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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, 2008**                                                                                                                                                                                                      |
| ** **                                                                                                                                                                                                                                             | ** **                                                                                               |
| **-OR-**                                                                                                                                                                                                                                               |
| ** **                                                                                                                                                                                                                                             | ** **                                                                                               |
| **o**                                                                                                                                                                                                                                                  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **                                                                                                                                                                                                                                             | ** **                                                                                               |
| **For  the transition period from                     to                  ** |

 

| **SALLY  HOLDINGS LLC**                                | ** ** | **SALLY  CAPITAL INC.**                                |
|--------------------------------------------------------|------------|--------------------------------------------------------|
| (Exact name of registrant as specified in its charter) |       | (Exact name of registrant as specified in its charter) |
| ** **                                             | ** ** | ** **                                             |
| **Delaware**                                           | ** ** | **Delaware**                                           |
| (State or other jurisdiction of                        |       | (State or other jurisdiction of                        |
| incorporation or organization)                         |       | incorporation or organization)                         |
| ** **                                             | ** ** | ** **                                             |
| **36-4472381**                                         | ** ** | **56-2620323**                                         |
| (I.R.S. Employer Identification Number)                |       | (I.R.S. Employer Identification Number)                |
| ** **                                             | ** ** | ** **                                             |
| **333-144427**                                         | ** ** | **333-144427-10**                                      |
| (Commission file number)                               |       | (Commission file number)                               |

 

**3001 Colorado Boulevard**

**Denton, Texas 76210**

(Address of principal executive offices)

 

**(940) 898-7500**

(Registrants’ telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

| **Title of Each Class**                                               | ** ** | **Name of Each Exchange on Which  Registered**   |
|-----------------------------------------------------------------------|------------|--------------------------------------------------|
| 9.25% Senior Notes Due 2014

10.5% Senior Subordinated Notes Due 2016 |       | New York Stock Exchange

New York Stock Exchange |

 

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

 

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

 

Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined under Rule 405 ofthe Securities Act. YES **o**     NO **x**

 

Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. YES **o**     NO **x**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports) and (2) has been subject to such filing requirementsfor the past 90 days. YES **o**     NO **x**

 

Indicate by check mark ifdisclosure 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**

 

Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler, a non-accelerated filer or a smaller reporting company. (See definitionof accelerated filer, large accelerated filer and smaller reporting company inRule 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) |                           |                               |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange 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, 2008. As of November 24, 2008, allmember units were owned by Sally Investment Holdings LLC, a wholly-ownedsubsidiary of Sally Beauty Holdings, Inc.

 

**DOCUMENTS INCORPORATED BY REFERENCE:NONE**

 

 

 

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**TABLE OF CONTENTS**

 
| ** **    | ** **                                                                                       | **Page** |
|---------------|--------------------------------------------------------------------------------------------------|----------|
| ** **    | **PART I**                                                                                  |     |
| ITEM 1.  | BUSINESS                                                                                         | 1        |
| ITEM 1A. | RISK FACTORS                                                                                     | 11       |
| ITEM 1B. | UNRESOLVED  STAFF COMMENTS                                                                       | 26       |
| ITEM 2.  | PROPERTIES                                                                                       | 26       |
| 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 DISCLOSURE ABOUT MARKET RISK                                       | 57       |
| ITEM 8.  | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                     | 58       |
| ITEM 9.  | CHANGE IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE             | 58       |
| ITEM 9A. | CONTROLS AND  PROCEDURES                                                                         | 58       |
| ITEM 9B. | OTHER INFORMATION                                                                                | 59       |
|          |                                                                                             |     |
| ** **    | **PART III**                                                                                |     |
| ITEM 10. | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                          | 60       |
| ITEM 11. | EXECUTIVE  COMPENSATION                                                                          | 60       |
| ITEM 12. | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS | 60       |
| ITEM 13. | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                       | 60       |
| ITEM 14. | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                          | 60       |
|          |                                                                                             |     |
| ** **    | **PART IV**                                                                                 |     |
| ITEM 15. | EXHIBITS AND  FINANCIAL STATEMENT SCHEDULES                                                 | 62       |

 

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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 Sally Investmentare beneficially owned by Sally Beauty. Prior to November 16, 2006, Sally Holdings was a Delawarecorporation named “Sally Holdings, Inc.” and was a wholly-owned subsidiaryof Alberto-Culver Company, or Alberto-Culver. On November 16, 2006, Sally Holdings, Inc.was converted to a Delaware limited liability company, was renamed “SallyHoldings LLC” and became a wholly-owned subsidiary of Sally Investment and anindirect subsidiary of Sally Beauty in connection with the separation of SallyHoldings’ business from Alberto-Culver. All operations of Sally Investment andSally Beauty are conducted through Sally Holdings and its consolidatedsubsidiaries.  Sally Capital Inc., aDelaware corporation, or Sally Capital, is a wholly-owned subsidiary of Sally Holdingsand does not have any assets or operations 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” orsimilar 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 highlycompetitive nature of, and the increasing consolidation of, the beauty productsdistribution industry;

 

·             anticipating changesin consumer preferences and buying trends and managing our product lines andinventory;

 

·             potential fluctuationin our same store sales and quarterly financial performance;

 

·             our dependence uponmanufacturers who may be unwilling or unable to continue to supply products tous;

 

·             the possibility ofmaterial interruptions in the supply of beauty supply products by ourmanufacturers;

 

·             products sold by usbeing found to be defective in labeling or content;

 

·             compliance with lawsand regulations or becoming subject to additional or more stringent laws andregulations;

 

·             product diversion tomass retailers;

 

·             the operational andfinancial performance of our Armstrong McCall, L.P. business;

 

·             the success of ournew Internet-based business;

 

·             successfullyidentifying acquisition candidates or successfully completing desirableacquisitions;

 

·             integratingbusinesses acquired in the future;

 

·             opening and operatingnew stores profitably;

 

·             the impact of adownturn in the economy upon our business;

 

·             the success of ourcost control plans;

 

·             protecting ourintellectual property rights, specifically our trademarks;

 

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·             conducting businessoutside the United States;

 

·             disruption in ourinformation technology systems;

 

·             natural disasters oracts of terrorism;

 

·             the preparedness ofour accounting and other management systems to meet financial reporting andother requirements and the upgrade of our existing financial reporting system;

 

·             being a holdingcompany, with no operations of our own, and depending on our subsidiaries forcash;

 

·             our substantialindebtedness;

 

·             the possibility thatwe may incur substantial additional debt;

 

·             restrictions andlimitations in the agreements and instruments governing our debt;

 

·             generating thesignificant amount of cash needed to service all of our debt and refinancingall or a portion of our indebtedness or obtaining additional financing;

 

·             changes in interestrates increasing the cost of servicing our debt or increasing our interestexpense due to our interest rate swap agreements;

 

·             the potential impacton us if the financial institutions we deal with become impaired;

 

·             therepresentativeness of our historical consolidated financial information withrespect to our future financial position, results of operations or cash flows;

 

·             our reliance uponAlberto-Culver for the accuracy of certain historical services and information;

 

·             the sharedistribution of Alberto-Culver common stock in our separation fromAlberto-Culver not constituting a tax-free distribution;

 

·             actions taken bycertain large stockholders of Sally Beauty adversely affecting the tax-freenature of the share distribution of Alberto-Culver common stock;

 

·             the voting power ofSally Beauty’s largest stockholder discouraging third party acquisitions ofSally Beauty at a premium; and

 

·             the interests ofSally Beauty’s largest stockholder differing from the interests of otherholders 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 3,580 stores and supplied 193franchised stores in North America as well as selected European countries andJapan, as of September 30, 2008. Within BSG, we also have one of thelargest networks of professional distributor sales consultants in NorthAmerica, with over 1,000 professional distributor sales consultants who selldirectly to salons and salon professionals. As of September 30, 2008,Sally Beauty Supply had 2,820 company-operated retail stores and supplied 24franchised stores (all outside the U.S.), and BSG had 760 company-operatedstores and supplied 169 franchised stores. We provide our customers with a widevariety of leading third-party branded and exclusive-label professional beautysupplies, including hair care products, styling appliances, skin and nail careproducts and other beauty items. Sally Beauty Supply stores target retailconsumers and salon professionals, while BSG exclusively targets salons andsalon professionals. Approximately 87%, 89% and 93% of our consolidated netsales for the fiscal years ended September 30, 2008, 2007 and 2006,respectively, were in the U.S. and Canada. For the year ended September 30,2008, our consolidated net sales were $2,648.2 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. On November 16,2006, our business separated from Alberto-Culver and we became an indirectwholly-owned subsidiary of Sally Beauty. Our separation from Alberto-Culver andits consumer products-focused business, which we refer to as the SeparationTransactions, was pursuant to an investment agreement, dated as of June 19,2006, as amended (hereafter, the “Investment Agreement”) among Alberto-Culverand certain of its subsidiaries, including Sally Holdings, Inc. (“SallyHoldings”), CDRS Acquisition LLC, or CDRS, and others. Sally Beauty is aDelaware corporation formed in June 2006 and became the accountingsuccessor company to Sally Holdings upon the completion of the SeparationTransactions. When we refer to Alberto-Culver, we mean Alberto-Culver Companyprior to the Separation Transactions or the company from which we separated,which is currently a separate public company, as the context requires.

 

In connection with the Separation Transactions, CDRSand CD&R Parallel Fund VII, L.P., or the Parallel Fund, and which werefer to together with CDRS as the CDR Investors, invested an aggregate of$575.0 million in cash equity, representing ownership subsequent to theseparation of approximately 48% of the outstanding shares of Sally Beauty’scommon stock on an undiluted basis. CDRS, which owned approximately 47.6% ofthe outstanding shares of Sally Beauty’s common stock on an undiluted basis asof September 30, 2008, is a Delaware limited liability company organizedby Clayton, Dubilier & Rice Fund VII, L.P., a private investmentfund managed by Clayton, Dubilier & Rice, Inc. Also in connectionwith the Separation Transactions, we incurred approximately $1,850.0 million ofindebtedness, as more fully described 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.

 

## **ProfessionalBeauty Supply 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 market 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 has begun sellingsome products through Sally Beauty’s web site (*www.sallybeauty.com*)during the past year.

 

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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. market, 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.

 

## **KeyIndustry 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 market fragmentation.*  TheU.S. salon market is highly fragmented with over 225,000salons. Given the fragmented and small-scale nature of the salon industry,we believe that salon operators will continue to depend onfull-service/exclusive distributors and open-line channels for a majority oftheir beauty supply purchases.

 

·             *Growth in booth renting and frequent 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.

 

·             *Continuing consolidation.*  Thereis continuing consolidation among professional beauty product distributors andprofessional beauty product manufacturers. We plan to continue to examine waysin which we can benefit from this trend, including reviewing opportunities toshift business from competitive distributors to the BSG network as well asseeking opportunistic value-added acquisitions. 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. Please see “Relationships with Suppliers;” “Risk Factors -The beauty products distribution industry is highly competitive and isconsolidating” and – “We depend upon manufacturers who may be unable to provideproducts of adequate quality or who may be unwilling to continue to supplyproducts to us.”

 

·             *High level of competition.*  SallyBeauty Supply competes with a number of domestic and international beautyproduct wholesale and retail outlets, including local and regional open-linebeauty supply stores, professional-only beauty supply stores, salons, massmerchandisers, drug stores and supermarkets, as well as sellers on the Internetand salons retailing hair care items. BSG competes with other domestic and internationalbeauty product wholesale and retail suppliers and manufacturers sellingprofessional beauty products directly to salons and individual salonprofessionals. We also face competition from authorized and unauthorizedretailers and Internet sites offering professional salon-only products.

 

·             *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 have animpact on our financial performance. Our continued success depends in largepart on our ability to anticipate, gauge and react in a timely and effectivemanner to changes in consumer spending patterns and preferences for beautyproducts. We continuously adapt ourmarketing and merchandising initiatives for Sally Beauty Supply and BSG in aneffort to expand our market reach or to respond to changing consumerpreferences.  For example, in fiscal year2008 we signed an exclusive merchandising agreement in the U.S. and Canada forcertain hair extension products promoted by celebrity Paris Hilton in anattempt to enhance our appeal to a younger customer base in these geographicareas.

 

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·             *Changes ineconomic conditions.*  Weappeal to a wide demographic consumer profile and offer a broad selection ofbeauty products sold directly to retail consumers, salons and salonprofessionals. Historically, these factors have provided us with reducedexposure to downturns in economic conditions in the countries in which weoperate.  However, downturns in theeconomy, especially for an extended period of time, could adversely impact consumerdemand of discretionary items such as beauty products and salon services,particularly affecting our electrical products category and our full-servicesales business. In addition, higher freight costs resulting from increases inthe cost of fuel, especially for an extended period of time, may impact ourexpenses at levels that we cannot pass through to our customers.

 

## **BusinessSegments, Geographic Area Information and Seasonality**

##  

We operate two business segments: (i) SallyBeauty Supply, a domestic and international open-line and exclusive-labeldistributor of professional beauty supplies offering professional beautysupplies to both retail consumers and salon professionals, and (ii) BSG, afull-service beauty supply distributor offering professional brands directly tosalons and salon professionals through our own sales force andprofessional-only stores, many in exclusive geographical territories in NorthAmerica. BSG operates stores under the CosmoProf service mark. BSG alsofranchises beauty supply outlets in the southwest portion of the U.S. andMexico, and supplies sub-distributors in Europe. Sales of Sally Beauty Supplyaccounted for approximately 63%, 62% and 60%; and BSG accounted forapproximately 37%, 38% and 40% of the company’s consolidated net sales for theyears ended September 30, 2008, 2007 and 2006, respectively.

 

Financial information about business segments andgeographic area information is incorporated herein by reference to the “BusinessSegments and Geographic Area Information,” Note 17 of the “Notes toConsolidated 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.

 

## ***Sally Beauty Supply***

##  

Sally Beauty Supply is the largest open-linedistributor of professional beauty supplies in the U.S. based on storecount. Its stores carry an extensive selection of professional beauty products,ranging between 5,000 and 8,000 stock keeping units, or SKUs, of beauty products,and includes products for hair care, nail care, beauty sundries and smallelectrical appliances targeting retail consumers and salon professionals. SallyBeauty Supply stores carry leading third-party brands such as Clairol, Revlonand Conair, as well as an extensive selection of exclusive-label merchandise.We believe that Sally Beauty Supply has differentiated itself from itscompetitors through its customer value proposition, attractive pricing,extensive selection of leading third-party branded and exclusive-labelproducts, broad ethnic product selection, the product knowledge of its salesassociates and convenient store locations.

 

### *  Store Design and Operations*

###  

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 1,700 square feet in size and are located primarily instrip shopping centers. Generally, Sally Beauty Supply stores follow a consistentformat, allowing customers familiarity between Sally Beauty 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 maintenance ofconsistently 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 trackand automatically replenish inventory levels, generally on a weekly basis,primarily in the U.S.

 

Sally Beauty Supply offers a comprehensive ethnicproduct selection with specific appeal to the African-American and Hispaniccustomers. Its ethnic product offerings are tailored by store based on marketdemographics and category performance. For example, sales to theAfrican-American marketplace represented approximately 9% of net sales in SallyBeauty Supply’s U.S. stores for fiscal 

 

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year 2008. We believe the breadth of selection ofethnic products available in Sally Beauty Supply stores is unique anddifferentiates its stores from its competition. Sally Beauty Supply also aimsto position itself to be competitive in price, but not a discount 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-Party BrandedProducts*

###  

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 Sally BeautySupply carries includes products from one or more of the leading manufacturersin each category. Sally Beauty Supply’s objective is not only to carry leadingbrands, but also to carry a full range of branded and exclusive-label productswithin each category. As hair trends continue to evolve, we expect to offer thechanging professional beauty product assortment necessary to meet the needs ofretail consumers and salon professionals.

 

### *  Exclusive-label Products*

###  

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 41% of Sally Beauty Supply’sproduct sales in the U.S. during fiscal year 2008. 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, 2008** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|
| Hair color                                 |       | 21.7                                              | %          |
| Skin and nail care               |       | 12.4                                              | %          |
| Hair care                                  |       | 18.5                                              | %          |
| Brushes, cutlery and accessories |       | 16.8                                              | %          |
| Electrical appliances                      |       | 13.2                                              | %          |
| Ethnic products                            |       | 9.1                                               | %          |
| Other beauty items                    |       | 8.3                                               | %          |
| Total                                           |       | 100.0                                             | %          |

###  

### *  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 salon professionals. ProCard members receive 

 

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discounts on all beauty products sold at Sally BeautySupply stores. We believe these programs are effective in developing andmaintaining 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 markets. In its existing markets, Sally Beauty Supplyadds stores as necessary to provide additional coverage. In new markets, SallyBeauty Supply generally seeks to expand in geographically contiguous areas toleverage its experience. We believe that Sally Beauty Supply’s knowledge oflocal markets is an important part of its success.

 

The following table provides a history of Sally BeautySupply store openings since the beginning of fiscal year 2004:

 
| ** **                         | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Stores open at beginning of period |       | 2,694                                       |       | 2,511 |   | 2,419 |   | 2,355 |   | 2,272 |   |
| Net store openings during period   |       | 110                                         |       | 83 |   | 92 |   | 62 |   | 83 |   |
| Stores acquired during period      |       | 40                                          |       | 100 |   | — |   | 2 |   | — |   |
| Stores open at end of period       |       | 2,844                                       |       | 2,694 |   | 2,511 |   | 2,419 |   | 2,355 |   |

##  

## ***Beauty Systems Group***

##  

We believe that BSG is the largest full-servicedistributor of professional beauty supplies in the U.S. As of September 30,2008, BSG had 760 company-operated stores, supplied 169 franchised storesand had a sales force of over 1,000 professional distributor sales consultantsselling exclusively to salons and salon professionals in substantially everystate in the U.S., in Puerto Rico and in portions of Canada, Mexico and certainEuropean countries.

 

### *  Store Design and Operations*

###  

BSG stores are designed to create a professionalshopping environment that embraces the salon professional and highlights itsextensive product offering. Company-operated BSG storesaverage 2,700 square feet and are located primarily in secondarystrip shopping centers. BSG store layouts are designed to provide optimalvariety and options to the salon professional. Stores are segmented intodistinctive 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.

 

### *  Professional Distributor SalesConsultants*

###  

BSG has a network of over 1,000 professionaldistributor sales consultants, which exclusively serve salons and salonprofessionals. The following table sets forth the number of consultants in theBSG network since the beginning of fiscal year 2004:

 
| ** **                                 | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                 | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Professional distributor sales consultants |       | 1,071                                       |       | 1,067 |   | 1,192 |   | 1,244 |   | 1,167 |   |

 

The decrease in distributor sales consultants infiscal year 2007 was in response to the loss of L’Oreal related sales discussedbelow under “Competition.” BSG’s sales force was reduced in fiscal year 2007and the remaining affected distributor sales consultants were offered certaincompensation related incentives to stay with us as BSG replaced lost L’Orealsales.

 

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.

 

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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 itselffrom other full-service/exclusive-channel distributors.

 

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

 

| ** **                                                 | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                    | ** ** | **2007** | ** ** |
| Company-operated retail stores                             |       | 57.0                                        | %          | 53.4 | % |
| Professional distributor sales consultants  (full-service) |       | 29.9                                        | %          | 31.2 | % |
| Franchise stores                                           |       | 13.1                                        | %          | 15.4 | % |
| 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 9,600 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 approximate percentageof sales attributable by merchandise category:

 

| ** **                       | ** ** | **Year Ended  September 30, 2008** | ** ** |
|----------------------------------|------------|---------------------------------------------------|------------|
| Hair care                        |       | 38.1                                              | %          |
| Hair color                       |       | 26.3                                              | %          |
| Promotional items(a)             |       | 12.4                                              | %          |
| Skin and nail care               |       | 8.0                                               | %          |
| Electrical appliances            |       | 6.5                                               | %          |
| Brushes, cutlery and accessories |       | 3.6                                               | %          |
| Salon equipment                  |       | 1.9                                               | %          |
| Other beauty items               |       | 2.2                                               | %          |
| Ethnic products                  |       | 1.0                                               | %          |
| Total                            |       | 100.0                                             | %          |

 

----

| (a) | Promotional  items consists of sales from other categories that are sold on a  discounted basis. |
|-----|-------------------------------------------------------------------------------------------------------|

###  

### *  Marketing and Advertising*

###  

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 storeopenings since the beginning of fiscal year 2004:

 

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| ** **                         | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Stores open at beginning of period |       | 874                                         |       | 828 |   | 822 |   | 692 |   | 543 |   |
| Net store openings during period   |       | 44                                          |       | 46 |   | 6 |   | 37 |   | 26 |   |
| Stores acquired during period      |       | 11                                          |       | — |   | — |   | 93 |   | 123 |   |
| Stores open at end of period       |       | 929                                         |       | 874 |   | 828 |   | 822 |   | 692 |   |

##  

## **OurStrategy**

##  

We believe there are significant opportunities toincrease our sales and profitability through the further implementation of ouroperating strategy and by growing our store base in existing and contiguousmarkets, both organically and through strategic acquisitions. Specific elementsof our growth 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 New Markets***

##### *** ***

In fiscal year 2008, we opened 110 and 44 net newstores for Sally Beauty Supply and BSG, respectively. Because of the limitedinitial capital outlay, rapid payback and attractive return on capital, weintend to continue to expand our Sally Beauty Supply and BSG store base. Webelieve there are growth opportunities for additional stores in the U.S.,Canada, Mexico and Europe. In addition, we are exploring the potential to enternew geographies such as South America. We expect new store openings in existingand new areas to be an important aspect of our future 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 also increase store loyalty.

 

##### ***Increase Operating Efficiency and Profitability***

##### *** ***

We believe there are opportunities to increase theprofitability of operations, especially in our BSG business. During fiscalyears 2007 and 2008, 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 will improve brand consistency,save on advertising and promotional costs and allow for a more focusedmarketing strategy. We also implemented a two-year, $19.2 million capitalspending 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. We have also undertaken a full review of our procurement strategy.This initiative is intended to identify low cost alternative sources ofsupply in certain product categories from countries with low manufacturingcosts. We also offer between 5,000 and 8,000 SKUs of our Sally Beauty Supply productsfor sale through Sally Beauty’s website (*www.sallybeauty.com*),which we expect will lead to additional sales for that business segment.

 

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

##### *** ***

We have completed more than 25 acquisitions over thelast 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 acquisitionsby incurring additional debt or issuing equity under our debt agreements. Forexample, in May 2008 we acquired Pro-Duo, N.V., a cash and carry retailerof both professional and retail hair products with stores located mainly inBelgium, France and Spain, for €19.3 million Euros (approximately $29.8 millionplus incidental costs capitalized) subject to certain adjustments. In February 2007,we acquired Chapelton 21 Limited, a private company 

 

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based in Scotland with almost 100 stores located inthe United Kingdom, Ireland, Germany and Spain, which we refer to as SalonServices.  In June 2006, we acquiredSalon Success, a United Kingdom-based distributor of professional beautyproducts with sales operations in the United Kingdom, Spain and the Netherlandsservicing sub distributors in a number of European countries. 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” for additionalinformation 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 market positions and multi-channel platform afford usseveral advantages, including strong positioning with suppliers, the ability tobetter service the highly fragmented beauty supply market, economies of scaleand 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 ten countries outside the U.S. and PuertoRico, offering up to 8,000 and 9,600 SKUs in Sally Beauty Supply (in our storesand online) and BSG stores, respectively, to a potential customer base thatincludes millions of retail consumers, and more than 225,000 salons in the U.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-label merchandise),high levels of in-stock merchandise, knowledgeable salespeople and competitivepricing. Our merchandise mix includes a comprehensive ethnic product selection,which is tailored by store based on market demographics and categoryperformance. For example, African-American products represented over 9% of netsales in our U.S. Sally Beauty Supply stores during fiscal year 2008, andwe believe that the breadth of our selection of these products furtherdifferentiates Sally Beauty Supply from its competitors. In addition, asdiscussed above, Sally Beauty Supply also offers a customer loyalty program forSally Beauty Supply customers, the Beauty Club, whereby members receive aspecial, discounted price on products and are also eligible for a special BeautyClub e-mail newsletter with additional promotional offerings, beauty tips andnew product information for a nominal annual fee. We believe that ourdifferentiated customer value proposition and strong brands drive customerloyalty and high repeat traffic, contributing to our consistent historicalfinancial performance. Our BSG professional distributor sales consultantsbenefit from their customers having access to the BSG store systems ascustomers have the ability to pick up the products they need between salesvisits from professional distributor sales consultants.

 

##### ***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. Sally Beauty Supply and BSG stores average approximately1,700 and 2,700 square feet in size, respectively, and are typicallylocated within strip shopping centers. Strong average sales per square footcombined with minimal staffing requirements, low rent expense and limitedinitial capital outlay, typically result in positive contribution marginswithin three to four months, and cash payback on investment withinapproximately 

 

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two years. Due to such attractive investment returnsand relatively high operating profit contributions per store, over the pastfive years Sally Beauty Supply and BSG have opened 430 and 159 net newstores, respectively.

 

##### ***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 3.3%, as set forth in the following table:

 
| ** **                                          | ** ** | **Year Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------|------------|
| **Same store sales growth (a)** | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Sally Beauty Supply                                 |       | 1.2                                         | %          | 2.7 | % | 2.4 | % | 2.4 | % | 3.8 | % |
| Beauty Systems Group                                |       | 6.9                                         | %          | 10.1 | % | 4.1 | % | (0.6 | )% | 8.5 | % |
| Consolidated                                        |       | 2.6                                         | %          | 4.5 | % | 2.8 | % | 1.8 | % | 4.6 | % |

 

----

##### ***(a) Same store is defined ascompany-operated stores that have been open for at least 14 months as of thelast day of a month.***

##### *** ***

##### ***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 Gary Winterhalterand has a strong record of net sales growth and profitability improvement. Oursenior management team has an average tenure of 12 years with us and oursubsidiaries and their predecessors and 21 years in the beauty supply industry.

 

## **CustomerService**

##  

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 increaseemployee and store productivity. Store employees are also required toparticipate in training on an ongoing basis to keep up-to-date on products andoperational practices.

 

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.

 

## **Relationshipswith Suppliers**

##  

We purchase our merchandise directly frommanufacturers through supply contracts and by purchase order. For fiscal year2008, our two largest suppliers were Procter & Gamble and theProfessional Products Division of L’Oreal USA S/D, Inc., or L’Oreal.Products are purchased from many manufacturers on an at-will basis or undercontracts which can be terminated without cause upon 90 days notice orless or expire without express rights of renewal. Such manufacturers coulddiscontinue sales to us at any time or upon short notice.

 

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 withsuppliers occur often, and could positively or negatively impact our net salesand operating profits. Please see “Risk Factors—We depend upon manufacturerswho may be unable to provide products of adequate quality or who may beunwilling to continue to supply products to us.” However, we believe that wecan be successful in mitigating negative effects resulting from unfavorablechanges in the relationships between us and our suppliers through, among otherthings, the development of new or expanded supplier relationships.

 

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**Distribution**

 

As of September 30, 2008, we operated 17 distributioncenters, seven of which serviced Sally Beauty Supply and 10 of which servicedBSG. During fiscal year 2007, we began implementing a two-year capital spendingprogram to consolidate warehouses and reduce administrative expenses related toBSG’s distribution network optimization program. As of the end of fiscal year2008, capital expenditures to date have been approximately $19.0 million andrelated expenses have been approximately $4.7 million for this program. Webelieve that annual savings from this program could range between $8.0 millionand $10.0 million beginning with fiscal year 2009.

 

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,distribution and store operations functions of our business.  A significant portion of these systems havebeen developed internally. The information gathered by the managementinformation systems supports automatic replenishment of in-store inventory andprovides support for product purchase decisions. Please see “Risk Factors—We may be adverselyaffected by any disruption in our information technology systems.”

 

## **Employees**

##  

In our domestic and foreign operations, we hadapproximately 21,140 employees as of September 30, 2008; consistingof approximately 5,850 salaried, 4,710 hourly and 10,580 part-timeemployees. We had approximately 19,820 employees as of September 30,2007; consisting of approximately 5,480 salaried, 4,610 hourly and 9,730part-time employees. Part-time employees are used to supplement schedules,particularly in North America.

 

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 federal agencies,including, in each case, one or more of the following: the Food and DrugAdministration, or FDA, the Federal Trade Commission, or FTC, and the ConsumerProducts Safety Commission. The transportation and disposal of many of ourproducts are also subject to federal regulation. State and local agenciesregulate many aspects of our business. In jurisdictions outside of the U.S.regulation is also focused and comprehensive.

 

Sally Beauty Supply supplies 24 and BSG supplies 169franchisee 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.

 

## **Trademarksand Other Intellectual 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. We and our subsidiaries ownover 230 trademark registrations in the U.S., and 740 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, in addition to confidentiality agreements with many vendors,employees, consultants and others who have access to our proprietaryinformation. The duration of our trademark registrations is generally 10or 15 years, depending on the country in which a mark is registered, andgenerally the registrations can be renewed. The scope and duration ofintellectual property protection varies by jurisdiction and by individualproduct.

 

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## **Accessto Public Filings**

##  

Our Annual Report on Form 10-K, our QuarterlyReports on Form 10-Q and current reports on Form 8-K, and amendmentsto such reports are available, without charge, on Sally Beauty’s website, *www.sallybeautyholdings.com*, as soon as reasonably possibleafter they are filed electronically with the Securities and ExchangeCommission, or SEC, under the Exchange Act. We will provide copies of suchreports to any person, without charge, upon written request to our office ofInvestor Relations by writing to: our Investor Relations Department at 3001Colorado Blvd, Denton, TX 76210. The information found on Sally Beauty’swebsite shall not be considered to be part of this or any other report filedwith 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. RISKFACTORS**

# ** **

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 whichwe are not aware or that we do not believe to be material that could materiallyand adversely affect our business. This Annual Report also containsforward-looking statements and the following risks could cause our actualresults to differ materially from those anticipated in such forward-lookingstatements.

 

## **RisksRelating to Our Business**

##  

***The beauty products distribution industryis highly competitive and is consolidating.***

 

Thebeauty products distribution industry is highly fragmented and there are fewsignificant barriers to entry into the marketplaces for most of the types ofproducts and services we sell. Sally Beauty Supply competes with other domesticand international beauty product wholesale and retail outlets, including localand regional 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 and Internet sites offering professionalsalon-only products. The increasing availability of diverted professional salonproducts in large format retail stores such as drug stores, grocery stores andothers could have a negative impact on our business. The primary competitivefactors in the beauty products distribution industry are the price at which wepurchase products from manufacturers, quality, perceived value, consumer brandname recognition, packaging and mix of the products we sell; customer service;the efficiency of our distribution network; and the availability of desirablestore locations. Competitive conditions may limit our ability to maintainprices or may require us to reduce prices to retain business or marketplace share.Some of our competitors are larger and have greater financial and otherresources than we do, and are less leveraged than our business, and maytherefore be able to spend more aggressively on advertising and promotionalactivities and respond more effectively to changing business and economicconditions. We expect existing competitors, business partners and new entrantsto the beauty products distribution industry to constantly revise or improvetheir business models in response to challenges from competing businesses,including ours. If these competitors introduce changes or developments that wecannot meet in a timely or cost-effective manner, our business may be adverselyaffected.

 

Inaddition, our industry is consolidating, which may give our competitorsincreased negotiating leverage and greater marketing resources, therebyproviding corresponding competitive advantages over us. For instance, we maylose customers if our competitors that own national chains acquire additionalsalons that are BSG customers or if professional beauty supply manufacturersalign themselves with other beauty product wholesale and retail suppliers whocompete with BSG. For example our largest supplier, L’Oreal, has moved amaterial amount of revenue out of specific regions of the BSG nationwidedistribution network and into competitive regional distribution networks. L’Orealhas also acquired distributors competitive with BSG in the southeastern U.S. aswell as the west coast of the U.S. As a result, L’Oreal entered into directcompetition with BSG and there can be no assurance that there will not befurther revenue losses over time at BSG, due to potential losses of additionalL’Oreal related products as well as from the increased competition from L’Oreal-affiliateddistribution networks. In addition, L’Oreal has acquired one supplier that doesnot currently do business with BSG. If L’Oreal acquired a supplier that didconduct business with BSG, we could lose that revenue as well. Suchconsolidation may increase competition from distribution channels related tosuppliers and place more leverage in the hands of those suppliers to negotiatebetter margins on products sold in our stores.

 

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Ifwe are unable to compete effectively in our marketplace or if competitors coulddivert our customers away from our stores and outside salespeople, it could adverselyimpact our business, financial condition and results of operations.

 

***We may be unable to anticipate changes inconsumer preferences and buying trends or manage our product lines andinventory commensurate with consumer demand.***

 

Oursuccess depends in part on our ability to anticipate, gauge and react in atimely manner to changes in consumer spending patterns and preferences forbeauty products. If we do not anticipate and respond to trends in themarketplace for beauty products and changing consumer demands in a timelymanner, our sales may decline significantly and we may be required to mark downcertain products to sell the resulting excess inventory at prices which can besignificantly lower than the normal retail or wholesale price, which could adverselyimpact our business, financial condition and results of operations. Inaddition, we depend on our inventory management and information technologysystems in order to replenish inventories and deliver products to storelocations in response to customer demands. Any systems-related problems couldresult in difficulties satisfying the demands of customers which, in turn,could adversely affect our sales and profitability.

 

Weexpect the aging baby boomer population to drive future growth in professionalbeauty supply sales through an increase in the use of hair color and hair lossproducts. Additionally, we expect continuously changing fashion-related trendsthat drive new hair styles to result in continued demand for hair stylingproducts. Changes in consumer tastes and fashion trends can have an impact onour financial performance. If we are unable to anticipate and respond to trendsin the marketplace for beauty products and changing consumer demands, ourbusiness could suffer.

 

***Our same store sales and quarterlyfinancial performance may fluctuate for a variety of reasons.***

 

Oursame store sales and quarterly results of operations have fluctuated in thepast, and we expect them to continue to fluctuate in the future. A variety ofother factors affect our same store sales and quarterly financial performance,including:

 

·                              changes in our merchandising strategy or mix;

 

·                              the performance of our new stores;

 

·                              the effectiveness of our inventorymanagement;

 

·                              timing and concentration of new storeopenings, including additional human resource requirements and relatedpre-opening and other start-up costs;

 

·                              levels of pre-opening expenses associatedwith new stores;

 

•                              a portion of a typical new store’s sales (or sales we make over theinternet channel) coming from customers who previously shopped at otherexisting stores;

 

·                              expenditures on our warehouse consolidationproject;

 

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

 

·                              timing and effectiveness of our marketingactivities;

 

·                              seasonal fluctuations due to weatherconditions;

 

·                              actions by our existing or new competitors;and

 

·                              general U.S. economic conditions and, in particular, the retail salesenvironment.

