**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, 2007**                                               |
| ** ** | ** **                                                                                      |
| ** ** | **-OR-**                                                                                        |
| ** ** | ** **                                                                                      |
| **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |

 

| **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 ARE THEREFOREFILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT PURSUANT TO GENERALINSTRUCTION I(2).

 

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

 

Indicate by checkmark if theregistrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act. YES **o**     NO **x**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days. YES **o**     NO **x**

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to thisForm 10-K.  **x**

 

Indicate by checkmark whetherthe registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. (See definition of accelerated filer and largeaccelerated filer in Rule 12b-2 of the Exchange Act). Large acceleratedfiler **o**

Accelerated filer **o**     Non-acceleratedfiler **x**

 

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 30, 2007. As of December 6, 2007, all memberunits were owned by Sally Investment Holdings, LLC, a wholly-owned subsidiaryof Sally Beauty Holdings, Inc.

 

**DOCUMENTS INCORPORATED BYREFERENCE: 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                                                                       |       | 24       |
| ITEM 2.  | PROPERTIES                                                                                       |       | 25       |
| ITEM 3.  | LEGAL PROCEEDINGS                                                                                |       | 25       |
| ITEM 4.  | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                             |       | 26       |
|          |                                                                                             |       |     |
|          | **PART II**                                                                                 |       |     |
| ITEM 5.  | MARKET  FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                      |       | 27       |
| ITEM 6.  | SELECTED FINANCIAL  DATA                                                                         |       | 28       |
| ITEM 7.  | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      |       | 29       |
| ITEM 7A  | QUANTITATIVE  AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                                       |       | 49       |
| ITEM 8.  | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                     |       | 51       |
| ITEM 9.  | CHANGE  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE             |       | 51       |
| ITEM 9A. | CONTROLS AND  PROCEDURES                                                                         |       | 51       |
| ITEM 9B. | OTHER INFORMATION                                                                                |       | 52       |
|          |                                                                                             |       |     |
|          | **PART III**                                                                                |       |     |
| ITEM 10. | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                          |       | 53       |
| ITEM 11. | EXECUTIVE  COMPENSATION                                                                          |       | 53       |
| ITEM 12. | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS |       | 53       |
| ITEM 13. | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                       |       | 53       |
| ITEM 14. | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                          |       | 53       |
|          |                                                                                             |       |     |
|          | **PART IV**                                                                                 |       |     |
| ITEM 15. | EXHIBITS AND  FINANCIAL STATEMENT SCHEDULES                                                 |       | 55       |

 

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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 are beneficiallyowned by Sally Investment, and all of the interests of Sally Investment arebeneficially owned by Sally Beauty. Prior to November 16, 2006, Sally Holdingswas a Delaware corporation named “Sally Holdings, Inc.” and was a wholly-ownedsubsidiary of Alberto-Culver Company, or Alberto-Culver. On November 16, 2006,Sally Holdings, Inc. was converted to a Delaware limited liability company, wasrenamed “Sally Holdings LLC” and became a wholly-owned subsidiary of SallyInvestment and an indirect subsidiary of Sally Beauty in connection with theseparation of Sally Holdings’ business from Alberto-Culver. All operations ofSally Investment and Sally Beauty are conducted through Sally Holdings and itsconsolidated subsidiaries. Sally Capital Inc., a Delaware corporation, or SallyCapital, is a wholly-owned subsidiary of Sally Holdings and does not have anyassets or operations of any kind.

 

In this report, references to “Sally Holdings,” “theCompany,” “our company,” “we,” “our,” “ours” and “us” refer to Sally HoldingsLLC and its consolidated subsidiaries for periods after the separation fromAlberto-Culver and to Sally Holdings, Inc. and its consolidated subsidiariesfor periods prior to the separation from Alberto-Culver unless otherwiseindicated or 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, as amended,and Section 21E of the Securities Exchange Act of 1934, as amended. Words suchas “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,”“target,” “can,” “could,” “may,” “should,” “will,” “would,” or similarexpressions 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:

 

•                  Sally Beauty’slimited history as a stand-alone company;

 

•                  the preparednessof our accounting and other management systems to meet financial reporting andother requirements and the upgrade of our existingfinancial reporting system;

 

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

 

•                  realizing theanticipated benefits of our separation from Alberto-Culver;

 

•                  since ourseparation from Alberto-Culver, our inability to achieve the benefits of scalethat were achieved by Alberto-Culver prior to our separation fromAlberto-Culver;

 

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

 

•                  the highlycompetitive and consolidating nature of the beauty products distributionindustry;

 

•                  anticipatingchanges in consumer preferences and buying trends or to manage our productlines and inventory;

 

•                  our dependenceupon manufacturers who may be unwilling or unable to continue to supplyproducts to us;

 

•                  products sold byus being found to be defective in labeling or content;

 

•                  compliance withlaws and regulations, or becoming subject to additional or more stringent lawsand regulations;

 

•                  productdiversion;

 

•                  the operationaland financial performance of our Armstrong McCall business;

 

•                  the success ofour new Internet-based business;

 

•                  successfullyidentifying acquisition candidates or successfully completing desirableacquisitions;

 

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•                  integration ofbusinesses acquired in the future;

 

•                  opening andoperating new stores profitably;

 

•                  the success ofour cost control plans;

 

•                  protecting ourintellectual property rights, specifically our trademarks;

 

•                  conductingbusiness in international markets;

 

•                  disruption inour information technology systems;

 

•                  naturaldisasters or acts of terrorism;

 

•                  our substantialindebtedness;

 

•                  the possibilitythat we 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 ininterest rates increasing the cost of servicing our debt or increasing ourinterest expense due to our interest rate swap agreements;

 

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

 

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

 

•                  significantrestrictions on Sally Beauty’s ability to issue equity securities;

 

•                  the voting powerof Sally 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 theforward-looking statements might not occur or might occur to a different extentor at a different time than we have described. As a result, our actual resultsmay differ materially from the results contemplated by these forward-lookingstatements. We assume no obligation to publicly update or revise anyforward-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 service mark),we operated a multi-channel platform of 3,368 stores and supplied 200franchised stores in North America as well as selected European countries andJapan, as of September 30, 2007. Within BSG, we also have one of thelargest networks of professional distributor sales consultants in NorthAmerica, with approximately 1,100 professional distributor sales consultantswho sell directly to salons and salon professionals. As of September 30,2007, Sally Beauty Supply owned and operated 2,669 company-owned retail storesand supplied 25 franchised stores, and BSG operated 699 company-ownedstores and supplied 175 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 90% of our net sales were in the U.S. andCanada for each of the last three fiscal years. For the year endedSeptember 30, 2007 our net sales were $2,513.8 million.

 

Sally Beauty Supply began as a single store in NewOrleans in 1964 and was purchased in 1969 by our former parent company,Alberto-Culver. BSG became a subsidiary of Alberto-Culver in 1985. OnNovember 16, 2006, our business separated from Alberto-Culver and becamean indirect wholly-owned subsidiary of Sally Beauty. Our separation from Alberto-Culverand its consumer products-focused business, which we refer to as the SeparationTransactions, was pursuant to an investment agreement, dated as ofJune 19, 2006, as amended, or the Investment Agreement, among SallyHoldings, Inc., Alberto-Culver, CDRS Acquisition LLC, or CDRS, and others.Sally Beauty was formed as a Delaware corporation in June of 2006 in connectionwith the Separation Transactions and, through us, owns and operates SallyBeauty Supply and BSG and other subsidiaries following 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, we andcertain of our subsidiaries incurred approximately $1,850.0 million ofindebtedness, as more fully described below. Also in connection with theSeparation Transactions, CDRS and CD&R Parallel Fund VII, L.P., or theParallel Fund, and which we refer to together with CDRS as the CDR Investors,invested an aggregate of $575.0 million in cash equity, representingownership subsequent to the separation of approximately 48% of the outstandingshares of Sally Beauty’s common stock on an undiluted basis. CDRS, which ownedapproximately 47.6% of the outstanding shares of Sally Beauty’s common stock onan undiluted basis as of September 30, 2007, is a Delaware limited liabilitycompany organized by Clayton, Dubilier & Rice Fund VII, L.P., aprivate investment fund managed by Clayton, Dubilier & Rice, Inc.

 

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

 

## **ProfessionalBeauty Supply Industry**

##  

We operate primarily within the large and growingU.S. professional beauty supply industry. Potential growth in the industryis expected to be driven by demographic and fashion trends, which we expectwill lead to increased usage of hair color, hair-loss prevention products andhair styling products.

 

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.

 

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##### ***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 recently begunselling some products through its web site (*www.sallybeauty.com*).

 

##### ***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-SalonStores***

##### *** ***

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

 

## **KeyFuture Industry Trends**

##  

We believe the following key industry trends andcharacteristics will influence our business, going forward:

 

##### ***High Level ofCustomer Fragmentation***

##### *** ***

The U.S. salon market is highly fragmented withover 230,000 salons. Given the fragmented and small-scale nature of the salonindustry, we believe that salon operators will continue to depend on fullservice/exclusive distributors and open-line channels for a majority of theirbeauty supply purchases.

 

##### ***Growth inBooth Renting***

##### *** ***

Many professional stylists are individual operatorswho rent booth space from salons, which we refer to as booth renters, and areresponsible for purchasing their own supplies. Over time, the number of boothrenters has significantly increased as a percentage of total salonprofessionals, and we expect this trend to continue. Given their smallerindividual purchases and relative capital constraints, booth renters are likelyto be dependent on frequent trips to professional beauty supply stores, likethose that BSG and Sally Beauty Supply operate.

 

##### ***FrequentRe-Stocking Needs***

##### *** ***

Salon professionals primarily rely on just-in-timeinventory due to capital constraints and a lack of warehouse and shelf space atsalons. These factors are key to driving demand for conveniently locatedprofessional beauty supply stores.

 

##### ***ContinuingConsolidation***

##### *** ***

There is continuing consolidation among professionalbeauty product distributors and among professional beauty supply manufacturers.We believe that suppliers are increasingly likely to focus on largerdistributors and retailers with broader scale and a retail footprint. We alsobelieve that we are well positioned to capitalize on this trend as well as toparticipate in the ongoing consolidation at the distributor/retail level.However, changes often occur in our relationships with suppliers thatpositively or negatively affect the net sales and operating profits of eachbusiness segment. Consolidation among suppliers could exacerbate the effects ofthese relationship changes and could increase pricing pressures or give ourcompetitors increased negotiating leverage and greater marketing resources. See“Risk Factors—The beauty products distribution industry is highly competitiveand is consolidating, and —We depend upon manufacturers who may be unable toprovide products of adequate quality or who may be unwilling to continue tosupply products to us.”

 

##### ***FavorableDemographic and Consumer Trends***

##### *** ***

The aging baby-boomer population is expected to drivefuture growth in professional beauty supply sales through increased usage ofhair color and hair-loss prevention products. Additionally, continuouslychanging fashion-related trends that drive new hair styles are expected to resultin continued demand for hair styling products.

 

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## **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 U.S. and Mexico, and suppliesfranchisees and sub-distributors in Europe. Sales of Sally Beauty Supplyaccounted for approximately 62%, 60% and 60% of the company’s consolidated netsales for the years ended September 30, 2007, 2006 and 2005, respectively.BSG accounted for approximately 38%, 40% and 40% of the company’s consolidatednet sales for the years ended September 30, 2007, 2006 and 2005,respectively.

 

Financial information about business segments andgeographic area information is incorporated herein by reference to the“Business Segments and Geographic Area Information,” Note 17 of the “Notesto Consolidated Financial Statements” in “Item 8—Financial Statements andSupplementary Data” of this 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. It carries an extensive selection of professional beauty products,ranging between 5,400 and 7,700 stock keeping units, or SKUs, of beautyproducts, including hair care, nail care, beauty sundries and appliances. Ittargets retail consumers and salon professionals. We believe that Sally BeautySupply has differentiated itself from its competitors through its customervalue proposition, attractive pricing, extensive selection of leadingthird-party branded and exclusive label products, broad ethnic productselection, the product knowledge of its sales associates and convenient storelocations.

 

### *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 aconsistent format, allowing customers familiarity between Sally Beauty Supplylocations.

 

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. Throughits information systems, Sally Beauty Supply actively monitors each store’scategory performance, allowing maintenance of consistently high levels ofin-stock merchandise. We believe Sally Beauty Supply’s tailored merchandisestrategy enables it to meet local demands and helps drive traffic in itsstores. Additionally, its information systems track and automatically replenishinventory levels, generally on a weekly basis.

 

Sally Beauty Supply offers a comprehensive ethnicproduct selection with specific appeal to the African-American marketplace. Itsethnic product offerings are tailored by store based on market demographics andcategory performance. For example, sales to the African-American marketplacerepresent approximately 10% of net sales in Sally Beauty Supply’sU.S. stores for fiscal year 2007. 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.

 

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### *Leading Third-Party Branded Products*

###  

Sally Beauty Supply offers an extensive selection ofhair care products, nail care products, beauty sundries and appliances fromleading third-party brands such as Clairol, Revlon and Conair, as well as anextensive selection of exclusive label merchandise. We believe that carrying abroad selection of the latest premier branded merchandise is critical tomaintaining long-term relationships with our customers. The merchandise SallyBeauty Supply carries includes products from one or more of the leadingmanufacturers in each category. Sally Beauty Supply’s objective is not only tocarry leading brands, but also to carry a full range of branded and exclusivelabel products within each category. As hair trends continue to evolve, weexpect to offer the changing professional beauty product assortment necessaryto meet the needs of retail 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, includingcontrolled label products, provide customers with an attractive alternative tohigher-priced leading third-party brands. Exclusive label products accountedfor approximately 40% of Sally Beauty Supply’s product sales in the U.S. duringfiscal year 2007. Generally, the exclusive label brands have higher grossmargins than the leading third-party branded products and we believe this areaoffers continued potential growth. Sally Beauty Supply maintains exclusivelabel products in a number of categories including hair care, appliances andsalon products. Sally Beauty Supply actively promotes its exclusive labelbrands through in-store promotions and monthly flyers. We believe our customersperceive these exclusive label products to be comparable in quality and namerecognition to leading third-party branded products.

 

The following table sets forththe approximate percentage of Sally Beauty Supply’s sales by merchandisecategory:

 

| ** **                       | ** ** | **Year Ended  September 30, 2007** | ** ** |
|----------------------------------|------------|---------------------------------------------------|------------|
| Hair color                       |       | 21.3                                              | %          |
| Skin and nail care               |       | 17.8                                              | %          |
| Hair care                        |       | 17.6                                              | %          |
| Brushes, cutlery and accessories |       | 14.1                                              | %          |
| Electrical appliances            |       | 13.8                                              | %          |
| Ethnic products                  |       | 9.8                                               | %          |
| Other beauty items               |       | 5.6                                               | %          |
| 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. Additionally, a Sally Beauty magazine that providescustomers with beauty trends and product information is sold in Sally BeautySupply stores.

 

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 discounts on allbeauty products sold at Sally Beauty Supply stores. We believe these programsare effective in developing and maintaining customer relationships.

 

### *Store Locations*

###  

Sally Beauty Supply selects geographic markets andstore sites 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.

 

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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 2003:

 

| ** **                         | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Stores open at beginning of period |       | 2,511                                       |       | 2,419 |   | 2,355 |   | 2,272 |   | 2,177 |   |
| Net store openings during period   |       | 83                                          |       | 92 |   | 62 |   | 83 |   | 95 |   |
| Stores acquired during period      |       | 100                                         |       | — |   | 2 |   | — |   | — |   |
| Stores open at end of period       |       | 2,694                                       |       | 2,511 |   | 2,419 |   | 2,355 |   | 2,272 |   |

 

## ***Beauty Systems Group***

 

We believe that BSG is the largest full-servicedistributor of professional beauty supplies in the U.S. As ofSeptember 30, 2007, BSG operated 699 company-owned stores, supplied175 franchised stores and had a sales force of approximately 1,100 professionaldistributor sales consultants selling exclusively to salons and salonprofessionals in 47 U.S. states and 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-owned BSG stores average 2,700 squarefeet and are located primarily in secondary strip shopping centers. BSG storelayouts are designed to provide optimal variety and options to the salonprofessional. Stores are segmented into distinctive areas arranged by producttype with certain areas dedicated to leading third-party brands, such as PaulMitchell, Wella, Sebastian, Goldwell and TIGI. The selection of these brandsvaries by territory.

 

### *Professional Distributor Sales Consultants*

###  

BSG has a network of approximately 1,100 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 2003:

 

| ** **                                 | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                 | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Professional distributor sales consultants |       | 1,067                                       |       | 1,192 |   | 1,244 |   | 1,167 |   | 989 |   |

 

The decrease in distributor sales consultants infiscal year 2007 is in response to the loss of L’Oreal related sales discussedbelow under “Competition.” BSG’s sales force was reduced and the remainingaffected distributor sales consultants were offered certain compensationrelated incentives to stay with us as BSG seeks to replace lost L’Oreal sales.

 

In order to provide a knowledgeable consultant team,BSG actively recruits professional cosmetologists and individuals with salesexperience, as we believe that new consultants with either broad knowledgeabout the products or direct sales experience will be more successful.

 

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

 

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

 

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

 

5

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| ** **                                 | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                 | ** ** | **2007**                                    | ** ** | **2006** | ** ** |
| Company-owned retail stores                |       | 53.4                                        | %          | 47.5 | % |
| Professional distributor sales consultants |       | 31.2                                        | %          | 37.2 | % |
| Franchise stores                           |       | 15.4                                        | %          | 15.3 | % |
| Total                                      |       | 100.0                                       | %          | 100.0 | % |

 

### *Merchandise*

###  

BSG stores carry a broad selection of branded beautysupplies, ranging between 2,700 and 9,800 SKUs of beauty products, includinghair care products, nail care, appliances and other beauty items from leadingthird-party brands. Some products are available in bulk packaging for highervolume salon needs. Through BSG’s information systems, each store’s productperformance is actively monitored, allowing maintenance of an optimalmerchandise mix. Additionally, BSG’s information systems track andautomatically replenish inventory levels on a weekly basis, enabling BSG tomaintain high levels of product in stock. Although BSG positions itself to becompetitive on price, its primary focus is to provide a comprehensive selectionof branded products to the salon professional. Certain BSG products are soldunder exclusive arrangements with suppliers, whereby BSG is designated the soledistributor for a specific brand name within certain geographic territories. Webelieve that carrying a broad selection of branded merchandise is critical tomaintaining relationships with our valued professional customers.

 

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

 

| ** **                       | ** ** | **Year Ended  September 30, 2007** | ** ** |
|----------------------------------|------------|---------------------------------------------------|------------|
| Hair care                        |       | 39.5                                              | %          |
| Hair color                       |       | 22.5                                              | %          |
| Promotional items(a)             |       | 12.7                                              | %          |
| Skin and nail care               |       | 8.7                                               | %          |
| Electrical appliances            |       | 7.5                                               | %          |
| Brushes, cutlery and accessories |       | 3.8                                               | %          |
| Salon equipment                  |       | 2.3                                               | %          |
| Other beauty items               |       | 2.0                                               | %          |
| Ethnic products                  |       | 1.0                                               | %          |
| Total                            |       | 100.0                                             | %          |

 

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(a)           Promotional items consists of salesfrom other categories that are sold on a discounted basis

 

### *Marketing and Advertising*

 

BSG’s marketing program is designed to promote itsextensive selection of brand name products at competitive prices. BSGdistributes at its stores and mails to its salon and salon professionalcustomers multi-page color flyers that highlight promotional products. Some BSGstores also host monthly manufacturer-sponsored classes for customers. Theseclasses are held at BSG stores and led by manufacturer-employed educators.Salon professionals, after paying a small fee to attend, are educated on newproducts and beauty trends. We believe these classes increase brand awarenessand 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 2003:

 

| ** **                         | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Stores open at beginning of period |       | 828                                         |       | 822 |   | 692 |   | 543 |   | 535 |   |
| Net store openings during period   |       | 46                                          |       | 6 |   | 37 |   | 26 |   | 8 |   |
| Stores acquired during period      |       | —                                      |       | — |   | 93 |   | 123 |   | — |   |
| Stores open at end of period       |       | 874                                         |       | 828 |   | 822 |   | 692 |   | 543 |   |

 

6

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## **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 SalesProductivity of Our Stores***

##### *** ***

We intend to grow comparable store sales by focusingon improving 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 NewStores and Exploring New Markets***

##### *** ***

In fiscal year 2007, we opened 83 and 46 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 markets such as South America. We expect new store openings in existing andnew markets to be an important aspect of our future growth opportunities.

 

##### ***Increase Salesof 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.

 

##### ***IncreaseOperating Efficiency and Profitability***

##### *** ***

We believe there are opportunities to increase theprofitability of operations, especially in our BSG business. During fiscal year2007 we made certain changes which included right-sizing the business(including some targeted reductions-in-force) and maximizing the efficiency of ourstructure. We completed a re-branding project at BSG that repositioned all ofour North American company-owned stores under a common name and store identity,CosmoProf, which we believe will improve brand consistency, save on advertisingand promotional costs and allow for a more focused marketing strategy. We arealso currently implementing a two-year, $19.0 million capital spending programto consolidate BSG warehouses and reduce administrative expenses related toBSG’s distribution network. Additionally during fiscal year 2007 we implementedworking capital improvement initiatives that are focused on the management ofreceivables, inventory and payables to further maximize our free cash flow. Wealso intend to undertake a full review of our procurement strategy. Thisinitiative is intended to identify low cost alternative sources of supplyin certain product categories from countries with low manufacturing costs. Wealso recently began offering some of our Sally Beauty Supply products for salethrough Sally Beauty’s website (*www.sallybeauty.com*),which we expect will lead to additional sales for that business segment.

 

##### ***PursueStrategic Acquisitions***

##### *** ***

We have completed more than 25 acquisitions over thelast 10 years, predominantly in our BSG segment. We believe our experiencein identifying attractive acquisition targets, our proven integration process,and our highly scalable infrastructure have created a strong platform forpotential future acquisitions, subject to: (i) restrictions on our abilityto finance acquisitions by incurring additional debt under our debt agreements;and (ii) restrictions on the amount of equity that we can issue to makeacquisitions for at least two years following the Separation Transactions. Weintend to continue to identify and evaluate acquisition targets bothdomestically and internationally, with a focus on expanding our exclusive BSGterritories and allowing Sally Beauty Supply to enter new markets outside theU.S.

 

7

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## **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 domestic and international competition,including mass merchandisers, drug stores, supermarkets and other chains,offering similar or substitute beauty products at comparable prices. Ourbusiness also faces competition from department stores. In addition, ourbusiness competes with local and regional open-line beauty supply stores andfull-service distributors selling directly to salons and salon professionalsthrough both professional distributor sales consultants and outlets open onlyto salons and salon professionals. Our business also faces increasingcompetition from certain manufacturers that use their own sales forces todistribute their professional beauty products directly or align themselves withour competitors. Some of these manufacturers are vertically integrating throughthe acquisition of distributors and stores. In addition, these manufacturersmay acquire additional brands that we currently distribute and attempt to shiftthese products to their own distribution channels. Our business also facescompetition from authorized and unauthorized retailers and Internet sitesoffering professional salon-only products. See “Risk Factors—The beautyproducts distribution industry is highly competitive.”

 

## **CompetitiveStrengths**

##  

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

 

##### ***The LargestProfessional Beauty Supply Distributor in the U.S. with Multi-ChannelPlatform***

##### *** ***

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 Puerto Rico,offering up to 7,700 and 9,800 SKUs in Sally Beauty Supply and BSG stores,respectively, to a potential customer base that includes millions of retailconsumers, and more than 230,000 salons in the U.S.

 

##### ***DifferentiatedCustomer 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 (in Sally BeautySupply stores) exclusive label merchandise), high levels of in-stockmerchandise, knowledgeable salespeople and competitive pricing. Our merchandisemix includes a comprehensive ethnic product selection, which is tailored bystore based on market demographics and category performance. African-Americanproducts represent approximately 10% of net sales in U.S. Sally BeautySupply stores during fiscal year 2007, and we believe that the breadth of itsselection of these products further differentiates Sally Beauty Supply from itscompetitors. In addition, as discussed above, Sally Beauty Supply also offers acustomer loyalty program for Sally Beauty Supply customers, the Beauty Club,whereby members receive a special, discounted price on products and are alsoeligible for a special Beauty Club e-mail newsletter with additionalpromotional offerings, beauty tips and new product information for a nominalannual fee. We believe that our differentiated customer value proposition andstrong brands drive customer loyalty and high repeat traffic, contributing toour consistent historical financial performance. Our BSG professionaldistributor sales consultants benefit from their customers having access to theBSG store system. Customers have the ability to pick up the products they needbetween sales visits from professional distributor sales consultants.

 

##### ***AttractiveStore 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 $60,000 and$75,000, 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 two years. Due to such attractive investment returns andrelatively high operating profit contributions per store, over the past fiveyears Sally Beauty Supply and BSG have opened 415 and 123 net new stores,respectively.

 

##### ***ConsistentFinancial 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, ourcomparable store sales growth has been positive in each year and has averaged3.5%, as set forth in the following table:

 

8

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| ** **                                        | ** ** | **Year Ended September 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------|------------|
| **Comparable store sales growth:** | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Sally Beauty Supply                               |       | 2.7                                         | %          | 2.4 | % | 2.4 | % | 3.8 | % | 2.7 | % |
| Beauty Systems Group                              |       | 10.1                                        | %          | 4.1 | % | (0.6 | )% | 8.5 | % | 4.6 | % |
| Consolidated                                      |       | 4.5                                         | %          | 2.8 | % | 1.8 | % | 4.6 | % | 3.8 | % |

 

##### ***ExperiencedManagement Team with a Proven Track Record***

 

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

 

## **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.

 

## **Suppliers**

 

We purchase our merchandise directly frommanufacturers and fillers through supply contracts and by purchase order. Forfiscal year 2007, our two largest suppliers were Procter & Gamble Co.,or P&G, and the Professional Products Division of L’Oreal USA S/D, Inc., orL’Oreal. Products are purchased from most manufacturers and fillers on anat-will basis or under contracts which can be terminated without cause upon90 days notice or less or expire without express rights of renewal. Suchmanufacturers and fillers could discontinue sales to us at any time or uponshort notice.

 

As is typical in 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. See “Risk Factors—We depend upon manufacturers who maybe unable to provide products of adequate quality or who may be unwilling tocontinue to supply products to us.” However, we believe that we can besuccessful in mitigating negative effects resulting from unfavorable changes inthe relationships between us and our suppliers through, among other things, thedevelopment of new or expanded supplier relationships.

 

On December 19, 2006, we announced that:(i) BSG, other than its Armstrong McCall L.P., or Armstrong McCall,division, would not retain its rights to distribute the professional productsof L’Oreal through its distributor sales consultants (effectiveJanuary 30, 2007, with exclusivity ending December 31, 2006) orin its stores on an exclusive basis (effective January 1, 2007) inthose geographic areas within the U.S. in which BSG had distributionrights; and (ii) BSG’s Armstrong McCall division would not retain therights to distribute Redken professional products through distributor salesconsultants or its stores. In an effort to replace these rights, BSG enteredinto long-term agreements with L’Oreal under which, as of January 1, 2007,BSG had non-exclusive rights to distribute the same L’Oreal professionalproducts in its stores that it previously had exclusive rights to in its storesand through its sales consultants. Sales of L’Oreal products in BSG U.S. basedstores (excluding BSG’s Armstrong McCall division) were approximately $121million during fiscal year 2007. Armstrong McCall retained its exclusive rightsto distribute Matrix professional products in its territories. During fiscalyear 2007, sales of L’Oreal products at Armstrong McCall were approximately $52million. See “Risk Factors—We depend upon manufacturers who may be unable toprovide products of adequate quality or who may be unwilling to continue tosupply products to us.”

 

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## **Distribution**

##  

As of September 30, 2007, we operated 21distribution centers, 6 of which serviced Sally Beauty Supply and 15 of whichserviced BSG. Our purchasing and distribution system is designed to minimizethe delivered cost of merchandise and maximize the level of merchandisein-stock in stores. This distribution system also allows for monitoring ofdelivery times and maintenance of appropriate inventory levels. Productdeliveries 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.

 

Weare currently implementing a two-year, $19.0 million capital spending program,which will continue into fiscal year 2008, to consolidate warehouses and reduceadministrative expenses related to BSG’s distribution network optimizationprogram. We expect to achieve annual cost savings of approximately $10.0million annually from this project within the next two years. See “Risk Factors—We are not certain that our ongoing cost control plans will continue to besuccessful.”

 

## **ManagementInformation Systems**

##  

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

 

## **Employees**

##  

In our domestic and foreign operations, we hadapproximately 18,500 full-time equivalent employees as ofSeptember 30, 2007 consisting of approximately 13,600 hourlypersonnel and 4,900 salaried employees.

 

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

 

## **Regulation**

##  

We are subject to a wide variety of laws andregulations, which historically have not had a material effect on our business.For example, in the U.S., most of the products sold and the content and methodsof advertising and marketing utilized are regulated by a host of federalagencies, including, in each case, one of more of the following: the Food andDrug Administration, or FDA, the Federal Trade Commission, or FTC, and theConsumer Products Safety Commission. The transportation and disposal of many ofour products are also subject to federal regulation. State and local agenciesregulate many aspects of our business. In markets outside of the U.S.,regulation is also focused and comprehensive.

 

The franchisor-franchisee relationship poses aspecific set of regulatory issues. We are subject to the regulation of offeringand sale of franchises in the U.S. and Mexico. The applicable laws andregulations affect our business practices, as franchisor, in a number of ways,including restrictions placed upon the offering, renewal, termination anddisapproval of assignment of franchises. To date, these laws and regulationshave not had a material effect upon operations.

 

## **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 200 trademarks in the U.S. We also rely upon trade secrets and know-how todevelop and maintain our competitive position. We protect intellectual propertyrights through a variety of methods, including reliance upon trademark, patentand trade secret laws, in addition to confidentiality agreements with manyvendors, 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 Exchange Commission,or SEC, under the Securities Exchange Act of 1934, as amended, which we referto as the Exchange Act. We will provide copies of such reports to any person,without charge, upon written request to our office of Investor Relations bywriting to: our Investor Relations Department at 3001 Colorado Blvd, Denton, TX76210. The information found on our website shall not be considered to be partof this or any other report filed with or furnished to the SEC.

 

In addition to Sally Beauty’s website, you may readand copy public reports we file with or furnish to the SEC at the SEC’s PublicReference Room at 100 F Street, NE, Washington, DC 20549. You may obtaininformation on the operation of the Public Reference Room by calling the SEC at1-800-SEC-0330. The SEC maintains an Internet site that contains our reports,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 report also contains forward-lookingstatements and the following risks could cause our actual results to differmaterially from those anticipated in such forward-looking statements.

 

## **RisksRelating to Our Business**

##  

##### ***We have alimited history as a stand-alone company, may be unable to continue to make thechanges necessary to operate effectively, and we rely upon Alberto-Culver forthe accuracy of certain historical services and information.***

##### *** ***

We recently separated from Alberto-Culver and becamean indirect subsidiary of Sally Beauty, an independent publicly-traded company.Apart from a limited number of services provided to us on a transitional basis,Alberto-Culver has no obligation to provide financial, operational ororganizational assistance to us or any of our subsidiaries. In addition, 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 Sally Beauty, as the successor entity to Alberto-Culverafter the separation, relies upon the prior-year federal income tax returns ofAlberto-Culver, and accounting methods established therein, for certain calculationsthat affect Sally Beauty’s and our U.S. federal income tax liability. Pleasesee “Risks Relating to the TaxTreatment of Our Separation from Alberto-Culver and Relating to Sally Beauty’sLargest Stockholder” below**.**We also rely upon Alberto-Culver for historical information related to ourinsurance programs and other benefits. There can be no assurance that ourseparation from Alberto-Culver, the resulting absence of its generaladministrative and professional assistance, or our reliance upon the accuracyor completeness of historical information or services previously provided bythem will not have an adverse impact on our business, financial condition andresults of operations.

