**Table ofContents**

 

 

 

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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| **x** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

**FOR THEQUARTERLY PERIOD ENDED: DECEMBER 31, 2009**

 

**-OR-**

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

 

**CommissionFile No. 333-144427**

 

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**SALLYHOLDINGS LLC**

(Exact name ofregistrant as specified in its charter)

 

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| **Delaware**

(State or other  jurisdiction of  incorporation or organization)               | ** ** | **36-4472381**

(I.R.S. Employer  Identification  No.) |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|
| ** **                                                                                   | ** ** | ** **                                             |
| **3001  Colorado Boulevard**

**Denton,  Texas**

(Address of  principal executive  offices) | ** ** | **76210**

(zip code)                                  |

 

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

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  YES x  NO o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files).  Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act.) YES o  NO x

 

Novoting or non-voting common equity of the registrant was held by non-affiliatesof the registrant as of December 31, 2009. As of January 31, 2010, all member units were owned by SallyInvestment Holdings LLC, a wholly-owned subsidiary of Sally Beauty Holdings, Inc.

 

 

 

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**TABLE OF CONTENTS**

 
| ** **                                                                                                | ** ** | **Page** |
|-----------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                      |       |     |
| PART I — FINANCIAL INFORMATION                                                                  |       |     |
|                                                                                                      |       |     |
| ITEM 1.  FINANCIAL STATEMENTS                                                                        |       | 5        |
| ITEM 2.  MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |       | 30       |
| ITEM 3.  QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |       | 44       |
| ITEM 4.  CONTROLS  AND PROCEDURES                                                                    |       | 45       |
|                                                                                                      |       |     |
| PART II  — OTHER INFORMATION                                                                    |       |     |
|                                                                                                      |       |     |
| ITEM  1.  LEGAL PROCEEDINGS                                                                          |       | 47       |
| ITEM  1A.  RISK FACTORS                                                                              |       | 47       |
| ITEM 2.  UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                |       | 48       |
| ITEM 3.  DEFAULTS  UPON SENIOR SECURITIES                                                            |       | 48       |
| ITEM 4.  SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        |       | 48       |
| ITEM  5.  OTHER INFORMATION                                                                          |       | 48       |
| ITEM 6.  EXHIBITS                                                                                    |       | 49       |

 

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Since November 2006, Sally Holdings LLC, which werefer to as “Sally Holdings,” a limited liability company organized under thelaws of the State of Delaware, has been a wholly-owned subsidiary of SallyInvestment Holdings LLC, which we refer to as “Sally Investment,” awholly-owned subsidiary of Sally Beauty Holdings, Inc., which we refer toas “Sally Beauty.” 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 2006, Sally Holdings was a Delaware corporationnamed “Sally Holdings, Inc.” and was a wholly-owned subsidiary of Alberto-CulverCompany, which we refer to as “Alberto-Culver.” In November 2006, SallyHoldings, 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.

 

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

 

Cautionary Notice Regarding Forward-Looking Statements

 

Statements in this Quarterly Report on Form 10-Qand the documents incorporated by reference herein which are not purelyhistorical facts or which depend upon future events may be forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended, which we refer to as the Exchange Act. Words such as “anticipate,” “believe,”“estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,”“should,” “will,” “would” or similar expressions may also identify suchforward-looking statements.

 

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

 

·                  the highlycompetitive nature of, and the increasing consolidation of, the beauty productsdistribution industry;

 

·                  anticipatingchanges in consumer preferences and buying trends and managing our productlines and inventory;

 

·                  potentialfluctuation in our same store sales and quarterly financial performance;

 

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

 

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

 

·                  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, L.P. (“Armstrong McCall”)business;

 

·                  the success ofour new internet-based business;

 

·                  successfullyidentifying acquisition candidates or successfully completing desirableacquisitions;

 

·                  integratingbusinesses acquired in the future;

 

·                  opening andoperating new stores profitably;

 

·                  the impact of acontinued downturn in the economy upon our business;

 

·                  the success ofour cost control plans;

 

·                  protecting ourintellectual property rights, specifically our trademarks;

 

·                  conductingbusiness outside the United States;

 

·                  disruption inour information technology systems;

 

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·                  naturaldisasters or acts of terrorism;

 

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

 

·                  Sally CapitalInc. and Sally Holdings being holding companies, with no operations of theirown, and depending on their subsidiaries for cash;

 

·                  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 potentialimpact on us if the financial institutions we deal with become impaired;

 

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

 

·                  our relianceupon Alberto-Culver for the accuracy of certain historical services andinformation;

 

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

 

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

 

·                  the voting 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.

 

Additional factors that could cause actual events orresults to differ materially from the events or results described in theforward-looking statements can be found in our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2009, as filed with the Securitiesand Exchange Commission. The events described in the forward-looking statementsmight not occur or might occur to a different extent or at a different timethan we have described. As a result, our actual results may differ materiallyfrom the results contemplated by these forward-looking statements. We assume noobligation to publicly update or revise any forward-looking statements.

 

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**PART I — FINANCIALINFORMATION**

** **

**Item 1.  Financial Statements.**

# ** **

The following are our consolidated balance sheets as of December 31,2009 and September 30, 2009, and our consolidated statements of earningsand our consolidated statements of cash flows for the three months ended December 31,2009 and 2008.  In November 2006, SallyHoldings, Inc. was converted to a Delaware limited liability company, wasrenamed “Sally Holdings LLC” and became an indirect wholly-owned subsidiary ofSally Beauty Holdings, Inc. in connection with our separation fromAlberto-Culver.  In these financialstatements and elsewhere in this Quarterly Report on Form 10-Q, we referto these transactions as the Separation Transactions.  See the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2009 for additional informationabout the Separation Transactions.

 

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**SALLYHOLDINGS LLC AND SUBSIDIARIES**Consolidated Statements of Earnings (In thousands)

(Unaudited)

 
| ** **                                       | ** ** | **Three Months Ended  December 31,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| Net  sales                                       |       | $                                         | 704,851    |   | $ | 645,576 |   |
| Cost  of products sold and distribution expenses |       | 371,637                                   |       | 342,032 |   |
| Gross  profit                                    |       | 333,214                                   |       | 303,544 |   |
| Selling,  general and administrative expenses    |       | 248,740                                   |       | 223,537 |   |
| Depreciation  and amortization                   |       | 11,889                                    |       | 11,747 |   |
| Operating  earnings                              |       | 72,585                                    |       | 68,260 |   |
| Interest  expense, net                           |       | 28,451                                    |       | 39,673 |   |
| Earnings  before provision for income taxes |       | 44,134                                    |       | 28,587 |   |
| Provision  for income taxes                      |       | 16,773                                    |       | 11,380 |   |
| Net  earnings                                    |       | $                                         | 27,361     |   | $ | 17,207 |   |

 

The accompanying condensed notes, together with theNotes to Consolidated Financial Statements contained in the Company’s AnnualReport on Form 10-K for the fiscal year ended September 30, 2009, are anintegral part of these financial statements.

 

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**SALLYHOLDINGS LLC AND SUBSIDIARIES**Consolidated Balance Sheets(In thousands)

 
| ** **                                                                                                                             | ** ** | **December 31,********2009** | ** ** | **September 30,********2009** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **(Unaudited)**                   | ** ** | ** **                         | ** ** |
| **Assets**                                                                                                                             | ** ** |                              | ** ** | ** **                         | ** ** |
| Current assets:                                                                                                                        |       |                              |       |                               |       |
| Cash and cash equivalents                                                                                                              |       | $                                 | 31,789     |                               | $          | 54,447 |   |
| Trade accounts receivable, less allowance for  doubtful accounts of $2,459 at December 31, 2009 and $2,266 at  September 30, 2009 |       | 44,434                            |       | 43,649                             |       |
| Other receivables                                                                                                                      |       | 36,291                            |       | 24,090                             |       |
| Inventories                                                                                                                            |       | 579,220                           |       | 559,689                            |       |
| Prepaid expenses                                                                                                                       |       | 18,311                            |       | 18,261                             |       |
| Deferred income tax assets                                                                                                             |       | 15,656                            |       | 15,629                             |       |
| Total current assets                                                                                                                   |       | 725,701                           |       | 715,765                            |       |
| Property and equipment, net of accumulated  depreciation of $274,176 at December 31, 2009 and $265,329 at September 30,  2009          |       | 165,444                           |       | 151,249                            |       |
| Goodwill                                                                                                                               |       | 488,874                           |       | 494,135                            |       |
| Intangible assets, net of accumulated amortization  of $26,268 at December 31, 2009 and $24,357 at September 30, 2009        |       | 98,965                            |       | 78,685                             |       |
| Other assets                                                                                                                           |       | 48,763                            |       | 50,676                             |       |
| Total assets                                                                                                                           |       | $                                 | 1,527,747  |                               | $          | 1,490,510 |   |
| **Liabilities and Member’s Deficit**                                                                                              |       |                              |       |                               |       |
| Current liabilities:                                                                                                                   |       |                              |       |                               |       |
| Current maturities of long-term debt                                                                                                   |       | $                                 | 26,476     |                               | $          | 24,517 |   |
| Accounts payable                                                                                                                       |       | 196,495                           |       | 193,592                            |       |
| Accrued expenses                                                                                                                       |       | 128,626                           |       | 153,842                            |       |
| Due to Sally Beauty                                                                                                                    |       | 36,248                            |       | 22,042                             |       |
| Income taxes                                                                                                                           |       | 6,736                             |       | 5,829                              |       |
| Total current liabilities                                                                                                              |       | 394,581                           |       | 399,822                            |       |
| Long-term debt                                                                                                                         |       | 1,664,712                         |       | 1,653,013                          |       |
| Other liabilities                                                                                                                      |       | 42,647                            |       | 43,586                             |       |
| Deferred income tax liabilities                                                                                                        |       | 36,394                            |       | 34,428                             |       |
| Total liabilities                                                                                                                      |       | 2,138,334                         |       | 2,130,849                          |       |
| Stock options subject to redemption                                                                                                    |       | 1,800                             |       | 1,800                              |       |
| Member’s deficit:                                                                                                                 |       |                              |       |                               |       |
| Member’s deficit                                                                                                                  |       | (598,880                          | )          | (626,241                           | )          |
| Accumulated other comprehensive loss                                                                                                   |       | (13,507                           | )          | (15,898                            | )          |
| Total member’s deficit                                                                                                            |       | (612,387                          | )          | (642,139                           | )          |
| Total liabilities and member’s deficit                                                                                            |       | $                                 | 1,527,747  |                               | $          | 1,490,510 |   |

 

The accompanying condensed notes, togetherwith the Notes to Consolidated Financial Statements contained in the Company’sAnnual Report on Form 10-K for the fiscal year ended September 30, 2009, are anintegral part of these financial statements.

 

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**SALLYHOLDINGS LLC AND SUBSIDIARIES**Consolidated Statements of Cash Flows(In thousands)

(Unaudited)

 
| ** **                                                                                           | ** ** | **Three Months Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2009**                                                | ** ** | **2008** | ** ** |
| **Cash Flows from Operating  Activities:**                                                           |       |                                                    |       |   |   |
| Net earnings                                                                                         |       | $                                                       | 27,361     |   | $ | 17,207 |   |
| Adjustments to reconcile net earnings to net cash  provided by operating activities:                 |       |                                                    |       |   |   |
| Depreciation and amortization                                                                        |       | 11,889                                                  |       | 11,747 |   |
| Share-based compensation expense (net of deferred  tax benefit of $1,773 in 2009 and $1,322 in 2008) |       | 3,050                                                   |       | 2,146 |   |
| Amortization of deferred financing costs                                                             |       | 2,043                                                   |       | 2,103 |   |
| Excess tax (benefit) shortfall from share-based  compensation                                        |       | (8                                                      | )          | 111 |   |
| Net gain on disposal of leaseholds and other  property                                               |       | (20                                                     | )          | (2 | ) |
| Deferred income taxes                                                                                |       | 3,171                                                   |       | 612 |   |
| Changes in (exclusive of effects of acquisitions):                                                   |       |                                                    |       |   |   |
| Trade accounts receivable                                                                            |       | 11,995                                                  |       | 2,927 |   |
| Other receivables                                                                                    |       | (12,558                                                 | )          | (9,694 | ) |
| Inventories                                                                                          |       | (7,279                                                  | )          | 9,850 |   |
| Prepaid expenses                                                                                     |       | 645                                                     |       | 1,478 |   |
| Other assets                                                                                         |       | (277                                                    | )          | 45 |   |
| Accounts payable and accrued expenses                                                                |       | (29,135                                                 | )          | (5,609 | ) |
| Income taxes                                                                                         |       | (933                                                    | )          | (396 | ) |
| Due to Sally Beauty                                                                                  |       | 9,383                                                   |       | 5,564 |   |
| Other liabilities                                                                                    |       | 409                                                     |       | (6,803 | ) |
| Net cash provided by operating activities                                                            |       | 19,736                                                  |       | 31,286 |   |
| **Cash Flows from Investing  Activities:**                                                           |       |                                                    |       |   |   |
| Capital expenditures                                                                                 |       | (12,112                                                 | )          | (8,400 | ) |
| Proceeds from sale of property and equipment                                                         |       | 45                                                      |       | 32 |   |
| Acquisitions, net of cash acquired                                                                   |       | (30,389                                                 | )          | (1,755 | ) |
| Net cash used by investing activities                                                                |       | (42,456                                                 | )          | (10,123 | ) |
| **Cash Flows from Financing  Activities:**                                                           |       |                                                    |       |   |   |
| Change in book cash overdraft                                                                        |       | —                                                  |       | (1,633 | ) |
| Proceeds from issuance of long-term debt                                                             |       | 98,000                                                  |       | 82,638 |   |
| Repayments of long-term debt                                                                         |       | (98,357                                                 | )          | (89,021 | ) |
| Excess tax benefit (shortfall) from share-based  compensation                                        |       | 8                                                       |       | (111 | ) |
| Net cash used by financing activities                                                                |       | (349                                                    | )          | (8,127 | ) |
| Effect of foreign exchange rate changes on cash and  cash equivalents                                |       | 411                                                     |       | (207 | ) |
| Net (decrease) increase in cash and cash  equivalents                                                |       | (22,658                                                 | )          | 12,829 |   |
| Cash and cash equivalents, beginning of period                                                       |       | 54,447                                                  |       | 99,788 |   |
| Cash and cash equivalents, end of period                                                             |       | $                                                       | 31,789     |   | $ | 112,617 |   |
|                                                                                                 |       |                                                    |       |   |   |
| **Supplemental Cash Flow  Information:**                                                             |       |                                                    |       |   |   |
| Cash paid for:                                                                                       |       |                                                    |       |   |   |
| Interest                                                                                             |       | $                                                       | 48,303     |   | $ | 57,732 |   |
| Income taxes                                                                                         |       | $                                                       | 1,713      |   | $ | 888 |   |

 

The accompanying condensed notes, together with theNotes to Consolidated Financial Statements contained in the Company’s AnnualReport on Form 10-K for the fiscal year ended September 30, 2009, are anintegral part of these financial statements.