 

Accordingly,our results for any one fiscal quarter are not necessarily indicative of theresults to be expected for any other quarter, and same store sales for anyparticular future period may decrease, which could have a material adverseeffect on our business, financial condition and results of operations.

 

***We depend upon manufacturers who may beunable to provide products of adequate quality or who may be unwilling tocontinue to supply products to us.***

 

Wedo not manufacture the brand name or exclusive label products we sell, and insteadpurchase our products from manufacturers. We depend on a limited number ofmanufacturers for a significant percentage of the products we sell. For fiscalyear 2008, our two 

 

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largestsuppliers were Procter & Gamble and L’Oreal. BSG’s largest supplier, L’Oreal,represented approximately 16.7% of BSG’s total net sales in fiscal year 2008.

 

Inaddition, since we purchase products from many manufacturers on an at-willbasis, under contracts which can generally be terminated without cause upon90 days notice or less or which expire without express rights of renewal,such manufacturers 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 2007 FaroukSystems, Inc. filed an action seeking a declaratory judgment that it isentitled to terminate a long-term distribution agreement with Armstrong McCall,and Armstrong McCall is vigorously defending its rights under the agreement. Wemay not be able to acquire desired merchandise in sufficient quantities or onacceptable terms in the future.

 

Changesin Sally Beauty Supply and BSG’s relationships with suppliers occur often, andcould positively or negatively impact the net sales and operating profits ofboth business segments. For example, net sales and operating profits of SallyBeauty Supply and BSG were negatively affected in fiscal year 2005 by thedecision of certain suppliers of the BSG business to begin selling theirproducts directly to salons in most areas. Subsequently, in fiscal year 2006one of those suppliers agreed to have BSG once again sell its product lines inBSG stores. In December 2006, we announced that: (i) BSG, other thanits Armstrong McCall division, would not retain its rights to distribute theprofessional products of L’Oreal through its distributor sales consultants(effective January 30, 2007, with exclusivity ending December 31,2006) or in its stores on an exclusive basis (effective January 1,2007) in those geographic areas within the U.S. in which BSG haddistribution rights, and (ii) BSG’s Armstrong McCall division would notretain the rights to distribute Redken professional products through itsfranchises. In an effort to replace these rights, BSG entered into long-termagreements with L’Oreal under which, as of January 1, 2007, BSG hadnon-exclusive rights to distribute the same L’Oreal professional products inits stores that it previously had exclusive rights to in its stores and throughits sales consultants. The loss of L’Oreal distribution rights through ourdistributor sales consultants and the loss of exclusive rights to distribute L’Orealproducts in our stores may result in margin pressure on BSG’s remaining L’Orealrevenues, and this pressure is currently projected to continue during fiscalyear 2009. As discussed above, L’Oreal is entering into direct competition withBSG and there can be no assurance that there will not be further revenue lossesover time at BSG, due to potential losses of additional L’Oreal relatedproducts as well as from the increased competition from L’Oreal-affiliateddistribution networks. For example, L’Oreal could attempt to terminate ourcontracts to carry certain of their products in BSG stores, which brought inrevenues of approximately $101.5 million in U.S. sales for fiscal year 2008 andhave expiration dates at the end of 2012. Therefore, there can be no assurancethat the impact of these developments will not adversely impact revenue to agreater degree than we currently expect, or that our efforts to mitigate theimpact of these developments will be successful. If the impact of thesedevelopments is greater than we expect or our efforts to mitigate the impact ofthese developments are not successful, this could have a material adverseeffect on our business, financial condition or results of operations.

 

Someof our suppliers may seek to decrease their reliance on distributionintermediaries, including full-service/exclusive and open-line distributorslike BSG and Sally Beauty Supply, by promoting their own distribution channels,as discussed above. These suppliers may offer advantages, such as discountedprices, when their products are purchased from distribution channels theycontrol. If our access to supplier-provided products were to be diminished relativeto our competitors, our business could be materially and adversely affected.Also, consolidation among suppliers may increase their negotiating leverage,thereby providing them with competitive advantages over us that may increaseour costs and reduce our revenues, adversely affecting our business, financialcondition and results of operations.

 

Althoughwe plan to mitigate the negative effects resulting from unfavorable changes inour relationships with suppliers, such as L’Oreal, there can be no assurancethat our efforts will partially or completely offset the loss of thesedistribution rights.

 

***Any significant interruption in the supplyof beauty supply products by manufacturers of our products could disrupt ourability to deliver merchandise to our stores and customers in a timely manner,which could have a material adverse effect on our business, financial conditionand results of operations.***

 

Manufacturersof 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, economic pressures and other external factors overwhich neither they nor we have control. In addition, due to the recent turmoil in the financial markets and thegeneral economic downturn throughout the world, some of our manufacturers ofbeauty supply products may face difficulties in continuing to operate 

 

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theirbusinesses and supply us their products.  Our operating results also depend to some extent on the orderlyoperation of our receiving and distribution process, which depends onmanufacturers’ adherence to shipping schedules and our effective management ofour distribution facilities and capacity.

 

Ifa material interruption of supply occurs, or a significant supplier ceases tosupply us or materially decreases its supply to us, we may not be able toacquire products with similar quality and consumer brand name recognition asthe products we currently sell, or acquire such products in sufficientquantities to meet our customers’ demands or on favorable terms to ourbusiness, any of which could adversely impact our business, financial conditionand results of operations.

 

***If products sold by us are found to bedefective in labeling or content, our credibility and that of the brands wesell may be harmed, marketplace acceptance of our products may decrease and wemay be exposed to liability in excess of our products liability insurancecoverage and manufacturer indemnities.***

 

Wedo not control the production process for the brand name and exclusive labelproducts we sell. We may not be able to identify a defect in a product wepurchase from a manufacturer or filler before we offer such product forresale.  In many cases, we rely onrepresentations of manufacturers about the products we purchase for resaleregarding whether such products have been manufactured in accordance withsamples and applicable governmental regulations. Our sale of certainproducts exposes us to potential product liability claims, recalls or otherregulatory or enforcement actions initiated by federal, state or foreignregulatory authorities or through private causes of action. Such claims,recalls or actions could be based on allegations that, among other things, theproducts sold by us are misbranded, contain contaminants, provide inadequateinstructions 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.

 

Anyactual defects or allegations of defects in products sold by us could result inadverse publicity and harm our credibility, which could adversely affect ourbusiness, financial condition and results of operations. Although we may haveindemnification rights against the manufacturers of many of the products wedistribute and rights as an “additional insured” under the manufacturer’sinsurance policies, it is not certain that any individual manufacturer orinsurer will be financially solvent and capable of making payment to any partysuffering loss or injury caused by products sold by us. Further, some types ofactions and penalties, including many actions or penalties imposed bygovernmental agencies and punitive damages awards, may not be remediablethrough reliance on indemnity agreements or insurance. Furthermore, potentialproduct liability claims may exceed the amount of indemnity or insurancecoverage or be excluded under the terms of an indemnity agreement or insurancepolicy. If we are forced to pay to satisfy such claims, it could have anadverse effect on our business, financial condition and results of operations.

 

***We could be adversely affected if we do notcomply with laws and regulations or if we become subject to additional or morestringent laws and regulations.***

 

Weare subject to a number of U.S. federal, state and local laws and regulations,as well as the laws and regulations applicable in each other marketplace inwhich we do business. These laws and regulations govern the composition,packaging, labeling and safety of the products we sell, the methods we use tosell these products and the methods we use to import these products.Non-compliance with applicable laws and regulations of governmentalauthorities, including the FDA and similar authorities in other jurisdictions,by us or the manufacturers of the products sold by us could result in fines,product recalls and enforcement actions or otherwise restrict our ability tomarket certain products, which could adversely affect our business, financialcondition and results of operations. The laws and regulations applicable to usor manufacturers of the products sold by us may become more stringent.Continued legal compliance could require the review and possible reformulationor relabeling of certain products, as well as the possible removal of someproducts from the marketplace altogether. Legal compliance could also lead toconsiderably higher internal regulatory costs. Manufacturers may try to recoversome or all of any increased costs of compliance by increasing the prices at whichwe purchase products and we may not be able to recover some or all of suchincreased cost in our own prices to our customers. We are also subject to stateand local laws and regulations that affect our franchisor-franchiseerelationships. Increased compliance costs and the loss of sales of certainproducts due to more stringent or new laws and regulations could adverselyaffect our business, financial condition and results of operations.

 

Lawsand regulations impact our business in many areas that have no direct relationto the products we sell. For example, as a reporting company, we are subject toa number of laws and regulations related to the issuance and sale of oursecurities. Another area of intense regulation is that of the relationships wehave with our employees, including compliance with many different wage/hour and

 

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nondiscriminationrelated regulatory schemes. Violation of any of the laws or regulationsgoverning our business and the assertion of individual or class-wide claimscould have an adverse effect on our business, financial condition and resultsof operations.

 

***Product diversion could have an adverseimpact on our revenues.***

 

Themajority of the products that BSG sells, including those sold by our ArmstrongMcCall franchisees, are meant to be used exclusively by salons and individualsalon professionals or are meant to be sold exclusively by the purchasers, suchas salons, 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.

 

Productdiversion is generally prohibited under our supplier contracts and we may beunder a contractual obligation to stop selling to salons, salon professionalsand other bulk purchasers who engage in product diversion. If we fail to stopdiversion as required (including any known diversion of products sold throughour Armstrong McCall franchisees), our supplier contracts could be adverselyaffected or even terminated. In addition, our investigation and enforcement ofour anti-diversion policies may result in reduced sales to our customer base,thereby decreasing our revenues and profitability.

 

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

 

BSGreceives revenue from products purchased by Armstrong McCall franchisees.Accordingly, a portion of BSG’s financial results is to an extent dependentupon the operational and financial success of these franchisees, includingtheir implementation of BSG’s strategic plans. If sales trends or economicconditions worsen for Armstrong McCall’s franchisees, their financial resultsmay worsen. When Armstrong McCall divests company-operated stores, ArmstrongMcCall is often required to remain responsible for lease payments for thesestores to the extent that the relevant franchisees default on their leases.Additionally, if Armstrong McCall franchisees fail to renew their franchiseagreements, or if Armstrong McCall fails to meet its obligations under itsfranchise agreements or vendor distribution agreements or is required torestructure its franchise agreements in connection with such renewal, it couldresult in decreased revenues for BSG or legal issues with our franchisees orvendors.

 

***Our new Internet-based business may beunsuccessful or may cause internal channel conflict.***

 

Werecently began offering some of our beauty products for sale through SallyBeauty’s website (*www.sallybeauty.com*).Therefore we will now encounter risks and difficulties frequently experiencedin Internet-based businesses, including risks related to our ability to attractand retain customers on a cost-effective basis and our ability to operate,support, expand and develop our Internet operations, Sally Beauty’s websites,and our software and other related operational systems. In addition, our newInternet-based business may conflict with the success of our Sally Beautystores. For example, our Internet-based business may compete with our SallyBeauty stores for the same customers. Although we believe that ourparticipation in both Internet-based and store-based sales is a distinctadvantage for us due to synergies and the potential for new customers, customerconflicts between these offerings could create issues that have the potentialto adversely affect our results of operations. For example, such conflict couldcause some of our current or potential Internet customers to consider competingdistributors of beauty products. These events could have an adverse effect onour business, financial condition and results of operations.

 

***We may not be able to successfully identifyacquisition candidates or successfully complete desirable acquisitions.***

 

Inthe past several years, we have completed several significant acquisitions. Weintend to continue to pursue additional acquisitions in the future. Ourbusiness has in the past actively reviewed acquisition prospects that wouldcomplement our existing lines of business, increase the size and geographicscope of our operations or otherwise offer growth and operating efficiencyopportunities. There can be no assurance that we will be able to identifysuitable acquisition candidates.

 

Ifsuitable candidates are identified, sufficient funds may not be available tomake such acquisitions. We compete against many other companies, some of whichare larger and have greater financial and other resources than we do. Increasedcompetition for acquisition candidates could result in fewer acquisitionopportunities and higher acquisition prices. In addition, because we are highlyleveraged and the agreements governing our indebtedness contain limits on ourability to incur additional debt, the amount of equity that Sally Beauty canissue to make acquisitions or raise additional capital will be severelylimited. We may be unable to finance acquisitions 

 

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thatwould increase our growth or improve our financial and competitive position. Tothe extent that debt financing is available to finance acquisitions, our netindebtedness could be increased as a result of any acquisitions.

 

***If we acquire any businesses in the future,they could prove difficult to integrate, disrupt our business or have anadverse effect on our results of operations.***

 

Anyacquisitions that we do make may be difficult to integrate profitably into ourbusiness and may entail numerous risks, including:

 

·                              difficulties in assimilating acquiredoperations, stores or products, including the loss of key employees fromacquired businesses;

 

·                              difficulties and costs associated withintegrating and evaluating the information systems and/or internal controlsystems of acquired businesses;

 

·                              expenses associated with the amortization ofidentifiable intangible assets;

 

·                              problems retaining key technical, operationaland administrative personnel;

 

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

 

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

 

·                              enforcement of intellectual property rightsin some foreign countries;

 

·                              adverse effects on existing businessrelationships with suppliers and customers, including the potential loss ofsuppliers of the acquired businesses;

 

·                              operating inefficiencies and negative impacton profitability;

 

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

 

·                              those related to general economic andpolitical conditions, including legal and other barriers to cross-borderinvestment in general, or by U.S. companies in particular.

 

Inaddition, during the acquisition process, we may fail or be unable to discoversome of the liabilities of businesses that we acquire. These liabilities mayresult from a prior owner’s noncompliance with applicable laws and regulations.Acquired businesses may also not perform as we expect or we may not be able toobtain financial improvements in acquired businesses that we may expect.

 

***If we are unable to profitably open andoperate new stores, our business, financial condition and results of operationsmay be adversely affected.***

 

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 Sally Beauty Supply or BSG store, excluding inventory,average approximately $70,000 and $80,000, respectively. However, we may not beable to open all of the new stores we plan to open and any new stores we openmay not be profitable, either of which could have a material adverse impact onour financial condition or results of operations. There are several factorsthat could affect our ability to open and profitably operate new stores,including:

 

·                              the inability to identify and acquiresuitable sites or to negotiate acceptable leases for such sites;

 

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

 

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

 

·                              the potential inability to obtain adequatefinancing to fund expansion because of our high leverage and limitations onSally Beauty’s ability to issue equity under our credit agreements, among otherthings;

 

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

 

·                              difficulties in obtaining any neededgovernmental and third-party consents, permits and licenses needed to operateadditional stores; and

 

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

 

***A 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.***

 

Ourresults of operations may be materially affected by conditions in the globalcapital markets and the economy generally, both in the U.S. and elsewherearound the world. The stress experienced by global capital markets that beganin the second half of fiscal year 2007 continued and substantially increasedduring the fourth quarter of 2008. Recently, concerns over inflation, energycosts, geopolitical issues, the availability and cost of credit, theU.S. mortgage market and a declining real estate market in the U.S. havecontributed to increased volatility and diminished expectations for theeconomy.  We appeal to a wide demographicconsumer profile and offer a broad selection of beauty products sold directlyto retail consumers and salons and salon professionals. A continued orprotracted downturn 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 full-service business. Factors thatcould affect consumers’ willingness to make such discretionary purchasesinclude general business conditions, levels of employment, interest rates andtax rates, the availability of consumer credit and consumer confidence infuture economic conditions. During an economic downturn, consumer spendinghabits could be adversely affected and we could experience lower than expectednet sales. In addition, a reduction in traffic to, or the closing of, the other destinationretailers in the shopping areas where our stores are located couldsignificantly reduce our sales and leave us with unsold inventory.  The occurrence of these events couldhave a material adverse effect on our business, financial condition and resultsof operations.

 

***We cannot be certain that our ongoing costcontrol plans will continue to be successful.***

 

Ourbusiness strategy depends, to a substantial degree, on continuing to control orreduce operating expenses. In furtherance of this strategy, we have engaged inongoing activities to reduce or control costs. These activities includeright-sizing the BSG business (including some targeted reductions-in-force) andmaximizing the efficiency of our structure, including through theimplementation of a capital spending program in fiscal years 2007 through 2009to consolidate BSG warehouses and reduce administrative expenses related to BSG’sdistribution network optimization program. We cannot be certain that ourefforts will result in the increased profitability, cost savings or otherbenefits that we expect, which could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

***If we are unable to protect ourintellectual property rights, specifically our trademarks, our ability tocompete could be negatively impacted.***

 

Thesuccess of our business depends to a certain extent upon the value associatedwith our intellectual property rights. We own certain trademark and brand namerights used in connection with our business including, but not limited to, “Sally,”“Sally Beauty,” “Sally “Beauty Supply,” “Sally ProCard,” “BSG,” “CosmoProf,” “ArmstrongMcCall,” “ion,” “Salon Services,” “Beauty Club” and “PROCLUB.” We protect ourintellectual property rights through a variety of methods, including trademarkswhich are registered or legally protected in the U.S., Canada and othercountries throughout the world in which our business operates. We also rely ontrade secret laws, in addition to confidentiality agreements with vendors,employees, consultants and others who have access to our proprietaryinformation. While we intend to vigorously protect our trademarks againstinfringement, we may not be successful in doing so. In addition, the laws ofcertain foreign countries may not protect our intellectual property rights tothe same extent as the laws of the U.S. The costs required to protect ourintellectual property rights and trademarks are expected to continue to besubstantial.

 

***Our ability to conduct business ininternational marketplaces may be affected by legal, regulatory and economicrisks.***

 

Ourability to capitalize on growth in new international marketplaces and to growor maintain our current level of operations in our existing internationalmarketplaces is subject to risks associated with our international operations.These risks include: unexpected changes in regulatory requirements; tradebarriers to some international marketplaces; economic and currency fluctuationsin specific marketplaces; potential difficulties in enforcing contracts,protecting assets, including intellectual property, and collecting receivables 

 

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incertain 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 anydisruption in our information technology systems.***

 

Ouroperations are dependent upon our information technology systems, whichencompass all of our major business functions. We rely upon such informationtechnology systems to manage and replenish inventory, to fill and ship customerorders on a timely basis, to coordinate our sales activities across all of ourproducts and services and to coordinate our administrative activities. Asubstantial disruption in our information technology systems for any prolongedtime period (arising from, for example, system capacity limits from unexpectedincreases in our volume of business, outages or delays in our service) couldresult in delays in receiving inventory and supplies or filling customer ordersand adversely affect our customer service and relationships. Our systems mightbe damaged 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, results ofoperations and cash flows.

 

Asour operations grow in both size and scope, we will continuously need toimprove and upgrade our systems and infrastructure while maintaining thereliability and integrity of our systems and infrastructure. The expansion ofour systems and infrastructure will require us to commit substantial financial,operational and technical resources before the volume of our businessincreases, with no assurance that the volume of business will increase. Inparticular, we have upgraded our financial reporting system and are currentlyupgrading our distribution systems (in connection with our capital spendingprogram to consolidate warehouses, as discussed below) and implementing a newpoint-of-sale system for tracking customer sales. These and any other requiredupgrades to our systems and information technology, or new technology, now andin the future, will require that our management and resources be diverted fromour core business to assist in compliance with those requirements. Since asignificant portion of 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.

 

***The occurrence of one or more naturaldisasters or acts of terrorism could adversely affect our operations andfinancial performance.***

 

Theoccurrence of one or more natural disasters or acts of terrorism could resultin physical damage to one or more of our properties, the temporary closure ofstores or distribution centers, the temporary lack of an adequate work force inan area, the temporary or long term disruption in the supply of products (or asubstantial increase in the cost of those products) from some domestic orforeign suppliers, the temporary disruption in the delivery of goods to ourdistribution centers (or a substantial increase in the cost of thosedeliveries), the temporary reduction in the availability of products in ourstores and/or the temporary reduction in visits to stores by customers.

 

Ifone or more natural disasters or acts of terrorism were to impact our business,we could, among other things, incur significantly higher costs and longer leadtimes associated with distributing products to stores. Furthermore, insurancecosts associated with our business may rise significantly in the event of alarge scale natural disaster or act of terrorism.

 

***The accounting and other managementsystems, controls and resources of Sally Beauty, our ultimate parent, may notbe adequately prepared to meet the financial reporting and other requirementsto which Sally Beauty and we are subject.***

 

SallyBeauty, as an independent publicly-traded company, is directly subject toreporting and other obligations under the Exchange Act. In addition, as aresult of the registered exchange offers for our senior notes and our seniorsubordinated notes, which we collectively refer to as the Notes, which wecompleted in July 2007, we are also directly subject to reporting andother obligations under the Exchange Act. These reporting and other obligationsplace significant demands on the management and administrative and operationalresources, including accounting resources, of Sally Beauty, us and oursubsidiaries. As reporting companies, we and Sally Beauty incur significantlegal, accounting, and other expenses. Under the SEC rules andregulations, as well as those of the New York Stock Exchange, we and SallyBeauty have significant compliance costs.

 

Inaddition, as reporting companies Sally Beauty and the Company are subject to rules adoptedby the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002,which require us to include in our Annual Report on Form 10-K ourmanagement’s report on, and assessment of, the effectiveness of our internalcontrols over financial reporting. In addition, our independent registeredpublic accounting firm must attest to and report on the effectiveness of suchinternal controls. If we fail to properly assess and/or achieve and 

 

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maintainthe adequacy of our internal controls, there is a risk that we will not complywith all of the requirements imposed by Section 404. Moreover, effectiveinternal controls are necessary to help prevent financial fraud. Any of thesepossible outcomes could result in an adverse reaction in the financialmarketplace due to a loss of investor confidence in the reliability of ourfinancial statements, which ultimately could harm our business and couldnegatively impact the market price of our debt instruments.

 

Tocomply with these requirements, Sally Beauty, we and our subsidiaries arecontinuously upgrading our systems, including our information technologysystems, and are implementing additional financial and management controls,reporting systems and procedures. In particular, during fiscal year 2008 weupgraded our financial reporting system. These and any other required upgradesto our financial and management controls, reporting systems, informationtechnology and procedures under the financial reporting requirements and other rules thatapply to reporting companies, now and in the future, will require that ourmanagement and resources be diverted from our core business to assist incompliance with those requirements. 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 upgrades, or the impact on the reliabilityof our data from these upgrades will not have a material adverse effect on ourbusiness, financial condition or results of operations.

 

***We are a holding company, with nooperations of our own, and we depend on our subsidiaries for cash.***

 

Weare a holding company and do not have any material assets or operations otherthan ownership of equity interests of our subsidiaries. Our operations areconducted almost entirely through our subsidiaries, and our ability to generatecash to meet our obligations or to pay dividends to Sally Beauty is highlydependent on the earnings of, and receipt of funds from, our subsidiariesthrough dividends or intercompany loans. The ability of our subsidiaries togenerate sufficient cash flow from operations to allow us and them to makescheduled payments on our obligations will depend on their future financialperformance, which will be affected by a range of economic, competitive andbusiness factors, many of which are outside of our control. We cannot assureyou that the cash flow and earnings of our operating subsidiaries will beadequate for our subsidiaries to service our and their debt obligations.   If our subsidiaries do not generatesufficient cash flow from operations to satisfy their obligations we may haveto undertake alternative financing plans, such as refinancing or restructuringour and their debt, selling assets, reducing or delaying capital investments orseeking to raise additional capital. We cannot assure you that any suchalternative refinancing would be possible, that any assets could be sold, or,if sold, of the timing of the sales and the amount of proceeds realized fromthose sales, that additional financing could be obtained on acceptable terms,if at all, or that additional financing would be permitted under the terms ofour various debt instruments then in effect. Our inability to generatesufficient cash flow to satisfy our obligations, or to refinance ourobligations on commercially reasonable terms, would have an adverse effect onour business, financial condition and results of operations.

 

Furthermore,we and our subsidiaries may be able to incur substantial additionalindebtedness in the future that may severely restrict or prohibit oursubsidiaries from making distributions, paying dividends or making loans to us.

 

**Risks Relating to Our Substantial Indebtedness**

 

***We have substantial debt and may incursubstantial additional debt, which could adversely affect our financial health,our ability to obtain financing in the future and our ability to react tochanges in our business.***

 

Inconnection with the Separation Transactions, together with certain of oursubsidiaries, we incurred approximately $1,850.0 million in debt. As of September 30,2008, we had an aggregate principal amount of approximately $1,825.3 million,including capital lease obligations, of outstanding debt, and a total debt toequity ratio of -2.53:1.00.

 

Oursubstantial debt could have important consequences to you. For example, itcould:

 

·                              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 additionalfinancing or raise even a small amount of equity capital for working capital,capital expenditures, acquisitions, debt service requirements or generalcorporate purposes;

 

·                              require us to dedicate a substantial portionof our cash flow from operations to the payment of principal and interest onour indebtedness, thereby reducing the availability of such cash flows to fundworking capital, capital expenditures and other general corporate purposes;

 

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·                              restrict the ability of our subsidiaries topay dividends or otherwise transfer assets to us, which could limit our abilityto make required payments on our debt facilities;

 

·                              increase our vulnerability to general adverseeconomic and industry conditions, including interest rate fluctuations becausea portion of our borrowings are at variable rates of interest, includingborrowings under our senior secured term loan facilities and our asset-backedsenior secured loan facility, which we refer to collectively as the seniorsecured credit facilities;

 

·                              place us at a competitive disadvantagecompared to our competitors with proportionately less debt or comparable debtat more favorable interest rates and that, as a result, may be betterpositioned to withstand economic downturns;

 

·                              limit our ability to refinance indebtednessor cause the associated costs of such refinancing to increase; and

 

·                              limit our flexibility to adjust to changingmarket conditions and ability to withstand competitive pressures, or prevent usfrom carrying out capital spending that is necessary or important to our growthstrategy and efforts to improve operating margins or our business.

 

Anyof the foregoing impacts of our substantial indebtedness could have a materialadverse effect on our business, financial condition and results of operations.

 

***Despite our current indebtedness levels, weand our subsidiaries may be able to incur substantially more debt, includingsecured debt, which could further exacerbate the risks associated with oursubstantial indebtedness.***

 

Weand our subsidiaries may incur substantial additional indebtedness in thefuture. The terms of the instruments governing our indebtedness do not fullyprohibit us or our subsidiaries from doing so. As of September 30, 2008,our senior credit facilities provided us commitments for additional borrowingsof up to approximately $276.4 million under the asset-backed seniorsecured loan, or ABL, facility, subject to borrowing base limitations. If newdebt is added to our current debt levels, the related risks that we now facewould increase and we may not be able to meet all our debt obligations. Inaddition, the agreements governing our senior credit facilities as well as theindentures governing our senior notes and senior subordinated notes, which werefer to collectively as the Notes, do not prevent us from incurringobligations that do not constitute indebtedness.

 

***The agreements and instruments governingour debt contain restrictions and limitations that could significantly impactour ability to operate our business.***

 

Thesenior secured term loan 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 make otherdistributions;

 

·             make voluntary prepayments on the Notes ormake amendments to the terms thereof;

 

·             prepay certain other debt or amend specificdebt agreements;

 

·             create liens on assets;

 

·             make investments (including joint ventures);

 

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

 

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

 

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·             engage in certain transactions withaffiliates; and

 

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

 

TheABL facility contains covenants that, among other things, restrict our and oursubsidiaries’ ability to:

 

·                              change our line of business;

 

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

 

·                              make certain dividends, stock repurchases andother distributions;

 

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

 

·                              dispose of certain assets;

 

·                              make voluntary prepayments on the Notes ormake amendments to the terms thereof;

 

·                              prepay certain other debt or amend specificdebt agreements;

 

·                              change the fiscal year of us or our directparent; and

 

·                              create or incur negative pledges.

 

TheTerm Loans contain a requirement that we not exceed a maximum ratio of netsenior secured debt to consolidated EBITDA (as those terms are defined in therelevant credit agreement). In addition, if we fail to maintain a specifiedminimum level of borrowing capacity under the ABL facility, we will then beobligated to maintain a specified fixed-charge coverage ratio. Our ability to complywith these 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.

 

Theindentures governing the Notes also contain restrictive covenants that, amongother things, limit Sally Beauty’s and our ability and the ability of ourrestricted subsidiaries to:

 

·                              dispose of assets;

 

·                              incur additional indebtedness (includingguarantees of additional indebtedness);

 

·                              pay dividends, repurchase stock or make otherdistributions;

 

·                              prepay subordinated debt;

 

·                              create liens on assets (which, in the case ofthe senior subordinated notes, would be limited in applicability to lienssecuring *pari passu* orsubordinated indebtedness);

 

·                              make investments (including joint ventures);

 

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

 

·                              engage in certain transactions withaffiliates; and

 

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

 

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Therestrictions in the indentures governing our Notes and the terms of our seniorcredit facilities may prevent us from taking actions that we believe would be inthe best interest of our business, and may make it difficult for us tosuccessfully execute our business strategy or effectively compete withcompanies that are not similarly restricted. We may also incur future debtobligations that might subject us to additional restrictive covenants thatcould affect our financial and operational flexibility. We cannot assure youthat we will be granted waivers or amendments to these agreements if for anyreason we are unable to comply with these agreements, or that we will be ableto refinance our debt on terms acceptable to us, or at all.

 

Ourability to comply with the covenants and restrictions contained in the seniorcredit facilities and the indentures for the Notes may be affected by economic,financial and industry conditions beyond our control. The breach of any ofthese covenants or restrictions could result in a default under either thesenior credit facilities or the indentures that would permit the applicablelenders or note holders, as the case may be, to declare all amounts outstandingthereunder to be due and payable, together with accrued and unpaid interest. Ifwe are unable to repay debt, lenders having secured obligations, such as thelenders under the senior credit facilities, could proceed against thecollateral securing the debt. In any such case, we may be unable to borrowunder the senior credit facilities and may not be able to repay the amounts dueunder the Term Loans and the Notes. This could have serious consequences to ourfinancial condition and results of operations and could cause us to becomebankrupt or insolvent.

 

***Our ability to generate the significantamount of cash needed to service all of our debt and our ability to refinanceall or a portion of our indebtedness or obtain additional financing depend onmany factors beyond our control.***

 

Ourability to make scheduled payments on, or to refinance our obligations under,our debt will depend on our financial and operating performance, which, inturn, will be subject to prevailing economic and competitive conditions and tothe financial and business factors, many of which may be beyond our control,described under “—Risks Relating to Our Business” above.

 

Ifour cash flow and capital resources are insufficient to fund our debt serviceobligations, we may be forced to reduce or delay capital expenditures, sellassets, seek to obtain additional equity capital or restructure our debt. Inthe future, our cash flow and capital resources may not be sufficient forpayments of interest on and principal of our debt, and such alternativemeasures may not be successful and may not permit us to meet our scheduled debtservice obligations.

 

Wecannot assure you that we will be able to refinance any of our indebtedness orobtain additional financing, particularly because of our high levels of debtand the debt incurrence restrictions imposed by the agreements governing ourdebt, as well as prevailing market conditions. In the absence of such operatingresults and resources, we could face substantial liquidity problems and mightbe required to dispose of material assets or operations to meet our debtservice and other obligations. Our senior credit facilities and the indenturesgoverning the Notes restrict our ability to dispose of assets and use theproceeds from any such dispositions. We cannot assure you we will be able toconsummate those sales, or if we do, what the timing of the sales will be orwhether the proceeds that we realize will be adequate to meet debt serviceobligations when due.

 

***You should not expect Sally Capital to participate in making paymentson the Notes.***

 

SallyCapital is our wholly-owned subsidiary, which acts as a co-issuer solely tofacilitate the issuance of the Notes. Sally Capital does not have any operations or assets of any kind and didnot receive any proceeds from the issuance of the Notes.  You should not expect Sally Capital toparticipate in servicing any of our obligations in the Notes.

 

***An increase in interest rates wouldincrease the cost of servicing our debt and could reduce our profitability.***

 

Asignificant portion of our outstanding debt, including under our senior creditfacilities, bears interest at variable rates. As a result, an increase ininterest rates, whether because of an increase in market interest rates or adecrease in our creditworthiness, would increase the cost of servicing our debtand could materially reduce our profitability and cash flows. The impact ofsuch an increase would be more significant for us than it would be for someother companies because of our substantial debt.

 

***A decrease in interest rates would increaseour interest expense (due to one of our interest rate swaps) and could reduceour profitability.***

 

Infiscal year 2007, we entered into four interest rate swap agreements, which werefer to as the “2007 Swap Agreements,” with an aggregate notional amount of$500.0 million. These 2007 Swap Agreements relate to $500.0 millionof the $1,070.0 million Term Loans A and B due in fiscal years 2013 and2014, respectively, to manage our risk associated with changing interest rates.Please see Note 12 of the “Notes to Consolidated Financial Statements” in “Item8—Financial Statements and Supplementary Data” of this Annual Report and “Item7A—Quantitative & Qualitative Disclosure About Market Risk—Interestrate risk” for a discussion of 

 

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interestrate swap agreements. We utilize interest rate swaps to manage our financialrisk associated with changing interest rates and account for them underStatement of Financial Accounting Standards, or SFAS, No. 133, *Accounting for Derivative Instruments and HedgingActivities*, as amended, or SFAS 133. SFAS 133 requiresthat all derivatives be marked to market (fair value). While we do have otherinterest rate swap agreements which do qualify as hedges, the 2007 SwapAgreements do not qualify as hedges and therefore, the change in fair value ofthe interest rate swap agreements, which are adjusted quarterly, are recordedin net interest expense in the consolidated statements of earnings. The markedto market impact of the 2007 Swap Agreements on interest expense was anincrease of approximately $4.6 million for fiscal year 2008. Our 2007 SwapAgreements with a notional amount of $150 million expire in November of2008.  Future changes in the fair valueof the remaining swap agreement will continue to increase or decrease ourinterest expense and could have the potential to affect our profitability.

 

***The Impairment of Other Financial Institutions Could Adversely AffectUs***

 

We have exposure todifferent counterparties with regard to our interest rate swaps. Thesetransactions expose us to credit risk in the event of default of ourcounterparty. We also have exposure to financial institutions used asdepositories of our corporate cash balances. If our counterparties and financial institutions become impaired orinsolvent, this could have serious consequences to our financial condition andresults of operations.

 

**Risks Relating to Our Separation from Alberto-Culver andRelating to Sally Beauty’s Largest Stockholder**

 

***Our historical consolidated financialinformation contained in this Annual Report does not represent our futurefinancial position, results of operations or cash flows nor does it reflectwhat our financial position, results of operations or cash flows would havebeen as a separate reporting company during the periods presented.***

 

Ourhistorical consolidated financial information for the periods prior to theSeparation Transactions included in this Annual Report is not representative ofour future financial position, results of operations or cash flows nor does itreflect what our financial position, results of operations or cash flows wouldhave been as a separate reporting company independent from Alberto-Culverduring the periods presented. This is primarily because:

 

·                              Our historical consolidated financialinformation for the periods prior to the Separation Transactions reflectsallocation of expenses from Alberto-Culver. Those allocations may be differentfrom the comparable expenses we would have incurred as a separate company.

