Hedges of Interest Rate Risk**

 

Interest rate swaps not designated as hedges are usedto manage the Company’s exposure to interest rate movements but do not meet thehedge accounting requirements of ASC 815. In connection with the SeparationTransactions, in November 2006, the Company entered into four interestrate swap agreements with an aggregate notional amount of $500 million. Interest rate swap agreements with anaggregate notional amount of $150 million expired in November 2008 andinterest rate swap agreements with a notional amount of $350 million expire in November 2009. These interest rate swap agreements arenot designated as hedges and, accordingly, the changes in fair value of theseinterest rate swap agreements (which are adjusted quarterly) are recorded innet interest expense in our consolidated statements of earnings. During the fiscal years ended September 30,2009, 2008 and 2007, net interest expense of $7.5 million, $10.5 million and$1.2 million, respectively, resulted from interest rate swaps not designated ashedges.

 

F-24

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Table ofContents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

The table below presentsthe fair value of the Company’s derivative financial instruments as well astheir classification on the consolidated balance sheet as of September 30, 2009(in thousands):

 

**Tabular Disclosure of Fair Values of DerivativeInstruments**

 
| ** **                                               | ** ** | **Asset Derivatives**        | ** ** | **Liability Derivatives**    |       |
|----------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **As of September 30, 2009** | ** ** | **As of September 30, 2009** |       |
| ** **                                               | ** ** | **Balance Sheet  Location**  | ** ** | **Fair Value**               | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** |   |
| Derivatives designated as hedging instruments:           |       |                         |       |                         |       |   |   |   |   |
| Interest Rate Swaps                                      |       | Prepaid  expenses            |       | $                            | —     |   | Accrued  expenses |   | $ | — |   |
| Interest Rate Swaps                                      |       | Other  assets                |       | $                            | —     |   | Other  liabilities |   | $ | 15,365 | (1) |
|                                                     |       |                         |       |                         |       |   |   |   |   |
| Total derivatives designated as hedging instruments      |       |                         |       | $                            | —     |   |   |   | $ | 15,365 |   |
|                                                     |       |                         |       |                         |       |   |   |   |   |
| Derivatives not designated as hedging instruments:       |       |                         |       |                         |       |   |   |   |   |
| Interest Rate Swaps                                      |       | Prepaid  expenses            |       | $                            | —     |   | Accrued  expenses |   | $ | 2,356 |   |
|                                                     |       |                         |       |                         |       |   |   |   |   |
| Total derivatives not designated as hedging  instruments |       |                         |       | $                            | —     |   |   |   | $ | 2,356 |   |

 

----

(1)          At September 30, 2009, the Company estimates thatapproximately $8.9 million of the fair value of these derivative financialinstruments will settle within the twelve months ending September 30, 2010.

 

The table below presentsthe fair value of the Company’s derivative financial instruments as well astheir classification on the consolidated balance sheet as of September 30, 2008(in thousands):

 

**Tabular Disclosure of Fair Values of DerivativeInstruments**

 
| ** **                                               | ** ** | **Asset Derivatives**        | ** ** | **Liability Derivatives**    |       |
|----------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **As of September 30, 2008** | ** ** | **As of September 30, 2008** |       |
| ** **                                               | ** ** | **Balance Sheet  Location**  | ** ** | **Fair Value**               | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** |   |
| Derivatives designated as hedging instruments:           |       |                         |       |                         |       |   |   |   |   |
| Interest Rate Swaps                                      |       | Prepaid  expenses            |       | $                            | —     |   | Accrued  expenses |   | $ | — |   |
| Interest Rate Swaps                                      |       | Other  assets                |       | $                            | 1,302      |   | Other  liabilities |   | $ | — |   |
|                                                     |       |                         |       |                         |       |   |   |   |   |
| Total derivatives designated as hedging instruments      |       |                         |       | $                            | 1,302      |   |   |   | $ | — |   |
|                                                     |       |                         |       |                         |       |   |   |   |   |
| Derivatives not designated as hedging instruments:       |       |                         |       |                         |       |   |   |   |   |
| Interest Rate Swaps                                      |       | Prepaid  expenses            |       | $                            | —     |   | Accrued  expenses |   | $ | 487 |   |
| Interest Rate Swaps                                      |       | Other  assets                |       | $                            | —     |   | Other  liabilities |   | $ | 7,167 |   |
|                                                     |       |                         |       |                         |       |   |   |   |   |
| Total derivatives not designated as hedging  instruments |       |                         |       | $                            | —     |   |   |   | $ | 7,654 |   |

 

F-25

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Table ofContents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

The tables below presentthe effect of the Company’s derivative financial instruments on theconsolidated statements of earnings for the fiscal year ended September 30,2009 (in thousands):

 

**Tabular Disclosure of the Effect of Derivative Instrumentson the Statement of Earnings for theFiscal Year Ended September 30, 2009**

 
| **Derivatives  in Cash  Flow Hedging  Relationships** | ** ** | **Amount  of  Gain or  (Loss)  Recognized  in OCI on  Derivative  (Effective  Portion), net  of tax** | ** ** | **Location  of Gain or  (Loss) Reclassified  from Accumulated  OCI into Income  (Effective Portion)** | ** **             | **Amount  of  Gain or (Loss)  Reclassified  from  Accumulated  OCI into  Income  (Effective  Portion)** | ** ** | **Location  of Gain or  (Loss) Recognized in  Income on Derivative  (Ineffective Portion  and Amount  Excluded from  Effectiveness Testing)** | ** ** | **Amount  of Gain  or (Loss)  Recognized in  Income on  Derivative  (Ineffective  Portion and  Amount  Excluded from  Effectiveness  Testing)** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------------------|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Interest Rate Swaps                                   |       | $                                                                                                     | (10,196    | )                                                                                                     | Interest  expense, net |                                                                                                    | $          | (7,935                                                                                                                                        | )          | Interest  expense, net                                                                                                                          |       | $ | — |   |
|                                                       |            |                                                                                                       |            |                                                                                                       |                        |                                                                                                         |            |                                                                                                                                               |            |                                                                                                                                                 |            |  |  |  |

 
| **Derivatives  Not Designated as Hedging  Instruments** | ** ** | **Location  of Gain or  (Loss) Recognized in  Income on  Derivative** | ** ** | **Amount  of  Gain or (Loss)  Recognized in  Income on  Derivative** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Interest Rate Swaps                                     |       | Interest expense, net                                                 |       | $                                                                    | (7,488     | )          | ** ** | ** ** | ** ** | ** ** |
|                                                         |            |                                                                       |            |                                                                      |            |            |            |            |            |  |

 

**Tabular Disclosure of the Effect of DerivativeInstruments on the Statement of Earnings for theFiscal Year Ended September 30, 2008**

 
| **Derivatives  in Cash  Flow Hedging  Relationships** | ** ** | **Amount  of  Gain or  (Loss)  Recognized  in OCI on  Derivative  (Effective********Portion), net  of tax** | ** ** | **Location  of Gain or  (Loss) Reclassified  from Accumulated  OCI into Income  (Effective Portion)** | ** **            | **Amount  of  Gain or (Loss)  Reclassified  from  Accumulated  OCI into  Income  (Effective  Portion)** | ** ** | **Location  of Gain or  (Loss) Recognized  in Income on  Derivative  (Ineffective Portion  and Amount  Excluded from  Effectiveness  Testing)** | ** ** | **Amount  of Gain  or (Loss)  Recognized in  Income on  Derivative  (Ineffective  Portion and  Amount Excluded  from  Effectiveness  Testing)** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|-----------------------|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Interest Rate Swaps                                   |       | $                                                                                                           | 793        |                                                                                                  | Interest expense, net |                                                                                                    | $          | (1,174                                                                                                                                          | )          | Interest expense, net                                                                                                                           |       | $ | — |   |
|                                                       |            |                                                                                                             |            |                                                                                                       |                       |                                                                                                         |            |                                                                                                                                                 |            |                                                                                                                                                 |            |  |  |  |

 
| **Derivatives  Not Designated as Hedging  Instruments** | ** ** | **Location  of Gain or  (Loss) Recognized  in Income on  Derivative** | ** ** | **Amount  of  Gain or (Loss)  Recognized in  Income on  Derivative** |   |   |    |   |   |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------|--------|--------|---------|--------|--------|
| Interest Rate Swaps                                     |       |                                                                  |       | Interest expense, net                                                |   | $      | (10,481 | )      |   |   |   |   |
|                                                         |            |                                                                       |            |                                                                      |        |        |         |        |        |  |  |  |