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

##### ***1.   Description of Business andBasis of Presentation***

##### *** ***

**Description of Business**

 

Sally Holdings is a wholly-owned subsidiary of SallyInvestment, a wholly-owned subsidiary of Sally Beauty.  All of the interests of Sally Holdings arebeneficially owned by Sally Investment, and all of the interests of SallyInvestment are beneficially owned by Sally Beauty. The Company was awholly-owned subsidiary of Alberto-Culver until November 16, 2006 when itwas converted to a Delaware limited liability company, was renamed “SallyHoldings LLC” and became a wholly-owned subsidiary of Sally Investment and anindirect subsidiary of Sally Beauty in connection with the separation of itsbusiness from Alberto-Culver. The Company and its consolidated subsidiariessell professional beauty supplies, primarily through its Sally Beauty Supplyretail stores in the U.S., Puerto Rico, Mexico, Canada, Chile, Belgium, France,Italy, the United Kingdom and certain other countries in Europe. Additionally,the Company distributes professional beauty products to salons and professionalcosmetologists through its Beauty Systems Group (“BSG”) store operations and acommissioned direct sales force that calls on salons primarily in the U.S.,Puerto Rico, Canada, the United Kingdom and certain other countries in Europe,and to franchises in the southern and southwestern U.S. and in Mexico throughthe operations of its subsidiary Armstrong McCall. Certain beauty products soldby BSG and Armstrong McCall are sold through exclusive territory agreementswith the manufacturers of the products.

 

Sally Beauty was formed in June 2006, and becamethe accounting successor company to Sally Holdings, Inc. upon thecompletion of the Separation Transactions. Please see the Company’s AnnualReport on Form 10-K for the fiscal year ended September 30, 2009 formore information about 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.  In addition, we have enteredinto a tax sharing agreement and we file consolidated tax returns with ourindirect parent, Sally Beauty.  See theCompany’s Annual Report on Form 10-K for the fiscal year ended September 30,2009 for more information about related parties.

 

**Basis of Presentation**

 

The consolidated interim financial statements include the accounts ofthe Company and its subsidiaries. All significant inter-company accounts andtransactions have been eliminated in consolidation. In the opinion ofmanagement, these consolidated financial statements reflect all adjustmentswhich are of a normal recurring nature and which are necessary to presentfairly the consolidated financial position as of December 31, 2009 and September 30,2009, and the consolidated results of operations and the consolidated cashflows for the three months ended December 31, 2009 and 2008.

 

All references in these notes to “management” are to the management ofSally Holdings. All references in these notes to the “Company” are to SallyHoldings LLC.

 

##### ***2.  ***SignificantAccounting Policies

##### *** ***

##### ***AccountingPrinciples***

##### *** ***

The consolidated interimfinancial statements included herein are unaudited and have been prepared bythe Company pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”). Certain information and note disclosures normallyincluded in annual financial statements prepared in accordance with accountingprinciples generally accepted in the United States (“GAAP”) have been condensedor omitted pursuant to those rules and regulations, although the Companybelieves that the disclosures made are adequate to make the information notmisleading. These consolidated interim financial statements should be read inconjunction with the financial statements and notes thereto included in theCompany’s Annual Report on Form 10-K for the fiscal year ended September 30,2009. The Company adheres to the same accounting policies in the preparation ofits interim financial statements. As permitted under GAAP, interim accountingfor certain expenses, including income taxes, is based on full yearassumptions. Such amounts are expensed in full in the year incurred.  For interim financial reporting purposes,income taxes are recorded based upon estimated annual effective income taxrates.

 

The results of operationsfor these interim periods are not necessarily indicative of the results thatmay be expected for any future interim period or the entire fiscal year.

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

The Company adopted theprovisions of Accounting Standards Codification (“ASC”) 855, *Subsequent Events*(“ASC 855”) during the third quarter ofthe fiscal year 2009. ASC 855 establishes standards of accounting for anddisclosure of transactions and events that occur after the balance sheet datebut before the financial statements are issued, and requires the disclosure,among other things, of the date through which an entity has evaluatedsubsequent events. In connection therewith, the Company has evaluated allmaterial transactions and events through February 03, 2010, the last fullbusiness day before this Quarterly Report was filed with the SEC.

 

The Company’s financial instruments consist of cashand cash equivalents, trade and other accounts receivable, accounts payable,interest rate swap agreements, foreign currency options and long-term debt.There were no significant changes in the methods and significant assumptionsused to estimate the fair value of the Company’s financial instruments since September 30,2009.

 

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

 

Theaggregate fair value of the interest rate swap agreements held at December 31,2009 was a net liability of $14.0 million included in other liabilities in the Company’sconsolidated balance sheet. Fair value amounts reported for these agreementsare based on third-party information and were determined using proprietarymodels based upon well-recognized financial principles and reasonable estimatesabout relevant future market conditions.

 

##### ***Theaggregate fair value of all foreign currency option agreements held at December 31,2009 was a net asset of $0.1 million included in prepaid expenses in the***Company’s consolidated balancesheet. Fair value amounts reported for these agreements are based onthird-party information and were determined using proprietary models based uponwell-recognized financial principles and reasonable estimates about relevantfuture market conditions. Please see Note 7 for more information about theCompany’s foreign currency options.

##### *** ***

##### ***At December 31, 2009, the fair value of theCompany’s long-term debt (including capital leases) was approximately $1,685.2million, while the carrying amount in the Company’s consolidated balance sheetwas $1,691.2 million. The fair values of the Company’s long-term borrowings arebased on quoted market prices where available or, if not available, based ondiscounted future cash flows using current market interest rates.***

##### *** ***

As required by ASC 815,*Derivatives and Hedging*, as amended, the Company recordsall derivative instruments on its balance sheet at fair value.  Theaccounting for changes in the fair value of derivative instruments depends onthe intended use of the derivative, whether the Company has elected todesignate a derivative instrument in a hedging relationship and apply hedgeaccounting, and whether the hedging relationship has satisfied the criterianecessary to apply hedge accounting. Derivative instruments designated andqualifying as a hedge of the exposure to variability in expected future cashflows, or other types of forecasted transactions, are considered cash flowhedges. Hedge accounting generally provides for the matching of the timing ofgain or loss recognition on the hedging instrument with the recognition of theimpact on earnings of the hedged transaction or transactions. The Company mayfrom time to time enter into derivative contracts that are intended to hedgecertain economic risks even though hedge accounting does not apply or theCompany elects not to apply hedge accounting to such derivative contracts.Please see Note 7 for more details about the Company’s derivative instrumentsand hedging activities as of December 31, 2009.

 

In the fiscal year 2009,the Company adopted the provisions of ASC 820, *Fair ValueMeasurements and Disclosures*(“ASC 820”), as it relates to itsfinancial instruments.  ASC 820, asamended, establishes a three-level hierarchy for measuring fair value andrequires an entity to maximize the use of observable inputs and minimize theuse of unobservable inputs when measuring fair value. This valuation hierarchyis based upon the transparency of inputs to the valuation of an asset orliability on the measurement date.  Thethree levels of that hierarchy are defined as follows:

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

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

 

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

 

Level 3 - Unobservable inputs for the asset orliability

 

The Company measurescertain financial instruments at fair value on a recurring basis, includinginterest rate swaps and foreign currency options. In accordance with ASC 820,the Company categorized certain of its financial assets and liabilities basedon priority of the inputs to the valuation technique for the instruments, asfollows at December 31, 2009 (in thousands):

 
| ** **                      | ** ** | **As of December 31, 2009** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **Total**                        | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Assets                          |       |                             |       |   |   |   |   |   |   |
| Foreign  currency options (b)   |       | $                                | 131        |   |   |   | $ | 131 |   |   |   |
| Total  assets                   |       | $                                | 131        |   |   |   | $ | 131 |   |   |   |
|                            |       |                             |       |   |   |   |   |   |   |
| Liabilities                     |       |                             |       |   |   |   |   |   |   |
| Long-term  debt (a)             |       | $                                | 1,685,198  |   | $ | 739,106 |   | $ | 946,092 |   |   |   |
| Hedged  interest rate swaps (b) |       | 14,004                           |       | — |   | 14,004 |   |   |   |
| Total  liabilities              |       | $                                | 1,699,202  |   | $ | 739,106 |   | $ | 960,096 |   |   |   |

 

----

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

(b)         Interest rateswaps and foreign currency options are valued using internal models based onmarket observable inputs, including market interest rates and foreign currencyexchange rates, as appropriate. Please see Note 7 for more information aboutthe Company’s foreign currency options.

 

The Company categorizedcertain of its financial assets and liabilities based on priority of the inputsto the valuation technique for the instruments, as follows at September 30,2009 (in thousands):

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

 

----

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

(b)         Interest rate swaps arevalued using internal models based on market observable inputs, includingmarket interest rates.

 

**RecentAccounting Pronouncements**

 

In December 2007, the Financial AccountingStandards Board (“FASB”) revised the accounting standards for businesscombinations. This new standard (currently contained in ASC 805, *Business Combinations*(“ASC 805”)), among other things,generally requires that an acquirer recognize the assets acquired andliabilities assumed 

 

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Tableof Contents

 

**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

measured at their “full fair values” on theacquisition date. This practice replaced the practice, under predecessoraccounting standards, of allocating the cost of an acquisition to theindividual assets acquired and liabilities assumed based on their relativeestimated fair values.  This new standardfurther requires that acquisition-related costs be recognized separately fromthe related acquisition. This standard must be applied prospectively tobusiness combinations consummated on or after the first annual reporting periodbeginning on or after December 15, 2008 and, accordingly, the Companyadopted it during the first quarter of the fiscal year 2010. Selling, generaland administrative expenses for the three months ended December 31, 2009,includes approximately $0.4 million of expenses related to acquisitions.

 

##### ***In April 2008, the FASB amended ASC 350,***Intangiblesand Other (“ASC350”). This new accounting standard, currently contained in ASC 350-30-35,specifically amends the factors that should be considered in developing renewalor extension assumptions used to determine the useful life of a recognizedintangible asset. The objective of this amendment is to improve the consistencybetween the useful life of a recognized intangible asset and the period ofexpected cash flows used to measure the fair value of the asset. This newstandard is effective for fiscal years beginning after December 15, 2008and, accordingly, the Company adopted it during the first quarter of the fiscal year 2010. The adoption of this standarddid not have a material effect on the Company’s consolidated financialposition, results of operations or cash flows.

##### *** ***

In August 2009, theFASB issued Accounting Standards Update 2009-05 which amended ASC 820 as itrelates to the measurement of liabilities at fair value, effective for interimreporting periods beginning after August 26, 2009. More specifically, thisamendment provided clarification for liabilities in which a quoted price in anactive market for an identical liability is not available. The Company adoptedthis amendment during the first quarter of the fiscal year 2010. The adoptionof this amendment did not have a material effect on the Company’s consolidatedfinancial position, results of operations or cash flows.

 

##### ***We have not yet adopted and are currently assessingany potential effect of the following pronouncement on our consolidatedfinancial statements:***

##### *** ***

In January 2010, theFASB issued Accounting Standards Update 2010-06 which amends ASC 820 as itrelates to certain disclosures of fair value measurements. The new standardwill require, among other things, (a) disclosure of the sensitivity of anentity’s fair value measurements using Level 3 inputs to changes in suchinputs, (b) a reconciliation of changes in such fair value measurementsand (c) disclosure of transfers between fair value measurements using Level 1and 2 inputs, if any. The new standard is effective for interim reportingperiods beginning after December 15, 2009.