 

·                              Our working capital requirements for theperiods prior to the Separation Transactions historically were satisfied aspart of Alberto-Culver’s corporate-wide cash management policies. In connectionwith the Separation Transactions, we incurred a large amount of indebtednessand assumed significant debt service costs. As a result, our cost of debt andcapitalization are significantly different from that reflected in ourhistorical consolidated financial information for periods prior to theSeparation Transactions.

 

·                              As a result of the Separation Transactions,there have been significant changes in our cost structure, including the costsof establishing an appropriate accounting and reporting system, debt serviceobligations and other costs of being a stand-alone company.

 

***Sally Beauty and we rely uponAlberto-Culver for the accuracy of certain historical services and information.***

 

Weoften rely upon Alberto-Culver for the accuracy and/or completeness of certainhistorical services and information provided to us when we were part of thatcompany. For example, as the successor entity to Alberto-Culver after theseparation, Sally Beauty and we rely upon the prior-year federal income taxreturns of Alberto-Culver, and accounting methods established therein, forcertain calculations that affect our U.S. federal income tax liability. We alsorely upon Alberto-Culver for historical information related to our insuranceprograms and other benefits. There can be no assurance that our reliance uponthe accuracy or completeness of historical information or services previouslyprovided by them will not have an adverse impact on our business, financialcondition and results of operations.

 

***If the share distribution of Alberto-Culvercommon stock in the transactions separating us from Alberto-Culver did notconstitute a tax-free distribution under Section 355 of the InternalRevenue Code of 1986, as amended, or the Code, or if Sally Beauty became liablefor additional taxes owed by Alberto-Culver, then we may be responsible forpayment of significant U.S. federal income taxes.***

 

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Thefollowing discussion describes the risk that the share distribution ofAlberto-Culver common stock in the Separation Transactions may have triggeredsignificant tax liabilities for Sally Beauty, our ultimate parent company,which could result in a material adverse effect on us.  Since we have been a member of Sally Beauty’sconsolidated group of companies for U.S. federal income tax purposes andcertain state tax purposes during the taxable year of the share distribution ofAlberto-Culver common stock, we (and other Sally Beauty subsidiaries that werealso members of such group) will generally be liable for the income taxliability of Sally Beauty’s consolidated group of companies for that taxyear.  Therefore, if Sally Beauty incurssignificant income tax liability as a result of the share distribution ofAlberto-Culver common stock and is unable to pay these taxes, we could beliable 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.

 

Ifthe Alberto-Culver share distribution were not to qualify as a tax-freedistribution under Section 355 of the Code, Sally Beauty would recognizetaxable gain equal to the excess of the fair market value of the Alberto-Culvercommon stock distributed to its stockholders over Sally Beauty’s tax basis inthe Alberto-Culver common stock.

 

Evenif the Alberto-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 is an acquisitionof its stock or stock of Alberto-Culver as part of a plan or series of relatedtransactions that includes the Alberto-Culver share distribution and thatresults in an acquisition of 50% or more of Alberto-Culver’s or Sally Beauty’soutstanding common stock.

 

Inthe event that Sally Beauty recognizes a taxable gain in connection with theAlberto-Culver share distribution (either (i) because the Alberto-Culvershare distribution did not qualify as a tax-free distribution under Section 355of the Code or (ii) because of an acquisition by CDR Investors of 50% ormore of Alberto-Culver or Sally Beauty’s outstanding common stock as part of aplan or series of related transactions that includes the Alberto-Culver sharedistribution), the taxable gain recognized by Sally Beauty would result insignificant U.S. federal income tax liabilities to Sally Beauty. Under theCode, Sally Beauty would be jointly and severally liable for these taxes forwhich Alberto-Culver may be required to indemnify Sally Beauty under their taxallocation agreement, and there can be no assurance that Alberto-Culver wouldbe able to fulfill its obligations under the tax allocation agreement ifAlberto-Culver was determined to be responsible for these taxes thereunder.

 

Forpurposes of determining whether the distribution of Alberto-Culver common stockto Sally Beauty’s stockholders in connection with the Alberto-Culver sharedistribution is disqualified as tax-free to Sally Beauty under the rules describedin the second preceding paragraph, any acquisitions by CDR Investors of SallyBeauty’s stock or the stock of Alberto-Culver within two years before or afterthe Alberto-Culver share distribution are presumed to be part of a plan, althoughthe parties may be able to rebut that presumption. For purposes of this test,the acquisition by CDR Investors of 48% of Sally Beauty’s outstanding commonstock on an undiluted basis that occurred in connection with the SeparationTransactions will be treated as part of such a plan or series of transactions.Thus, a relatively minor additional change in the ownership of Sally Beauty’scommon stock could trigger a significant tax liability for Sally Beauty under Section 355of the Code.

 

Theprocess for determining whether a prohibited change in control has occurredunder the rules is complex, inherently factual and subject tointerpretation of the facts and circumstances of a particular case. IfAlberto-Culver does not carefully monitor its, or Sally Beauty does notcarefully monitor its compliance with these rules, this might inadvertentlycause or permit a prohibited change in the ownership of Sally Beauty or ofAlberto-Culver to occur, thereby triggering Alberto-Culver’s or Sally Beauty’srespective obligations to indemnify the other pursuant to the tax allocationagreement, which would have a material adverse effect on Sally Beauty, usand/or Alberto-Culver.

 

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Asthe successor entity to Alberto-Culver after the separation, Sally Beautyrelies upon the prior-year federal income tax returns of Alberto-Culver, andaccounting methods established therein, for certain calculations that affectSally Beauty’s current U.S. federal income tax liability.

 

Ifany of the above events occur, Sally Beauty will be jointly and severallyliable for these taxes, and there can be no assurance that Alberto-Culver wouldbe able to fulfill its indemnification obligations to Sally Beauty under thetax allocation 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 familystockholders or by the CDR Investors could adversely affect the tax-free natureof the share distribution of Alberto-Culver common stock in connection with thetransactions separating us from Alberto-Culver.***

 

Salesand/or acquisitions by the Lavin family stockholders of Sally Beauty’s commonstock or Alberto-Culver’s common stock may adversely affect the tax-free natureof the share 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 were found tohave an intent to effect such sale at the time of the share distribution. Ifthe IRS successfully asserted that the share distribution was used principallyas such a device, the share distribution would not qualify as a tax-freedistribution, and thus would be taxable to Sally Beauty. Second, with certainexceptions, if any of the Lavin family stockholders had sold an amount of SallyBeauty’s common stock that it received in connection with the SeparationTransactions (or acquired additional shares of Sally Beauty’s common stock)within the two year period following completion of the Alberto-Culver sharedistribution, and that amount of stock, if added to the common stock comprisingapproximately 48% of Sally Beauty’s outstanding common stock on an undilutedbasis that was acquired by CDR Investors were to equal or exceed 50% of SallyBeauty’s outstanding common stock, as determined under the Code and applicableTreasury regulations, a deemed acquisition of control of Sally Beauty inconnection with the Alberto-Culver share distribution would be presumed. Ifthis presumption were not rebutted, Sally Beauty would be subject tosignificant U.S. federal income tax liabilities, which, if not reimbursed byAlberto-Culver, would have a material adverse effect on us.

 

***The voting power of Sally Beauty’s largeststockholder may discourage third party acquisitions of Sally Beauty at apremium.***

 

CDRS,Sally Beauty’s largest stockholder, owns approximately 48% of its outstandingcommon stock on an undiluted basis. Pursuant to the stockholders agreemententered into by Sally Beauty, the CDR Investors and the Lavin family stockholders,which we refer to as the Stockholders Agreement, CDRS has designated five ofSally Beauty’s initial eleven directors, as well as the Chairman of SallyBeauty’s Board of Directors, and CDRS’ rights to nominate certain numbers ofdirectors will continue so long as it owns specified percentages of SallyBeauty’s common stock. The CDR Investors’ ownership of approximately 48% ofSally Beauty’s common stock and their rights to nominate directors of SallyBeauty may have the effect of discouraging offers to acquire control of SallyBeauty and may preclude holders of its common stock from receiving any premiumabove market price for their shares that may otherwise be offered in connectionwith any attempt to acquire control of Sally Beauty.

 

***The interests of Sally Beauty’s largeststockholder may differ from the interests of other holders of its common stock.***

 

CDRS, Sally Beauty’s largest stockholder, ownsapproximately 48% of its outstanding common stock on an undiluted basis.Pursuant to the Stockholders Agreement, CDRS has designated five of Sally’sBeauty’s initial eleven directors and CDRS’ rights to nominate certain numbersof directors will continue so long as it owns specified percentages of SallyBeauty’s common stock, as discussed above. In addition, the current Chairman ofSally Beauty’s Board of Directors is affiliated with CDRS. The interests ofCDRS may differ from those of other holders of Sally Beauty’s common stock inmaterial respects. 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 us and/or to the other holders of Sally Beauty’s common stock.

 

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# **ITEM 1B.UNRESOLVED STAFF COMMENTS**

# ** **

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 with customaryrenewal options. The following table provides the number of stores in the U.S.and globally, as of September 30, 2008:

 
| ** **                            | ** ** | **Sally Beauty Supply** | ** ** | **Beauty Systems Group** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| **Location**                          | ** ** | **Company-Operated**              | ** ** | **Franchise**                      | ** ** | **Company-Operated** | ** ** | **Franchise** | ** ** |
| United States (excluding Puerto Rico) |       | 2,314                             |       | —                             |       | 672 |   | 140 |   |
| Puerto Rico                           |       | 34                                |       | —                             |       | — |   | — |   |
| International:                        |       |                              |       |                               |       |   |   |   |   |
| United Kingdom                        |       | 262                               |       | 7                                  |       | — |   | — |   |
| Belgium                               |       | 23                                |       | 4                                  |       | — |   | — |   |
| Canada                                |       | 27                                |       | —                             |       | 88 |   | — |   |
| France                                |       | 13                                |       | —                             |       | — |   | — |   |
| Germany                               |       | 31                                |       | —                             |       | — |   | — |   |
| Ireland                               |       | 8                                 |       | 11                                 |       | — |   | — |   |
| Japan                                 |       | 24                                |       | —                             |       | — |   | — |   |
| Mexico                                |       | 82                                |       | —                             |       | — |   | 29 |   |
| Spain                                 |       | 2                                 |       | 2                                  |       | — |   | — |   |
| Total International                   |       | 472                               |       | 24                                 |       | 88 |   | 29 |   |
| Total Store Count                     |       | 2,820                             |       | 24                                 |       | 760 |   | 169 |   |

 

The following table provides locations for oursignificant offices and warehouses and corporate headquarters, as of September 30,2008:

** **
| **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            |       |      (1)(2) |
| Jacksonville, Florida          |       | Warehouse                      |       | 237,000           |       | (1)                                  |
| Reno, Nevada                   |       | Warehouse                      |       | 253,000           |       | (1)                                  |
| Leased  Properties:            |       |                           |       |              |       |                                 |
| Benicia, California            |       | Office,  Warehouse             |       | 187,000           |       | (2)                                  |
| Blackburn, Lancashire, England |       | Warehouse                      |       | 107,000           |       | (1)                                  |
| Thornliebank, Scotland         |       | Office,  Warehouse             |       | 94,000            |       | (1)                                  |
| Gent, Belgium                  |       | Office,  Warehouse             |       | 83,000            |       | (1)                                  |
| Calgary, Alberta, Canada       |       | Warehouse                      |       | 62,000            |       | (2)                                  |
| Greenville, Ohio               |       | Office,  Warehouse             |       | 246,000           |       | (2)                                  |
| Clackamas, Oregon              |       | Warehouse                      |       | 104,000           |       | (2)                                  |
| Fresno, California             |       | Warehouse                      |       | 200,000           |       | (2)                                  |
| Mississauga, Ontario, Canada   |       | Office,  Warehouse             |       | 60,000            |       | (2)                                  |
| Spartanburg, South Carolina    |       | Warehouse                      |       | 100,000           |       | (2)                                  |
| Guadalupe, Nuevo Leon, Mexico  |       | Warehouse                      |       | 40,000            |       | (1)                                  |

 

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| (1)    |   | Sally  Beauty Supply |
|--------|--------|----------------------|
|   |   |                 |
| (2)    |   | BSG                  |

 

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# **ITEM 3.LEGAL PROCEEDINGS**

# ** **

There were no material legal proceedings pendingagainst us or our subsidiaries, as of September 30, 2008. 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 market in which we do business. These laws and regulations govern,among other things, the composition, packaging, labeling and safety of theproducts we sell, the methods we use to sell these products and the methods weuse to import these products.  We believethat we are in material compliance with such laws and regulations, although noassurance can be provided that this will remain true going forward.

 

## **OnFebruary 25, 2008, Sally Beauty disclosed in a Current Report on Form 8-Kthat 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.  The suit also alleged, among other issues, that SD Hairinduced AMLP to breach its agreement to distribute Matrix branded products (the“Matrix Agreement”) in some unspecified manner.**  L’Oreal’s complaint against SD Hair was subsequently amended to deletethe reference to AMLP’s breach of the Matrix Agreement as one of the specificcontractual relationships that SD Hair allegedly induced and caused to bebreached.  However, the amended complaintdoes not designate which distributors are at issue, and L’Oreal has not statedon the record whether it continues to allege that SD Hair induced and causedAMLP to breach the Matrix Agreement.  Asof November 10, 2008, neither we nor any of our subsidiaries (including AMLP)were a defendant in the lawsuit filed by L’Oreal.   On March 24,2008, however, SD Hair filed a cross-complaint in the same case naming AMLP andBSG as cross-defendants, seeking, among other things, i) declaratory relieffrom BSG and AMLP in the form of a judicial finding thatSD Hair is not in breach of its franchiseagreement and that L’Oreal has no rights as a third-party beneficiary to SDHair’s franchise agreement, and ii) injunctive relief in the form of a judicialorder compelling AMLP and BSG to take appropriate legal action against L’Orealto enforce SD Hair’s claimed rights under AMLP’s Matrix distributionagreement.  We have answered the cross-complaint. No monetary relief isbeing sought by SD Hair.

##  

# **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 Holding LLC.  Sally InvestmentHoldings LLC, a wholly-owned subsidiary of Sally Beauty Holdings, Inc.,owns all of the member units of Sally Holdings LLC.**

##  

We do not expect to pay dividends for the foreseeablefuture.  The agreements governing ourindebtedness restrict our ability to pay dividends.   Please see “Risk Factors – Risks Relating toOur Substantial Indebtedness” and Note 11 of the “Notes to ConsolidatedFinancial Statements” in “Item 8 - Financial Statements and Supplementary Data.”

 

In connection with the Separation Transactions, wepaid a cash distribution in the aggregate amount of $1,809.7 million to ourindirect parent, Sally Beauty Holdings, Inc.

 

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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 30,2008 and 2007, and of Sally Holdings, Inc. and its consolidatedsubsidiaries for the years ended September 30, 2006, 2005 and 2004 (inthousands, except per share data). Sally Holdings, Inc. was a wholly ownedsubsidiary of Alberto-Culver until November 16, 2006 when it was convertedto a Delaware limited liability company, was renamed “Sally Holdings LLC,” andbecame an indirect wholly owned subsidiary of Sally Beauty in connection withthe Separation Transactions.

 
| ** **                                                                                   | ** ** | **Year Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Results of operations information:**                                                       |       |                                        |       |   |   |   |   |   |   |   |   |
| Net sales                                                                                    |       | $                                           | 2,648,191  |   | $ | 2,513,772 |   | $ | 2,373,100 |   | $ | 2,254,307 |   | $ | 2,097,667 |   |
| Cost of products sold and distribution  expenses                                             |       | 1,413,597                                   |       | 1,360,025 |   | 1,286,329 |   | 1,227,307 |   | 1,146,814 |   |
| Gross profit                                                                                 |       | 1,234,594                                   |       | 1,153,747 |   | 1,086,771 |   | 1,027,000 |   | 950,853 |   |
| Selling, general and administrative  expenses(a)                                             |       | 895,632                                     |       | 850,159 |   | 798,211 |   | 768,847 |   | 703,528 |   |
| Depreciation and amortization                                                                |       | 48,533                                      |       | 42,605 |   | 38,032 |   | 33,906 |   | 24,619 |   |
| Sales-based service fee charged by  Alberto-Culver                                           |       | —                                      |       | 3,779 |   | 28,852 |   | 27,615 |   | 26,051 |   |
| Non-cash charge related to Alberto-Culver’s  conversion to one class of common stock(b) |       | —                                      |       | — |   | — |   | 4,051 |   | 27,036 |   |
| Transaction expenses(c)                                                                      |       | —                                      |       | 21,502 |   | 41,475 |   | — |   | — |   |
| Operating earnings                                                                           |       | 290,429                                     |       | 235,702 |   | 180,201 |   | 192,581 |   | 169,619 |   |
| Interest expense, net(d)                                                                     |       | 158,897                                     |       | 145,972 |   | 92 |   | 2,966 |   | 2,250 |   |
| Earnings before provision for income taxes                                                   |       | 131,532                                     |       | 89,730 |   | 180,109 |   | 189,615 |   | 167,369 |   |
| Provision for income taxes                                                                   |       | 48,664                                      |       | 41,169 |   | 69,916 |   | 73,154 |   | 62,059 |   |
| Net earnings                                                                                 |       | $                                           | 82,868     |   | $ | 48,561 |   | $ | 110,193 |   | $ | 116,461 |   | $ | 105,310 |   |
| ** **                                                                                   |       |                                        |       |   |   |   |   |   |   |   |   |
| **Operating data:**                                                                          |       |                                        |       |   |   |   |   |   |   |   |   |
| Number of retail stores (end of period):                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Sally Beauty Supply                                                                          |       | 2,844                                       |       | 2,694 |   | 2,511 |   | 2,419 |   | 2,355 |   |
| Beauty Systems Group                                                                         |       | 929                                         |       | 874 |   | 828 |   | 822 |   | 692 |   |
| Total                                                                                        |       | 3,773                                       |       | 3,568 |   | 3,339 |   | 3,241 |   | 3,047 |   |
| Professional distributor sales consultants  (end of period)                                  |       | 1,071                                       |       | 1,067 |   | 1,192 |   | 1,244 |   | 1,167 |   |
| Same store sales growth(e):                                                                  |       |                                        |       |   |   |   |   |   |   |   |   |
| Sally Beauty Supply                                                                          |       | 1.2                                         | %          | 2.7 | % | 2.4 | % | 2.4 | % | 3.8 | % |
| Beauty Systems Group                                                                         |       | 6.9                                         | %          | 10.1 | % | 4.1 | % | (0.6 | )% | 8.5 | % |
| Consolidated                                                                                 |       | 2.6                                         | %          | 4.5 | % | 2.8 | % | 1.8 | % | 4.6 | % |
| **Financial condition information (at period  end):**                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Working capital                                                                              |       | $                                           | 348,560    |   | $ | 341,891 |   | $ | 479,107 |   | $ | 382,482 |   | $ | 377,708 |   |
| Cash, cash equivalents and short-term  Investments                                           |       | 99,788                                      |       | 38,272 |   | 107,571 |   | 38,612 |   | 68,003 |   |
| Property, plant and equipment, net                                                           |       | 156,260                                     |       | 154,068 |   | 142,735 |   | 149,354 |   | 125,810 |   |
| Total assets                                                                                 |       | 1,525,658                                   |       | 1,404,261 |   | 1,338,841 |   | 1,225,507 |   | 1,102,428 |   |
| Long-term debt, including notes payable to  affiliated companies                             |       | 1,724,684                                   |       | 1,758,594 |   | 621 |   | 18,828 |   | 34,872 |   |
| Member’s/Stockholder’s (deficit) equity                                            |       | $                                           | (722,280   | ) | $ | (780,317 | ) | $ | 1,005,967 |   | $ | 900,296 |   | $ | 786,163 |   |

 

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| (a)    | We adopted SFAS No. 123(R), *Share-Based  Payment*, or SFAS 123(R), using the modified prospective method,  effective October 1, 2005. Fiscal years 2008, 2007 and 2006 include  share-based compensation of $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 years 2005 and 2004  include 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 an agreement with Regis. Please see Note 3  of the “Notes to Consolidated Financial Statements” in “Item 8—Financial  Statements and Supplementary Data.” |

 

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| (d)    | Interest expense after November 16, 2006 is primarily  attributable to the debt incurred in connection with the Separation  Transactions. 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. Sally Beauty  Supply has begun selling some products through the internet during the past  year. Internet sales for fiscal year 2008 were not significant and are not  included in same store sales growth. |

 

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 Sally HoldingsLLC, 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, 2008 and 2007. 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. The results of operationsand cash flows for the fiscal year ended September 30, 2006 are of SallyHoldings, Inc. 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 Capital, a Delaware corporation, is awholly-owned subsidiary of Sally Holdings and does not have any assets oroperations of any kind. This section should be read in conjunction with theaudited consolidated financial statements of Sally Holdings, and for periodsprior to the Separation Transactions, the audited consolidated financialstatements of Sally Holdings, Inc., and the related notes includedelsewhere in this Annual Report. This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contains forward-lookingstatements. Please see “Cautionary Notice Regarding Forward-Looking Statements”for a discussion of the uncertainties, risks and assumptions associated withthese forward-looking statements that could cause results to differ materiallyfrom those reflected in such forward-looking statements.

 

## **Highlightsof the Fiscal Year Ended September 30, 2008**

##  

·                  Our net sales for the fiscal year ended September 30,2008 increased $134.4 million, or 5.3%, to $2,648.2 million compared to thefiscal year ended September 30, 2007;

 

·                  Our same store sales increased 2.6% for thefiscal year ended September 30, 2008 and contributed $51.5 million or2.0%, to the net sales increase. This increase includes the anticipated lowersales of L’Oreal brand products in the first four months of fiscal year 2008,resulting from the changes in the L’Oreal distribution agreement as reported infiscal year 2007;

 

·                  Our consolidated gross profit for the fiscalyear ended September 30, 2008 increased 7.0% to $1,234.6 million comparedto $1,153.7 million for the fiscal year ended September 30, 2007. As apercentage of net sales, gross profit was 46.6% for the fiscal year ended September 30,2008 compared to 45.9% for the fiscal year ended September 30, 2007;

 

·                  Our consolidated operating earnings for thefiscal year ended September 30, 2008 increased $54.7 million, or 23.2%, to$290.4 million compared to $235.7 million for the fiscal year ended September 30,2007. As a percentage of net sales, operating earnings were 11.0% for thefiscal year ended September 30, 2008 compared to 9.4% for the fiscal yearended September 30, 2007;

 

·                  Sally Beauty Supply and BSG opened 110 and 44 net new stores,respectively, in the fiscal year ended September 30, 2008;

 

·                  In May 2008, we acquired Pro-Duo, N.V. (“Pro-Duo”),a 40-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. We financed this acquisitionsubstantially through borrowings under our ABL facility which we repaid duringfiscal year 2008.  We also assumed €3.0million (approximately $4.7 million) of debt from Pro-Duo in connection withthe acquisition;

 

·                  During fiscal year 2008, we completed severalother acquisitions within our BSG business unit including: (a) theacquisition of certain assets and the distribution rights in four states fromtwo distributors of Goldwell/KMS products which we now distribute in 12additional states; (b) the acquisition of certain assets and thedistribution rights in California, Arizona and southern Nevada from adistributor of Joico and ISO products and (c) the acquisition of certainassets and distribution rights in a territory consisting of the entire state ofTexas from two distributors of Paul Mitchell products;

 

·                  We are in the process of completing our2-year program to consolidate warehouses and reduce administrative expenses ofthe BSG segment and anticipate completion of the program in the first half offiscal year 2009; and

 

·                  On September 18, 2008, we borrowed $75.0million under our existing $400 million revolving credit facility to increaseour cash position in order to preserve our financial flexibility in light ofthe recent dislocation of the financial markets.  We currently intend torepay these funds as economic conditions allow in the next twelve months**.**At September 30, 2008, we had $276.4 millionavailable for additional borrowings under our ABL facility. Please see “Industryand Business Trends – Economic Conditions” and “Other Significant Items” below.

 

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**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 3,580 stores and supplied 193 franchised stores inNorth America as well as selected European countries and Japan, as of September 30,2008. Within BSG, we also have one of the largest networks of professionaldistributor sales consultants in North America, with over 1,000 professionaldistributor sales consultants who sell directly to salons and salonprofessionals.  We provide our customerswith a wide variety of leading third-party branded and exclusive-labelprofessional beauty supplies, including hair care products, styling appliances,skin and nail care products and other beauty items. Sally Beauty Supply storestarget retail consumers and salon professionals, while BSG exclusively targetssalons and salon professionals. For the year ended September 30, 2008, ournet sales and operating earnings were $2,648.2 million and$290.4 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, 2008, Sally Beauty Supply operated 2,820company-operated retail stores and supplied 24 franchised stores acquired inthe Salon Services acquisition (which is discussed in greater detail belowunder “—Recent Acquisitions”), 2,314 of which are located in the U.S. (with theremainder in the United Kingdom and certain other countries in Europe, Canada,Puerto Rico, Mexico and Japan). Sally Beauty Supply storesaverage 1,700 square feet and are primarily located in strip shoppingcenters. The product selection in Sally Beauty Supply stores ranges between5,000 and 8,000 SKUs of beauty products and includes products for hair care,skin and nail care, beauty sundries and electrical appliances targeting retailconsumers and salon professionals. Sally Beauty Supply stores carry leadingthird-party brands such as Clairol, Revlon and Conair, as well as an extensiveselection of exclusive-label merchandise. For the year ended September 30,2008, Sally Beauty Supply’s net sales and segment operating profit were $1,672.9 millionand $285.2 million, respectively, representing 63.2% and 77.9% of ourconsolidated net sales and operating profit before unallocated corporateexpenses, respectively.

 

We believe BSG is the largest full-service distributorof professional beauty supplies in the U.S. As of September 30, 2008,BSG had 760 company-operated stores, supplied 169 franchised stores andhad a sales force of over 1,000 professional distributor sales consultantsselling exclusively to salons and salon professionals in substantially allstates in the U.S. and in portions of Canada, Mexico and certain Europeancountries. BSG stores average 2,700 square feet and are primarilylocated in secondary strip shopping centers. Through BSG’s large store base andsales force, BSG is able to access a significant portion of the highlyfragmented U.S. salon channel. The product selection in BSG stores,ranging between 4,000 and 9,600 SKUs of beauty products, includes hair care andcolor, skin and nail care, beauty sundries and electrical appliances; targetingsalons and salon professionals. BSG carries leading professional beauty productbrands, intended for use in salons and for resale by the salon to consumers.Certain BSG products are sold under exclusive distribution agreements withsuppliers, whereby BSG is designated as the sole distributor for a product linewithin certain geographic territories. For the year ended September 30,2008, BSG’s net sales and segment operating profit were $975.3 million and$80.9 million, respectively, representing 36.8% and 22.1% of ourconsolidated net sales and operating profit before unallocated corporateexpenses, 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 customer fragmentation.*  TheU.S. salon channel is highly fragmented with over 225,000salons. Given the fragmented and small-scale nature of the salon industry,we believe that salon operators will continue to depend onfull-service/exclusive distributors and open-line channels for a majority oftheir beauty supply purchases.

 

·             *Growth in booth renting and frequent 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 of Exclusive-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 

 

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depend upon manufacturers who may be unableto provide products of adequate quality or who may be unwilling to continue tosupply products to us.”

 

·             *InternationalGrowth Strategies. *A keyelement of our growth strategy depends on our ability to capitalize on growth inthe international marketplace and to grow our current level of non-U.S.operations.  In May 2008, we acquired Pro-Duo, N.V., a cash and carry retailerof both professional and retail hair products with approximately 40 storeslocated in Belgium, France and Spain. In February 2007, we acquired Chapelton21 Limited, a private company based in Scotland with almost 100 stores locatedin the United Kingdom, Ireland, Germany, France and Spain, which we refer to asSalon Services.  In June 2006, weacquired Salon Success, a United Kingdom-based distributor of professionalbeauty products with sales operations in the United Kingdom, Spain and theNetherlands. These acquisitions furtherour expansion plans in Europe and are a significant part of Sally Beauty Supply’sinternational growth initiative.  Weintend to continue to identify and evaluate non-U.S. acquisition targets andare actively considering expansion into South America.  Our ability to grow our non-U.S. operations,integrate our new non-U.S. acquisitions and to successfully pursue additionalnon-U.S. acquisitions may be affected by business, legal, regulatory andeconomic 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.*  Thereis continuing consolidation among professional beauty product distributors andprofessional beauty product manufacturers. We plan to continue to examine waysin which we can benefit from this trend, including reviewing opportunities toshift business from competitive distributors to the BSG network as well asseeking opportunistic value-added acquisitions. We believe that suppliers areincreasingly likely to focus on larger distributors and retailers with broaderscale and retail footprint. We also believe that we are well positioned tocapitalize on this trend as well as participate in the ongoing consolidation atthe distributor/retail level. However, changes often occur in our relationshipswith suppliers that may materially affect the net sales and operating earningsof our business segments. Consolidation among suppliers could exacerbate theeffects of these relationship changes and could increase pricing pressures. Forexample, as we announced in December 2006, our largest supplier, L’Oreal,moved a material amount of revenue out of the BSG nationwide distributionnetwork and into competitive regional distribution networks. More recently, L’Orealalso acquired distributors competing with BSG in the southeastern and westcoast of the U.S. and a supplier that does not currently do business withBSG.  As a result, L’Oreal directly competes with BSG in certaingeographic areas. If L’Oreal acquired other distributors or suppliers that conductsignificant business with BSG, we could lose related revenue. There can be noassurance that there will not be further loss of revenue over time by BSG(including within its franchise-based business) due to potential losses ofadditional L’Oreal-related products as well as from the increased competitionfrom L’Oreal-affiliated distribution networks. Please see “Relationships withSuppliers” and “Risk Factors - The beauty products distribution industry ishighly competitive and is consolidating, and - We depend upon manufacturers whomay be unable to provide products of adequate quality or who may be unwillingto continue to supply products to us.”

 

·             *High level of competition.*  SallyBeauty Supply competes with other domestic and international beauty productwholesale and retail outlets, including local and regional open-line beautysupply stores, professional-only beauty supply stores, salons, massmerchandisers, drug stores and supermarkets, as well as sellers on the Internetand salons retailing hair care items. BSG competes with other domestic andinternational beauty product wholesale and retail suppliers and manufacturersselling professional beauty products directly to salons and individual salonprofessionals. We also face competition from authorized and unauthorizedretailers and Internet sites offering professional salon-only products. Theincreasing availability of unauthorized professional salon products in largeformat retail stores such as drug stores, grocery stores and others could alsohave a negative impact on our business.

 

·             *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 have animpact on our financial performance. Our continued success depends in largepart on our ability to anticipate, gauge and react in a timely and effectivemanner to changes in consumer spending patterns and preferences for beautyproducts. We continuously adapt ourmarketing and merchandising initiatives for Sally Beauty Supply in an effort toexpand our market reach or to respond to changing consumer preferences.  For example, in fiscal year 2008 we signed anexclusive merchandising agreement in the U.S. and Canada for certain hairextension products promoting celebrity Paris Hilton in an attempt to enhanceour appeal to a younger customer base in these geographic areas. If weare unable to anticipate and respond to trends in the market for beautyproducts and changing consumer demands, our business could suffer.

 

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·             *Economicconditions.*  We appeal to awide demographic consumer profile and offer a broad selection of beautyproducts sold directly to retail consumers and salons and salon professionals.Historically, these factors have provided us with reduced exposure to downturnsin economic conditions in the countries in which we operate.  However, downturns in the economy, especiallyfor an extended period of time, could adversely impact consumer demand ofdiscretionary items such as beauty products and salon services, particularlyaffecting our electrical products category and our full service sales business.In addition, higher freight costs resulting from increases in the cost of fuel,especially for an extended period of time, may impact our expenses at levelsthat we cannot pass through to our customers. These factors could have a material adverse effect on our business,financial condition and results of operations.

 

·             *Controllingexpenses*.  Another importantaspect of our business is our ability to control costs, especially in our BSGbusiness segment, by right-sizing the business and maximizing the efficiency ofour structure. In fiscal year 2007, in response to the loss of L’Oreal relatedrevenue discussed above, BSG’s sales force was reduced and the remainingaffected distributor sales consultants were offered certain compensationrelated incentives to stay with BSG as BSG has sought and continues to seekadditional non-L’Oreal revenue. During fiscal year 2007, we began implementinga two-year capital spending program to consolidate warehouses and reduceadministrative expenses related to BSG’s distribution network optimizationprogram. During the fiscal year 2008,project capital expenditures were approximately $14.0 million and relatedexpenses were approximately $4.7 million, including depreciation expense. Webelieve that cost savings from this program could range between $8 million and$10 million in fiscal year 2009 and annualized savings of $10 million beginningin fiscal year 2010.  Please see “RiskFactors – We are not certain that our ongoing cost control plans will continueto be successful.”

 

·             *Opening NewStores*.  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. However, we may not beable to open all of the new stores we plan to open and any new stores we openmay not be profitable, either of which could have a material adverse impact onour financial condition or results of operations. Please see “Risk Factors – Ifwe are unable to profitably open and operate new stores, our business,financial condition and 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 andinfrastructure.  The expansion of oursystems and infrastructure will require us to commit substantial financial,operational and technical resources in advance of any increase in the volume ofour business, with no assurance that the volume of business will increase.  For example, in fiscal year 2008 we haveupgraded our Lawson financial reporting system and implemented CustomerRelationship Management, or CRM, programs for our Sally Beauty Supply storesand are currently upgrading our distribution information systems (in connectionwith our capital spending program to consolidate warehouses, as discussedabove), upgrading our AS400 iSeries servers and implementing a newpoint-of-sale system for tracking customer sales.  These and any other required upgrades to ourinformation systems and information technology (or new technology), now or inthe future, will require that our management and resources be diverted from ourcore business to assist in completion of these projects. 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 any new orupgraded technology (and customer issues therewith), or the impact on thereliability of our data from any new or upgraded technology will not have amaterial adverse effect on our financial reporting, business, financialcondition or results of operations. Please see “Risk Factors – We may be adversely affected by anydisruption in our information technology systems.”

 

·             *Relationshipswith suppliers*.  We do notmanufacture the brand name or exclusive-label products we sell, and insteadpurchase our products from manufacturers. We depend upon a limited number ofmanufacturers for a significant percentage of the products we sell, and ourrelationships with these suppliers change often.  Please see “Relationships with Suppliers.”