 

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Table ofContents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

**Tabular Disclosure of the Effect of DerivativeInstruments on the Statement of Earnings for theFiscal Year Ended September 30, 2007**

 
| **Derivatives  in Cash  Flow Hedging  Relationships**   | ** ** | **Amount  of  Gain or  (Loss)  Recognized  in OCI on  Derivative  (Effective  Portion), net  of tax** | ** ** | **Location  of Gain or  (Loss) Reclassified  from Accumulated  OCI into Income  (Effective Portion)** | ** **            | **Amount  of  Gain or (Loss)  Reclassified  from  Accumulated  OCI into  Income  (Effective  Portion)** | ** ** | **Location  of Gain or  (Loss) Recognized  in Income on  Derivative  (Ineffective Portion  and Amount  Excluded from  Effectiveness  Testing)** | ** ** | **Amount  of Gain  or (Loss)  Recognized in  Income on  Derivative  (Ineffective  Portion and  Amount Excluded  from  Effectiveness  Testing)** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|-----------------------|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Interest Rate Swaps                                     |       | $                                                                                                     | —     |                                                                                                  | Interest expense, net |                                                                                                    | $          | —                                                                                                                                          |       | Interest expense, net                                                                                                                           |       | $ | — |   |
|                                                    |       |                                                                                                  |       |                                                                                                  |                  |                                                                                                    |       |                                                                                                                                            |       |                                                                                                                                            |       |
| **Derivatives  Not Designated as Hedging  Instruments** | ** ** | **Location  of Gain or  (Loss) Recognized  in Income on  Derivative**                                 | ** ** | **Amount  of  Gain or (Loss)  Recognized in  Income on  Derivative**                                  |                  |                                                                                                    |       |                                                                                                                                            |       |
| Interest Rate Swaps                                     |       |                                                                                                  |       | Interest expense, net                                                                                 |                  | $                                                                                                       | (1,221     | )                                                                                                                                               |       |                                                                                                                                            |       |   |
|                                                         |            |                                                                                                       |            |                                                                                                       |                       |                                                                                                         |            |                                                                                                                                                 |            |                                                                                                                                                 |            |  |  |  |

 

**Credit-risk-related ContingentFeatures**

 

The agreements governing the Company’s interest rateswaps contain provisions pursuant to which the Company could be declared indefault on its interest rate swap obligations in the event the Companydefaulted under certain terms of the loan documents governing the Company’s ABLfacility. As of September 30, 2009, the fair value of interest rate swaps in aliability position related to these agreements was $17.7 million. As of September30, 2009, the Company was under no obligation to post and had not posted anycollateral related to these agreements. If the Company breached any of theseprovisions, it would be required to settle its obligations under the agreementsat their termination value of $20.1 million, including accrued interest andother termination costs.

 

Thecounterparties to all ourinterest rate swap instruments are deemed by the Companyto be of substantial resources and strong creditworthiness. However, thesetransactions result in exposure to credit risk in the event of default by acounterparty. The recent financial crisis affecting the banking systems andfinancial markets resulted in many well-known financial institutions becomingless creditworthy or having diminished liquidity, which could expose us to anincreased level of counterparty risk.  Inthe event that a counterparty defaults in its obligation under our interestrate swaps, we could incur substantial financial losses. However, at thepresent time, no such losses are deemed probable.

 

The Company’s foreignoperations expose the Company to fluctuations in foreign currency exchangerates and foreign interest rates.  Thesefluctuations may impact, among other things, the amount of the Company’s past andfuture cash flows in terms of the Company’s functional currency, the U.S.dollar.  From time to time, the Companymay enter into derivative instruments, such as foreign currency swaps, intendedto fix the amount of certain foreign assets and obligations relative to its functionalcurrency. At September 30, 2009, the Company did not have any such derivativeinstruments.

 

## **13.   401(k)and Profit Sharing Plan**

##  

The Company has no benefit plans of its own. Since theSeparation Transactions, the Company has been an indirect wholly-ownedsubsidiary of Sally Beauty, and its employees participate in benefits providedunder the plans of Sally Beauty. Sally Beauty sponsors the Sally Beauty 401(k) andProfit Sharing Plan (the “401k Plan”), which is a qualified definedcontribution plan. The 401k Plan covers employees of the Company who meetcertain eligibility requirements and who are not members of a collectivebargaining unit. Under the terms of the 401k Plan, employees may contribute apercentage of their annual compensation to the 401k Plan up to certainmaximums, as defined by the 401k Plan and by the U. S. Internal Revenue Code.The Company currently matches a percentage of employee contributions. TheCompany recognized expense of $4.0 million, $3.8 million and $3.3 million infiscal years 2009, 2008 and 2007, respectively, related to its employercontributions under these plans. These amounts are included in selling, generaland administrative expenses.

 

In addition, pursuant to the 401k Plan, the Companymay make profit sharing contributions to the accounts of the Company’semployees who meet certain eligibility requirements and who are not members ofa collective bargaining unit. The Company’s profit sharing contributions to the401k Plan are determined by the Compensation Committee of the Sally Beauty’sBoard of Directors. Prior to the Separation Transactions, employees of theCompany participated in the Alberto-Culver Profit Sharing Plan and theCompany’s

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

contributions to the plan were determined at thediscretion of the Alberto-Culver board of directors. The Company recognizedexpense of $2.4 million, $7.1 million and $6.2 million in fiscal years 2009,2008 and 2007, respectively, related to its profit sharing contributions underthese plans. These amounts are included in selling, general and administrative expenses.

 

## **14.   IncomeTaxes**

##  

Sally Beauty and its subsidiaries, including theCompany, file income tax returns in the U.S. federal jurisdiction and moststate jurisdictions as well as in various foreign countries. As described inNote16, the Company has entered into a tax sharing agreement with its ultimateparent, Sally Beauty.

 

The provision for income taxes for the fiscal years2009, 2008 and 2007 consists of the following (in thousands):

 
| ** **                      | ** ** | **Year Ended  September 30,** | ** ** |
|---------------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | **2009**                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Current:                        |       |                          |       |   |   |   |   |
| Federal                         |       | $                             | 50,738     |   | $ | 33,194 |   | $ | 30,538 |   |
| Foreign                         |       | 4,276                         |       | 8,763 |   | 6,446 |   |
| State                           |       | 5,734                         |       | 4,203 |   | 4,359 |   |
| Total current portion           |       | 60,748                        |       | 46,160 |   | 41,343 |   |
| Deferred:                       |       |                          |       |   |   |   |   |
| Federal                         |       | 8,601                         |       | 2,242 |   | 778 |   |
| Foreign                         |       | (1,676                        | )          | 346 |   | (319 | ) |
| State                           |       | 751                           |       | (84 | ) | (633 | ) |
| Total deferred portion          |       | 7,676                         |       | 2,504 |   | (174 | ) |
| Total provision for  income tax |       | $                             | 68,424     |   | $ | 48,664 |   | $ | 41,169 |   |

 

The difference between the U.S. statutory federalincome tax rate and the effective income tax rate is summarized below:

 
| ** **                                      | ** ** | **Year Ended  September 30,** | ** ** |
|-------------------------------------------------|------------|-------------------------------|------------|
| ** **                                      | ** ** | **2009**                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Statutory tax rate                              |       | 35.0                          | %          | 35.0 | % | 35.0 | % |
| State income taxes, net  of federal tax benefit |       | 2.6                           |       | 2.0 |   | 2.5 |   |
| Effect of foreign  operations                   |       | 0.8                           |       | (2.1 | ) | (0.4 | ) |
| Nondeductible  transaction costs                |       | —                        |       | — |   | 6.4 |   |
| Other, net                                      |       | 1.1                           |       | 2.1 |   | 2.4 |   |
| Effective tax rate                              |       | 39.5                          | %          | 37.0 | % | 45.9 | % |