 

##### ***3.   Comprehensive Income (Loss)***

##### *** ***

Comprehensive income (loss) consists of net earnings, foreign currencytranslation adjustments and deferred gain (loss) on interest rate swaps asfollows (in thousands):

 
| ** **                                       | ** ** | **Three Months Ended********December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                                  | ** ** | **2008** | ** ** |
| Net  earnings                                    |       | $                                                         | 27,361     |   | $ | 17,207 |   |
| Other  comprehensive income (loss) adjustments:  |       |                                                      |       |   |   |
| Foreign  currency translation adjustments (a)    |       | 1,558                                                     |       | (32,283 | ) |
| Deferred  gain (loss) on interest rate swaps (b) |       | 833                                                       |       | (10,873 | ) |
| Comprehensive  income (loss)                     |       | $                                                         | 29,752     |   | $ | (25,949 | ) |

 

----

(a)          There were no income tax amounts relatedto foreign currency translation adjustments recorded in other comprehensiveincome (loss) for the three months ended December 31, 2009 and 2008.

(b)         Amounts are net of income tax expense of$0.5 million and net of income tax benefit of $7.0 million for the three monthsended December 31, 2009 and 2008, respectively.

 

12

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Table ofContents

 

**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

##### ***The components of accumulated othercomprehensive (loss) income as of December 31, 2009 and September 30,2009 are as follows (in thousands):***

 
| ** **                                          | ** ** | **As of December 31, 2009** | ** ** | **As of September 30, 2009** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|-----------------------------------|------------|
| ** **                                          | ** ** | **Amount  Before Tax**           | ** ** | **Deferred********Tax**           | ** ** | **Net********Amount** | ** ** | **Amount  Before Tax** | ** ** | **Deferred********Tax** | ** ** | **Net********Amount** | ** ** |
| Cumulative foreign currency translation adjustments |       | $                                | (4,937     | )                                 | —     |   | $ | ( 4,937 | ) | $ | (6,495 | ) | — |   | $ | (6,495 | ) |
| Deferred (losses) gains on interest rate swaps (a)  |       | (14,004                          | )          | 5,434                             |       | (8,570 | ) | (15,365 | ) | 5,962 |   | (9,403 | ) |
| Total accumulated other comprehensive (loss) income |       | $                                | (18,941    | )                                 | $          | 5,434 |   | $ | (13,507 | ) | $ | (21,860 | ) | $ | 5,962 |   | $ | (15,898 | ) |
|                                                     |            |                                  |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

## **(a)  See Note 7 formore information about our interest rate swaps.**

##  

##### ***4.  Share-BasedPayments***

##### *** ***

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

 

The Company accounts for stock option and stockawards, which include share-based payment plans in accordance with ASC 718, *Compensation — Stock Compensation.* Accordingly, the Companymeasures the cost of employee services received in exchange for an award ofequity instruments based on the fair value of the award on the grant date, andrecognizes compensation expense on a straight-line basis over the vestingperiod or to the date a participant becomes eligible for retirement, ifearlier. During its fiscal year 2007, Sally Beauty adopted the Sally BeautyHoldings 2007 Omnibus Incentive Plan (the “2007 Plan”), a share-basedcompensation plan which allows for the issuance of up to 10.0 million shares ofSally Beauty’s common stock.

 

Sally Beauty granted approximately 2.8 million and 2.7million stock options to the Company’s employees and consultants during thethree months ended December 31, 2009 and 2008, respectively. During thethree months ended December 31, 2009, the Company granted 2.3 million stockoptions under the 2007 Plan and 0.5 million stock options under theAlberto-Culver Company Employee Stock Option Plan of 2003 (the “2003 Plan”).Upon issuance of such grants, the Company recognized accelerated share-basedcompensation expense of $2.5 million and $2.0 million in the first quarter offiscal years 2010 and 2009, respectively, in connection with certain retirementeligible employees who are eligible to continue vesting awards upon retirementunder the terms contained in both the 2007 Plan and the 2003 Plan.

 

The following table presents the total compensationcost charged against income and included in selling, general and administrativeexpenses for share-based compensation arrangements and the related tax benefitsrecognized in our statements of earnings (in thousands):

 
| ** **                                                      | ** ** | **Three Months Ended  December 31,** | ** ** |
|-----------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                      | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| Share-based  compensation expense                               |       | $                                         | 4,823      |   | $ | 3,468 |   |
| Income  tax benefit related to share-based compensation expense |       | $                                         | 1,773      |   | $ | 1,322 |   |

 

## **Stock Options**

##  

Each option has an exercise price that equals 100% ofthe market price of Sally Beauty’s common stock on the date of grant andgenerally has a maximum term of 10 years. Options generally vest ratably over afour year period and 

 

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Tableof Contents

 

**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

are generally subject to forfeiture until the fouryear vesting period is complete, subject to certain retirement provisionscontained in both the 2007 Plan and the 2003 Plan.

 

The following table presents a summary of the activityfor Sally Beauty’s stock options issued to the Company’s employees andconsultants for the three months ended December 31, 2009:

 
| ** **                             | ** ** | **Number  of  Outstanding  Options (in  Thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  Years)** | ** ** | **Aggregate  Intrinsic  Value (in  Thousands)** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------------------|------------|
| Outstanding at September 30, 2009 |       | 10,025                                               |       | $                                      | 7.40       |                                                            | 7.7        |                                            | $          | 10,678 |   |
| Granted                                |       | 2,807                                                |       | 7.42                                   |       |                                                            |       |                                            |       |
| Exercised                              |       | —                                               |       | —                                 |       |                                                            |       |                                            |       |
| Forfeited or expired                   |       | (4                                                   | )          | 8.88                                   |       |                                                            |       |                                            |       |
| Outstanding at December 31, 2009  |       | 12,828                                               |       | $                                      | 7.40       |                                                            | 8.0        |                                            | $          | 13,378 |   |
|                                   |       |                                                 |       |                                   |       |                                                            |       |                                            |       |
| Exercisable at December 31, 2009  |       | 5,934                                                |       | $                                      | 7.48       |                                                            | 6.9        |                                            | $          | 8,050 |   |

 

The following table summarizes information about SallyBeauty’s stock options held by the Company’s employees and consultants underSally Beauty’s option plans at December 31, 2009:

 
| ** **                      | ** ** | **Options  Outstanding**                                       | ** ** | **Options  Exercisable**                                        | ** ** |
|---------------------------------|------------|----------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| **Range  of  Exercise  Prices** | ** ** | **Number  Outstanding  at December  31, 2009 (in  Thousands)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable  at December  31, 2009 (in  Thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $2.00                           |       | 1,144                                                          |       | 4.5                                                             |       | $ | 2.00 |   | 1,144 |   | $ | 2.00 |   |
| $5.24 – 9.66               |       | 11,684                                                         |       | 8.3                                                             |       | 7.93 |   | 4,790 |   | 8.79 |   |
| Total                           |       | 12,828                                                         |       | 8.0                                                             |       | $ | 7.40 |   | 5,934 |   | $ | 7.48 |   |

 

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

 

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

 
| ** **                 | ** ** | **Three Months Ended December 31,** | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | **2009**                                                | ** ** | **2008** | ** ** |
| Expected  lives (in years) |       | 5.0                                                     |       | 5.0 |   |
| Expected  volatility       |       | 64.4                                                    | %          | 47.9 | % |
| Risk-free  interest rate   |       | 2.4                                                     | %          | 2.6  | % |
| Dividend  yield            |       | 0.0                                                     | %          | 0.0 | % |

 

The expected life of options represents the period oftime that the options granted are expected to be outstanding and is based onhistorical experience of employees of the Company who have been granted stockoptions, including grants under stock option plans of Alberto-Culver prior tothe Separation Transactions. Expected volatility is derived using the averagevolatility of both Sally Beauty and similar companies (based on industrysector) since it is not practicable to estimate Sally Beauty’s expectedvolatility on a stand-alone basis due to a lack of sufficient trading 

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

history. The risk-free interest rate is based on thezero-coupon U.S. Treasury issue as of the date of the grant. Since Sally Beautydoes not currently expect to pay dividends, the dividend yield is 0%.

 

The weighted average fair value of the Sally Beautystock options issued to the Company’s employees and consultants at the date ofgrant, in the three months ended December 31, 2009 and 2008 was $4.13 and$2.33 per option, respectively. Option exercises during the three months ended December 31,2009, were not material.

 

At December 31, 2009, approximately $15.8 millionof total unrecognized compensation costs related to unvested stock optionawards are expected to be recognized over the weighted average period of 2.8years.

 

## **Stock Awards**

##  

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

##### *** ***

As an indirect subsidiary of Sally Beauty, the Companyhas no employee stock award plans; however certain employees (and consultants)of the Company have been granted restricted stock awards under Sally Beauty’sstock award plans. A restricted stock award is an award of shares of SallyBeauty’s common stock (which have full voting rights but are restricted withregard to sale or transfer), the restrictions over which lapse ratably over aspecified period of time (generally five years). Restricted stock awards areindependent of stock option grants and are generally subject to forfeiture ifemployment terminates prior to these restrictions lapsing, subject to certainretirement provisions contained in both the 2007 Plan and the 2003 RestrictedStock Plan.

 

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

 

The following table presents a summary of the activityfor Sally Beauty’s restricted stock awarded to the Company’s employees (andconsultants) for the three months ended December 31, 2009:

 
| **Restricted  Stock Awards**        | ** ** | **Number  of  Shares (in  Thousands)** | ** ** | **Weighted  Average Fair  Value Per Share** | ** ** | **Weighted  Average  Remaining  Vesting Term  (in Years)** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------------|------------|
| Unvested at September 30, 2009 |       | 331                                    |       | $                                           | 7.45       |                                                       | 3.3        |   |
| Granted                             |       | 118                                    |       | 7.42                                        |       |                                                       |       |
| Vested                              |       | (40                                    | )          | 7.00                                        |       |                                                       |       |
| Forfeited                           |       | —                                 |       | —                                      |       |                                                       |       |
| Unvested at December 31, 2009  |       | 409                                    |       | $                                           | 7.48       |                                                       | 3.8        |   |

 

At December 31, 2009, approximately $2.6 millionof total unrecognized compensation costs related to unvested restricted stockawards are expected to be recognized over the weighted average period of 3.8years.

 

##### ***5.   Goodwill and OtherIntangibles***

 

During the three months ended December 31, 2009, intangible assetssubject to amortization in the amount of $22.2 million were recorded inconnection with the September 30, 2009 acquisition of Schoeneman BeautySupply, Inc. This amount was previously reported in Goodwill pending thevaluation of the assets acquired. Please see Note 15 to our financialstatements contained in Item 8 of our Annual Report on Form 10-K for thefiscal year ended September 30, 2009.

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

The change in the carrying amounts of goodwill by operating segment forthe three months ended December 31, 2009 is as follows (in thousands):

 
| ** **                                    | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|---------------------------|------------|-----------|------------|
| Balance  at September 30, 2009           |       | $                        | 73,208     |                      | $          | 420,927   |       | $ | 494,135 |   |
| Additions  and purchase price adjustments (a) |       | 18,169                   |       | (1,953                    | )          | 16,216    |       |
| Reclassifications                             |       | —                   |       | (22,200                   | )          | (22,200   | )          |
| Foreign  currency translation                 |       | (33                      | )          | 756                       |       | 723       |       |
| Balance  at December 31, 2009            |       | $                        | 91,344     |                      | $          | 397,530   |       | $ | 488,874 |   |

 

----

(a)          Please see note9 for additional information about businesses acquired.

 

The following tableprovides the gross carrying value and accumulated amortization for intangibleassets with indefinite lives and intangible assets subject to amortization byoperating segment at December 31, 2009 (in thousands):

 
| ** **                                  | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|--------------------------|------------|--------------------------------|------------|-----------|------------|
| Balance  at December 31, 2009          |       |                     |       |                           |       |      |       |
| Intangible  assets with indefinite lives:   |       |                     |       |                           |       |      |       |
| Trade  names                                |       | $                        | 20,115     |                           | $          | 33,857    |       | $ | 53,972 |   |
| Other  intangibles                          |       | —                   |       | 5,700                          |       | 5,700     |       |
| Total                                       |       | 20,115                   |       | 39,557                         |       | 59,672    |       |
| Intangible  assets subject to amortization: |       |                     |       |                           |       |      |       |
| Gross  carrying amount                      |       | 6,935                    |       | 58,626                         |       | 65,561    |       |
| Accumulated  amortization                   |       | (2,576                   | )          | (23,692                        | )          | (26,268   | )          |
| Net  value                                  |       | 4,359                    |       | 34,934                         |       | 39,293    |       |
| Total  intangible assets, net               |       | $                        | 24,474     |                           | $          | 74,491    |       | $ | 98,965 |   |

 

Amortization expense was $1.9 million and $1.5 millionfor the three months ended December 31, 2009 and 2008, respectively. As ofDecember 31, 2009, future amortization expense related to intangibleassets subject to amortization is estimated to be as follows (in thousands):

 
| **Fiscal Year:** |   |   |   |
|------------------|--------|--------|--------|
| 2010             |   | $      | 5,142  |   |
| 2011             |   | 5,928  |   |
| 2012             |   | 4,478  |   |
| 2013             |   | 3,863  |   |
| 2014             |   | 3,771  |   |
| Thereafter       |   | 16,111 |   |
|             |   | $      | 39,293 |   |