 

##### ***The accountingand other management systems and resources of Sally Beauty, our ultimateparent, may not be adequately prepared to meet the financial reporting andother requirements to which Sally Beauty and we are subject following ourseparation from Alberto-Culver.***

##### *** ***

Our financial results previously were included within theconsolidated results of Alberto-Culver, and the reporting and control systemswere appropriate for those of subsidiaries of a reporting company. However,neither we nor any of our subsidiaries was directly subject to reporting andother requirements of the Exchange Act. Sally Beauty, as an independentpublicly-traded company, is now directly subject to reporting and otherobligations under the Exchange Act. In addition, as a result of the registeredexchange offers for our senior notes and our senior subordinated notes, whichwe refer to collectively as the Notes, which was completed in July 2007, we arenow directly subject to reporting and other requirements of the Exchange Act.These reporting and other requirements place significant demands on the managementand administrative and operational resources, including accounting resources,of Sally Beauty, us and our subsidiaries. As reporting companies, we and SallyBeauty incur significant legal, accounting, and other expenses that we and itdid not incur as non-reporting companies. Under the SEC rules and regulations,as well as those of the New York Stock Exchange, our compliance costs haveincreased.

 

In addition, we are subject to rules adopted by theSEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, whichrequire us to include in our Annual Report on Form 10-K our management’sreport on, and assessment of, the effectiveness of our internal

 

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controls over financial reporting. In addition, ourindependent registered public accounting firm must attest to and report on theeffectiveness of such internal controls. Such reports will first be requiredwith respect to our Annual Report for the fiscal year ending September 30,2008. If we fail to properly assess and/or achieve and maintain the adequacy ofour internal controls, there is a risk that we will not comply with all of therequirements imposed by Section 404. Moreover, effective internal controlsare necessary to help prevent financial fraud. Any of these possible outcomescould result in an adverse reaction in the financial marketplace due to a lossof investor confidence in the reliability of our financial statements, whichultimately could harm our business and could negatively impact the market priceof our debt instruments.

 

To comply with these requirements, Sally Beauty, weand our subsidiaries are upgrading our systems, including informationtechnology, implementing additional financial and management controls,reporting systems and procedures, and have hired additional legal, accountingand finance staff. In particular, during fiscal year 2008 we will be upgradingour financial reporting system. These and any other required upgrades to ourfinancial and management controls, reporting systems, information technologyand 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.

 

##### ***Our historicalconsolidated financial information contained in this report does not representour 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 during the periods presented.***

##### *** ***

Our historical consolidated financial information forthe periods prior to the Separation Transactions included in this report is notrepresentative of our future financial position, results of operations or cashflows nor does it reflect what our financial position, results of operations orcash flows would have been as a separate reporting company independent fromAlberto-Culver during 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 as partof Alberto-Culver’s corporate-wide cash management policies. In connection withthe Separation Transactions, we incurred a large amount of indebtedness andassumed 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.

 

##### ***We may not beable to realize the anticipated benefits of our separation from Alberto-Culveron a timely basis or at all.***

##### *** ***

The success of the Separation Transactions depends, inpart, on our ability to realize the anticipated benefits of our separation fromAlberto-Culver. These anticipated benefits include increased brand and productrecognition as a result of our increased ability to engage in more aggressivemarketing and advertising campaigns following the elimination of difficultiesarising from our businesses’ competition with the customers and suppliers ofAlberto-Culver’s consumer products business, and the potential for increasedoperating earnings of our business expected to result from allowing us to focusour attention and resources on our business and customers. We cannot assure youthese benefits will occur or that we will be able to achieve growth in thefuture comparable to our businesses’ recent historical sales and earningsgrowth.

 

##### ***As a separateentity, we do not enjoy all of the benefits of scale that Alberto-Culverachieved with the combination of the consumer products business and our business.***

##### *** ***

Prior to the Separation Transactions, Alberto-Culverbenefited from the scope and scale of the consumer products business and ourbusiness in certain areas, including, among other things, risk management,employee benefits, regulatory compliance, administrative services and humanresources. Our loss of these benefits as a consequence of our separation fromAlberto-Culver could have an adverse effect on our business, results ofoperations and financial condition. For example, it is possible that some costswill be greater for us than they were for Alberto-Culver due to the loss ofvolume discounts and the position of being a large customer to service

 

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providers and vendors. In addition, the separationeliminated Alberto-Culver’s diversification that resulted from operating theconsumer products business of Alberto-Culver alongside our distributionbusiness that tended to mitigate financial and operations volatility. As aresult, we may experience increased volatility in terms of cash flow, operatingresults, working capital and financing requirements.

 

##### ***We are aholding company, with no operations of our own, and we depend on oursubsidiaries for cash.***

##### *** ***

We are a holding company and do not have any materialassets or operations other than ownership of equity interests of oursubsidiaries. Our operations are conducted almost entirely through oursubsidiaries, and our ability to generate cash to meet our obligations or topay dividends to Sally Beauty is highly dependent on the earnings of, andreceipt of funds from, our subsidiaries through dividends or intercompanyloans. However, none of our subsidiaries are obligated to make funds availableto us for payment of dividends. Furthermore, we and our subsidiaries may beseverely restricted or prohibited from making distributions, paying dividendsor making loans to us.

 

##### ***The beautyproducts distribution industry is highly competitive and is consolidating.***

##### *** ***

The beauty products distribution industry is highlyfragmented and there are few significant barriers to entry into the markets formost of the types of products and services we sell. Sally Beauty Supplycompetes with other domestic and international beauty product wholesale andretail outlets, including local and regional open-line beauty supply stores,professional-only beauty supply stores, salons, mass merchandisers, drug storesand supermarkets. BSG competes with other domestic and international beautyproduct wholesale and retail suppliers and with 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. Theincreasing availability of unauthorized professional salon products in largeformat retail stores such as drug stores, grocery stores and others could havea negative impact on our business. The primary competitive factors in thebeauty products distribution industry are the price at which we purchaseproducts from manufacturers, quality, perceived value, consumer brand namerecognition, packaging and mix of the products we sell; customer service; theefficiency of our distribution network; and the availability of desirable storelocations. Competitive conditions may limit our ability to maintain prices ormay require us to reduce prices to retain business or marketplace share. Someof our competitors are larger and have greater financial and other resourcesthan we do, and are less leveraged than our business, and may therefore be ableto spend more aggressively on advertising and promotional activities andrespond more effectively to changing business and economic conditions. Weexpect existing competitors, business partners and new entrants to the beautyproducts distribution industry to constantly revise or improve their businessmodels in response to challenges from competing businesses, including ours. Ifthese competitors introduce changes or developments that we cannot meet in atimely or cost-effective manner, our business may be adversely affected.

 

In addition, our industry is consolidating, which maygive our competitors increased negotiating leverage and greater marketingresources, thereby providing corresponding competitive advantages over us. Forinstance, we may lose customers if our competitors that own national chainsacquire additional salons that are BSG customers or if professional beautysupply manufacturers align themselves with other beauty product wholesale andretail suppliers who compete with BSG. For example, our largest supplier,L’Oreal, has moved a material amount of revenue out of the BSG nationwidedistribution network and into competitive regional distribution networks. Morerecently, L’Oreal has also announced the acquisition of distributorscompetitive with BSG in the southeastern U.S. as well as the west coast of theU.S. As a result, L’Oreal is entering into direct competition with BSG andthere can be no assurance that there will not be further revenue losses overtime at BSG, due to potential losses of additional L’Oreal related products aswell as from the increased competition from L’Oreal-affiliated distributionnetworks. In addition, L’Oreal has announced the acquisition of a supplier(Pureology) that does not currently do business with BSG. If L’Oreal acquired asupplier that did conduct business with BSG, we could lose that revenue aswell. Such consolidation may increase competition from distribution channelsrelated to suppliers and place more leverage in the hands of those suppliers tonegotiate better margins on products sold in our stores.

 

If we are unable to compete effectively in ourmarketplace or if competitors could divert our customers away from our stores,it could adversely impact our business, financial condition and results ofoperations.

 

##### ***We may beunable to anticipate changes in consumer preferences and buying trends ormanage our product lines and inventory commensurate with consumer demand.***

##### *** ***

Our success depends in part on our ability toanticipate, gauge and react in a timely manner to changes in consumer spendingpatterns and preferences for beauty products. If we do not anticipate andrespond to trends in the market for beauty products and changing consumerdemands in a timely manner, our sales may decline significantly and we may berequired to mark down certain products to sell the resulting excess inventoryat prices which can be significantly lower than the normal retail or wholesaleprice, which could adversely impact our business, financial condition andresults of operations. In addition, we depend on our inventory management and

 

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information technology systems in order to replenishinventories and deliver products to store locations in response to customerdemands. Any systems-related problems could result in difficulties satisfyingthe demands of customers which, in turn, could adversely affect our sales andprofitability.

 

We expect the aging baby-boomer population to drivefuture growth in professional beauty supply sales through an increase in theusage of hair color and hair-loss products. Additionally, we expectcontinuously changing fashion-related trends that drive new hair styles toresult in continued demand for hair styling products. Changes in consumertastes and fashion trends can have an impact on our financial performance. Ifwe are unable to anticipate and respond to trends in the market for beautyproducts and changing consumer demands, our business could suffer.

 

##### ***We depend uponmanufacturers who may be unable to provide products of adequate quality or whomay be unwilling to continue to supply products to us.***

##### *** ***

We do not manufacture the brand name or exclusivelabel products we sell, and instead purchase our products from manufacturersand fillers. We depend on a limited number of manufacturers for a significantpercentage of the products we sell. For fiscal year 2007, our two largestsuppliers were Procter & Gamble Co., or P&G, and the Professional ProductsDivision of L’Oreal USA S/D, Inc., or L’Oreal. BSG’s largest supplier, L’Oreal,represented approximately 24% of BSG’s total net sales in fiscal year 2007.

 

In addition, since we purchase products from manymanufacturers and fillers on an at-will basis, under contracts which cangenerally be terminated without cause upon 90 days notice or less or whichexpire without express rights of renewal, such manufacturers and fillers coulddiscontinue sales to us at any time or upon the expiration of the distributionperiod. Some of our contracts with manufacturers may be terminated by suchmanufacturers if we fail to meet specified minimum purchase requirements. Insuch cases, we do not have contractual assurances of continued supply, pricingor access to new products and vendors may change the terms upon which theysell. Infrequently, a supplier will seek to terminate a distributionrelationship through legal action. For example, in April 2007 Farouk Systems,Inc. filed an action seeking a declaratory judgment that it is entitled toterminate a long-term distribution agreement with Armstrong McCall. ArmstrongMcCall is vigorously defending its rights under the agreement. We may not beable to acquire desired merchandise in sufficient quantities or on acceptable termsin the future.

 

Changes in Sally Beauty Supply and BSG’s relationshipswith suppliers occur often, and could positively or negatively impact the netsales and operating profits of both business segments. For example, net salesand operating profits of Sally Beauty Supply and BSG were negatively affectedin fiscal year 2005 by the decision of certain suppliers of the BSG business tobegin selling their products directly to salons in most markets. Subsequently,in fiscal year 2006 one of those suppliers agreed to have BSG once again sellits product lines in BSG stores.

 

Some of our suppliers may seek to decrease theirreliance on distribution intermediaries, including full-service/exclusive andopen-line distributors like BSG and Sally Beauty Supply, by promoting their owndistribution channels, as discussed above. These suppliers may offeradvantages, such as discounted prices, when their products are purchased fromdistribution channels they control. If our access to supplier-provided productswere to be diminished relative to our competitors, our business could bematerially and adversely affected. Also, consolidation among suppliers mayincrease their negotiating leverage, thereby providing them with competitiveadvantages over us that may increase our costs and reduce our revenues,adversely affecting our business, financial condition and results ofoperations.

 

On December 19, 2006, we announced that:(i) BSG, other than its Armstrong McCall division, would not retain itsrights to distribute the professional products of L’Oreal through itsdistributor sales consultants (effective January 30, 2007, withexclusivity ending December 31, 2006) or in its stores on anexclusive basis (effective January 1, 2007) in those geographic areaswithin the U.S. in which BSG had distribution rights; and (ii) BSG’sArmstrong McCall division would not retain the rights to distribute Redkenprofessional products through its franchises. In an effort to replace theserights, BSG entered into long-term agreements with L’Oreal under which, as ofJanuary 1, 2007, BSG had non-exclusive rights to distribute the sameL’Oreal professional products in its stores that it previously had exclusiverights to in its stores and through its sales consultants. Armstrong McCallretained its exclusive rights to distribute Matrix professional products in itsterritories.

 

Although we plan to mitigate the negative effectsresulting from unfavorable changes in our relationships with suppliers, such asL’Oreal, there can be no assurance that our efforts will partially orcompletely offset the loss of these distribution rights. BSG’s loss ofdistribution rights through its distributor sales consultants, as well as theloss of exclusive rights to distribute L’Oreal products in its stores, has alsoresulted in margin pressure on BSG’s remaining L’Oreal revenues, and thispressure is currently projected to continue during fiscal year 2008. Inaddition, one of our key strategies in dealing with the loss of the L’Orealdistribution rights has been to attempt to shift a portion of the L’Orealpurchases by BSG customers previously served by the distributor salesconsultants to our BSG stores. We did not significantly shift a portion ofL’Oreal purchases by BSG customers previously served by the distribution

 

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sales consultants to stores during fiscal year 2007,and we no longer expect to do so in the future. As discussed above, L’Oreal isentering into direct competition with BSG and there can be no assurance thatthere will not be further revenue losses over time at BSG, due to potentiallosses of additional L’Oreal related products as well as from the increasedcompetition from L’Oreal-affiliated distribution networks. For example, L’Orealcould attempt to terminate our contracts to carry certain of their products inBSG stores, which brought in revenues of approximately $121 million in U.S.sales for fiscal year 2007 and have expiration dates at the end of 2012.Therefore, there can be no assurance that the impact of these developments willnot adversely impact revenue to a greater degree than we currently expect, orthat our efforts to mitigate the impact of these developments will besuccessful. If the impact of these developments is greater than we expect orour efforts to mitigate the impact of these developments are not successful,this could have a material adverse effect on our business, financial conditionor results of operations.

 

Manufacturers and fillers of beauty supply productsare subject to certain risks that could adversely impact their ability toprovide us with their products on a timely basis, including industrialaccidents, environmental events, strikes and other labor disputes, unionorganizing activity, disruptions in logistics or information systems, loss orimpairment of key manufacturing sites, product quality control, safety, andlicensing requirements and other regulatory issues, as well as naturaldisasters and other external factors over which neither they nor we havecontrol. In addition, our operating results depend to some extent on theorderly operation of our receiving and distribution process, which depends onmanufacturers’ adherence to shipping schedules and our effective management ofour distribution facilities and capacity.

 

If a material interruption of supply occurs, or asignificant supplier ceases to supply us or materially decreases its supply tous, we may not be able to acquire products with similar quality and consumerbrand name recognition as the products we currently sell, or acquire suchproducts in sufficient quantities to meet our customers’ demands or onfavorable terms to our business, any of which could adversely impact ourbusiness, financial condition and results of operations.

 

We do not control the production process for the brandname and exclusive label products we sell. In many cases, we rely onrepresentations of manufacturers and fillers about the products we purchase forresale regarding whether such products have been manufactured in accordance withapplicable governmental regulations. We may not be able to identify a defect ina product we purchase from a manufacturer or filler before we offer suchproduct for resale, which could result in fines or other actions by governmentregulators, product liability claims, product recalls, harm to our credibility,impairment of customer relationships or a decrease in the market acceptance ofbrand names, any of which could adversely affect our business, financialcondition and results of operations.

 

##### ***If productssold by us are found to be defective in labeling or content, our credibilityand that of the brands we sell may be harmed, market acceptance of our productsmay decrease and we may be exposed to liability in excess of our productsliability insurance coverage and manufacturer indemnities.***

##### *** ***

Our sale of certain products exposes us to potentialproduct liability claims, recalls or other regulatory or enforcement actionsinitiated by federal, state or foreign regulatory authorities or throughprivate causes of action. Such claims, recalls or actions could be based onallegations that, among other things, the products sold by us are misbranded,contain contaminants, provide inadequate instructions regarding their use ormisuse, or include inadequate warnings concerning flammability or interactionswith other substances. Claims against us could also arise as a result of themisuse by purchasers of such products or as a result of their use in a mannerdifferent than the intended use. We may be required to pay for losses orinjuries actually or allegedly caused by the products we sell and to recall anyproduct we sell that is alleged to be or is found to be defective.

 

Any actual defects or allegations of defects inproducts sold by us could result in adverse publicity and harm our credibility,which could adversely affect our business, financial condition and results ofoperations. Although we may have indemnification rights against themanufacturers of many of the products we distribute and rights as an “additionalinsured” under the manufacturer’s insurance policies, it is not certain thatany individual manufacturer or insurer will be financially solvent and capableof making payment to any party suffering loss or injury caused by products soldby us. Further, some types of actions and penalties, including many actions orpenalties imposed by governmental agencies and punitive damages awards, may notbe remediable through reliance on indemnity agreements or insurance.Furthermore, potential product liability claims may exceed the amount ofindemnity or insurance coverage or be excluded under the terms of an indemnityagreement or insurance policy. If we are forced to pay to satisfy such claims,it could have an adverse effect on our business, financial condition andresults of operations.

 

##### ***We could beadversely affected if we do not comply with laws and regulations or if webecome subject to additional or more stringent laws and regulations.***

##### *** ***

We are subject to a number of U.S. federal, stateand local laws and regulations, as well as the laws and regulations applicablein each other market in which we do business. These laws and regulations governthe composition, packaging, labeling and safety of the

 

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products we sell, the methods we use to sell theseproducts and the methods we use to import these products. Non-compliance withapplicable laws and regulations of governmental authorities, including the FDAand similar authorities in other jurisdictions, by us or the manufacturers ofthe products sold by us could result in fines, product recalls and enforcementactions or otherwise restrict our ability to market certain products, whichcould adversely affect our business, financial condition and results ofoperations. The laws and regulations applicable to us or manufacturers of theproducts sold by us may become more stringent. Continued legal compliance couldrequire the review and possible reformulation or relabeling of certainproducts, as well as the possible removal of some products from the marketaltogether. Legal compliance could also lead to considerably higher internalregulatory costs. Manufacturers may try to recover some or all of any increasedcosts of compliance by increasing the prices at which we purchase products andwe may not be able to recover some or all of such increased cost in our ownprices to our customers. We are also subject to state and local laws andregulations that affect our franchisor-franchisee relationships. Increasedcompliance costs and the loss of sales of certain products due to morestringent or new laws and regulations could adversely affect our business,financial condition and results of operations.

 

Laws and regulations impact our business in many areasthat have no direct relation to the products we sell. For example, as areporting company, we are subject to a number of laws and regulations relatedto the issuance and sale of our securities. Another area of intense regulationis that of the relationships we have with our employees, including compliancewith many different wage/hour and nondiscrimination related regulatory schemes.Violation of any of the laws or regulations governing our business and theassertion of individual or class-wide claims could have an adverse effect onour business, financial condition and results of operations.

 

##### ***Productdiversion could have an adverse impact on our revenues.***

##### *** ***

The majority of the products that BSG sells, includingthose sold by our Armstrong McCall franchisees, are meant to be usedexclusively by salons and individual salon professionals or are meant to besold exclusively by the purchasers, such as salons, to their retail consumers.However, despite our efforts to prevent diversion, incidents of productdiversion occur, whereby our products are sold by these purchasers (andpossibly by other bulk purchasers such as franchisees) to wholesalers andgeneral merchandise retailers. These retailers, in turn, sell such products toconsumers. The diverted product may be old, tainted or damaged and sold throughunapproved outlets, all of which could diminish the value of the particularbrand. Diversion may result in lower net sales for BSG should consumers chooseto purchase diverted products from retailers rather than purchasing from our customers,or choose other products altogether because of the perceived loss of brandprestige.

 

Product diversion is generally prohibited under oursupplier contracts and we may be under a contractual obligation to stop sellingto salons, salon professionals and other bulk purchasers who engage in productdiversion. If we fail to stop diversion as required (including known diversionof products sold through our Armstrong McCall franchisees), our suppliercontracts could be adversely affected or even terminated. In addition, ourinvestigation and enforcement of our anti-diversion policies may result inreduced sales to our customer base, thereby decreasing our revenues andprofitability.

 

##### ***BSG’sfinancial results are affected by the financial results of BSG’s franchised-basedbusiness (Armstrong McCall).***

##### *** ***

BSG receives revenue from products purchased byArmstrong McCall franchisees. Accordingly, a portion of BSG’s financialresults is to an extent dependent upon the operational and financial success ofthese franchisees, including their implementation of BSG’s strategic plans. Ifsales trends or economic conditions worsen for Armstrong McCall’s franchisees,their financial results may worsen. When Armstrong McCall divestscompany-owned stores, Armstrong McCall is often required to remainresponsible for lease payments for these stores to the extent that therelevant franchisees default on their leases. Additionally, if ArmstrongMcCall franchisees fail to renew their franchise agreements, or ifArmstrong McCall fails to meet its obligations under its franchise agreementsor vendor distribution agreements or is required to restructure its franchiseagreements in connection with such renewal, it could result in decreasedrevenues for BSG or legal issues with our franchisees or vendors.

 

##### ***Our newInternet-based business may be unsuccessful or may cause internal channelconflict.***

##### *** ***

We recently began offering some of our beauty productsfor sale through Sally Beauty'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, our websites, and oursoftware 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.

 

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##### ***We may not beable to successfully identify acquisition candidates or successfully completedesirable acquisitions.***

##### *** ***

In the past several years, we have completed severalsignificant acquisitions, the majority of which were for the BSG business. 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.

 

If suitable candidates are identified, sufficientfunds may not be available to make such acquisitions. We compete against manyother companies, some of which are larger and have greater financial and otherresources than we do. Increased competition for acquisition candidates couldresult in fewer acquisition opportunities and higher acquisition prices. Inaddition (as discussed below), the amount of equity that Sally Beauty can issueto make acquisitions or raise additional capital will be severely limited forat least two years following the Separation Transactions (or November 2008),which will make equity generally unavailable to fund acquisitions. Also,because we are highly leveraged and the agreements governing our indebtednesscontain limits on our ability to incur additional debt, we may be unable tofinance acquisitions that would increase our growth or improve our financialand competitive position. To the extent that debt financing is available tofinance acquisitions, our net indebtedness could be increased as a result ofany acquisitions.

 

##### ***If we acquireany businesses in the future, they could prove difficult to integrate, disruptour business or have an adverse effect on our results of operations.***

##### *** ***

Any acquisitions that we do make may be difficult tointegrate profitably into our business and may entail numerous risks,including:

 

•             difficulties inassimilating acquired operations, stores or products, including the loss of keyemployees from acquired businesses;

 

•             difficulties andcosts associated with integrating and evaluating the information systems and/orinternal control systems of acquired businesses;

 

•             expenses associatedwith the amortization of identifiable intangible assets;

 

•             problems retainingkey technical, operational and administrative personnel;

 

•             diversion ofmanagement’s attention from our core business, including loss of managementfocus on marketplace developments;

 

•             complying withforeign regulatory requirements, including multi-jurisdictional competitionrules;

 

•             enforcement ofintellectual property rights in some foreign countries;

 

•             adverse effects onexisting business relationships with suppliers and customers, including thepotential loss of suppliers of the acquired businesses;

 

•             operatinginefficiencies and negative impact on profitability;

 

•             entering markets inwhich we have limited or no prior experience; and

 

•             those related togeneral economic and political conditions, including legal and other barriersto cross-border investment in general, or by U.S. companies in particular.

 

In addition, during the acquisition process, we mayfail or be unable to discover some of the liabilities of businesses that weacquire. These liabilities may result from a prior owner’s noncompliance withapplicable laws and regulations. Acquired businesses may also not perform as weexpect or we may not be able to obtain financial improvements in acquiredbusinesses that we may expect.

 

##### ***If we areunable to profitably open and operate new stores, our business, financialcondition and results of operations may be adversely affected.***

##### *** ***

Our future growth strategy depends in part on ourability to open and profitably operate new stores in existing and additionalgeographic markets. The capital requirements to open a U.S. based Sally BeautySupply or BSG store, excluding inventory, average approximately $60,000 and$75,000, respectively. However, we may not be able to open all of the newstores we plan to open and any new stores we open may not be profitable, eitherof which could have a material adverse impact on our financial condition orresults of operations. There are several factors that could affect our abilityto open and profitably operate new stores, including:

 

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•             the inability toidentify and acquire suitable sites or to negotiate acceptable leases for suchsites;

 

•             proximity to existingstores that may reduce new stores’ sales or the sales of existing stores;

 

•             difficulties inadapting our distribution and other operational and management systems to anexpanded network of stores;

 

•             the potentialinability to obtain adequate financing to fund expansion because of our highleverage and limitations on Sally Beauty’s ability to issue equity for at leasttwo years following the Separation Transactions, among other things;

 

•             increased (andsometimes unanticipated) costs associated with opening stores in newinternational markets;

 

•             difficulties inobtaining any needed governmental and third-party consents, permits andlicenses needed to operate additional stores; and

 

•             potential limitationson capital, expenditures which may be included in financing documents that weenter into.

 

##### ***We are notcertain that our ongoing cost control plans will continue to be successful.***

##### *** ***

Our business strategy depends, to a substantialdegree, on continuing to control or reduce operating expenses. In furtheranceof this strategy, we have engaged in ongoing activities to reduce or controlcosts. These activities include right-sizing the BSG business (including sometargeted reductions-in-force) and maximizing the efficiency of our structure,including through  the implementation ofa two-year, $19.0 million capital spending program in fiscal years 2007 and2008 to consolidate BSG warehouses and reduce administrative expenses relatedto BSG’s distribution network optimization program. We cannot assure you thatour efforts will result in the increased profitability, cost savings or otherbenefits that we expect.

 

##### ***If we areunable to protect our intellectual property rights, specifically ourtrademarks, our ability to compete could be negatively impacted.***

##### *** ***

The success of our business depends to a certainextent upon the value associated with our intellectual property rights. We owncertain trademark and brand name rights used in connection with our businessincluding, but not limited to, “Sally,” “Sally Beauty,” “Sally Beauty Supply,”“Sally ProCard,” “BSG,” “CosmoProf,” “Armstrong McCall,” “ion,” “SalonServices” and “Beauty Club.” We protect our intellectual property rightsthrough a variety of methods, including trademarks which are registered orlegally protected in the U.S., Canada and other countries throughout the worldin which our business operates. We also rely on trade secret laws, in additionto confidentiality agreements with vendors, employees, consultants, and otherswho have access to our proprietary information. While we intend to vigorouslyprotect our trademarks against infringement, we may not be successful in doingso. In addition, the laws of certain foreign countries may not protect ourintellectual property rights to the same extent as the laws of the U.S. Thecosts required to protect our intellectual property rights and trademarks areexpected to continue to be substantial.

 

##### ***Our ability toconduct business in international markets may be affected by legal, regulatory,and economic risks.***

##### *** ***

Our ability to capitalize on growth in newinternational markets and to grow or maintain our current level of operationsin our existing international markets is subject to risks associated with ourinternational operations. These risks include: unexpected changes in regulatoryrequirements; trade barriers to some international markets; economic andcurrency fluctuations in specific markets; potential difficulties in enforcingcontracts, protecting assets, including intellectual property, and collectingreceivables in certain foreign jurisdictions; potential tax liabilitiesassociated with repatriating funds from foreign operations; and difficultiesand costs of staffing, managing and accounting for foreign operations.

 

##### ***We may beadversely affected by any disruption in our information technology systems.***

##### *** ***

Our operations are dependent upon our informationtechnology systems, which encompass all of our major business functions. Werely upon such information technology systems to manage and replenish inventory,to fill and ship customer orders on a timely basis, to coordinate our salesactivities across all of our products and services and to coordinate ouradministrative activities. A substantial disruption in our informationtechnology systems for any prolonged time period (arising from, for example,system capacity limits from unexpected increases in our volume of business,outages or delays in our service) could result in delays in receiving inventoryand supplies or filling customer orders and adversely affect our customerservice and relationships. Our systems might be damaged or interrupted bynatural or man-made events or by computer viruses, physical or electronicbreak-ins and similar disruptions affecting the global Internet. There can beno assurance that such delays, problems, or costs will not have a materialadverse effect on our financial condition, results of operations and cashflows.

 

As our operations grow in both size and scope, we will continuouslyneed to improve and upgrade our systems and infrastructure while maintainingthe reliability and integrity of our systems and infrastructure. The expansionof our systems and infrastructure will

 

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require us to commit substantial financial, operational and technicalresources before the volume of our business increases, with no assurance thatthe volume of business will increase. In particular, during fiscal year 2008 wewill be upgrading our financial reporting system, our distribution systems (inconnection with our capital spending program to consolidate warehouses, asdiscussed below), implementing new warehouse systems at our Armstrong McCallwarehouse and implementing a new point-of-sale system for tracking customersales. These and any other required upgrades to our systems and informationtechnology, or new technology, now and in the future, will require that ourmanagement and resources be diverted from our core business to assist incompliance with those requirements. Since our systems are proprietary, ouroptions are limited in seeking third-party help with the operation and upgradeof these systems. There can be no assurance that the time and resources ourmanagement will need to devote to these upgrades, service outages or delays dueto the installation of any new or upgraded technology (and customer issuestherewith), or the impact on the reliability of our data from any new orupgraded technology will not have a material adverse effect on our business,financial condition or results of operations.

 

##### ***The occurrenceof one or more natural disasters or acts of terrorism could adversely affectour operations and financial performance.***

##### *** ***

The occurrence of one or more natural disasters oracts of terrorism could result in physical damage to one or more of ourproperties, the temporary closure of stores or distribution centers, thetemporary lack of an adequate work force in a market, the temporary or longterm disruption in the supply of products (or a substantial increase in thecost of those products) from some local suppliers, the temporary disruption inthe delivery of goods to our distribution centers (or a substantial increase inthe cost of those deliveries), the temporary reduction in the availability ofproducts in our stores and/or the temporary reduction in visits to stores bycustomers.

 

If one or more natural disasters or acts of terrorismwere to impact our business, we could, among other things, incur significantlyhigher costs and longer lead times associated with distributing products tostores. Furthermore, insurance costs associated with our business may risesignificantly in the event of a large scale natural disaster or act ofterrorism.

 

## **RisksRelating to Our Substantial Indebtedness**

##  

##### ***We havesubstantial debt and may incur substantial additional debt, which couldadversely affect our financial health, our ability to obtain financing in thefuture and our ability to react to changes in our business.***

##### *** ***

In connection with the Separation Transactions,together with certain of our subsidiaries, we incurred approximately$1,850.0 million in debt. As of September 30, 2007, we had anaggregate principal amount of approximately $1,775.7 million, including capitallease obligations, of outstanding debt, and a total debt to equity ratio of -2.28:1.00.

 

Our substantial debt could have important consequencesto you. For example, it could:

 

•             make it moredifficult for us to satisfy our obligations to our lenders, resulting inpossible defaults on and acceleration of such indebtedness;

 

•             limit our ability toobtain additional financing for working capital, capital expenditures,acquisitions, debt service requirements or general corporate purposes;

 

•             require us todedicate a substantial portion of our cash flow from operations to the paymentof principal and interest on our indebtedness, thereby reducing theavailability of such cash flows to fund working capital, capital expendituresand other general corporate purposes;

 

•             increase ourvulnerability to general adverse economic and industry conditions, includinginterest rate fluctuations because a portion of our borrowings are at variablerates of interest, including borrowings under our senior secured term loanfacilities and our asset-backed senior secured loan facility, which we refer tocollectively as the senior secured credit facilities;

 

•             place us at acompetitive disadvantage compared to our competitors with proportionately lessdebt or comparable debt at more favorable interest rates and that, as a result,may be better positioned to withstand economic downturns;

 

•             limit our ability torefinance indebtedness or cause the associated costs of such refinancing toincrease; and

 

•             limit our flexibilityto adjust to changing market conditions and ability to withstand competitivepressures, or prevent us from carrying out capital spending that is necessaryor important to our growth strategy and efforts to improve operating margins orour business.