 

##### ***Relationships with Suppliers***

##### *** ***

Most of the net sales of Sally Beauty Supply and BSGare generated through retail stores with respect to the Sally Beauty Supplybusiness, and both professional only stores and professional distribution salesconsultants with respect to the BSG business. In addition, BSG has a number offranchisees located primarily in the south and southwestern portions of theU.S. and in Mexico, which buy products directly from BSG for resale in theirassigned territories. A very small percentage of sales are generated throughfranchisees or sub-distributors (primarily in Europe), which also buy productsdirectly from Sally Beauty Supply or BSG for resale. Sally Beauty Supply/BSGand their suppliers are dependent on each other for the distribution of beautyproducts. As is typical in distribution businesses, these relationships aresubject to change from time to time (including the expansion or loss ofdistribution rights in various geographies and the addition or loss of productslines).

 

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Since we purchase products from many manufacturers onan at-will basis, under contracts which can generally be terminated withoutcause upon 90 days notice or less or which expire without express rightsof renewal, such manufacturers could discontinue sales to us at any time orupon the expiration 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.

 

Changes in our relationships with suppliers occuroften, and could positively or negatively impact our net sales and operatingprofits. For example, during the second quarter of fiscal year 2007, FaroukSystems, Inc., or Farouk Systems, terminated its distribution agreementwith us. Subsequently, effective July 2007, BSG stores and professionaldistributor sales consultants were once again given approval to distributeFarouk Systems products, with an expanded distribution area. In the firstquarter of fiscal 2009, Farouk Systems again terminated its distributionagreement with us except through our Armstrong McCall franchisees. In December 2006,we announced the loss of certain L’Oreal distribution rights, including (amongother things) distribution rights through our BSG distributor salesconsultants and the loss of exclusive rights to distribute L’Oreal products inour BSG stores.  These losses have resulted in margin pressure on BSG’sremaining L’Oreal revenues, and this pressure is currently projected tocontinue into fiscal year 2009. As discussed above, L’Oreal has entered intodirect competition with BSG and there can be no assurance that there will notbe further revenue losses over time at BSG due to potential losses ofadditional L’Oreal related products as well as from the increased competitionfrom L’Oreal-affiliated distribution networks. BSG has entered into long-termagreements with L’Oreal under which, as of January 1, 2007, BSG hadnon-exclusive rights to distribute the same L’Oreal professional products inits stores that it previously had exclusive rights to distribute in its storesand through its sales consultants. Armstrong McCall retained its exclusiverights to distribute Matrix professional products in its territories. Althoughwe have focused on developing new revenue and cost management initiatives tomitigate the negative effects resulting from unfavorable changes in oursupplier relationships, there can be no assurance that our efforts willcontinue to completely offset the loss of these or other distribution rights.Please see “Risk Factors*—* Wedepend upon manufacturers who may be unable to provide products of adequatequality or who may be unwilling to continue to supply products to us.”

 

BSG continues to expand our product line offeringsincluding Wella, Sebastian and Graham Webb into additional geographic areas forBSG stores and distributor sales consultants. Additionally, during fiscal years2007 and 2008, our expansion of the BSG segment included the acquisition ofcertain assets, and the award of distribution rights, which allow us todistribute Goldwell/KMS products and Paul Mitchell products on an incremental basisin various areas, as well as a number of other brands. We expect to gaincertain additional distribution rights over time through either furthernegotiations with suppliers, or by strategic acquisitions of existingdistributors.  Although we are focused ondeveloping new revenue and cost management initiatives, there can be noassurance that our efforts will partially or completely offset any potentialloss of distribution rights in the future. 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.”

 

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

##### *** ***

During the fiscal year ended September 30, 2008,we completed several acquisitions at an aggregate cost of $53.4 million, ofwhich substantially all was allocated to intangible assets and goodwill.  Generally, we funded these acquisitions withcash from operations as well as borrowings under our ABL facility.  On May 7, 2008, we acquired Pro-Duo, 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. This acquisition provided the Sally Beauty Supply segment with anexpanded geographic footprint in continental Europe and was funded with cashfrom operations and borrowings on our ABL facility.  We also assumed €3.0 million (approximately$4.7 million) of pre-acquisition debt of Pro-Duo in connection with theacquisition.

 

In February 2007, we acquired Chapelton 21Limited, a private company based in Scotland, which we refer to as SalonServices. This acquisition provided the Sally Beauty Supply segment a strongEuropean presence. We acquired Salon Services for an aggregate cash purchase priceof approximately $57.8 million of which $30.0 million was allocated togoodwill and $17.6 million was allocated to identifiable intangible assets. Wefinanced the purchase price through a draw down of approximately $57.0 millionunder our ABL facility. In addition, we extinguished approximately$3.9 million of pre-acquisition debt of Salon Services. Salon Services,through its direct and indirect subsidiaries supplies professional hair andbeauty products primarily to salon and spa operators and independent hair andbeauty professionals in the United Kingdom, Germany, Ireland and Spain.

 

In addition, during June 2006 we acquired SalonSuccess, a United Kingdom based distributor of professional beauty products inorder to expand BSG’s presence in the United Kingdom and expand the geographicarea served by BSG into other portions of Europe. This acquisition enabled BSGto enter new markets in Europe, including the United Kingdom, Spain and theNetherlands and to expand its

 

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operations in Florida. The total purchase price, asadjusted pursuant to the terms of the purchase agreement, was approximately$23.2 million. In accordance with the purchase agreement, additionalconsideration of approximately $1.2 million has been paid pursuant to thisagreement as of September 30, 2008.

 

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

##### *** ***

Our business historically constituted two operating segmentswithin 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 byAlberto-Culver prior to the Separation Transactions; (iii) at the closingof the Separation Transactions, the stockholders of Alberto-Culver priorthereto became the beneficial owners of approximately 52% of Sally Beauty’soutstanding common stock on an undiluted basis and the CDR Investors, who inthe aggregate invested $575.0 million in Sally Beauty, received an equityinterest representing approximately 48% of our 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 by (i) drawing on our ABL facility in anamount equal to $70.0 million, (ii) entering into two term loan facilities(Term Loans A and B) in an aggregate amount of $1,070.0 million, and (iii) issuingsenior notes in an aggregate amount of $430.0 million and senior subordinatednotes in an aggregate amount of $280.0 million.

 

Sally Beauty used approximately $2,342.1 million,a substantial portion of the proceeds of the investment by the CDR Investorsand the distribution from us, to pay a $25.00 per share special cashdividend to holders of record of Sally Beauty’s common stock, who wereAlberto-Culver stockholders as of the record date for the SeparationTransactions. In addition, pursuant to the Investment Agreement, Sally Beautypaid: (i) a transaction fee of $30.0 million to Clayton, Dubilier &Rice, Inc., the manager of both Clayton, Dubilier & Rice FundVII, L.P., the sole member of CDRS, and Parallel Fund, (ii) approximately$1.1 million to CDRS in merger and transaction expenses incurred in connectionwith its investment in Sally Beauty, and the Separation Transactions and (iii) approximately$20.4 million to Alberto-Culver for its expenses incurred in connection withthe Separation Transactions. Separately, we also paid approximately $58.5million in third-party fees and expenses related to the debt financing incurredin connection with the Separation Transactions.

 

On November 16, 2006, pursuant to the terms of aseparation agreement entered into in connection with the SeparationTransactions, all cash, cash equivalents and short-term investments of SallyBeauty and its subsidiaries were transferred to Alberto-Culver other than $91.1million, equal to the sum of $52.7 million plus an additional amount inconnection with the sum of (i) an estimate of the amount needed to covercertain income taxes (as specified in a tax allocation agreement entered intoin connection with the Separation Transactions); (ii) an amount determinedpursuant to a formula intended to reflect the limitations placed on the numberof shares of Sally Beauty that CDRS may acquire in order not to jeopardize theintended tax-free nature of the share distribution; and (iii) unpaidbalances on certain of Sally Beauty’s specified liabilities, minus otherspecified transaction costs. In connection with the Separation Transactions,Sally Beauty 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 our portion of the transaction expensesdescribed above) between Sally Beauty or any of its subsidiaries, on the onehand, and Alberto-Culver or any of its subsidiaries (other than Sally Beautyand its subsidiaries), on the other hand, were canceled prior to completion ofthe Separation Transactions. In addition, prior thereto, all intercompanyagreements between Sally Beauty or any of its subsidiaries and Alberto-Culveror any of its subsidiaries were terminated, other than certain agreementsspecifically designated in the separation agreement to survive following thetransactions.

 

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 firstquarter of fiscal year 2007 we recorded a charge of approximately$5.3 million, which represents the amount of future compensation expensethat would have been recognized in subsequent periods as the stock options andrestricted shares for our employees vested over the original vesting periods.Upon completion of the Separation Transactions all outstanding Alberto-Culverstock options held by our employees became options to purchase shares of SallyBeauty’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

 

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any time withoutpremium or penalty. Such facility is subject to mandatory prepayment in anamount equal to 50% of excess cash flow (as defined in the agreement governingthe Term Loans) for any fiscal year (commencing in fiscal year 2008) 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.

 

Details of long-term debt (excluding capitalizedleases) as of September 30, 2008 are as follows (dollars in thousands):

 
| ** **                | ** ** | **Amount** | ** ** | **Maturity dates  (Fiscal Year)** | ** ** | **Interest Rates** | ** **                            |
|---------------------------|------------|------------|------------|---------------------------------------------|------------|-------------------------|---------------------------------------|
| ABL facility              |       | $          | 75,000     |                                        | 2012       |                    | (i)                                   | PRIME and up  to 0.50% or; |   |
|                      |       |       |       |                                        |       | (ii)                    | LIBOR  (a) plus (1.00% to 1.50%) |   |
| Term Loan A               |       | 135,000    |       | 2013                                        |       | (i)                     | PRIME plus  (1.00% to 1.50%) or;      |   |
|                      |       |       |       |                                        |       | (ii)                    | LIBOR plus  (2.00% to 2.50%)          |   |
| Term Loan B               |       | 901,600    |       | 2014                                        |       | (i)                     | PRIME plus  (1.25% to 1.50%) or;      |   |
|                      |       |       |       |                                        |       | (ii)                    | LIBOR plus  (2.25% to 2.50%)          |   |
| Other (b)                 |       | 2,963      |       | 2009-2014                                   |       | 4.05% to 7.0%           |                                  |
| Total                     |       | $          | 1,114,563  |                                        |       |                    |                                  |   |
|                      |       |       |       |                                        |       |                    |                                  |
| Senior notes              |       | $          | 430,000    |                                        | 2015       |                    | 9.25%                                 |   |
| Senior subordinated notes |       | 280,000    |       | 2017                                        |       | 10.50%                  |                                  |
| Total                     |       | $          | 710,000    |                                        |       |                    |                                  |   |

 

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

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

 

##### ***Other Information Related to the SeparationTransactions***

##### *** ***

References to our historical assets, liabilities,products, businesses or activities are generally intended to refer to thehistorical assets, liabilities, products, businesses or activities of SallyHoldings, Inc. as a wholly-owned subsidiary of Alberto-Culver prior to theSeparation Transactions. The historical financial results of Sally Holdings, Inc.as part of Alberto-Culver contained herein do not reflect what the financialresults of Sally Holdings, Inc. would have been had it been operated as asubsidiary of Sally Beauty during the periods presented. Please see “RiskFactors—Risks Relating to Our Business.”

 

We depend on our subsidiaries for cash and unless wereceive dividends, distributions, advances, transfers of funds or other cashpayments from our subsidiaries, we will be unable to meet our obligations orpay dividends in the future. However, none of our subsidiaries are obligated tomake funds available to us for payment of dividends. Further, the terms of ourdebt agreements significantly restrict our ability to pay dividends orotherwise transfer assets. 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.”

 

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

##### *** ***

*Interest Rate Swap Agreements*

 

The Company utilizes interest rate swap agreements tomanage its cash flow risk associated with changing interest rates as it relateto its Term Loans. We do not purchase or hold any derivative instruments fortrading or speculative purposes. The counterparties are deemed to be ofsubstantial resources and strong creditworthiness. However, these transactionsdo result in exposure to credit risks in the event of default by acounterparty. The current financial crisis affecting the banking systems andfinancial markets has resulted in many well-known financial institutionsbecoming less creditworthy or having diminished liquidity and, thus, we couldbe exposed to an increased level of counterparty risk.  In the event that a counterparty defaults inits obligation under our interest rate swaps, we could incur substantialfinancial loss. At September 30, 2008, the aggregate fair market value ofall our interest rate swaps was a net liability of $6.4million.

 

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Effective in November 2006, we entered into fourinterest rate swap agreements with an aggregate notional amount of $500.0million. These interestrate swap agreements do not currently qualify as hedges and, therefore, thechange in fair value of these interest rate swap agreements is recorded in netinterest expense in the consolidated statements of earnings.

 

Additionally, effective in May 2008, we enteredinto two interest rate swap agreements with an aggregate notional amount of$300.0 million. These interest rate swap agreements are designated as effectivehedges, consistent with Statement of Financial Accounting Standards No. 133,*Accounting for Derivative Instruments and HedgingActivities*.  Adjustments toreflect the change in the fair values of these interest rate swap agreementsare recorded in accumulated other comprehensive income until the hedgedobligation is settled or the swap agreements expire, whichever is earlier.  Any ineffectiveness is recognized in netinterest expense in the consolidated statements of earnings. Please see “Item7A—Quantitative and Qualitative Disclosures about Market Risk—Interest raterisk” and Note 12 of the “Notes to Consolidated Financial Statements” in Item 8- “Financial Statements and Supplementary Data.”

 

*Termination of Spin/Merge Transaction withRegis Corporation*

###  

In January 2006, Alberto-Culver entered into anagreement with Regis Corporation, or Regis, pursuant to which our business wasto be spun off to Alberto-Culver’s stockholders by way of a tax-freedistribution and, immediately thereafter, combined with a subsidiary of Regisin a tax-free stock-for-stock merger. In April 2006, Alberto-Culver andRegis terminated the merger negotiations. In connection with the terminatedmerger transaction, we and Alberto-Culver incurred transaction expenses,primarily the termination fee paid to Regis and certain legal and investmentbanking fees. The transaction expenses, including the termination fee, incurredby us were approximately $41.5 million ($27.2 million after applicable incometaxes), and were expensed by us during the fiscal year 2006.

 

*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. Prior to the SeparationTransactions, we were a wholly-owned subsidiary of Alberto-Culver, and certainof our employees had been granted stock options and restricted stock awardsunder its share-based compensation plans.

 

For fiscal years 2008, 2007 and 2006, totalshare-based compensation cost charged against earnings was $9.6 million, $12.3million and $5.2 million, respectively. Share-based compensation for fiscalyear 2007 includes $5.3 million of accelerated expense related to theSeparation Transactions.  Share-basedcompensation for fiscal year 2008 and 2007 includes $3.1 million and $2.6million, respectively, of accelerated expense related to certain retirementeligible employees who are eligible to continue vesting awards upon retirementunder the terms of Sally Beauty’s 2007 Omnibus Incentive Plan, which is ashare-based compensation plan adopted by the stockholders of Sally Beautyduring fiscal year 2007. For fiscal years 2008, 2007 and 2006, the total incometax benefit recognized in the consolidated statements of earnings from all share-basedcompensation plans in which our employees participate or participated was $2.3million, $4.8 million and $1.8 million, respectively. The net balance sheeteffect of recognizing stock option expense increased due to Sally Beauty by$2.3 million, $4.8 million and $1.8 million for fiscal years 2008, 2007and 2006, respectively, and resulted in the recognition of deferred tax assetsof the same amount. Our consolidated statements of cash flows for fiscal years2008, 2007 and 2006 reflect $0.5 million, $0.8 million and $0.6 million,respectively, of excess tax benefits from employee exercises of stock optionsas financing cash inflow. As of September 30, 2008, we had $10.7 millionof unrecognized compensation expense related to non-vested stock option awardsthat is expected to be charged to expense over the weighted average period of2.7 years and $2.1 million of unrecognized compensation expense related tonon-vested restricted stock awards that is expected to be charged to expenseover the weighted average period of 3.8 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.

 

Effective October 1, 2005, we adopted SFAS No. 123(R) usingthe modified prospective method. Under this method, compensation expenserelated to Alberto-Culver stock options granted to employees of our business isrecognized for new stock option grants

 

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beginning in fiscal year 2006 and for the unvestedportion of outstanding stock options that were granted prior to the adoption ofSFAS No. 123(R). In accordance with the modified prospective method,the financial statements for fiscal years prior to 2006 have not been restated.

 

## **Resultsof Operations**

##  

The following table shows the condensed results ofoperations of our business for the fiscal years ended September 30, 2008,2007 and 2006 (in millions):

 
| ** **                                       | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                        |       | $                                           | 2,648.2    |   | $ | 2,513.8 |   | $ | 2,373.1 |   |
| Cost of products sold and distribution  expenses |       | 1,413.6                                     |       | 1,360.0 |   | 1,286.3 |   |
| Gross profit                                     |       | 1,234.6                                     |       | 1,153.8 |   | 1,086.8 |   |
| Total other operating costs and expenses         |       | 944.2                                       |       | 918.1 |   | 906.6 |   |
| Operating earnings                               |       | 290.4                                       |       | 235.7 |   | 180.2 |   |
| Interest expense, net(a)                         |       | 158.9                                       |       | 146.0 |   | 0.1 |   |
| Earnings before provision for income taxes       |       | 131.5                                       |       | 89.7 |   | 180.1 |   |
| Provision for income taxes                       |       | 48.6                                        |       | 41.2 |   | 69.9 |   |
| Net earnings                                     |       | $                                           | 82.9       |   | $ | 48.5 |   | $ | 110.2 |   |

 

----

(a)                                  For the fiscal years 2008 and 2007, netinterest expense is primarily associated with debt incurred in connection withthe Separation Transactions. Please see Note 11 of the “Notes to ConsolidatedFinancial Statements” in Item 8 - “Financial Statements and SupplementaryData.”

 

The following table shows the condensed results ofoperations of our business for the fiscal years ended September 30, 2008,2007 and 2006, expressed as a percentage of net sales for the respectiveperiods:

 
| ** **                                       | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                        |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Cost of products sold and distribution  expenses |       | 53.4                                        | %          | 54.1 | % | 54.2 | % |
| Gross profit                                     |       | 46.6                                        | %          | 45.9 | % | 45.8 | % |
| Total other costs and expenses                   |       | 35.6                                        | %          | 36.5 | % | 38.2 | % |
| Operating earnings                               |       | 11.0                                        | %          | 9.4 | % | 7.6 | % |
| Interest expense, net                            |       | 6.0                                         | %          | 5.8 | % | 0.0 | % |
| Earnings before provision for income taxes       |       | 5.0                                         | %          | 3.6 | % | 7.6 | % |
| Provision for income taxes                       |       | 1.9                                         | %          | 1.7 | % | 3.0 | % |
| Net earnings                                     |       | 3.1                                         | %          | 1.9 | % | 4.6 | % |

 

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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,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                    | ** ** | **2007(a)** | ** ** | **2006** | ** ** |
| Net sales:                                                 |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                        |       | $                                           | 1,672,897  |   | $ | 1,569,088 |   | $ | 1,419,332 |   |
| BSG                                                        |       | 975,294                                     |       | 944,684 |   | 953,768 |   |
|                                                       |       | $                                           | 2,648,191  |   | $ | 2,513,772 |   | $ | 2,373,100 |   |
| Gross Profit                                               |       | $                                           | 1,234,594  |   | $ | 1,153,747 |   | $ | 1,086,771 |   |
| Gross profit margin                                        |       | 46.6                                        | %          | 45.9 | % | 45.8 | % |
|                                                       |       |                                        |       |   |   |   |   |
| Selling, general and administrative  expenses              |       | $                                           | 895,632    |   | $ | 850,159 |   | $ | 798,211 |   |
| Depreciation and amortization                              |       | $                                           | 48,533     |   | $ | 42,605 |   | $ | 38,032 |   |
|                                                       |       |                                        |       |   |   |   |   |
| Earnings before provision for income taxes:                |       |                                        |       |   |   |   |   |
| Segment operating profit:                                  |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                        |       | $                                           | 285,234    |   | $ | 272,034 |   | $ | 235,419 |   |
| BSG                                                        |       | 80,927                                      |       | 63,456 |   | 88,445 |   |
| Segment operating profit                                   |       | 366,161                                     |       | 335,490 |   | 323,864 |   |
| Unallocated expenses                                       |       | (66,118                                     | )          | (62,240 | ) | (68,150 | ) |
| Share-based compensation expense                           |       | (9,614                                      | )          | (12,267 | ) | (5,186 | ) |
| Sales-based service fee charged by  Alberto-Culver         |       | —                                      |       | (3,779 | ) | (28,852 | ) |
| Transaction expenses                                       |       | —                                      |       | (21,502 | ) | (41,475 | ) |
| Operating earnings                                         |       | 290,429                                     |       | 235,702 |   | 180,201 |   |
| Interest expense, net of interest income                   |       | (158,897                                    | )          | (145,972 | ) | (92 | ) |
| Earnings before provision for income taxes                 |       | $                                           | 131,532    |   | $ | 89,730 |   | $ | 180,109 |   |
|                                                       |       |                                        |       |   |   |   |   |
| Segment operating profit margin:                           |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 17.1                                        | %          | 17.3 | % | 16.6 | % |
| BSG                                                        |       | 8.3                                         | %          | 6.7 | % | 9.3 | % |
| Consolidated operating profit margin                       |       | 11.0                                        | %          | 9.4 | % | 7.6 | % |
| Number of stores at end-of-period  (including franchises): |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 2,844                                       |       | 2,694 |   | 2,511 |   |
| BSG                                                        |       | 929                                         |       | 874 |   | 828 |   |
|                                                       |       | 3,773                                       |       | 3,568 |   | 3,339 |   |
| Same store sales growth(b)                                 |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 1.2                                         | %          | 2.7 | % | 2.4 | % |
| BSG                                                        |       | 6.9                                         | %          | 10.1 | % | 4.1 | % |
| Consolidated                                               |       | 2.6                                         | %          | 4.5 | % | 2.8 | % |

 

----

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

(b)         Samestores are defined as company-operated stores that have been open for at least14 months as of the last day of a month. Sally Beauty Supply has begunselling some products through the internet during the past year. Internet salesfor fiscal year 2008 were not significant and are not included in same storesales growth.

 

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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 41% 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.*  BSG generatesnet sales by selling products to salon professionals and independent styliststhrough company-operated and franchised stores as well as through its networkof professional distributor sales consultants. BSG sells hair care, hair colorproducts, skin and nail care products, electrical appliances and other beautyrelated accessories. These products are not sold directly to the general publicand are generally not the same products as those sold in our Sally BeautySupply stores. Various factors influence BSG’s net sales, including productbreadth and availability, competitive activity, relationships with suppliers,new product introductions and price. BSG’s product assortment and sales aregenerally not seasonal in nature.

 

*Cost of Products Sold and DistributionExpenses.*Cost of products sold and distribution expensesconsist of the cost to purchase merchandise from suppliers, less rebates andallowances, and certain overhead expenses including purchasing costs, freightfrom distribution centers to stores and handling costs in the distributioncenters. Cost of products sold and distribution expenses are also affected bystore inventory shrinkage, which represents products that are lost, stolen ordamaged 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 theSeparation Transactions, the arrangements giving rise to this fee fromAlberto-Culver were terminated and the related charges have ceased. We believethat had we been a stand-alone company, we would have not incurred a comparableexpense.

 

*Transaction Expenses*.  For fiscal year 2007, transaction expensesare costs associated with the Separation Transactions and are primarily paymentsto Alberto-Culver as defined in the separation agreements. In addition, werecognized severance costs for two executives and certain professional feesrelated to the Separation Transactions. For fiscal year 2006, transactionexpenses are related to the termination of the agreement with Regis that calledfor us to merge with a subsidiary of Regis in a tax-free transaction. Thisproposed transaction was terminated in April 2006 and we expensedapproximately $41.5 million ($27.2 million after income taxes) in terminationfee and legal and investment banking fees associated with the terminatedagreement.

 

*Net Interest Expense*.  Net interest expense includes theamortization of deferred debt issuance costs, and is stated net of interestincome. For the fiscal years 2008 and 2007, net interest expense is primarilyassociated with debt incurred in connection with the Separation Transactions.Prior to the Separation Transactions, net interest expense was primarilyattributable to notes with affiliates.

 

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

 

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

 

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| ** **                       | ** ** | **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 forprior fiscal years have been reclassified to conform to the current year’spresentation.

###  

### *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 (net of acquisitions) ofapproximately $45.0 million, or 1.8%; and $56.3 million, or 2.2%, in additionalsales from acquired businesses; partially offset by a decrease in franchisestore sales of approximately $15.7 million, or 0.6%, and in distributor salesconsultant revenue of approximately $12.0 million, or 0.5%. These amounts areinclusive of approximately $18.4 million, or 0.7%, in positive impact fromforeign exchange rates. Current period net sales were positively impacted bythe introduction of new product lines during the fiscal year 2008 butnegatively impacted by lower L’Oreal product sales of approximately $36.2million due to the previously-disclosed contractual changes during fiscal year2007.

 

*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 (net ofacquisitions) of approximately $26.6 million, or 1.7%; and $56.3 million, or3.6%, in additional sales from acquired businesses. These sales are inclusiveof approximately $8.0 million, or 0.5%, in positive impact from foreignexchange rates.  Same store sales werepositively impacted by continued growth of exclusive-label product sales andcertain merchandise categories as well as an increase in promotional 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 exchangerates.  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 

 

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principally theresult of a shift in product mix including an increase in sales ofexclusive-label products and other higher-margin products.  This increase was partially offset by anincrease in promotional initiatives in the U.S. and higher freight costs.

 

*BeautySystems Group*. BSG’s gross profit increased $21.1 million for 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 aswell as a shift in sales mix during the fiscal year ended September 30,2008, towards higher company-operated store sales volume (with higher grossprofit margins as opposed to both franchise store and distributor salesconsultants’ sales), as well as the introduction of new product lines duringthe fiscal year 2008.

 

#### *Selling, General and Administrative 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 the L’Orealcontractual changes reported during fiscal year 2007 for the fiscal year ended September 30,2008 and 2007, respectively. Most of the retention incentives related to the L’Orealcontractual changes have been expensed during 2007 and 2008 and are notexpected to be significant during fiscal year 2009. Fiscal 2008 results alsoinclude professional fees incurred for a corporate reorganization projectrelated to the rationalization 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 and Amortization*

####  

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 by Alberto-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.

 

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*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**                                 | ** ** | **2007(a)** | ** ** | **Increase (Decrease)** | ** ** |
| Operating Earnings:                                |       |                                     |       |   |   |   |   |   |   |
| Segment operating profit:                          |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply                                |       | $                                        | 285,234    |   | $ | 272,034 |   | $ | 13,200 |   | 4.9 | % |
| BSG                                                |       | 80,927                                   |       | 63,456 |   | 17,471 |   | 27.5 | % |
| Segment operating profit                           |       | 366,161                                  |       | 335,490 |   | 30,671 |   | 9.1 | % |
| Unallocated expenses                               |       | (66,118                                  | )          | (62,240 | ) | 3,878 |   | 6.2 | % |
| 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 | % |

 

----

(a) Certain amounts for prior fiscalyears have been reclassified to conform to the current year’s presentation.

 

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 thefiscal year ended September 30, 2007. Operating earnings, as a percentageof net sales, were 11.0% for the fiscal year ended September 30, 2008compared to 9.4% 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 $13.2 million, or 4.9%, to$285.2 million for the fiscal year ended September 30, 2008 compared to$272.0 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 17.3% 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 administrativeexpenses.  In addition, operatingearnings were improved from the non-recurrence of certain consulting fees andexpenses related to the L’Oreal contractual changes incurred for the fiscalyear ended September 30, 2007. These improvements were offset, in part, by the operating expensesattributable to stores opened and businesses acquired as well as by warehouseoptimization project expenses of $4.7 million (including depreciation) in thefiscal year ended September 30, 2008.

 

*Unallocatedexpenses.*Unallocatedexpenses, which represent corporate costs that have not been charged to theoperating segments, increased to $66.1 million, or by approximately $3.9million, for the year ended September 30, 2008 compared to the year ended September 30,2007.  The increase was due primarily tohigher payroll related costs to provide support for the growth in segmentoperations.

 

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#### *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 by Alberto-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.

 

#### *Interest Expense, net*

####  

Interestexpense, net of interest income of $0.7 million, was $159.0 million for thefiscal year ended September 30, 2008 compared to $146.0 million, net ofinterest income of $1.7 million, for the fiscal year ended September 30,2007.  The increase in interest expensewas primarily attributable to the impact of interest associated with the debtincurred on November 16, 2006 which was outstanding for 47 less days infiscal year 2007 than in fiscal year 2008. Net interest expense also reflects non-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 for certain interestrate swaps, as described in Note 12 of the “Notes to Consolidated FinancialStatements” in Item 8 - “Financial Statements and Supplementary Data.”

 

#### *Provision for Income Taxes*

####  

Provision for income taxeswas $48.7 million during the fiscal year ended September 30, 2008 comparedto $41.2 million for the fiscal year ended September 30, 2007 Theeffective tax rate is 37.0% for fiscal year 2008 compared to 45.9% for fiscalyear 2007.  The reduction in theestimated annual effective tax rate primarily relates to non-deductible costsrelated to the Separation Transactions included in the tax rate for the fiscalyear 2007 and the reduced impact of permanent items on higher earnings and areduction in foreign 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.

 

##### ***The Fiscal Year Ended September 30, 2007compared to the Fiscal Year Ended September 30, 2006***

##### *** ***

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

 
| ** **

** **           | ** ** | **Fiscal Year Ended September 30,** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|
| ** **                       | ** ** | **2007(a)**                              | ** ** | **2006** | ** ** | **Increase (Decrease)** | ** ** |
| Net sales:                       |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                        | 1,569,088  |   | $ | 1,419,332 |   | $ | 149,756 |   | 10.6 | % |
| BSG                              |       | 944,684                                  |       | 953,768 |   | (9,084 | ) | (1.0 | )% |
| Consolidated net sales           |       | $                                        | 2,513,772  |   | $ | 2,373,100 |   | $ | 140,672 |   | 5.9 | % |
|                             |       |                                     |       |   |   |   |   |   |   |
| Gross profit:                    |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                        | 798,656    |   | $ | 713,970 |   | $ | 84,686 |   | 11.9 | % |
| BSG                              |       | 355,091                                  |       | 372,801 |   | (17,710 | ) | (4.8 | )% |
| Consolidated gross profit        |       | $                                        | 1,153,747  |   | $ | 1,086,771 |   | $ | 66,976 |   | 6.2 | % |
|                             |       |                                     |       |   |   |   |   |   |   |
| Gross profit margin:             |       |                                     |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | 50.9                                     | %          | 50.3 | % | 0.6 | % |   |   |
| BSG                              |       | 37.6                                     | %          | 39.1 | % | (1.5 | )% |   |   |
| Consolidated gross profit margin |       | 45.9                                     | %          | 45.8 | % | 0.1 | % |   |   |

 

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(a) Certainamounts for prior fiscal years have been reclassified to conform to the fiscalyear 2008 presentation.

###  

### *Net Sales*

###  

Consolidated net sales increased $140.7 million, or5.9%, to $2,513.8 million for fiscal year 2007 compared to $2,373.1 million forthe same period in 2006. This increase was primarily the result of same storesales growth of 4.5%, the addition of 83 Sally Beauty Supply and 46 BSG storesduring fiscal year 2007, and the acquisitions of Salon Services and SalonSuccess. Salon Services, which was acquired during the second quarter of 2007,contributed approximately $74.0 million of incremental revenue, and SalonSuccess, which was acquired during the third quarter of 2006, contributedapproximately $21.4 million of incremental revenue during fiscal year 2007.

 

*Sally Beauty Supply*. Net sales for Sally Beauty Supply increased $149.8 million, or 10.6%, to$1,569.1 million for fiscal year 2007 compared to $1,419.3 million for the sameperiod in 2006. Net sales increased primarily due to a 5.2% increase resultingfrom the Salon Services acquisition, which contributed $74.0 million of netsales during fiscal year 2007, the opening of 83 net new stores over the last12 months (excluding acquisitions) and a same store sales growth of 2.7%,which includes a decline in same store number of transactions. In addition, theeffect of exchange rates contributed $13.0 million, or an increase in sales of0.9%.

 

*Beauty Systems Group*. Net sales for BSG decreased $9.1 million, or 1.0%, to $944.7 million for fiscalyear 2007 compared to $953.8 million for the same period in 2006. Net sales forfiscal year 2007 were impacted by changes in the L’Oreal distributionagreement, resulting in the loss of approximately $80 million of sales of L’Orealproducts compared to fiscal year 2006. BSG also experienced a decline in salesat its franchised-based business. These declines were mostly offset by samestore sales growth of 10.1% and incremental sales of $21.4 million resultingfrom the acquisition of Salon Success, an increase in sales of non-L’Orealbrands and the addition of 46 new stores over the last 12 months (excludingacquisitions) and the effect of exchange rates. The effect of exchange ratescontributed approximately $3.7 million or an increase in sales of approximately0.4%.

 

### *Gross Profit*

###  

Consolidated gross profit increased $67.0 million, or6.2%, to $1,153.8 million for fiscal year 2007 compared to $1,086.8 million forthe same period in 2006. Consolidated gross profit, as a percentage of netsales, was 45.9% for fiscal year 2007 compared to 45.8% for the prior yearperiod. Gross profit margins increased slightly during fiscal year 2007 due tohigher gross profit margins at Sally Beauty Supply, partially offset by lowergross profit margins at BSG. Gross profit margins for Sally Beauty Supplyincreased, in part, because of a continued increase in sales of higher marginexclusive-label products, margin increases on certain products, and continuedfavorable changes in customer mix, partially offset by an increased weightingof revenues from our international business, where gross margins are typicallylower than in the U.S. Gross profit margins for BSG declined, in part, becauseof the loss of the exclusive distributorship rights for L’Oreal productsresulting in margin pressure on the remaining L’Oreal sales, the growth insales of lower margin products to replace the lost L’Oreal sales, and margindeclines at BSG’s franchise-based business.

 

### *Selling, General and Administrative Expenses*

###  

Consolidated selling, general and administrativeexpenses increased $52.0 million, or 6.5%, to $850.2 million for fiscal year2007 compared to $798.2 million for the same period in 2006. These expenses, asa percentage of net sales, were 33.8% for fiscal year 2007 compared to 33.6%for the prior year period. The increasein expense is partly attributable to selling and administrative costsassociated with the unit growth of the Sally Beauty Supply and BSG businesses,costs associated with the realignment of our BSG business, acquisitions, andadditional expenses at our corporate support center. Additionally,selling, general and administrative expenses for fiscal year 2007 includes$12.3 million of share-based compensation expense, compared to $5.2 million forfiscal year 2006. Share-based compensation expense for fiscal year 2007includes $2.6 million of acceleratedexpenses related to certain retirement eligible employees who areeligible to continue vesting awards upon retirement under the terms of the 2007Omnibus Incentive Plan, and $5.3million of expenses related to early vesting of equity awards as a result ofthe Separation Transactions.