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

##### ***6.   Long-Term Debt***

##### *** ***

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

 
| ** **                   | ** ** | **As of  December 31,  2009** | ** ** | **Maturity  dates** | ** **     | **Interest  Rates**                                    | ** **                                        |
|------------------------------|------------|------------------------------------|------------|---------------------|----------------|--------------------------------------------------------|---------------------------------------------------|
| ABL facility                 |       | $                                  | —     |                | —         |                                                   | (i)    Prime  plus up to 0.50% or; |   |
|                         |       |                               |       |                |           | (ii)   LIBOR  plus (1.00% to 1.50%)          |                                              |
| Term Loan A                  |       | 105,000                            |       | Nov. 2012      |           | (i)    Prime  plus (1.00% to 1.50%) or; |                                              |
|                         |       |                               |       |                |           | (ii)   LIBOR  plus (2.00% to 2.50%)          |                                              |
| Term Loan B                  |       | 863,856                            |       | Nov. 2013      |           | (i)    Prime  plus (1.25% to 1.50%) or; |                                              |
|                         |       |                               |       |                |           | (ii)   LIBOR  plus (2.25% to 2.50%)          |                                              |
| Other (a)                    |       | 8,458                              |       | 2010-2014           |           | 4.05% to 6.75%                                         |                                              |
| Total                        |       | $                                  | 977,314    |                |           |                                                   |                                              |   |
|                         |       |                               |       |                |           |                                                   |                                              |
| Senior notes                 |       | $                                  | 430,000    |                | Nov. 2014 |                                                   | 9.25%                                             |   |
| Senior subordinated notes    |       | 275,000                            |       | Nov. 2016      |           | 10.50%                                                 |                                              |
| Total                        |       | $                                  | 705,000    |                |           |                                                   |                                              |   |
|                         |       |                               |       |                |           |                                                   |                                              |
| Capitalized leases and other |       | $                                  | 8,874      |                |           |                                                   |                                              |   |
| Less: current portion        |       | (26,476                            | )          |                |           |                                                   |                                              |
| Total long-term debt         |       | $                                  | 1,664,712  |                |           |                                                   |                                              |   |

 

----

(a) Representspre-acquisition debt of Pro-Duo, N.V. and Sinelco Group, NV. Please see Note 9.

 

In connection with the Separation Transactions in November 2006,the Company and certain of its subsidiaries incurred $1,850.0 million ofindebtedness by (i) drawing on a revolving (asset-based lending (“ABL”))facility in an amount equal to $70.0 million, (ii) entering into two term loanfacilities (term loans A and B) in an aggregate amount of $1,070.0 million and (iii) together(jointly and severally) with another of Sally Beauty’s indirect subsidiaries,Sally Capital Inc., issuing senior notes in an aggregate amount of $430.0million and senior subordinated notes in an aggregate amount of $280.0 million.

 

The term loan facilities and the ABL facility aresecured by substantially all of our assets, those of Sally Investment, those ofour domestic subsidiaries and, in the case of the ABL facility, those of ourCanadian subsidiaries. The senior term loan facilities may be prepaid at theoption of the Company at any time without premium or penalty and are subject tomandatory prepayment in an amount equal to 50% of excess cash flow (as definedin the agreement governing the term loan facilities) for any fiscal year unlessa specified leverage ratio is met. In January 2010, the Company made amandatory prepayment on the senior term loan facilities in the amount of $22.3million. Amounts paid pursuant to said provision may be applied, at the optionof the Company, against minimum loan repayments otherwise required of us overthe twelve-month period following any such payment under the terms of the loanagreement. Additionally, borrowings under the term loan facility would besubject to mandatory prepayment in an amount equal to 100% of the proceeds ofspecified asset sales that are not reinvested in the business or applied torepay borrowings under the ABL facility.

 

The senior notes and seniorsubordinated notes are unsecured obligations of the issuers and are jointly andseverally guaranteed on a senior basis (in the case of the senior notes) and ona senior subordinated basis (in the case of the senior subordinated notes) byeach material domestic subsidiary of the Company. Furthermore, theagreements underlying the Company’s credit facilities contain terms whichsignificantly restrict the ability of Sally Holdings and its subsidiaries topay dividends or otherwise transfer assets to Sally Beauty. Please see theCompany’s Annual Report on Form 10-K for the fiscal year ended September 30,2009, for additional information about the Company’s long-term debt.

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

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

 
| **Fiscal Year:**          |   |    |      |
|---------------------------|--------|---------|-----------|
| 2010                      |   | $       | 25,263    |   |
| 2011                      |   | 9,299   |      |
| 2012                      |   | 76,466  |      |
| 2013                      |   | 9,583   |      |
| 2014                      |   | 856,703 |      |
| Thereafter                |   | 705,000 |      |
|                      |   | $       | 1,682,314 |   |
| Capital leases  and other |   | 8,874   |      |
| Less: current  portion    |   | (26,476 | )         |
| Total                     |   | $       | 1,664,712 |   |

 

We are a holding company and do not have any materialassets or operations other than ownership of equity interests of oursubsidiaries.  The agreements andinstruments governing our debt contain material limitations on our and oursubsidiaries’ ability to pay dividends and other restricted payments to ourindirect parent, Sally Beauty.

 

Under the agreements andindentures governing the term loan facilities and the notes, we may not makecertain restricted payments to Sally Beauty if a default then exists under thecredit agreement or the indentures or if our consolidated interest coverageratio is less than 2.0 to 1.0 at the time of the making of such restrictedpayment.  As of December 31, 2009,our consolidated interest coverage ratio exceeded 2.0 to 1.0.  Further, the aggregate amount of restrictedpayments we are able to make is limited pursuant to various baskets ascalculated pursuant to the credit agreement and indentures.

 

The agreements governing our ABL facility generally permit the makingof distributions and certain other restricted payments so long as borrowing availabilityunder the facility equals or exceeds $60.0 million. If borrowing availabilityfalls below this amount, we may nevertheless make restricted payments to SallyBeauty in the aggregate since the date of the Separation Transactions, togetherwith the aggregate cash amount paid in acquisitions since said date, of notgreater than $50.0 million, together with certain other exceptions.  As of December 31, 2009, borrowingavailability under the ABL facility exceeded $60.0 million.  As of December 31, 2009, the net assetsof the Company and its consolidated subsidiaries that were unrestricted fromtransfer under our credit arrangements totaled $240.9 million, subject tocertain adjustments.

 

##### ***7.   DerivativeInstruments and Hedging Activities***

##### *** ***

**RiskManagement Objectives of Using Derivative Instruments**

 

The Company is exposed to a wide variety of risks,including risks arising from changing economic conditions. The Company managesits exposure to certain economic risks (including liquidity, credit risk and changesin interest rates) primarily (a) by closely managing its cash flows fromoperating and investing activities and the amounts and sources of its debtobligations; (b) by assessing periodically the creditworthiness of itsbusiness partners; and (c) through the use of interest rate swaps.  The Company uses interest rate swaps as partof its overall economic risk management strategy to add stability to theinterest payments due in connection with its term loan obligations. Interestpayments related to the term loans are impacted by changes in LIBOR. Interestrate swap agreements involve the periodic receipt by the Company of amountsbased on a variable rate in exchange for the Company making payments based on afixed rate over the term of the interest rate swap agreements, without exchangeof the underlying notional amount. At December 31, 2009, the Company didnot purchase or hold any derivative instruments for trading or speculativepurposes.

 

**DesignatedCash Flow Hedges**

 

In May of 2008, theCompany entered into two interest rate swap agreements with an aggregate notional amount of $300 million. These interest rate swap agreements expire in May of 2012 andare designated and qualify as effective

 

18

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

cash flow hedges, inaccordance with ASC 815. Accordingly, changes in the fair value of derivativesdesignated and qualifying as cash flow hedges are recorded quarterly, net ofincome tax, in accumulated other comprehensive (loss) income (“OCI”) until thehedged obligation is settled or the swap agreements expire, whichever isearlier. Any hedge ineffectiveness, as this term is used in ASC 815, isrecognized in net interest expense in our consolidated statements of earnings.No hedge ineffectiveness on cash flow hedges was recognized during the threemonths ended December 31, 2009 and 2008. Please see the Company’s AnnualReport on Form 10-K for the fiscal year ended September 30, 2009 foradditional information about the Company’s interest rate swap agreements.

 

Amounts reported in OCI related to interest rate swapsare reclassified into net interest expense, as a yield adjustment, in the sameperiod in which interest on the Company’s variable-rate debt obligations affectearnings. During the three months ended December 31, 2009 and 2008, netinterest expense of $2.6 million and $0.7 million, respectively, resulted fromsuch reclassifications. During the twelve months ending December 31, 2010,the Company estimates that an additional $8.8 million, before income tax, ofthe amount reported in OCI will be reclassified into interest expense.

 

**Non-designatedCash Flow Hedges**

 

In connectionwith the Separation Transactions, in November 2006, the Company enteredinto four interest rate swap agreements with an aggregate notional amount of$500 million. Interestrate swap agreements with an aggregate notional amount of $150 million expiredin November 2008 and interest rate swap agreements with a notional amountof $350 million expired in November 2009. These interest rate swap agreements were notdesignated as hedges and, accordingly, the changes in fair value of theseinterest rate swap agreements (which were adjusted quarterly) were recorded innet interest expense in our consolidated statements of earnings. Interest expense includes non-cash incomeof $2.4 million and non-cash expense of $3.0 million of marked-to-marketadjustments related to these interest rate swaps for the three months ended December 31,2009 and 2008, respectively. Please see the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2009 for additional informationabout these interest rate swap agreements.

 

As a result of the Company’s acquisition of SinelcoGroup NV (“Sinelco”), on December 16, 2009, the Company, through Sinelco,uses foreign currency options to manage the exposure to certain foreigncurrencies in connection with Sinelco’s purchases of merchandise. These foreigncurrency option agreements are not designated as hedges and do not meet thehedge accounting requirements of ASC 815. Accordingly, the changes in fair value of these derivativeinstruments (which are adjusted quarterly) are recorded in selling, general andadministrative expenses in our consolidated statements of earnings. Please seeNote 9 for information about the acquisition of Sinelco.

 

The table below presentsthe fair value of the Company’s derivative financial instruments as well astheir classification on the balance sheet as of December 31, 2009 (inthousands):

 

**Tabular Disclosure of Fair Values of DerivativeInstruments**

 
| ** **                                               | ** ** | **Asset Derivatives**            | ** ** | **Liability Derivatives**        | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                               | ** ** | **As of December 31, 2009** | ** ** | **As of December 31, 2009** | ** ** |
| ** **                                               | ** ** | **Balance Sheet  Location**      | ** ** | **Fair Value**                   | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** | ** ** |
| Derivatives designated as hedging instruments:           |       |                             |       |                             |       |   |   |   |   |
| Interest Rate Swaps                                      |       | Other  assets                    |       | $                                | —     |   | Other  liabilities |   | $ | 14,004 |   |
| Total derivatives designated as hedging instruments      |       |                             |       | $                                | —     |   |   |   | $ | 14,004 |   |
|                                                     |       |                             |       |                             |       |   |   |   |   |
| Derivatives not designated as hedging instruments:       |       |                             |       |                             |       |   |   |   |   |
| Foreign Currency Options                                 |       | Prepaid  expenses                |       | $                                | 131        |   | Accrued  expenses |   | $ | — |   |
| Interest Rate Swaps                                      |       | Prepaid  expenses                |       | —                           |       | Accrued  expenses |   | — |   |
| Total derivatives not designated as hedging  instruments |       |                             |       | $                                | 131        |   |   |   | $ | — |   |

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

The table below presentsthe fair value of the Company’s derivative financial instruments as well astheir classification on the balance sheet as of September 30, 2009 (inthousands):

 

**Tabular Disclosure of Fair Values of DerivativeInstruments**

 
| ** **                                               | ** ** | **Asset Derivatives**             | ** ** | **Liability Derivatives**         | ** ** |
|----------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                                               | ** ** | **As of September 30, 2009** | ** ** | **As of September 30, 2009** | ** ** |
| ** **                                               | ** ** | **Balance Sheet  Location**       | ** ** | **Fair Value**                    | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** | ** ** |
| Derivatives designated as hedging instruments:           |       |                              |       |                              |       |   |   |   |   |
| Interest Rate Swaps                                      |       | Other  assets                     |       | $                                 | —     |   | Other  liabilities |   | $ | 15,365 |   |
| Total derivatives designated as hedging instruments      |       |                              |       | $                                 | —     |   |   |   | $ | 15,365 |   |
|                                                     |       |                              |       |                              |       |   |   |   |   |
| Derivatives not designated as hedging instruments:       |       |                              |       |                              |       |   |   |   |   |
| Interest Rate Swaps                                      |       | Prepaid  expenses                 |       | $                                 | —     |   | Accrued  expenses |   | $ | 2,356 |   |
| Total derivatives not designated as hedging  instruments |       |                              |       | $                                 | —     |   |   |   | $ | 2,356 |   |

 

The tables below presentthe effect of the Company’s derivative financial instruments on the statementsof earnings for the three months ended December 31, 2009 and 2008 (inthousands):

 