 

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Any of the foregoing impacts of our substantialindebtedness could have a material adverse effect on our business, financialcondition and results of operations.

 

##### ***Despite ourcurrent indebtedness levels, we and our subsidiaries may be able to incursubstantially more debt, including secured debt, which could further exacerbatethe risks associated with our substantial indebtedness.***

##### *** ***

We and our subsidiaries may incur substantialadditional indebtedness in the future. The terms of the instruments governingour indebtedness do not fully prohibit us or our subsidiaries from doing so. Asof September 30, 2007, our senior credit facilities provided uscommitments for additional borrowings of up to approximately$334.6 million under the asset-backed senior secured loan, or ABL,facility, subject to borrowing base limitations. If new debt is added to ourcurrent debt levels, the related risks that we now face would increase and wemay not be able to meet all our debt obligations. In addition, the agreementsgoverning our senior credit facilities as well as the indentures governing oursenior notes and senior subordinated notes, which we refer to collectively asthe Notes, do not prevent us from incurring obligations that do not constituteindebtedness.

 

##### ***The agreementsand instruments governing our debt contain restrictions and limitations thatcould significantly impact our ability to operate our business.***

##### *** ***

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

 

•             dispose of assets;

 

•             incur additionalindebtedness (including guarantees of additional indebtedness);

 

•             pay dividends,repurchase stock or make other distributions;

 

•             make voluntaryprepayments on the Notes or make amendments to the terms thereof;

 

•             prepay certain otherdebt or amend specific debt agreements;

 

•             create liens onassets;

 

•             make investments(including joint ventures);

 

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

 

•             engage in certaintransactions with affiliates; and

 

•                  permitrestrictions on our subsidiaries’ ability to pay dividends.

 

The ABL facility contains covenants that, among otherthings, restrict us and our subsidiaries’ ability to:

 

•             change our line ofbusiness;

 

•             engage in certainmergers, consolidations and transfers of all or substantially all of ourassets;

 

•             make certaindividends, stock repurchases and other distributions;

 

•             make acquisitions ofall of the business or assets of, or stock representing beneficial ownershipof, any person;

 

•             dispose of certainassets;

 

•             make voluntaryprepayments on the Notes or make amendments to the terms thereof;

 

•             prepay certain otherdebt or amend specific debt agreements;

 

•             change the fiscalyear of us or our direct parent; and

 

•             create or incurnegative pledges.

 

The Term Loans contain a requirement that we notexceed a maximum ratio of net senior secured debt to consolidated EBITDA (asthose terms are defined in the relevant credit agreement). In addition, if wefail to maintain a specified minimum level of borrowing capacity under the ABLfacility, we will then be obligated to maintain a specified fixed-chargecoverage ratio. Our ability to comply with these covenants in future periodswill depend on our ongoing financial and operating performance, which in turnwill be subject to economic conditions and to financial, market and competitivefactors, many of which are beyond our control. Our ability to comply

 

20

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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.

 

The indentures governing the senior notes and theNotes also contain restrictive covenants that, among other things, limit ourability and the ability of our restricted subsidiaries to:

 

•             dispose of assets;

 

•             incur additionalindebtedness (including guarantees of additional indebtedness);

 

•             pay dividends,repurchase stock or make other distributions;

 

•             prepay subordinateddebt;

 

•             create liens onassets (which, in the case of the senior subordinated notes, would be limitedin applicability to liens securing pari passu or subordinated indebtedness);

 

•             make investments(including joint ventures);

 

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

 

•             engage in certaintransactions with affiliates; and

 

•             permit restrictionson our subsidiaries’ ability to pay dividends.

 

The restrictions in the indentures governing our Notesand the terms of our senior credit facilities may prevent us from takingactions that we believe would be in the best interest of our business, and maymake it difficult for us to successfully execute our business strategy oreffectively compete with companies that are not similarly restricted. We mayalso incur future debt obligations that might subject us to additionalrestrictive covenants that could affect our financial and operationalflexibility. We cannot assure you that we will be granted waivers or amendmentsto these agreements if for any reason they are unable to comply with theseagreements, or that we will be able to refinance our debt on terms acceptableto us, or at all.

 

Our ability to comply with the covenants andrestrictions contained in the senior credit facilities and the indentures forthe Notes may be affected by economic, financial and industry conditions beyondour control. The breach of any of these covenants or restrictions could resultin a default under either the senior credit facilities or the indentures thatwould permit the applicable lenders or note holders, as the case may be, todeclare all amounts outstanding thereunder to be due and payable, together withaccrued and unpaid interest. If we are unable to repay debt, lenders havingsecured obligations, such as the lenders under the senior credit facilities,could proceed against the collateral securing the debt. In any such case, wemay be unable to borrow under the senior credit facilities and may not be ableto repay the amounts due under the Term Loans and the Notes. This could haveserious consequences to our financial condition and results of operations andcould cause us to become bankrupt or insolvent.

 

##### ***Our ability togenerate the significant amount of cash needed to service all of our debt andour ability to refinance all or a portion of our indebtedness or obtainadditional financing depend on many factors beyond our control.***

##### *** ***

Our ability to make scheduled payments on, or torefinance our obligations under, our debt will depend on our financial andoperating performance, which, in turn, will be subject to prevailing economicand competitive conditions and to the financial and business factors, many ofwhich may be beyond our control, described under “—Risks Relating to OurBusiness” above.

 

If our cash flow and capital resources areinsufficient to fund our debt service obligations, we may be forced to reduceor delay capital expenditures, sell assets, seek to obtain additional equitycapital or restructure our debt. In the future, our cash flow and capitalresources may not be sufficient for payments of interest on and principal ofour debt, and such alternative measures may not be successful and may notpermit us to meet our scheduled debt service obligations.

 

We cannot assure you that we will be able to refinanceany of our indebtedness or obtain additional financing, particularly because ofour high levels of debt and the debt incurrence restrictions imposed by theagreements governing our debt, as well as prevailing market conditions. In theabsence of such operating results and resources, we could face substantialliquidity problems and might be required to dispose of material assets oroperations to meet our debt service and other obligations. Our senior creditfacilities and the indentures governing the Notes restrict our ability todispose of assets and use the proceeds from any such dispositions. We cannotassure you we will be able to consummate those sales, or if we do, what thetiming of the sales will be or whether the proceeds that we realize will beadequate to meet debt service obligations when due.

 

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##### ***You should notexpect Sally Capital to participate in making payments on the Notes.***

##### *** ***

Sally Capital is our wholly-owned subsidiary, whichacts as a co-issuer solely to facilitate the issuance of the Notes. SallyCapital does not have any operations or assets of any kind and did not receiveany proceeds from the issuance of the Notes. You should not expect SallyCapital to participate in servicing any of our obligations in the Notes.

 

##### ***An increase ininterest rates would increase the cost of servicing our debt and could reduceour profitability.***

##### *** ***

A significant portion of our outstanding debt,including under our senior credit facilities, bears interest at variable rates.As a result, an increase in interest rates, whether because of an increase inmarket interest rates or a decrease in our creditworthiness, would increase thecost of servicing our debt and could materially reduce our profitability andcash flows. The impact of such an increase would be more significant for usthan it would be for some other companies because of our substantial debt.

 

##### ***A decrease ininterest rates would increase our interest expense (due to our interest rateswaps) and could reduce our profitability.***

##### *** ***

We have entered into two interest rate swap agreementswith a notional amount of $150.0 million and $350.0 million. Theseinterest rate swap agreements relate to $500.0 million of the$1,070.0 million term loans A and B due in fiscal years 2013 and 2014,respectively, to manage our risk associated with changing interest rates.Please see Note 12 of the “Notes to Consolidated Financial Statements” in“Item 8—Financial Statements and Supplementary Data” of this report and“Item 7A—Quantitative and Qualitative Disclosures about MarketRisk—Interest rate risk” for a discussion of interest rate swap agreements. Weutilize interest rate swaps to manage our financial risk associated withchanging interest rates and account for them under Statement of FinancialAccounting Standards, or SFAS, No. 133, *Accounting for DerivativeInstruments and Hedging Activities*, as amended, or SFAS 133. SFAS133 requires that all derivatives be marked to market (fair value). Our currentinterest rate swap agreements do not qualify as hedges and therefore, thechange in fair value of the interest rate swap agreements, which are adjustedquarterly, are recorded in the consolidated statements of earnings. The markedto market impact of the swap agreements on interest expense was an increase ofapproximately $3.0 million for fiscal year 2007. Future changes in the fairvalue of the interest rate swap agreements will continue to increase ordecrease our interest expense and could have the potential to affect ourprofitability.

 

## **RisksRelating to the Tax Treatment of Our Separation from Alberto-Culver andRelating To Sally Beauty’s Largest Stockholder**

##  

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

##### *** ***

The following discussion describes the risk that theshare distribution of Alberto-Culver common stock in the SeparationTransactions may have triggered significant tax liabilities for Sally Beauty,our ultimate parent company, possibly resulting in a material adverse effect onus. Since we will have been a member of Sally Beauty’s consolidated group ofcompanies for U.S. federal income tax purposes and certain state tax purposesduring the taxable year of the share distribution of Alberto-Culver commonstock, we (and any other Sally Beauty subsidiaries that were also members ofsuch group) will generally be liable for the income tax liabilities of SallyBeauty’s consolidated group of companies for that taxable year. Therefore, ifSally Beauty incurs significant income tax liabilities as a result of the sharedistribution of Alberto-Culver common stock and is unable to pay these taxes,we could be liable for such taxes to the taxing authorities.

 

In connection with the share distribution ofAlberto-Culver common stock in the separation, Sally Beauty received (i) aprivate letter ruling from the Internal Revenue Service, or IRS, and(ii) an opinion of Sidley Austin LLP, counsel to Alberto-Culver, in eachcase, to the effect that the transactions qualify as a reorganization underSection 368(a)(1)(D) of the Code and a distribution eligible fornon-recognition under Sections 355(a) and 361(c) of the Code. The privateletter ruling and the opinion of counsel were based, in part, on assumptionsand representations as to factual matters made by, among others,Alberto-Culver, Sally Beauty and representatives of Mrs. Carol L. Bernick,Mr. Leonard H. Lavin and certain other of Sally Beauty’s stockholders towhom we refer as the Lavin family stockholders, as requested by the IRS orcounsel, which, if incorrect, could jeopardize the conclusions reached by theIRS and counsel. The private letter ruling also did not address certainmaterial legal issues that could affect its conclusions, and reserved the rightof the IRS to raise such issues upon a subsequent audit. Opinions of counselneither bind the IRS or any court, nor preclude the IRS from adopting acontrary position.

 

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If the Alberto-Culver share distribution were not toqualify as a tax-free distribution under Section 355 of the Code, SallyBeauty would recognize taxable gain equal to the excess of the fair marketvalue of the Alberto-Culver common stock distributed to its stockholders overSally Beauty’s tax basis in the Alberto-Culver common stock.

 

Even if the Alberto-Culver share distributionotherwise qualified as a tax-free distribution under Section 355 of theCode, it would result in significant U.S. federal income tax liabilities toSally Beauty if there is an acquisition of its stock or stock of Alberto-Culveras part of a plan or series of related transactions that includes theAlberto-Culver share distribution and that results in an acquisition of 50% ormore of Alberto-Culver’s or Sally Beauty’s outstanding common stock.

 

In the event that Sally Beauty recognizes a taxablegain in connection with the Alberto-Culver share distribution (either(i) because the Alberto-Culver share distribution did not qualify as atax-free distribution under Section 355 of the Code or (ii) becauseof an acquisition by CDR Investors of 50% or more of Alberto-Culver or SallyBeauty’s outstanding common stock as part of a plan or series of relatedtransactions that includes the Alberto-Culver share distribution), the taxablegain recognized by Sally Beauty would result in significant U.S. federal incometax liabilities to Sally Beauty. Under the Code, Sally Beauty and we would bejointly and severally liable for these taxes for which Alberto-Culver may berequired to indemnify Sally Beauty under a tax allocation agreement, and therecan be no assurance that Alberto-Culver would be able to fulfill itsobligations under the tax allocation agreement if Alberto-Culver was determinedto be responsible for these taxes thereunder.

 

For purposes of determining whether the distributionof Alberto-Culver common stock to Sally Beauty’s stockholders in connectionwith the Alberto-Culver share distribution is disqualified as tax-free to SallyBeauty under the rules described in the second preceding paragraph, anyacquisitions by CDR Investors of Sally Beauty’s stock or the stock ofAlberto-Culver within two years before or after the Alberto-Culver sharedistribution are presumed to be part of a plan, although the parties may beable to rebut that presumption. For purposes of this test, the acquisition byCDR Investors, of 48% of Sally Beauty’s outstanding common stock on anundiluted basis that occurred in connection with the Separation Transactionswill be treated as part of such a plan or series of transactions. Thus, arelatively minor additional change in the ownership of Sally Beauty’s commonstock could trigger a significant tax liability for Sally Beauty underSection 355 of the Code.

 

The process for determining whether a prohibitedchange in control has occurred under the rules is complex, inherently factualand subject to interpretation of the facts and circumstances of a particularcase. If Alberto-Culver does not carefully monitor its, or Sally Beauty doesnot carefully monitor its, compliance with these rules, this mightinadvertently cause or permit a prohibited change in the ownership of SallyBeauty or of Alberto-Culver to occur, thereby triggering Alberto-Culver’s orSally Beauty’s respective obligations to indemnify the other pursuant to thetax allocation agreement, which would have a material adverse effect on usand/or Alberto-Culver.

 

As the successor entity to Alberto-Culver after theseparation, Sally Beauty relies upon the prior-year federal income tax returnsof Alberto-Culver, and accounting methods established therein, for certaincalculations that affect Sally Beauty’s and our U.S. federal income taxliability.

 

If any of the above events occur, Sally Beauty and uswill be jointly and severally liable for these taxes, and there can be noassurance that Alberto-Culver would be able to fulfill its indemnificationobligations to Sally Beauty under the tax allocation agreement ifAlberto-Culver was determined to be responsible for these taxes thereunder. Inaddition, these mutual indemnity obligations could discourage or prevent athird party from making a proposal to acquire Sally Beauty.

 

##### ***Actions takenby the Lavin family stockholders or by the CDR Investors could adversely affectthe tax-free nature of the share distribution of Alberto-Culver common stock inconnection with the transactions separating us from Alberto-Culver.***

##### *** ***

Sales and/or acquisitions by the Lavin familystockholders of Sally Beauty’s common stock or Alberto-Culver common stock mayadversely affect the tax-free nature of the share distribution ofAlberto-Culver common stock in the Separation Transactions. First, with certainexceptions, sales by the Lavin family stockholders of Sally Beauty’s commonstock or Alberto-Culver common stock at any time after the SeparationTransactions might be considered evidence that the share distribution was usedprincipally as a device for the distribution of earnings and profits,particularly if the selling stockholder were found to have an intent to effectsuch sale at the time of the share distribution. If the IRS successfullyasserted that the share distribution was used principally as such a device, theshare distribution would not qualify as a tax-free distribution, and thus wouldbe taxable to Sally Beauty. Second, with certain exceptions, if any of theLavin family stockholders were to sell an amount of Sally Beauty’s common stockthat it received in connection with the Separation Transactions (or to acquireadditional shares of Sally Beauty’s common stock) within the two year periodfollowing completion of the Alberto-Culver share distribution, and that amountof stock, if added to the common stock comprising approximately 48% of SallyBeauty’s outstanding common stock on an undiluted basis that was acquired byCDR Investors were to equal or exceed 50% of Sally Beauty’s outstanding commonstock, as determined under the Code and applicable

 

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Treasury regulations, a deemed acquisition of controlof Sally Beauty in connection with the Alberto-Culver share distribution wouldbe presumed. If this presumption were not rebutted, Sally Beauty would besubject to significant U.S. federal income tax liabilities, which, if notreimbursed by Alberto-Culver, would have a material adverse effect on us.Similarly, acquisitions by the CDR Investors or their affiliates of SallyBeauty’s common stock may cause a deemed acquisition of control of Sally Beautyin connection with the Alberto-Culver share distribution.

 

##### ***Sally Beautyis affected by significant restrictions on its ability to issue equitysecurities following completion of the transactions separating us fromAlberto-Culver.***

##### *** ***

Because of certain limitations imposed by the Code andregulations thereunder, the amount of equity that Sally Beauty can issue tomake acquisitions or raise additional capital is severely limited and willcontinue to be so for at least two years following completion of the SeparationTransactions, or November 2008. As a result, Sally Beauty may not be able toraise even a small amount of equity capital during that period. Theselimitations may restrict our ability to carry out our business objectives andto take advantage of opportunities that could be favorable to our business. Inaddition, because we, together with our subsidiaries, incurred approximately$1,850.0 million in debt in connection with those transactions, and theinstruments governing our indebtedness contain limits on our ability to incuradditional debt, Sally Beauty’s inability to raise even a small amount ofequity capital at a time when we need additional capital could have a materialadverse effect on our ability to service our debt and operate our business.

 

##### ***The votingpower of Sally Beauty’s largest stockholder may discourage third partyacquisitions of Sally Beauty at a premium.***

##### *** ***

CDRS, Sally Beauty’s largest stockholder, ownsapproximately 48% of its outstanding common stock on an undiluted basis.Pursuant to the stockholders agreement entered into by Sally Beauty, the CDRInvestors and the Lavin family stockholders, which we refer to as theStockholders Agreement, CDRS has designated five of Sally Beauty’s initialeleven directors, as well as the Chairman of the Board of Directors, and CDRS’rights to nominate certain numbers of directors will continue so long as itowns specified percentages of Sally Beauty’s common stock. The CDR Investors’ownership of Sally Beauty’s common stock may have the effect of discouragingoffers to acquire control of Sally Beauty and may preclude holders of itscommon stock from receiving any premium above market price for their sharesthat may otherwise be offered in connection with any attempt to acquire controlof Sally Beauty.

 

##### ***The interestsof the largest stockholder of Sally Beauty may differ from the interests ofother 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 SallyBeauty’s initial eleven directors and CDRS’ rights to nominate certain numbersof directors will continue so long as it owns specified percentages of itscommon stock, as discussed above. In addition, the current Chairman of SallyBeauty’s Board of Directors is affiliated with CDRS. The interests of CDRS maydiffer from those of other holders of Sally Beauty’s common stock in materialrespects. For example, CDRS may have an interest in pursuing acquisitions,divestitures, financings, re-financings, stockholder dividends or othertransactions that, in its judgment, could enhance its overall equity portfolioor the short-term value of their investment in Sally Beauty, even though suchtransactions might involve substantial risks to holders of Sally Beauty’scommon stock. The manager of CDRS’ ultimate parent is in the business of makinginvestments in companies, and may from time to time in the future, acquireinterests in businesses that directly or indirectly compete with certainportions of our business or are suppliers of our customers. Additionally, CDRSmay determine that the disposition of some or all of its interests in SallyBeauty 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.Moreover, the ownership by CDRS of approximately 48% of Sally Beauty’soutstanding common stock may have the effect of discouraging offers to acquirecontrol of Sally Beauty and may preclude holders of Sally Beauty’s common stockfrom receiving any premium above market price for their shares that mayotherwise be offered in connection with any attempt to acquire control of SallyBeauty.

 

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

 

Not applicable.

 

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# **ITEM 2.PROPERTIES**

 

Substantially all of our store and warehouse locationsare leased and our corporate headquarters and four warehouses/distributioncenters are owned. The average store lease is for a term of five years withcustomary renewal options. The following table provides the number of stores inthe U.S. and globally, as of September 30, 2007:

 

| ** **          | ** ** | **Sally Beauty Supply** | ** ** | **Beauty Systems Group** | ** ** |
|---------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| **Location**        | ** ** | **Company-Owned**                 | ** ** | **Franchise**                      | ** ** | **Company-Owned** | ** ** | **Franchise** | ** ** |
| United States       |       | 2,226                             |       | —                             |       | 623 |   | 143 |   |
| International:      |       |                              |       |                               |       |   |   |   |   |
| Puerto Rico         |       | 33                                |       | —                             |       | — |   | — |   |
| Spain               |       | 1                                 |       | 3                                  |       | — |   | — |   |
| United Kingdom      |       | 261                               |       | 12                                 |       | — |   | — |   |
| Canada              |       | 16                                |       | —                             |       | 76 |   | — |   |
| Japan               |       | 28                                |       | —                             |       | — |   | — |   |
| Germany             |       | 31                                |       | —                             |       | — |   | — |   |
| Mexico              |       | 70                                |       | —                             |       | — |   | 32 |   |
| Ireland             |       | 3                                 |       | 10                                 |       | — |   | — |   |
| Total International |       | 443                               |       | 25                                 |       | 76 |   | 32 |   |
| Total Store Count   |       | 2,669                             |       | 25                                 |       | 699 |   | 175 |   |

 

The following table provides locations for significantoffices and warehouses and our corporate headquarters, as of September 30,2007:

 

| **Location**                   | ** ** | **Type of Facility** | ** ** | **Business Segment** | ** ** |
|--------------------------------|------------|--------------------------------|------------|---------------------------|------------|
| Company-Owned Properties:      |       |                           |       |                      |       |
| Columbus, Ohio                 |       | Warehouse                      |       |                      | (1)        |
| Denton, Texas                  |       | Corporate Headquarters         |       |                      | (1)(2)     |
| Denton, Texas                  |       | Warehouse                      |       |                      | (1)(2)     |
| Jacksonville, Florida          |       | Warehouse                      |       |                      | (1)        |
| Reno, Nevada                   |       | Warehouse                      |       |                      | (1)        |
| Leased Properties:             |       |                           |       |                      |       |
| Austin, Texas                  |       | Office,  Warehouse             |       |                      | (2)        |
| Benicia, California            |       | Office,  Warehouse             |       |                      | (2)        |
| Blackburn, Lancashire, England |       | Warehouse                      |       |                      | (1)        |
| Calgary, Alberta, Canada       |       | Office,  Warehouse             |       |                      | (2)        |
| Chatsworth, California         |       | Office,  Warehouse             |       |                      | (2)        |
| Greenville, Ohio               |       | Office,  Warehouse             |       |                      | (2)        |
| Mississauga, Ontario, Canada   |       | Office,  Warehouse             |       |                      | (2)        |
| Spartanburg, South Carolina    |       | Office,  Warehouse             |       |                      | (2)        |
| Monterrey, Nuevo Leon, Mexico  |       | Office,  Warehouse             |       |                      | (1)        |

 

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

 

# **ITEM 3.LEGAL PROCEEDINGS**

 

There were no material legal proceedings pendingagainst us or our subsidiaries, as of September 30, 2007. 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 believe that we are in material compliancewith such laws and regulations, although no assurance can be provided that thiswill remain true going forward.

 

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

 

Omitted pursuant to General Instruction I to Form10-K.

 

26

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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 themember units of Sally Holdings LLC. Sally Investment Holdings, LLC, a wholly-owned subsidiary of SallyBeauty Holdings, Inc. owns all of the member units of Sally HoldingsLLC.

 

We do not expect to pay dividends for the foreseeablefuture. The agreements governing our indebtedness restrict our ability to paydividends. See “Risk Factors—Risks Relating to Our Substantial Indebtedness”and Note 11 of the “Notes to Consolidated Financial Statements” in “Item8—Financial Statements and Supplementary Data.”

 

On November 16, 2006, immediately prior to theSeparation Transactions, Sally Holdings LLC paid a cash distribution in theaggregate amount of $1,809.7 million to its indirect parent, Sally BeautyHoldings, Inc.

 

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# **ITEM 6.SELECTED FINANCIAL DATA**

 

The following tables present selected financial dataof Sally Holdings LLC and its consolidated subsidiaries for the year endedSeptember 30, 2007, and of Sally Holdings, Inc. and its consolidatedsubsidiaries for the years ended September 30, 2006, 2005, 2004 and 2003 (inthousands). Sally Holdings, Inc. was a wholly owned subsidiary ofAlberto-Culver until November 16, 2006 when it was converted to a Delawarelimited liability company, was renamed “Sally Holdings LLC,” and became anindirect wholly owned subsidiary of Sally Beauty in connection with theSeparation Transactions. 

 

| ** **                                                                                   | ** ** | **Year Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Results of operations information:**                                                       |       |                                        |       |   |   |   |   |   |   |   |   |
| Net sales                                                                                    |       | $                                           | 2,513,772  |   | $ | 2,373,100 |   | $ | 2,254,307 |   | $ | 2,097,667 |   | $ | 1,824,008 |   |
| Cost of products sold and distribution  expenses                                             |       | 1,360,025                                   |       | 1,286,329 |   | 1,227,307 |   | 1,146,814 |   | 1,016,941 |   |
| Gross profit                                                                                 |       | 1,153,747                                   |       | 1,086,771 |   | 1,027,000 |   | 950,853 |   | 807,067 |   |
| Selling, general and administrative  expenses(a)                                             |       | 850,159                                     |       | 798,211 |   | 768,847 |   | 703,528 |   | 591,307 |   |
| Depreciation and amortization                                                                |       | 42,605                                      |       | 38,032 |   | 33,906 |   | 24,619 |   | 22,335 |   |
| Sales-based service fee charged by  Alberto-Culver                                           |       | 3,779                                       |       | 28,852 |   | 27,615 |   | 26,051 |   | 23,360 |   |
| 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                                                                           |       | 235,702                                     |       | 180,201 |   | 192,581 |   | 169,619 |   | 170,065 |   |
| Interest expense, net(d)                                                                     |       | 145,972                                     |       | 92 |   | 2,966 |   | 2,250 |   | 347 |   |
| Earnings before provision for income taxes                                                   |       | 89,730                                      |       | 180,109 |   | 189,615 |   | 167,369 |   | 169,718 |   |
| Provision for income taxes                                                                   |       | 41,169                                      |       | 69,916 |   | 73,154 |   | 62,059 |   | 62,205 |   |
| Net earnings                                                                                 |       | $                                           | 48,561     |   | $ | 110,193 |   | $ | 116,461 |   | $ | 105,310 |   | $ | 107,513 |   |
| **Operating data:**                                                                          |       |                                        |       |   |   |   |   |   |   |   |   |
| Number of retail stores (end of period):                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Sally Beauty Supply                                                                          |       | 2,694                                       |       | 2,511 |   | 2,419 |   | 2,355 |   | 2,272 |   |
| Beauty Systems Group                                                                         |       | 874                                         |       | 828 |   | 822 |   | 692 |   | 543 |   |
| Total                                                                                        |       | 3,568                                       |       | 3,339 |   | 3,241 |   | 3,047 |   | 2,815 |   |
| Professional distributor sales consultants  (end of period)                                  |       | 1,067                                       |       | 1,192 |   | 1,244 |   | 1,167 |   | 989 |   |
| Comparable store sales growth(e):                                                            |       |                                        |       |   |   |   |   |   |   |   |   |
| Sally Beauty Supply                                                                          |       | 2.7                                         | %          | 2.4 | % | 2.4 | % | 3.8 | % | 2.7 | % |
| Beauty Systems Group                                                                         |       | 10.1                                        | %          | 4.1 | % | (0.6 | )% | 8.5 | % | 4.6 | % |
| Consolidated                                                                                 |       | 4.5                                         | %          | 2.8 | % | 1.8 | % | 4.6 | % | 3.8 | % |
| **Financial condition information (at period  end):**                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Working capital                                                                              |       | $                                           | 341,891    |   | $ | 479,107 |   | $ | 382,482 |   | $ | 377,708 |   | $ | 383,643 |   |
| Cash, cash equivalents and short-term investments                                            |       | 38,272                                      |       | 107,571 |   | 38,612 |   | 68,003 |   | 118,214 |   |
| Property, plant and equipment, net                                                           |       | 154,068                                     |       | 142,735 |   | 149,354 |   | 125,810 |   | 93,691 |   |
| Total assets                                                                                 |       | 1,404,261                                   |       | 1,338,841 |   | 1,225,507 |   | 1,102,428 |   | 932,163 |   |
| Long-term debt, including notes payable to  affiliated companies                             |       | 1,758,594                                   |       | 621 |   | 18,828 |   | 34,872 |   | 24,173 |   |
| Member’s (stockholder’s) (deficit) equity                                          |       | $                                           | (780,317   | ) | $ | 1,005,967 |   | $ | 900,296 |   | $ | 786,163 |   | $ | 678,166 |   |

 

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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 2007 and 2006 include  share-based compensation of $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. See Note 3 of the  “Notes to Consolidated Financial Statements” in “Item 8—Financial  Statements and Supplementary Data.” |
|   |                                                                                                                                                                                                                                                                                                                                                     |
| (d)    | Interest expense in fiscal year 2007 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)    | Comparable stores are defined as company-owned stores that have been  open for at least 14 months as of the last day of a month.                                                                                                                                                                                                                    |

 

Prior toNovember 16, 2006, Alberto-Culver owned all shares of issued and outstandingcommon stock of Sally Holdings, Inc. Since November 16, 2006, all member unitsof Sally Holdings LLC have been owned by Sally Investment, a wholly-ownedsubsidiary 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, a wholly-ownedsubsidiary of Sally Beauty Holdings, Inc., and its consolidated subsidiaries,as of and for the fiscal year ended September 30, 2007. All of theinterests of Sally Holdings are beneficially owned by Sally Investment, and allof the interests of Sally Investment are beneficially owned by Sally Beauty.The financial condition as of September 30, 2006, and results of operations andcash flows for the fiscal years ended September 30, 2006 and 2005 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 included elsewhere inthis Annual Report. This Management’s Discussion and Analysis of FinancialCondition and Results of Operations contains forward-looking statements. See“Cautionary Notice Regarding Forward-Looking Statements” for a discussion ofthe uncertainties, risks and assumptions associated with these forward-lookingstatements that could cause results to differ materially from those reflectedin such forward-looking statements.

 

## **Highlightsof Fiscal Year Ended September 30, 2007**

 

•             On November 16, 2006,we separated from our parent, Alberto-Culver. In connection with theseparation:

 

•                        We becamean indirect wholly-owned subsidiary of Sally Beauty.

 

•                        We andcertain of our subsidiaries incurred approximately $1,850.0 million ofindebtedness.

 

•                        We usedthe proceeds of the indebtedness to make a $1,809.7 million distribution toSally Beauty.

 

•                        Regular-waytrading of Sally Beauty’s common stock commenced on November 17, 2006 on theNYSE under the symbol “SBH.”

 

•                        CDRInvestors invested $575.0 million in Sally Beauty for an equity investment ofapproximately 48% of Sally Beauty’s common stock.

 

•                        Throughthe proceeds of the distribution and the investment, Sally Beauty issued aspecial cash dividend of $25.00 to Alberto-Culver stockholders for each shareof common stock held as of the record date of the separation.

 

•             Financial andoperating information:

 

•                        Net salesfor fiscal year 2007 increased $140.7 million, or 5.9%, to $2,513.8 million,compared to fiscal year 2006.

 

•                        OnDecember 19, 2006, we announced that BSG would no longer retain certaindistribution rights to one of our major suppliers, which affected our fiscalyear 2007 results.

 

•                        Operatingearnings for fiscal year 2007 increased $55.5 million, or 30.8%, to $235.7million, compared to fiscal year 2006.

 

•                        Consolidatedcomparable stores sales growth increased 4.5%.

 

•                        SallyBeauty Supply and BSG opened 83 and 46 net stores, respectively, in fiscal year2007.

 

•                        OnFebruary 15, 2007, we completed an acquisition in our Sally Beauty Supplybusiness segment that expanded our presence in Europe.

 

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## **Overview**

 

##### ***Description ofBusiness***

 

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, we operate a multi-channel platform of 3,368 stores and supplied 200franchised stores in North America as well as selected European countries andJapan, as of September 30, 2007. Within BSG, we also have one of the largestnetworks of professional distributor sales consultants in North America, with approximately1,100 professional distributor sales consultants who sell directly to salonsand salon professionals. We provide our customers with a wide variety ofleading third-party branded and exclusive label professional beauty supplies,including hair care products, styling appliances, skin and nail care productsand other beauty items. Sally Beauty Supply stores target retail consumers andsalon professionals, while BSG exclusively targets salons and salonprofessionals. For the year ended September 30, 2007, our net sales andoperating earnings were $2,513.8 million and $235.7 million,respectively.