 

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### *Depreciation and Amortization*

###  

Consolidated depreciation and amortization increased$4.6 million, or 12.1%, to $42.6 million for fiscal year 2007 compared to $38.0million for the same period in 2006, primarilydue to the addition of assets associated with acquisitions and the unit growthof the Sally Beauty Supply and BSG businesses.

 

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

###  

The sales-based service fee charged to us byAlberto-Culver declined to $3.8 million for fiscal year 2007 from $28.9 millionfor fiscal year 2006 due to the cancellation of the consulting, businessdevelopment and advisory services agreement between certain of our subsidiariesand Alberto-Culver in connection with the Separation Transactions.

 

### *Transaction Expenses*

###  

During fiscal year 2007 we recorded $21.5 million inexpenses related to the Separation Transactions. These expenses were for feesallocated to us by Alberto-Culver and for the severance payments to Mr. Renzulli,former Chairman of Sally Holdings, Inc, as called for in the separationagreement from Alberto-Culver, of approximately $20.0 million, as well asseverance payments to Mr. Robinson, our former Chief Financial Officer andTreasurer, prior to his retirement, of approximately $0.9 million, and forother professional fees. During fiscal year 2006, we recorded $41.5 million inexpenses related to the terminated transaction with Regis.

 

### *Operating Earnings*

###  

Consolidated operating earnings increased by $55.5 million,or 30.8%, to $235.7 million for fiscal year 2007 compared to $180.2 million forthe same period in 2006. Operating earnings, as a percentage of net sales, were9.4% for fiscal year 2007 compared to 7.6% for the same period in 2006. Theincrease in consolidated operating earnings was primarily due to thecancellation of the consulting, business development and advisory servicesagreement between certain of our subsidiaries and Alberto-Culver in connectionwith the Separation Transactions, and the expenses incurred as a result of theSeparation Transactions being less than the expenses we recognized in 2006related to the proposed but terminated Regis transaction. We do not allocatethese expenses to our operating segments and these expenses are not reflectedin the segment operating earnings of Sally Beauty Supply and BSG discussedbelow.

 

*Sally Beauty Supply*. Sally Beauty Supply’s segment operating earnings increased $36.6 million, or15.6%, to $272.0 million for fiscal year 2007 compared to $235.4 million forthe same period in 2006. Segment operating earnings, as a percentage of netsales, was 17.3% for fiscal year 2007 compared to 16.6% for fiscal year 2006.Sally Beauty Supply operating earnings were positively impacted by additionalearnings from the Salon Services acquisition, growth in the number of stores,same store sales increases along with sales growth in certain merchandisecategories, operating expense controls, as well as a gross margin improvement.Operating earnings margins improvements at our Sally Beauty Supply U.S. basedbusiness were partially offset by a greater weighing of international basedearnings that typically carry lower operating earnings margins.

 

*Beauty Systems Group*. BSG’s segment operating earnings decreased $25.0 million, or 28.3%, to $63.5million for fiscal year 2007 compared to $88.4 million for the same period in2006, in part, due to an increase of approximately $8.6 million in selling,general and administrative expenses related to the closure of a warehouse andexpenses related to the realignment of its sales force, including expendituresrelated to the retention of certain professional distributor sales consultants,while also experiencing lower gross profit margins on a decreased sales volume.Sales volumes declined primarily as a result of certain L’Oreal sales asdiscussed earlier. Gross profit margins declined primarily as a result of theloss of L’Oreal related sales being partially replaced with lower marginproducts, margin declines on remaining L’Oreal product sales. BSG’sfranchise-based business also experienced a decline in profitability for fiscalyear 2007. Segment operating earnings, as a percentage of net sales, was 6.7%for fiscal year 2007 compared to 9.3% for the same period in 2006.

 

### *Interest Expense, net*

###  

Interest expense, net of interest income, was $146.0million and $0.1 million for fiscal years 2007 and 2006, respectively. Theincrease in interest expense was primarily attributable to the interestassociated with the new debt incurred on November 16, 2006. The interestexpense was partially offset by interest income of $1.7 million and $1.8million for fiscal years 2007 and 2006, respectively. Included in interestexpense for fiscal year 2007 is a marked to market fair value expenseadjustment for interest rate swaps of $3.0 million.

 

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### *Provision for Income Taxes*

###  

Provision for income taxes was $41.2 million duringfiscal year 2007 compared to $69.9 million for the same period of 2006. Thedecreased provision for income taxes for fiscal year 2007 was principally theresult of lower earnings before provision for income taxes due to increasedinterest expense. The effective tax rate was 45.9% in fiscal year 2007 and38.8% in fiscal year 2006. The increase in the effective tax rate was primarilyrelated to nondeductible transaction costs related to the SeparationTransactions.

 

### *Net Earnings*

###  

As a result of the foregoing, consolidated netearnings decreased $61.7 million, or 56.0%, to $48.5 million forfiscal year 2007 compared to $110.2 million for the same period in 2006.Net earnings, as a percentage of net sales, were 1.9% for fiscal year 2007compared to 4.6% for fiscal year 2006. Net earnings for fiscal year 2007 werereduced as a result of the expenses related to the Separation Transactions andincreased interest expense associated with the debt incurred.

 

## **FinancialCondition**

##  

##### ***September 30, 2008 Compared to September 30,2007***

##### *** ***

Workingcapital (current assets less current liabilities) at September 30, 2008was $348.6 million compared to $341.9 million at September 30, 2007,representing an increase of $6.7 million. The resulting ratio of current assetsto current liabilities was 1.76 to 1.00 at September 30, 2008, compared to1.92 to 1.00 at September 30, 2007. The increase in working capitalreflects a $92.3 million increase in current assets partially offset by an$85.7 million increase in current liabilities. Current assets as of September 30, 2008 reflect an increase ininventory levels and an increase in cash and cash equivalents (please see “Liquidityand Capital Resources” below).  Theincrease in current liabilities as of September 30, 2008 was primarily theresult of an increase in current maturities of long-term debt.

 

Cash and cashequivalents increased $61.5 million, to $99.8 million at September 30,2008, compared to September 30, 2007 due primarily to the proceeds of$75.0 million borrowed under the ABL revolving credit facility in September 2008to increase our cash position in order to preserve our financial flexibility inlight of the recent dislocation of the financial markets.

 

Inventoriesincreased $28.8 million to $598.2 million at September 30, 2008, comparedto $569.4 million at September 30, 2007 due primarily to purchases in connectionwith new and expanded BSG brands, the seeding of a new BSG warehouse and anincrease in certain product lines for Sally Beauty Supply and inventoryacquired in connection with acquisitions completed in fiscal year 2008.

 

Net property and equipment increased $2.2 million to$156.3 million at September 30, 2008, compared to $154.1 millionat September 30, 2007. Of this increase, approximately $3.0 million wasattributable to acquisitions, with the remainder due primarily to the openingof new stores and remodeling of existing facilities offset in part bydepreciation expense.

 

Goodwill increased $18.3 million to$425.0 million at September 30, 2008, compared to $406.6 millionat September 30, 2007, primarily due to acquisitions and the effect ofchanges in foreign exchange rates.

 

Intangible assets increased $14.9 million to$85.4 million at September 30, 2008, compared to $70.5 millionat September 30, 2007, primarily due to acquisitions; offset in part byamortization expense.

 

Other assets decreased $6.4 million to $54.7 millionat September 30, 2008, compared to $61.1 million at September 30,2007, 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.

 

Accounts payabledecreased by $4.7 million to $172.0 million at September 30, 2008 from$176.7 million at September 30, 2007 due primarily to the timing ofpayments to vendors in connection with purchases of inventory and propertyplant and equipment.  Accrued expensesincreased by $0.9 million to $154.5 million at September 30, 2008 from$153.7 million at September 30, 2007 due primarily to the volume ofbusiness growth; partially offset by lower interest payable.

 

Deferred income tax liabilities increased $7.4 millionto $37.9 million at September 30, 2008, compared to $30.6 million at September 30,2007. This increase was primarily due to differences between depreciationincluded for tax purposes versus depreciation included in our statements ofearnings, the tax effect of deferred gains on certain interest rate swaps, andpurchase accounting adjustments.

 

Stock options subject to redemption decreased to $5.9million at September 30, 2008, compared to $6.5 million as of September 30,2007, primarily due to exercises of these options.

 

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Total member’s deficit decreased by $58.0 million as aresult of net earnings of $82.9 million and a $1.0 million adjustment of afiscal year 2007 distribution to Alberto-Culver; partially offset byaccumulated other comprehensive loss of $25.8 million, mainly resulting fromcumulative translation adjustments. At September 30, 2007, we had a member’sdeficit as a result of distributions to Sally Beauty and Alberto-Culver, whichwere partially offset by the conversion of stockholder’s equity to member’sequity in connection with the Separation Transactions. We used proceeds fromthe issuance of debt to make a cash distribution of approximately $1,809.7million to Sally Beauty. We made a distribution of approximately $44.4 millionto Alberto-Culver as a result of the settlement of the inter-companyagreements.

 

Accumulated other comprehensive income decreased to$8.7 million, at September 30, 2008, due to foreign currency translationadjustments of $26.6 million during fiscal year 2008; partially offset bydeferred gains on hedged interest rate swaps of $0.8 million (net of incometax).

 

## **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.

 

Following the completion of the SeparationTransactions, we are highly leveraged and a substantial portion of ourliquidity needs will arise from debt service on indebtedness incurred primarilyin connection with the Separation Transactions and from funding the costs ofoperations, working capital and capital expenditures. As a holding company, wedepend on our subsidiaries to distribute funds to us so that we may pay ourobligations and expenses. The ability of our subsidiaries to make suchdistributions will be subject to their operating results, cash requirements andfinancial condition. In addition, under Delaware law, the ability of our subsidiariesto make distributions to us will be limited to the extent: (i) of theirsurplus, or if there is no surplus, of its net earnings for the fiscal year inwhich the distribution is declared and/or the preceding fiscal year, if suchsubsidiary is a corporation; or (ii) the fair value of their assetsexceeds its liabilities, in the case of a subsidiary that is a limitedliability company. Please see “Risk Factors—Risks Relating to Our Business,”and “—Risks Relating to Our Substantial Indebtedness.”

 

During the fiscal year ended September 30, 2008,we made scheduled payments on our senior Term Loans in the aggregate amount of$16.7 million.

 

Based upon the current level of operations andanticipated growth, we anticipate that existing cash balances, funds generatedby operations and funds available under the ABL facility will be sufficient tomeet our working capital requirements and to finance capital expenditures,excluding acquisitions, over the next 12 months.

 

There can be no assurance that our business willgenerate sufficient cash flows from operations, that anticipated net salesgrowth and operating improvements will be realized or that future borrowingswill be available under our ABL facility in an amount sufficient to enable usto service our indebtedness or to fund our other liquidity needs. In addition,our ability to meet our debt service obligations and liquidity needs aresubject to certain risks, which include, but are not limited to, increases incompetitive activity, the loss of key suppliers, rising interest rates, theloss of key personnel, the ability to execute our business strategy and generaleconomic conditions. Please see “Risk Factors.”

 

We utilize ourABL facility for the issuance of letters of credit, as well as to manage normalfluctuations in operational cash flow. In that regard, we may from time to timedraw funds under the revolving credit facility for general corporate purposesincluding acquisitions and interest payments due on our indebtedness.  Thefunds drawn on individual occasions during the fiscal year ended September 30,2008 have varied in amounts of up to $75.0**million,with total amounts outstanding ranging from $2.3 million up to $99.3 million.The amounts drawn are generally outstanding for a short period of time and aregenerally paid down with cash provided by our operating activities.

 

Both in the U.S. and incertain European areas in which we operate the economic stress and thedislocation of the financial markets that began in late calendar year 2007 has continuedand substantially increased in the recent months. Recently, concerns overinflation, energy costs, the availability and cost of credit, the conditions ofthe U.S. mortgage market and declining real estate prices in the U.S. havecontributed to increased market volatility and diminished expectations aboutU.S. and the global economies and the financial markets going forward. Thesefactors, combined with the volatility in oil prices, declining business andconsumer confidence, and increases in unemployment rates, have precipitated aneconomic slowdown and fears of a potential recession on a global scaleOn September 18, 2008, we borrowed $75.0million under our existing $400 million ABL facility to increase our cashposition in order to 

 

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preserve our financialflexibility in light of the recent dislocation of the financialmarkets. We currently intend to repay these funds as economic conditionsallow in the next twelve months.**  **As of September 30,2008, we had $276.4 million available for additional borrowings under our ABLfacility, subject to borrowing base limitations, as reduced by outstandingletters of credit.

 

We may from time to timerepurchase or otherwise retire our debt and take other steps to reduce our debtor otherwise improve our balance sheet. These actions may include open marketrepurchases of our Notes or other retirements of outstanding debt. The amountof debt that may be repurchased or otherwise retired, if any, would be decidedupon at the sole discretion of Sally Beauty’s Board of Directors and willdepend on market conditions, trading levels of the Company’s debt from time totime, the Company’s cash position and other considerations.

 

During the fiscal year ended September 30, 2008,we completed several small acquisitions at an aggregate cost of $53.4 million.Substantially all of the purchase price for these acquisitions was allocated tointangible assets and goodwill. Generally, we funded these acquisitions with cash from operations aswell as borrowings under our ABL facility. On May 7, 2008, we acquired Pro-Duo, a 40-store beauty supply chainlocated in Belgium, France and Spain, for €19.3 million (approximately $29.8million plus incidental costs capitalized) subject to certain adjustments.  This acquisition provided the Sally BeautySupply segment an expanded geographic footprint in continental Europe and wasfunded with cash from operations and borrowings on our ABL facility.  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 2008 and 2007, from borrowings. The primary uses of cashduring the past three years were for acquisitions and capital expenditures and,for fiscal year 2007, for the cash distribution paid in connection with theSeparation Transactions. The following table shows our sources and uses offunds for the fiscal years ended September 30, 2008, 2007 and 2006 (inthousands):*

 
| ** **                                            | ** ** | **Fiscal Year Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                            | ** ** | **2008**                                                | ** ** | **2007** | ** ** | **FY Change** | ** ** | **2007** | ** ** | **2006** | ** ** | **FY Change** | ** ** |
| Cash provided by operating activities                 |       | $                                                       | 111,415    |   | $ | 194,267 |   | $ | (82,852 | ) | $ | 194,267 |   | $ | 156,721 |   | $ | 37,546 |   |
| Cash used by investing activities                     |       | (98,162                                                 | )          | (121,364 | ) | 23,202 |   | (121,364 | ) | (52,158 | ) | (69,206 | ) |
| Cash provided (used) by financing  activities         |       | 47,134                                                  |       | (143,814 | ) | 190,948 |   | (143,814 | ) | (32,205 | ) | (111,609 | ) |
| Effect of foreign exchange rates                      |       | 1,129                                                   |       | 1,612 |   | (483 | ) | 1,612 |   | (3,399 | ) | 5,011 |   |
| Net increase (decrease) in cash and cash  equivalents |       | $                                                       | 61,516     |   | $ | (69,299 | ) | $ | 130,815 |   | $ | (69,299 | ) | $ | 68,959 |   | $ | (138,258 | ) |

 

### *Cash Provided by Operating Activities*

###  

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 million during the fiscal year ended September 30, 2007. Thedecrease was due primarily to an increase in cash used to purchase inventory ofapproximately $69.6 million as our inventory levels increased and a reductionin accounts payable and accrued expenses of $35.6 million.  This decrease was offset, in part, byimproved earnings for the fiscal year ended September 30, 2008 ofapproximately $34.3 million.

 

Net cash provided by operating activities duringfiscal year 2007 increased by $37.5 million to $194.3 million,compared to $156.7 million during fiscal year 2006. The increase wasprimarily due to a reduction in cash used for inventory as we reduced ourinventory levels, partially offset by lower net earnings due to interestexpense.

 

### *Cash Used by Investing Activities*

###  

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 yearended September 30, 2007.   Thisdecrease was due primarily to a reduction in cash used for acquisitions of$23.5 million (including approximately $29.8 million in connection with theacquisition of Pro-Duo in 2008 

 

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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.

 

Net cash used by investing activities during fiscalyear 2007 increased by $69.2 million to $121.4 million, compared to$52.2 million during fiscal year 2006, primarily due to the acquisition ofSalon Services, and capital expenditures for new stores and remodels ofexisting facilities. Included in fiscal year 2007 are proceeds from sale ofproperty and equipment in the ordinary course of business of approximately $8.0million.

 

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

###  

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 were offset, in part, by theabsence, during the fiscal year ended September 30, 2008, proceeds fromthe issuance of debt in connection with the Separation Transactions during thefiscal year ended September 30, 2007.

 

Net cash used by financing activities during fiscalyear 2007 increased by $111.6 million to $143.8 million, compared to$32.2 million during fiscal year 2006, primarily due to distributions toAlberto-Culver and costs associated with the Separation Transactions (includingdebt issuance costs and the cash distribution paid) partially offset byproceeds from the issuance of debt.

 

##### ***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, 2008, there were outstandingborrowings of $1,036.6 million under the Term Loans, at a weighted averageinterest rate of 5.32%, and outstanding borrowings of $710.0 million under theNotes, at a weighted average interest rate of 9.75%. In addition, we had $75.0million outstanding borrowings under our ABL facility (please see “Liquidityand Capital Resources” above). As of September 30, 2008, we had $276.4million available for additional borrowings under our ABL facility, subject toborrowing base limitations, as reduced by outstanding letters of credit.

 

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 (including guarantees of additional indebtedness)                              |
|                                                                                                                                                      |
| ·     stock  repurchase, 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 assets of , 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 (commencing infiscal year 2008) unless a specified leverage 

 

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ratio is met. Additionally, the Term Loans are subjectto mandatory 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 comply with maximum consolidated secured leverage ratio levels,which will decline over time. The consolidated secured leverage ratio will betested quarterly, with a maximum ratio of 4.75 as of September 30, 2008.The consolidated secured leverage ratio is a ratio of (A) net consolidatedsecured debt to (B) Consolidated EBITDA as defined in the agreementunderlying the Term Loans.

 

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 (asincluded in the definition of the fixed-charge coverage ratio in the agreementgoverning the 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 consolidated securedleverage ratio covenant under the Term Loans would result in a default undersuch facilities. Failure to comply with the fixed-charge coverage ratiocovenant (if and when applicable) under the ABL facility would result in adefault under such facility. Either default could also result in a defaultunder the other facility or facilities, as the case may be, and the Notes.Absent a waiver or an amendment from our lenders and note holders, suchdefaults could permit the acceleration of all indebtedness under the ABLfacility, the Term Loans and the Notes, which would have a material adverseeffect on our results of 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 ourability to successfully implement our overall business strategy. Please see “RiskFactors—Risks Relating to Our Substantial Indebtedness.”

 

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

##### *** ***

For fiscal year 2008, we had total capitalexpenditures of approximately $45.6 million which were primarily to fund theaddition of new stores; our warehouse optimization program; the remodel, expansionand relocation of existing stores in the ordinary course of our business andcorporate projects. For fiscal year 2009, we anticipate total capitalexpenditures in the range of approximately $40.0 million to $45.0 million,excluding acquisitions. Capital expenditures will be primarily for the additionof new stores; the remodel, expansion or relocation of existing stores in theordinary course of our business and corporate projects.

 

## **ContractualObligations**

##  

The following table is a summary of our contractualcash obligations and commitments outstanding by future payment dates at September 30,2008 (in thousands):

 

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| ** **                                         | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | **Less than 1  year**           | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5  years** | ** ** | **Total** | ** ** |
| Long-term debt, including interest  obligations(a) |       | $                                         | 236,943    |   | $ | 310,292 |   | $ | 324,589 |   | $ | 1,708,066 |   | $ | 2,579,890 |   |
| Operating leases(b)                                |       | 120,984                                   |       | 184,411 |   | 96,366 |   | 57,307 |   | 459,068 |   |
| Purchase obligations(c)                            |       | 35,140                                    |       | 70,530 |   | 19,305 |   | — |   | 124,975 |   |
| Other long-term obligations(d)                     |       | 9,233                                     |       | 16,794 |   | 3,365 |   | 3,553 |   | 32,945 |   |
| Total                                              |       | $                                         | 402,300    |   | $ | 582,027 |   | $ | 443,625 |   | $ | 1,768,926 |   | $ | 3,196,878 |   |

 

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| (a)    | Long-term  debt includes capital leases and future interest payments on debt facilities,  based upon outstanding principal amounts and interest rates as of  September 30, 2008.                                                                                                                                                        |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                         |
| (b)    | In  accordance with GAAP, these obligations are not reflected in the accompanying  consolidated balance sheets. The operating leases do not include executory  costs.                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                         |
| (c)    | Purchase  obligations reflect legally binding agreements entered into by us to purchase  goods that specify minimum quantities to be purchased with variable price  provisions. In accordance with GAAP, these obligations are not reflected in  the accompanying consolidated balance sheets.                                               |
|   |                                                                                                                                                                                                                                                                                                                                         |
| (d)    | Other  long-term obligations principally represent commitments under various  acquisition-related agreements including non-compete, consulting and  severance agreements and deferred compensation arrangements. These  obligations are included in accrued expenses 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, 2008 and 2007, we had nooff-balance sheet financing arrangements other than operating leases incurredin the ordinary course of business, as well as outstanding letters of credit relatedto inventory purchases and self insurance programs, which totaled $12.1 millionand $9.4 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, share-based payments and related 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 netsales in fiscal years 2008, 2007 and 2006.

 

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

##### *** ***

We account for cash consideration received fromvendors under Emerging Issues Task Force, or EITF, Issue No. 02-16, *Accounting by a Customer (Including a Reseller) for CertainConsideration Received from a Vendor*, or EITF 02-16. EITF02-16 states that cash consideration received by a customer is presumed tobe a reduction of the cost of sales unless it is for an asset or service or areimbursement of a specific, incremental, identifiable cost incurred by thecustomer in selling the vendor’s products. The majority of cash considerationwe receive is considered to be a reduction of the cost of sales and isallocated 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 statements of earnings. We recordcash consideration expected to be received from vendors in other receivables.These receivables are recorded at the amount we believe will be collected basedon the provisions of the programs in place and are computed by estimating thepoint in time that we have completed our performance under the agreements andthe amounts earned. These receivables could be significantly affected if actualresults differ from management’s expectations.

 

##### ***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,projected premium costs and the number of plan participants. We review ourliability on a regular basis and adjust our accruals accordingly. As of September 30,2008 and 2007, we accrued an estimated liability relating to employee healthinsurance of $7.1 million and $6.1 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.

 

### *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 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 30,2008 and 2007, our balance sheet included an estimated liability related to thedeductible and retention limits of approximately $16.5 million and $10.7million, 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.

 

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

 

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| ** **                              | ** ** | **Year Ended September 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                    | ** ** | **2007** | ** ** |
| Balance at beginning of period          |       | $                                           | 18,663     |   | $ | 1,955 |   |
| Self-insurance expense                  |       | 46,511                                      |       | 41,723 |   |
|                                    |       |                                        |       |   |   |
| Transfer from Alberto-Culver            |       | —                                      |       | 3,621 |   |
| Payments, net of employee contributions |       | (39,759                                     | )          | (28,636 | ) |
| Balance at end of period                |       | $                                           | 25,415     |   | $ | 18,663 |   |

##### *** ***

##### ***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.

 

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

##### *** ***

Effective October 1, 2005, we adoptedSFAS 123(R) using the modified prospective method. Under this method,compensation expense is recognized for new stock option grants beginning infiscal year 2006 and for the unvested portion of outstanding stock options thatwere granted prior to the adoption of SFAS 123(R). We recognizecompensation expense on a straight-line basis over the vesting period or to thedate a participant becomes eligible for retirement, if earlier. For fiscalyears 2008, 2007 and 2006, total compensation cost charged against income andincluded in selling, general and administrative expenses, for share-basedcompensation arrangements was $10.2 million, $13.1 million and $5.2 million,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, 2008. Our estimates forfuture periods may be based on different assumptions and accordingly maydiffer.

 

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

##### *** ***

On January 1, 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 notnecessarily be indicative of the costs which would be incurred by Sally Beautyas an independent 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.

 

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## **RecentAccounting Pronouncements**

##  

Weare currently assessing any potential effect of the pronouncements discussedbelow on our consolidated financial statements.

 

InJune 2008, the FASB Emerging Issues Task Force reached consensus onEmerging Issues Task Force Issue No. 08-3, *Accounting by Lessees for Nonrefundable Maintenance Deposits*(“EITF 08-3”). Under EITF 08-3, lessees should account for nonrefundablemaintenance deposits as deposit assets if it is probable that maintenanceactivities will occur and the deposit is therefore realizable. Amounts ondeposit that are not probable of being used to fund future maintenanceactivities should be expensed. EITF 08-3 is effective for fiscal yearsbeginning after December 15, 2008. Early application is not permitted.

 

InApril 2008, the FASB issued Staff Position FAS No. 142-3, *Determination of the Useful Life of Intangible Assets* (“FAS142-3”). FAS 142-3 amends the factors that should be considered in developingrenewal or extension assumptions used to determine the useful life of arecognized intangible asset under SFAS No. 142, *Goodwill andOther Intangible Assets* (“SFAS 142”). The objective of theStaff Position is to improve the consistency between the useful life of arecognized intangible asset under SFAS 142 and the period of expected cashflows used to measure the fair value of the asset under SFAS No. 141(Revised 2007): *Business Combinations* (“SFAS 141R”)and other GAAP. FAS 142-3 is effective for fiscal years beginning after December 15,2008. Early application is not permitted.

 

In March 2008, the FASBissued SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133*(“SFAS 161”). SFAS 161 requires companies to provide qualitative disclosuresabout the objectives and strategies for using derivatives, quantitative dataabout the fair value of and gains and losses on derivative contracts, anddetails of credit-risk-related contingent features in their hedgedpositions.  The statement also requirescompanies to disclose more information about the location and amounts ofderivative instruments in financial statements; how derivatives and relatedhedges are accounted for under SFAS 133, *Accounting for DerivativeInstruments and Hedging Activities*; and how the hedges affect theentity’s financial position, financial performance and cash flows. SFAS 161 iseffective for periods beginning after November 15, 2008.

 

In December 2007, theFASB issued SFAS No. 160, *Noncontrolling Interestsin Consolidated Financial Statements, an amendment to ARB No. 51*(“SFAS 160”), which requires, among other things, that the noncontrollinginterest (previously referred to as minority interest) in a consolidatedsubsidiary’s equity be reported as a component of equity separate from theparent’s interest and that net income or loss attributable to thenoncontrolling interest be included in consolidated net income on the face ofthe income statement. In addition, purchases and sales of equity interest thatdo not result in a change in control will be accounted for as equitytransactions and, upon a loss of control, the interest sold, as well as anyinterest retained, will be recorded at fair value with any gain or lossrecognized in earnings. SFAS 160 is effective for annual periods on or after December 15,2008.  Early application is notpermitted.

 

In December 2007, the FASB issued SFAS 141R.Among other things, SFAS 141R generally requires that an acquirer recognize theassets acquired and liabilities assumed measured at their “full fair values” onthe acquisition date. This practice replaces the practice, under predecessorSFAS 141: *Business Combinations,* of allocating thecost of an acquisition to the individual assets acquired and liabilitiesassumed based on their relative estimated fair values.  SFAS 141R further requires thatacquisition-related costs be recognized separately from the related acquisition.SFAS 141R is effective for business combinations consummated in annual periodsbeginning on or after December 15, 2008. Early application is not permitted.

 

In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assets andFinancial Liabilities - including an amendment of FASB Statement No. 115*(“SFAS 159”). SFAS 159 permits entities to choose to measure many financialinstruments and certain other items at fair value that are not currentlyrequired to be measured at fair value, with unrealized gains and losses relatedto these financial instruments reported in earnings at each subsequentreporting date. SFAS 159 is effective for fiscal years beginning after November 15,2007. In September 2008, the FASB and the Securities and ExchangeCommission staff issued joint guidance on issues related to fair value measuresduring the current period of volatile market conditions. On October 10,2008, the FASB issued Staff Position FAS No. 157-3 (“FAS 157-3”), *Determining the Fair Value of a Financial Asset When the Market ForThat Asset Is Not Active*. FAS 157-3 is effective upon issuance.

 

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements* (“SFAS 157”),which defines fair value, establishes a framework for measuring fair valueunder GAAP, and expands disclosures about fair value measurements.SFAS 157 is effective for fiscal years beginning after November 15,2007. In November 2007, the FASB provided a one year deferral for theimplementation of SFAS 157 for other nonfinancial assets and liabilities. In September 2008,the FASB and the Securities and Exchange Commission staff issued joint guidanceon issues related to fair value measures during the current period of volatilemarket conditions.

 

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# **ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

# ** **

As a multinational corporation, we are subject tocertain market risks including foreign currency fluctuations, interest ratesand government actions. We consider a variety of practices to manage thesemarket risks, including, when deemed appropriate, the occasional use ofderivative financial 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 currency exposures at timesoffset each other providing a natural hedge against currency risk. For fiscalyear 2008, 2007 and 2006, approximately 18%, 16% and 11%, respectively, of oursales were made in currencies other than the U.S. dollar. Fluctuations inU.S. dollar exchange rates within the range of the rates for fiscal years2008, 2007 and 2006 did not have a material effect on our financial conditionand results of operations. We currently have no derivative financialinstruments intended to manage foreign currency exchange rate risk.

 

## **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 $1.1 billion of borrowings under the Term Loans andthe ABL facility as of September 30, 2008, a change in the estimatedapplicable interest rate up or down by 1/8% will increase or decrease earningsbefore provision for income taxes by approximately $1.3 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.

 

Effective November 24, 2006, the Company enteredinto four interest rate swap agreements with an aggregate notional amount of$500.0 million. These agreements expire between November 24, 2008 and November 24,2009. The agreements allow us to convert a portion of our variable interestrate obligations to fixed rate obligations with interest rates ranging from7.19% to 7.498%. 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 Part I,“Item 1A. Risk Factors” above, changes in the fair value of these interest rateswap agreements are mainly driven by interest rate changes and will increase ordecrease our net interest expense and may therefore affect our earnings.

 

Effective May 27, 2008, the Company entered intotwo additional interest rate swap agreements with anaggregate notional amount of $300 million (each agreementwith a notional amount of $150 million). These agreements expire on May 31, 2012 and allow us to convert aportion of our variable interest rate obligations to fixed rate obligationswith interest ranging from 5.818% to 6.090%. These agreements are designated as effective hedges, consistent withStatement of Financial Accounting Standards No. 133, *Accountingfor Derivative Instruments and Hedging Activities*(“SFAS 133”).  Adjustments to reflect the change in the fairvalues of these interest rate swap agreements, which areadjusted quarterly, are recorded in accumulated othercomprehensive income until the hedged obligation is settled or the swapagreements expire, whichever is earlier. Any ineffectiveness of these interest rate swaps is recognized in earnings.

 

## **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.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

# ** **

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

 

# **ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE**

# ** **

None.

 

# **ITEM 9A.  CONTROLS AND PROCEDURES**

# ** **

*Background.*  Attached as exhibits to this Form 10-Kare certifications of our Chief Executive Officer (“CEO”) and Chief FinancialOfficer (“CFO”), which are required in accordance with Rule 13a-14 of theExchange Act. This “Controls and Procedures” section includes informationconcerning 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, our legal department and by personnel in our finance organization.The overall goals of these various evaluation activities are to monitor ourdisclosure controls and procedures on an ongoing basis, and to maintain them asdynamic 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 30,2008, 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 the SEC’srules and forms, and that such information is accumulated and communicatedto our management, including our CEO and CFO, as appropriate to allow timelydecisions regarding required disclosure.

 

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*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.

 

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, 2008 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 30,2008 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.