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

The tax effects of temporary differences that giverise to the Company’s deferred tax assets and liabilities are as follows (inthousands):

 
| ** **                                 | ** ** | **September 30,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|
| ** **                                 | ** ** | **2009**          | ** ** | **2008** | ** ** |
| Deferred tax assets  attributable to:      |       |              |       |   |   |
| Share-based  compensation expense          |       | $                 | 11,624     |   | $ | 9,978 |   |
| Accrued expenses                           |       | 18,739            |       | 19,275 |   |
| Inventory adjustments                      |       | 2,378             |       | 1,894 |   |
| Foreign loss  carryforwards                |       | 12,593            |       | 10,250 |   |
| Long-term liabilities                      |       | 913               |       | 2,969 |   |
| Unrecognized tax  benefits                 |       | 1,127             |       | 2,789 |   |
| Interest rate swaps                        |       | 5,962             |       | (510 | ) |
| Other                                      |       | 1,264             |       | 505 |   |
| Total deferred tax  assets                 |       | 54,600            |       | 47,150 |   |
| Valuation allowance                        |       | (14,640           | )          | (11,972 | ) |
| Total deferred tax  assets, net            |       | 39,960            |       | 35,178 |   |
|                                       |       |              |       |   |   |
| Deferred tax  liabilities attributable to: |       |              |       |   |   |
| Depreciation and  amortization             |       | 58,759            |       | 52,347 |   |
| Total deferred tax  liabilities            |       | 58,759            |       | 52,347 |   |
| Net deferred tax  liability                |       | $                 | 18,799     |   | $ | 17,169 |   |

 

Management believes that it is more likely than notthat the results of future operations will generate sufficient taxable incometo realize the deferred tax assets, net of the valuation allowance. The Companyhas recorded a valuation allowance to account for uncertainties regardingrecoverability of certain foreign loss carryforwards.

 

In the fiscal year 2007, the Company made certainadjustments in connection with the reconciliation of tax balances transferredto the Company in connection with the Separation Transactions.  This amount was included in the settlement ofintercompany agreements with Alberto-Culver, as an adjustment to the Company’smember’s deficit. There were no such adjustments in the fiscal years 2008 and2009.

 

Domestic earnings before provision for income taxeswere $173.4 million, $106.4 million and $77.7 million in the fiscal years 2009,2008 and 2007, respectively. Foreign operations had earnings (losses) beforeprovision for income taxes of $(0.3) million, $25.1 million and $12.0 millionin the fiscal years 2009, 2008 and 2007, respectively.

 

Tax reserves are evaluated and adjusted asappropriate, while taking into account the progress of audits by various taxingjurisdictions and other changes in relevant facts and circumstances evident ateach balance sheet date. Management does not expect the outcome of tax auditsto have a material adverse effect on the Company’s financial condition, resultsof operations or cash flow.

 

Undistributed earnings of the Company’s foreignoperations are intended to remain permanently invested to finance anticipatedfuture growth and expansion. Accordingly, no U.S. income taxes have beenprovided on those earnings at September 30, 2009, 2008 and 2007.

 

The transactions separating us from Alberto-Culverwere intended to qualify as a reorganization under Section 368(a)(1)(D) of theInternal Revenue Code of 1986, as amended (the “Code”) and a distribution eligiblefor non-recognition under Sections 355(a) and 361(c) of the Code. In connectionwith the share distribution of Alberto-Culver common stock in the SeparationTransactions, Sally Beauty received: (i) a private letter ruling from the IRS;and (ii) an opinion of Sidley Austin LLP, counsel to Alberto-Culver, in eachcase, to the effect that the transactions qualify as a reorganization under Section368(a)(1)(D) of the Code and a distribution eligible for non-recognition underSections 355(a) and 361(c) of the Code.

 

Certain internal restructurings also occurred at orimmediately prior to the Separation Transactions. As a result of the internalrestructurings and Separation Transactions, Sally Beauty inherited the federaltax identification number of the old Alberto-Culver parent for U.S. federalincome tax purposes. In addition, as the successor entity to Alberto-Culverafter the Separation Transactions, Sally Beauty relies upon the prior yearfederal income tax returns of Alberto-Culver, and accounting methodsestablished therein, for certain calculations that affect Sally Beauty’s andthe Company’s current U.S. federal income tax liability.

 

Sally Beauty and Alberto-Culver entered into a taxallocation agreement as part of the Separation Transactions. The agreementprovides generally that Sally Beauty is responsible for its pre-separationincome tax liabilities, calculated on a stand-alone basis, and Alberto-Culveris responsible for the remainder. In the event an additional U.S federal incometax liability related to the period prior to the Separation Transactions weredetermined, Sally Beauty will be jointly and severally liable for these taxes,and there can be no

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

assurance that Alberto-Culver would be able to fulfillits indemnification obligations to Sally Beauty under the tax allocationagreement if Alberto-Culver was determined to be responsible for these taxesthereunder.

 

In June 2006, the FASBissued an interpretive amendment to ASC 740, *IncomeTaxes*, to create a single model to address accounting foruncertainty in tax positions (currently ASC 740-10-25). This amendment, whichbecame effective for fiscal years beginning after December 15, 2006, clarifiedthe accounting for income taxes by prescribing a minimum recognition thresholda tax position is required to meet before being recognized in the financialstatements. It also provided guidance on (1) the recognition, de-recognition,and measurement of uncertain tax positions in a period subsequent to that inwhich the tax position is taken, (2) the accounting for interest and penalties,(3) the presentation and classification of recorded amounts in the financialstatements, and (4) disclosure requirements. The Company adopted the provisionsof this amendment on October 1, 2007 and the adoption did not require a changeto the Company’s liability for unrecognized tax benefits and had no impact onthe Company’s opening balance of member’s deficit.  The total amount of unrecognized tax benefits(excluding interest accruals) as of the date of adoption on October 1, 2007 was$2.9 million.

 

The changes in the amountof unrecognized tax benefits for the fiscal year ended September 30, 2009 and2008 are as follows (in thousands):

 
| ** **                                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Balance at  beginning of the fiscal year         |       | $        | 4,291      |     | $          | 2,903 |   |
| Increases  related to prior year tax positions   |       | 7,379    |       | 1,872    |       |
| Decreases  related to prior year tax positions   |       | (1,482   | )          | (52      | )          |
| Increases  related to current year tax positions |       | 4,722    |       | 552      |       |
| Settlements                                      |       | —   |       | (571     | )          |
| Lapse of statute                                 |       | (532     | )          | (413     | )          |
| Balance at end  of fiscal year                   |       | $        | 14,378     |     | $          | 4,291 |   |

 

If recognized, these positions would affect theCompany’s effective tax rate.

 

The Company classifies and recognizes interest andpenalties accrued related to unrecognized tax benefits in income taxexpense.    The total amount of accruedinterest and penalties as of October 1, 2007, September 30, 2008, and September30, 2009 was $1.0 million, $1.4 million and $4.0 million, respectively.

 

The balance at September 30, 2008 includes $1.4million of tax positions for which the ultimate deductibility is highly certainbut for which there is uncertainty about the timing of such deductibility.  Because of the impact of the deferred taxaccounting, other than interest, the disallowance of the shorter deductibilityperiod would not affect the annual effective tax rate but would accelerate thepayment of cash to the taxing authority to an earlier period.

 

Because existing tax positions will continue togenerate increased liabilities for unrecognized tax benefits over the next 12 months,and the fact that we are routinely under audit by various taxing authorities,it is reasonably possible that the amount of unrecognized tax benefits willchange during the next 12 months. An estimate of the amount or range of suchchange cannot be made at this time. However, we do not expect the change, ifany, to have a material effect on our consolidated financial condition orresults of operations within the next 12 months.

 

The IRS has audited theCompany’s consolidated federal income tax returns through the tax year ended September30, 2006, thus our statute remains open from the year ended September 30, 2007forward.  Our foreign subsidiaries areimpacted by various statutes of limitations, which are generally open from 2004forward. Generally, states’ statutes in the United States are open for taxreviews from 2005 forward.

 

The IRS has previously audited the consolidatedfederal income tax returns of Alberto-Culver through the fiscal year ending September30, 2006. The Company has not recorded a reserve for Alberto-Culver related taxliabilities because the Company believes any exposure is immaterial.