 

Sally Beauty Supply is the largest open-linedistributor of professional beauty supplies in the U.S. based on storecount. As of September 30, 2007, Sally Beauty Supply operated 2,669company-owned retail stores and supplied 25 franchised stores acquired in theSalon Services acquisition, which is discussed in greater detail below under“—Recent Acquisitions,” 2,226 of which are located in the U.S., and the remainderin the U.K. and certain other countries in Europe, Canada, Puerto Rico, Mexicoand Japan. Sally Beauty Supply stores average 1,700 square feet andare primarily located in strip shopping centers. The product selection in SallyBeauty Supply stores ranges between 5,400 and 7,700 SKUs of beauty products,and includes products for hair care, nail care, beauty sundries and appliances,targeting retail consumers and salon professionals. Sally Beauty Supply storescarry leading third-party brands such as Clairol, Revlon and Conair, as well asan extensive selection of exclusive label merchandise. For the year endedSeptember 30, 2007, Sally Beauty Supply’s net sales and segment operatingprofit were $1,567.4 million and $273.4 million, respectively, representing62.4% and 80.9% of consolidated net sales and segment operating profit,respectively.

 

We believe BSG is the largest full-service distributorof professional beauty supplies in the U.S. As of September 30, 2007,BSG operated 699 company-owned stores, supplied 175 franchised stores andhad a sales force of approximately 1,100 professional distributor salesconsultants selling exclusively to salons and salon professionals in 47U.S. states and portions of Canada, Mexico and certain European countries.BSG stores average 2,700 square feet and are primarily located insecondary strip shopping centers. Through BSG’s large store base and salesforce, BSG is able to access a significant portion of the highly fragmentedU.S. salon market. The product selection in BSG stores, ranging between2,700 and 9,800 SKUs of beauty products, includes hair care, nail care, beautysundries and appliances targeting salons and salon professionals. BSG carriesleading professional beauty product brands, intended for use in salons and forresale by the salon to consumers. Certain BSG products are sold under exclusivedistribution agreements with suppliers, whereby BSG is designated as the soledistributor for a product line within certain geographic territories. For theyear ended September 30, 2007, BSG’s net sales and segment operatingprofit were $946.4 million and $64.6 million, respectively,representing 37.6% and 19.1% of consolidated net sales and segment operatingprofit, respectively.

 

##### ***BusinessTrends***

##### *** ***

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. We believe the following key industry trends and characteristicswill influence our business going forward:

 

•             *High level of customer fragmentation.*  TheU.S. salon market is highly fragmented with over 230,000salons. 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.*  Boothrenters are responsible for purchasing their own supplies. Historically, booth rentershave significantly increased as a percentage of total salon professionals andwe expect 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.

 

•             *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. Exclusive 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 the leadingthird-party branded products and we believe this area offers potential growth.

 

•             *Frequent re-stocking needs.*  Salonprofessionals primarily rely on just-in-time inventory due to capitalconstraints and a lack of warehouse and shelf space at salons. These factorsare key to driving demand for conveniently located professional beauty supplystores.

 

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•             *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 ourrelationships with suppliers that can materially affect the net sales andoperating earnings of our business segments. Consolidation among supplierscould exacerbate the effects of these relationship changes and could increasepricing pressures. For example, as we announced in December 2006, our largestsupplier, L’Oreal, has moved a material amount of revenue out of the BSGnationwide distribution network and into competitive regional distributionnetworks. More recently, L’Oreal has also announced the acquisition ofdistributors competitive with BSG in the southeastern and west coast of theU.S. In addition, L’Oreal has announced the acquisition of a supplier(Pureology) that does not currently do business with BSG. If L’Oreal acquiredanother supplier that conducts significant business with BSG, we could losethat revenue as well. As a result, L’Oreal is entering into direct competitionwith BSG and there can be no assurance that there will not be further revenuelosses over time at BSG, due to potential losses of additional L’Oreal relatedproducts as well as from the increased competition from L’Oreal-affiliateddistribution networks.

 

•             *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 havea 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 andhair-loss products. Additionally, continuously changing fashion-related trendsthat drive 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. If we are unable to anticipate and respond to trends in the marketfor beauty products and changing consumer demands, our business could suffer.

 

•             *Controllingexpenses*. Another important aspect of our business is our ability tocontrol costs, especially in our BSG business by right-sizing the business(including some targeted reductions-in-force) and maximizing the efficiency ofour structure. In response to the loss of L’Oreal related revenue discussedbelow, BSG made certain changes with its distributor sales consultants. BSG’ssales force was reduced and the remaining affected distributor salesconsultants were offered certain compensation related incentives to stay withBSG as BSG seeks to replace lost L’Oreal revenue. BSG has substantiallycompleted a store re-branding project that repositioned all of its NorthAmerican company-owned stores under a common name and store identity,CosmoProf. This project is expected to provide brand consistency, save onadvertising and promotional costs and allow for a more focused marketingstrategy. Further, we continue to study our distribution function as we seek torationalize our infrastructure. During fiscal year 2007, we began implementinga two-year $19.0 million capital spending program to consolidate warehouses andreduce administrative expenses related to BSG’s distribution networkoptimization program. We currently believe that this plan could produce significantannual expense savings within the next two years.

 

•             *Relationshipswith suppliers*. We do not manufacture the brand name or exclusivelabel products we sell, and instead purchase our products from manufacturers.We depend upon a limited number of manufacturers for a significant percentageof the products we sell, and our relationships with these suppliers changeoften. Please see the next section for more information on this trend.

 

##### ***RelationshipsWith 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 through

 

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franchisees or sub-distributors (primarily in Europe),which also buy products directly from Sally Beauty Supply or BSG for resale.Sally Beauty Supply/BSG and their suppliers are dependent on each other for thedistribution of beauty products. As is typical in distribution businesses,these relationships are subject to change from time to time (including theexpansion 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. For example, during the second quarter of 2007, FaroukSystems, Inc., or Farouk Systems, terminated its distribution agreement withus. Subsequently, effective July 2007, BSG stores and professional distributorsales consultants were once again given approval to distribute Farouk Systemsproducts, with an expanded distribution area.

 

On December 19, 2006, we announced that:(i) BSG, other than its Armstrong McCall division, would not retain itsrights to distribute the professional products of L’Oreal through itsdistributor sales consultants (effective January 30, 2007, withexclusivity ending December 31, 2006) or in its stores on an exclusivebasis (effective January 1, 2007) in those geographic areas withinthe U.S. in which BSG had distribution rights, and (ii) BSG’sArmstrong McCall division would not retain the rights to distribute Redkenprofessional products through its franchises. In an effort to replace theserights, BSG entered into long-term agreements with L’Oreal under which, as ofJanuary 1, 2007, BSG had non-exclusive rights to distribute the same L’Orealprofessional products in its stores that it previously had exclusive rights toin its stores and through its sales consultants. Armstrong McCall retained itsexclusive rights to distribute Matrix professional products in its territories.

 

We plan to mitigate the negative effects resultingfrom unfavorable changes in our relationships with suppliers, such as L’Oreal,by taking the following steps: (i) adding new products to replace lines withour distributor sales consultants; (ii) adding new product lines to our BSGstores; (iii) expanding existing product lines into new territories; and (iv)managing costs to maximize the efficiency of the BSG structure (in fiscal year2007 we undertook a right-sizing of the BSG business, including some targetedreductions-in-force). Although we are focused on developing new revenue andcost management initiatives, there can be no assurance that our efforts willpartially or completely offset the loss of these distribution rights. Inaddition, BSG’s loss of distribution rights through its distributor salesconsultants, as well as the loss of exclusive rights to distribute L’Orealproducts in its stores, has resulted in margin pressure on BSG’s remainingL’Oreal revenues. See “Risk Factors—We depend upon manufacturers who may beunable to provide products of adequate quality or who may be unwilling tocontinue to supply products to us.”

 

Regarding other suppliers, BSG continues to expand theP&G Professional Care product lines including Wella, Sebastian and GrahamWebb into additional geographies for BSG stores and distributor salesconsultants. Additionally, during fiscal year 2007, our expansion of the BSGsegment included the acquisition of certain assets, and the award ofdistribution rights, which allow us to distribute Goldwell/KMS products andPaul Mitchell products in various markets, as well as a number of other brands.We expect to gain certain other distribution rights over time through eitherfurther awards, or by acquisitions of existing distributors.

 

##### ***RecentAcquisitions***

 

On February 15, 2007, we entered into andcompleted an Agreement for the Sale and Purchase of the Entire Issued ShareCapital of Chapelton 21 Limited, or the Agreement, a private company limited byshares and incorporated in Scotland, which we refer to as Salon Services, byand among Ogee Limited, an indirect subsidiary of ours, and the registeredshareholders of Salon Services. This acquisition provided the Sally BeautySupply segment a strong European presence. Pursuant to the Agreement, weacquired all of the issued share capital of Salon Services for an aggregate cashpurchase price of approximately $57.7 million. We financed the purchaseprice through a draw down of approximately $57.0 million under our ABLfacility. In addition, we extinguished approximately $3.9 million of SalonServices’ debt. Salon Services, through its direct and indirect subsidiariesincluding Salon Services (Hair and Beauty Supplies) Ltd., supplies professionalhair and beauty products primarily to salon and spa operators and independenthair and beauty professionals in the U.K., Germany, Ireland, Spain and Norway.

 

In addition, during June 2006, we acquired SalonSuccess, a U.K. based distributor of professional beauty products in order toexpand BSG’s presence in the U.K. and expand the geographic area served by BSGinto other portions of Europe. This acquisition enabled BSG to enter newmarkets in Europe, including the U.K., Spain and the Netherlands and to expandits operations in Florida. The total purchase price as of September 30, 2007,was approximately $23.2 million. In accordance with the purchaseagreement, additional consideration of up to $2.1 million, plus interest,may be paid over the three year period following the closing of theacquisition, based on sales to a specific customer. As of September 30, 2007,approximately $1.2 million has been paid pursuant to this agreement.

 

##### ***Our Separationfrom Alberto-Culver***

 

Our business historically constituted two operatingsegments within the consolidated financial statements of Alberto-Culver. OnNovember 16, 2006, we separated from Alberto-Culver, pursuant to theInvestment Agreement. As a result: (i) we became an indirect wholly-ownedsubsidiary of Sally Beauty; (ii) Sally Beauty, through us, owns andoperates the Sally Beauty Supply and BSG

 

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distribution businesses that were owned and operatedby Alberto-Culver prior to the Separation Transactions; (iii) at theclosing of the Separation Transactions, the stockholders of Alberto-Culverprior thereto became the beneficial owners of approximately 52% of SallyBeauty’s outstanding common stock on an undiluted basis and the CDR Investors,who in the aggregate invested $575.0 million in Sally Beauty, received anequity interest representing approximately 48% of Sally Beauty’s outstandingcommon stock on an undiluted basis; and (iv) Alberto-Culver continues toown and operate its consumer products business.

 

In addition, in connection with the SeparationTransactions:

 

•             We and certain of oursubsidiaries incurred approximately $1,850.0 million of indebtedness,including: (i) $1,070.0 million by drawing on our Term Loans;(ii) $70.0 million by drawing on our ABL facility; and(iii) $710.0 million from the issuance of $430.0 million ofsenior notes and $280.0 million of senior subordinated notes;

 

•                  We used asubstantial portion of the proceeds of the debt incurrence to make a $1,809.7million distribution to Sally Beauty; and

 

•             Sally Beauty usedapproximately $2,342.1 million, a substantial portion of the proceeds ofthe investment by the CDR Investors and the distribution from us, to pay a$25.00 per share special cash dividend to holders of record of SallyBeauty’s common stock, who were Alberto-Culver shareholders as of the recorddate for the Separation Transactions.

 

Pursuant to the Investment Agreement, Sally Beautypaid a transaction fee of $30.0 million to Clayton, Dubilier & Rice, Inc.,the manager of both Clayton, Dubilier & Rice Fund VII, L.P., the solemember of CDRS, and Parallel Fund, as well as approximately $1.1 million toCDRS in merger and transaction expenses incurred in connection with itsinvestment in Sally Beauty, and the Separation Transactions. Pursuant to theInvestment Agreement, Sally Beauty also paid approximately $20.4 toAlberto-Culver for its expenses incurred in connection with the SeparationTransactions. Sally Beauty also paid approximately $58.5 million in fees forthe debt financing incurred in 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 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 of Sally Beauty’sspecified liabilities, minus other specified transaction costs. In connectionwith the Separation Transactions, Sally Beauty became the parent company forall U.S. tax returns filed under the employer identification number ofAlberto-Culver prior to the completion of the Separation Transactions. Allintercompany receivables, payables and loans (other than trade payables and ourportion of the transaction expenses described above) between Sally Beauty orany of its subsidiaries, on the one hand, and Alberto-Culver or any of itssubsidiaries (other than Sally Beauty and its subsidiaries), on the other hand,were canceled prior to completion of the Separation Transactions. In addition,prior thereto, all intercompany agreements between Sally Beauty or any of itssubsidiaries and Alberto-Culver or any of its subsidiaries were terminated,other than certain agreements specifically designated in the separationagreement to survive following the transactions.

 

In addition, upon completion of the SeparationTransactions, Michael H. Renzulli, former Chairman of Sally Holdings, Inc.,terminated his employment with Alberto-Culver and us. As a result, we providedMr. Renzulli with certain benefits primarily consisting of a lump-sum cashpayment of $3.6 million that was paid within 30 days after completionof the Separation Transactions.

 

 We treated theSeparation Transactions as though they constituted a change in control for allemployees and directors under Sally Beauty’s equity and incentive compensationplans, and as a change in control for our employees under Alberto-Culver’sdeferred compensation plan. As a result, in accordance with the terms of theseplans, all outstanding stock options and restricted shares of Alberto-Culver,including those held by our employees, became fully vested upon completion ofthe Separation Transactions. Due to the Separation Transactions, we recorded acharge at that time of approximately $5.3 million, which represents theamount of future compensation expense that would have been recognized insubsequent periods as the stock options and restricted shares for our employeesvested over the original vesting periods. Upon completion of the SeparationTransactions all outstanding Alberto-Culver stock options held by our employeesbecame options to purchase shares of Sally Beauty’s common stock.

 

##### ***Senior SecuredCredit Facilities***

##### *** ***

The Term Loans and the ABLfacility are secured by substantially all of our assets, those of SallyInvestment, those of our domestic subsidiaries and, in the case of the ABLfacility, those of our Canadian subsidiaries. The Term Loans may be prepaid atour option at any time without premium or penalty and is subject tomandatory prepayment in an amount equal to 50% of excess cash flow (as

 

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defined in the agreement governing the Term Loans) forany fiscal year (commencing in fiscal year 2008) unless a specified leverageratio is met and 100% of the proceeds of specified asset sales that are notreinvested in the business or applied to repay borrowings under the ABLfacility.

 

The 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). The Notes carry optional redemption features whereby we have theoption to redeem the Notes on or before November 15, 2010 andNovember 15, 2011, respectively, at par plus a premium, plus accrued andunpaid 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.

 

Details of the senior secured credit facilities as ofSeptember 30, 2007 are as follows (dollars in thousands):

 

| ** **                | ** ** | **Amount** | ** ** | **Maturity dates  (fiscal year)** | ** ** | **Interest rates** | ** **                       |
|---------------------------|------------|------------|------------|-----------------------------------|------------|--------------------|----------------------------------|
| ABL facility              |       | $          | 11,400     |                              | 2012       |               | (i)                              | PRIME and up to 0.50% or; |   |
|                      |       |       |       |                              |       | (ii)               | LIBOR plus (1.00% to  1.50%)     |   |
| Term loan A          |       | 142,500    |       | 2013                              |       | (i)                | PRIME plus (1.00% to  1.50%) or; |   |
|                      |       |       |       |                              |       | (ii)               | LIBOR plus (2.00% to  2.50%)     |   |
| Term loan B          |       | 910,800    |       | 2014                              |       | (i)                | PRIME plus (1.25% to  1.50%) or; |   |
|                      |       |       |       |                              |       | (ii)               | LIBOR plus (2.25% to  2.50%)     |   |
|                      |       | $          | 1,064,700  |                              |       |               |                             |   |   |
|                      |       |       |       |                              |       |               |                             |   |
| Senior notes              |       | $          | 430,000    |                              | 2015       |               |                             | 9.25% |   |   |
| Senior subordinated notes |       | 280,000    |       | 2017                              |       |               | 10.50%                           |   |   |
|                      |       | $          | 710,000    |                              |       |               |                             |   |   |

 

##### ***OtherInformation Related to the Separation Transactions***

 

On November 24, 2006, we entered into twointerest rate swap agreements. See “Item 7A—Quantitative and QualitativeDisclosures about Market Risk—Interest rate risk.”

 

References to our historical assets, liabilities,products, businesses or activities are generally intended to refer to thehistorical assets, liabilities, products, businesses or activities of Sally Holdings,Inc. as a wholly-owned subsidiary of Alberto-Culver prior to the SeparationTransactions. The historical financial results of Sally Holdings, Inc. as partof Alberto-Culver contained herein do not reflect what the financial results ofSally Holdings, Inc. would have been had it been operated as a subsidiary ofSally Beauty during the periods presented. See “Risk Factors—Risks Relating toOur 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. See “Risk Factors—RisksRelating to Our Substantial Indebtedness” and Note 11 of the “Notes toConsolidated Financial Statements” in “Item 8—Financial Statements andSupplementary Data.”

 

##### ***OtherSignificant Items***

 

### *Termination of Spin/Merge Transaction withRegis Corporation*

 

On January 10, 2006, Alberto-Culver entered intoan agreement with Regis Corporation, or Regis, to merge us with a subsidiary ofRegis in a tax-free transaction. Pursuant to the terms and conditions of themerger agreement, our business was to be spun off to Alberto-Culver’sstockholders by way of a tax-free distribution and, immediately thereafter,combined with Regis in a tax-free stock-for-stock merger. On April 5,2006, Alberto-Culver and Regis terminated the merger agreement. In connectionwith the termination of the merger agreement, we and Alberto-Culver incurredtransaction expenses, primarily the termination fee paid to Regis and legal andinvestment banking fees, during fiscal years 2005 and 2006. The total amount oftransaction expenses, including the termination fee, incurred by us wasapproximately $41.5 million ($27.2 million after taxes), and was expensed by usduring fiscal year 2006 in accordance with the terms of those transactionagreements.

 

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### *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 2007 and 2006, total share-basedcompensation cost charged against earnings was $12.3 million and $5.2 million,respectively. Included for fiscal year 2007 is $5.3 million of acceleratedexpense related to the Separation Transactions and $2.6 million of acceleratedexpense related to certain retirement eligible employees who are eligible tocontinue vesting awards upon retirement under the terms of Sally Beauty’s 2007Omnibus Incentive Plan, which is a share-based compensation plan adopted by thestockholders of Sally Beauty during fiscal year 2007. For fiscal years 2007 and2006, the total income tax benefit recognized in the consolidated statements ofearnings from these plans was $4.8 million and $1.8 million, respectively. Thenet balance sheet effect of recognizing stock option expense increased totalstockholder’s equity by $4.8 million and $1.8 million for fiscal years2007 and 2006, respectively, and resulted in the recognition of deferred taxassets of the same amount. Our consolidated statements of cash flows for fiscalyears 2007 and 2006 reflect $0.8 million and $0.6 million, respectively,of excess tax benefits from employee exercises of stock options as financingcash inflow. For fiscal year 2005, our consolidated statement of cash flowsreflects $1.2 million of excess tax benefits from employee exercises ofstock options as operating cash inflow. As of September 30, 2007, we had$10.2 million of unrecognized compensation cost related to stock optionsissued to employees of our business that is expected to be recognized over theweighted average period of 3.1 years, and $2.4 million of unearnedcompensation related to restricted stock awards that is expected to beamortized to expense over the weighted average period of 4.3 years.

 

Prior to the Separation Transactions, we were asubsidiary of Alberto-Culver and had no share-based compensation plans of ourown; however, certain of our employees had been granted stock options andrestricted stock awards under share-based compensation plans of Alberto-Culver.The Separation Transactions constituted a change in control for purposes ofAlberto-Culver’s stock option and stock award plans. As a result, in accordancewith the terms of these plans, all outstanding stock options and stock awards ofAlberto-Culver, including those held by our employees, became fully vested uponcompletion of the Separation Transactions on November 16, 2006. For fiscal year2007, we recorded a charge equal to the amount of future compensation expenseof approximately $5.3 million that would have been recognized in subsequentperiods had these stock options and stock awards for our employees vested overthe original vesting periods. Upon completion of the Separation Transactions,all outstanding Alberto-Culver stock options held by our employees becameoptions to purchase shares of Sally Beauty’s common stock.

 

Effective October 1, 2005, we adoptedSFAS No. 123(R) using the modified prospective method. Under thismethod, compensation expense related to Alberto-Culver stock options granted toemployees of our business is recognized for new stock option grants beginningin fiscal year 2006 and for the unvested portion of outstanding stock optionsthat were granted prior to the adoption of SFAS No. 123(R). In accordancewith the modified prospective method, the financial statements for fiscal year2005 have not been restated.

 

## **Resultsof Operations**

 

The following table shows the condensed results ofoperations of our business for the fiscal years ended September 30, 2007,2006 and 2005 (amounts in millions):

 

| ** **                                       | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                        |       | $                                           | 2,513.8    |   | $ | 2,373.1 |   | $ | 2,254.3 |   |
| Cost of products sold and distribution  expenses |       | 1,360.0                                     |       | 1,286.3 |   | 1,227.3 |   |
| Gross profit                                     |       | 1,153.8                                     |       | 1,086.8 |   | 1,027.0 |   |
| Total other costs and expenses                   |       | 918.1                                       |       | 906.6 |   | 834.4 |   |
| Operating earnings                               |       | 235.7                                       |       | 180.2 |   | 192.6 |   |
| Interest expense, net(a)                         |       | 146.0                                       |       | 0.1 |   | 3.0 |   |
| Earnings before provision for income taxes       |       | 89.7                                        |       | 180.1 |   | 189.6 |   |
| Provision for income taxes                       |       | 41.2                                        |       | 69.9 |   | 73.1 |   |
| Net earnings                                     |       | $                                           | 48.5       |   | $ | 110.2 |   | $ | 116.5 |   |

 

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(a)                                  For the fiscal year 2007, net interest expenseis primarily associated with debt incurred in connection with the SeparationTransactions. See Note 11 of the “Notes to Consolidated Financial Statements”in “Item 8—Financial Statements and Supplementary Data.”

 

35

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The following table shows thecondensed results of operations of our business for the fiscal years endedSeptember 30, 2007, 2006 and 2005, expressed as a percentage of net salesfor the respective periods:

 

| ** **                                       | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                        |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Cost of products sold and distribution  expenses |       | 54.1                                        | %          | 54.2 | % | 54.4 | % |
| Gross profit                                     |       | 45.9                                        | %          | 45.8 | % | 45.6 | % |
| Total other costs and expenses                   |       | 36.5                                        | %          | 38.2 | % | 37.1 | % |
| Operating earnings                               |       | 9.4                                         | %          | 7.6 | % | 8.5 | % |
| Interest expense, net(a)                         |       | 5.8                                         | %          | 0.0 | % | 0.1 | % |
| Earnings before provision for income taxes       |       | 3.6                                         | %          | 7.6 | % | 8.4 | % |
| Provision for income taxes                       |       | 1.7                                         | %          | 3.0 | % | 3.2 | % |
| Net earnings                                     |       | 1.9                                         | %          | 4.6 | % | 5.2 | % |

 

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##### ***Key OperatingMetrics***

 

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,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales:                                                                                |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | $                                           | 1,567,365  |   | $ | 1,419,332 |   | $ | 1,358,899 |   |
| BSG                                                                                       |       | 946,407                                     |       | 953,768 |   | 895,408 |   |
|                                                                                      |       | $                                           | 2,513,772  |   | $ | 2,373,100 |   | $ | 2,254,307 |   |
| Gross Profit                                                                              |       | $                                           | 1,153,747  |   | $ | 1,086,771 |   | $ | 1,027,000 |   |
| Gross profit margin                                                                       |       | 45.9                                        | %          | 45.8 | % | 45.6 | % |
|                                                                                      |       |                                        |       |   |   |   |   |
| Selling, general and administrative  expenses                                             |       | $                                           | 850,159    |   | $ | 798,211 |   | $ | 768,847 |   |
| Depreciation and amortization                                                             |       | $                                           | 42,605     |   | $ | 38,032 |   | $ | 33,906 |   |
|                                                                                      |       |                                        |       |   |   |   |   |
| Earnings before provision for income taxes:                                               |       |                                        |       |   |   |   |   |
| Segment operating profit:                                                                 |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | $                                           | 273,364    |   | $ | 235,419 |   | $ | 222,679 |   |
| BSG                                                                                       |       | 64,652                                      |       | 88,445 |   | 71,210 |   |
| Segment operating profit                                                                  |       | 338,016                                     |       | 323,864 |   | 293,889 |   |
| Unallocated expenses                                                                      |       | (64,766                                     | )          | (68,150 | ) | (69,642 | ) |
| Share-based compensation expense                                                          |       | (12,267                                     | )          | (5,186 | ) | — |   |
| Sales-based service fee charged by  Alberto-Culver                                        |       | (3,779                                      | )          | (28,852 | ) | (27,615 | ) |
| Non-cash charge related to Alberto-Culver’s  conversion to one class of common stock |       | —                                      |       | — |   | (4,051 | ) |
| Transaction expenses                                                                      |       | (21,502                                     | )          | (41,475 | ) | — |   |
| Operating earnings                                                                        |       | 235,702                                     |       | 180,201 |   | 192,581 |   |
| Interest expense, net of interest income                                                  |       | (145,972                                    | )          | (92 | ) | (2,966 | ) |
| Earnings before provision for income taxes                                                |       | $                                           | 89,730     |   | $ | 180,109 |   | $ | 189,615 |   |
|                                                                                      |       |                                        |       |   |   |   |   |
| Segment operating profit margin:                                                          |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | 17.4                                        | %          | 16.6 | % | 16.4 | % |
| BSG                                                                                       |       | 6.8                                         | %          | 9.3 | % | 8.0 | % |
| Consolidated operating profit margin                                                      |       | 9.4                                         | %          | 7.6 | % | 8.5 | % |
| Number of stores at end-of-period  (including franchises):                                |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | 2,694                                       |       | 2,511 |   | 2,419 |   |
| BSG                                                                                       |       | 874                                         |       | 828 |   | 822 |   |
|                                                                                      |       | 3,568                                       |       | 3,339 |   | 3,241 |   |
| Comparable store sales growth(a)                                                          |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | 2.7                                         | %          | 2.4 | % | 2.4 | % |
| BSG                                                                                       |       | 10.1                                        | %          | 4.1 | % | (0.6 | )% |
| Consolidated                                                                              |       | 4.5                                         | %          | 2.8 | % | 1.8 | % |

 

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| (a)                                                                                                            | Comparable  stores are defined as company-owned stores that have been open for at least  14 months as of the last day of a month. |
|----------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                           |                                                                                                                                   |
| Certain  amounts for prior periods have been reclassified to conform to the current  year’s presentation. |

 

##### ***Description ofSales 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 sells haircare, hair color, skin and nail care products, electrical appliances and otherbeauty related accessories. Because approximately 40% of our U.S. Sally BeautySupply product sales come from exclusive or control label brands, most of thesesame products are generally not sold in most other retail stores and are notsold in our BSG business. Various factors influence Sally Beauty Supply’s netsales including local competition,

 

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productassortment and availability, price, hours of operation and marketing andpromotional activity. Sally Beauty Supply’s product assortment and sales aregenerally not seasonal in nature.

 

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

 

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

 

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

 

*Sales-based Service Fee.*Priorto the Separation Transactions, we were charged a sales-based service fee underthe consulting, business development and advisory services agreement betweencertain of our subsidiaries and Alberto-Culver. In conjunction with 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 expenses are costs associated with theSeparation Transactions and are primarily payments to Alberto-Culver as definedin the separation agreements. In addition, we recognized severance costs fortwo executives and certain professional fees related to the SeparationTransactions. For fiscal year 2006, transaction expenses are related to thetermination of the agreement with Regis that called for us to merge with asubsidiary of Regis in a tax-free transaction. This proposed transaction wasterminated in April 2006 and we expensed approximately $41.5 million ($27.2million after taxes) in fees associated with the termination.

 

*Net Interest Expense*.Net interest expense includes the amortization of deferred debt issuance costs,and is stated net of interest income. For the fiscal year 2007, net interestexpense is primarily associated with debt incurred in connection with theSeparation Transactions. Prior to the Separation Transactions, net interestexpense was primarily attributable to notes with affiliates.

 

##### ***Comparison ofFiscal Years Ended September 30, 2007 and 2006***

##### *** ***

### *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 comparablestore sales growth of 4.5%, the addition of 83 Sally Beauty Supply and 46 BSGstores during fiscal year 2007, and the acquisitions of Salon Services andSalon Success. Salon Services, which was acquired during the second quarter of2007, 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 $148.1 million, or 10.4%, to$1,567.4 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 comparable store sales growth of2.7%, which includes a decline in same store number of transactions. Inaddition, the effect of exchange rates contributed $13.0 million or an increasein sales of 0.9%.

 

*Beauty Systems Group*. Net sales for BSG decreased $7.4 million, or 0.8%, to $946.4 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 ofL’Oreal products compared to fiscal year 2006. BSG also experienced a declinein sales at its franchised based business. These declines were mostly offset bycomparable store sales growth of 10.1% and incremental sales of $21.4 millionresulting from the acquisition of Salon Success, an increase in sales of nonL’Oreal brands and the

 

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addition of 46 new stores over the last 12 months(excluding acquisitions) and the effect of exchange rates. The effect ofexchange rates contributed approximately $3.7 million or an increase in salesof approximately 0.4%.

 

### *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.

 

### *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.

 

### *Other 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 theseparation agreement from Alberto-Culver, of approximately $20.0 million, aswell as severance payments to Mr. Robinson, our former Chief Financial Officerand Treasurer, 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 $55.5million, or 30.8%, to $235.7 million for fiscal year 2007 compared to $180.2million for the same period in 2006. Operating earnings, as a percentage of netsales, were 9.4% for fiscal year 2007 compared to 7.6% for the same period in2006. The increase 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.

 

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*Sally Beauty Supply*. Sally Beauty Supply’s segment operating earnings increased $38.0 million, or16.1%, to $273.4 million for fiscal year 2007 compared to $235.4 million forthe same period in 2006. Segment operating earnings, as a percentage of netsales, was 17.4% for fiscal year 2007 compared to 16.6% for the same period in2006. Sally Beauty Supply operating earnings were positively impacted byadditional earnings from the Salon Services acquisition, growth in the numberof stores, same store sales increases along with sales growth in certainmerchandise categories, operating expense controls, as well as a gross marginimprovement. Operating earnings margins improvements at our Sally Beauty SupplyU.S. based business were partially offset by a greater weighing ofinternational based earnings that typically carry lower operating earningsmargins.

 

*Beauty Systems Group*. BSG’s segment operating earnings decreased $23.8 million, or 26.9%, to $64.6million 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’s franchise-basedbusiness also experienced a decline in profitability for fiscal year 2007.Segment operating earnings, as a percentage of net sales, was 6.8% for fiscalyear 2007 compared to 9.3% for the same period in 2006.

 

### *Net Interest Expense*

###  

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.

 

### *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 the resultof lower earnings before provision for income taxes due to increased interestexpense. The effective tax rate was 45.9% in fiscal year 2007 and 38.8% infiscal year 2006. The increase in the effective tax rate was primarily relatedto nondeductible transaction costs related to the Separation Transactions.