**Tabular Disclosure of the Effect of DerivativeInstruments on the Statement of Earnings for the**

**Three Months Ended December 31, 2009**

 
| **Derivatives  in Cash  Flow Hedging  Relationships** | ** ** | **Amount  of  Gain or  (Loss)  Recognized  in OCI on  Derivative  (Effective  Portion), net  of tax** | ** ** | **Location  of Gain or  (Loss) Reclassified  from Accumulated  OCI into Income  (Effective Portion)** | ** **             | **Amount  of  Gain or (Loss)  Reclassified  from  Accumulated  OCI into  Income  (Effective  Portion)** | ** ** | **Location  of Gain or  (Loss) Recognized in  Income on Derivative  (Ineffective Portion  and Amount  Excluded from  Effectiveness Testing)** | ** ** | **Amount  of Gain  or (Loss)  Recognized in  Income on  Derivative  (Ineffective  Portion and  Amount  Excluded from  Effectiveness  Testing)** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------------------|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Interest Rate Swaps                                   |       | $                                                                                                     | 833        |                                                                                                  | Interest  expense, net |                                                                                                    | $          | (2,559                                                                                                                                        | )          | Interest expense, net                                                                                                                           |       | $ | — |   |
|                                                       |            |                                                                                                       |            |                                                                                                       |                        |                                                                                                         |            |                                                                                                                                               |            |                                                                                                                                                 |            |  |  |  |

 
| **Derivatives  Not Designated as Hedging  Instruments** | ** ** | **Location  of Gain or  (Loss) Recognized in  Income on  Derivative** | ** ** | **Amount  of  Gain or (Loss)  Recognized in  Income on  Derivative** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Foreign  Currency Options                               | ** ** | Selling,  general and administrative expenses                         |       | —                                                               |       | ** ** | ** ** | ** ** | ** ** |
| Interest  Rate Swaps                                    | ** ** | Interest  expense, net                                                |       | $                                                                    | (4,735     | )          | ** ** | ** ** | ** ** | ** ** |
| Total derivatives not designated as hedging instruments | ** ** |                                                                  |       | $                                                                    | (4,735     | )          | ** ** | ** ** | ** ** | ** ** |

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

**TabularDisclosure of the Effect of Derivative Instruments on the Statement of Earningsfor the**

**ThreeMonths Ended December 31, 2008**

 
| **Derivatives  in Cash  Flow Hedging  Relationships** | ** ** | **Amount  of  Gain or  (Loss)  Recognized  in OCI on  Derivative  (Effective  Portion), net  of tax** | ** ** | **Location  of Gain or  (Loss) Reclassified  from Accumulated  OCI into Income  (Effective Portion)** | ** **             | **Amount  of  Gain or (Loss)  Reclassified  from  Accumulated  OCI into  Income  (Effective  Portion)** | ** ** | **Location  of Gain or  (Loss) Recognized  in Income on  Derivative  (Ineffective Portion  and Amount  Excluded from  Effectiveness  Testing)** | ** ** | **Amount  of Gain  or (Loss)  Recognized in  Income on  Derivative  (Ineffective  Portion and  Amount Excluded  from  Effectiveness  Testing)** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------------------|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Interest Rate Swaps                                   |       | $                                                                                                     | (10,873    | )                                                                                                     | Interest  expense, net |                                                                                                    | $          | (668                                                                                                                                            | )          | Interest expense, net                                                                                                                           |       | $ | — |   |
|                                                       |            |                                                                                                       |            |                                                                                                       |                        |                                                                                                         |            |                                                                                                                                                 |            |                                                                                                                                                 |            |  |  |  |

 
| **Derivatives  Not Designated as Hedging  Instruments** | ** ** | **Location  of Gain or  (Loss) Recognized  in Income on  Derivative** | ** ** | **Amount  of  Gain or (Loss)  Recognized in  Income on  Derivative** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Interest Rate Swaps                                     |       | Interest  expense, net                                                |       | $                                                                    | (5,646     | )          | ** ** | ** ** | ** ** | ** ** |
|                                                         |            |                                                                       |            |                                                                      |            |            |            |            |            |  |

 

**Credit-risk-related ContingentFeatures**

 

The agreements governing the Company’s interest rateswaps contain provisions pursuant to which the Company could be declared indefault on its interest rate swap obligations in the event the Companydefaulted under certain terms of the loan documents governing the Company’s ABLfacility. As of December 31, 2009, the fair value of interest rate swapsin a liability position related to these agreements was $14.0 million. As of December 31,2009, the Company was under no obligation to post and had not posted anycollateral related to these agreements. If the Company breached any of theseprovisions, it would be required to settle its obligations under the agreementsat their termination value of $14.6 million, including accrued interest andother termination costs.

 

The Company’s foreign operations expose the Company to fluctuations inforeign currency exchange rates and foreign interest rates.  These fluctuations may impact, among otherthings, the amount of the Company’s past and future cash flows in terms of theCompany’s functional currency, the U.S. dollar. As a result of the Company’s acquisition of Sinelco on December 16,2009, the Company, through Sinelco, uses foreign currency options to manage theexposure to certain foreign currencies in connection with Sinelco’s purchasesof merchandise. Please see Note 9 for information aboutthe acquisition of Sinelco.

 

The counterparties to all our derivative instruments aredeemed by the Company to be of substantial resources and strongcreditworthiness. However, these transactions result in exposure to credit riskin the event of default by a counterparty. The recent financial crisisaffecting the banking systems and financial markets resulted in many well-knownfinancial institutions becoming less creditworthy or having diminishedliquidity, which could expose us to an increased level of counterpartyrisk.  In the event that a counterpartydefaults in its obligation under our derivative instruments, we could incursubstantial financial losses. However, at the present time, no such losses aredeemed probable.

 

**8.   Income Taxes**

 

**SallyBeauty and its subsidiaries, including the Company, file consolidated incometax returns in the U.S. federal jurisdiction and most state jurisdictions, aswell as in various foreign jurisdictions.**

 

The transactionsseparating us from Alberto-Culver were intended to qualify as a reorganizationunder Section 368(a)(1)(D) of the Internal Revenue Code of 1986, asamended (the “Code”) and a distribution eligible for non-recognition underSections 355(a) and 361(c) of the Code. In connection with the sharedistribution of Alberto-Culver common stock in the Separation Transactions,Sally Beauty received: (i) a private letter ruling from the IRS and (ii) anopinion of Sidley Austin LLP, counsel to Alberto-Culver, in each case, to theeffect that the transactions 

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

qualify as areorganization under Section 368(a)(1)(D) of the Code and adistribution eligible for non-recognition under Sections 355(a) and 361(c) ofthe Code. Certain internal restructurings also occurred at or immediately priorto the Separation 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.

 

Sally Beauty andAlberto-Culver entered into a tax allocation agreement as part of theSeparation Transactions. The agreement provides generally that Sally Beauty isresponsible for its pre-separation income tax liabilities, calculated on astand-alone basis, and Alberto-Culver is responsible for the remainder. In theevent an additional U.S. federal income tax liability related to the periodprior to the Separation Transactions were determined, Sally Beauty will bejointly and severally liable for these taxes, and there can be no assurancethat Alberto-Culver would be able to fulfill its indemnification obligations toSally Beauty under the tax allocation agreement if Alberto-Culver wasdetermined to be responsible for these taxes thereunder.

 

In addition, as thesuccessor entity to Alberto-Culver after the Separation Transactions, SallyBeauty relies upon the prior year federal income tax returns of Alberto-Culverand accounting methods established therein for certain calculations that affectSally Beauty’s and the Company’s current consolidated U.S. federal income taxliability.

 

The IRS has audited theCompany’s consolidated federal income tax returns through the tax year ended September 30,2006, thus our statute remains open from the year ended September 30, 2007forward.  Our foreign subsidiaries areimpacted by various statutes of limitations, which are generally open from 2004forward. Generally, states’ statutes in the United States are open for taxreviews from 2005 forward.

 

**9.   Acquisitions**

 

On December 16,2009, the Company acquired Sinelco, a wholesale distributor of professionalbeauty products based in Ronse, Belgium, for approximately €25.5 million(approximately $37.1 million). Sinelco serves over 1,500 customers through aproduct catalog and website and has sales offices in Belgium, France and Italy.Goodwill of $17.6 million was recorded as a result of this acquisition. Thevaluation of the assets acquired and liabilities assumed was based on theirestimated fair values at the acquisition date. The final valuation of theassets acquired and liabilities assumed will be completed during the fiscalyear 2010.

 

**10.   Subsequent Events**

 

On January 27, 2010,Sally Beauty adopted the Sally Beauty Holdings 2010 Omnibus Incentive Plan (the“2010 Plan”), a share-based compensation plan which allows for the issuance ofup to 29.8 million shares of Sally Beauty’s common stock.  No material awards have been granted to theCompany’s employees and consultants under the 2010 Plan.

 

##### ***11.  Business Segments***

##### *** ***

The Company’s business isorganized into two separate segments: (i) Sally Beauty Supply, a domesticand international chain of cash and carry retail stores which offersprofessional beauty supplies to both salon professionals and retail customersand (ii) BSG, including its franchise-based business Armstrong McCall, afull service beauty supply distributor which offers professional brands ofbeauty products directly to salons through its own sales force and professionalonly stores (including franchise stores) in generally exclusive geographical territories inNorth America and parts of Europe.

 

Sales between segments, which were eliminated in consolidation, werenot material during the periods ended December 31, 2009 and 2008.  Segment data for the three months ended December 31,2009 and 2008 is as follows (in thousands):

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 
| ** **                                   | ** ** | **Three months ended********December 31,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                   | ** ** | **2009**                                        | ** ** | **2008** | ** ** |
| Net  sales:                                  |       |                                            |       |   |   |
| Sally  Beauty Supply                         |       | $                                               | 438,315    |   | $ | 410,537 |   |
| BSG                                          |       | 266,536                                         |       | 235,039 |   |
| Total  net sales                             |       | $                                               | 704,851    |   | $ | 645,576 |   |
| Earnings  before provision for income taxes: |       |                                            |       |   |   |
| Segment  operating profit:                   |       |                                            |       |   |   |
| Sally  Beauty Supply                         |       | $                                               | 71,106     |   | $ | 65,286 |   |
| BSG                                          |       | 25,597                                          |       | 20,236 |   |
| Total  segment operating profit              |       | 96,703                                          |       | 85,522 |   |
| Unallocated  corporate expenses (a)          |       | (19,295                                         | )          | (13,794 | ) |
| Share-based  compensation expense            |       | (4,823                                          | )          | (3,468 | ) |
| Interest  expense, net of interest income    |       | (28,451                                         | )          | (39,673 | ) |
| Earnings  before provision for income taxes  |       | $                                               | 44,134     |   | $ | 28,587 |   |

 

----

(a)          Unallocated expenses consistof corporate and shared costs.

 

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

 

The following condensed consolidating financialinformation presents the Condensed Consolidated Balance Sheets as of December 31,2009 and September 30, 2009, and the Condensed Consolidated Statements ofEarnings and the Condensed Consolidated Statements of Cash Flows for the threemonths ended December 31, 2009 and 2008 of: (i) Sally Holdings, or “theParent;” (ii) the guarantor subsidiaries; (iii) the non-guarantorsubsidiaries; (iv) elimination entries necessary to consolidate the Parentwith the guarantor and non-guarantor subsidiaries; and (v) the Parent on aconsolidated basis.

 

Investments in subsidiaries are accounted for usingthe equity method for purposes of the consolidating presentation.  The principal elimination entries relate toinvestments in subsidiaries and intercompany balances and transactions.  Separate financial statements and otherdisclosures with respect to the subsidiary guarantors have not been provided asmanagement believes the following information is sufficient, as guarantorsubsidiaries are 100 percent indirectly owned by the Parent and all guaranteesare full and unconditional. 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 general creditors.