 

## **15.   Acquisitions**

##  

On September 30, 2009, the Company acquired SchoenemanBeauty Supply, Inc. (“Schoeneman”), at a cost of approximately $71.0 million,subject to certain adjustments. The acquisition of Schoeneman, a 43-storebeauty supply chain located in the central northeast United States, waspursuant to a merger agreement between Schoeneman, the former stockholders ofSchoeneman and a subsidiary of the Company. The Company currently expects torealize approximately $10 million of future tax savings as a result ofanticipated incremental depreciation and amortization tax deductions relatingto the assets acquired in this transaction. Goodwill of approximately

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

$61.0 million was recorded as a result of thisacquisition. In addition, during the fiscal year 2009, the Company completedseveral other individually immaterial acquisitions at an aggregate cost of$11.3 million. The purchase prices of all acquisitions completed during thefiscal year 2009 have been allocated to assets acquired and liabilities assumedbased on their preliminary estimated fair values at the date of acquisition.The final valuation of the assets acquired and liabilities assumed will becompleted during fiscal year 2010. Generally, we funded these acquisitions withcash from operations.

 

On May 7, 2008, the Company acquired Pro-Duo, N.V., a40-store beauty supply chain located in Belgium, France and Spain for €19.3million (approximately $29.8 million) plus incidental acquisition costscapitalized, subject to certain adjustments. The acquisition was funded through $29.8 million in cash and borrowingson our ABL facility. We also assumed €3.0 million (approximately $4.7 million)of debt from Pro-Duo in connection with the acquisition. Goodwill of $23.9 millionand certain identifiable intangible assets of $11.4 million were recorded as aresult of such acquisition and are not expected to be deductible for taxpurposes. Of this amount, $10.2 million was assigned to registered trade namesand $1.2 million to other identifiable intangible assets, which will beamortized over a weighted average life of approximately eight years. Inaddition, during the fiscal year 2008, the Company completed several otherindividually immaterial acquisitions at an aggregate cost of $22.9 million ofwhich a significant portion was allocated to intangible assets and goodwill.The purchase prices of these acquisitions have been allocated to assetsacquired and liabilities assumed based on their estimated fair values at thedate of acquisition. The final valuation of the assets and liabilities acquiredwas completed during the fiscal year 2009. We funded these acquisitions withcash from operations and borrowings on our ABL facility.

 

In February 2007, the Company acquired Chapelton 21Limited, a private company based in Scotland (which we refer to as “SalonServices”) for an aggregate cash purchase price of approximately $57.8 million.Certain of the Company’s subsidiaries financed the purchase price through adraw-down of approximately $57.0 million under the ABL facility. In addition,the Company extinguished approximately $3.9 million of Salon Services’ debt.Salon Services, through its direct and indirect subsidiaries including SalonServices (Hair and Beauty Supplies) Ltd., supplies professional hair and beautyproducts primarily to salon and spa operators and independent hair and beautyprofessionals in the United Kingdom, Germany, Ireland, Spain and Norway.Goodwill of $30.0 million and certain identifiable intangible assets of $17.6million were recorded as a result of such acquisition and are not expected tobe deductible for tax purposes. Of this amount, $14.4 million was assigned toregistered trade names and $3.2 million to other identifiable intangibleassets, which will be amortized over a weighted average life of approximatelyfive years. Salon Services is included in the Sally Beauty Supply segment. Thepurchase price of Salon Services was allocated to assets acquired andliabilities assumed based on their estimated fair values at the date ofacquisition and were subsequently adjusted when more accurate valuations becameavailable.

 

In addition, during fiscal year 2007 the Company madefive other individually immaterial acquisitions, which were accounted for usingthe purchase method. None of these acquisitions individually had a materialimpact on the Company’s consolidated results of operations. The results ofoperations for two of the acquisitions are included in the Sally Beauty Supplysegment and these acquisitions included the recording of: (i) goodwill in theamount of $3.4 million and (ii) certain intangible assets of $0.6 million. Theresults of operations for the remaining acquisitions are included in the BSGsegment, and these acquisitions included the recording of: (i) goodwill in theamount of $0.3 million and (ii) certain intangible assets of $2.9 million. Theintangible assets acquired were amortized over a weighted average life ofapproximately one year.

 

## **The valuation ofidentifiable intangible assets of Pro-Duo, Salon Services and Salon Success wasdetermined using discounted cash flow methods with the assistance ofthird-party valuation experts. The acquired entities have been accounted forusing the purchase method of accounting and, accordingly, the results ofoperations of the entities have been included in the consolidated financialstatements since their respective dates of acquisition.**

##  

## **16.   Related Party Transactions**

##  

In January 2007, the Company entered into an agreementwith Sally Beauty under which the Company agreed to provide certain general andadministrative services to Sally Beauty including accounting, finance, payroll,legal and tax sharing services. The cost of these services, which were based ona percentage of certain key employees’ salaries and benefits, is approximately$182,000 per month, and totaled approximately $2.2 million, $2.1 million and$1.0 million for fiscal years 2009, 2008 and 2007, respectively.  The cost of these services may notnecessarily be indicative of the costs which would be incurred by Sally Beautyas an independent stand alone entity.

 

As described more fully in Note 5, certain employeesof the Company have been granted stock options and share awards undershare-based compensation plans of Sally Beauty.

 

The Company has entered into a tax sharing agreementwith its parent, Sally Beauty.  Inaccordance with this tax sharing agreement, Sally Beauty shall cause each ofits subsidiaries that are eligible to be a member of the relevant combined taxgroup to join in filing a combined tax return with respect to each jurisdictionfor all tax years for which such subsidiary is eligible to do so under theapplicable tax law.  Sally Beauty shallmake all payments to the applicable taxing authority of all combined taxes thatthe relevant combined tax group is required to pay.

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

Where allowed by current tax law, the Company isincluded in the consolidated income tax returns filed by Sally Beauty.  The Company’s provision for income taxes isrecorded on the basis of filing a separate income tax return.  Income taxes currently payable or receivableunder the consolidated income tax returns are paid to or received from SallyBeauty.

 

As of September 30, 2009 and 2008, the Company had anet intercompany payable to Sally Beauty of approximately $22.0 million and$17.2 million, respectively. This consists primarily of income tax andshare-based compensation expenses, which are partially offset by general andadministrative services provided to Sally Beauty.

 

In connection with the Separation Transactions, theCompany terminated substantially all intercompany agreements withAlberto-Culver and its subsidiaries. All intercompany receivables, payables andloans between the Company, on the one hand, and Alberto-Culver and itssubsidiaries, on the other hand, other than those specifically designated tosurvive following the Separation Transactions, were cancelled. In addition,Sally Beauty became the parent company for all U.S. tax returns which werefiled under the employer identification number of Alberto-Culver prior to thecompletion of the Separation Transactions.

 

Prior to the Separation Transactions, the Companypurchased inventory and conducted business with, and/or had transactions with,Alberto-Culver and its subsidiaries. In fiscal year 2007, the Company purchasedinventory from Alberto-Culver of approximately $3.7 million.

 

Alberto-Culver and its affiliates performed certainadministrative services for the Company and incurred certain direct expenses onbehalf of the Company prior to the Separation Transactions. Costs for certainadministrative services and other corporate functions and direct expensesincurred on behalf of the Company were allocated by Alberto-Culver to theCompany and totaled $1.0 million in fiscal year 2007. These amounts areincluded in selling, general and administrative expenses in the consolidatedstatements of earnings and are classified as part of unallocated expenses forthe Company’s segment reporting purposes.

 

Alberto-Culver also charged the Company a sales-basedservice fee under the consulting, business development and advisory servicesagreement between Alberto-Culver and certain subsidiaries of the Company. Thesales-based service fees totaled $3.8 million in fiscal year 2007. Managementbelieves that had the Company been operating as a stand-alone entity notaffiliated with Alberto-Culver during all of fiscal year 2007, the Companylikely would not have needed to engage any third party or incur additionalcosts as a stand-alone company for the services provided to its subsidiariesunder these agreements.

 

The Company also had an agreement with Alberto-Culverthat required the Company to make equity distributions to Alberto-Culverwhenever employees of the Company exercised Alberto-Culver stock options.During fiscal year 2007, the Company paid $4.8 million to Alberto-Culver inconnection with this agreement.