 

### *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.

 

##### ***Comparison ofFiscal Years Ended September 30, 2006 and 2005***

##### *** ***

### *Net Sales*

###  

Consolidated net sales increased $118.8 million,or 5.3%, to $2,373.1 million for fiscal year 2006 compared to$2,254.3 million for the same period in 2005. This increase was primarilythe result of comparable store sales growth of 2.8%, the inclusion of a fullreporting period for CosmoProf for fiscal year 2006 which resulted in a 1.1%increase in net sales, the acquisition of Salon Success, which resulted in a0.5% increase in net sales and the opening of new stores, including 98 netnew stores opened during fiscal year 2006. CosmoProf was acquired in the first quarter of fiscal year 2005and Salon Success was acquired during the third quarter of fiscal year 2006.

 

*Sally Beauty Supply.*  Netsales for Sally Beauty Supply increased $60.4 million, or 4.4%, to$1,419.3 million for fiscal year 2006 compared to $1,358.9 millionfor the same period in 2005. Net sales increased primarily due to a 2.3% increaseresulting from the opening of new stores, including 92 net new storesopened during fiscal year 2006, and comparable store sales growth of 2.4%.These increases were partially offset by the effect of foreign exchange rates,which decreased net sales by 0.2%.

 

*Beauty Systems Group.*  Netsales for BSG increased $58.4 million, or 6.5%, to $953.8 million forfiscal year 2006 compared to $895.4 million for the same period in 2005.This improvement in net sales resulted primarily from the inclusion of a fullreporting period for CosmoProf for fiscal year 2006, which provided 2.8% of theincrease in net sales and the acquisition of Salon Success

 

40

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which provided 1.0% increase in net sales. Theremaining increase was principally due to a 0.6% increase in net salesresulting from the opening of new stores, including 6 net new storesopened during fiscal year 2006 (including franchised stores), comparable storesales growth of 4.1% and a 0.7% positive impact from foreign exchange rates.These increases for fiscal year 2006 were partially offset by lower sales byBSG’s professional distributor sales consultants as salon professionals shiftedsome of their purchases from sales consultants to BSG stores.

 

### *Gross Profit*

###  

Consolidated gross profit increased$59.8 million, or 5.8%, to $1,086.8 million for fiscal year 2006compared to $1,027.0 million for the same period in 2005. Consolidatedgross profit, as a percentage of net sales, was 45.8% for the year ended September 30,2006 compared to 45.6% for the prior year period. The gross profit marginimprovement is primarily attributable to improved vendor pricing, an increasein the percentage of sales made to retail customers (since such sales are at ahigher gross profit margin than those made to salons and salon professionals)and with an increase in sales of exclusive label products.

 

### *Selling, General and Administrative Expenses*

###  

Consolidated selling, general and administrativeexpenses increased $29.4 million, or 3.8%, to $798.2 million forfiscal year 2006 compared to $768.8 million for the same period in 2005.These expenses, as a percentage of net sales, were 33.6% for fiscal year 2006compared to 34.1% for the prior year period. The increase in expense isprimarily attributable to selling and administrative costs associated with thegrowth of the Sally Beauty Supply and BSG businesses, including$9.0 million of selling and administrative costs from the acquiredCosmoProf business and $3.3 million of costs from Salon Success, alongwith $5.2 million of stock option expense recognized pursuant toSFAS 123(R) and costs related to our corporate support facility.

 

### *Depreciation and Amortization*

###  

Consolidated depreciation and amortization increased$4.1 million, or 12.1%, to $38.0 million for fiscal year 2006 compared to $33.9million for the same period in 2005, 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 increased to $28.9 million for fiscal year 2006 from $27.6million for fiscal year 2005, which is consistent with the increase in netsales. The consulting, business development and advisory services agreementbetween certain of our subsidiaries and Alberto-Culver was subsequentlycancelled in fiscal year 2007 in connection with the Separation Transactions.

 

### *Other Expenses*

###  

Other expenses for fiscal year 2006 include expensesrelated to the terminated transaction with Regis. In accordance with the termsof the related transaction agreement, Alberto-Culver allocated to our business$41.5 million in expenses for fiscal year 2006 representing our share ofthe termination fee paid to Regis as well as legal and other professional feesand expenses related to the transaction. Other expenses for fiscal year 2005include $4.1 million in non-cash charges related to Alberto-Culver’sconversion to one class of common stock.

 

### *Operating Earnings*

###  

Consolidated operating earnings decreased by$12.4 million, or 6.4%, to $180.2 million for fiscal year 2006compared to $192.6 million for the same period in 2005. Operating earnings, asa percentage of net sales, were 7.6% for fiscal year 2006 compared to 8.5% forthe same period in 2005. The decrease in consolidated operating earnings wasprimarily due to the allocation to our business by Alberto-Culver of$41.5 million of expenses related to the terminated Regis transaction. Wedo not allocate these expenses to our operating segments and these expenses arenot reflected in the segment operating profit of Sally Beauty Supply and BSGdiscussed below.

 

*Sally Beauty Supply.*  Asa result of the foregoing, Sally Beauty Supply’s segment operating profitincreased $12.7 million, or 5.7%, to $235.4 million for fiscal year2006 compared to $222.7 million for the same period in 2005. Segmentoperating profit, as a percentage of net sales, was 16.6% for fiscal year 2006compared to 16.4% for the same period in 2005.

 

*Beauty Systems Group.*  Asa result of the foregoing, BSG’s segment operating profit increased$17.2 million, or 24.2%, to $88.4 million for fiscal year 2006compared to $71.2 million for the same period in 2005. Segment operatingprofit, as a percentage of net sales, was 9.3% for fiscal year 2006 compared to8.0% to the same period in 2005.

 

41

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### *Net Interest Expense*

###  

Interest expense, net of interest income, was$0.1 million and $3.0 million for fiscal years 2006 and 2005,respectively. Interest expense decreased $2.2 million to $1.9 millionfor fiscal year 2006 compared to $4.1 million for the same period in 2005.The decrease in interest expense was primarily attributable to the repayment ofall notes payable to affiliated companies in December 2005. These expenses werepartially offset by interest income of $1.8 million and $1.1 millionfor fiscal years 2006 and 2005, respectively.

 

### *Provision for Income Taxes*

###  

Provision for income taxes was $69.9 millionduring fiscal year 2006 compared to $73.1 million for the same period of2005. The decreased provision for income taxes for fiscal year 2006 wasprincipally the result of lower earnings before provision for income taxes. Theeffective tax rate was 38.8% in fiscal year 2006 and 38.6% in fiscal year 2005.The increase in the effective tax rate was primarily related to a change in themix of earnings from foreign operations and higher state income taxes.

 

### *Net Earnings*

###  

As a result of the foregoing, consolidated netearnings decreased $6.3 million, or 5.4%, to $110.2 million forfiscal year 2006 compared to $116.5 million for the same period in 2005.Net earnings, as a percentage of net sales, were 4.6% for fiscal year 2006compared to 5.2% for fiscal year 2005. Net earnings for fiscal year 2006 wereimpacted by expenses related to the terminated spin/merge transaction withRegis and share-based compensation expense recognized pursuant toSFAS 123(R). Net earnings for fiscal year 2005 were impacted by the non-cashcharge from Alberto-Culver’s conversion to one class of common stock and anadjustment related to lease accounting.

 

## **FinancialCondition**

 

##### ***September 30,2007 Compared to September 30, 2006***

 

Working capital (current assets less currentliabilities) at September 30, 2007 was $341.9 million compared to $479.1million at September 30, 2006, representing a decrease of $137.2 million. Theresulting ratio of current assets to current liabilities was 1.92 to 1.00 atSeptember 30, 2007 compared to 2.65 to 1.00 at September 30, 2006. The decreasein current assets at September 30, 2007 was primarily impacted by a $69.3million reduction in cash, which was primarily attributable to the payment offees associated with the Separation Transactions, distributions to Alberto-Culvermade in connection with the Separation Transactions and a $5.6 million declinein inventory levels, partially offset by an increase in trade accountsreceivable, the prepayment of certain expenses and deferred income tax assets.The increase in current liabilities at September 30, 2007 was primarilyimpacted by the addition of the current maturities of long-term debt, which wasincurred in connection with the Separation Transactions, of approximately $17.1million, and accrued interest thereon of $34.5 million. In addition, we had anincrease in accrued operating expenses and income taxes. A reduction in workingcapital is part of our business strategy to minimize the amount of capitalemployed in the business while maximizing the related operating profits.

 

Net property and equipment increased $11.4 million to$154.1 million at September 30, 2007, compared to $142.7 millionat September 30, 2006. Of this increase, approximately $4.2 million wasattributable to acquisitions, with the remainder due primarily to the openingof new stores and remodeling of existing facilities.

 

Goodwill increased $41.9 million to$406.6 million at September 30, 2007, compared to $364.7 millionat September 30, 2006, primarily due to the acquisition of Salon Servicesand the effects of changes in foreign exchange rates.

 

Intangible assets increased $17.3 million to$70.5 million at September 30, 2007, compared to $53.2 millionat September 30, 2006, primarily due to the acquisition of Salon Services.

 

Other assets increased $53.2 million to $61.1 millionat September 30, 2007, compared to $7.9 million at September 30, 2006,primarily due to the costs associated with the issuance of debt, which will beamortized as interest expense over the term of the debt.

 

Accrued expenses increased $39.6 million to $153.7million at September 30, 2007, compared to $114.1 million at September 30,2006. This increase was primarily a result of $34.5 million of interest expenserelated to the new debt incurred in connection with the SeparationTransactions, and an increase in operating expenses and legal and otherprofessional fees.

 

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Deferred income tax liabilities increased $9.0 millionto $30.6 million at September 30, 2007, compared to $21.6 million at September30, 2006. This increase was primarily due to differences between depreciationincluded for tax returns versus depreciation included in our statements ofearnings, and purchase accounting adjustments.

 

Stock options subject to redemption declined to $6.5million at September 30, 2007, compared to $7.5 million as ofSeptember 30, 2006, primarily due to exercises of these options.

 

At September 30, 2007, we had a member’s deficit as aresult of distributions to Sally Beauty and Alberto-Culver, which werepartially offset by the conversion of stockholder’s equity to member’s equityin connection with the Separation Transactions. We used proceeds from theissuance of debt to make a cash distribution of approximately $1,809.7 million toSally Beauty. We made a distribution of approximately $44.4 to Alberto-Culveras a result of the settlement of the inter-company agreements.

 

Accumulated other comprehensive income—foreigncurrency translation increased $18.2 million to $34.5 million atSeptember 30, 2007, compared to $16.3 million at September 30,2006. The increase was primarily due to the weakening of the U.S. dollarversus certain foreign currencies, primarily the British pound and Canadiandollar.

 

## **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 in connectionwith the Separation Transactions and from funding the costs of operations,working capital and capital expenditures. As a holding company, we depend onour subsidiaries to distribute funds to us so that we may pay our obligationsand expenses. The ability of our subsidiaries to make such distributions willbe subject to their operating results, cash requirements and financialcondition. In addition, under Delaware law, the ability of our subsidiaries tomake distributions to us will be limited to the extent: (i) of their surplus,or if there is no surplus, of its net earnings for the fiscal year in which thedistribution is declared and/or the preceding fiscal year, if such subsidiaryis a corporation; or (ii) the fair value of their assets exceeds its liabilities,in the case of a subsidiary that is a limited liability company. See “RiskFactors—Risks Relating to Our Business, and —Risks Relating to Our SubstantialIndebtedness.”

 

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 the 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, restrictions onSally Beauty’s ability to issue public or private equity for at least two yearsafter the Separation Transactions, increases in competitive activity, the lossof key suppliers, rising interest rates, the loss of key personnel, the abilityto execute our business strategy and general economic conditions. See “RiskFactors.”

 

##### ***HistoricalCash Flow***

 

Our primary source of cash has been from fundsprovided by operating activities and, for fiscal year 2007, from borrowings.The primary uses of cash during the past three years were for acquisitions andcapital expenditures and, for fiscal year 2007, for the cash distribution paidin connection with the Separation Transactions. The following table shows oursources and uses of funds for the fiscal years ended September 30, 2007,2006 and 2005 (in thousands):

 

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| ** **                                            | ** ** | **Year Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                            | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Cash provided by operating activities                 |       | $                                           | 194,267    |   | $ | 156,721 |   | $ | 115,455 |   |
| Cash used by investing activities                     |       | (121,364                                    | )          | (52,158 | ) | (126,045 | ) |
| Cash provided (used) by financing  activities         |       | (143,814                                    | )          | (32,205 | ) | 3,737 |   |
| Effect of foreign exchange rates                      |       | 1,612                                       |       | (3,399 | ) | 12 |   |
| Net increase (decrease) in cash and cash  equivalents |       | $                                           | (69,299    | ) | $ | 68,959 |   | $ | (6,841 | ) |

 

### *Cash Provided by Operating Activities*

 

Net cash provided by operating activities duringfiscal year 2007 increased by $37.6 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.

 

Net cash provided by operating activities duringfiscal year 2006 increased by $41.2 million to $156.7 million,compared to $115.5 million during fiscal year 2005. The increase wasprimarily due to the timing of payments of amounts due to Alberto-Culver and tovendors and improved collections of other receivable balances, partially offsetby lower net earnings adjusted for non-cash items and for increased amountspaid for inventories.

 

### *Cash Used by Investing Activities*

###  

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 is $7.6 million paid toexercise an operating lease purchase option of a warehouse building that wassubsequently sold for $8.0 million, which proceeds are included in the proceedsfrom sale of property and equipment.

 

Net cash used by investing activities during fiscalyear 2006 decreased by $73.8 million to $52.2 million, compared to$126.0 million in fiscal year 2005, primarily due to lower cashacquisition costs and capital expenditures in fiscal year 2006. Cash used forthe acquisition of Salon Success during fiscal year 2006 was substantially lessthan the cash used for the acquisition of CosmoProf in the prior year period.Capital expenditures were $30.3 million for fiscal year 2006 compared to$52.2 million during the prior year period with the higher amount in 2005principally related to the new corporate support facility in Denton, Texas.

 

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

###  

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 toSally Beauty and Alberto-Culver in connection with the Separation Transactions,which were partially offset by the net proceeds from the issuance of debt.

 

Net cash used by financing activities was$32.2 million during fiscal year 2006 compared to net cash provided byfinancing activities of $3.7 million during fiscal year 2005. Net cashprovided (used) by financing activities was negatively impacted in fiscal year2006 by the net repayment of $16.7 million of notes with affiliatedcompanies and the change in the book cash overdraft balance. For fiscal year2005, we borrowed $52.3 million from affiliated companies, which wasoffset by repayments of $52.1 million, and $40.0 million underAlberto-Culver’s revolving credit facility, which was offset by repayments of$40.0 million.

 

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

 

In connection with the Separation Transactions, we:(i) entered into the Term Loans in an aggregate amount of $1,070.0million; (ii) issued senior notes in an aggregate amount of $430.0 million andsenior subordinated notes in an aggregate amount of $280.0 million (the Notes);and (iii) entered into the $400.0 million ABL facility, subject toborrowing base limitations, of which approximately $70.0 million was drawn atclosing, which resulted in the incurrence of aggregate indebtedness in connectionwith the Separation Transactions of approximately $1,850.0 million. Proceedsfrom this new debt and the $575.0 million equity investment in SallyBeauty by the CDR Investors were used to pay a $25.00 per share cash dividendto holders of record of Alberto-Culver shares as of the record date for theSeparation Transactions. See “Risk Factors—Risks Relating to Our SubstantialIndebtedness.”

 

As of September 30, 2007, there were outstandingborrowings of $1,053.3 million under the Term Loans, at a weighted averageinterest rate of 8.0%, and outstanding borrowings of $710.0 million under theNotes, at a weighted average interest rate of 9.75%. In addition, we had $11.4million outstanding borrowings under our ABL facility. As of September 30,2007, we had $334.6 million

 

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available for additional borrowings under our ABLfacility, subject to borrowing base limitations, as reduced by outstandingletters 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 ourassets

•                  transactions with affiliates

•                  ability to pay dividends

 

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 is 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 ratio is met and 100% of theproceeds of specified asset sales that are not reinvested in the business orapplied to repay borrowings 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 5.25 for the four quarter periodending September 30, 2007. The consolidated secured leverage ratio is a ratioof (A) net consolidated secured debt to (B) Consolidated EBITDA as defined inthe agreement underlying 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 when availability under the ABL facility falls below $40.0 million. Thefixed-charge coverage ratio is defined as the ratio of (A) EBITDA (as definedin the agreement underlying the ABL facility, or Credit Agreement EBITDA), lessunfinanced capital expenditures to (B) fixed charges (as included in thedefinition of the fixed-charge coverage ratio in the agreement governing theABL facility). The ABL facility uses fixed amounts for Credit Agreement EBITDAfor periods preceding the Separation Transactions.

 

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 such a default could also result in adefault under the other facility or facilities, as the case may be, and theNotes. 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.

 

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. See “RiskFactors—Risks Relating to Our Substantial Indebtedness.”

 

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##### ***CapitalRequirements***

##### *** ***

For fiscal year 2008, we anticipate total capitalexpenditures of approximately $60.0 million. Capital expenditures will beprimarily for the addition of new stores, our BSG distribution project, theremodel, expansion or relocation of existing facilities and various corporateprojects.

 

## **ContractualObligations**

##  

The following table is a summary of our contractualcash obligations and commitments outstanding by future payment dates atSeptember 30, 2007 (dollars in thousands):

 

| ** **                                         | ** ** | **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) |       | $                                         | 174,607    |   | $ | 355,672 |   | $ | 426,633 |   | $ | 1,858,891 |   | $ | 2,815,803 |   |
| Operating leases(b)                                |       | 110,561                                   |       | 169,323 |   | 92,863 |   | 56,881 |   | 429,628 |   |
| Purchase obligations(c)                            |       | 34,629                                    |       | 68,274 |   | 58,858 |   | 1,684 |   | 163,445 |   |
| Other long-term obligations(d)                     |       | 5,092                                     |       | 7,781 |   | 2,284 |   | 1,411 |   | 16,568 |   |
| Total                                              |       | $                                         | 324,889    |   | $ | 601,050 |   | $ | 580,638 |   | $ | 1,918,867 |   | $ | 3,425,444 |   |

 

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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, 2007.                                                                                                                                                             |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                         |
| (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. See Note 12 of the “Notes toConsolidated Financial Statements” in “Item 8—Financial Statements andSupplementary Data” of this report and “Item 7A—Quantitative and QualitativeDisclosures about Market Risk—Interest rate risk” for a discussion of interestrate 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, 2007 and 2006, we had nooff-balance sheet financing arrangements other than operating leases incurredin the ordinary course of business, as well as outstanding letters of creditrelated to inventory purchases and self-insurance programs, which totaled $9.4million and $3.0 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

 

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statements. Actual results may differ from theseestimates. We believe these estimates and assumptions are reasonable. Weconsider accounting policies to be critical when they require us to makeassumptions about matters that are highly uncertain at the time the accountingestimate is made and when different estimates that our management reasonablycould have used have a material effect on the presentation of our financialcondition, changes in financial condition or results of operations.

 

Our critical accounting policies relate to thevaluation of inventories, vendor allowances, retention of risk, income taxes,share-based payments and related party transactions.

 

##### ***Valuation ofInventories***

##### *** ***

When necessary, we provide allowances to adjust thecarrying value of inventories to the lower of cost or market, including coststo sell or dispose, and for estimated inventory shrinkage. Inventories arestated at the lower of cost (first-in, first-out method) or market (netrealizable value). Estimates of the future demand for our products, age of theinventory and changes in stock keeping units are some of the key factors usedby our management in assessing the net realizable value of inventories. Weestimate inventory shrinkage based on historical experience. Actual resultsdiffering from these estimates could significantly affect our inventories andcost of products sold and distribution expenses.

 

##### ***VendorAllowances***

##### *** ***

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 ofRisk***

##### *** ***

### *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 ofSeptember 30, 2007, we have accrued an estimated liability relating to employeehealth insurance of approximately $6.1 million. Prior to the SeparationTransactions, our employees were covered by healthcare plans provided byAlberto-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 the liability. This liability could be significantly affected ifactual 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 ofSeptember 30, 2007, our balance sheet included an estimated liability relatedto the deductible and retention limits of approximately $10.7 million. Prior tothe Separation Transactions, we were covered by the workers’ compensation,general liability and automobile and property liability plans provided byAlberto-Culver.

 

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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 factors such as claims incidence and severity of injury or damages. Theliabilities could be significantly affected if actual results differ frommanagement’s expectations.

 

##### ***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 have beenestablished 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 results of future operations will generate sufficient taxableincome to realize our deferred tax assets, net of the valuation allowancecurrently recorded. In the future, if we determine that certain deferred taxassets will not be realizable, the related adjustments could significantlyaffect our effective tax rate at that time.

 

##### ***Share-BasedPayments***

##### *** ***

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.

 

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 its 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, 2007. Our estimates for futureperiods may be based on different assumptions and accordingly may differ.

 

##### ***Related PartyTransactions***

##### *** ***

On January 1, 2007, we entered into an agreement withSally 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, Sally Beauty.See Note 16 of the “Notes to Consolidated Financial Statements” in“Item 8—Financial Statements and Supplementary Data” of this report forfurther information.

 

## **RecentAccounting Pronouncements**

##  

In February 2007, the Financial Accounting StandardsBoard, or FASB, issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities – including an amendment of FASBStatement No. 115*, or SFAS 159. SFAS 159 permits entities to chooseto measure many financial instruments and certain other items at fair valuethat are not currently required to be measured at fair value, with unrealizedgains and losses related to these financial instruments reported in earnings ateach subsequent reporting date. SFAS 159 is effective in fiscal years beginningafter November 15, 2007. We are currently assessing the effect of thispronouncement on our consolidated financial statements.

 

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In September 2006, the FASB issuedSFAS No. 157, *Fair Value Measurements*,or SFAS 157, which defines fair value, establishes a framework for measuringfair value in generally accepted accounting principles, and expands disclosuresabout fair value measurements. SFAS 157 is effective in fiscal yearsbeginning after November 15, 2007. We are currently assessing the effectof this pronouncement on our consolidated financial statements.

 

In September 2006, the SEC issued Staff AccountingBulletin No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying the Misstatements in Current YearFinancial Statements*, or SAB 108, which provides interpretiveguidance on how the effects of the carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.We implemented the provisions of SAB 108 during the first quarter of fiscalyear 2007 and it did not have a material impact on our consolidated financialposition, statements of earnings or cash flows.

 

In July 2006, the FASB issued FASB InterpretationNo. 48, *Accounting for Uncertainty in Income Taxes,an interpretation of FASB Statement No. 109*, or FIN 48.FIN 48 clarifies the accounting for the uncertainty in income taxesrecognized by prescribing a recognition threshold that a tax position isrequired to meet before being recognized in the financial statements. It alsoprovides guidance on derecognition, classification, interest and penalties,interim period accounting and disclosure. FIN 48 is effective for fiscalyears beginning after December 15, 2006. We do not expect the adoption ofFIN 48 to have a material impact on our consolidated financial position,statements of earnings or cash flows.

 

# **ITEM 7A. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT 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 2007, approximately 16% of our sales were made in currencies other thanthe U.S. dollar. Fluctuations in U.S. dollar exchange rates within therange of the rates for fiscal years 2007, 2006 and 2005 did not have a materialeffect on our financial condition and results of operations. We do not usederivative financial instruments 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 and theABL facility as of September 30, 2007, a change in the estimated interest rateup or down by 1/8% will increase or decrease earnings before provision forincome taxes by approximately $1.3 million on an annual basis, withoutconsidering the effect of any interest rate swap agreements we may have fromtime 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, the agreement underlying our Term Loans requirethat we hedge a portion of our floating interest rate exposure for a specifiedperiod.

 

On November 24, 2006, we entered into two interestrate swap agreements with a notional amount of $150.0 million and $350.0million, respectively. These agreements expire on November 24, 2008 and 2009,respectively. The agreements allow us to convert a portion of our variable rateinterest to a fixed rate of 4.9975% plus (2.00% to 2.50%) and 4.94% plus (2.00%to 2.50%), respectively. As discussed in “Risk Factors” herein, changes in thefair value of these interest rate swap agreements driven by interest ratechanges will increase or decrease our net interest expense and may thereforeaffect our earnings.

 

49

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## **Creditrisk**

##  

We are exposed to credit risk on certain assets,primarily cash equivalents, short-term investments and accounts receivable. Thecredit risk associated with cash equivalents and short-term investments ismitigated by our policy of investing in a diversified portfolio of securitieswith high credit ratings.

 

We provide credit to customers in the ordinary courseof business and perform ongoing credit evaluations. Our exposure toconcentrations of credit risk with respect to trade receivables is mitigated byour broad customer base. We believe our allowance for doubtful accounts issufficient to cover customer credit risks.

 

50

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

 

See “Index to Financial Statements” which is locatedon page 61 of this report.

 

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

 

None.

 

# **ITEM 9A. CONTROLSAND PROCEDURES**

 

*Background.*Attached as exhibitsto this Form 10-K are certifications of our Chief Executive Officer (“CEO”) andChief Financial Officer (“CFO”), which are required in accordance with Rule13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).This “Controls and Procedures” section includes information concerning thecontrols and controls evaluation referred to in the certifications. Part II,“Item 8—Financial Statements and Supplementary Data” of this Annual Report onForm 10-K sets forth the attestation report of KPMG LLP, our independentregistered public accounting firm, regarding its audit of our internal controlover financial reporting and of management’s assessment of internal controlover financial reporting set forth below in this section. This section shouldbe read in conjunction with the certifications and the KPMG attestation reportfor a 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 report. The controls evaluation was conductedby our Disclosure Committee, comprised of senior representatives from our finance,accounting, internal audit, and legal departments under the supervision of ourCEO 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 report. This “Controls and Procedures” section includes theinformation 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 report. In the course of the evaluation, we sought to identify whetherwe had any data errors, control problems or acts of fraud and to confirm thatappropriate corrective action, including process improvements, was beingundertaken if needed. This type of evaluation is performed on a quarterly basisso that conclusions concerning the effectiveness of our disclosure controls andprocedures can be reported in our Quarterly Reports on Form 10-Q and ourAnnual Reports on Form 10-K. Many of the components of our disclosurecontrols and procedures are also evaluated by our internal audit department,our legal department and by personnel in our finance organization. The overallgoals of these various evaluation activities are to monitor our disclosurecontrols and procedures on an ongoing basis, and to maintain them as dynamicsystems 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 ofSeptember 30, 2007, we maintain disclosure controls and procedures thatare effective in providing reasonable assurance that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission (“SEC”) rules and forms, and thatsuch information is accumulated and communicated to our management, includingour CEO and CFO, as appropriate to allow timely decisions regarding requireddisclosure.

 

51

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*Management’s Annual Reporton Internal Control over Financial Reporting and Attestation Report of PublicAccounting Firm.*

 

 This annualreport does not include a report of management’s assessment regarding internalcontrol over financial reporting or an attestation report of our registeredpublic accounting firm due to a transition period established by the rules ofthe SEC for newly public companies.

 

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

 

# **ITEM 9B. OTHERINFORMATION**

 

None.

 

52

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###### **PART III**

###### ** **

# **ITEM 10. DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

 

Omitted pursuant to General Instruction I to Form10-K.

 

# **ITEM 11. EXECUTIVECOMPENSATION**

 

Omitted pursuant to General Instruction I to Form10-K.

 

# **ITEM 12. SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

Omitted pursuant to General Instruction I to Form10-K.

 

# **ITEM 13. CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

Omitted pursuant to General Instruction I to Form10-K.

 

# **ITEM 14. PRINCIPALACCOUNTANT FEES AND SERVICES**

 

## **Pre-ApprovalPolicies and Procedures**

 

The Audit Committee of the Board of Directors of SallyBeauty is responsible for the appointment, compensation and oversight of thework of our independent public accountant. The Audit Committee has reviewed thenon-audit services provided by KPMG and determined that the provision of theseservices during fiscal year 2007 is compatible with maintaining KPMG’sindependence.

 

*Pre-ApprovalPolicy.*Since the May6, 2003 effective date of the SEC rules stating that an auditor is notindependent of an audit client if the services it provides to the client arenot appropriately approved, each new engagement of KPMG through November 16,2006 was approved in advance by Alberto-Culver’s Audit Committee. From andafter November 16, 2006, the Audit Committee approved all audit and permissiblenon-audit fees during fiscal year 2007.

 

The Audit Committee has the sole and direct authorityto engage, appoint and replace our independent auditors. In addition, the AuditCommittee has established an Audit and Non-Audit Services Pre-Approval Policy,whereby every engagement of KPMG to perform audit or permissible non-auditservices on behalf of Sally Beauty, us or any of our subsidiaries requirespre-approval from the Audit Committee or its designee before KPMG is engaged toprovide those services. Pursuant to that policy, we expect that on an annualbasis, the Audit Committee will review and provide pre-approval for certaintypes of services that may be rendered by the independent auditors, togetherwith a budget for the applicable fiscal year. The pre-approval policy alsorequires the pre-approval of any fees that are in excess of the amount budgetedby the Audit Committee. The pre-approval policy contains a provision delegatinglimited pre-approval authority to the chairman of the Audit Committee ininstances when pre-approval is needed prior to a scheduled Audit Committeemeeting. The chairman of the Audit Committee would be required to report onsuch pre-approvals at the next scheduled Audit Committee meeting. As a result,the Audit Committee or its designee approved 100% of all services performed byKPMG on behalf of Sally Beauty, us or any of our subsidiaries subsequent toNovember 16, 2006, the date that Sally Beauty became a public company

 

## **FeesPaid to KPMG**

 

The fees billed by KPMG for benefit of the Company orbilled to Alberto-Culver for benefit of Sally Holdings, Inc. with respect tothe years ended September 30, 2007 and September 30, 2006 were as follows:

 

53

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| ** **            | ** ** | **Year Ended September 30,** | ** ** |
|-----------------------|------------|---------------------------------------------|------------|
| ** **            | ** ** | **2007**                                    | ** ** | **2006** | ** ** |
| Audit Fees(1)         |       | $                                           | 2,179,000  |   | $ | 864,000 |   |
| Audit-Related Fees(2) |       | 87,500                                      |       | — |   |
| Tax Fees(3)           |       | 23,636                                      |       | 355,000 |   |
| All Other Fees        |       | —                                      |       | — |   |
| Total Fees(4)         |       | $                                           | 2,290,136  |   | $ | 1,219,000 |   |

 

----

(1)          Aggregate fees billed for professional services for the audit of annualfinancial statements as well as accounting and reporting advisory servicesrelated to regulatory filings and acquisition activities.

 

(2)  Audit-related fees consist of fees for auditsof Sally Beauty’s employee benefit plans.

 

(3)          Tax fees consist of fees for tax consultation and tax complianceservices.

 

(4)          The Audit Committee pre-approved all fees.

 

54

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

 

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

 

Documents filed as part of this report:

 

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

 

See “Index to Financial Statements” which is locatedon page 61 of this report.