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Condensed Consolidating Balance Sheet

December 31, 2009

(In thousands)

(Unaudited)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings  LLC &  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|---------------------------------------------------|------------|
| **Assets**                                                                  |       |       |       |                        |       |                              |       |             |       |                                              |       |
| Cash and cash equivalents                                                   |       | $          | 20         |                        | $          | 10,107                            |       | $                | 21,662     |                                              | $          | — |   | $ | 31,789 |   |
| Trade accounts and other receivables, less allowance for doubtful  accounts |       | —     |       | 56,232                      |       | 24,493                            |       | —           |       | 80,725                                            |       |
| Due from affiliates                                                         |       | —     |       | 370,461                     |       | 8,908                             |       | (379,369         | )          | —                                            |       |
| Inventories                                                                 |       | —     |       | 444,400                     |       | 134,820                           |       | —           |       | 579,220                                           |       |
| Prepaid expenses                                                            |       | 183        |       | 9,013                       |       | 9,115                             |       | —           |       | 18,311                                            |       |
| Deferred income tax assets                                                  |       | 929        |       | 18,015                      |       | (3,288                            | )          | —           |       | 15,656                                            |       |
| Property and equipment, net                                                 |       | —     |       | 115,873                     |       | 49,571                            |       | —           |       | 165,444                                           |       |
| Investment in subsidiaries                                                  |       | 1,409,792  |       | 313,791                     |       | —                            |       | (1,723,583       | )          | —                                            |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | 424,078                     |       | 163,761                           |       | —           |       | 587,839                                           |       |
| Other assets                                                                |       | 31,339     |       | 12,682                      |       | 4,742                             |       | —           |       | 48,763                                            |       |
| Total assets                                                                |       | $          | 1,442,263  |                        | $          | 1,774,652                         |       | $                | 413,784    |                                              | $          | (2,102,952 | ) | $ | 1,527,747 |   |
|                                                                        |       |       |       |                        |       |                              |       |             |       |                                              |       |
| **Liabilities and Member’s (Deficit) Equity**                          |       |       |       |                        |       |                              |       |             |       |                                              |       |
| Accounts payable                                                            |       | $          | —     |                        | $          | 150,159                           |       | $                | 46,336     |                                              | $          | — |   | $ | 196,495 |   |
| Due to affiliates                                                           |       | 357,749    |       | 8,908                       |       | 12,712                            |       | (379,369         | )          | —                                            |       |
| Accrued expenses                                                            |       | 8,916      |       | 98,206                      |       | 21,504                            |       | —           |       | 128,626                                           |       |
| Due to Sally Beauty                                                         |       | —     |       | 36,248                      |       | —                            |       | —           |       | 36,248                                            |       |
| Income taxes                                                                |       | 4,425      |       | 1,861                       |       | 450                               |       | —           |       | 6,736                                             |       |
| Long-term debt                                                              |       | 1,673,856  |       | 158                         |       | 17,174                            |       | —           |       | 1,691,188                                         |       |
| Other liabilities                                                           |       | 14,004     |       | 27,539                      |       | 1,104                             |       | —           |       | 42,647                                            |       |
| Deferred income tax liabilities                                             |       | (6,100     | )          | 41,781                      |       | 713                               |       | —           |       | 36,394                                            |       |
| Total liabilities                                                           |       | 2,052,850  |       | 364,860                     |       | 99,993                            |       | (379,369         | )          | 2,138,334                                         |       |
| Stock options subject to redemption                                         |       | 1,800      |       | —                      |       | —                            |       | —           |       | 1,800                                             |       |
| Total member’s (deficit) equity                                        |       | (612,387   | )          | 1,409,792                   |       | 313,791                           |       | (1,723,583       | )          | (612,387                                          | )          |
| Total liabilities and member’s (deficit) equity                        |       | $          | 1,442,263  |                        | $          | 1,774,652                         |       | $                | 413,784    |                                              | $          | (2,102,952 | ) | $ | 1,527,747 |   |

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Condensed Consolidating Balance Sheet

September 30, 2009

(In thousands)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings  LLC &  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|---------------------------------------------------|------------|
| **Assets**                                                                  |       |       |       |                        |       |                              |       |             |       |                                              |       |
| Cash and cash equivalents                                                   |       | $          | 20         |                        | $          | 37,593                            |       | $                | 16,834     |                                              | $          | — |   | $ | 54,447 |   |
| Trade accounts and other receivables, less allowance for doubtful  accounts |       | —     |       | 49,128                      |       | 18,611                            |       | —           |       | 67,739                                            |       |
| Due from affiliates                                                         |       | —     |       | 297,407                     |       | 11,169                            |       | (308,576         | )          | —                                            |       |
| Inventories                                                                 |       | —     |       | 439,396                     |       | 120,293                           |       | —           |       | 559,689                                           |       |
| Prepaid expenses                                                            |       | 113        |       | 9,165                       |       | 8,983                             |       | —           |       | 18,261                                            |       |
| Deferred income tax assets                                                  |       | 929        |       | 18,015                      |       | (3,315                            | )          | —           |       | 15,629                                            |       |
| Property and equipment, net                                                 |       | —     |       | 115,459                     |       | 35,790                            |       | —           |       | 151,249                                           |       |
| Investment in subsidiaries                                                  |       | 1,320,325  |       | 265,511                     |       | —                            |       | (1,585,836       | )          | —                                            |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | 427,555                     |       | 145,265                           |       | —           |       | 572,820                                           |       |
| Other assets                                                                |       | 33,384     |       | 12,655                      |       | 4,637                             |       | —           |       | 50,676                                            |       |
| Total assets                                                                |       | $          | 1,354,771  |                        | $          | 1,671,884                         |       | $                | 358,267    |                                              | $          | (1,894,412 | ) | $ | 1,490,510 |   |
|                                                                        |       |       |       |                        |       |                              |       |             |       |                                              |       |
| **Liabilities and Member’s (Deficit) Equity**                          |       |       |       |                        |       |                              |       |             |       |                                              |       |
| Accounts payable                                                            |       | $          | —     |                        | $          | 145,845                           |       | $                | 47,747     |                                              | $          | — |   | $ | 193,592 |   |
| Due to affiliates                                                           |       | 276,767    |       | 11,169                      |       | 20,640                            |       | (308,576         | )          | —                                            |       |
| Accrued expenses                                                            |       | 30,994     |       | 102,573                     |       | 20,275                            |       | —           |       | 153,842                                           |       |
| Due to Sally Beauty                                                         |       | —     |       | 22,042                      |       | —                            |       | —           |       | 22,042                                            |       |
| Income taxes                                                                |       | 5,217      |       | 1,929                       |       | (1,317                            | )          | —           |       | 5,829                                             |       |
| Long-term debt                                                              |       | 1,673,856  |       | 191                         |       | 3,483                             |       | —           |       | 1,677,530                                         |       |
| Other liabilities                                                           |       | 15,365     |       | 27,157                      |       | 1,064                             |       | —           |       | 43,586                                            |       |
| Deferred income tax liabilities                                             |       | (7,089     | )          | 40,653                      |       | 864                               |       | —           |       | 34,428                                            |       |
| Total liabilities                                                           |       | 1,995,110  |       | 351,559                     |       | 92,756                            |       | (308,576         | )          | 2,130,849                                         |       |
| Stock options subject to redemption                                         |       | 1,800      |       | —                      |       | —                            |       | —           |       | 1,800                                             |       |
| Total member’s (deficit) equity                                        |       | (642,139   | )          | 1,320,325                   |       | 265,511                           |       | (1,585,836       | )          | (642,139                                          | )          |
| Total liabilities and member’s (deficit) equity                        |       | $          | 1,354,771  |                        | $          | 1,671,884                         |       | $                | 358,267    |                                              | $          | (1,894,412 | ) | $ | 1,490,510 |   |

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of EarningsThree months ended December 31, 2009

(In thousands)

(Unaudited)

 
| ** **                                        | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally********Holdings LLC  &** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|--------------------------------------|------------|
| ** **                                        | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **Subsidiaries**                     | ** ** |
| ** **                                        | ** ** | ** ** | ** ** | ** **       | ** ** | ** **          | ** ** | ** **       | ** ** | ** **                           | ** ** |
| Net sales                                         |       | $          | —     |             | $          | 569,951             |       | $                | 134,900    |                                 | $          | — |   | $ | 704,851 |   |
| Related party sales                               |       | —     |       | 815              |       | —              |       | (815             | )          | —                               |       |
| Cost of products sold and distribution expenses   |       | —     |       | 298,302          |       | 74,150              |       | (815             | )          | 371,637                              |       |
| Gross profit                                      |       | —     |       | 272,464          |       | 60,750              |       | —           |       | 333,214                              |       |
| Selling, general and administrative expenses      |       | 188        |       | 195,407          |       | 53,145              |       | —           |       | 248,740                              |       |
| Depreciation and amortization                     |       | —     |       | 8,863            |       | 3,026               |       | —           |       | 11,889                               |       |
| Operating earnings (loss)                         |       | (188       | )          | 68,194           |       | 4,579               |       | —           |       | 72,585                               |       |
| Interest income                                   |       | —     |       | (18              | )          | (1                  | )          | —           |       | (19                                  | )          |
| Interest expense                                  |       | 28,263     |       | 44               |       | 163                 |       | —           |       | 28,470                               |       |
| Earnings (loss) before provision for income taxes |       | (28,451    | )          | 68,168           |       | 4,417               |       | —           |       | 44,134                               |       |
| Provision (benefit) for income taxes              |       | (11,415    | )          | 26,982           |       | 1,206               |       | —           |       | 16,773                               |       |
| Equity in earnings of subsidiaries (net of tax)   |       | 44,397     |       | 3,211            |       | —              |       | (47,608          | )          | —                               |       |
| Net earnings                                      |       | $          | 27,361     |             | $          | 44,397              |       | $                | 3,211      |                                 | $          | (47,608 | ) | $ | 27,361 |   |

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of EarningsThree months ended December 31, 2008

(In thousands)

(Unaudited)

 
| ** **                                        | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings LLC  &** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|--------------------------------|------------|
| ** **                                        | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **Subsidiaries**               | ** ** |
|                                              |       |       |       |             |       |                |       |             |       |                           |       |
| Net sales                                         |       | $          | —     |             | $          | 526,444             |       | $                | 119,132    |                           | $          | — |   | $ | 645,576 |   |
| Related party sales                               |       | —     |       | 777              |       | —              |       | (777             | )          | —                         |       |
| Cost of products sold and distribution expenses   |       | —     |       | 275,555          |       | 67,254              |       | (777             | )          | 342,032                        |       |
| Gross profit                                      |       | —     |       | 251,666          |       | 51,878              |       | —           |       | 303,544                        |       |
| Selling, general and administrative expenses      |       | 209        |       | 176,652          |       | 46,676              |       | —           |       | 223,537                        |       |
| Depreciation and amortization                     |       | —     |       | 9,039            |       | 2,708               |       | —           |       | 11,747                         |       |
| Operating earnings (loss)                         |       | (209       | )          | 65,975           |       | 2,494               |       | —           |       | 68,260                         |       |
| Interest income                                   |       | —     |       | (62              | )          | (86                 | )          | —           |       | (148                           | )          |
| Interest expense                                  |       | 39,647     |       | 68               |       | 106                 |       | —           |       | 39,821                         |       |
| Earnings (loss) before provision for income taxes |       | (39,856    | )          | 65,969           |       | 2,474               |       | —           |       | 28,587                         |       |
| Provision (benefit) for income taxes              |       | (16,729    | )          | 27,531           |       | 578                 |       | —           |       | 11,380                         |       |
| Equity in earnings of subsidiaries (net of tax)   |       | 40,334     |       | 1,896            |       | —              |       | (42,230          | )          | —                         |       |
| Net earnings                                      |       | $          | 17,207     |             | $          | 40,334              |       | $                | 1,896      |                           | $          | (42,230 | ) | $ | 17,207 |   |

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of Cash FlowsThree months ended December 31, 2009

(In thousands)

(Unaudited)

 
| ** **                                                                 | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings  LLC** | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|--------------------------|------------|
| ** **                                                                 | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **&  Subsidiaries**  | ** ** |
| Net cash (used) provided  by operating activities                          |       | $          | —     |             | $          | (20,194             | )          | $                | 39,930     |                     | $          | — |   | $ | 19,736 |   |
| Cash Flows from Investing  Activities:                                     |       |       |       |             |       |                |       |             |       |                     |       |
| Capital expenditures, net of proceeds from sale of  property and equipment |       | —     |       | (7,878           | )          | (4,189              | )          | —           |       | (12,067                  | )          |
| Acquisitions, net of cash acquired                                         |       | —     |       | 611              |       | (31,000             | )          | —           |       | (30,389                  | )          |
| Net cash used by investing activities                                      |       | —     |       | (7,267           | )          | (35,189             | )          | —           |       | (42,456                  | )          |
| Cash Flows from Financing  Activities:                                     |       |       |       |             |       |                |       |             |       |                     |       |
| Change in book cash overdraft                                              |       | —     |       | —           |       | —              |       | —           |       | —                   |       |
| Proceeds from issuance of long-term debt                                   |       | 98,000     |       | —           |       | —              |       | —           |       | 98,000                   |       |
| Repayments of long-term debt                                               |       | (98,000    | )          | (33              | )          | (324                | )          | —           |       | (98,357                  | )          |
| Excess tax benefit from share-based compensation                           |       | —     |       | 8                |       | —              |       | —           |       | 8                        |       |
| Net cash used by financing activities                                      |       | —     |       | (25              | )          | (324                | )          | —           |       | (349                     | )          |
| Effect of foreign exchange rate changes on cash and  cash equivalents      |       | —     |       | —           |       | 411                 |       | —           |       | 411                      |       |
| Net (decrease) increase in cash and cash  equivalents                      |       | —     |       | (27,486          | )          | 4,828               |       | —           |       | (22,658                  | )          |
| Cash and cash equivalents, beginning of period                             |       | 20         |       | 37,593           |       | 16,834              |       | —           |       | 54,447                   |       |
| Cash and cash equivalents, end of period                                   |       | $          | 20         |             | $          | 10,107              |       | $                | 21,662     |                     | $          | — |   | $ | 31,789 |   |

 

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**SallyHoldings LLC and Subsidiaries**

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Statement of Cash FlowsThree months ended December 31, 2008

(In thousands)