 

## **17.   Business Segments and Geographic Area Information**

##  

The Company’s business is organized into two separatesegments: (i) Sally Beauty Supply, a domestic and international chain of cashand carry retail stores, which offers professional beauty supplies to bothsalon professionals and retail customers; and (ii) BSG, a full service beautysupply distributor, which offers professional brands of beauty productsdirectly to salons through its own sales force and professional only stores incertain exclusive geographical territories primarily in North and South Americaand parts of Europe.

 

In connection with the Separation Transactions, in thefiscal year 2007 the Company’s management evaluated the structure of itsinternal organization to identify and separate the costs incurred at thecorporate level from the business units, as well as costs incurred that benefitboth the Sally Beauty Supply and BSG segments. Accordingly, management definedits reportable segments as Sally Beauty Supply and BSG, to report thesesegments separately from the Company’s shared corporate expenses, and revisedthe comparable prior years for comparability purposes.

 

The accounting policies of both of our businesssegments are the same as described in the summary of significant accountingpolicies in Note 2. Sales between segments, which were eliminated inconsolidation, were not material for the fiscal years ended September 30, 2009,2008 and 2007.

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

##### ***Business Segments Information***

##### *** ***

Segment data for the fiscal years ended September 30,2009, 2008 and 2007 is as follows (in thousands):

 
| ** **                                         | ** ** | **Year Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|-------------------------------|------------|
| ** **                                         | ** ** | **2009**                      | ** ** | **2008(a)** | ** ** | **2007(a)** | ** ** |
| Net sales:                                         |       |                          |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                             | 1,695,652  |   | $ | 1,672,897 |   | $ | 1,569,088 |   |
| BSG                                                |       | 940,948                       |       | 975,294 |   | 944,684 |   |
| Total                                              |       | $                             | 2,636,600  |   | $ | 2,648,191 |   | $ | 2,513,772 |   |
| Earnings before  provision for income taxes:       |       |                          |       |   |   |   |   |
| Segment operating  profit:                         |       |                          |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                             | 283,872    |   | $ | 285,615 |   | $ | 272,364 |   |
| BSG                                                |       | 91,604                        |       | 80,927 |   | 63,456 |   |
| Segment operating  profit                          |       | 375,476                       |       | 366,542 |   | 335,820 |   |
| Unallocated expenses(b)                            |       | (62,289                       | )          | (66,499 | ) | (62,570 | ) |
| Share-based  compensation expense                  |       | (7,992                        | )          | (9,614 | ) | (12,267 | ) |
| Sales based service fee  charges by Alberto-Culver |       | —                        |       | — |   | (3,779 | ) |
| Transaction expenses  (c)                          |       | —                        |       | — |   | (21,502 | ) |
| Interest expense, net  of interest income          |       | (132,043                      | )          | (158,897 | ) | (145,972 | ) |
| Total                                              |       | $                             | 173,152    |   | $ | 131,532 |   | $ | 89,730 |   |
| Identifiable assets:                               |       |                          |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                             | 652,184    |   | $ | 696,780 |   | $ | 555,252 |   |
| BSG                                                |       | 792,879                       |       | 752,029 |   | 757,276 |   |
| Sub-total                                          |       | 1,445,063                     |       | 1,448,809 |   | 1,312,528 |   |
| Shared services                                    |       | 45,447                        |       | 76,849 |   | 91,733 |   |
| Total                                              |       | $                             | 1,490,510  |   | $ | 1,525,658 |   | $ | 1,404,261 |   |
| Depreciation and  amortization:                    |       |                          |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                             | 24,175     |   | $ | 23,134 |   | $ | 20,377 |   |
| BSG                                                |       | 18,735                        |       | 20,666 |   | 17,686 |   |
| Corporate                                          |       | 4,156                         |       | 4,733 |   | 4,542 |   |
| Total                                              |       | $                             | 47,066     |   | $ | 48,533 |   | $ | 42,605 |   |
| Capital expenditures:                              |       |                          |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                             | 23,203     |   | $ | 22,094 |   | $ | 20,831 |   |
| BSG                                                |       | 8,470                         |       | 18,683 |   | 27,941 |   |
| Corporate                                          |       | 5,644                         |       | 4,799 |   | 4,573 |   |
| Total                                              |       | $                             | 37,317     |   | $ | 45,576 |   | $ | 53,345 |   |

 

----

| (a)    |   | Certain amounts for prior  years have been reclassified to conform to the current year’s presentation.                                                                                                                               |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                      |
| (b)    |   | Unallocated expenses  consist of corporate and shared costs. The amounts include $1.0 million of  overhead charges allocated from Alberto-Culver for the fiscal year 2007.  There were no such charges after the Separation Transactions. |
|   |   |                                                                                                                                                                                                                                      |
| (c)    |   | Transaction expenses are  one-time charges associated with the Separation Transactions in the fiscal  year 2007. Please see Note 3 for additional information.                                                                            |

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

##### ***Geographic Area Information***

##### *** ***

Geographic data for the fiscal years ended September 30,2009, 2008 and 2007 is as follows (in thousands):

 
| ** **           | ** ** | **Year Ended  September 30,** | ** ** |
|----------------------|------------|-------------------------------|------------|
| ** **           | ** ** | **2009**                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales:(a)        |       |                          |       |   |   |   |   |
| United States        |       | $                             | 2,202,218  |   | $ | 2,170,708 |   | $ | 2,110,864 |   |
| Foreign              |       | 434,382                       |       | 477,483 |   | 402,908 |   |
| Total                |       | $                             | 2,636,600  |   | $ | 2,648,191 |   | $ | 2,513,772 |   |
| Identifiable assets: |       |                          |       |   |   |   |   |
| United States        |       | $                             | 1,105,026  |   | $ | 1,098,614 |   | $ | 972,094 |   |
| Foreign              |       | 340,037                       |       | 350,195 |   | 340,434 |   |
| Shared services      |       | 45,447                        |       | 76,849 |   | 91,733 |   |
| Total                |       | $                             | 1,490,510  |   | $ | 1,525,658 |   | $ | 1,404,261 |   |

 

----

| (a) |   | Net sales are attributable  to individual countries based on the location of the customer. |
|-----|--------|--------------------------------------------------------------------------------------------|

##  

## **18.   Guarantor and Non-Guarantor CondensedConsolidated Financial Statements**

##  

The following condensed consolidating financialinformation presents the Condensed Consolidated Balance Sheets as of September 30,2009 and 2008, the Condensed Consolidated Statements of Earnings for the yearsended September 30, 2009, 2008 and 2007, and the Condensed ConsolidatedStatements of Cash Flows for the years ended September 30, 2009, 2008 and 2007of: (i) Sally Holdings LLC, or “the Parent;” (ii) the guarantor subsidiaries; (iii)the non-guarantor subsidiaries; (iv) elimination entries necessary toconsolidate the Parent with the guarantor and non-guarantor subsidiaries; and (v)the Parent on a consolidated basis.

 

Investments insubsidiaries are accounted for using the equity method for purposes of theconsolidating presentation.  Theprincipal elimination entries relate to investments in subsidiaries andintercompany balances and transactions. Separate financial statements and other disclosures with respect to thesubsidiary guarantors have not been provided as management believes thefollowing information is sufficient, as guarantor subsidiaries are 100 percentindirectly owned by the Parent and all guarantees are full andunconditional.  Additionally, substantiallyall of the assets of the guarantor subsidiaries are pledged under the term loanfacilities and the ABL facility and consequently may not be available tosatisfy the claims of general creditors.