 

*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.  OTHER INFORMATION**

# ** **

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 “AuditCommittee”) is responsible for the appointment, compensation and oversight ofthe work of our independent public accountant. The Audit Committee of SallyBeauty has reviewed the non-audit services provided by KPMG and determined thatthe provision of these services during fiscal year 2008 was compatible withmaintaining KPMG’s independence.**

##  

## ***Pre-Approval Policy.*** The Audit Committee (or its designee, asdescribed below) approved all audit and permissible non-audit fees duringfiscal year 2008.  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 ascheduled Audit Committee meeting. The chairman of the Audit Committee would berequired to report on such pre-approvals at the next scheduled Audit Committeemeeting. As a result, the Audit Committee or its designee has approved 100% ofall services 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 or billed toAlberto-Culver for benefit of Sally Holdings, Inc. with respect to theyears ended September 30, 2008 and 2007 were as follows:**

 
| ** **            | ** ** | **Fiscal Years Ended September 30,** | ** ** |
|-----------------------|------------|----------------------------------------------------------|------------|
| ** **            | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| Audit Fees(1)         |       | $                                                        | 2,293,496  |   | $ | 2,179,000 |   |
| Audit-Related Fees(2) |       | 57,000                                                   |       | 87,500 |   |
| Tax Fees(3)           |       | 33,750                                                   |       | 23,636 |   |
| All Other Fees        |       | —                                                   |       | — |   |
| Total Fees(4)         |       | $                                                        | 2,384,246  |   | $ | 2,290,136 |   |

 

----

| **(1)**    | ** ** | **Aggregate fees billed for  professional services for the audit of annual financial statements as well as  accounting and reporting advisory services related to regulatory filings and  acquisition activities.** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                          |
| **(2)**    | ** ** | **Audit-related fees consist of  fees for audits of Sally Beauty’s employee benefit plans.**                                                                                                                   |
| ** ** | ** ** | ** **                                                                                                                                                                                                          |
| **(3)**    | ** ** | **Tax fees consist of fees for  tax consultation and tax compliance services.**                                                                                                                                     |
| ** ** | ** ** | ** **                                                                                                                                                                                                          |
| **(4)**    | ** ** | **The Audit Committee  pre-approved all fees.**                                                                                                                                                                     |

 

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

###### ** **

# **ITEM 15.  EXHIBITS AND 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 arefiled as part of this Annual 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 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 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 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 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 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 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 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 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                                                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.3                  |       | Certificate  of Incorporation of Sally Capital Inc., which is incorporated by reference to  Exhibit 3.3 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                                                                                                                                                                                        |

 

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| 3.4    |   | By-Laws  of Sally Capital Inc., which is incorporated by reference to Exhibit 3.4  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 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 by reference  from Exhibit 4.1 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 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  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 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 by reference from  Exhibit 4.4 to the Current Report on Form 8- 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 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 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 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 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 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                                                                                                                                                                                                               |

 

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| 4.14   |   | Intercreditor  Agreement, dated as of November 16, 2006, by and between Merrill Lynch  Capital, a division of Merrill Lynch Business Financial Services Inc., 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 by reference from  Exhibit 4.7 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 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 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 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 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 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 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 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 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 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 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 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 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  |   | Form of  Indemnification Agreement with Directors, which is incorporated by reference  from Exhibit 10.1 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on December 7, 2006                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.13  |   | Sally  Beauty Holdings, Inc. Independent Director Compensation Policy, which is  incorporated by reference from Exhibit 10.10 to the Quarterly Report on  Form 10-Q of Sally Beauty Holdings, Inc. filed on February 9,  2007                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.14  |   | Alberto-Culver  Company Employee Stock Option Plan of 2003, which is incorporated by  reference from Exhibit 10.16 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  |   | Alberto-Culver  Company 2003 Stock Option Plan for Non-Employee Directors, which is  incorporated 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                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.16  |   | Alberto-Culver  Company 2003 Restricted Stock Plan, which is incorporated 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,                                                                                                                                                                                                                                                                                                                                     |

 

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|   |   | 2007                                                                                                                                                                                                                                                                                                                                                                              |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.17  |   | Sally  Beauty Holdings, Inc. Annual Incentive Plan, which is incorporated by  reference from Exhibit 10.1 to the Quarterly Report on Form 10-Q of  Sally Beauty Holdings, Inc. filed on May 8, 2008                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.18  |   | Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  by reference from Exhibit 4.4 to the Registration Statement on  Form S-8 of Sally Beauty Holdings, Inc. filed on May 3, 2007                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.19  |   | Form of  Stock Option Agreement for Independent Directors pursuant to the Sally Beauty  Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated by  reference form Exhibit 10.1 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on April 27, 2007                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.20  |   | 2007  Form of Stock Option Agreement for Employees pursuant to the Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  by reference from Exhibit 10.2 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed April 27, 2007                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.21  |   | 2007  Form of Restricted Stock Unit Agreement for Independent Directors  pursuant to the Sally Beauty Holdings, Inc. 2007 Omnibus Incentive Plan,  which is incorporated by reference from Exhibit 10.3 to the Current  Report on Form 8-K of Sally Beauty Holdings, Inc. filed on  April 27, 2007                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.22  |   | 2007  Form of Restricted Stock Agreement for Employees pursuant to the Sally  Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  by reference form Exhibit 10.4 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on April 27, 2007                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.23  |   | 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                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.24  |   | 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                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.25  |   | 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                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.26  |   | 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 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 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*                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 32.1   |   | Section 1350  Certification of Mark J. Flaherty *                                                                                                                                                                                                                                                                                                                            |

 

----

*Included herewith

 

PLEASE NOTE: It is inappropriate for investors toassume the accuracy of any covenants, representations or warranties that may becontained in agreements or other documents filed as exhibits to this AnnualReport on Form 10-K.  In certaininstances the disclosure schedules to such agreements or documents containinformation that modifies, qualifies and creates exceptions to therepresentations, warranties and covenants. Moreover, some of the representationsand warranties may not be complete or accurate as of a particular date becausethey are subject to a contractual standard of materiality that is differentfrom those generally applicable to stockholders and/or were used for thepurpose of allocating risk among the parties rather than establishing certainmatters as facts. Accordingly, you should not rely on the representations andwarranties as characterizations of the actual state of facts at the time theywere made or otherwise.

 

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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 26th day of November, 2008.

 
|   | SALLY HOLDINGS LLC                                                    |
|--------|-----------------------------------------------------------------------|
|   |                                                                  |
|   |                                                                  |
|   | By:                                                                   | /s/ Gary G. Winterhalter |
|   | Gary G. Winterhalter                                                  |
|   | President and Chief  Executive Officer (Principal                     |
|   | Executive Officer) 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)                                        |
|   |                                                                  |
|   |                                                                  |
|   | By:                                                                   | /s/ Janna S. Minton |
|   | Janna S. Minton                                                       |
|   | Vice President, Chief  Accounting Officer and Controller              |
|   | (Principal Accounting  Officer)                                       |

 

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 Holdings, Inc.* |       | November 26, 2008 |
| James G. Berges                          |       |                                                               |       |                   |
| /s/  Kathleen J.  Affeldt      |       | Director of Sally  Holdings, Inc.*                            |       | November 26, 2008 |
| Kathleen J. Affeldt                      |       |                                                               |       |                   |
| /s/  Marshall E.  Eisenberg    |       | Director of Sally  Holdings, Inc.*                            |       | November 26, 2008 |
| Marshall E. Eisenberg                    |       |                                                               |       |                   |
| /s/  Kenneth A.  Giuriceo      |       | Director of Sally  Holdings, Inc.*                            |       | November 26, 2008 |
| Kenneth A. Giuriceo                      |       |                                                               |       |                   |
| /s/  Robert R.  McMaster       |       | Director of Sally  Holdings, Inc.*                            |       | November 26, 2008 |
| Robert R. McMaster                       |       |                                                               |       |                   |
| /s/  Walter  Metcalfe          |       | Director of Sally  Holdings, Inc.*                            |       | November 26, 2008 |
| Walter Metcalfe                          |       |                                                               |       |                   |
| /s/  John A.  Miller           |       | Director of Sally  Holdings, Inc.*                            |       | November 26, 2008 |
| John A. Miller                           |       |                                                               |       |                   |
| /s/  Martha  Miller de Lombera |       | Director of Sally  Holdings, Inc.*                            |       | November 26, 2008 |
| Martha Miller de Lombera                 |       |                                                               |       |                   |
| /s/  Edward W.  Rabin          |       | Director of Sally  Holdings, Inc.*                            |       | November 26, 2008 |
| Edward W. Rabin                          |       |                                                               |       |                   |
| /s/  Richard J.  Schnall       |       | Director of Sally  Holdings, Inc.*                            |       | November 26, 2008 |
| Richard J. Schnall                       |       |                                                               |       |                   |

 

----

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

 

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

###### ** **

Financial StatementsYears ended September 30, 2008, 2007 and 2006

 

###### **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, 2008 and 2007                                                                       |       | F-4      |       |
| Consolidated Statements of Earnings for the  years ended September 30, 2008, 2007 and 2006                                           |       | F-5      |       |
| Consolidated Statements of Cash Flows for  the years ended September 30, 2008, 2007 and 2006                                         |       | F-6      |       |
| Consolidated Statements of  Member’s/Stockholder’s (Deficit) Equity for the years ended  September 30, 2008, 2007 and 2006 |       | F-7      |       |
| Notes to Consolidated Financial Statements  for the years ended September 30, 2008, 2007 and 2006                                    |       | F-8      |       |

 

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

##  

The Board of Directors

Sally Beauty Holdings, Inc.:

 

Wehave audited Sally Holdings LLC’s internal control over financial reporting asof September 30, 2008, based on criteria established in *Internal Control–Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO).  Sally Holdings LLC’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting, included in the accompanying Management’s Annual Report on InternalControl over Financial Reporting.  Ourresponsibility is to express an opinion on the Company’s internal control overfinancial reporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether effective internal control over financialreporting was maintained in all material respects.  Our audit included obtaining an understandingof internal control over financial reporting, assessing the risk that amaterial weakness exists, and testing and evaluating the design and operatingeffectiveness of internal control based on the assessed risk.  Our audit also included performing such otherprocedures as we considered necessary in the circumstances.  We believe that our audit provides areasonable basis for our opinion.

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal control over financial reporting includes thosepolicies and procedures that (1) pertain to the maintenance of recordsthat, in reasonable 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 generally accepted accounting principles,and that receipts and expenditures of the company are being made only inaccordance with authorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

Inour opinion, Sally Holdings LLC maintained, in all material respects, effectiveinternal control over financial reporting as of September 30, 2008, basedon criteria established in *Internal Control–IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission.

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofSally Holdings LLC (prior to November 16, 2006, Sally Holdings, Inc.)and subsidiaries as of September 30, 2008 and 2007, and the relatedconsolidated statements of earnings, cash flows and member’s/stockholder’s(deficit) equity for each of the years in the three-year period ended September 30,2008, and our report dated November 25, 2008 expressed an unqualifiedopinion on those consolidated financial statements.

 

 
| /s/  KPMG LLP           |   |
|-------------------------|--------|
|                    |   |
| KPMG  LLP               |   |
| Dallas,  Texas          |   |
| November 25,  2008 |   |

 

F-1

----

Table of Contents

 

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

##  

The Board of Directors

Sally Beauty Holdings, Inc.:

 

Wehave audited the accompanying consolidated balance sheets of Sally Holdings LLC(prior to November 16, 2006, Sally Holdings, Inc.) and subsidiariesas of September 30, 2008 and 2007, and the related consolidated statementsof earnings, cash flows and member’s/stockholder’s (deficit) equity for each ofthe years in the three-year period ended September 30, 2008.  These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimates madeby management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Sally Holdings LLCand subsidiaries as of September 30, 2008 and 2007, and the results oftheir operations and their cash flows for each of the years in the three-yearperiod ended September 30, 2008, in conformity with U.S. generallyaccepted accounting principles.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), Sally Holdings LLC’s internalcontrol over financial reporting as of September 30, 2008, based oncriteria established in *Internal Control–IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO), and our report dated November 25, 2008expressed an unqualified opinion on the effectiveness of the Company’s internalcontrol over financial reporting.

 

/s/KPMG LLP

 

KPMGLLP

Dallas,Texas

November 25,2008

 

F-2

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Table of Contents

 

## **ConsolidatedFinancial Statements**

##  

The following consolidated balance sheets as of September 30,2008 and 2007 and the financial statements for the fiscal years ended September 30,2008 and 2007 are those of Sally Holdings LLC (“Sally Holdings” or the “Company”)and its consolidated subsidiaries. The financial statements for the fiscal yearended September 30, 2006 are those of Sally Holdings, Inc. and itsconsolidated subsidiaries. Sally Holdings, Inc. was a wholly-ownedsubsidiary of Alberto-Culver Company (“Alberto-Culver”) until November 16,2006 when it was converted to a Delaware limited liability company, was renamed“Sally Holdings LLC” and became an indirect wholly-owned subsidiary of SallyBeauty Holdings, Inc. (“Sally Beauty”) in connection with the separationof our business from Alberto-Culver. Sally Beauty was formed on June 16, 2006 in connection with theseparation of our business from Alberto-Culver. Sally Capital Inc. (“SallyCapital”) is a wholly-owned subsidiary of Sally Holdings and does not have anyassets or operations of any kind.

 

F-3

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Table of Contents

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

#### Consolidated Balance Sheets

September 30, 2008 and 2007

(In thousands)

 
| ** **                                                                                                                               | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Assets**                                                                                                                               |       |       |       |       |       |
| Current assets:                                                                                                                          |       |       |       |       |       |
| Cash and cash equivalents                                                                                                                |       | $          | 99,788     |       | $          | 38,272 |   |
| Trade accounts receivable, less allowance  for doubtful accounts of $2,702 and $2,564 at September 30, 2008 and  2007, respectively |       | 44,481     |       | 51,409     |       |
| Other receivables                                                                                                                        |       | 21,596     |       | 22,194     |       |
| Inventories                                                                                                                              |       | 598,195    |       | 569,404    |       |
| Prepaid expenses                                                                                                                         |       | 19,449     |       | 15,375     |       |
| Deferred income tax assets                                                                                                               |       | 20,772     |       | 15,291     |       |
| Total current assets                                                                                                                     |       | 804,281    |       | 711,945    |       |
| Property and equipment, net of accumulated  depreciation of $243,185 and $215,826 at September 30, 2008 and 2007,  respectively     |       | 156,260    |       | 154,068    |       |
| Goodwill                                                                                                                                 |       | 424,963    |       | 406,623    |       |
| Intangible assets, net of accumulated  amortization of $18,203 and $11,904 at September 30, 2008 and 2007,  respectively            |       | 85,434     |       | 70,505     |       |
| Other assets                                                                                                                             |       | 54,720     |       | 61,120     |       |
| Total assets                                                                                                                             |       | $          | 1,525,658  |       | $          | 1,404,261 |   |
| **Liabilities and Member’s Deficit**                                                                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                     |       |       |       |       |       |
| Current maturities of long-term debt                                                                                                     |       | $          | 100,601    |       | $          | 17,147 |   |
| Accounts payable                                                                                                                         |       | 171,962    |       | 176,660    |       |
| Accrued expenses                                                                                                                         |       | 154,529    |       | 153,671    |       |
| Income taxes                                                                                                                             |       | 11,386     |       | 3,712      |       |
| Due to Sally Beauty                                                                                                                      |       | 17,243     |       | 18,864     |       |
| Total current liabilities                                                                                                                |       | 455,721    |       | 370,054    |       |
| Long-term debt                                                                                                                           |       | 1,724,684  |       | 1,758,594  |       |
| Other liabilities                                                                                                                        |       | 23,708     |       | 18,828     |       |
| Deferred income tax liabilities                                                                                                          |       | 37,941     |       | 30,553     |       |
| Total liabilities                                                                                                                        |       | 2,242,054  |       | 2,178,029  |       |
| Stock options subject to redemption                                                                                                      |       | 5,884      |       | 6,549      |       |
| Member’s deficit:                                                                                                                   |       |       |       |       |       |
| Member’s deficit                                                                                                                    |       | (730,969   | )          | (814,839   | )          |
| Accumulated other comprehensive income                                                                                                   |       | 8,689      |       | 34,522     |       |
| Total member’s deficit                                                                                                              |       | (722,280   | )          | (780,317   | )          |
| Total liabilities and member’s deficit                                                                                              |       | $          | 1,525,658  |       | $          | 1,404,261 |   |

 

The accompanying notes to consolidated financial statements are anintegral part of these financial statements.

 

F-4

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Table of Contents

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

#### ConsolidatedStatements of Earnings

Years ended September 30, 2008, 2007 and 2006

(In thousands)

 
| ** **                                         | ** ** | **2008**  | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|----------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Net sales                                          |       | $         | 2,648,191  |      | $          | 2,513,772 |       | $ | 2,373,100 |   |
| Cost of products sold and distribution  expenses   |       | 1,413,597 |       | 1,360,025 |       | 1,286,329 |       |
| Gross profit                                       |       | 1,234,594 |       | 1,153,747 |       | 1,086,771 |       |
| Selling, general and administrative  expenses      |       | 895,632   |       | 850,159   |       | 798,211   |       |
| Depreciation and amortization                      |       | 48,533    |       | 42,605    |       | 38,032    |       |
| Sales-based service fee charged by  Alberto-Culver |       | —    |       | 3,779     |       | 28,852    |       |
| Transaction expenses                               |       | —    |       | 21,502    |       | 41,475    |       |
| Operating earnings                                 |       | 290,429   |       | 235,702   |       | 180,201   |       |
| Interest expense, net (a)                          |       | 158,897   |       | 145,972   |       | 92        |       |
| Earnings before provision for income taxes         |       | 131,532   |       | 89,730    |       | 180,109   |       |
| Provision for income taxes                         |       | 48,664    |       | 41,169    |       | 69,916    |       |
| Net earnings                                       |       | $         | 82,868     |      | $          | 48,561    |       | $ | 110,193 |   |

 

----

(a)                                  Interest expense is net of interest income of$0.7 million, $1.7 million and $1.8 million for the fiscal year ended September 30,2008, 2007 and 2006, respectively.

 

The accompanying notes to consolidated financial statements are anintegral part of these financial statements.

 

F-5

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Table of Contents

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

#### ConsolidatedStatements of Cash Flows

Years ended September 30, 2008, 2007 and 2006

(In thousands)

 
| ** **                                                                                                                         | ** ** | **2008** | ** ** | **2007**   | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|------------|------------|----------|------------|
| **Cash Flows from Operating Activities:**                                                                                          |       |     |       |       |       |     |       |
| Net earnings                                                                                                                       |       | $        | 82,868     |       | $          | 48,561   |       | $ | 110,193 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities:                                               |       |     |       |       |       |     |       |
| Depreciation and amortization                                                                                                      |       | 48,533   |       | 42,605     |       | 38,032   |       |
| Share-based compensation expense (net of  deferred tax benefit of $2,268, $4,794 and $1,815 in 2008, 2007 and 2006,  respectively) |       | 7,346    |       | 7,473      |       | 3,371    |       |
| Amortization of deferred financing costs                                                                                           |       | 8,469    |       | 7,407      |       | —   |       |
| Excess tax benefit from share-based  compensation                                                                                  |       | (451     | )          | (780       | )          | —   |       |
| Net loss on disposal of leaseholds and  other property                                                                             |       | 116      |       | 1,820      |       | 1,615    |       |
| Deferred income taxes                                                                                                              |       | 3,013    |       | 3,718      |       | 2,360    |       |
| Changes in (exclusive of effects of  acquisitions):                                                                                |       |     |       |       |       |     |       |
| Trade accounts receivable                                                                                                          |       | 7,629    |       | 2,297      |       | (2,324   | )          |
| Other receivables                                                                                                                  |       | (58      | )          | 359        |       | (1,468   | )          |
| Inventories                                                                                                                        |       | (29,527  | )          | 40,035     |       | (40,859  | )          |
| Prepaid expenses                                                                                                                   |       | (4,599   | )          | (2,153     | )          | 1,237    |       |
| Other assets                                                                                                                       |       | 61       |       | (1,005     | )          | (242     | )          |
| Accounts payable and accrued expenses                                                                                              |       | (11,200  | )          | 24,427     |       | 38,443   |       |
| Income taxes                                                                                                                       |       | 5,394    |       | 2,136      |       | —   |       |
| Due from Alberto-Culver                                                                                                            |       | —   |       | 463        |       | 13,017   |       |
| Due to Sally Beauty                                                                                                                |       | (11,900  | )          | 5,619      |       | —   |       |
| Other liabilities                                                                                                                  |       | 5,721    |       | 11,285     |       | (6,654   | )          |
| Net cash provided by operating activities                                                                                          |       | 111,415  |       | 194,267    |       | 156,721  |       |
|                                                                                                                               |       |     |       |       |       |     |       |
| **Cash Flows from Investing Activities:**                                                                                          |       |     |       |       |       |     |       |
| Capital expenditures                                                                                                               |       | (45,576  | )          | (53,345    | )          | (30,342  | )          |
| Proceeds from sale of property and  equipment                                                                                      |       | 288      |       | 8,395      |       | 596      |       |
| Acquisitions, net of cash acquired                                                                                                 |       | (52,874  | )          | (76,414    | )          | (22,412  | )          |
| Net cash used by investing activities                                                                                              |       | (98,162  | )          | (121,364   | )          | (52,158  | )          |
|                                                                                                                               |       |     |       |       |       |     |       |
| **Cash Flows from Financing Activities:**                                                                                          |       |     |       |       |       |     |       |
| Change in book cash overdraft                                                                                                      |       | 1,633    |       | (6,515     | )          | (10,269  | )          |
| Proceeds from issuance of long-term debt                                                                                           |       | 527,735  |       | 2,204,625  |       | 571      |       |
| Repayments of long-term debt                                                                                                       |       | (482,685 | )          | (430,012   | )          | (826     | )          |
| Proceeds related to notes with affiliated  companies                                                                               |       | —   |       | —     |       | 15,230   |       |
| Payments related to notes with affiliated companies                                                                                |       | —   |       | —     |       | (31,880  | )          |
| Debt issuance costs                                                                                                                |       | —   |       | (58,541    | )          | —   |       |
| Excess tax benefit from share-based  compensation                                                                                  |       | 451      |       | 780        |       | —   |       |
| Distributions to Sally Beauty                                                                                                      |       | —   |       | (1,809,740 | )          | —   |       |
| Distributions to Alberto-Culver                                                                                                    |       | —   |       | (44,411    | )          | (5,661   | )          |
| Excess tax benefit from exercises of  Alberto-Culver stock options                                                                 |       | —   |       | —     |       | 630      |       |
| Net cash provided (used) by financing  activities                                                                                  |       | 47,134   |       | (143,814   | )          | (32,205  | )          |
| Effect of foreign exchange rate changes on  cash and cash equivalents                                                              |       | 1,129    |       | 1,612      |       | (3,399   | )          |
| Net (decrease) increase in cash and cash  equivalents                                                                              |       | 61,516   |       | (69,299    | )          | 68,959   |       |
| Cash and cash equivalents, beginning of  year                                                                                      |       | 38,272   |       | 107,571    |       | 38,612   |       |
| Cash and cash equivalents, end of year                                                                                             |       | $        | 99,788     |       | $          | 38,272   |       | $ | 107,571 |   |
|                                                                                                                               |       |     |       |       |       |     |       |
| **Supplemental Cash Flow Information:**                                                                                            |       |     |       |       |       |     |       |
| Cash paid for:                                                                                                                     |       |     |       |       |       |     |       |
| Interest                                                                                                                           |       | $        | 149,842    |       | $          | 111,336  |       | $ | 2,339 |   |
| Income taxes                                                                                                                       |       | $        | 6,432      |       | $          | 5,197    |       | $ | 63,922 |   |

 

The accompanying notes to consolidated financial statements are anintegral part of these financial statements.

 

F-6

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Table of Contents

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

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

Years ended September 30, 2008, 2007 and 2006

(In thousands)

 
| ** **                                                  | ** ** | **Number of  Shares**     | ** ** | **Dollars**                      | ** ** |
|-------------------------------------------------------------|------------|--------------------------------|------------|----------------------------------|------------|
| ** **                                                  | ** ** | **Common  Stock  Outstanding** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  (Deficit)  Earnings** | ** ** | **Member’s  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total  Member’s  Deficit** | ** ** |
| Balance at  September 30, 2005                         |       | 1                              |       | $                                | 63,884     |   | $ | 822,980 |   | $ | — |   | $ | 13,432 |   | $ | 900,296 |   |
| Net earnings                                                |       | —                         |       | —                           |       | 110,193 |   | — |   | — |   | 110,193 |   |
| Foreign currency  translation                               |       | —                         |       | —                           |       | — |   | — |   | 2,851 |   | 2,851 |   |
| Total  comprehensive income                                 |       |                           |       |                             |       |   |   |   |   |   |   | 113,044 |   |
| Tax benefit from  exercises of Alberto-Culver stock options |       | —                         |       | 630                              |       | — |   | — |   | — |   | 630 |   |
| Distributions to  Alberto-Culver                            |       |                           |       | —                           |       | (5,661 | ) | — |   | — |   | (5,661 | ) |
| Vesting of  share-based compensation                        |       |                           |       | 5,186                            |       | — |   | — |   | — |   | 5,186 |   |
| Stock options  subject to redemptions                       |       | —                         |       | (7,528                           | )          | — |   | — |   | — |   | (7,528 | ) |
| 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 |       | —                         |       | —                           |       | — |   | — |   | 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 | ) |
|                                                             |            |                                |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Priorto November 16, 2006, Alberto-Culver owned all shares of issued andoutstanding common stock of Sally Holdings, Inc. Since November 16,2006, all member units of Sally Holdings LLC have been owned by SallyInvestment, a wholly-owned subsidiary of Sally Beauty.

 

The accompanying notes to consolidated financial statements are an integralpart of these financial statements.

 

F-7

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Table of Contents

 

Sally Holdings LLC and 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, Mexico, Canada, Japan, the UnitedKingdom and certain other countries in Europe. Additionally, the Companydistributes professional beauty products to salons and professionalcosmetologists through its Beauty Systems Group (“BSG”) store operations and acommissioned direct sales force that calls on salons in the U.S., Canada, theUnited Kingdom and certain other countries in Europe, and to franchises in thesouthern and southwestern U.S. and in Mexico through the operations of itssubsidiary Armstrong McCall, L.P. (“Armstrong McCall”). Certain beauty productssold by BSG and Armstrong McCall are sold through exclusive territoryagreements 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 Holdings was a wholly-owned subsidiary ofAlberto-Culver until November 16, 2006, when it was converted to aDelaware limited liability company, was renamed “Sally Holdings LLC,” andbecame an indirect wholly-owned subsidiary of Sally Beauty. Sally Beauty wasformed on June 16, 2006, and became the accounting successor company toSally Holdings, Inc. upon the completion 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**

##  

### *Principlesof Consolidation*

###  

Theseconsolidated financial statements include the Company and its subsidiaries. Allsignificant intercompany accounts and transactions have been eliminated in theconsolidated financial statements.

 

### *Reclassifications*

###  

Certainamounts for prior periods have been reclassified to conform to the current year’spresentation.

 

### *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.

 

F-8

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Table of Contents

 

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 $6.8 million and $10.9 million at September 30,2008 and 2007, 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 30,2008 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; and a liability of approximately $3.0 million at September 30,2007 included in other liabilities. Fair value amounts reported for the swapagreements are based on third-party information and were determined usingproprietary models based upon well-recognized financial principles and reasonableestimates about relevant future market conditions.

 

The fair value of the Company’s long-term borrowingswas approximately $1,676.1 million and $1,759.3 million at September 30,2008 and 2007. 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 Statement of Financial Accounting Standards (“SFAS”) No. 133, *Accounting for Derivative Instruments and Hedging Activities*,as amended (“SFAS 133”). The Company does not purchase or hold any derivativeinstruments for speculative or trading purposes. Certain interestrate swap agreements owned by the Company at September 30,2008 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 SFAS 133, is recognized in net interest expense in the consolidatedstatements of earnings. Certain other interestrate swap agreements owned by the Company at September 30,2008 are not designated as hedges and adjustments to reflect changes in theirfair values, which are adjusted quarterly, arerecorded in net interest expense.

 

### *Concentration of Credit Risk*

###  

Financial instruments that potentially expose theCompany to concentration of credit risk consist primarily of investments incash equivalents and accounts receivable. The Company invests from time to timein securities 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 onhistorical collection data and current customer information. Account balancesare charged against the allowance after all means of collection have beenexhausted and the potential 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.

 

F-9

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Table of Contents

 

Sally Holdings LLC and 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 2008, 2007 and 2006.

 

### *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 annually, and whenever events or changes in circumstances indicateit is more likely than not that the fair value of a reporting unit is less thanits carrying amount. Management considers whether there has been a permanentimpairment to the value of goodwill and other intangibles by evaluating ifvarious factors, including current operating results, anticipated futureresults and cash flows, and market and economic conditions, indicate possibleimpairment. Based on the annual reviews performed, after taking into accountthe recent economic downturn in certain geographies in which we operate, therewas no impairment in the current or prior 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 toten years. The weighted average amortization period is approximatelyfour years.

 

F-10

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

### *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.

 

### *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 oftheir net present value, while healthcare plan liabilities are not discounted.These estimates are reviewed on a regular basis to ensure that the recordedliability is adequate. The Company believes the amounts accrued at September 30,2008 and 2007 are adequate, although actual losses may differ from the amountsprovided.

 

### *Advertising Costs*

###  

Advertising costs relate mainly to print, radio andtelevision advertisements and trade shows and are expensed either as incurredor the first time the advertisement is run. Advertising costs wereapproximately $50.6 million, $49.2 million and $49.1 million in the fiscalyears ended September 30, 2008, 2007 and 2006, respectively, and areincluded in selling, general and administrative expenses in the consolidatedstatements of earnings.

 

### *Vendor Rebates and Concessions*

###  

The Company accounts for cash consideration receivedfrom vendors under Emerging Issues Task Force (“EITF”) Issue No. 02-16, *Accounting by a Customer (Including a**Reseller) for Certain Consideration Received from aVendor* (“EITF 02-16”)*.*EITF 02-16 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 SFAS No. 109, *Accounting forIncome Taxes* (“SFAS 109”).Under SFAS 109 deferred income taxes are recognized for the estimated futuretax consequences attributable to temporary differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichtemporary differences are estimated to be recovered or settled. The effect ondeferred taxes of a change in tax rates is recognized in the consolidatedstatements of earnings in the period of enactment. A valuation allowance isrecorded to reduce the carrying amounts of deferred tax assets to the amountexpected to be realized unless it is more-likely-than-not that such assets willbe realized in full.  The estimated taxbenefit of an uncertain tax position is recorded in our financial statementsonly after determining a more-likely-than-not probability that the uncertain taxposition will withstand challenge, if any, from applicable taxing authorities.

 

Effective October 1, 2007, the Company adoptedthe provisions of Financial Accounting Standards Board Interpretation No. 48,*Accounting for Uncertainty in Income Taxes,*an interpretation of SFAS 109 (“FIN 48”). The adoption of FIN 48 did notrequire a change to the Company’s liability for unrecognized tax benefits andhad no impact on the Company’s opening balance of retained deficit.  Please see 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/stockholder’s equity. Foreigncurrency transaction gains or

 

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

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 customer consummatesa point of sale transaction in a store. The cost of sales incentive programs,such as customer and consumer coupons, are recognized as a reduction of revenueat 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 sales returns and cash discounts are made at the time the salesare recorded. Sales returns and allowances averaged approximately 2.3% of netsales 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,general and administrative expenses in the consolidated statements of earningsand amounted to $35.8 million, $38.3 million and $41.9 million for thefiscal years 2008, 2007 and 2006, respectively.

 

### *Share-BasedCompensation*

###  

The Company accounts for stock option and stock awards,which include share-based payment plans of Sally Beauty in accordance withSFAS 123 (Revised 2004), *Share-BasedPayment*(“SFAS 123(R)”).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.

 

Effective October 1, 2005, the Company adoptedSFAS 123(R) using the modified prospective method. Under this method,compensation expense related to stock options granted to the Company employeeswas recognized for new stock option grants beginning in fiscal year 2006 andfor the unvested portion of outstanding stock options that were granted priorto the adoption of SFAS 123(R).

 

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 of member’s/stockholder’sequity (deficit). Share-based compensation plans that were previously underAlberto-Culver stock option plans granted stock options to Company employeeswith a contingent cash settlement provision upon the occurrence of certainchange in control events. As such, the contingent cash settlement of the stockoptions as a result of such event would not be solely in the control of theCompany or Alberto-Culver. In accordance with ASR 268, the Company reported$5.9 million and $6.5 million in “Stock options subject to redemption”outside of member’s/stockholder’s equity (deficit) on its consolidated balancesheet as of September 30, 2008 and 2007, respectively. This amount will bereclassified into due to Sally Beauty in future periods as the related stockoptions are exercised or canceled or otherwise terminated.

 

### *Comprehensive income*

##### *** ***

##### ***Comprehensive income reflects changes instockholders’ (deficit) equity from sources other than transactions withstockholders and, as such, include net earnings and certain other specifiedcomponents. The Company’s only components of comprehensive income, other thannet earnings, are the cumulative foreign currency translation adjustments anddeferred gains (losses) on certain interest rate swap agreements.***

##### *** ***

### *Recent Accounting Pronouncements*

##  

Weare currently assessing any potential effect of the pronouncements discussedbelow on our consolidated financial statements.

 

InJune 2008, the Emerging Issues Task Force reached consensus on EmergingIssues Task Force Issue No. 08-3, *Accountingby Lessees for Nonrefundable Maintenance Deposits* (“EITF 08-3”).Under EITF 08-3, lessees should account for nonrefundable

 

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

maintenancedeposits as deposit assets if it is probable that maintenance activities willoccur and the deposit is therefore realizable. Amounts on deposit that are notprobable of being used to fund future maintenance activities should beexpensed. EITF 08-3 is effective for fiscal years beginning after December 15,2008. Early application is not permitted.

 

InApril 2008, the FASB issued Staff Position FAS No. 142-3, *Determination of the Useful Life of Intangible Assets* (“FAS142-3”). FAS 142-3 amends the factors that should be considered in developingrenewal or extension assumptions used to determine the useful life of arecognized intangible asset under SFAS No. 142, *Goodwill andOther Intangible Assets* (“SFAS 142”). The objective of theStaff Position is to improve the consistency between the useful life of arecognized intangible asset under SFAS 142 and the period of expected cashflows used to measure the fair value of the asset under SFAS No. 141(Revised 2007): *Business Combinations* (“SFAS 141R”)and other GAAP. FAS 142-3 is effective for fiscal years beginning after December 15,2008. Early application is not permitted.

 

In March 2008, the FASBissued SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133*(“SFAS 161”). SFAS 161 requires companies to provide qualitative disclosuresabout the objectives and strategies for using derivatives, quantitative dataabout the fair value of and gains and losses on derivative contracts, anddetails of credit-risk-related contingent features in their hedgedpositions.  The statement also requirescompanies to disclose more information about the location and amounts ofderivative instruments in financial statements; how derivatives and relatedhedges are accounted for under SFAS 133, *Accounting for DerivativeInstruments and Hedging Activities*; and how the hedges affect theentity’s financial position, financial performance and cash flows. SFAS 161 iseffective for periods beginning after November 15, 2008.

 

In December 2007, theFASB issued SFAS No. 160, *Noncontrolling Interestsin Consolidated Financial Statements, an amendment to ARB No. 51*(“SFAS 160”), which requires, among other things, that the noncontrollinginterest (previously referred to as minority interest) in a consolidated subsidiary’sequity be reported as a component of equity separate from the parent’s interestand that net income or loss attributable to the noncontrolling interest beincluded in consolidated net income on the face of the income statement. Inaddition, purchases and sales of equity interest that do not result in a changein control will be accounted for as equity transactions and, upon a loss ofcontrol, the interest sold, as well as any interest retained, will be recordedat fair value with any gain or loss recognized in earnings. SFAS 160 iseffective for annual periods beginning on or after December 15, 2008.  Early application is not permitted.

 

In December 2007, the FASB issued SFAS 141R, *Business Combinations (“SFAS 141R”)*. Among other things,SFAS 141R generally requires that an acquirer recognize the assets acquired andliabilities assumed measured at their “full fair values” on the acquisitiondate. This practice replaces the practice, under predecessor SFAS 141: *Business Combinations,* of allocating the cost of anacquisition to the individual assets acquired and liabilities assumed based ontheir relative estimated fair values. SFAS 141R further requires that acquisition-related costs be recognizedseparately from the related acquisition. SFAS 141R is effective for businesscombinations consummated in annual periods beginning on or after December 15,2008.  Early application is notpermitted.

 

In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assets andFinancial Liabilities - including an amendment of FASB Statement No. 115*(“SFAS 159”). SFAS 159 permits entities to choose to measure many financialinstruments and certain other items at fair value that are not currentlyrequired to be measured at fair value, with unrealized gains and losses relatedto these financial instruments reported in earnings at each subsequentreporting date. SFAS 159 is effective for fiscal years beginning after November 15,2007. In September 2008, the FASB and the Securities and Exchange Commissionstaff issued joint guidance on issues related to fair value measures during thecurrent period of volatile market conditions. On October 10, 2008, theFASB issued Staff Position FAS No. 157-3 (“FAS 157-3”), *Determining the Fair Value of a Financial Asset When the Market ForThat Asset Is Not Active*. FAS 157-3 is effective upon issuance.

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*, (“SFAS 157”), which defines fairvalue, establishes a framework for measuring fair value under GAAP, and expandsdisclosures about fair value measurements. SFAS 157, as it relates tofinancial instruments, is effective for fiscal years beginning after November 15,2007. In November 2007, the FASB provided a one year deferral for theimplementation of SFAS 157 for other nonfinancial assets and liabilities. In September 2008,the FASB and the Securities and Exchange Commission staff issued joint guidanceon issues related to fair value measures during the current period of volatilemarket conditions.