 

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

 

The following exhibits arefiled as part of this report or are incorporated herein by reference:

 

**Exhibits (numberedin accordance with Item 601 of****Regulation S-K)**

 
| **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. 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. filed on October 30, 2006                                                                                                                                                                   |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 2.7             |       | Agreement  for the sale and purchase of the entire issued share capital of Chapelton 21  Limited, a private company incorporated in Scotland, dated as of February 15,  2007 by and among Ogee Limited, a company incorporated under the laws of  England and Wales and an indirect wholly-owned subsidiary of Sally Beauty  Holdings, Inc., and the shareholders named therein, which is incorporated by  reference from Exhibit 2.7 to the Quarterly Report on Form 10-Q of Sally  Beauty Holdings, Inc. filed May 10, 2007 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 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                                                                                                                                                                                                                                                                                   |

 

55

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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 Sally Beauty  Holdings, Inc., 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 Sally Beauty Holdings, Inc. 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-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.9    |   | Credit  Agreement, dated November 16, 2006, with respect to a Term Loan  Facility, by and among Sally Holdings LLC, the several lenders from time to  time parties thereto, and Merrill Lynch Capital Corporation, as  Administrative Agent and Collateral Agent, which is incorporated 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 Sally  Beauty 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  and Consulting Agreement, dated as of June 19, 2006, among Michael H.  Renzulli, Alberto-Culver Company and Sally Holdings, Inc., which is  incorporated by reference from Exhibit 10.2 to the Current Report on  Form 8-K of Sally Beauty Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.10  |   | 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                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.11  |   | 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                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.12  |   | Form  of Severance Agreement for Executive Officers (Gary G. Winterhalter, Michael  G. Spinozzi, John R. Golliher, Neil B. Riemer, W. Richard Dowd, Bennie L.  Lowery, Raal H. Roos), which is incorporated by reference from  Exhibit 10.1 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.13  |   | 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                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.14  |   | Form  of Termination Agreement for Executive Officers (Gary T. Robinson, W. Richard  Dowd, Bennie L. Lowery, Raal H. Roos) which is incorporated by reference from  Exhibit 10.14 to the Annual Report on Form 10-K of Sally Beauty Holdings,  Inc. filed December 22, 2006                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.15  |   | Severance  Letter, dated as May 25, 2006, from Sally Beauty Company, Inc. to  Michael G. Spinozzi, which is incorporated by reference from Exhibit 10.10 to  the Annual Report on Form 10-K of Sally Beauty Holdings, Inc. filed on  December 22, 2006                                                                                                                                                                                                                                                                                                                                   |

 

57

----

 
| 10.16     |   | Director  and Officer Indemnification Agreement, dated as of January 15, 2007, between  Sally Beauty Holdings, Inc. and David L. Rea, 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 16, 2007                                                   |
|-----------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.17     |   | Letter  Agreement, dated as of January 9, 2007, between Sally Beauty Holdings,  Inc. and David L. Rea, which is incorporated by reference from Exhibit 10.2  to the Current Report on Form 8-K of Sally Beauty Holdings, Inc. filed  on January 16, 2007                                                                                  |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.18     |   | 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                                                                                                                             |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.19     |   | 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                                                                                                  |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.20     |   | 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                                                                                   |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.21     |   | 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, 2007                                                                                                           |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.22     |   | Alberto-Culver  Company 1994 Shareholder Value Incentive Plan, as amended, which is  incorporated by reference from Exhibit 10.19 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                                                                                   |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.23     |   | Alberto-Culver  Company Management Incentive Plan, which is incorporated by reference from  Exhibit 10.20 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                                                                                                            |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.24     |   | Sally  Beauty Holdings, Inc. Annual Incentive Plan, which is incorporated by  reference from Exhibit 10.21 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                                                                                                          |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.25     |   | 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                                                                                                                                            |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.26     |   | 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                                                                      |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.27     |   | 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                                                                                     |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.28     |   | 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                                                             |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.29     |   | 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                                                                              |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.30     |   | Statement  relating to relocation payments to John R. Golliher, President of Beauty  Systems Group LLC incorporated by reference from Exhibit 10.13 to the  Quarterly Report on Form 10-Q of Sally Beauty Holdings, Inc. filed on August  9, 2007                                                                                                        |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.31     |   | 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*                                                                                                                                                                                                                                                                                                                                        |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 31.1-31.2 |   | Rule 13(a)-14(a)/15(d)-14(a)  Certifications*                                                                                                                                                                                                                                                                                                       |
|      |   |                                                                                                                                                                                                                                                                                                                                                     |
| 32.1-32.2 |   | Section 1350  Certifications*                                                                                                                                                                                                                                                                                                                       |

 

----

*Included herewith

 

PLEASE NOTE:It is inappropriate for investors to assume the accuracy of any covenants,representations or warranties that may be contained in agreements or otherdocuments filed as exhibits to this Annual Report 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 therepresentations and warranties may not be complete or accurate as of aparticular date because they are subject to a contractual standard ofmateriality that is different from those generally applicable to stockholders and/orwere used for the purpose of allocating risk among the parties rather thanestablishing certain matters as facts. Accordingly, you should not rely on therepresentations and warranties as characterizations of the actual state offacts at the time they were made or otherwise.

 

58

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized, on the 7th day of December, 2007.

 
| 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/  DAVID L. REA |   |
|                | David L. Rea |
|                | Senior Vice President and  Chief Financial Officer |
|                | (Principal Financial  Officer) |
|                |   |   |
|                | By: | /s/  MARK J. FLAHERTY |   |
|                | Mark J. Flaherty |
|                | 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 Beauty Holdings, Inc.* |       | December 7, 2007 |
| James G. Berges                          |       |                                                                |       |             |
| /s/  Kathleen J.  Affeldt      |       | Director of Sally Beauty  Holdings, Inc.*                           |       | December 7, 2007 |
| Kathleen J. Affeldt                      |       |                                                                |       |             |
| /s/  Marshall E.  Eisenberg    |       | Director of Sally Beauty  Holdings, Inc.*                           |       | December 7, 2007 |
| Marshall E. Eisenberg                    |       |                                                                |       |             |
| /s/  Donald J.  Gogel          |       | Director of Sally Beauty  Holdings, Inc.*                           |       | December 7, 2007 |
| Donald J. Gogel                          |       |                                                                |       |             |
| /s/  Robert R.  McMaster       |       | Director of Sally Beauty  Holdings, Inc.*                           |       | December 7, 2007 |
| Robert R. McMaster                       |       |                                                                |       |             |
| /s/  Walter  Metcalfe          |       | Director of Sally Beauty  Holdings, Inc.*                           |       | December 7, 2007 |
| Walter Metcalfe                          |       |                                                                |       |             |
| /s/  John A.  Miller           |       | Director of Sally Beauty  Holdings, Inc.*                           |       | December 7, 2007 |
| John A. Miller                           |       |                                                                |       |             |
| /s/  Martha  Miller de Lombera |       | Director of Sally Beauty  Holdings, Inc.*                           |       | December 7, 2007 |
| Martha Miller de Lombera                 |       |                                                                |       |             |
| /s/  Edward W.  Rabin          |       | Director of Sally Beauty  Holdings, Inc.*                           |       | December 7, 2007 |
| Edward W. Rabin                          |       |                                                                |       |             |
| /s/  Richard J.  Schnall       |       | Director of Sally Beauty  Holdings, Inc.*                           |       | December 7, 2007 |
| Richard J. Schnall                       |       |                                                                |       |             |
|                                          |            |                                                                     |            |                  |  |  |  |  |  |  |  |  |  |  |

 

----

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

 

59

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized, on the 7th day of December, 2007.

 
| SALLY CAPITAL INC. |
|--------------------|
|               |   |   |
|               | By: | /s/  GARY G. WINTERHALTER |   |
|               | Gary G. Winterhalter |
|               | President and Chief  Executive Officer |
|               | (Principal Executive  Officer) and |
|               | Sole Director |
|               |   |   |
|               | By: | /s/  DAVID L. REA |   |
|               | David L. Rea |
|               | Senior Vice President and  Chief Financial Officer |
|               | (Principal Financial  Officer) |
|               |   |   |
|               | By: | /s/  MARK J. FLAHERTY |   |
|               | Mark J. Flaherty |
|               | Vice President, Chief  Accounting Officer and Controller |
|               | (Principal Accounting  Officer) |
|                    |  |  |  |  |  |

 

60

----

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

 

FinancialStatements

Yearsended September 30, 2007, 2006, and 2005

 

**INDEX TO FINANCIAL STATEMENTS**

 
| ** **                                                                                                                           | ** ** | **Page** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report of Independent Registered Public Accounting  Firm                                                                             |       | F-1      |
| Introduction                                                                                                                         |       | F-2      |
| Consolidated Financial Statements:                                                                                                   |       |     |
| Consolidated  Balance Sheets as of September 30, 2007 and 2006                                                                       |       | F-3      |
| Consolidated  Statements of Earnings for the years ended September 30, 2007, 2006 and 2005                                           |       | F-4      |
| Consolidated  Statements of Cash Flows for the years ended September 30, 2007, 2006 and  2005                                        |       | F-5      |
| Consolidated Statements of  Member’s/Stockholder’s (Deficit) Equity for the years ended September 30,  2007, 2006 and 2005 |       | F-6      |
| Notes to Consolidated Financial Statements for the  years ended September 30, 2007, 2006 and 2005                                    |       | F-7      |

 

61

----

 

## **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 subsidiaries as ofSeptember 30, 2007 and 2006 and the related consolidated statements ofearnings, cash flows, and member’s/stockholder’s (deficit) equity for each ofthe years in the three-year period ended September 30, 2007. Theseconsolidated financial statements are the responsibility of the Company’smanagement. 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 weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide 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, 2007 and 2006, and the results oftheir operations and their cash flows for each of the years in the three-yearperiod ended September 30, 2007 in conformity with U.S. generallyaccepted accounting principles.

 

Asdiscussed in Note 2 to the consolidated financial statements, SallyHoldings LLC adopted the provisions of the Financial Accounting StandardsBoard’s Statement of Financial Accounting Standards No. 123 (revised2004), *Share-Based Payment* infiscal year 2006.

 

 

 
| /s/ KPMG LLP     |   |
|------------------|--------|
|             |
| KPMG LLP         |
| Dallas, Texas    |
| December 6, 2007 |

 

F-1

----

 

## **Introduction**

 

The following financial statements as of and for thefiscal year ended September 30, 2007 are those of Sally Holdings LLC(“Sally Holdings” or the “Company”) and its consolidated subsidiaries. Thefinancial condition as of September 30, 2006 and the financial statements forthe fiscal years ended September 30, 2006 and 2005 are those of Sally Holdings,Inc. and its consolidated 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 separation of theCompany’s business from Alberto-Culver. Sally Beauty was formed on June 16,2006 in connection with the separation of the Company’s business fromAlberto-Culver. Sally Capital Inc. (“Sally Capital”) is a wholly-ownedsubsidiary of Sally Holdings and does not have any assets or operations of anykind.

 

F-2

----

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Consolidated Balance Sheets

September 30,2007 and 2006

(Inthousands)

 
| ** **                                                                                                                               | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| **Assets**                                                                                                                               |       |      |       |      |       |
| Current assets:                                                                                                                          |       |      |       |      |       |
| Cash and cash equivalents                                                                                                                |       | $         | 38,272     |      | $          | 107,571 |   |
| Trade accounts receivable, less allowance  for doubtful accounts of $2,564 and $2,246 at September 30, 2007 and  2006, respectively |       | 51,409    |       | 45,462    |       |
| Other receivables                                                                                                                        |       | 22,194    |       | 21,228    |       |
| Inventories                                                                                                                              |       | 569,404   |       | 574,983   |       |
| Prepaid expenses                                                                                                                         |       | 15,375    |       | 10,255    |       |
| Due from Alberto-Culver                                                                                                                  |       | —    |       | 463       |       |
| Deferred income tax assets                                                                                                               |       | 15,291    |       | 10,327    |       |
| Total current assets                                                                                                                     |       | 711,945   |       | 770,289   |       |
| Property and equipment, net of accumulated  depreciation of $215,826 and $187,089 at September 30, 2007 and 2006,  respectively          |       | 154,068   |       | 142,735   |       |
| Goodwill                                                                                                                                 |       | 406,623   |       | 364,693   |       |
| Intangible assets, net of accumulated  amortization of $11,904 and $8,195 at September 30, 2007 and 2006,  respectively                  |       | 70,505    |       | 53,238    |       |
| Other assets                                                                                                                             |       | 61,120    |       | 7,886     |       |
| Total assets                                                                                                                             |       | $         | 1,404,261  |      | $          | 1,338,841 |   |
|                                                                                                                                     |       |      |       |      |       |
| **Liabilities and Member’s/Stockholder’s  (Deficit) Equity**                                                                   |       |      |       |      |       |
| Current liabilities:                                                                                                                     |       |      |       |      |       |
| Current maturities of long-term debt                                                                                                     |       | $         | 17,147     |      | $          | 503 |   |
| Accounts payable                                                                                                                         |       | 176,660   |       | 176,623   |       |
| Accrued expenses                                                                                                                         |       | 153,671   |       | 114,056   |       |
| Due to Sally Beauty Holdings, Inc.                                                                                                       |       | 18,864    |       | —    |       |
| Income taxes                                                                                                                             |       | 3,712     |       | —    |       |
| Total current liabilities                                                                                                                |       | 370,054   |       | 291,182   |       |
| Long-term debt                                                                                                                           |       | 1,758,594 |       | 621       |       |
| Other liabilities                                                                                                                        |       | 18,828    |       | 11,953    |       |
| Deferred income tax liabilities                                                                                                          |       | 30,553    |       | 21,590    |       |
| Total liabilities                                                                                                                        |       | 2,178,029 |       | 325,346   |       |
|                                                                                                                                     |       |      |       |      |       |
| Stock options subject to redemption                                                                                                      |       | 6,549     |       | 7,528     |       |
|                                                                                                                                     |       |      |       |      |       |
| Member’s/Stockholder’s (deficit) equity:                                                                                       |       |      |       |      |       |
| Common stock, no par value. Authorized 1  share; issued and outstanding 1 share at September 30, 2006                                    |       | —    |       | —    |       |
| Additional paid-in capital                                                                                                               |       | —    |       | 62,172    |       |
| Retained earnings                                                                                                                        |       | —    |       | 927,512   |       |
| Member’s deficit                                                                                                                    |       | (814,839  | )          | —    |       |
| Accumulated other comprehensive  income—foreign currency translation                                                                |       | 34,522    |       | 16,283    |       |
| Total member’s/stockholder’s (deficit)  equity                                                                                 |       | (780,317  | )          | 1,005,967 |       |
| Total liabilities and  member’s/stockholder’s (deficit) equity                                                                 |       | $         | 1,404,261  |      | $          | 1,338,841 |   |

 

Prior to November 16, 2006,Alberto-Culver owned all shares of issued and outstanding common stock of SallyHoldings, Inc. Since November 16, 2006, all member units of Sally Holdings LLChave been owned by Sally Investment Holdings LLC (“Sally Investment”), awholly-owned subsidiary of Sally Beauty.

 

Seeaccompanying notes to consolidated financial statements.

 

F-3

----

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Consolidated Statements of Earnings

Yearsended September 30, 2007, 2006, and 2005

(Inthousands)

 
| ** **                                                                                | ** ** | **2007**  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Net sales                                                                                 |       | $         | 2,513,772  |      | $          | 2,373,100 |       | $ | 2,254,307 |   |
| Cost of products sold and distribution  expenses                                          |       | 1,360,025 |       | 1,286,329 |       | 1,227,307 |       |
| Gross profit                                                                              |       | 1,153,747 |       | 1,086,771 |       | 1,027,000 |       |
| Selling, general and administrative  expenses                                             |       | 850,159   |       | 798,211   |       | 768,847   |       |
| Depreciation and amortization                                                             |       | 42,605    |       | 38,032    |       | 33,906    |       |
| Sales-based service fee charged by Alberto-Culver                                         |       | 3,779     |       | 28,852    |       | 27,615    |       |
| Non-cash charge related to Alberto-Culver’s  conversion to one class of common stock |       | —    |       | —    |       | 4,051     |       |
| Transaction expenses                                                                      |       | 21,502    |       | 41,475    |       | —    |       |
| Operating earnings                                                                        |       | 235,702   |       | 180,201   |       | 192,581   |       |
| Interest expense, net                                                                     |       | 145,972   |       | 92        |       | 2,966     |       |
| Earnings before provision for income taxes                                                |       | 89,730    |       | 180,109   |       | 189,615   |       |
| Provision for income taxes                                                                |       | 41,169    |       | 69,916    |       | 73,154    |       |
| Net earnings                                                                              |       | $         | 48,561     |      | $          | 110,193   |       | $ | 116,461 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

F-4

----

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Consolidated Statements of Cash Flows

Yearsended September 30, 2007, 2006, and 2005

(Inthousands)

 
| ** **                                                                                                                                 | ** ** | **2007**   | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| **Cash Flows from Operating Activities:**                                                                                                  |       |       |       |     |       |     |       |
| Net earnings                                                                                                                               |       | $          | 48,561     |     | $          | 110,193  |       | $ | 116,461 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities:                                                       |       |       |       |     |       |     |       |
| Depreciation and amortization                                                                                                              |       | 42,605     |       | 38,032   |       | 33,906   |       |
| Non-cash charge related to Alberto-Culver’s  conversion to one class of common stock (net of deferred tax benefit of  $1,418 in 2005) |       | —     |       | —   |       | 2,633    |       |
| Share-based compensation expense (net of  deferred tax benefit of $4,794 and $1,815 in 2007 and 2006, respectively)                        |       | 7,473      |       | 3,371    |       | —   |       |
| Amortization of deferred financing costs                                                                                                   |       | 7,407      |       | —   |       | —   |       |
| Excess tax benefit from share-based  compensation                                                                                          |       | (780       | )          | —   |       | —   |       |
| Net loss on disposal of leaseholds and  other property                                                                                     |       | 1,820      |       | 1,615    |       | 1,686    |       |
| Deferred income taxes                                                                                                                      |       | 3,718      |       | 2,360    |       | 9,706    |       |
| Changes in (exclusive of effects of  acquisitions):                                                                                        |       |       |       |     |       |     |       |
| Trade accounts receivable                                                                                                                  |       | 2,297      |       | (2,324   | )          | 8        |       |
| Other receivables                                                                                                                          |       | 359        |       | (1,468   | )          | (4,992   | )          |
| Inventories                                                                                                                                |       | 40,035     |       | (40,859  | )          | (23,123  | )          |
| Prepaid expenses                                                                                                                           |       | (2,153     | )          | 1,237    |       | (92      | )          |
| Other assets                                                                                                                               |       | (1,005     | )          | (242     | )          | (1,039   | )          |
| Accounts payable and accrued expenses                                                                                                      |       | 24,427     |       | 38,443   |       | (13,674  | )          |
| Income taxes                                                                                                                               |       | 2,136      |       | —   |       | —   |       |
| Due from Alberto-Culver                                                                                                                    |       | 463        |       | 13,017   |       | (7,477   | )          |
| Due to Sally Beauty                                                                                                                        |       | 5,619      |       | —   |       | —   |       |
| Other liabilities                                                                                                                          |       | 11,285     |       | (6,654   | )          | 1,452    |       |
| Net cash provided by operating activities                                                                                                  |       | 194,267    |       | 156,721  |       | 115,455  |       |
|                                                                                                                                       |       |       |       |     |       |     |       |
| **Cash Flows from Investing Activities:**                                                                                                  |       |       |       |     |       |     |       |
| Proceeds from sales of short-term  investments                                                                                             |       | —     |       | —   |       | 44,600   |       |
| Payments for purchases of short-term  investments                                                                                          |       | —     |       | —   |       | (22,050  | )          |
| Capital expenditures                                                                                                                       |       | (53,345    | )          | (30,342  | )          | (52,236  | )          |
| Proceeds from sale of property and  equipment                                                                                              |       | 8,395      |       | 596      |       | 559      |       |
| Acquisitions, net of cash acquired                                                                                                         |       | (76,414    | )          | (22,412  | )          | (96,918  | )          |
| Net cash used by investing activities                                                                                                      |       | (121,364   | )          | (52,158  | )          | (126,045 | )          |
|                                                                                                                                       |       |       |       |     |       |     |       |
| **Cash Flows from Financing Activities:**                                                                                                  |       |       |       |     |       |     |       |
| Change in book cash overdraft                                                                                                              |       | (6,515     | )          | (10,269  | )          | 15,386   |       |
| Proceeds from issuance of long-term debt                                                                                                   |       | 2,204,625  |       | 571      |       | 40,228   |       |
| Repayments of long-term debt                                                                                                               |       | (430,012   | )          | (826     | )          | (40,269  | )          |
| Proceeds related to notes with affiliated  companies                                                                                       |       | —     |       | 15,230   |       | 52,281   |       |
| Payments related to notes with affiliated  companies                                                                                       |       | —     |       | (31,880  | )          | (52,053  | )          |
| Debt issuance costs                                                                                                                        |       | (58,541    | )          | —   |       | —   |       |
| Excess tax benefit from share-based  compensation                                                                                          |       | 780        |       | —   |       | —   |       |
| Distributions to Sally Beauty                                                                                                              |       | (1,809,740 | )          | —   |       | —   |       |
| Distributions to Alberto-Culver                                                                                                            |       | (44,411    | )          | (5,661   | )          | (11,836  | )          |
| Excess tax benefit from exercises of  Alberto-Culver stock options                                                                         |       | —     |       | 630      |       | —   |       |
| Net cash (used) provided by financing  activities                                                                                          |       | (143,814   | )          | (32,205  | )          | 3,737    |       |
|                                                                                                                                       |       |       |       |     |       |     |       |
| Effect of foreign exchange rate changes on  cash and cash equivalents                                                                      |       | 1,612      |       | (3,399   | )          | 12       |       |
| Net (decrease) increase in cash and cash  equivalents                                                                                      |       | (69,299    | )          | 68,959   |       | (6,841   | )          |
| Cash and cash equivalents, beginning of  year                                                                                              |       | 107,571    |       | 38,612   |       | 45,453   |       |
| Cash and cash equivalents, end of year                                                                                                     |       | $          | 38,272     |     | $          | 107,571  |       | $ | 38,612 |   |
|                                                                                                                                       |       |       |       |     |       |     |       |
| **Supplemental Cash Flow Information:**                                                                                                    |       |       |       |     |       |     |       |
| Cash paid for interest                                                                                                                     |       | $          | 111,336    |     | $          | 2,339    |       | $ | 4,109 |   |
| Cash paid for income taxes                                                                                                                 |       | $          | 5,197      |     | $          | 63,922   |       | $ | 55,986 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

F-5

----

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Consolidated Statements ofMember’s/Stockholder’s (Deficit) Equity

Yearsended September 30, 2007, 2006, and 2005

(Inthousands)

 
| ** **                                                                                      | ** ** | **Number of  Shares** | ** ** | **Dollars**    | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------|------------|
| ** **                                                                                      | ** ** | ** **                 | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | **Total** | ** ** |
| ** **                                                                                      | ** ** | **Common**                 | ** ** | **Additional** | ** ** | ** ** | ** ** | ** ** | ** ** | **Other** | ** ** | **Member’s/** | ** ** |
| ** **                                                                                      | ** ** | **Stock**                  | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Member’s** | ** ** | **Comprehensive** | ** ** | **Stockholder’s** | ** ** |
| ** **                                                                                      | ** ** | **Outstanding**            | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **(Deficit)** | ** ** | **Income (Loss)** | ** ** | **(Deficit) Equity** | ** ** |
| Balance at  September 30, 2004                                                             |       | 1                          |       | $              | 58,584     |   | $ | 718,355 |   | $ | — |   | $ | 9,224 |   | $ | 786,163 |   |
| Net earnings                                                                                    |       | —                     |       | —         |       | 116,461 |   | — |   | — |   | 116,461 |   |
| Foreign currency  translation                                                                   |       | —                     |       | —         |       | — |   | — |   | 4,208 |   | 4,208 |   |
| Total  comprehensive income                                                                     |       | —                     |       | —         |       | 116,461 |   | — |   | 4,208 |   | 120,669 |   |
| Capital  contribution related to Alberto-Culver’s conversion to one class of common  stock |       | —                     |       | 4,051          |       | — |   | — |   | — |   | 4,051 |   |
| Tax benefit from  exercises of Alberto-Culver stock options                                     |       | —                     |       | 1,249          |       | — |   | — |   | — |   | 1,249 |   |
| Distributions to  Alberto-Culver                                                                |       | —                     |       | —         |       | (11,836 | ) | — |   | — |   | (11,836 | ) |
| 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                                                                     |       | —                     |       | —         |       | 110,193 |   | — |   | 2,851 |   | 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                                                                     |       | —                     |       | —         |       | — |   | 48,561 |   | 18,239 |   | 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 | ) |
|                                                                                                 |            |                            |            |                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

Seeaccompanying notes to consolidated financial statements.

 

F-6

----

 

**SallyHoldings 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 of Sally Holdings are beneficially ownedby Sally Investment, and all of the interests of Sally Investment arebeneficially owned by Sally Beauty. The Company was a wholly-owned subsidiaryof Alberto-Culver until November 16, 2006 when it was converted to a Delawarelimited liability company, was renamed “Sally Holdings LLC” and became awholly-owned subsidiary of Sally Investment and an indirect subsidiary of SallyBeauty in connection with the separation of its business from Alberto-Culver.The Company and its consolidated subsidiaries sell professional beautysupplies, primarily through its Sally Beauty Supply retail stores, in the U.S.,Puerto Rico, Mexico, Canada, Japan, United Kingdom and certain other countriesin Europe. Additionally, the Company distributes professional beauty productsto salons and professional cosmetologists through its Beauty Systems Group(“BSG”) store operations and a commissioned direct sales force that calls onsalons in the U.S., Canada, United Kingdom and certain other countries inEurope, and to franchises in the southern and southwestern U.S. and Mexicothrough the operations of its subsidiary Armstrong McCall, L.P. (“ArmstrongMcCall”). Certain beauty products sold by BSG and Armstrong McCall are soldthrough exclusive territory agreements with the manufacturers of the products.

 

On November 10, 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”). The Separation Transactions were effected pursuant to aninvestment agreement dated as of June 19, 2006 (the “InvestmentAgreement”), among Alberto-Culver and certain of its subsidiaries, includingSally Holdings, Inc. and CDRS Acquisition LLC (“CDRS”). Sally Holdings was awholly-owned subsidiary of Alberto-Culver until November 16, 2006, when it wasconverted to a Delaware limited liability company, was renamed “Sally HoldingsLLC,” and became an indirect wholly-owned subsidiary of Sally Beauty. SallyBeauty was formed on June 16, 2006, and became the accounting successor companyto Sally 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. See Note 16 for further information.

 

## **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 the Company’s 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 theconditions that would have existed or the results of operations if the Companyhad been operated as an unaffiliated 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, SallyHoldings, 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 currentyear’s presentation.

 

### * Use of Estimates*

###  

The preparation of financial statements in conformitywith GAAP requires management to make estimates and assumptions that affect thereported amounts of assets, liabilities, revenues and expenses and disclosureof contingent assets and liabilities in the financial statements. The level ofuncertainty in estimates and assumptions increases with the length of timeuntil the underlying transactions

 

F-7

----

 

SallyHoldings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

are completed. Actual results may differ from theseestimates in amounts that may be material to the financial statements.Management believes the estimates and assumptions are reasonable.

 

### *Cash and Cash Equivalents*

###  

All highly liquid investments purchased with anoriginal maturity of three months or less are considered to be cashequivalents. These investments are stated at cost, which approximates market value.Also included in cash equivalents are proceeds due from credit and debit cardtransactions, which generally settle within five to seven days, and wereapproximately $10.9 million and $8.2 million at September 30, 2007 and 2006,respectively.

 

### *Fair Value of Financial Instruments*

###  

The Company’s financial instruments consist of cashand cash equivalents, accounts receivable, accounts payable, interest rate swapagreements and borrowings. The carrying amounts of cash and cash equivalents,accounts receivable and accounts payable approximate fair value due to theshort term nature of these financial instruments.

 

The Company utilizes interest rate swap agreements tomanage the cash flow risk associated with changing interest rates and accountsfor them in accordance with SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities*, (“SFAS 133”). The Company doesnot purchase or hold any derivative instruments for speculative or tradingpurposes. These derivative instruments are not designated as hedges, andchanges in the fair value of these agreements are recorded as increases(decreases) to interest expense in the consolidated statements of earnings.

 

The fair value of the Company’s long-term borrowingswas approximately $1,759.3 million at September 30, 2007. The fair valuesof the Company’s long-term borrowings are based on quoted market prices whereavailable or, if not available, based on discounted future cash flows usingcurrent market interest rates.

 

### * Concentration of Credit Risk*

###  

Financial instruments that potentially expose theCompany to concentration of credit risk consist primarily of cash investmentsand accounts receivable. The Company places its cash investments withhigh-credit quality financial institutions. Accounts receivable are generallydiversified due to the number of entities comprising the Company’s customerbase and their dispersion across many geographical regions. The Companybelieves no significant concentration of credit risk exists with respect tothese cash investments and accounts receivable.

 

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

###  

Trade accounts receivable are recorded at the value ofsales 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 off 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.

 

### *Other Receivables*

###  

Other receivables consist primarily of amountsexpected from vendors under various contractual agreements. Other receivablesare recorded at the amount management estimates will be collected under theseagreements.

 

### * Inventories*

###  

Inventories are stated at the lower of cost(determined by the first-in, first-out method) or market (net realizablevalue). When necessary, the Company provides allowances to adjust the carryingvalue of inventories to the lower of cost or market, including costs to sell ordispose, and for estimated inventory shrinkage. Estimates of the future demandfor the Company’s products, age of the inventory and changes in stock keepingunits (“SKUs”) are some of the key factors used by management in assessing thenet realizable value of inventories. The Company estimates inventory shrinkagebased on historical experience.

 

F-8

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

### *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.Buildings and building improvements are depreciated over periods ranging fromfive to 40 years. Furniture, fixtures and equipment are depreciated overperiods ranging from three to ten years. Leasehold improvements are amortizedover the lesser of the estimated useful lives of the assets or the term of therelated lease, including renewals determined to be reasonably assured.Expenditures for maintenance and repairs are expensed as incurred while expendituresfor major renewals and improvements are capitalized. Upon the disposition ofproperty and equipment, the cost and related accumulated depreciation areremoved from the accounts.

 

### *Lease Accounting*

###  

The Company’s leases for office space, retail storesand the distribution facilities are accounted for as operating leases. Rentexpense 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 provide for tenantimprovement allowances. The allowances are recorded as a deferred lease credit,included in accrued expenses and other liabilities, on the balance sheet andamortized on a straight-line basis over the lease term as a reduction of rentexpense, which is consistent with the amortization period for the constructedassets.

 

### *Valuation of Long-Lived Assets*

###  

Long-lived assets, such as property and equipment andpurchased intangibles subject to amortization, are reviewed for impairmentannually, and whenever events or changes in circumstances indicate that thecarrying 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.

 

### *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, there was no impairment inthe current or prior fiscal years presented.

 

Other intangibles with indefinite lives includecertain distribution rights. Other intangible assets subject to amortizationinclude customer relationships, certain distribution rights and non-competitionagreements, and are amortized over periods of one to ten years. Theweighted average amortization period is approximately four years.

 

### *Deferred Financing Costs*

###  

Expenses incurred with the issuance of long-term debtare capitalized and amortized over the life of the related debt agreements on astraight line-basis, or by using the effective interest method. These expensesare recorded on the consolidated balance sheet as other assets.

 

### *Self-Insurance Programs*

###  

The Company retains a substantial portion of the riskrelated to certain workers’ compensation, general liability and auto andproperty insurance plans. Predetermined loss limits have been arranged withinsurance companies to limit the per occurrence and aggregate cash outlay.Certain of our employees and their dependents are also covered by aself-insurance program for healthcare, up to a certain maximum lifetime limit.Currently these costs, other than payroll deductions and certain out-of-pocketamounts, are largely funded by the Company. The Company maintains an annualstop loss insurance policy for the healthcare 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 losses incurred but not yet reported. TheCompany estimates the ultimate cost based on an analysis of

 

F-9

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

historical data and actuarial estimates. Workers’compensation, general liability and auto and property insurance liabilities arerecorded at the estimate of their net present value, while healthcare planliabilities are not discounted. These estimates are reviewed on a regular basisto ensure that the liability is appropriate. The Company believes the amountsaccrued are adequate, although actual losses may differ from the amountsprovided.

 

### *Advertising Costs*

###  

Advertising costs are expensed either as incurred orthe first time the advertising occurs. Advertising costs were approximately$49.2 million, $49.1 million and $45.3 million in the fiscal yearsended September 30, 2007, 2006 and 2005, respectively, and are included inselling, general and administrative expenses in the consolidated statements ofearnings.

 

### *Vendor Allowances*

###  

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 unless it ismore likely than not that such assets will be realized.

 

### * Foreign Currency*

###  

The functional currency of the Company’s foreignoperations is the applicable local currency. Balance sheet accounts aretranslated into U.S. dollars at the rates of exchange in effect at thebalance sheet date, while the results of operations are translated using theaverage exchange rates during the period presented. The resulting translationadjustments are recorded as a component of accumulated other comprehensiveincome within member’s/stockholder’s equity. Foreign currency transaction gainsor losses are included in the consolidated statements of earnings and were notsignificant in any period presented.