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

Condensed ConsolidatedBalance Sheet

September 30, 2009

(In thousands)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-  Guarantor   Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings   LLC &   Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------------|------------|------------------|------------|-------------------------------------------------|------------|
| **Assets**                                                                  |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Cash and cash equivalents                                                   |       | $          | 20         |                         | $          | 37,593                             |       | $                | 16,834     |                                            | $          | — |   | $ | 54,447 |   |
| Trade accounts and other receivables, less  allowance for doubtful accounts |       | —     |       | 49,128                       |       | 18,611                             |       | —           |       | 67,739                                          |       |
| Due from affiliates                                                         |       |       |       | 297,407                      |       | 11,169                             |       | (308,576         | )          | —                                          |       |
| Inventories                                                                 |       | —     |       | 439,396                      |       | 120,293                            |       | —           |       | 559,689                                         |       |
| Prepaid expenses                                                            |       | 113        |       | 9,165                        |       | 8,983                              |       | —           |       | 18,261                                          |       |
| Deferred income tax assets                                                  |       | 929        |       | 18,015                       |       | (3,315                             | )          | —           |       | 15,629                                          |       |
| Property and equipment, net                                                 |       | —     |       | 115,459                      |       | 35,790                             |       | —           |       | 151,249                                         |       |
| Investment in subsidiaries                                                  |       | 1,320,325  |       | 265,511                      |       | —                             |       | (1,585,836       | )          | —                                          |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | 427,555                      |       | 145,265                            |       | —           |       | 572,820                                         |       |
| Other assets                                                                |       | 33,384     |       | 12,655                       |       | 4,637                              |       | —           |       | 50,676                                          |       |
| Total assets                                                                |       | $          | 1,354,771  |                         | $          | 1,671,884                          |       | $                | 358,267    |                                            | $          | (1,894,412 | ) | $ | 1,490,510 |   |
|                                                                        |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Liabilities and Member’s  (Deficit) Equity**                         |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Accounts payable                                                            |       | $          | —     |                         | $          | 145,845                            |       | $                | 47,747     |                                            | $          | — |   | $ | 193,592 |   |
| Due to affiliates                                                           |       | 276,767    |       | 11,169                       |       | 20,640                             |       | (308,576         | )          | —                                          |       |
| Accrued expenses                                                            |       | 30,994     |       | 102,573                      |       | 20,275                             |       | —           |       | 153,842                                         |       |
| Due to Sally Beauty                                                         |       | —     |       | 22,042                       |       | —                             |       | —           |       | 22,042                                          |       |
| Income taxes                                                                |       | 5,217      |       | 1,929                        |       | (1,317                             | )          | —           |       | 5,829                                           |       |
| Long-term debt                                                              |       | 1,673,856  |       | 191                          |       | 3,483                              |       | —           |       | 1,677,530                                       |       |
| Other liabilities                                                           |       | 15,365     |       | 27,157                       |       | 1,064                              |       | —           |       | 43,586                                          |       |
| Deferred income tax liabilities                                             |       | (7,089     | )          | 40,653                       |       | 864                                |       | —           |       | 34,428                                          |       |
| Total liabilities                                                           |       | 1,995,110  |       | 351,559                      |       | 92,756                             |       | (308,576         | )          | 2,130,849                                       |       |
| Stock options subject to redemption                                         |       | 1,800      |       | —                       |       | —                             |       | —           |       | 1,800                                           |       |
| Total member’s (deficit) equity                                        |       | (642,139   | )          | 1,320,325                    |       | 265,511                            |       | (1,585,836       | )          | (642,139                                        | )          |
| Total liabilities and member’s (deficit) equity                        |       | $          | 1,354,771  |                         | $          | 1,671,884                          |       | $                | 358,267    |                                            | $          | (1,894,412 | ) | $ | 1,490,510 |   |

 

F-35

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

Condensed ConsolidatedBalance Sheet

September 30, 2008

(In thousands)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-  Guarantor   Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings   LLC &   Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------------|------------|------------------|------------|-------------------------------------------------|------------|
| **Assets**                                                                  |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Cash and cash equivalents                                                   |       | $          | 1,645      |                         | $          | 85,384                             |       | $                | 12,759     |                                            | $          | — |   | $ | 99,788 |   |
| Trade accounts and other receivables, less  allowance for doubtful accounts |       | —     |       | 45,631                       |       | 20,446                             |       | —           |       | 66,077                                          |       |
| Due from affiliates                                                         |       | 36,219     |       | 15,389                       |       | 15,860                             |       | (67,468          | )          | —                                          |       |
| Inventories                                                                 |       | —     |       | 465,319                      |       | 132,876                            |       | —           |       | 598,195                                         |       |
| Prepaid expenses                                                            |       | 113        |       | 10,532                       |       | 8,804                              |       | —           |       | 19,449                                          |       |
| Deferred income tax assets                                                  |       | 2,968      |       | 21,251                       |       | (3,447                             | )          | —           |       | 20,772                                          |       |
| Property and equipment, net                                                 |       | —     |       | 120,051                      |       | 36,209                             |       | —           |       | 156,260                                         |       |
| Investment in subsidiaries                                                  |       | 1,064,199  |       | 272,094                      |       | —                             |       | (1,336,293       | )          | —                                          |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | 370,178                      |       | 140,219                            |       | —           |       | 510,397                                         |       |
| Other assets                                                                |       | 44,034     |       | 1,612                        |       | 9,074                              |       | —           |       | 54,720                                          |       |
| Total assets                                                                |       | $          | 1,149,178  |                         | $          | 1,407,441                          |       | $                | 372,800    |                                            | $          | (1,403,761 | ) | $ | 1,525,658 |   |
|                                                                        |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Liabilities and Member’s  (Deficit) Equity**                         |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Accounts payable                                                            |       | $          | 1,633      |                         | $          | 120,917                            |       | $                | 49,412     |                                            | $          | — |   | $ | 171,962 |   |
| Due to affiliates                                                           |       | —     |       | 52,079                       |       | 15,389                             |       | (67,468          | )          | —                                          |       |
| Accrued expenses                                                            |       | 31,503     |       | 100,678                      |       | 22,348                             |       | —           |       | 154,529                                         |       |
| Due to Sally Beauty                                                         |       | 474        |       | 16,769                       |       | —                             |       | —           |       | 17,243                                          |       |
| Income taxes                                                                |       | 5,727      |       | 476                          |       | 5,183                              |       | —           |       | 11,386                                          |       |
| Long-term debt                                                              |       | 1,821,600  |       | 386                          |       | 3,299                              |       | —           |       | 1,825,285                                       |       |
| Other liabilities                                                           |       | 7,163      |       | 15,436                       |       | 1,109                              |       | —           |       | 23,708                                          |       |
| Deferred income tax liabilities                                             |       | (2,526     | )          | 36,501                       |       | 3,966                              |       | —           |       | 37,941                                          |       |
| Total liabilities                                                           |       | 1,865,574  |       | 343,242                      |       | 100,706                            |       | (67,468          | )          | 2,242,054                                       |       |
| Stock options subject to redemption                                         |       | 5,884      |       | —                       |       | —                             |       | —           |       | 5,884                                           |       |
| Total member’s (deficit) equity                                        |       | (722,280   | )          | 1,064,199                    |       | 272,094                            |       | (1,336,293       | )          | (722,280                                        | )          |
| Total liabilities and member’s (deficit) equity                        |       | $          | 1,149,178  |                         | $          | 1,407,441                          |       | $                | 372,800    |                                            | $          | (1,403,761 | ) | $ | 1,525,658 |   |

 

F-36

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

Condensed ConsolidatedStatement of Earnings

Fiscal Year Ended September30, 2009

(In thousands)

 
| ** **                                          | ** ** | **Parent** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-  Guarantor   Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings   LLC &   Subsidiaries** | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------------|------------|------------------|------------|-------------------------------------------------|------------|
|                                                |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Net sales                                           |       | $          | —     |                         | $          | 2,169,528                          |       | $                | 467,072    |                                            | $          | — |   | $ | 2,636,600 |   |
| Related party sales                                 |       | —     |       | 2,823                        |       | —                             |       | (2,823           | )          | —                                          |       |
| Cost of products sold and distribution expenses     |       | —     |       | 1,127,447                    |       | 268,659                            |       | (2,823           | )          | 1,393,283                                       |       |
| Gross profit                                        |       | —     |       | 1,044,904                    |       | 198,413                            |       | —           |       | 1,243,317                                       |       |
| Selling, general and administrative expenses        |       | 727        |       | 711,055                      |       | 179,274                            |       | —           |       | 891,056                                         |       |
| Depreciation and amortization                       |       | —     |       | 35,157                       |       | 11,909                             |       | —           |       | 47,066                                          |       |
| Sales-based service fee charged by Alberto-Culver   |       | —     |       | —                       |       | —                             |       | —           |       | —                                          |       |
| Transaction expenses                                |       | —     |       | —                       |       | —                             |       | —           |       | —                                          |       |
| Operating earnings (loss)                           |       | (727       | )          | 298,692                      |       | 7,230                              |       | —           |       | 305,195                                         |       |
| Interest income                                     |       | —     |       | (205                         | )          | (140                               | )          | —           |       | (345                                            | )          |
| Interest expense                                    |       | 131,698    |       | 378                          |       | 312                                |       | —           |       | 132,388                                         |       |
| Earnings (losses) before provision for income taxes |       | (132,425   | )          | 298,519                      |       | 7,058                              |       | —           |       | 173,152                                         |       |
| Provision (benefit) for income taxes                |       | (44,559    | )          | 107,193                      |       | 5,790                              |       | —           |       | 68,424                                          |       |
| Equity in earnings of subsidiaries (net of tax)     |       | 192,594    |       | 1,268                        |       | —                             |       | (193,862         | )          | —                                          |       |
| Net earnings                                        |       | $          | 104,728    |                         | $          | 192,594                            |       | $                | 1,268      |                                            | $          | (193,862 | ) | $ | 104,728 |   |