(Unaudited)

 
| ** **                                                             | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings,  LLC** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|---------------------------|------------|
| ** **                                                             | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **&  Subsidiaries**   | ** ** |
| Net cash (used) provided  by operating activities                      |       | $          | 6,056      |             | $          | 14,787              |       | $                | 10,443     |                      | $          | — |   | $ | 31,286 |   |
| Cash Flows from Investing  Activities:                                 |       |       |       |             |       |                |       |             |       |                      |       |
| Capital expenditures and proceeds from sale of  property and equipment |       | —     |       | (6,204           | )          | (2,164              | )          | —           |       | (8,368                    | )          |
| Acquisitions, net of cash acquired                                     |       | —     |       | (1,085           | )          | (670                | )          | —           |       | (1,755                    | )          |
| Net cash used by investing activities                                  |       | —     |       | (7,289           | )          | (2,834              | )          | —           |       | (10,123                   | )          |
| Cash Flows from Financing  Activities:                                 |       |       |       |             |       |                |       |             |       |                      |       |
| Change in book cash overdraft                                          |       | (1,633     | )          | —           |       | —              |       | —           |       | (1,633                    | )          |
| Proceeds from issuance of long-term debt                               |       | 81,000     |       | —           |       | 1,638               |       | —           |       | 82,638                    |       |
| Repayments of long-term debt                                           |       | (87,050    | )          | (60              | )          | (1,911              | )          | —           |       | (89,021                   | )          |
| Excess tax shortfall from share-based compensation                     |       | —     |       | (111             | )          | —              |       | —           |       | (111                      | )          |
| Net cash provided (used) by financing activities                       |       | (7,683     | )          | (171             | )          | (273                | )          | —           |       | (8,127                    | )          |
| Effect of foreign exchange rate changes on cash and  cash equivalents  |       | —     |       | —           |       | (207                | )          | —           |       | (207                      | )          |
| Net (decrease) increase in cash and cash  equivalents                  |       | (1,627     | )          | 7,327            |       | 7,129               |       | —           |       | 12,829                    |       |
| Cash and cash equivalents, beginning of period                         |       | 1,645      |       | 85,384           |       | 12,759              |       | —           |       | 99,788                    |       |
| Cash and cash equivalents, end of period                               |       | $          | 18         |             | $          | 92,711              |       | $                | 19,888     |                      | $          | — |   | $ | 112,617 |   |

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

The following section discusses management’s view ofthe financial condition, results of operations and cash flows of SallyHoldings, a wholly-owned subsidiary of Sally Investment, a wholly-ownedsubsidiary of SallyBeauty, and its consolidated subsidiaries. All of the interests ofSally Holdings are beneficially owned by Sally Investment, and all of theinterests of Sally Investment are beneficially owned by Sally Beauty. This section should be read in conjunctionwith the audited consolidated financial statements and the related notesincluded in our Annual Report on Form 10-K for the fiscal year ended September 30,2009, as well as the Risk Factors section of that Annual Report, andinformation contained elsewhere in this Quarterly Report, including theconsolidated interim financial statements and condensed notes to thosestatements. This Management’s Discussion and Analysis of Financial Conditionand Results of Operations contains forward-looking statements. See “CautionaryNotice Regarding Forward-Looking Statements,” included at the beginning of thisQuarterly Report for a discussion of the uncertainties, risks and assumptionsassociated with these forward-looking statements that could cause results todiffer materially from those reflected in such forward-looking statements.

 

**HighlightsFor the First Three Months of Fiscal Year 2010:**

 

·                  Our same store sales increased by 3.8% for the threemonths ended December 31, 2009;

·                  Our consolidated net sales for the three months ended December 31,2009, increased by $59.3 million, or 9.2%, to $704.9 million compared to $645.6million for the three months ended December 31, 2008;

·                  Net sales reported for the three months ended December 31,2009, reflect approximately $9.1 million, or 1.3%, in positive impact fromchanges in foreign exchange rates;

·                  Our consolidated gross profit for the three monthsended December 31, 2009, increased $29.7 million, or 9.8%, to $333.2million compared to $303.5 million for the three months ended December 31,2008. As a percentage of net sales, gross profit increased 30 basis points to47.3% for the three months ended December 31, 2009 compared to 47.0% forthe three months ended December 31, 2008;

·                  Our consolidated operating earnings for the threemonths ended December 31, 2009, increased $4.3 million, or 6.3%, to $72.6million compared to $68.3 million for the three months ended December 31,2008;

·                  Net earnings increased $10.2 million, or 59.0%, to$27.4 million for the three months ended December 31, 2009 compared to$17.2 million for the three months ended December 31, 2008;

·                  Cash provided by operations decreased by$11.6 million to $19.7 million for the three months ended December 31,2009 compared to $31.3 million for the three months ended December 31,2008; and

·                  On December 16, 2009, we acquired Sinelco GroupNV (“Sinelco”), a wholesale distributor of professional beauty products basedin Ronse, Belgium, for approximately €25.5 million (approximately $37.1million).

 

**Overview**

 

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

 

We are the largest distributor of professional beautysupplies in the U.S. based on store count. We operate primarily through twobusiness units, Sally Beauty Supply and BSG. Through Sally Beauty Supply andBSG (which operates stores under the CosmoProf service mark), we operated amulti-channel platform of 3,750 stores and supplied 185 franchised stores inNorth America, South America and selected European countries, as of December 31,2009. Within BSG, we also have one of the largest networks of professionaldistributor sales consultants in North America, with approximately 1,091professional distributor sales consultants who sell directly to salons andsalon professionals.  We provide our customerswith a wide variety of leading third-party branded and exclusive-labelprofessional beauty supplies, including hair care products, styling appliances,skin and nail care products and other beauty items. Sally Beauty Supply storestarget retail consumers and salon professionals while BSG exclusively targetssalons and salon professionals. For the three months ended December 31,2009, our net sales and operating earnings were $704.9 million and $72.6million, respectively.

 

We believe Sally Beauty Supply is the largestopen-line distributor of professional beauty supplies in the U.S. based onstore count. As of December 31, 2009, Sally Beauty Supply operated 2,911company-operated retail stores, 2,361 of which are located in the U.S. (withthe remainder in the United Kingdom and certain other countries in Europe,Canada, Puerto Rico, Mexico and Chile) and supplied 27 franchised stores (alloutside the U.S.). Sally Beauty Supply stores in the U.S. range insize between 1,200 square feet and 1,700 square feet and areprimarily located in strip shopping centers. The product selection in SallyBeauty Supply stores ranges between 4,000 and 8,000 SKUs of beauty products andincludes products for hair care, skin and nail care, beauty sundries andelectrical appliances 

 

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targeting retail consumers and salon professionals.Sally Beauty Supply stores carry leading third-party brands such as Clairol,Revlon and Conair, as well as an extensive selection of exclusive-labelmerchandise.

 

We believe BSG is thelargest full-service distributor of professional beauty supplies in theU.S. As of December 31, 2009, BSG had 839 company-operated stores,supplied 158 franchised stores and had a sales force of approximately 1,091professional distributor sales consultants selling exclusively to salons andsalon professionals in substantially all states in the U.S. and inportions of Canada, Puerto Rico, Mexico and certain European countries. BSGstores average approximately 2,700 square feet and are primarilylocated in secondary strip shopping centers. Through BSG’s large store base andsales force, BSG is able to access a significant portion of the highlyfragmented U.S. salon channel. The product selection in BSG stores,ranging between 4,000 and 9,000 SKUs of beauty products, includes hair care andcolor, skin and nail care, beauty sundries and electrical appliances andtargets salons and salon professionals. BSG carries leading professional beautyproduct brands, intended for use in salons and for resale by the salon toconsumers. Certain BSG products are sold under exclusive distributionagreements with suppliers whereby BSG is designated as the sole distributor fora product line within certain geographic territories.

 

##### ***Industryand Business Trends***

 

We operate within the large and growingU.S. professional beauty supply industry. Potential growth in the industryis expected to be driven by increases in hair color, hair loss prevention andhair styling products, accompanied by declines in sales of electrical productsduring periods of prolonged economic slowdown. We believe the following keyindustry and business trends and characteristics will influence our businessand our financial results going forward:

 

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

 

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

 

·                  *Increasing use of exclusive-label products.*  We offer a broad range of privatelabel and control label products, which we generally refer to collectively as “exclusive-labelproducts.” Private label products are brands for which we own or license thetrademark and, in some instances, the formula. Control label products arebrands that are owned by the manufacturer, but for which we have been grantedsole distribution rights. Generally, our exclusive-label products have highergross margins than the leading third-party branded products, and we believe thisarea offers potential growth. Please see “Risk Factors - We depend uponmanufacturers who may be unable to provide products of adequate quality or whomay be unwilling to continue to supply products to us” in Item 1A of our AnnualReport on Form 10-K for the fiscal year ended September 30, 2009.

 

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

 

·                  *Internationalgrowth strategies. *A key element of our growth strategy dependson our ability to capitalize on growth in the international marketplace and togrow our current level of non-U.S. operations. For example, on December 16, 2009, we acquired Sinelco, a wholesale distributor ofprofessional beauty products with operations in Belgium, France and Italy.In addition, on September 4, 2009, we acquired Distribuidora IntersalonLimitada, a leading distributor of premier beauty supply products with 16stores 

 

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located in Chile.  These acquisitions furthered our expansionplans in Europe and Latin America, a significant part of Sally Beauty Supply’sinternational growth initiative.  Weintend to continue to identify and evaluate non-U.S. acquisition targets.  Our ability to grow our non-U.S. operations,integrate our new non-U.S. acquisitions and successfully pursue additionalnon-U.S. acquisitions may be affected by business, legal, regulatory andeconomic risks. Please see “Risk Factors - We may not be able to successfullyidentify acquisition candidates and complete desirable acquisitions,” “If weacquire any businesses in the future they could prove difficult to integrate,disrupt our business or have an adverse effect on our results of operations”and “Our ability to conduct business in international marketplaces may beaffected by legal, regulatory and economic risks” in Item 1A of our AnnualReport on Form 10-K for the fiscal year ended September 30, 2009.

 

·                  *Continuing consolidation.*  There is continuing consolidationamong professional beauty product distributors and professional beauty productmanufacturers. We plan to continue to examine ways in which we can benefit fromthis trend, including reviewing opportunities to shift business fromcompetitive distributors to the BSG network as well as seeking opportunistic,value-added acquisitions which complement our long-term growth strategy. Webelieve that suppliers are increasingly likely to focus on larger distributorsand retailers with a broader scale and retail footprint. We also believe thatwe are well positioned to capitalize on this trend as well as participate inthe ongoing consolidation at the distributor/retail level. However, changesoften occur in our relationships with suppliers that may materially affect thenet sales and operating earnings of our business segments. Consolidation amongsuppliers could exacerbate the effects of these relationship changes and couldincrease pricing pressures. For example, as we announced in December 2006,our largest supplier, L’Oreal, moved a material amount of revenue out of theBSG nationwide distribution network and into competitive regional distributionnetworks. More recently, L’Oreal acquired distributors competing with BSG inthe southeastern and west coast of the U.S. and a supplier that does notcurrently do business with BSG. As a result, L’Oreal directly competes with BSGin certain geographic areas. If L’Oreal acquired other distributors orsuppliers that conduct significant business with BSG, we could lose relatedrevenue. There can be no assurance that there will not be further loss ofrevenue over time by BSG (including within its franchise-based business) due topotential losses of additional products (both from L’Oreal and from othersuppliers) as well as from the increased competition from L’Oreal-affiliateddistribution networks. Please see “Risk Factors - The beauty productsdistribution industry is highly competitive and is consolidating” and “Wedepend upon manufacturers who may be unable to provide products of adequatequality or who may be unwilling to continue to supply products to us” in Item1A of our Annual Report on Form 10-K for the fiscal year ended September 30,2009.

 

·                  *Relationshipswith suppliers.*   Sally Beauty Supply/BSG and theirsuppliers are dependent on each other for the distribution of beauty products. We do not manufacture the brand name or exclusive-labelproducts we sell. We purchase our products from a limited number ofmanufacturers. As is typical in distribution businesses, theserelationships are subject to change from time to time (including the expansionor loss of distribution rights in various geographies and the addition or lossof product lines). Since we purchase products from many manufacturers on anat-will basis, under contracts which can generally be terminated without causeupon 90 days’ notice or less or which expire without express rights ofrenewal, such manufacturers could discontinue sales to us at any time or uponthe expiration of the distribution period. Some of our contracts withmanufacturers may be terminated by such manufacturers if we fail to meetspecified minimum purchase requirements. In such cases, we do not havecontractual assurances of continued supply, pricing or access to new productsand vendors may change the terms upon which they sell. Infrequently, a supplierwill seek to terminate a distribution relationship through legal action.Changes in our relationships with suppliers occur often and could positively ornegatively impact our net sales and operating profits. Although we focus ondeveloping new revenue and cost management initiatives to mitigate the negativeeffects resulting from unfavorable changes in our supplier relationships, therecan be no assurance that our efforts will continue to completely offset theloss of these or other distribution rights. Please see “Risk Factors*—* We depend upon manufacturers who may beunable to provide products of adequate quality or who may be unwilling tocontinue to supply products to us” inItem 1A of our Annual Report on Form 10-K for the fiscal year ended September 30,2009.

 

We expect to continue to expand our product line offerings and to gainadditional distribution rights over time through either further negotiationwith suppliers or by strategic acquisitions of existing distributors.  Although we are focused on developing newrevenue and cost management initiatives, there can be no assurance that ourefforts will partially or completely offset any potential loss of distributionrights in the future. Please see “Risk Factors—We depend upon manufacturers whomay be unable to provide products of adequate quality or who may be unwillingto continue to supply products to us” in Item 1A of our Annual Report onForm 10-K for the fiscal year ended September 30, 2009.

 

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·                  *Highlevel of competition.  *Sally Beauty Supply competes with other domestic and internationalbeauty product wholesale and retail outlets, including local and regionalopen-line beauty supply stores, professional-only beauty supply stores, salons,mass merchandisers, drug stores and supermarkets, as well as sellers on theinternet and salons retailing hair care items. BSG competes with other domesticand international beauty product wholesale and retail suppliers andmanufacturers selling professional beauty products directly to salons andindividual salon professionals. We also face competition from authorized andunauthorized retailers and internet sites offering professional salon-onlyproducts. The increasing availability of unauthorized professional salonproducts in large format retail stores such as drug stores, grocery stores andothers could also have a negative impact on our business. Please see “Risk Factors — The beautyproducts distribution industry is highly competitive and is consolidating” in Item 1A of our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2009.