 

## **3.  Regis Merger Negotiations and the Separation Transactions**

##  

In January 2006, Alberto-Culver entered into anagreement with Regis Corporation (“Regis”) to merge Sally Holdings Inc. with asubsidiary of Regis in a tax-free transaction. Pursuant to the terms andconditions of the merger agreement, Sally Holdings, Inc. was to be spunoff to Alberto-Culver’s stockholders by way of a tax-free distribution and,immediately thereafter, combined with Regis in a tax-free stock-for-stockmerger. In April 2006, Alberto-Culver and Regis terminated the mergernegotiations. In connection with the termination of the proposed mergertransaction, Alberto-Culver and the Company incurred transaction expenses,primarily the

 

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

termination fee paid to Regis and legal and investmentbanking fees, during fiscal years 2005 and 2006. The total amount oftransaction expenses, including the termination fee, was approximately$41.5 million ($27.2 million after taxes), which was expensed by theCompany in fiscal year 2006. All transaction related expenses were deducted fortax purposes.

 

In June 2006, Alberto-Culver announced a plan tosplit its beauty supply distribution business from its consumer productsbusiness. On November 16, 2006, the Company separated from Alberto-Culver,pursuant to the Investment Agreement. As a result, Sally Beauty owns andoperates, through the Company, the Sally Beauty Supply and BSG distributionbusinesses that were previously owned and operated by Alberto-Culver, andAlberto-Culver continues to own and operate its consumer products business. TheCompany and certain subsidiaries incurred approximately $1,850.0 million of newdebt in connection with the Separation Transactions. In addition, pursuant tothe Investment Agreement: (i) the Company became an indirect wholly-ownedsubsidiary of Sally Beauty; (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 SallyBeauty. Upon closing of the Separation Transactions, the Company made adistribution to Sally Beauty of approximately $1,809.7 million, which wasfunded primarily from the issuance of new debt. Also upon closing of theSeparation Transactions, Alberto-Culver stockholders received, for each shareof Alberto-Culver common stock then owned: (i) one share of common stockof New Alberto-Culver, which owns and operates Alberto-Culver’s consumerproducts business; (ii) one share of common stock of Sally Beauty; and (iii) a$25.00 per share special cash dividend.

 

Pursuant to the Investment Agreement, Sally Beauty andthe Company paid approximately $1.1 million to CDRS and approximately $20.4million to Alberto-Culver for merger and transactions expenses incurred inconnection with the Separation Transactions. Most expenses related to theSeparation Transactions are not expected to be deductible for tax purposes. TheCompany also paid approximately $58.5 million in fees for the debt financingincurred in connection with the separation, which were recorded on theconsolidated balance sheet as other assets.

 

On November 16, 2006, pursuant to the terms of aseparation agreement entered into in connection with the SeparationTransactions, all cash, cash equivalents and short-term investments of theCompany and its subsidiaries was transferred to Alberto-Culver other than $91.1million, equal to the sum of $52.7 million plus an additional amount equalto $38.4 million. The additional amount is the sum of (i) an estimate ofthe amount needed to cover certain income taxes (as specified in a taxallocation agreement entered into in connection with the SeparationTransactions); (ii) an amount determined pursuant to a formula intended toreflect the limitations placed on the number of shares of Sally Beauty thatCDRS may acquire in order not to jeopardize the intended tax-free nature of theshare distribution; and (iii) unpaid balances on certain specifiedliabilities of the Company, minus other specified transaction costs. In fiscalyears 2007 and 2008, the Company made adjustments in connection with thereconciliation of tax balances transferred to the Company in connection withthe Separations Transactions.  Thisamount was included in the settlement of intercompany agreements withAlberto-Culver, as an adjustment to the Company’s member’s deficit.

 

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 (otherthan trade payables and the Company’s portion of the transaction expensesdescribed above) between the Company or any of its subsidiaries, on the onehand, and Alberto-Culver or any of its subsidiaries (other than the Company andits subsidiaries), on the other hand, were canceled prior to completion of theSeparation Transactions. In addition, prior thereto, all intercompanyagreements between the Company or any of its subsidiaries and Alberto-Culver orany of its subsidiaries were terminated, other than certain agreementsspecifically designated in the Separation Agreement to survive following thetransactions.

 

In addition, upon completion of the transactionseparating us from Alberto-Culver, Michael H. Renzulli, former Chairman ofSally Holdings, Inc., terminated his employment with Alberto-Culver andthe Company. The Company provided Mr. Renzulli with certain benefitsprimarily consisting of a lump-sum cash payment of $3.6 million within30 days after completion of the transactions. The Company expensed thecash payment at the time of completion of the transactions.

 

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.

 

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

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

 

At September 30, 2006 the additional paid-incapital and the retained earnings were part of the stockholder’s equity ofSally Holdings, Inc. and its subsidiaries. On November 16, 2006, in connection with the SeparationTransactions and the Limited Liability Company Agreement of Sally Holdings LLCentered into by Alberto-Culver, Sally Holdings, Inc. contributed itsstockholder’s equity to Sally Holdings LLC, thereby converting stockholder’sequity 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 of the Company have been granted stockoptions and share awards under the plans of Sally Beauty.

 

The Company accounts for stock option and stock awardplans, which we refer to as share-based payment plans, in accordance withSFAS 123(R). Accordingly, the Company measures the cost of employeeservices received in exchange for an award of equity instruments based on thegrant-date fair value of the award and recognizes compensation expense on astraight-line basis over the vesting period or to the date a participantbecomes eligible for retirement, if earlier. During fiscal year 2007, SallyBeauty adopted the 2007 Omnibus Incentive Plan (the “2007 Plan”), a newshare-based compensation plan, which allows for the issuance of up to 10.0million shares of Sally Beauty’s common stock. During fiscal years 2008 and2007, Sally Beauty granted to the Company’s employees approximately 2.8 millionand 2.4 million stock options, respectively, under the 2007 Plan. Upon issuanceof such grants, the Company recognized accelerated share-based compensationexpense of $3.1 million and $2.6 million in the fiscal years 2008 and 2007,respectively, in connection with certain retirement eligible employees who areeligible to continue vesting awards upon retirement under the terms of the 2007Plan.

 

For fiscal years 2008, 2007 and 2006, totalcompensation cost charged against income and included in selling, general andadministrative expenses, for share-based compensation arrangements was $9.6million, $12.3 million and $5.2 million, respectively. These amounts included,for fiscal year 2008, $3.1 million ofaccelerated expense related to certain retirement eligible employees whoare eligible to continue vesting awards upon retirement and, for fiscal year2007, $5.3 million of acceleratedexpense related to the Separation Transactions and $2.6 million of acceleratedexpense related to certain retirement eligible employees who areeligible to continue vesting awards upon retirement, under the terms of the2007 Plan. For fiscal years 2008 and 2007, the total income tax benefitrecognized in the statements of earnings from these plans was $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 0.4 million restricted shareawards to the Company’s employees under these plans.

 

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## **Table of Contents**

 

Sally Holdings LLC and SubsidiariesNotes to Consolidated Financial Statements

## **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:

 
| ** **                             | ** ** | **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, 2006 |       | 1,969                                                         |       | $                                      | 37.47      |                                                                 |       |                                                 |       |   |
| Shares conversion (a)                  |       | 1,073                                                         |       | 2.00                                   |       |                                                                 |       |                                                 |       |
| Granted                                |       | 5,112                                                         |       | 9.54                                   |       |                                                                 |       |                                                 |       |
| Exercised                              |       | (1,011                                                        | )          | 7.56                                   |       |                                                                 |       |                                                 |       |
| Forfeited or expired                   |       | (419                                                          | )          | 9.79                                   |       |                                                                 |       |                                                 |       |
| Outstanding at September 30, 2007 |       | 6,724                                                         |       | 7.33                                   |       | 8.8                                                                  |       | $                                                    | 12,862     |   |
| Granted                                |       | 2,787                                                         |       | 8.70                                   |       |                                                                 |       |                                                 |       |
| Exercised                              |       | (537                                                          | )          | 2.00                                   |       |                                                                 |       |                                                 |       |
| Forfeited or expired                   |       | (836                                                          | )          | 8.86                                   |       |                                                                 |       |                                                 |       |
| Outstanding at September 30, 2008 |       | 8,138                                                         |       | $                                      | 7.99       |                                                                 | 8.1        |                                                 | $          | 9,680 |   |
|                                   |       |                                                          |       |                                   |       |                                                                 |       |                                                 |       |
| Exercisable at September 30, 2008 |       | 3,062                                                         |       | $                                      | 6.03       |                                                                 | 7.2        |                                                 | $          | 9,500 |   |

 

----

| (a)                                 In  connection with the Separation Transactions, options to purchase shares of  Alberto-Culver’s common stock, which were held by the Company’s employees,  were converted into options to purchase shares of Sally Beauty’s common  stock. In order to maintain the same intrinsic value as before the  separation, all of Sally Beauty’s stock options that were converted from  Alberto-Culver were adjusted accordingly. |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The following table summarizes information about stockoptions under Sally Beauty’s option plans at September 30, 2008 (shares inthousands):

 
| ** **                                  | ** ** | **Options Outstanding**                              | ** ** | **Options Exercisable**                                         | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number  Outstanding at  September 30,  2008** | ** ** | **Weighted  Average  Remaining  Contractual  Term (In  Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable at  September 30,  2008** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $2.00                                       |       | 1,431                                                     |       | 5.8                                                                  |       | $ | 2.00 |   | 1,431 |   | $ | 2.00 |   |
| $7.42 – 9.66                           |       | 6,707                                                     |       | 8.6                                                                  |       | 9.27 |   | 1,631 |   | 9.56 |   |
| Total                                       |       | 8,138                                                     |       | 8.1                                                                  |       | $ | 7.99 |   | 3,062 |   | $ | 6.03 |   |

 

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:

 

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Tableof Contents

 

Sally Holdings LLC and SubsidiariesNotes to Consolidated Financial Statements

 
| ** **              | ** ** | **Year Ended September 30,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006 (a)** | ** ** |
| Expected lives (years)  |       | 5.0                                         |       | 5.0 |   | 3.5 – 4.5 |   |
| Expected volatility     |       | 37.5%-41.3                                  | %          | 41.2% - 41.9 | % | 20.0 | % |
| Risk-free interest rate |       | 3.5-4.0                                     | %          | 4.4% - 4.6 | % | 4.2% - 5.0 | % |
| Dividend yield          |       | 0.0                                         | %          | 0.0 | % | 1.0 | % |

 

----

| (a) |   | Assumptions  were calculated based on the Company being a wholly-owned subsidiary of  Alberto-Culver and using historical assumptions of Alberto-Culver, such as  expected volatility and dividend yield of Alberto-Culver’s common stock at  the time. |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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 not expectto 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 years2008, 2007 and 2006 was $3.73, $4.11 and $9.48, respectively.

 

The total intrinsic value of options exercised duringfiscal years 2008, 2007 and 2006 was $3.3 million, $5.9 million and $7.5 million,respectively; and the tax benefit realized for the tax deductions from theseoption exercises was $1.3 million, $2.3 million and $2.5 million, respectively.The total cash received from these option exercises was $1.1 million and $1.7million during fiscal years 2008 and 2007. Prior to the Separation Transactionsthe total cash received by the Company from these option exercises was zero asthe cash went to Alberto-Culver. The total fair value of stock options issuedto Company employees that vested during fiscal years 2008, 2007 and 2006 was$0.4 million, $7.3 million and $4.4 million, respectively.

 

At September 30, 2008, approximately $10.7million of total unrecognized compensation cost related to non-vested stockoption awards is expected to be recognized over the weighted average period of2.7 years.

 

## **StockAwards**

##  

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

##### *** ***

As a subsidiary of Sally Beauty, the Company has noemployee stock award plans; however, certain employees of the Company have beengranted restricted stock awards under the 2003 Restricted Stock Plan of SallyBeauty (the “RSP”) and under the 2007 Plan. A restricted stock award is anaward of shares of Sally Beauty’s common stock that is subject to time-basedvesting during a specified period. Restricted stock awards are independent ofoption grants and are generally subject to forfeiture if employment terminatesprior to the vesting of the awards. Participants have full voting and dividendrights with respect to shares of stock awards. Restricted stock awards issuedunder the RSP and the 2007 Plan generally vest ratably over a five-year periodand are subject to forfeiture until the vesting period is complete.

 

The Company expenses the cost of the restricted stockawards, which is determined to be the fair market value of the restricted stockaward at the date of grant, on a straight-line basis over the vesting period(generally 5 years). For these purposes, the fair market value of therestricted stock award is determined based on the closing price of Sally Beauty’scommon stock on the grant date.

 

The following table presents a summary of the activityfor Sally Beauty’s restricted stock awards:

 

F-17

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Tableof Contents

 

Sally Holdings LLC and SubsidiariesNotes to Consolidated Financial Statements

 
| **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, 2006 |       | 31                                              |       | $                                                          | 38.95      |                                                                 |       |   |
| Accelerated vesting(a)                |       | (31                                             | )          | 38.95                                                      |       |                                                                 |       |
| Granted                               |       | 350                                             |       | 8.10                                                       |       |                                                                 |       |
| Vested, forfeited or expired          |       | —                                          |       | —                                                     |       |                                                                 |       |
| Non-vested at September 30, 2007 |       | 350                                             |       | $                                                          | 8.10       |                                                                 | 4.3        |   |
| Granted                               |       | 136                                             |       | 8.48                                                       |       |                                                                 |       |
| Vested                                |       | (70                                             | )          | 8.10                                                       |       |                                                                 |       |
| Forfeited or expired                  |       | (120                                            | )          | 7.70                                                       |       |                                                                 |       |
| Non-vested at September 30, 2008 |       | 296                                             |       | $                                                          | 8.44       |                                                                 | 3.8        |   |

 

----

| (a)                                 In  connection with the Separation Transactions, all Alberto-Culver restricted  stock awards, which were held by the Company’s employees, became vested  immediately. |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

At September 30, 2008, approximately $2.1 millionof total unrecognized compensation expense related to non-vested restrictedstock awards is expected to be recognized over the weighted average period of3.8 years. In fiscal year 2007, approximately 31,000 restricted stock awardsvested in connection with the Separation Transactions.

 

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

##  

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

 
| ** **                                             | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Balance at beginning of period                         |       | $                                           | 2,564      |   | $ | 2,246 |   | $ | 2,073 |   |
| Bad debt expense                                       |       | 2,353                                       |       | 2,632 |   | 2,403 |   |
| Uncollected accounts written off, net of  recoveries   |       | (2,218                                      | )          | (2,568 | ) | (2,252 | ) |
| Allowance for doubtful accounts of acquired  companies |       | 3                                           |       | 254 |   | 22 |   |
| Balance at end of period                               |       | $                                           | 2,702      |   | $ | 2,564 |   | $ | 2,246 |   |

##  

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

##  

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

 
| ** **                                      | ** ** | **September 30,** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **2008**               | ** ** | **2007** | ** ** |
| Land                                            |       | $                      | 9,774      |   | $ | 9,773 |   |
| Buildings and building improvements             |       | 49,139                 |       | 48,885 |   |
| Leasehold improvements                          |       | 130,945                |       | 118,816 |   |
| Furniture, fixtures and equipment               |       | 209,587                |       | 192,420 |   |
| Total property and equipment, gross             |       | 399,445                |       | 369,894 |   |
| Less accumulated depreciation and  amortization |       | (243,185               | )          | (215,826 | ) |
| Total property and equipment, net               |       | $                      | 156,260    |   | $ | 154,068 |   |

 

Depreciationexpense for fiscal years 2008, 2007 and 2006 was $42.2 million, $38.9 millionand $35.0 million, respectively. As further described in Note 11, the termloan facilities and the ABL facility are secured by substantially all of ourassets, those of Sally Investment Holdings LLC, a wholly-owned subsidiary ofSally Beauty and the direct parent of Sally Holdings, those of our domesticsubsidiaries and, in the case of the ABL facility, those of our Canadiansubsidiaries.

 

F-18

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## **Table of Contents**

 

Sally Holdings LLC and SubsidiariesNotes to Consolidated Financial Statements

 

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

##  

The change in the carrying amounts of goodwill byoperating segment for the fiscal years 2008 and 2007 is as follows (inthousands):

 
| ** **                                    | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------|------------|
| Balance at September 30, 2006            |       | $                             | 10,160     |                           | $          | 354,533   |       | $ | 364,693 |   |
| Additions, net of purchase price  adjustments |       | 32,691                        |       | 2,559                          |       | 35,250    |       |
| Foreign currency translation                  |       | 1,697                         |       | 4,983                          |       | 6,680     |       |
| 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 |   |

 

As further described in Note 15, $23.9 million ofthe increase in Sally Beauty Supply’s goodwill in fiscal year 2008 wasprincipally attributable to the acquisition of Pro-Duo in May 2008, net ofpurchase price adjustments, and the remaining $3.1 million was attributable toother acquisitions. As further described in Note 15, $29.3 million ofthe increase in Sally Beauty Supply’s goodwill in fiscal year 2007 wasattributable to the acquisition of Salon Services in February 2007, net ofpurchase price adjustments, and the remaining $3.4 million was attributable toother acquisitions not individually material. Additionally, each of theincreases in BSG’s goodwill in fiscal years 2008 and 2007 was attributable toseveral acquisitions (which were not individually material).

 

The following table provides the carrying value for intangibleassets with indefinite lives and the gross carrying value and accumulatedamortization for intangible assets subject to amortization by operating segmentat September 30, 2008 and 2007 (in thousands):

 
| ** **                                 | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------|------------|
| 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 |   |
| Balance at September 30, 2007:        |       |                          |       |                           |       |      |       |
| Intangible assets with indefinite lives:   |       |                          |       |                           |       |      |       |
| Trade names                                |       | $                             | 15,802     |                           | $          | 34,886    |       | $ | 50,688 |   |
| Other intangibles                          |       | —                        |       | 6,053                          |       | 6,053     |       |
| Total                                      |       | 15,802                        |       | 40,939                         |       | 56,741    |       |
| Intangible assets subject to amortization: |       |                          |       |                           |       |      |       |
| Gross carrying amount                      |       | 3,574                         |       | 22,094                         |       | 25,668    |       |
| Accumulated amortization                   |       | (374                          | )          | (11,530                        | )          | (11,904   | )          |
| Net value                                  |       | 3,200                         |       | 10,564                         |       | 13,764    |       |
| Total intangible assets, net               |       | $                             | 19,002     |                           | $          | 51,503    |       | $ | 70,505 |   |

 

The increase in Sally Beauty Supply’s intangibleassets in fiscal year 2008 was primarily due the acquisition of Pro-Duo and theincrease in BSG’s intangible assets in fiscal year 2008 was due to severalacquisitions which were not individually material. The changes in fiscal year2008 also reflect the effect of translation adjustments. Amortization expensetotaled $6.3 million, $3.7 million and $3.0 million in fiscal years 2008,2007 and 2006, respectively. As of September 30, 2008, future amortizationexpense related to intangible assets subject to amortization is estimated to beas follows (in millions):

 

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Tableof Contents

 

Sally Holdings LLC and SubsidiariesNotes to Consolidated Financial Statements

 

| **Fiscal Year:** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| 2009                  |       | $          | 6.0        |   |
| 2010                  |       | 4.5        |       |
| 2011                  |       | 3.6        |       |
| 2012                  |       | 2.2        |       |
| 2013                  |       | 1.5        |       |
| Thereafter            |       | 6.2        |       |
|                  |       | $          | 24.0       |   |

 

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

 

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

##  

Accountspayable at September 30, 2008 include book cash overdrafts of $1.6million. There were no book cash overdrafts at September 30, 2007.

 

Accrued expenses consist of the following (inthousands):

 
| ** **                   | ** ** | **September 30,** | ** ** |
|------------------------------|------------|------------------------|------------|
| ** **                   | ** ** | **2008**               | ** ** | **2007** | ** ** |
| Compensation and benefits    |       | $                      | 58,873     |   | $ | 53,440 |   |
| Interest payable             |       | 31,013                 |       | 34,540 |   |
| Deferred revenue             |       | 11,003                 |       | 11,209 |   |
| Rental obligations           |       | 10,139                 |       | 9,575 |   |
| Property and other taxes     |       | 7,012                  |       | 6,495 |   |
| Insurance reserves           |       | 5,973                  |       | 3,615 |   |
| Acquisition related payables |       | 3,121                  |       | 3,202 |   |
| Operating accruals and other |       | 27,395                 |       | 31,595 |   |
| Total accrued expenses       |       | $                      | 154,529    |   | $ | 153,671 |   |

##  

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

##  

## **Commitments**

##  

The Company’s principal leases relate to retail storesand warehousing properties. At September 30, 2008, future minimum paymentsunder non-cancelable operating leases, net of sublease income, are as follows(in thousands):

 

| **Fiscal Year:** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| 2009                  |       | $          | 120,983    |   |
| 2010                  |       | 102,344    |       |
| 2011                  |       | 82,067     |       |
| 2012                  |       | 59,531     |       |
| 2013                  |       | 36,836     |       |
| Thereafter            |       | 57,307     |       |
|                  |       | $          | 459,068    |   |

 

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.

 

During the third quarter of fiscal year 2007, theCompany exercised an option to purchase a warehouse building for approximately$7.6 million that was subsequently sold for approximately $8.0 million. Inconnection with the sale of the building, the Company entered into a leaseagreement under which it is required to pay monthly rent for continued use ofthe building. The lease has an initial term of 24 months and the monthly rentis subject to certain escalation clauses over the life of the lease.

 

Total rental expense for operating leases amounted toapproximately $163.7 million, $147.3 million and $133.5 million in fiscalyears 2008, 2007 and 2006, respectively, and is included in selling, generaland administrative expenses in the consolidated statements of earnings.Included in this amount is $0.8 million, $0.8 million and $0.7 million forcontingent rents for the years ended September 30, 2008, 2007 and 2006,respectively.

 

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

## **Contingencies**

##  

##### ***Legal Proceedings and Other***

##### *** ***

There were no material legal proceedings pendingagainst the Company or its subsidiaries, as of September 30, 2008. TheCompany is involved in various claims and lawsuits incidental to the conduct ofits business in the ordinary course. The Company does not believe that theultimate resolution of these matters will have a material adverse impact on theCompany’s consolidated financial position, statements of earnings or cashflows.

 

## **OnFebruary 25, 2008, Sally Beauty disclosed in a Current Report on Form 8-Kthat 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.  The suit also alleged, among other issues, that SD Hairinduced AMLP to breach its agreement to distribute Matrix branded products (the“Matrix Agreement”) in some unspecified manner.**  L’Oreal’s complaint against SD Hair was subsequently amended to deletethe reference to AMLP’s breach of the Matrix Agreement as one of the specificcontractual relationships that SD Hair allegedly induced and caused to bebreached.  However, the amended complaintdoes not designate which distributors are at issue, and L’Oreal has not statedon the record whether it continues to allege that SD Hair induced and causedAMLP to breach the Matrix Agreement.  Asof November 10, 2008, neither we nor any of our subsidiaries (including AMLP)were a defendant in the lawsuit filed by L’Oreal.   On March 24,2008, however, SD Hair filed a cross-complaint in the same case naming AMLP andBSG as cross-defendants, seeking, among other things, i) declaratory relieffrom BSG and AMLP in the form of a judicial finding thatSD Hair is not in breach of its franchiseagreement and that L’Oreal has no rights as a third-party beneficiary to SDHair’s franchise agreement, and ii) injunctive relief in the form of a judicialorder compelling AMLP and BSG to take appropriate legal action against L’Orealto enforce SD Hair’s claimed rights under AMLP’s Matrix distributionagreement.  We have answered the cross-complaint. No monetary relief isbeing sought by SD Hair.

##  

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, 2008 and 2007.

 

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

##  

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

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 
| ** **                   | ** ** | **September 30,  2008** | ** ** | **Maturity dates  (Fiscal Year)** | ** ** | **Interest Rates** | ** ** |
|------------------------------|------------|------------------------------|------------|-----------------------------------|------------|--------------------|------------|
| ABL facility                 |       | $                            | 75,000     |                              | 2012       |               | (i)        |   | PRIME and up to 0.50% or; |   |
|                         |       |                         |       |                              |       | (ii)               |       | LIBOR (a) plus (1.00% to 1.50%) |   |
| Term Loan A                  |       | 135,000                      |       | 2013                              |       | (i)                |       | PRIME plus (1.00% to 1.50%) or; |   |
|                         |       |                         |       |                              |       | (ii)               |       | LIBOR plus (2.00% to 2.50%) |   |
| Term Loan B                  |       | 901,600                      |       | 2014                              |       | (i)                |       | PRIME plus (1.25% to 1.50%) or; |   |
|                         |       |                         |       |                              |       | (ii)               |       | LIBOR plus (2.25% to 2.50%) |   |
| Other (b)                    |       | 2,963                        |       | 2009-2014                         |       |               |       | 4.05% to 7.00% |   |
| Total                        |       | $                            | 1,114,563  |                              |       |               |       |   |   |   |
|                         |       |                         |       |                              |       |               |       |   |   |
| Senior notes                 |       | $                            | 430,000    |                              | 2015       |               |       |   | 9.25 | % |   |
| Senior subordinated notes    |       | 280,000                      |       | 2017                              |       |               |       | 10.50 | % |   |
| Total                        |       | $                            | 710,000    |                              |       |               |       |   |   |   |
|                         |       |                         |       |                              |       |               |       |   |   |
| Capitalized leases and other |       | $                            | 722        |                              |       |               |       |   |   |   |
| Less: current portion        |       | (100,601                     | )          |                              |       |               |       |   |   |
| Total long-term debt         |       | $                            | 1,724,684  |                              |       |               |       |   |   |   |

 

----

(a) London InterbankOffered Rate (“LIBOR”)

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

 

In connection with the Separation Transactions on November 16,2006, the Company incurred $1,850.0 million of indebtedness by: (i) drawingon a $400.0 million revolving (asset-based lending (“ABL”)) facility in anamount equal to $70.0 million; (ii) entering into two term loan facilities(term loans A and B) in an aggregate amount of $1,070.0 million; (iii) andissuing senior notes in an aggregate amount of $430.0 million and seniorsubordinated notes in an aggregate amount of $280.0 million. The Companyincurred approximately $58.5 million in costs related to the issuance of thedebt, which was capitalized and is being amortized to interest expense over thelife of the related debt instruments. Proceeds from the initial debt were usedprimarily to pay the $1,809.7 million distribution to Sally Beauty and forcertain expenses associated 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 under the ABL facility is subjectto a borrowing base calculation, which is based on specified percentages of thevalue of eligible inventory and eligible accounts receivables, subject tocertain reserves and other adjustments and reduced by certain outstandingletters of credit. At September 30, 2008, the Company had $276.4 availablefor additional borrowings under the ABL facility. Additionally, the Company isrequired to pay a commitment fee ranging from 0.20% to 0.35% on the unusedportion of the ABL facility. At September 30, 2008, the commitment feerate was 0.20%.

 

The ABL facility contains a covenant requiring SallyHoldings and its subsidiaries to maintain a fixed-charge coverage ratio of atleast 1.0 to 1.0 when availability under the ABL facility falls below $40.0million. The fixed-charge coverage ratio is defined as the ratio of EBITDA (asdefined in the agreement underlying the ABL facility, or Credit AgreementEBITDA), less unfinanced capital expenditures to fixed charges (as included inthe definition of the fixed-charge coverage ratio in the agreement governingthe ABL facility). The ABL facility uses fixed amounts for Credit AgreementEBITDA for periods preceding the Separation Transactions.

 

The Term Loan facilities consist of (i) a $150.0million senior term loan A facility and (ii) a $920.0 million senior termloan B facility. Principal and interest is payable on a quarterly basis.

 

The Term Loan facilities contain a covenant requiringSally Holdings and its subsidiaries to comply with maximum consolidated securedleverage ratio levels, which will decline over time. The consolidated securedleverage ratio, which is tested quarterly, was a maximum ratio of 4.75 as of September 30,2008. The consolidated secured leverage ratio is a ratio of net consolidatedsecured debt to Consolidated EBITDA (as defined in the underlying agreements).

 

The Term Loan facilities andthe ABL facility are secured by substantially all of our assets, those of SallyInvestment, those of the Company’s domestic subsidiaries and, in the case ofthe ABL facility, those of the Company’s Canadian subsidiaries. The Term Loanfacilities may be prepaid at the Company’s option at any time withoutpremium or penalty and are subject to mandatory prepayment in an amount equalto 50% of excess cash flow (as defined in the agreement governing the term loanfacilities) for any fiscal year (commencing in fiscal year 2008) unless aspecified leverage ratio is met. Additionally, the Term Loan is 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.

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

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.

 

In May 2008, the Company entered into twoadditional interest rate swap agreements with an aggregate notional amount of$300.0 million. In November 2006, the Company entered into four interestrate swap agreements with an aggregate notional amount of $500.0 million inconnection with its cash flow risk associated with changing interest ratesrelated to its Term Loans. Please see Note 12 for further information on theinterest rate swap agreements.

 

Maturities of the Company’s long-term debt are asfollows (in thousands):

 

| **Fiscal Year:**    | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| 2009                     |       | $          | 100,515    |   |
| 2010                     |       | 24,820     |       |
| 2011                     |       | 39,560     |       |
| 2012                     |       | 84,522     |       |
| 2013                     |       | 9,391      |       |
| Thereafter               |       | 1,565,755  |       |
|                     |       | $          | 1,824,563  |   |
| Capital leases and other |       | 722        |       |
| Less: current portion    |       | (100,601   | )          |
| Total                    |       | $          | 1,724,684  |   |

 

At September 30, 2008 and 2007, 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 $12.1 million and $9.4 million at September 30,2008 and 2007, respectively.

 

## **12.  Interest Rate Swaps**

##  

TheCompany utilizes interest rate swap agreements to manage its cash flow exposureassociated with changing interest rates in connection with its term loanobligations. The Company does not purchase or hold any derivative instrumentsfor trading or speculative purposes.

 

In connection with the SeparationTransactions, effective November 24, 2006, the Company entered into fourinterest rate swap agreements with an aggregate notional amount of $500million.  These agreements allow the Company to converta portion of its variable interest rate obligations to a fixed rate obligationwith interest rates ranging from 7.19% to 7.498%.  Theseinterest rate swap agreements do not qualify as effective 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. The fair value of these swap agreements was aliability of approximately $7.7 million at September 30, 2008.  The marked-to-market impact of these swap arrangements on net interestexpense was an increase of approximately $4.6 million and $3.0 million for thefiscal years ended September 30, 2008 and 2007, respectively. Changes inthe fair value of these interest rate swap agreements will either increase ordecrease the Company’s net interest expense and, therefore, may affect theCompany’s future earnings.

 

EffectiveMay 27, 2008, the Company entered into two additional interest rate swapagreements with an aggregatenotional amount of$300 million (each agreement with a notional amount of $150 million).  These agreements expire on May 31, 2012and allow the Company to convert a portion of its variable interest rateobligations to a fixed rate obligation with interest rates ranging from 5.818%to 6.090%.  Both of these interestrate swap agreementsare designated as effective cash flow hedges, in accordance with SFAS 133.  Adjustments to reflect the change in the fairvalues of these interest rate swap agreements, which areadjusted quarterly, arerecorded, net of income tax, in accumulated other comprehensive income untilthe hedged obligation is settled or the swap agreements expire, whichever isearlier.  Any hedge ineffectiveness, asthis term is used in SFAS 133, is recognized in net interest expense in theconsolidated statements of earnings.  Thefair value of these hedged swap agreements was an asset of approximately $1.3million at September 30, 2008. The aggregate amount of deferred gainsrecorded in accumulated other comprehensive income was approximately $0.8million, net of income taxes. There were no gains or losses reclassified intoearnings, from accumulated other comprehensive income, in connection with theseswap agreements during the three years ended September 30, 2008.

 

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 in other liabilities and $1.3 millionincluded in other assets. Fair value 

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

estimatesused for the swap agreements held by the Company are based on third-partyinformation and were determined using proprietary models based uponwell-recognized financial principles and reasonable estimates about relevantfuture market conditions.

 

The counterparties to all our interest rate swap instrumentsare deemed by theCompany to be of substantial resources and strong creditworthiness. However,these transactions do result in exposure to credit risks in the event ofdefault by a counterparty. The current financial crisis affecting the bankingsystems and financial markets has resulted in many well-known financialinstitutions becoming less creditworthy or having diminished liquidity and,thus, we could be exposed to an increased level of counterparty risk.  In the event that a counterparty defaults inits obligation under our interest rate swaps, we could incur substantialfinancial losses. However, at the present time, no such losses are deemedprobable.

 

## **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 certain maximums,as defined by the 401k Plan and by the U. S. Internal Revenue Code. The Companycurrently matches a percentage of employee contributions. Prior to theSeparation Transactions, employees of the Company participated in the SallyBeauty 401(k) Savings Plan. The Company recognized expense of $3.8million, $3.3 million and $2.1 million in fiscal years 2008, 2007 and2006, respectively, related to these plans. These amounts are included inselling, general and administrative expenses.

 

In addition, pursuant to the 401k Plan, employees whomeet certain eligibility requirements and who are not members of a collectivebargaining unit may participate in the profit sharing program. The Company’sprofit sharing contributions to the 401k Plan are determined by the CompensationCommittee of Sally Beauty’s board of directors. Prior to the SeparationTransactions, employees of the Company participated in the Alberto-CulverProfit Sharing Plan and the Company’s contributions to the plan were determinedat the discretion of the Alberto-Culver board of directors. The Companyrecognized expense of $7.1 million, $6.2 million and $8.6 million infiscal years 2008, 2007 and 2006, respectively, related to these plans. Theseamounts are included in selling, general and administrative expenses.

 

## **14.  Income Taxes**

##  

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. In conjunctionwith the Separation Transactions, Sally Beauty became a separate entity for taxreporting purposes. As described in Note 16, the Company has entered into a taxsharing agreement with its ultimate parent, Sally Beauty. Prior to theSeparation Transactions, the Company was included in the U.S. Federal incometax return of Alberto-Culver; however, income taxes are provided in theaccompanying consolidated historical financial statements as if the Company wasfiling separate returns.