 

F-37

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

Condensed ConsolidatedStatement of Earnings

Fiscal Year Ended September30, 2008

(In thousands)

 
| ** **                                          | ** ** | **Parent** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-  Guarantor   Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings   LLC &   Subsidiaries** | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------------|------------|------------------|------------|-------------------------------------------------|------------|
|                                                |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Net sales                                           |       | $          | —     |                         | $          | 2,137,113                          |       | $                | 511,078    |                                            | $          | — |   | $ | 2,648,191 |   |
| Related party sales                                 |       | —     |       | 2,827                        |       | —                             |       | (2,827           | )          | —                                          |       |
| Cost of products sold and distribution expenses     |       | —     |       | 1,135,903                    |       | 280,521                            |       | (2,827           | )          | 1,413,597                                       |       |
| Gross profit                                        |       | —     |       | 1,004,037                    |       | 230,557                            |       | —           |       | 1,234,594                                       |       |
| Selling, general and administrative expenses        |       | 827        |       | 787,586                      |       | 107,219                            |       | —           |       | 895,632                                         |       |
| Depreciation and amortization                       |       | —     |       | 36,082                       |       | 12,451                             |       | —           |       | 48,533                                          |       |
| Sales-based service fee charged by Alberto-Culver   |       | —     |       | —                       |       | —                             |       | —           |       | —                                          |       |
| Transaction expenses                                |       | —     |       | —                       |       | —                             |       | —           |       | —                                          |       |
| Operating earnings (loss)                           |       | (827       | )          | 180,369                      |       | 110,887                            |       | —           |       | 290,429                                         |       |
| Interest income                                     |       | —     |       | (139                         | )          | (606                               | )          | —           |       | (745                                            | )          |
| Interest expense                                    |       | 158,762    |       | 423                          |       | 457                                |       | —           |       | 159,642                                         |       |
| Earnings (losses) before provision for income taxes |       | (159,589   | )          | 180,085                      |       | 111,036                            |       | —           |       | 131,532                                         |       |
| Provision (benefit) for income taxes                |       | (61,598    | )          | 103,616                      |       | 6,646                              |       | —           |       | 48,664                                          |       |
| Equity in earnings of subsidiaries (net of tax)     |       | 180,859    |       | 104,390                      |       | —                             |       | (285,249         | )          | —                                          |       |
| Net earnings                                        |       | $          | 82,868     |                         | $          | 180,859                            |       | $                | 104,390    |                                            | $          | (285,249 | ) | $ | 82,868 |   |

 

F-38

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

**SALLYHOLDINGS, INC. AND SUBSIDIARIES**

Condensed ConsolidatedStatement of Earnings

Fiscal Year Ended September30, 2007

(In thousands)

 
| ** **                                          | ** ** | **Parent** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-  Guarantor   Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings   LLC &   Subsidiaries** | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------------|------------|------------------|------------|-------------------------------------------------|------------|
|                                                |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Net sales                                           |       | $          | —     |                         | $          | 2,079,580                          |       | $                | 434,192    |                                            | $          | — |   | $ | 2,513,772 |   |
| Related party sales                                 |       | —     |       | 3,257                        |       | —                             |       | (3,257           | )          | —                                          |       |
| Cost of products sold and distribution expenses     |       | —     |       | 1,117,424                    |       | 245,858                            |       | (3,257           | )          | 1,360,025                                       |       |
| Gross profit                                        |       | —     |       | 965,413                      |       | 188,334                            |       | —           |       | 1,153,747                                       |       |
| Selling, general and administrative expenses        |       | 556        |       | 692,888                      |       | 156,715                            |       | —           |       | 850,159                                         |       |
| Depreciation and amortization                       |       | —     |       | 32,373                       |       | 10,232                             |       | —           |       | 42,605                                          |       |
| Sales-based service fee charged by Alberto-Culver   |       | —     |       | 3,779                        |       | —                             |       | —           |       | 3,779                                           |       |
| Transaction expenses                                |       | 21,502     |       | —                       |       | —                             |       | —           |       | 21,502                                          |       |
| Operating earnings (loss)                           |       | (22,058    | )          | 236,373                      |       | 21,387                             |       | —           |       | 235,702                                         |       |
| Interest income                                     |       | (3,426     | )          | (331                         | )          | (655                               | )          | 2,689            |       | (1,723                                          | )          |
| Interest expense                                    |       | 146,937    |       | 2,630                        |       | 817                                |       | (2,689           | )          | 147,695                                         |       |
| Earnings (losses) before provision for income taxes |       | (165,569   | )          | 234,074                      |       | 21,225                             |       | —           |       | 89,730                                          |       |
| Provision (benefit) for income taxes                |       | (58,878    | )          | 92,146                       |       | 7,901                              |       | —           |       | 41,169                                          |       |
| Equity in earnings of subsidiaries (net of tax)     |       | 155,252    |       | 13,324                       |       | —                             |       | (168,576         | )          | —                                          |       |
| Net earnings                                        |       | $          | 48,561     |                         | $          | 155,252                            |       | $                | 13,324     |                                            | $          | (168,576 | ) | $ | 48,561 |   |

 

F-39

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

Condensed ConsolidatedStatement of Cash Flows

Fiscal Year Ended September30, 2009

(In thousands)

 
| ** **                                                                 | ** ** | **Parent** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-  Guarantor   Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings   LLC &   Subsidiaries** | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------------|------------|------------------|------------|-------------------------------------------------|------------|
|                                                                       |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Net cash provided by operating  activities**                             |       | $          | 147,735    |                         | $          | 49,387                             |       | $                | 26,862     |                                            | $          | — |   | $ | 223,984 |   |
|                                                                       |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Cash Flows from Investing  Activities:**                                 |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Capital expenditures, net of proceeds from sale of  property and equipment |       | —     |       | (24,705                      | )          | (12,395                            | )          | —           |       | (37,100                                         | )          |
| Acquisitions, net of cash acquired                                         |       | —     |       | (72,084                      | )          | (9,375                             | )          | —           |       | (81,459                                         | )          |
| Net cash used by investing activities                                      |       | —     |       | (96,789                      | )          | (21,770                            | )          | —           |       | (118,559                                        | )          |
|                                                                       |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Cash Flows from Financing  Activities:**                                 |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Change in book cash overdraft                                              |       | (1,633     | )          | —                       |       | —                             |       | —           |       | (1,633                                          | )          |
| Proceeds from issuance of long-term debt                                   |       | 94,637     |       | —                       |       | 940                                |       | —           |       | 95,577                                          |       |
| Repayments of long-term debt                                               |       | (242,364   | )          | (195                         | )          | (1,107                             | )          | —           |       | (243,666                                        | )          |
| Excess tax benefit from share-based compensation                           |       | —     |       | (194                         | )          | —                             |       | —           |       | (194                                            | )          |
| Net cash used by financing activities                                      |       | (149,360   | )          | (389                         | )          | (167                               | )          | —           |       | (149,916                                        | )          |
|                                                                       |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Effect of foreign exchange rate changes on cash and  cash equivalents      |       | —     |       | —                       |       | (850                               | )          | —           |       | (850                                            | )          |
| Net (decrease) increase in cash and cash  equivalents                      |       | (1,625     | )          | (47,791                      | )          | 4,075                              |       | —           |       | (45,341                                         | )          |
| Cash and cash equivalents, beginning of period                             |       | 1,645      |       | 85,384                       |       | 12,759                             |       | —           |       | 99,788                                          |       |
| Cash and cash equivalents, end of period                                   |       | $          | 20         |                         | $          | 37,593                             |       | $                | 16,834     |                                            | $          | — |   | $ | 54,447 |   |