 

### * Revenue Recognition*

###  

The Company recognizes revenue when a customerconsummates a point of sale transaction in a store. The cost of sales incentiveprograms, such as customer and consumer coupons, are recognized as a reductionof revenue at the time of sale. Taxes collected from customers and remitted togovernmental authorities are recorded by the Company on a net basis, and areexcluded from revenue. The Company also recognizes revenue on merchandiseshipped to customers when title and risk of loss pass to the customer.Appropriate provisions for sales returns and cash discounts are made at thetime the sales are recorded. Sales returns and allowances were approximately2.4% of net sales over the past three fiscal years.

 

### * Shipping and Handling*

###  

Shipping and handling costs related to freight anddistribution expenses for delivery directly to customers are included inselling, general and administrative expenses in the consolidated statements ofearnings and amounted to $38.3 million, $41.9 million and$41.1 million for the fiscal years 2007, 2006 and 2005, respectively. Allother shipping and handling costs, such as freight from distribution centers tostores and handling costs in the distribution centers, are included in cost ofproducts sold and distribution expenses.

 

### * Share-Based Compensation*

###  

The Company accounts for stock option and stock award,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

 

F-10

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

compensation expense on a straight-line basis over thevesting period or to the date a participant becomes eligible for retirement, ifearlier.

 

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). In accordance with the modifiedprospective method, the financial statements for fiscal year 2005 have not beenrestated.

 

Prior to fiscal year 2006, the Company measuredstock-based compensation expense using the intrinsic value method prescribed byAPB Opinion No. 25, *Accounting for StockIssued to Employees*, and provided the required pro forma disclosuresrequired by SFAS 123, *Accounting for Stock-BasedCompensation*, and, accordingly, no compensation expense related tostock options was recognized in the consolidated statements of earnings, exceptfor a non-cash charge related to Alberto-Culver’s conversion to one class ofcommon stock.

 

Had total compensation expense been determined basedupon the fair value of stock options and stock awards on the dates of grant andrecognized over the vesting period consistent with SFAS No. 123(R),the Company’s pro forma net earnings for fiscal year 2005 would have been asfollows (in thousands):

 

| Reported net earnings:                                                                                                                  |   | $      | 116,461 |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|--------|---------|--------|
| Add: Stock-based compensation expense  included in reported net earnings, net of related income tax effects                             |   | 2,985  |    |
| Less: Stock-based compensation expense  determined under the fair value based method for all awards, net of related  income tax effects |   | (3,289 | )       |
| Pro-forma net earnings                                                                                                                  |   | $      | 116,157 |   |

 

The $3.0 million addition to reported netearnings in fiscal year 2005 for share-based compensation expense includes$2.6 million of after-tax non-cash charges related to Alberto-Culver’sconversion to a single class of common stock.

 

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 ofstockholder’s equity. 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 hasreclassified $6.5 million from additional paid-in capital to “stock optionssubject to redemption” outside of member’s/stockholder’s equity (deficit) onits consolidated balance sheet as of September 30, 2007. This amount willbe reclassified back into member’s/stockholder’s equity (deficit) in futureperiods as the related stock options are exercised or canceled.

 

##### ***RecentAccounting Pronouncements***

 

In February 2007, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities – including an amendment of FASBStatement No. 115* (“SFAS 159”). SFAS 159 permits entities to chooseto measure many financial instruments and certain other items at fair valuethat are not currently required to be measured at fair value, with unrealizedgains and losses related to these financial instruments reported in earnings ateach subsequent reporting date. SFAS 159 is effective in fiscal years beginningafter November 15, 2007. The Company is currently assessing the effect of thispronouncement on the Company’s consolidated financial statements.

 

In September 2006, the FASB issuedSFAS No. 157, *Fair Value Measurements*(“SFAS 157”), which defines fair value, establishes a framework for measuringfair value in generally accepted accounting principles, and expands disclosuresabout fair value measurements. SFAS 157 is effective in fiscal yearsbeginning after November 15, 2007. The Company is currently assessing theeffect of this pronouncement on the Company’s consolidated financialstatements.

 

In September 2006, the SEC issued Staff AccountingBulletin No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying the Misstatements in Current YearFinancial Statements* (“SAB 108”) which provides interpretiveguidance on how the effects of the carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.The

 

F-11

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

Company implemented the provisions of SAB 108 duringthe first quarter of fiscal year 2007 and it did not have a material impact onthe Company’s consolidated financial position, statements of earnings or cashflows.

 

In July 2006, the FASB issued FASB InterpretationNo. 48, *Accounting for Uncertainty in Income Taxes,an interpretation of FASB Statement No. 109* (“FIN 48”).FIN 48 clarifies the accounting for the uncertainty in income taxesrecognized by prescribing a

recognition threshold that a tax position is requiredto meet before being recognized in the financial statements. It also providesguidance on derecognition, classification, interest and penalties, interimperiod accounting and disclosure. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. The Company does not expect theadoption of FIN 48 to have a material impact on the Company’s consolidatedfinancial position, statements of earnings or cash flows.

 

## **3.  Regis Agreement and Separation Transactions**

##  

On January 10, 2006, Alberto-Culver entered intoan agreement with Regis Corporation (“Regis”) to merge Sally Holdings, Inc.with a subsidiary of Regis in a tax-free transaction. Pursuant to the terms andconditions of the merger agreement, Sally Holdings, Inc. was to be spun off toAlberto-Culver’s stockholders by way of a tax-free distribution and,immediately thereafter, combined with Regis in a tax-free stock-for-stockmerger.

 

On April 5, 2006, Alberto-Culver provided noticeto Regis that its board of directors had withdrawn its recommendation forshareholders to approve the transaction. Following Alberto-Culver’s notice toRegis, also on April 5, 2006, Regis provided notice to Alberto-Culver thatit was terminating the merger agreement effective immediately. In connectionwith the termination of the merger agreement, Alberto-Culver and the Companyincurred transaction expenses, primarily the termination fee paid to Regis andlegal and investment banking fees, during fiscal years 2005 and 2006. The totalamount of transaction expenses, including the termination fee, wasapproximately $41.5 million ($27.2 million after taxes), which wasexpensed by the Company in fiscal year 2006. All transaction related expenseswere deducted for tax purposes.

 

On June 19, 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-Culver immediatelyprior to the Separation Transactions became the beneficial owners ofapproximately 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 on a fully-diluted basis. Upon closing of the Separation Transactions,the Company made a distribution to Sally Beauty of approximately $1,809.7million, which was funded primarily from the issuance of new debt. Also uponclosing of the Separation Transactions, Alberto-Culver shareholders received,for each share of Alberto-Culver common stock then owned: (i) one share ofcommon stock of New Alberto-Culver, which owns and operates Alberto-Culver’sconsumer products business; (ii) one share of common stock of SallyBeauty; 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 $20.4 toAlberto-Culver for merger and transactions expenses incurred in connection withthe Separation Transactions. Most expenses related to the SeparationTransactions are not expected to be deductible for tax purposes. Sally Beautyand the Company also paid approximately $58.5 million in fees for the debtfinancing incurred in connection with the separation, which were recorded onthe consolidated 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 fiscalyear 2007, the Company made adjustments in connection with the reconciliationof tax balances transferred to the Company in connection with the SeparationsTransactions. This amount was included in the settlement of intercompanyagreements with Alberto-Culver, as an adjustment to the Company’s member’sdeficit.

 

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

 

F-12

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

receivables, payables and loans (other than tradepayables and the Company’s portion of the transaction expenses described above)between the Company or any of its subsidiaries, on the one hand, andAlberto-Culver or any of its subsidiaries (other than the Company and itssubsidiaries), 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 and theCompany. The Company provided Mr. Renzulli with certain benefits primarilyconsisting of a lump-sum cash payment of $3.6 million within 30 daysafter completion of the transactions. The Company expensed the cash payment atthe 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.

 

## **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. Inconnection with the separation from Alberto-Culver, the Company received theproceeds from the issuance of the debt and contributed cash of approximately$1,809.7 million to Sally Beauty to enable it to make the dividend payments toexisting stockholders in accordance with the separation agreements entered intoin connection with the Separation Transactions. 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-in capitaland the retained earnings were part of the stockholder’s equity of SallyHoldings, Inc. and its subsidiaries. On November 16, 2006, in connection withthe Separation Transactions, and the Limited Liability Company Agreement ofSally Holdings LLC entered into by Alberto-Culver, Sally Holdings, Inc.contributed its stockholder’s equity to Sally Holdings LLC, thereby convertingstockholder’s equity into member’s equity.

 

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

##  

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

 

The Company accounts for stock option and stock award,which include share-based payment plans in accordance with 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. For fiscal years 2007 and 2006, total compensation costcharged against income and included in selling, general and administrativeexpenses, for share-based compensation arrangements was $12.3 million and $5.2million, respectively, which included for fiscal year 2007, $5.3 million of accelerated expense relatedto the separation of Alberto-Culver and $2.6 million of accelerated expenserelated to certain retirement eligible employees who are eligible tocontinue vesting awards upon retirement under the terms of Sally Beauty’s 2007Omnibus Incentive Plan (the “2007 Plan”). For fiscal years 2007 and 2006, thetotal income tax benefit recognized in the statements of earnings from theseplans was $4.8 and $1.8 million, respectively.

 

During fiscal year 2007, Sally Beauty adopted the 2007Plan, a new share-based compensation plan, which allows for the issuance of upto 10.0 million shares of Sally Beauty’s common stock. During fiscal year 2007,Sally Beauty granted approximately 2.4 million stock options to the Company’semployees. Upon issuance of such grants, the Company recognized acceleratedshare-based compensation expense of $2.6 million in connection with certainretirement eligible employees who are eligible to continue vesting awards uponretirement under the terms of the 2007 Plan.

 

F-13

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

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-Culvertreated the Separation Transactions as though they constituted a change incontrol for purposes of Alberto-Culver’s stock options and stock awards. As aresult, in accordance with the terms of these plans, all outstanding stockoptions and stock awards of Alberto-Culver, including those held by the Company’semployees, became fully vested upon completion of the Separation Transactionson November 16, 2006. Due to the Separation Transactions, the Company recordeda charge at that time equal to the amount of future compensation expense ofapproximately $5.3 million that would have been recognized in subsequentperiods as the stock options and stock awards for the Company’s employeesvested over the original vesting periods. Upon completion of the Separation Transactions,all outstanding Alberto-Culver stock options and stock awards held by employeesof the Company became options to purchase shares of Sally Beauty’s commonstock.

 

As a result of the Separation Transactions, theEmployee Stock Option Plan of 2003, the 2003 Stock Option Plan for Non-EmployeeDirectors and the 2003 Restricted Stock Plan that were previously plans ofAlberto-Culver became plans of Sally Beauty. During fiscal year 2007, SallyBeauty granted approximately 2.7 million stock options to the Company’semployees, and granted approximately 0.4 million restricted share awards to theCompany’s employees under these plans.

 

## **StockOptions**

##  

Each option has an exercise price which equals 100% ofthe market price of Sally Beauty’s stock on the date of grant and generally hasa maximum term of 10 years. Options generally vest ratably over a four yearperiod and are subject to forfeiture until the four year vesting period iscomplete.

 

The following table presents a summary of the activityfor 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 |   |
|                              |       |                                                          |       |                                   |       |                                                                 |       |                                                 |       |
| Exercisable at September 30, 2007 |       | 2,559                                                         |       | $                                      | 3.76       |                                                                 | 7.8        |                                                 | $          | 12,705 |   |

 

----

(a)                               Per the Employee MattersAgreement, in connection with the Separation Transactions, options to purchaseshares of Alberto-Culver’s common stock, which were held by the Company’semployees, were converted into options to purchase shares of Sally Beauty’scommon stock. In order to maintain the same intrinsic value as before theseparation, all of Sally Beauty’s stock options that were converted fromAlberto-Culver were adjusted accordingly.

 

The following table summarizesinformation about stock options under Sally Beauty’s option plans at September30, 2007 (shares in thousands):

 

| ** **                                  | ** ** | **Options Outstanding**                              | ** ** | **Options Exercisable**                                         | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number  Outstanding at  September 30,  2007** | ** ** | **Weighted  Average  Remaining  Contractual  Term (In  Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable at  September 30,  2007** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $2.00                                       |       | 1,970                                                     |       | 7.3                                                                  |       | $ | 2.00 |   | 1,970 |   | $ | 2.00 |   |
| $7.70 – 9.66                           |       | 4,754                                                     |       | 9.4                                                                  |       | 9.51 |   | 589 |   | 9.66 |   |
| Total                                       |       | 6,724                                                     |       | 8.8                                                                  |       | $ | 7.33 |   | 2,559 |   | $ | 3.76 |   |

 

The Company uses the Black-Scholes option-pricingmethod 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

 

F-14

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

stock option awards, which generally vest ratably overa four year period, is expensed on a straight-line basis over the vestingperiod of the stock options or to the date a participant becomes eligible forretirement, if earlier.

 

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

 
| ** **              | ** ** | **Year Ended September 30,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2007 (a)**                           | ** ** | **2006 (b)** | ** ** | **2005 (b)** | ** ** |
| Expected lives (years)  |       | 5.0                                         |       | 3.5 – 4.5 |   | 3.5 – 5.0 |   |
| Expected volatility     |       | 41.2% - 41.9                                | %          | 20.0 | % | 20.0 | % |
| Risk-free interest rate |       | 4.4% - 4.6                                  | %          | 4.2% - 5.0 | % | 3.4 | % |
| Dividend yield          |       | 0.0                                         | %          | 1.0 | % | 0.9 | % |

 

----

| (a)    | Assumptions  are based on the Company’s future expectations.                                                                                                                                                                                            |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                         |
| (b)    | 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 of Sally Beauty’sstock options issued to Company employees at the date of grant in fiscal years2007, 2006 and 2005 was $4.11, $9.48 and $9.41 per option, respectively.

 

The total intrinsic value of options exercised duringfiscal years 2007, 2006 and 2005 was $5.9 million, $7.5 million and $11.8million, respectively, and the tax benefit realized for the tax deductions fromthese option exercises was $2.3 million, $2.5 million and $4.3 million,respectively. The total cash received from these option exercises was $1.7million during fiscal year 2007. Prior to the Separation Transactions the totalcash received by the Company from these option exercises was zero as the cashwent to Alberto-Culver. The total fair value of stock options issued to Companyemployees that vested during fiscal years 2007, 2006 and 2005 was $7.3 million,$4.4 million and $4.3 million, respectively.

 

At September 30, 2007, approximately $10.2 million oftotal unrecognized compensation cost related to non-vested stock option awardsis expected to be recognized over the weighted average period of 3.1 years.

 

## **StockAwards**

 

##### ***RestrictedStock Awards***

 

As a subsidiary of Sally Beauty, the Company has noemployee stock award plans; however, certain employees of the Company have beengranted stock awards under the 2003 Restricted Stock Plan (the “RSP”). Arestricted stock award is an award of shares of Sally Beauty’s common stockthat is subject to time-based vesting during a specified period. Restrictedstock awards are independent of option grants and are generally subject toforfeiture if employment terminates prior to the vesting of the awards. Participantshave full voting and dividend rights with respect to shares of stock awards.

 

The RSP provides for the grant of restricted stockawards for up to 900,000 shares of Sally Beauty’s common stock to key employees(including officers) of the Company. Restricted stock awards issued under theRSP generally vest ratably over a five year period and are subject toforfeiture until the five year 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. Forthese purposes, the fair market value of the restricted stock award isdetermined based on the closing price of Sally Beauty’s common stock on thegrant date.

 

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

 

F-15

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 
| **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                             |       | —                                          |       | —                                                     |       |                                                                 |       |
| Non-vested at September 30, 2007      |       | 350                                             |       | $                                                          | 8.10       |                                                                 | 4.3        |   |

 

----

(a)                                  Perthe Employee Matters Agreement, in connection with the Separation Transactions,all Alberto-Culver restricted stock awards, which were held by the Company’semployees, became vested immediately.

 

For fiscal year 2007, approximately 31,000 restrictedstock awards vested, all in connection with the Separation Transactions. Theremaining unrecognized compensation cost related to unvested restricted stockawards at September 30, 2007 was $2.4 million and the weighted average periodof time over which this cost will be recognized is 4.3 years.

 

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

 

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

 

| ** **                                             | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Balance at beginning of period                         |       | $                                           | 2,246      |   | $ | 2,073 |   | $ | 2,500 |   |
| Bad debt expense                                       |       | 2,632                                       |       | 2,403 |   | 1,754 |   |
| Uncollected accounts written off, net of  recoveries   |       | (2,568                                      | )          | (2,252 | ) | (2,292 | ) |
| Allowance for doubtful accounts of acquired  companies |       | 254                                         |       | 22 |   | 111 |   |
| Balance at end of period                               |       | $                                           | 2,564      |   | $ | 2,246 |   | $ | 2,073 |   |

 

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

 

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

 

| ** **                                      | ** ** | **September 30,** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Land                                            |       | $                      | 9,773      |   | $ | 9,632 |   |
| Buildings and building improvements             |       | 48,885                 |       | 48,510 |   |
| Leasehold improvements                          |       | 118,816                |       | 96,479 |   |
| Furniture, fixtures and equipment               |       | 192,420                |       | 175,203 |   |
| Total property and equipment, gross             |       | 369,894                |       | 329,824 |   |
| Less accumulated depreciation and  amortization |       | (215,826               | )          | (187,089 | ) |
| Total property and equipment, net               |       | $                      | 154,068    |   | $ | 142,735 |   |

 

Depreciationexpense totaled $38.9 million, $35.0 million and $30.6 million infiscal years 2007, 2006 and 2005, respectively.

 

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

 

The change in the carryingamounts of goodwill by operating segment for the fiscal years 2007 and 2006 isas follows (in thousands):

 

F-16

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

| ** **                                    | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------|------------|
| Balance at September 30, 2005            |       | $                             | 10,089     |                           | $          | 343,436   |       | $ | 353,525 |   |
| Additions, net of purchase price  adjustments |       | —                        |       | 9,087                          |       | 9,087     |       |
| Foreign currency translation                  |       | 71                            |       | 2,010                          |       | 2,081     |       |
| Balance at September 30, 2006            |       | 10,160                        |       | 354,533                        |       | 364,693   |       |
| Additions, net of purchase price  adjustments |       | 30,832                        |       | 4,418                          |       | 35,250    |       |
| Foreign currency translation                  |       | 1,531                         |       | 5,149                          |       | 6,680     |       |
| Balance at September 30, 2007            |       | $                             | 42,523     |                           | $          | 364,100   |       | $ | 406,623 |   |

 

As described in Note 15, the $30.8 millionincrease in Sally Beauty Supply’s goodwill in fiscal year 2007 was principallyattributable to the acquisition of Salon Services in February 2007, net ofpurchase price adjustments. The $4.4 million increase in BSG’s goodwill infiscal year 2007 was principally attributable to several smaller acquisitionsand purchase price adjustments for prior years’ acquisitions. The$9.1 million increase in BSG’s goodwill in fiscal year 2006 wasprincipally attributable to the acquisition of Salon Success in June 2006, netof purchase price adjustments for prior years’ acquisitions.

 

The following table provides the gross carrying valueand accumulated amortization for intangible assets with indefinite lives andintangible assets subject to amortization by operating segment at September 30,2007 and 2006 (in thousands):

 

| ** **                                 | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------|------------|
| 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                      |       | 540                           |       | 25,128                         |       | 25,668    |       |
| Accumulated amortization                   |       | (18                           | )          | (11,886                        | )          | (11,904   | )          |
| Net value                                  |       | 522                           |       | 13,242                         |       | 13,764    |       |
| Total intangible assets, net               |       | $                             | 16,324     |                           | $          | 54,181    |       | $ | 70,505 |   |
|                                       |       |                          |       |                           |       |      |       |
| Balance at September 30, 2006:        |       |                          |       |                           |       |      |       |
| Intangible assets with indefinite lives:   |       |                          |       |                           |       |      |       |
| Trade names                                |       | $                             | 713        |                           | $          | 34,480    |       | $ | 35,193 |   |
| Other intangibles                          |       | —                        |       | 6,053                          |       | 6,053     |       |
| Total                                      |       | 713                           |       | 40,533                         |       | 41,246    |       |
| Intangible assets subject to amortization: |       |                          |       |                           |       |      |       |
| Gross carrying amount                      |       | —                        |       | 20,187                         |       | 20,187    |       |
| Accumulated amortization                   |       | —                        |       | (8,195                         | )          | (8,195    | )          |
| Net value                                  |       | —                        |       | 11,992                         |       | 11,992    |       |
| Total intangible assets, net               |       | $                             | 713        |                           | $          | 52,525    |       | $ | 53,238 |   |

 

The increase in Sally Beauty Supply’s trade names andintangible assets subject to amortization in fiscal year 2007 was primarily dueto the acquisition of Salon Services. The increase in BSG’s trade names andintangible assets subject to amortization in fiscal year 2006 was primarily dueto the acquisition of Salon Success. Amortization expense totaled $3.7 million,$3.0 million and $3.3 million in fiscal years 2007, 2006 and 2005,respectively. As of September 30, 2007, future amortization expenserelated to intangible assets subject to amortization is estimated to be asfollows (in millions):

 

| **Fiscal Year:** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| 2008                  |       | $          | 4.2        |   |
| 2009                  |       | 3.2        |       |
| 2010                  |       | 2.5        |       |
| 2011                  |       | 1.9        |       |
| 2012                  |       | 1.0        |       |
| Thereafter            |       | 1.0        |       |
|                  |       | $          | 13.8       |   |

 

F-17

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

The weighted average amortization period isapproximately four years.

 

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

 

Accounts payable at September 30, 2006 includebook cash overdrafts of $6.5 million. There were no book cash overdraftsat September 30, 2007.

 

Accrued expenses consist of the following (inthousands):

 

| ** **                   | ** ** | **September 30,** | ** ** |
|------------------------------|------------|------------------------|------------|
| ** **                   | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Compensation and benefits    |       | $                      | 53,440     |   | $ | 55,886 |   |
| Interest payable             |       | 34,540                 |       | — |   |
| Deferred revenue             |       | 11,209                 |       | 9,823 |   |
| Rental obligations           |       | 9,575                  |       | 9,114 |   |
| Property and other taxes     |       | 6,495                  |       | 7,620 |   |
| Insurance reserves           |       | 3,615                  |       | — |   |
| Acquisition related payables |       | 3,202                  |       | 8,714 |   |
| Operating accruals and other |       | 31,595                 |       | 22,899 |   |
| Total accrued expenses       |       | $                      | 153,671    |   | $ | 114,056 |   |

 

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

 

## **Commitments**

 

The Company’s principal leases relate to retail storesand warehousing properties. At September 30, 2007, future minimum paymentsunder non-cancelable operating leases, net of sublease income, are as follows(in thousands):

 

| **Fiscal Year:** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| 2008                  |       | $          | 110,561    |   |
| 2009                  |       | 94,439     |       |
| 2010                  |       | 74,884     |       |
| 2011                  |       | 57,179     |       |
| 2012                  |       | 35,684     |       |
| Thereafter            |       | 56,881     |       |
|                  |       | $          | 429,628    |   |

 

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 will pay monthly rent for continued use of thebuilding. The lease has an initial term of 24 months and the monthly rent issubject to certain escalation clauses over the life of the lease.

 

Total rental expense for operating leases amounted toapproximately $147.3 million, $133.5 million and $123.1 million infiscal years 2007, 2006 and 2005, respectively, and is included in selling,general and administrative expenses in the consolidated statements of earnings.Included in this amount is $0.8 million, $0.7 million and$1.3 million for contingent rents for the years ended September 30,2007, 2006 and 2005, respectively.

 

## **Contingencies**

 

##### ***LegalProceedings and Other***

 

There were no material legal proceedings pendingagainst the Company or its subsidiaries, as of September 30, 2007. 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.

 

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

 

F-18

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

Company records an estimated liability for theultimate cost of claims incurred and unpaid as of the balance sheet date. Theestimated liability is included in accrued expenses (current portion) and otherliabilities (long-term portion) in our consolidated balance sheets. The Companycarries insurance coverage in such amounts in excess of its self-insuredretention 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, 2007 and 2006.

 

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

 

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

 

| ** **                    | ** ** | **September 30,  2007** | ** ** | **Maturity dates  (Fiscal Year)** | ** ** | **Interest Rates** |
|-------------------------------|------------|-------------------------|------------|-----------------------------------|------------|--------------------|
| ABL facility                  |       | $                       | 11,400     |                              | 2012       |               | (i) | PRIME and up to 0.50% or; |
|                          |       |                    |       |                              |       | (ii)               | LIBOR (a) plus (1.00% to  1.50%) |
| Term Loan A                   |       | 142,500                 |       | 2013                              |       | (i)                | PRIME plus (1.00% to 1.50%)  or; |
|                          |       |                    |       |                              |       | (ii)               | LIBOR plus (2.00% to 2.50%) |
| Term Loan B                   |       | 910,800                 |       | 2014                              |       | (i)                | PRIME plus (1.25% to 1.50%)  or; |
|                          |       |                    |       |                              |       | (ii)               | LIBOR plus (2.25% to 2.50%) |
| Total                         |       | $                       | 1,064,700  |                              |       |               |   |
|                          |       |                    |       |                              |       |               |
| Senior notes                  |       | $                       | 430,000    |                              | 2015       |               | 9.25% |   |
| Senior subordinated notes     |       | 280,000                 |       | 2017                              |       | 10.50%             |   |
| Total                         |       | $                       | 710,000    |                              |       |               |   |
|                          |       |                    |       |                              |       |               |
| Capitalized leases and  other |       | $                       | 1,041      |                              |       |               |   |
| Less: current portion         |       | (17,147                 | )          |                              |       |               |
| Total  long-term debt         |       | $                       | 1,758,594  |                              |       |               |   |
|                               |            |                         |            |                                   |            |                    |  |  |  |

 

----

(a) LondonInterbank Offered Rate (“LIBOR”)

 

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

 

The ABL facility provides for senior secured revolvingloans up to a maximum aggregate principal amount of $400.0 million, subject toborrowing base limitations. The availability 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, 2007, the Company had $334.6 available foradditional 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, 2007, the commitment fee rate was0.20%.

 

The ABL facility contains a covenant requiring theCompany 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 term loanB facility. Interest is payable on a quarterly basis.

 

The term loan facilities contain a covenant requiringthe Company and its subsidiaries to comply with maximum consolidated securedleverage ratio levels, which will decline over time. The consolidated securedleverage ratio will be tested quarterly, with a maximum ratio of 5.25 for thefour quarter period ending September 30, 2007. The consolidated securedleverage ratio is a ratio of net consolidated secured debt to ConsolidatedEBITDA (as defined in the underlying agreements).

 

F-19

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

The term loan facilities andthe ABL facility are secured by substantially all of the Company’s assets,those of Sally Investment, those of the Company’s domestic subsidiaries and, inthe case of the ABL facility, those of the Company’s Canadian subsidiaries. Theterm loan facilities may be prepaid at the Company’s option at any time withoutpremium or penalty and is subject to mandatory prepayment in an amount equal to50% 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 and 100% of the proceeds of specified assetsales that are not reinvested in the business or applied to repay borrowingsunder the ABL facility.

 

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 beforeNovember 15, 2010 and November 15, 2011, respectively, at par plus a premium,plus accrued and unpaid interest, and on or after November 15, 2010 andNovember 15, 2011, respectively, at par plus a premium declining ratably topar, plus accrued and unpaid interest. Interest on the senior notes and seniorsubordinated notes is payable semi-annually.

 

On November 24, 2006, the Company entered into twointerest rate swap agreements related to $500.0 million of the $1,070.0 millionterm loans A and B due in 2012 and 2013, respectively. See Note 12 for furtherinformation on the interest rate swap agreements.

 

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

 

| **Fiscal Year:**    | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| 2008                     |       | $          | 16,700     |   |
| 2009                     |       | 24,200     |       |
| 2010                     |       | 24,200     |       |
| 2011                     |       | 39,200     |       |
| 2012                     |       | 95,600     |       |
| Thereafter               |       | 1,574,800  |       |
|                     |       | $          | 1,774,700  |   |
| Capital leases and other |       | 1,041      |       |
| Less: current portion    |       | (17,147    | )          |
| Total                    |       | $          | 1,758,594  |   |

 

At September 30, 2007 and 2006, 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 $9.4 million and $3.0 million, respectively, atSeptember 30, 2007 and 2006.

 

## **12.  Interest Rate Swaps**

 

On November 24, 2006, the Company entered into twointerest rate swap agreements with notional amounts of $150.0 million and$350.0 million. These agreements expire on November 24, 2008 and 2009,respectively. These agreements allow the Company to convert a portion of itsvariable rate interest to a fixed rate at 4.9975% plus (2.00% to 2.50%) and4.94% plus (2.00% to 2.50%), respectively. These interest rate swap agreementsrelate to $500.0 million of the $1,070.0 million term loans A and B due infiscal years 2013 and 2014, respectively, to manage the Company’s cash flowrisk associated with changing interest rates. The Company will pay fixed rates of 4.9975% plus(2.00% to 2.50%) and 4.94% plus (2.00%to 2.50%) on a quarterly basis inexchange for receiving floating rate payments based on the three-month LIBORrate.

 

The Company utilizes interestrate swaps to manage the cash flow risk associated with changing interest ratesand accounts for them under SFAS 133, which requires that all derivatives bemarked to market (fair value). The Company does not purchase or hold anyderivative instruments for trading purposes. The interest rate swap agreementsdo not currently qualify as hedges and, therefore, the change in fair value ofthe interest rate swap agreements are recorded in the consolidated statementsof earnings. The fair value of the swap agreements at September 30, 2007 wasrecorded as a liability of approximately $3.0 million.

 

Fair value estimatespresented for the swap agreements are based on third-party information and weredetermined using proprietary models based upon well-recognized financialprinciples and reasonable estimates about relevant future market conditions.

 

The counter-parties to theseswap instruments are large financial institutions which the Company believesare of high quality creditworthiness. While the Company may be exposed topotential losses due to the credit risk of nonperformance by thesecounter-parties, such losses are not anticipated.

 

F-20

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

The marked to market impact of the swap arrangementson interest expense was an increase of approximately $3.0 million in fiscalyear 2007. Changes in thefair value of the interest rate swap agreements will either increase ordecrease the Company’s net interest expense and therefore may affect theCompany’s earnings.

 

## **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 401k Plan, employees may contribute a percentage oftheir annual compensation to the 401k Plan up to certain maximums, as definedby the 401k Plan and by the Internal Revenue Service (“IRS”). 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 $3.3 million,$2.1 million and $2.2 million in fiscal years 2007, 2006 and 2005,respectively, related to these plans. These amounts are included in selling,general and administrative expenses.

 

In addition,pursuant to the 401k Plan, employees who meet certain eligibility requirementsand who are not members of a collective bargaining unit may participate in theprofit sharing program. The Company’s profit sharing contributions to the 401kPlan are determined by the Compensation Committee of Sally Beauty’s board ofdirectors. Prior to the Separation Transactions, employees of the Companyparticipated in the Alberto-Culver Profit Sharing Plan. The Company’scontributions to the plan were determined at the discretion of theAlberto-Culver board of directors. The Company recognized expense of $6.2million, $8.6 million and $9.0 million in fiscal years 2007, 2006 and2005, respectively, related to these plans. These amounts are included inselling, general and administrative expenses.

 

## **14.  Income Taxes**

 

In conjunction with the Separation Transactions, SallyBeauty became a separate entity for tax reporting purposes. As described inNote 16, the Company has entered into a tax sharing agreement with its ultimateparent, Sally Beauty. Prior to the Separation Transactions, the Company wasincluded in the U.S. federal income tax return of Alberto-Culver.

 

The Company’s provision for income taxes is recordedon the basis of filing a separate return.