 

The provision for income taxes for the fiscal years2008, 2007 and 2006 consists of the following (in thousands):

 
| ** **                     | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|
| ** **                     | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Current:                       |       |                                        |       |   |   |   |   |
| Federal                        |       | $                                           | 33,194     |   | $ | 30,538 |   | $ | 57,025 |   |
| Foreign                        |       | 8,763                                       |       | 6,446 |   | 3,141 |   |
| State                          |       | 4,203                                       |       | 4,359 |   | 9,197 |   |
| Total current portion          |       | 46,160                                      |       | 41,343 |   | 69,363 |   |
| Deferred:                      |       |                                        |       |   |   |   |   |
| Federal                        |       | 2,242                                       |       | 778 |   | 1,053 |   |
| Foreign                        |       | 346                                         |       | (319 | ) | (255 | ) |
| State                          |       | (84                                         | )          | (633 | ) | (245 | ) |
| Total deferred portion         |       | 2,504                                       |       | (174 | ) | 553 |   |
| Total provision for income tax |       | $                                           | 48,664     |   | $ | 41,169 |   | $ | 69,916 |   |

 

The difference between the U.S. statutory federalincome tax rate and the effective income tax rate is summarized below:

 

F-24

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 
| ** **                                           | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Statutory tax rate                                   |       | 35.0                                        | %          | 35.0 | % | 35.0 | % |
| State income taxes, net of federal tax  benefit |       | 2.0                                         |       | 2.5 |   | 3.2 |   |
| Effect of foreign operations                         |       | (0.3                                        | )          | (0.4 | ) | (0.1 | ) |
| Nondeductible transaction costs                      |       | —                                      |       | 6.4 |   | — |   |
| Uncertain tax positions                              |       | 0.6                                         |       | — |   | — |   |
| U.S. deduction of foreign losses                     |       | (1.7                                        | )          | — |   | — |   |
| Other, net                                           |       | 1.4                                         |       | 2.4 |   | 0.7 |   |
| Effective tax rate                                   |       | 37.0                                        | %          | 45.9 | % | 38.8 | % |

 

The tax effects of temporary differences that giverise to the Company’s deferred tax assets and liabilities are as follows (inthousands):

 
| ** **                                | ** ** | **September 30,** | ** ** |
|-------------------------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **2008**               | ** ** | **2007** | ** ** |
| Deferred tax assets attributable to:      |       |                   |       |   |   |
| Share-based compensation expense          |       | $                      | 9,978      |   | $ | 7,497 |   |
| Accrued expenses                          |       | 19,275                 |       | 15,542 |   |
| Inventory adjustments                     |       | 1,894                  |       | 2,437 |   |
| Foreign loss carryforwards                |       | 10,250                 |       | 8,718 |   |
| Long-term liabilities                     |       | 2,964                  |       | 1,319 |   |
| Unrecognized tax benefits                 |       | 2,789                  |       | — |   |
| Other                                     |       | —                 |       | 1,439 |   |
| Total deferred tax assets                 |       | 47,150                 |       | 36,952 |   |
| Valuation allowance                       |       | (11,972                | )          | (9,823 | ) |
| Total deferred tax assets, net            |       | 35,178                 |       | 27,129 |   |
| Deferred tax liabilities attributable to: |       |                   |       |   |   |
| Depreciation and amortization             |       | 52,347                 |       | 42,391 |   |
| Total deferred tax liabilities            |       | 52,347                 |       | 42,391 |   |
| Net deferred tax liability                |       | $                      | 17,169     |   | $ | 15,262 |   |

 

Management believes that it is more likely than notthat results of future operations will generate sufficient taxable income torealize the deferred tax assets, net of the valuation allowance. The Companyhas recorded a valuation allowance to account for uncertainties regardingrecoverability of most foreign loss carryforwards.

 

In fiscal year 2007, the Company made certainadjustments in connection with the reconciliation of tax balances transferredto the Company in connection with the Separations Transactions.  This amount was included in the settlement ofintercompany agreements with Alberto-Culver, as an adjustment to the Company’smember’s deficit.

 

Domestic earnings before provision for income taxeswere $106.4 million, $77.7 million and $174.6 million in fiscal years2008, 2007 and 2006, respectively. Foreign operations had earnings beforeprovision for income taxes of $25.1 million, $12.0 million and$5.5 million in fiscal year 2008, 2007 and 2006, 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, 2008, 2007 and 2006.

 

The transactions separating us from Alberto-Culverwere intended to qualify as a reorganization under Section 368(a)(1)(D) ofthe Internal Revenue Code of 1986, as amended (the “Code”) and a distributioneligible for non-recognition under Sections 355(a) and 361(c) of theCode. In connection with the share distribution of Alberto-Culver common stockin the Separation Transactions, Sally Beauty received: (i) a privateletter ruling from the IRS; and (ii) an opinion of Sidley Austin LLP,counsel to Alberto-Culver, in each case, to the effect that the transactionsqualify as a reorganization under Section 368(a)(1)(D) of the Codeand a distribution eligible for non-recognition under Sections 355(a) and361(c) of the Code.

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

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 assurance that Alberto-Culver would be able to fulfill itsindemnification obligations to Sally Beauty under the tax allocation agreementif Alberto-Culver was determined to be responsible for these taxes thereunder.

 

InJune 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48, “*Accounting forUncertainty in Income Taxes,*” an interpretation of SFAS No. 109,“*Accounting for Income Taxes*” (“FIN48”), to create a single model to address accounting for uncertainty in taxpositions. This interpretation, which became effective for fiscal yearsbeginning after December 15, 2006, clarifies the accounting for incometaxes by prescribing a minimum recognition threshold a tax position is requiredto meet before being recognized in the financial statements. FIN 48 alsoprovides guidance on (1) the recognition, derecognition, and measurementof uncertain tax positions in a period subsequent to that in which the taxposition is taken; (2) the accounting for interest and penalties; (3) thepresentation and classification of recorded amounts in the financialstatements; and (4) disclosure requirements.

 

TheCompany adopted the provisions of FIN 48 on October 1, 2007.  The adoption of FIN 48 did not require achange to the Company’s liability for unrecognized tax benefits and had noimpact on the Company’s opening balance of member’s deficit.  The total amount of unrecognized tax benefits(including interest accruals) as of the date of adoption on October 1,2007 was $3.9 million.

 

Areconciliation of the beginning and ending amount of unrecognized tax benefitsis as follows (in thousands):

 
|                                             |   |   |   |
|--------------------------------------------------|--------|--------|--------|
| Balance at October 1, 2007                  |   | $      | 3,901  |   |
| Increases related to prior year tax  positions   |   | 2,429  |   |
| Decreases related to prior year tax  positions   |   | (52    | )      |
| Increases related to current year tax  positions |   | 565    |   |
| Settlements                                      |   | (571   | )      |
| Lapse of statute                                 |   | (545   | )      |
| Balance at September 30, 2008               |   | $      | 5,727  |   |

 

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 was $1.0 million and, as of September 30,2008, was $1.4 million.

 

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 next12 months, and the fact that we are routinely under audit by varioustaxing authorities, it is reasonably possible that the amount of unrecognizedtax benefits will change during the next 12 months. An estimate of theamount or range of such change cannot be made at this time. However, we do notexpect the change, if any, to have a material effect on our consolidatedfinancial condition or results of operations within the next 12 months.

 

The IRS has initiated an examination of the Company’sconsolidated federal income tax returns for the tax years ended September 30,2005 and 2006, thus our statute remains open from the year ended September 30,2005 forward.  Our European subsidiariesare impacted by various statutes of limitations, which are generally open from2004 forward. The statute of limitations on our Canadian operations is openfrom 2004 forward.  Generally, states’statutes in the United States are open for tax reviews from 2002 forward. TheIRS has previously audited the consolidated federal income tax returns ofAlberto-Culver through the fiscal year ending September 30, 2004. TheCompany has not recorded a reserve for Alberto-Culver related liability becausethe Company believes any exposure is immaterial.

 

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

## **15.  Acquisitions**

##  

During the fiscal year ended September 30, 2008,the Company completed several individually immaterial acquisitions, includingPro-Duo, N.V., at an aggregate cost of $53.4 million of which a significantportion was allocated to intangible assets and goodwill. The purchase prices ofthese acquisitions have been allocated to assets acquired and liabilitiesassumed based on their estimated fair values at the date of acquisition. Weexpect that the final valuation of the assets and liabilities acquired will becompleted during fiscal year 2009. We funded these acquisitions with cash fromoperations and borrowings on our ABL facility. On May 7, 2008, the Company acquired Pro-Duo, N.V., a 40-storebeauty supply chain located in Belgium, France and Spain for €19.3 million(approximately $29.8 million plus incidental acquisition costs capitalized)subject to certain adjustments.  Theacquisition was funded through $29.8 million in cash and borrowings on our ABLfacility. We also assumed €3.0 million (approximately $4.7 million) of debtfrom 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 tax purposes.Of this amount, $10.2 million was assigned to registered trade names and $1.2million to other identifiable intangible assets, which will be amortized over aweighted average life of approximately eight years.

 

In February 2007, the Company acquired Chapelton21 Limited (the “Agreement”), a private company based in Scotland (“SalonServices”) for an aggregate cash purchase price of approximately$57.8 million. Certain of the Company’s subsidiaries financed the purchaseprice through a draw down of approximately $57.0 million under the ABLfacility. In addition, the Company extinguished approximately $3.9 millionof Salon Services’ debt. Salon Services, through its direct and indirectsubsidiaries including Salon Services (Hair and Beauty Supplies) Ltd., suppliesprofessional hair and beauty products primarily to salon and spa operators andindependent hair and beauty professionals in the United Kingdom, Germany,Ireland, Spain and Norway. Goodwill of $30.0 million and certainidentifiable intangible assets of $17.6 million were recorded as a result ofsuch acquisition and are not expected to be deductible for tax purposes. Ofthis amount, $14.4 million was assigned to registered trade names and $3.2million to other identifiable intangible assets, which will be amortized over aweighted average life of approximately five years. Salon Services is includedin the Sally Beauty Supply segment. Pro-forma information for Salon Services isnot provided since it is not material to the Company’s consolidated results ofoperations. The purchase price of Salon Services was allocated to assetsacquired and liabilities assumed based on their estimated fair values at thedate of acquisition and were subsequently adjusted when more accuratevaluations became available.

 

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. Such acquisitions included the recording of: (i) goodwill in theamount of $3.4 million; and (ii) certain intangible assets of $0.6 million.The results of operations for the remaining acquisitions are included in theBSG segment, and these acquisitions included the recording of: (i) goodwillin the amount of $0.3 million; and (ii) certain intangible assets of $2.9million. The intangible assets acquired are being amortized over a weightedaverage life of approximately one year.

 

In June 2006, the Company acquired Salon Success,a United Kingdom-based distributor of professional beauty products, in order toexpand the geographic area served by BSG, for a total purchase price ofapproximately $23.2 million. Approximately $1.8 million of thepurchase price was to be paid in equal annual amounts over the three yearsfollowing the closing of the acquisition. In accordance with the purchaseagreement, additional consideration of up to $2.1 million, plus interest,may be paid over the same three-year period based on sales to a specificcustomer. As of September 30, 2008, approximately $1.2 million has beenpaid pursuant to this agreement. Goodwill of $11.6 million and certainidentifiable intangible assets of $7.6 million were recorded as a resultof the acquisition and are not expected to be deductible for tax purposes.Salon Success is included in the BSG segment. Pro-forma information for SalonSuccess is not provided since it is not material to the Company’s consolidatedresults of operations. The purchase price of Salon Success has been allocatedto assets acquired and liabilities assumed based on their estimated fair valuesat the date of acquisition.

 

## **Thevaluation of identifiable intangible assets of Pro-Duo, Salon Services andSalon Success was determined using discounted cash flow methods with theassistance of third party valuation experts. The acquired entities have beenaccounted for using the purchase method of accounting and, accordingly, theresults of operations of the entities have been included in the consolidatedfinancial statements since their respective dates of acquisition.**

##  

## **16.  Related Party Transactions**

##  

In January 2007, the Company entered into anagreement with Sally Beauty under which the Company agreed to provide certaingeneral and administrative services to Sally Beauty including accounting,finance, payroll, legal and tax sharing services. The cost of 

these services, which were based on a percentage ofcertain key employees’ salaries and benefits, is approximately $173,000 permonth, and totaled approximately $2.1 million and $1.0 million for fiscal years2008 and 2007, respectively.  The cost ofthese services may not necessarily be indicative of the costs which wouldbe incurred by Sally Beauty as an independent stand alone entity.

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

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.

 

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, 2008 and 2007, the Companyhad a net intercompany payable to Sally Beauty of approximately $17.2 millionand $18.9 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 its subsidiaries,on the other hand, other than those specifically designated to survivefollowing the Separation Transactions, were cancelled. In addition, SallyBeauty became the parent company for all U.S. tax returns which were filedunder 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 years 2007 and 2006, the Companypurchased inventory from Alberto-Culver of approximately $3.7 million and$26.9 million, respectively. There were no such purchases in fiscal year2008.

 

Alberto-Culver and its affiliates performed certainadministrative services for the Company and incurred certain direct expenses onbehalf of the Company. Charges for these services based on Alberto-Culver’sdirect and allocated expenses are included in selling, general andadministrative expenses in the consolidated statements of earnings. Inaddition, certain subsidiaries of the Company had entered into consulting,business development, and advisory services agreements with Alberto-Culver,pursuant to which Alberto-Culver charged a sales-based service fee. Costs forcertain administrative services and other corporate functions and directexpenses incurred on behalf of the Company were allocated by Alberto-Culver tothe Company based on the most relevant allocation method to the specific costsbeing allocated, and totaled $1.0 million and $13.5 million in fiscalyears 2007 and 2006, respectively. These amounts are classified as part ofunallocated expenses for the Company’s segment reporting purposes inNote 17. The costs for direct expenses incurred on behalf of the Companyand certain administrative services and corporate functions were allocatedbased on specific identification of activities performed or costs incurred byAlberto-Culver on behalf of the Company. Costs of certain other administrativeservices and corporate functions that benefited the consolidated Alberto-Culverentity were allocated equally between the Company and Alberto-Culver’s consumerproducts business. Management believes the methods of allocation used werereasonable. Management estimates that had the Company been operating as astand-alone entity not affiliated with Alberto-Culver during fiscal years 2007and 2006, the costs incurred for administrative services and certain othercorporate functions and direct expenses incurred on behalf of the Company wouldhave been approximately the same as the amount charged by Alberto-Culver.

 

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 and $28.9 million in fiscalyears 2007 and 2006, respectively. Management believes that had the Companybeen operating as a stand-alone entity not affiliated with Alberto-Culverduring the fiscal years 2007 and 2006, the Company likely would not have neededto engage any third party or incur additional costs as a stand-alone companyfor the services provided to its subsidiaries under 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 years 2007 and 2006, the Company paid $4.8 million and$5.7 million, respectively, to Alberto-Culver in connection with thisagreement.

 

The Company had various notes payable and borrowingsunder revolving credit facilities with affiliated companies all of which wererepaid in December 2005. These borrowings bore interest at market ratesand interest expense was approximately $0.4 million for fiscal year 2006.Additionally, the Company had a note receivable and receivables under a creditfacility with an affiliated company all of which were repaid in December 2005.These receivables bore interest at market rates and the interest income wasapproximately $0.1 million for fiscal year 2006.

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 

## **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 ofcash and carry retail stores, which offers professional beauty supplies to bothsalon professionals and retail customers; and (ii) BSG, a full servicebeauty supply distributor, which offers professional brands of beauty productsdirectly to salons through its own sales force and professional only stores incertain exclusive geographical territories in North America and parts ofEurope.

 

In connection with the Separation Transactions, theCompany’s management evaluated the structure of its internal organization toidentify and separate the costs incurred at the corporate level from thebusiness units, as well as costs incurred that benefit both the Sally BeautySupply and BSG segments. Accordingly, management has defined its reportablesegments as Sally Beauty Supply and BSG, to report these segments separatelyfrom the Company’s shared corporate expenses, and has revised the comparableprior years for comparability purposes.

 

The accounting policies of the segments are the sameas described in the summary of significant accounting policies in Note 2. TheCompany does not sell between segments.

 

##### ***Business Segments Information***

##### *** ***

Segment data for the fiscal years ended September 30,2008, 2007 and 2006 is as follows (in thousands):

 
| ** **                                         | ** ** | **Year Ended September 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                         | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales:                                         |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                                           | 1,672,897  |   | $ | 1,569,088 |   | $ | 1,419,332 |   |
| BSG                                                |       | 975,294                                     |       | 944,684 |   | 953,768 |   |
| Total                                              |       | $                                           | 2,648,191  |   | $ | 2,513,772 |   | $ | 2,373,100 |   |
| Earnings before provision for income taxes:        |       |                                        |       |   |   |   |   |
| Segment operating profit:                          |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                                           | 285,234    |   | $ | 272,034 |   | $ | 235,419 |   |
| BSG                                                |       | 80,927                                      |       | 63,456 |   | 88,445 |   |
| Segment operating profit                           |       | 366,161                                     |       | 335,490 |   | 323,864 |   |
| Unallocated expenses(a)                            |       | (66,118                                     | )          | (62,240 | ) | (68,150 | ) |
| Share-based compensation expense                   |       | (9,614                                      | )          | (12,267 | ) | (5,186 | ) |
| Sales based service fee charges by  Alberto-Culver |       | —                                      |       | (3,779 | ) | (28,852 | ) |
| Transaction expenses (b)                           |       | —                                      |       | (21,502 | ) | (41,475 | ) |
| Interest expense, net of interest income           |       | (158,897                                    | )          | (145,972 | ) | (92 | ) |
| Total                                              |       | $                                           | 131,532    |   | $ | 89,730 |   | $ | 180,109 |   |
| Identifiable assets:                               |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                                           | 696,780    |   | $ | 555,252 |   | $ | 448,737 |   |
| BSG                                                |       | 752,029                                     |       | 757,276 |   | 759,714 |   |
| Sub-total                                          |       | 1,448,809                                   |       | 1,312,528 |   | 1,208,451 |   |
| Shared services                                    |       | 76,849                                      |       | 91,733 |   | 119,600 |   |
| Other corporate(c)                                 |       | —                                      |       | — |   | 10,790 |   |
| Sub-total                                          |       | 76,849                                      |       | 91,733 |   | 130,390 |   |
| Total                                              |       | $                                           | 1,525,658  |   | $ | 1,404,261 |   | $ | 1,338,841 |   |
| Depreciation and amortization:                     |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                                           | 23,134     |   | $ | 20,377 |   | $ | 18,762 |   |
| BSG                                                |       | 20,666                                      |       | 17,686 |   | 14,872 |   |
| Corporate                                          |       | 4,733                                       |       | 4,542 |   | 4,398 |   |
| Total                                              |       | $                                           | 48,533     |   | $ | 42,605 |   | $ | 38,032 |   |
| Capital expenditures:                              |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                                           | 22,094     |   | $ | 20,831 |   | $ | 19,493 |   |
| BSG                                                |       | 18,683                                      |       | 27,941 |   | 8,748 |   |
| Corporate                                          |       | 4,799                                       |       | 4,573 |   | 2,101 |   |
| Total                                              |       | $                                           | 45,576     |   | $ | 53,345 |   | $ | 30,342 |   |

 

----

| (a) | Unallocated expenses  consist of corporate and shared costs. The amounts include $1.0 million and  $13.5 million of overhead charges allocated from Alberto-Culver for fiscal  years 2007 and 2006, |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

 
|   | respectively. There were no  such charges after the Separation Transactions.                                                                                                                                                                                      |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                              |
| (b)    | Transaction expenses are  one-time charges associated with the Separation Transactions in fiscal year  2007, and one-time charges associated with the termination of the agreement  with Regis in fiscal year 2006. Please see Note 3 for additional information. |
|   |                                                                                                                                                                                                                                                              |
| (c)    | Other corporate  identifiable assets consist of amounts due from Alberto-Culver, deferred tax  assets and notes receivable from affiliated companies.                                                                                                             |

##### *** ***

##### ***Geographic Area Information***

##### *** ***

Geographic data for the fiscal years ended September 30,2008, 2007 and 2006 is as follows (in thousands):

 
| ** **           | ** ** | **Year Ended September 30,** | ** ** |
|----------------------|------------|---------------------------------------------|------------|
| ** **           | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales:(a)        |       |                                        |       |   |   |   |   |
| United States        |       | $                                           | 2,170,708  |   | $ | 2,110,864 |   | $ | 2,106,525 |   |
| Foreign              |       | 477,483                                     |       | 402,908 |   | 266,575 |   |
| Total                |       | $                                           | 2,648,191  |   | $ | 2,513,772 |   | $ | 2,373,100 |   |
| Identifiable assets: |       |                                        |       |   |   |   |   |
| United States        |       | $                                           | 1,098,614  |   | $ | 972,094 |   | $ | 994,551 |   |
| Foreign              |       | 350,195                                     |       | 340,434 |   | 213,900 |   |
| Shared services      |       | 76,849                                      |       | 91,733 |   | 119,600 |   |
| Other corporate(b)   |       | —                                      |       | — |   | 10,790 |   |
| Total                |       | $                                           | 1,525,658  |   | $ | 1,404,261 |   | $ | 1,338,841 |   |

 

----

| (a)    | Net sales are attributable  to individual countries based on the location of the customer.                                                            |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                  |
| (b)    | Other corporate  identifiable assets consist of amounts due from Alberto-Culver, deferred tax assets  and notes receivable from affiliated companies. |

 

## **18.   Guarantor and Non-Guarantor CondensedConsolidated Financial Statements**

##  

The following condensed consolidating financialinformation presents the Condensed Consolidated Balance Sheets as of September 30,2008 and September 30, 2007, the Condensed Consolidated Statements ofEarnings for the years ended September 30, 2008, 2007 and 2006, and theCondensed Consolidated Statements of Cash Flows for the years ended September 30,2008, 2007 and 2006 of: (i) Sally Holdings LLC, or “the Parent;” (ii) SallyCapital Inc., or “Co-Issuer;” (iii) the guarantor subsidiaries; (iv) thenon-guarantor subsidiaries; (v) elimination entries necessary toconsolidate the Parent with the guarantor and non-guarantor subsidiaries; and (vi) theParent on a consolidated basis.

 

Investmentsin subsidiaries are accounted for using the equity method for purposes of theconsolidating presentation.  Theprincipal elimination entries relate to investments in subsidiaries and intercompanybalances and transactions.  Separatefinancial statements and other disclosures with respect to the subsidiaryguarantors have not been provided as management believes the followinginformation is sufficient, as guarantor subsidiaries are 100 percent indirectlyowned by the Parent and all guarantees are full and unconditional.  Additionally, substantially all of the assetsof the guarantor subsidiaries are pledged under the term loan facilities andthe ABL facility and consequently may not be available to satisfy the claims ofgeneral creditors.

 

F-30

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Balance Sheet

September 30,2008

(Inthousands)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **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 Holdings, Inc.                                     |       | 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-31

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Balance Sheet

September 30,2007

(Inthousands)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings  LLC &  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|---------------------------------------------------|------------|
| **Assets**                                                                  |       |       |       |          |       |                        |       |                              |       |             |       |                                              |       |
| Cash and cash equivalents                                                   |       | $          | 7          |          | $          | —                      |       | $                                 | 9,316      |             | $          | 28,949                                            |       | $ | — |   | $ | 38,272 |   |
| Trade accounts and other receivables, less  allowance for doubtful accounts |       | 286        |       | —        |       | 47,884                      |       | 25,433                            |       | —           |       | 73,603                                            |       |
| Due from affiliates                                                         |       | 105,771    |       | —        |       | 10,112                      |       | 13,777                            |       | (129,660         | )          | —                                            |       |
| Inventories                                                                 |       | —     |       | —        |       | 442,978                     |       | 126,426                           |       | —           |       | 569,404                                           |       |
| Prepaid expenses                                                            |       | 43         |       | —        |       | 6,702                       |       | 8,630                             |       | —           |       | 15,375                                            |       |
| Deferred income tax assets                                                  |       | 1,191      |       | —        |       | 16,885                      |       | (2,785                            | )          | —           |       | 15,291                                            |       |
| Property and equipment, net                                                 |       | —     |       | —        |       | 115,048                     |       | 39,020                            |       | —           |       | 154,068                                           |       |
| Investment in subsidiaries                                                  |       | 878,650    |       | —        |       | 255,144                     |       | —                            |       | (1,133,794       | )          | —                                            |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | —        |       | 361,013                     |       | 116,115                           |       | —           |       | 477,128                                           |       |
| Other assets                                                                |       | 51,135     |       | —        |       | 1,866                       |       | 8,119                             |       | —           |       | 61,120                                            |       |
| Total assets                                                                |       | $          | 1,037,083  |          | $          | —                      |       | $                                 | 1,266,948  |             | $          | 363,684                                           |       | $ | (1,263,454 | ) | $ | 1,404,261 |   |
|                                                                        |       |       |       |          |       |                        |       |                              |       |             |       |                                              |       |
| **Liabilities and Member’s (Deficit) Equity**                          |       |       |       |          |       |                        |       |                              |       |             |       |                                              |       |
| Accounts payable                                                            |       | $          | —     |          | $          | —                      |       | $                                 | 132,658    |             | $          | 44,002                                            |       | $ | — |   | $ | 176,660 |   |
| Due to affiliates                                                           |       | —     |       | —        |       | 103,225                     |       | 26,435                            |       | (129,660         | )          | —                                            |       |
| Accrued expenses                                                            |       | 34,540     |       | —        |       | 93,099                      |       | 26,032                            |       | —           |       | 153,671                                           |       |
| Due to Sally Beauty Holdings, Inc.                                     |       | —     |       | —        |       | 16,291                      |       | 2,573                             |       | —           |       | 18,864                                            |       |
| Income taxes                                                                |       | —     |       | —        |       | 392                         |       | 3,320                             |       | —           |       | 3,712                                             |       |
| Long-term debt                                                              |       | 1,774,700  |       | —        |       | 558                         |       | 483                               |       | —           |       | 1,775,741                                         |       |
| Other liabilities                                                           |       | 3,047      |       | —        |       | 13,866                      |       | 1,915                             |       | —           |       | 18,828                                            |       |
| Deferred income tax liabilities                                             |       | (1,436     | )          | —        |       | 28,209                      |       | 3,780                             |       | —           |       | 30,553                                            |       |
| Total liabilities                                                           |       | 1,810,851  |       | —        |       | 388,298                     |       | 108,540                           |       | (129,660         | )          | 2,178,029                                         |       |
| Stock options subject to redemption                                         |       | 6,549      |       | —        |       | —                      |       | —                            |       | —           |       | 6,549                                             |       |
| Total member’s (deficit) equity                                        |       | (780,317   | )          | —        |       | 878,650                     |       | 255,144                           |       | (1,133,794       | )          | (780,317                                          | )          |
| Total liabilities and member’s (deficit)  equity                       |       | $          | 1,037,083  |          | $          | —                      |       | $                                 | 1,266,948  |             | $          | 363,684                                           |       | $ | (1,263,454 | ) | $ | 1,404,261 |   |

 

F-32

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Statement of Earnings

FiscalYear Ended September 30, 2008

(Inthousands)

 
| ** **                                           | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **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 |   |

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Statement of Earnings

FiscalYear Ended September 30, 2007

(Inthousands)

 
| ** **                                           | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **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 |   |

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

**SALLY HOLDINGS, INC. AND SUBSIDIARIES**

CondensedConsolidated Statement of Earnings

FiscalYear Ended September 30, 2006

(Inthousands)

 
| ** **                                           | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings,  Inc. &  Subsidiaries** | ** ** |
|------------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-----------------------------------------------------|------------|
|                                                 |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Net sales                                            |       | $          | —     |          | $          | —                      |       | $                                 | 2,075,934  |             | $          | 297,166                                             |       | $ | — |   | $ | 2,373,100 |   |
| Related party sales                                  |       | —     |       | —        |       | 1,943                       |       | —                            |       | (1,943           | )          | —                                              |       |
| Cost of products sold and distribution  expenses     |       | —     |       | —        |       | 1,120,662                   |       | 167,610                           |       | (1,943           | )          | 1,286,329                                           |       |
| Gross profit                                         |       | —     |       | —        |       | 957,215                     |       | 129,556                           |       | —           |       | 1,086,771                                           |       |
| Selling, general and administrative  expenses        |       | 3          |       | —        |       | 693,529                     |       | 104,679                           |       | —           |       | 798,211                                             |       |
| Depreciation and amortization                        |       | —     |       | —        |       | 30,620                      |       | 7,412                             |       | —           |       | 38,032                                              |       |
| Sales-based service fee charged by  Alberto-Culver   |       | —     |       | —        |       | 28,852                      |       | —                            |       | —           |       | 28,852                                              |       |
| Transaction expenses                                 |       | 41,475     |       | —        |       | —                      |       | —                            |       | —           |       | 41,475                                              |       |
| Operating earnings (loss)                            |       | (41,478    | )          | —        |       | 204,214                     |       | 17,465                            |       | —           |       | 180,201                                             |       |
| Interest income                                      |       | (21,961    | )          | —        |       | (1,190                      | )          | (444                              | )          | 21,797           |       | (1,798                                              | )          |
| Interest expense                                     |       | —     |       | —        |       | 19,842                      |       | 3,845                             |       | (21,797          | )          | 1,890                                               |       |
| Earnings (losses) before provision for  income taxes |       | (19,517    | )          | —        |       | 185,562                     |       | 14,064                            |       | —           |       | 180,109                                             |       |
| Provision for income taxes                           |       | —     |       | —        |       | 67,483                      |       | 2,433                             |       | —           |       | 69,916                                              |       |
| Equity in earnings of subsidiaries (net of  tax)     |       | 129,710    |       | —        |       | 11,631                      |       | —                            |       | (141,341         | )          | —                                              |       |
| Net earnings                                         |       | $          | 110,193    |          | $          | —                      |       | $                                 | 129,710    |             | $          | 11,631                                              |       | $ | (141,341 | ) | $ | 110,193 |   |

 

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Tableof Contents

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Statement of Cash Flows

FiscalYear Ended September 30, 2008

(Inthousands)

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **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                                               |       |
| Proceeds related to notes with affiliates                              |       | —     |       | —        |       | —                      |       | —                            |       | —           |       | —                                            |       |
| Payments related to notes with affiliates                              |       | —     |       | —        |       | —                      |       | —                            |       | —           |       | —                                            |       |
| Distributions to Sally Beauty                                          |       | —     |       | —        |       | —                      |       | —                            |       | —           |       | —                                            |       |
| Distributions to Alberto-Culver                                        |       | —     |       | —        |       | —                      |       | —                            |       | —           |       | —                                            |       |
| Change in Hedged Fair Value                                            |       | —     |       | —        |       | —                      |       | —                            |       | —           |       | —                                            |       |
| 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-36

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Tableof Contents

 

Sally Holdings LLC andSubsidiaries

Notes to Consolidated Financial Statements

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

Condensed Consolidated Statement of Cash Flows

Fiscal Year Ended September 30, 2007

(In thousands)

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **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 |   |

 

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Table of Contents

 

Sally Holdings LLC andSubsidiaries

Notes to Consolidated Financial Statements

**SALLY HOLDINGS, INC. AND SUBSIDIARIES**

Condensed Consolidated Statement of Cash Flows

Fiscal Year Ended September 30, 2006

(In thousands)

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings,  Inc. &  Subsidiaries** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-----------------------------------------------------|------------|
|                                                                   |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| **Net cash provided (used) by operating  activities**                  |       | $          | (25,092    | )             | $          | —                      |       | $                                 | 163,192    |             | $          | 18,621                                              |       | $ | — |   | $ | 156,721 |   |
|                                                                   |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| **Cash Flows from Investing Activities:**                              |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Capital expenditures and proceeds from sale  of property and equipment |       | —     |       | —        |       | (22,795                     | )          | (6,951                            | )          | —           |       | (29,746                                             | )          |
| Acquisitions, net of cash acquired                                     |       | —     |       | —        |       | (4,323                      | )          | (18,089                           | )          | —           |       | (22,412                                             | )          |
| Net cash used by investing activities                                  |       | —     |       | —        |       | (27,118                     | )          | (25,040                           | )          | —           |       | (52,158                                             | )          |
|                                                                   |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| **Cash Flows from Financing Activities:**                              |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Change in book cash overdraft                                          |       | —     |       | —        |       | (10,269                     | )          | —                            |       | —           |       | (10,269                                             | )          |
| Proceeds from issuance of long-term debt                               |       | —     |       | —        |       | 331                         |       | 240                               |       | —           |       | 571                                                 |       |
| Repayments of long-term debt                                           |       | —     |       | —        |       | (257                        | )          | (569                              | )          | —           |       | (826                                                | )          |
| Proceeds related to notes with affiliates                              |       | 78,852     |       | —        |       | 17,765                      |       | 16,613                            |       | (98,000          | )          | 15,230                                              |       |
| Payments related to notes with affiliates                              |       | —     |       | —        |       | (129,880                    | )          | —                            |       | 98,000           |       | (31,880                                             | )          |
| Distributions to Alberto-Culver                                        |       | —     |       | —        |       | (5,661                      | )          | —                            |       | —           |       | (5,661                                              | )          |
| Excess tax benefit from share-based  compensation                      |       | —     |       | —        |       | 630                         |       | —                            |       | —           |       | 630                                                 |       |
| Net cash provided (used) by financing  activities                      |       | 78,852     |       | —        |       | (127,341                    | )          | 16,284                            |       | —           |       | (32,205                                             | )          |
|                                                                   |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Effect of foreign exchange rate changes on  cash and cash equivalents  |       | (30        | )          | —        |       | (1,118                      | )          | (2,251                            | )          | —           |       | (3,399                                              | )          |
| Net increase in cash and cash equivalents                              |       | 53,730     |       | —        |       | 7,615                       |       | 7,614                             |       | —           |       | 68,959                                              |       |
| Cash and cash equivalents, beginning of  period                        |       | 62         |       | —        |       | 29,019                      |       | 9,531                             |       | —           |       | 38,612                                              |       |
| Cash and cash equivalents, end of period                               |       | $          | 53,792     |          | $          | —                      |       | $                                 | 36,634     |             | $          | 17,145                                              |       | $ | — |   | $ | 107,571 |   |

 

F-38

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Tableof Contents

 

Sally Holdings LLC andSubsidiaries

Notes to Consolidated FinancialStatements

 

## **19.   Quarterly Financial Data(Unaudited)**

##  

Unaudited quarterlyconsolidated statement of earnings information for the fiscal years ended September 30,2008 and 2007 is summarized below (in thousands, except per share data):

 
| ** **           | ** ** | **1****st** | ** ** | **2nd**     | ** ** | **3rd**     | ** ** | **4****th** | ** ** |
|----------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **Fiscal Year** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| 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 |   |
|                 |       |        |       |        |       |        |       |        |       |
| 2007:                |       |        |       |        |       |        |       |        |       |
| Net sales            |       | $           | 629,879    |        | $          | 609,276     |       | $           | 634,880    |   | $ | 639,737 |   |
| Gross profit         |       | $           | 284,492    |        | $          | 283,018     |       | $           | 290,887    |   | $ | 295,350 |   |
| Net earnings         |       | $           | 3,702      |        | $          | 12,256      |       | $           | 14,655     |   | $ | 17,948 |   |

 

F-39

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