 

F-40

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

Condensed Consolidated Statementof Cash Flows

Fiscal Year Ended September30, 2008

(In thousands)

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-  Guarantor   Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings   LLC &   Subsidiaries** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------------|------------|------------------|------------|-------------------------------------------------|------------|
|                                                                   |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Net cash provided (used) by  operating activities**                  |       | $          | (64,781    | )                            | $          | 144,625                            |       | $                | 31,571     |                                            | $          | — |   | $ | 111,415 |   |
|                                                                   |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Cash Flows from Investing  Activities:**                             |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Capital expenditures and proceeds from sale of  property and equipment |       | —     |       | (36,048                      | )          | (9,240                             | )          | —           |       | (45,288                                         | )          |
| Acquisitions, net of cash acquired                                     |       | —     |       | (14,896                      | )          | (37,978                            | )          | —           |       | (52,874                                         | )          |
| Net cash used by investing activities                                  |       | —     |       | (50,944                      | )          | (47,218                            | )          | —           |       | (98,162                                         | )          |
|                                                                   |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Cash Flows from Financing  Activities:**                             |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Change in book cash overdraft                                          |       | —     |       | 1,633                        |       | —                             |       | —           |       | 1,633                                           |       |
| Proceeds from issuance of long-term debt                               |       | 496,185    |       | 72                           |       | 31,478                             |       | —           |       | 527,735                                         |       |
| Repayments of long-term debt                                           |       | (449,285   | )          | (250                         | )          | (33,150                            | )          | —           |       | (482,685                                        | )          |
| Debt issuance costs                                                    |       | —     |       | —                       |       | —                             |       | —           |       | —                                          |       |
| Excess tax benefit from share-based compensation                       |       | —     |       | 451                          |       | —                             |       | —           |       | 451                                             |       |
| Distributions to Sally Beauty                                          |       | —     |       | —                       |       | —                             |       | —           |       | —                                          |       |
| Distributions received (made)                                          |       | 19,519     |       | (19,519                      | )          | —                             |       | —           |       | —                                          |       |
| Net cash provided (used) by financing activities                       |       | 66,419     |       | (17,613                      | )          | (1,672                             | )          | —           |       | 47,134                                          |       |
|                                                                   |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Effect of foreign exchange rate changes on cash and  cash equivalents  |       | —     |       | —                       |       | 1,129                              |       | —           |       | 1,129                                           |       |
| Net (decrease) increase in cash and cash  equivalents                  |       | 1,638      |       | 76,068                       |       | (16,190                            | )          | —           |       | 61,516                                          |       |
| Cash and cash equivalents, beginning of period                         |       | 7          |       | 9,316                        |       | 28,949                             |       | —           |       | 38,272                                          |       |
| Cash and cash equivalents, end of period                               |       | $          | 1,645      |                         | $          | 85,384                             |       | $                | 12,759     |                                            | $          | — |   | $ | 99,788 |   |

 

F-41

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

**SALLYHOLDINGS, INC. AND SUBSIDIARIES**

Condensed ConsolidatedStatement of Cash Flows

Fiscal Year Ended September30, 2007

(In thousands)

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-  Guarantor   Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings   LLC &   Subsidiaries** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------------|------------|------------------|------------|-------------------------------------------------|------------|
|                                                                   |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Net cash provided (used) by  operating activities**                  |       | $          | (203,959   | )                            | $          | 230,104                            |       | $                | 168,122    |                                            | $          | — |   | $ | 194,267 |   |
|                                                                   |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Cash Flows from Investing  Activities:**                             |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Capital expenditures and proceeds from sale of  property and equipment |       | —     |       | (31,886                      | )          | (13,064                            | )          | —           |       | (44,950                                         | )          |
| Acquisitions, net of cash acquired                                     |       | —     |       | (11,170                      | )          | (65,244                            | )          | —           |       | (76,414                                         | )          |
| Net cash used by investing activities                                  |       | —     |       | (43,056                      | )          | (78,308                            | )          | —           |       | (121,364                                        | )          |
|                                                                   |       |       |       |                         |       |                               |       |             |       |                                            |       |
| **Cash Flows from Financing  Activities:**                             |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Change in book cash overdraft                                          |       | —     |       | (6,515                       | )          | —                             |       | —           |       | (6,515                                          | )          |
| Proceeds from issuance of long-term debt                               |       | 2,204,625  |       | —                       |       | —                             |       | —           |       | 2,204,625                                       |       |
| Repayments of long-term debt                                           |       | (430,012   | )          | —                       |       | —                             |       | —           |       | (430,012                                        | )          |
| Debt issuance costs                                                    |       | (58,541    | )          | —                       |       | —                             |       | —           |       | (58,541                                         | )          |
| Excess tax benefit from share-based compensation                       |       | —     |       | 780                          |       | —                             |       | —           |       | 780                                             |       |
| Proceeds related to notes with affiliates                              |       | 287,548    |       | 60,038                       |       | —                             |       | (347,586         | )          | —                                          |       |
| Payments related to notes with affiliates                              |       | —     |       | (268,400                     | )          | (79,186                            | )          | 347,586          |       | —                                          |       |
| Distributions to Sally Beauty.                                         |       | (1,809,740 | )          | —                       |       | —                             |       | —           |       | (1,809,740                                      | )          |
| Distributions to Alberto-Culver                                        |       | (44,411    | )          | —                       |       | —                             |       | —           |       | (44,411                                         | )          |
| Net cash provided (used) by financing activities                       |       | 149,469    |       | (214,097                     | )          | (79,186                            | )          | —           |       | (143,814                                        | )          |
|                                                                   |       |       |       |                         |       |                               |       |             |       |                                            |       |
| Effect of foreign exchange rate changes on cash and  cash equivalents  |       | 705        |       | (269                         | )          | 1,176                              |       | —           |       | 1,612                                           |       |
| Net (decrease) increase in cash and cash  equivalents                  |       | (53,785    | )          | (27,318                      | )          | 11,804                             |       | —           |       | (69,299                                         | )          |
| Cash and cash equivalents, beginning of period                         |       | 53,792     |       | 36,634                       |       | 17,145                             |       | —           |       | 107,571                                         |       |
| Cash and cash equivalents, end of period                               |       | $          | 7          |                         | $          | 9,316                              |       | $                | 28,949     |                                            | $          | — |   | $ | 38,272 |   |

 

F-42

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

## **19.   Quarterly Financial Data (Unaudited)**

##  

Unaudited quarterly consolidated statement of earningsinformation for the fiscal years ended September 30, 2009 and 2008 issummarized below (in thousands, except per share data):

 
| **Fiscal Year** | ** ** | **1****st********Quarter** | ** ** | **2****nd********Quarter** | ** ** | **3****rd********Quarter** | ** ** | **4****th********Quarter** | ** ** |
|-----------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| 2009:           |       |                       |       |                       |       |                       |       |                       |       |
| Net sales       |       | $                          | 645,576    |                       | $          | 641,511                    |       | $                          | 673,337    |   | $ | 676,176 |   |
| Gross profit    |       | $                          | 303,544    |                       | $          | 302,112                    |       | $                          | 317,845    |   | $ | 319,816 |   |
| Net earnings    |       | $                          | 17,207     |                       | $          | 25,739                     |       | $                          | 32,855     |   | $ | 28,927 |   |
|            |       |                       |       |                       |       |                       |       |                       |       |
| 2008:           |       |                       |       |                       |       |                       |       |                       |       |
| Net sales       |       | $                          | 655,787    |                       | $          | 643,346                    |       | $                          | 676,830    |   | $ | 672,228 |   |
| Gross profit    |       | $                          | 306,169    |                       | $          | 298,424                    |       | $                          | 315,066    |   | $ | 314,935 |   |
| Net earnings    |       | $                          | 15,346     |                       | $          | 13,780                     |       | $                          | 30,626     |   | $ | 23,116 |   |

 

F-43

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