 

The provision for income taxes for the fiscal years2007, 2006 and 2005 consists of the following (in thousands):

 
| ** **                     | ** ** | **Year Ended September 30,** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|
| ** **                     | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Current:                       |       |                                        |       |   |   |   |   |
| Federal                        |       | $                                           | 30,538     |   | $ | 57,025 |   | $ | 57,244 |   |
| Foreign                        |       | 6,446                                       |       | 3,141 |   | 1,288 |   |
| State                          |       | 4,359                                       |       | 9,197 |   | 6,334 |   |
| Total current portion          |       | 41,343                                      |       | 69,363 |   | 64,866 |   |
| Deferred:                      |       |                                        |       |   |   |   |   |
| Federal                        |       | 778                                         |       | 1,053 |   | 7,319 |   |
| Foreign                        |       | (319                                        | )          | (255 | ) | 1,246 |   |
| State                          |       | (633                                        | )          | (245 | ) | (277 | ) |
| Total deferred portion         |       | (174                                        | )          | 553 |   | 8,288 |   |
| Total provision for income tax |       | $                                           | 41,169     |   | $ | 69,916 |   | $ | 73,154 |   |

 

The difference between theU.S. statutory federal income tax rate and the effective income tax rateis summarized below:

 
| ** **                                      | ** ** | **Year Ended September 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Statutory tax rate                              |       | 35.0                                        | %          | 35.0 | % | 35.0 | % |
| State income taxes, net of federal tax  benefit |       | 2.5                                         |       | 3.2 |   | 2.1 |   |
| Effect of foreign operations                    |       | (0.4                                        | )          | (0.1 | ) | 1.5 |   |
| Nondeductible transaction costs                 |       | 6.4                                         |       | — |   | — |   |
| Other, net                                      |       | 2.4                                         |       | 0.7 |   | — |   |
| Effective tax rate                              |       | 45.9                                        | %          | 38.8 | % | 38.6 | % |

 

The tax effects of temporarydifferences that give rise to the Company’s deferred tax assets and liabilitiesare as follows (in thousands):

 

F-21

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Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

| ** **                                | ** ** | **September 30,** | ** ** |
|-------------------------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Deferred tax assets attributable to:      |       |                   |       |   |   |
| Share-based compensation expense          |       | $                      | 7,497      |   | $ | 4,918 |   |
| Accrued expenses                          |       | 15,542                 |       | 7,770 |   |
| Inventory adjustments                     |       | 2,437                  |       | 2,557 |   |
| Foreign loss carryforwards                |       | 8,718                  |       | 7,303 |   |
| Long-term liabilities                     |       | 1,319                  |       | 1,621 |   |
| Other                                     |       | 1,439                  |       | — |   |
| Total deferred tax assets                 |       | 36,952                 |       | 24,169 |   |
| Valuation allowance                       |       | (9,823                 | )          | (6,977 | ) |
| Total deferred tax assets, net            |       | 27,129                 |       | 17,192 |   |
|                                      |       |                   |       |   |   |
| Deferred tax liabilities attributable to: |       |                   |       |   |   |
| Depreciation and amortization             |       | 42,391                 |       | 28,194 |   |
| Other income taxes                        |       | —                 |       | 261 |   |
| Total deferred tax liabilities            |       | 42,391                 |       | 28,455 |   |
| Net deferred tax liability                |       | $                      | 15,262     |   | $ | 11,263 |   |

 

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 adjustments inconnection with the reconciliation of tax balances transferred to the Companyin connection with the Separations Transactions. This amount was included inthe settlement of intercompany agreements with Alberto-Culver, as an adjustmentto the Company’s member’s deficit.

 

Domestic earnings before provision for income taxeswere $77.7 million, $174.6 million and $192.0 million in fiscal years2007, 2006 and 2005, respectively. Foreign operations had earnings beforeprovision for income taxes of $12.0 million in fiscal year 2007, earningsbefore provision for income taxes of $5.5 million in fiscal year 2006 anda loss before provision for income taxes of $2.4 million in fiscal year2005.

 

Tax reserves are evaluated and adjusted asappropriate, while taking into account the progress of audits of various taxingjurisdictions. Management does not expect the outcome of tax audits to have amaterial adverse effect on the Company’s financial condition, results ofoperations or cash flow.

 

## **Undistributedearnings of the Company’s foreign operations are intended to remain permanentlyinvested to finance anticipated future growth and expansion. Accordingly, noU.S. income taxes have been provided on those earnings atSeptember 30, 2007.**

##  

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 the Code. Inconnection with the share distribution of Alberto-Culver common stock in theSeparation Transactions, Sally Beauty received: (i) a private letterruling from the IRS; and (ii) an opinion of Sidley Austin LLP, counsel toAlberto-Culver, in each case, to the effect that the transactions qualify as areorganization under Section 368(a)(1)(D) of the Code and a distributioneligible for non-recognition under Sections 355(a) and 361(c) of the Code.Certain internal restructurings also occurred at or immediately prior to theSeparation Transactions. As a result of the internal restructurings andSeparation Transactions, Sally Beauty inherited the federal tax identificationnumber of the old Alberto-Culver parent for U.S. federal income tax purposes.

 

A tax allocation agreement was signed as part of theSeparation Transactions. The agreement provides generally that Sally Beauty andthe Company are responsible for the Company's pre-separation income taxliabilities, calculated on a stand-alone basis, and Alberto-Culver isresponsible for the remainder.

 

In addition Sally Beauty, as the successor entity toAlberto-Culver after the Separation Transactions, 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.

 

In the event an additional U.S federal income taxliability related to the period prior to the Separation Transactions weredetermined, Sally Beauty and the Company will be jointly and severally liablefor these taxes, and there can be no assurance that Alberto-Culver would beable to fulfill its indemnification obligations to Sally Beauty under the taxallocation agreement if Alberto-Culver was determined to be responsible forthese taxes thereunder.

 

F-22

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

The IRS has previously audited the consolidatedfederal income tax returns of Alberto-Culver through the fiscal year endingSeptember 30, 2004. The Company has not recorded a reserve for Alberto-Culverrelated liability because the Company believes any exposure is immaterial.

 

## **15.  Acquisitions**

 

On February 15, 2007, the Company entered intoand completed an Agreement for the Sale and Purchase of the Entire Issued ShareCapital of Chapelton 21 Limited (the “Agreement”), a private company limited byshares and incorporated in Scotland (“Salon Services”) by and among OgeeLimited, an indirect subsidiary of the Company, and the registered shareholdersof Salon Services. Pursuant to the Agreement, the Company acquired all of theissued share capital of Salon Services for an aggregate cash purchase price ofapproximately $57.7 million. Certain of the Company’s subsidiariesfinanced the purchase price through a draw down of approximately $57.0 millionunder the ABL facility. In addition, the Company extinguished approximately$3.9 million of Salon Services’ debt. Salon Services, through its directand indirect subsidiaries including Salon Services (Hair and Beauty Supplies)Ltd., supplies professional hair and beauty products primarily to salon and spaoperators and independent hair and beauty professionals in the United Kingdom,Germany, Ireland, Spain and Norway. Goodwill of $29.3 million and certainidentifiable intangible assets of $17.6 million were recorded as a result ofacquisition and are not expected to be deductible for tax purposes. Of thisamount, $14.4 million was assigned to registered trade names and $3.2 millionto other identifiable intangible assets, which will be amortized over aweighted average life of approximately five years. The acquisition wasaccounted for using the purchase method and, accordingly, the results ofoperations of Salon Services have been included in the consolidated financialstatements from the date of acquisition. Salon Services is included in theSally Beauty Supply segment. Pro-forma information for Salon Services is notprovided since it is not material to the Company’s consolidated results ofoperations. The purchase price of Salon Services has been allocated to assetsacquired and liabilities assumed based on their estimated fair values at thedate of acquisition. We expect that the final valuation of the acquired assetsand liabilities will be completed during fiscal year 2008.

 

In addition, during fiscal year 2007 the Company madefive other acquisitions, which were accounted for using the purchase method.None of these acquisitions individually had a material impact on the Company’sconsolidated results of operations. The results of operations for one of theacquisitions are included in the Sally Beauty Supply segment. Such acquisitionincluded the recording of: (i) goodwill in the amount of $1.5 million; and (ii)certain intangible assets of $0.6 million. The results of operations for theremaining acquisitions are included in the BSG segment, and these acquisitionsincluded the recording of: (i) goodwill in the amount of $3.7 million; and (ii)certain intangible assets of $1.4 million. The intangible assets will beamortized over a weighted average life of approximately one year. We expectthat the final valuation of the acquired assets and liabilities related tothese transactions will be completed during fiscal year 2008.

 

On June 8, 2006, the Company acquired SalonSuccess, a U.K. based distributor of professional beauty products, in order toexpand the geographic area served by BSG, for a total purchase price as ofSeptember 30, 2007, of $23.2 million. Approximately $1.8 million ofthe purchase 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, 2007, approximately $1.2 million has been paidpursuant 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. Theacquisition was accounted for using the purchase method and, accordingly, theresults of operations of Salon Success have been included in the consolidatedfinancial statements from the date of acquisition. Salon Success is included inthe BSG segment. Pro-forma information for Salon Success is not provided sinceit is not material to the Company’s consolidated results of operations. Thepurchase price of Salon Success has been allocated to assets acquired andliabilities assumed based on their estimated fair values at the date ofacquisition.

 

On December 31, 2004, the Company acquiredInnovation Successful Salon Services, Inc., XRG Enterprises, Inc., ArtisticSalon Services, Inc., and Pacific Salon Services, Inc., full-servicedistributors of professional beauty products under common ownership(collectively referred to as CosmoProf), in order to continue to expand thegeographic area served by Beauty Systems Group. The acquisition was accountedfor using the purchase method and, accordingly, the results of operations ofCosmoProf have been included in the consolidated financial statements from thedate of acquisition. CosmoProf is included in the BSG segment. The followingtable provides pro forma results for the fiscal year ended September 30,2005 as if CosmoProf had been acquired on October 1, 2004 (in thousands).Anticipated cost savings and other effects of the integration of CosmoProf arenot included in the pro forma results. 

 

| ** **             | ** ** | **2005** | ** ** |
|------------------------|------------|----------|------------|
| Pro-forma net sales    |       | $        | 2,278,690  |   |
| Pro-forma net earnings |       | 114,373  |       |
|                        |            |          |            |  |

 

## **Thevaluation of identifiable intangible assets of Salon Services, Salon Successand CosmoProf was determined using discounted cash flow methods with theassistance of third party valuation experts. The acquired entities have beenaccounted for using the purchase**

 

F-23

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

## **methodof accounting and, accordingly, the results of operations of the entities havebeen included in the consolidated financial statements since their respectivedates of acquisition.**

 

## **16.  Related Party Transactions**

 

On January 1, 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 of certain key employees’ salaries andbenefits, is approximately $88,000 per month, and totaled approximately $1.0million for fiscal year 2007. The cost of these services may notnecessarily be indicative of the costs which would be incurred by Sally Beautyas an independent stand alone entity.

 

As described more fully in Note 5, certain employeesof the Company have been granted stock options and share awards undershare-based compensation plans of Sally Beauty.

 

The Company has entered into a tax sharing agreementwith its parent, Sally Beauty. In accordance with this tax sharing agreement,Sally Beauty shall cause each of its subsidiaries that are eligible to be amember of the relevant combined tax group to join in filing a combined taxreturn with respect to each jurisdiction for all tax years for which suchsubsidiary is eligible to do so under the applicable tax law. Sally Beautyshall make all payments to the applicable taxing authority of all combinedtaxes that the 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. TheCompany’s provision for income taxes is recorded on the basis of filing aseparate income tax return. Income taxes currently payable or receivable underthe consolidated income tax returns are paid to or received from Sally Beauty.

 

As of September 30, 2007, the Company had a netintercompany payable to Sally Beauty of approximately $18.9 million. Thisconsists primarily of income tax and share-based compensation expenses, whichare partially offset by general and administrative services provided to SallyBeauty.

 

Prior to the Separation Transactions, the Companyconducted business with, and/or had transactions with, Alberto-Culver and itssubsidiaries.

 

In connection with the Separation Transactions, theCompany terminated substantially all intercompany agreements withAlberto-Culver and its subsidiaries. All intercompany receivables, payables andloans between the Company, on the one hand, and Alberto-Culver and itssubsidiaries, on the other hand, other than those specifically designated tosurvive following the Separation Transactions, were cancelled. In addition,Sally Beauty became the parent company for all U.S. tax returns which werefiled under the employer identification number of Alberto-Culver prior to thecompletion of the Separation Transactions.

 

In fiscal years 2007, 2006 and 2005, the Companypurchased inventory from Alberto-Culver of approximately $3.7 million,$26.9 million and $28.3 million, respectively.

 

Current income taxes payable of approximately$54.4 million at September 30, 2006 were netted against the amountsdue from Alberto-Culver in the accompanying consolidated balance sheets, asAlberto-Culver made income tax payments on behalf of the Company for primarilyall of the Company’s tax liabilities.

 

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 and administrativeexpenses in the consolidated statements of earnings. In addition, certainsubsidiaries of the Company had entered into consulting, business development,and advisory services agreements with Alberto-Culver, pursuant to whichAlberto-Culver charged a sales-based service fee.

 

Costs for certain administrative services and othercorporate functions and direct expenses incurred on behalf of the Company wereallocated by Alberto-Culver to the Company based on the most relevantallocation method to the specific costs being allocated, and totaled $1.0million, $13.5 million and $13.3 million in fiscal years 2007, 2006and 2005, respectively. These amounts are classified as part of unallocatedexpenses for the Company’s segment reporting purposes in Note 17. Thecosts for direct expenses incurred on behalf of the Company and certainadministrative services and corporate functions were allocated based onspecific 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 2007,2006 and

 

F-24

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

2005, the costs incurred for administrative servicesand certain other corporate functions and direct expenses incurred on behalf ofthe Company would have been approximately the same as the amount charged byAlberto-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. The sales-basedservice fees totaled $3.8 million, $28.9 million and $27.6 million infiscal years 2007, 2006 and 2005, respectively. Management believes that hadthe Company been operating as a stand-alone entity not affiliated withAlberto-Culver during the fiscal years 2007, 2006 and 2005, the Company likelywould not have needed to engage any third party or incur additional costs as astand-alone company for the services provided to its subsidiaries under theseagreements.

 

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, 2006 and 2005, the Company paid $4.8 million,$5.7 million and $11.8 million, respectively, to Alberto-Culver inconnection with this agreement.

 

The Company had various notes payable and borrowingsunder revolving credit facilities with affiliated companies atSeptember 30, 2005. All notes payable to affiliated companies weresubsequently repaid in December, 2005. These borrowings bore interest at marketrates and interest expense was approximately $0.4 million and$2.5 million for fiscal years 2006 and 2005, respectively.

 

The Company had a note receivable and receivablesunder a credit facility with an affiliated company at September 30, 2005.All notes receivables from affiliated companies were subsequently repaid inDecember, 2005. These receivables bore interest at market rates and theinterest income was approximately $0.1 million and $0.7 million forfiscal years 2006 and 2005, respectively.

 

## **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.

 

##### ***BusinessSegments Information***

 

Segment data for the fiscal years endedSeptember 30, 2007, 2006 and 2005 is as follows (in thousands):

 

F-25

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

| ** **                                                                                | ** ** | **Year Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales:                                                                                |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | $                                           | 1,567,365  |   | $ | 1,419,332 |   | $ | 1,358,899 |   |
| BSG                                                                                       |       | 946,407                                     |       | 953,768 |   | 895,408 |   |
| Total                                                                                     |       | $                                           | 2,513,772  |   | $ | 2,373,100 |   | $ | 2,254,307 |   |
| Earnings before provision for income taxes:                                               |       |                                        |       |   |   |   |   |
| Segment operating profit:                                                                 |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | $                                           | 273,364    |   | $ | 235,419 |   | $ | 222,679 |   |
| BSG                                                                                       |       | 64,652                                      |       | 88,445 |   | 71,210 |   |
| Segment operating profit                                                                  |       | 338,016                                     |       | 323,864 |   | 293,889 |   |
| Unallocated expenses(a)                                                                   |       | (64,766                                     | )          | (68,150 | ) | (69,642 | ) |
| Share-based compensation expense                                                          |       | (12,267                                     | )          | (5,186 | ) | — |   |
| Non-cash charge related to Alberto-Culver’s  conversion to one class of common stock |       | —                                      |       | — |   | (4,051 | ) |
| Sales based service fee charges by  Alberto-Culver                                        |       | (3,779                                      | )          | (28,852 | ) | (27,615 | ) |
| Transaction expenses (b)                                                                  |       | (21,502                                     | )          | (41,475 | ) | — |   |
| Interest expense, net of interest income                                                  |       | (145,972                                    | )          | (92 | ) | (2,966 | ) |
| Total                                                                                     |       | $                                           | 89,730     |   | $ | 180,109 |   | $ | 189,615 |   |
| Identifiable assets:                                                                      |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | $                                           | 555,252    |   | $ | 448,737 |   | $ | 418,942 |   |
| BSG                                                                                       |       | 757,276                                     |       | 759,714 |   | 715,986 |   |
| Sub-total                                                                                 |       | 1,312,528                                   |       | 1,208,451 |   | 1,134,928 |   |
| Shared services                                                                           |       | 91,733                                      |       | 119,600 |   | 56,345 |   |
| Other corporate(c)                                                                        |       | —                                      |       | 10,790 |   | 34,234 |   |
| Sub-total                                                                                 |       | 91,733                                      |       | 130,390 |   | 90,579 |   |
| Total                                                                                     |       | $                                           | 1,404,261  |   | $ | 1,338,841 |   | $ | 1,225,507 |   |
| Depreciation and amortization:                                                            |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | $                                           | 20,377     |   | $ | 18,762 |   | $ | 17,065 |   |
| BSG                                                                                       |       | 17,686                                      |       | 14,872 |   | 13,287 |   |
| Corporate                                                                                 |       | 4,542                                       |       | 4,398 |   | 3,554 |   |
| Total                                                                                     |       | $                                           | 42,605     |   | $ | 38,032 |   | $ | 33,906 |   |
| Capital expenditures:                                                                     |       |                                        |       |   |   |   |   |
| Sally Beauty Supply                                                                       |       | $                                           | 20,831     |   | $ | 19,493 |   | $ | 16,235 |   |
| BSG                                                                                       |       | 27,941                                      |       | 8,748 |   | 12,703 |   |
| Corporate                                                                                 |       | 4,573                                       |       | 2,101 |   | 23,298 |   |
| Total                                                                                     |       | $                                           | 53,345     |   | $ | 30,342 |   | $ | 52,236 |   |

 

----

| (a)    | Unallocated expenses  consist of corporate and shared costs. The amounts include $1.0 million,  $13.5 million and $13.3 million of overhead charges allocated from  Alberto-Culver for fiscal years 2007, 2006 and 2005, respectively.                     |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                       |
| (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. 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.                                                                                                      |

 

##### ***GeographicArea Information***

 

Geographic data for the fiscal years endedSeptember 30, 2007, 2006 and 2005is as follows (in thousands):

 

F-26

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 
| ** **           | ** ** | **Year Ended September 30,** | ** ** |
|----------------------|------------|---------------------------------------------|------------|
| ** **           | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales:(a)        |       |                                        |       |   |   |   |   |
| United States        |       | $                                           | 2,110,864  |   | $ | 2,106,525 |   | $ | 2,007,947 |   |
| Foreign              |       | 402,908                                     |       | 266,575 |   | 246,360 |   |
| Total                |       | $                                           | 2,513,772  |   | $ | 2,373,100 |   | $ | 2,254,307 |   |
| Identifiable assets: |       |                                        |       |   |   |   |   |
| United States        |       | $                                           | 972,094    |   | $ | 994,551 |   | $ | 963,528 |   |
| Foreign              |       | 340,434                                     |       | 213,900 |   | 171,400 |   |
| Shared services      |       | 91,733                                      |       | 119,600 |   | 56,345 |   |
| Other corporate(b)   |       | —                                      |       | 10,790 |   | 34,234 |   |
| Total                |       | $                                           | 1,404,261  |   | $ | 1,338,841 |   | $ | 1,225,507 |   |

 

----

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

 

## **18.  Guarantor and Non-Guarantor Condensed Consolidated Financial Statements**

 

The following condensed consolidating financialinformation presents the Condensed Consolidated Balance Sheets as of September30, 2007 and September 30, 2006, the Condensed Consolidated Statements ofEarnings for the years ended September 30, 2007, 2006 and 2005, and theCondensed Consolidated Statements of Cash Flows for the years ended September30, 2007, 2006 and 2005 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 to consolidatethe Parent with the guarantor and non-guarantor subsidiaries; and (vi) theParent on a consolidated basis.

 

Investments in subsidiaries are accounted for usingthe equity method for purposes of the consolidating presentation. The principalelimination entries relate to investments in subsidiaries and intercompanybalances and transactions. Separate financial statements and other disclosureswith respect to the subsidiary guarantors have not been provided as managementbelieves the following information is sufficient, as guarantor subsidiaries are100 percent indirectly owned by the Parent and all guarantees are full andunconditional. Additionally, substantially all of the assets of the guarantorsubsidiaries are pledged under the term loan facilities and the ABL facilityand consequently may not be available to satisfy the claims of generalcreditors.

 

F-27

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

**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-28

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

**SALLY HOLDINGS, INC. AND SUBSIDIARIES**

CondensedConsolidated Balance Sheet

September 30,2006

(Inthousands)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings,  Inc. &  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-----------------------------------------------------|------------|
| **Assets**                                                                  |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Cash and cash equivalents                                                   |       | $          | 53,792     |          | $          | —                      |       | $                                 | 36,634     |             | $          | 17,145                                              |       | $ | — |   | $ | 107,571 |   |
| Trade accounts and other receivables, less  allowance for doubtful accounts |       | 38         |       | —        |       | 54,730                      |       | 11,922                            |       | —           |       | 66,690                                              |       |
| Due from affiliates                                                         |       | 300,737    |       | —        |       | 73,860                      |       | 12,775                            |       | (387,372         | )          | —                                              |       |
| Inventories                                                                 |       | —     |       | —        |       | 479,122                     |       | 95,861                            |       | —           |       | 574,983                                             |       |
| Prepaid expenses and other                                                  |       | —     |       | —        |       | 8,338                       |       | 10,266                            |       | —           |       | 18,604                                              |       |
| Deferred income tax assets                                                  |       | —     |       | —        |       | 13,549                      |       | (3,222                            | )          | —           |       | 10,327                                              |       |
| Property and equipment, net                                                 |       | —     |       | —        |       | 113,892                     |       | 28,843                            |       | —           |       | 142,735                                             |       |
| Investment in subsidiaries                                                  |       | 658,928    |       | —        |       | 78,697                      |       | —                            |       | (737,625         | )          | —                                              |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | —        |       | 357,696                     |       | 60,235                            |       | —           |       | 417,931                                             |       |
| Total assets                                                                |       | $          | 1,013,495  |          | $          | —                      |       | $                                 | 1,216,518  |             | $          | 233,825                                             |       | $ | (1,124,997 | ) | $ | 1,338,841 |   |
|                                                                        |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| **Liabilities and Stockholder’s Equity**                               |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Accounts payable                                                            |       | $          | —     |          | $          | —                      |       | $                                 | 147,556    |             | $          | 29,067                                              |       | $ | — |   | $ | 176,623 |   |
| Due to affiliates                                                           |       | —     |       | —        |       | 279,820                     |       | 107,552                           |       | (387,372         | )          | —                                              |       |
| Accrued expenses                                                            |       | —     |       | —        |       | 98,057                      |       | 15,999                            |       | —           |       | 114,056                                             |       |
| Long-term debt                                                              |       | —     |       | —        |       | 603                         |       | 521                               |       | —           |       | 1,124                                               |       |
| Other liabilities                                                           |       | —     |       | —        |       | 9,122                       |       | 2,831                             |       | —           |       | 11,953                                              |       |
| Deferred income tax liabilities                                             |       | —     |       | —        |       | 22,432                      |       | (842                              | )          | —           |       | 21,590                                              |       |
| Total liabilities                                                           |       | —     |       | —        |       | 557,590                     |       | 155,128                           |       | (387,372         | )          | 325,346                                             |       |
| Stock options subject to redemption                                         |       | 7,528      |       | —        |       | —                      |       | —                            |       | —           |       | 7,528                                               |       |
| Total stockholder’s equity                                             |       | 1,005,967  |       | —        |       | 658,928                     |       | 78,697                            |       | (737,625         | )          | 1,005,967                                           |       |
| Total liabilities stockholder’s equity                                 |       | $          | 1,013,495  |          | $          | —                      |       | $                                 | 1,216,518  |             | $          | 233,825                                             |       | $ | (1,124,997 | ) | $ | 1,338,841 |   |

 

F-29

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

**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 |   |

 

F-30

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

**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 |   |

 

F-31

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

**SALLY HOLDINGS, INC. AND SUBSIDIARIES**

CondensedConsolidated Statement of Earnings

FiscalYear Ended September 30, 2005

(Inthousands)

 
| ** **                                                                                | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings,  Inc. &  Subsidiaries** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-----------------------------------------------------|------------|
|                                                                                      |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Net sales                                                                                 |       | $          | —     |          | $          | —                      |       | $                                 | 1,979,674  |             | $          | 274,633                                             |       | $ | — |   | $ | 2,254,307 |   |
| Related party sales                                                                       |       | —     |       | —        |       | 2,380                       |       | —                            |       | (2,380           | )          | —                                              |       |
| Cost of products sold and distribution  expenses                                          |       | —     |       | —        |       | 1,067,595                   |       | 162,092                           |       | (2,380           | )          | 1,227,307                                           |       |
| Gross profit                                                                              |       | —     |       | —        |       | 914,459                     |       | 112,541                           |       | —           |       | 1,027,000                                           |       |
| Selling, general and administrative  expenses                                             |       | 2          |       | —        |       | 660,940                     |       | 107,905                           |       | —           |       | 768,847                                             |       |
| Depreciation and amortization                                                             |       | —     |       | —        |       | 27,326                      |       | 6,580                             |       | —           |       | 33,906                                              |       |
| Sales-based service fee charged by  Alberto-Culver                                        |       | —     |       | —        |       | 27,615                      |       | —                            |       | —           |       | 27,615                                              |       |
| Non-cash charge related to Alberto-Culver’s  conversion to one class of common stock |       | —     |       | —        |       | 3,861                       |       | 190                               |       | —           |       | 4,051                                               |       |
| Operating earnings (loss)                                                                 |       | (2         | )          | —        |       | 194,717                     |       | (2,134                            | )          | —           |       | 192,581                                             |       |
| Interest income                                                                           |       | (20,895    | )          | —        |       | (1,009                      | )          | (89                               | )          | 20,850           |       | (1,143                                              | )          |
| Interest expense                                                                          |       | —     |       | —        |       | 21,926                      |       | 3,033                             |       | (20,850          | )          | 4,109                                               |       |
| Earnings (losses) before provision for  income taxes                                      |       | 20,893     |       | —        |       | 173,800                     |       | (5,078                            | )          | —           |       | 189,615                                             |       |
| Provision for income taxes                                                                |       | 7,429      |       | —        |       | 63,823                      |       | 1,902                             |       | —           |       | 73,154                                              |       |
| Equity in earnings (loss) of subsidiaries  (net of tax)                                   |       | 102,997    |       | —        |       | (6,980                      | )          | —                            |       | (96,017          | )          | —                                              |       |
| Net earnings                                                                              |       | $          | 116,461    |          | $          | —                      |       | $                                 | 102,997    |             | $          | (6,980                                              | )          | $ | (96,017 | ) | $ | 116,461 |   |

 

F-32

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Statement of Cash Flows

FiscalYear Ended September 30, 2007

(Inthousands)

 
| ** **                                                             | ** ** | **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 |   |

 

F-33

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

**SALLY HOLDINGS, INC. AND SUBSIDIARIES**

CondensedConsolidated Statement of Cash Flows

FiscalYear Ended September 30, 2006

(Inthousands)

 
| ** **                                                             | ** ** | **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-34

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 

**SALLY HOLDINGS, INC. AND SUBSIDIARIES**

CondensedConsolidated Statement of Cash Flows

FiscalYear Ended September 30, 2005

(Inthousands)

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings,  Inc. &  Subsidiaries** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-----------------------------------------------------|------------|
|                                                                   |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| **Net cash provided (used) by operating  activities**                  |       | $          | 95,095     |          | $          | —                      |       | $                                 | 54,963     |             | $          | (34,603                                             | )          | $ | — |   | $ | 115,455 |   |
|                                                                   |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| **Cash Flows from Investing Activities:**                              |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Proceeds from sales of short-term  investments                         |       | —     |       | —        |       | 44,600                      |       | —                            |       | —           |       | 44,600                                              |       |
| Payments for purchases of short-term  investments                      |       | —     |       | —        |       | (22,050                     | )          | —                            |       | —           |       | (22,050                                             | )          |
| Capital expenditures and proceeds from sale  of property and equipment |       | —     |       | —        |       | (42,529                     | )          | (9,148                            | )          | —           |       | (51,677                                             | )          |
| Acquisitions, net of cash acquired                                     |       | —     |       | —        |       | (95,746                     | )          | (1,172                            | )          | —           |       | (96,918                                             | )          |
| Net cash used by investing activities                                  |       | —     |       | —        |       | (115,725                    | )          | (10,320                           | )          | —           |       | (126,045                                            | )          |
|                                                                   |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| **Cash Flows from Financing Activities:**                              |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Change in book cash overdraft                                          |       | —     |       | —        |       | 15,386                      |       | —                            |       | —           |       | 15,386                                              |       |
| Proceeds from issuance of long-term debt                               |       | —     |       | —        |       | 40,228                      |       | —                            |       | —           |       | 40,228                                              |       |
| Repayments of long-term debt                                           |       | —     |       | —        |       | (40,269                     | )          | —                            |       | —           |       | (40,269                                             | )          |
| Proceeds related to notes with affiliates                              |       | —     |       | —        |       | 52,677                      |       | 47,684                            |       | (48,080          | )          | 52,281                                              |       |
| Payments related to notes with affiliates                              |       | (100,133   | )          | —        |       | —                      |       | —                            |       | 48,080           |       | (52,053                                             | )          |
| Distributions to Alberto-Culver                                        |       | (11,836    | )          | —        |       | —                      |       | —                            |       | —           |       | (11,836                                             | )          |
| Net cash provided (used) by financing  activities                      |       | (111,969   | )          | —        |       | 68,022                      |       | 47,684                            |       | —           |       | 3,737                                               |       |
|                                                                   |       |       |       |          |       |                        |       |                              |       |             |       |                                                |       |
| Effect of foreign exchange rate changes on  cash and cash equivalents  |       | —     |       | —        |       | 1,646                       |       | (1,634                            | )          | —           |       | 12                                                  |       |
| Net (decrease) increase in cash and cash  equivalents                  |       | (16,874    | )          | —        |       | 8,906                       |       | 1,127                             |       | —           |       | (6,841                                              | )          |
| Cash and cash equivalents, beginning of  period                        |       | 16,936     |       | —        |       | 20,113                      |       | 8,404                             |       | —           |       | 45,453                                              |       |
| Cash and cash equivalents, end of period                               |       | $          | 62         |          | $          | —                      |       | $                                 | 29,019     |             | $          | 9,531                                               |       | $ | — |   | $ | 38,612 |   |

 

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

 

Unaudited quarterly consolidated statement of earningsinformation for the fiscal years ended September 30, 2007 and 2006 issummarized below (in thousands):

 

F-35

----

 

Sally Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

 
| **Fiscal Year** | ** ** | **1st  Quarter** | ** ** | **2nd  Quarter** | ** ** | **3rd  Quarter** | ** ** | **4th  Quarter** | ** ** |
|----------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| 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 |   |
|                 |       |             |       |             |       |             |       |             |       |
| 2006:                |       |             |       |             |       |             |       |             |       |
| Net sales            |       | $                | 586,355    |             | $          | 581,101          |       | $                | 599,534    |   | $ | 606,110 |   |
| Gross profit         |       | $                | 266,868    |             | $          | 269,959          |       | $                | 276,407    |   | $ | 273,537 |   |
| Net earnings         |       | $                | 33,804     |             | $          | 31,175           |       | $                | 14,551     |   | $ | 30,663 |   |

 

F-36

----