 

·                  *Economicconditions.*  We appeal to a wide demographic consumerprofile and offer a broad selection of beauty products sold directly to retailconsumers and salons and salon professionals. Historically, these factors haveprovided us with reduced exposure to downturns in economic conditions in thecountries in which we operate.  However,a continued downturn in the economy, especially for an extended period of time,could adversely impact consumer demand of discretionary items such as beautyproducts and salon services, particularly affecting our electrical productscategory and our full-service sales business. In addition, higher freight costsresulting from increases in the cost of fuel, especially for an extended periodof time, may impact our expenses at levels that we cannot pass through to ourcustomers.  These factors could have amaterial adverse effect on our business, financial condition and results ofoperations. Please see “Risk Factors — A further downturn in the economy may affectconsumer purchases of discretionary items such as beauty products and salonservices, which could have a material adverse effect on our business, financialcondition and results of operations” in Item 1A of our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2009.

 

·                  *Controllingexpenses*.  Another important aspect of our business isour ability to control costs, especially in our BSG business segment, byright-sizing the business and maximizing the efficiency of our structure. Inlate fiscal year 2009, we completed implementation of an approximately $22.0million capital spending program to consolidate warehouses and reduceadministrative expenses related to BSG’s distribution network optimizationprogram. This program resulted in cost savings of approximately $8.0 million inthe fiscal year 2009 and we believe that annualized cost savings**fromthis program could approximate $10.0 million beginning in fiscal year2010. Please see “Risk Factors — We are not certain that our ongoing costcontrol plans will continue to be successful” in Item 1A of our Annual Reporton Form 10-K for the fiscal year ended September 30, 2009.

 

·                  *Openingnew stores*.  Our future growth strategy depends in part onour ability to open and profitably operate new stores in existing andadditional geographic areas. The capital requirements to open a U.S. - basedSally Beauty Supply or BSG store, excluding inventory, average approximately$70,000 and $80,000, respectively, with the capital requirements forinternational stores costing less or substantially more depending upon themarketplace. However, in response to economic conditions and to allowflexibility to capitalize on potential real estate revaluations in keylocations, in the fiscal year 2009 we slowed our new store openings. We may notbe able to open all of the new stores we plan to open and any new stores weopen may not be profitable, any of which could have a material adverse impacton our financial condition or results of operations. Please see “Risk Factors —If we are unable to profitably open and operate new stores, our business,financial condition and results of operations may be adversely affected” inItem 1A of our Annual Report on Form 10-K for the fiscal year ended September 30,2009.

 

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

 

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condition or results of operations.  Please see “Risk Factors — We may beadversely affected by any disruption in our information technology systems”in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30,2009.

 

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

 

In November 2006,Sally Holdings, Inc. was converted to a Delaware limited liabilitycompany, was renamed “Sally Holdings LLC” and became an indirect wholly-ownedsubsidiary of Sally Beauty in connection with our separation from Alberto-Culver.  In this Quarterly Report on Form 10-Q,we refer to these transactions as the Separation Transactions. Sally Beauty wasformed in June 2006 and became the accounting successor company to SallyHoldings upon the completion of the Separation Transactions.  See the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2009 for more information aboutthe Separation Transactions.

 

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

 

*DerivativeInstruments*

 

The Company is exposed to a wide variety of risks,including risks arising from changing economic conditions. The Company managesits exposure to certain economic risks (including liquidity, credit risk andchanges in interest rates) primarily (a) by closely managing its cashflows from operating and investing activities and the amounts and sources ofits debt obligations; (b) by assessing periodically the creditworthinessof its business partners; and (c) through the use of interest rateswaps.  The Company uses interest rateswaps as part of its overall economic risk management strategy to add stabilityto the interest payments due in connection with its term loan obligations. Interestpayments related to the term loans are impacted by changes in LIBOR. Interestrate swap agreements involve the periodic receipt by the Company of amountsbased on a variable rate in exchange for the Company making payments based on afixed rate over the term of the agreements without exchange of the underlyingnotional amount.

 

In November 2006, the Company entered into fourinterest rate swap agreements with an aggregate notional amount of $500million. Interest rate swap agreements with an aggregate notional amount of$150 million expired in November 2008 and agreements with a notionalamount of $350 million expired in November 2009. These interest rate swapagreements did not qualify as hedges and, therefore, the changes in fair valueof these agreements were recorded in net interest expense in our consolidatedstatements of earnings.

 

Additionally, in May 2008, the Company enteredinto two interest rate swap agreements with an aggregate notional amount of$300 million. These interest rate swap agreements expire in May 2012 andare designated as effective hedges, consistent with ASC 815.  Accordingly, adjustments to reflect thechange in the fair values of these interest rate swap agreements are recordedin accumulated other comprehensive income until the hedged obligation issettled or the swap agreements expire, whichever is earlier.  Any ineffectiveness is recognized in netinterest expense in the consolidated statements of earnings. Please see “Item3—Quantitative and Qualitative Disclosures about Market Risk—Interest rate risk”and Note 12 of the “Notes to Consolidated Financial Statements” in Item 8 - “FinancialStatements and Supplementary Data” contained in our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2009.

 

The Company is exposed to potential gains or lossesfrom foreign currency fluctuations affecting net investments and earningsdenominated in foreign currencies. The Company’s primary exposures are tochanges in exchange rates for the U.S. dollar versus the British poundsterling, the Canadian dollar, the Euro, the Chilean peso, and the Mexicanpeso. The Company’s various foreign currency exposures at times offset eachother providing a natural hedge against foreign currency risk.

 

As a result of the Company’s acquisition of Sinelco,on December 16, 2009, the Company, through Sinelco, uses foreign currencyoptions to manage the exposure to certain foreign currencies in connection withSinelco’s purchases of merchandise. The Company’s foreign currency optionagreements are not designated as hedges and do not meet the hedge accountingrequirements of ASC 815. Accordingly, the changesin fair value of these derivative instruments (which are adjusted quarterly)and the option fees, if any, are recorded in selling, general andadministrative expenses in our consolidated statements of earnings. During thethree months ended December 31, 2009, these derivative instruments did nothave a material impact in results of operations or cash flows.

 

Our counterparties in the Company’s interest rateswaps and foreign currency options are deemed to be of substantial resourcesand strong creditworthiness. However, these transactions result in exposure tocredit risks in the event of default by a counterparty. The current financialcrisis affecting the banking systems and financial markets has resulted in manywell-known financial institutions becoming less creditworthy or havingdiminished liquidity, which could expose us to an increased level ofcounterparty risk.  In the event that acounterparty defaults in its obligation under our derivative instruments, wecould incur substantial financial loss. At December 31, 2009,

 

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the aggregate fair value of all our interest rateswaps was a net liability of $14.0 million andthe aggregate fair value of all our foreign currency options was a net asset of$0.1 million.

 

## **Results of Operations**

 

The following table shows the condensed results ofoperations of our business for the three months ended December 31, 2009and 2008 (in thousands):

 
| ** **                                       | ** ** | **Three Months Ended********December 31,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                        | ** ** | **2008** | ** ** |
| Net  sales                                       |       | $                                               | 704,851    |   | $ | 645,576 |   |
| Cost  of products sold and distribution expenses |       | 371,637                                         |       | 342,032 |   |
| Gross  profit                                    |       | 333,214                                         |       | 303,544 |   |
| Total  other operating costs and expenses        |       | 260,629                                         |       | 235,284 |   |
| Operating  earnings                              |       | 72,585                                          |       | 68,260 |   |
| Interest  expense, net                           |       | 28,451                                          |       | 39,673 |   |
| Earnings  before provision for income taxes      |       | 44,134                                          |       | 28,587 |   |
| Provision  for income taxes                      |       | 16,773                                          |       | 11,380 |   |
| Net  earnings                                    |       | $                                               | 27,361     |   | $ | 17,207 |   |

 

The following table shows the condensed results ofoperations of our business for the three months ended December 31, 2009and 2008, expressed as a percentage of net sales for each respective periodshown:

 
| ** **                                       | ** ** | **Three Months Ended********December 31,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                        | ** ** | **2008** | ** ** |
| Net  sales                                       |       | 100.0                                           | %          | 100.0 | % |
| Cost  of products sold and distribution expenses |       | 52.7                                            | %          | 53.0 | % |
| Gross  profit                                    |       | 47.3                                            | %          | 47.0 | % |
| Total  other operating costs and expenses        |       | 37.0                                            | %          | 36.4 | % |
| Operating  earnings                              |       | 10.3                                            | %          | 10.6 | % |
| Interest  expense, net                           |       | 4.0                                             | %          | 6.2 | % |
| Earnings  before provision for income taxes      |       | 6.3                                             | %          | 4.4 | % |
| Provision  for income taxes                      |       | 2.4                                             | %          | 1.7 | % |
| Net  earnings                                    |       | 3.9                                             | %          | 2.7 | % |

 

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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):

 
| ** **                                                 | ** ** | **Three Months Ended********December 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                 | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| Net  sales:                                                |       |                                       |       |   |   |
| Sally  Beauty Supply                                       |       | $                                          | 438,315    |   | $ | 410,537 |   |
| BSG                                                        |       | 266,536                                    |       | 235,039 |   |
| Total                                                      |       | $                                          | 704,851    |   | $ | 645,576 |   |
| Gross  profit                                              |       | $                                          | 333,214    |   | $ | 303,544 |   |
| Gross  profit margin                                       |       | 47.3                                       | %          | 47.0 | % |
| Selling,  general and administrative expenses              |       | $                                          | 248,740    |   | $ | 223,537 |   |
| Depreciation  and amortization                             |       | $                                          | 11,889     |   | $ | 11,747 |   |
| Earnings  before provision for income taxes:               |       |                                       |       |   |   |
| Segment  operating profit:                                 |       |                                       |       |   |   |
| Sally  Beauty Supply                                       |       | $                                          | 71,106     |   | $ | 65,286 |   |
| BSG                                                        |       | 25,597                                     |       | 20,236 |   |
| Segment  operating profit                                  |       | 96,703                                     |       | 85,522 |   |
| Unallocated  expenses                                      |       | (19,295                                    | )          | (13,794 | ) |
| Share-based  compensation expense                          |       | (4,823                                     | )          | (3,468 | ) |
| Operating  earnings                                        |       | 72,585                                     |       | 68,260 |   |
| Interest  expense, net of interest income                  |       | (28,451                                    | )          | (39,673 | ) |
| Earnings  before provision for income taxes                |       | $                                          | 44,134     |   | $ | 28,587 |   |
| Segment  operating profit margin:                          |       |                                       |       |   |   |
| Sally  Beauty Supply                                       |       | 16.2                                       | %          | 15.9 | % |
| BSG                                                        |       | 9.6                                        | %          | 8.6 | % |
| Consolidated  operating profit margin                      |       | 10.3                                       | %          | 10.6 | % |
| Number  of stores at end-of-period (including franchises): |       |                                       |       |   |   |
| Sally  Beauty Supply                                       |       | 2,938                                      |       | 2,849 |   |
| BSG                                                        |       | 997                                        |       | 920 |   |
|                                                       |       | 3,935                                      |       | 3,769 |   |
| Same  store sales growth (decrease) (a)                    |       |                                       |       |   |   |
| Sally  Beauty Supply                                       |       | 3.66                                       | %          | (0.21 | )% |
| BSG                                                        |       | 4.31                                       | %          | 0.76 | % |
| Consolidated                                               |       | 3.82                                       | %          | 0.04 | % |

 

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|   | (a) | Same  stores are defined as company-operated stores that have been open for at  least 14 months as of the last day of a month. Our internet site has  generated sales for at least 14 months and, accordingly, internet-based sales  are included in same store sales for the periods ended December 31, 2009 and  2008. |
|--------|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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***The Three Months Ended December 31,2009 compared to the Three Months Ended December 31, 2008***

 

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

 
| ** **                       | ** ** | **Three Months Ended December 31,** | ** ** |
|----------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **2009**                            | ** ** | **2008** | ** ** | **Increase** | ** ** |
| Net sales:                       |       |                                |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                   | 438,315    |   | $ | 410,537 |   | $ | 27,778 |   | 6.8 | % |
| BSG                              |       | 266,536                             |       | 235,039 |   | 31,497 |   | 13.4 | % |
| Consolidated net sales           |       | $                                   | 704,851    |   | $ | 645,576 |   | $ | 59,275 |   | 9.2 | % |
|                             |       |                                |       |   |   |   |   |   |   |
| Gross profit:                    |       |                                |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                   | 230,264    |   | $ | 212,927 |   | $ | 17,337 |   | 8.1 | % |
| BSG                              |       | 102,950                             |       | 90,617 |   | 12,333 |   | 13.6 | % |
| Consolidated gross profit        |       | $                                   | 333,214    |   | $ | 303,544 |   | $ | 29,670 |   | 9.8 | % |
|                             |       |                                |       |   |   |   |   |   |   |
| Gross profit margin:             |       |                                |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | 52.5                                | %          | 51.9 | % | 0.6 | % |   |   |
| BSG                              |       | 38.6                                | %          | 38.6 | % | — |   |   |   |
| Consolidated gross profit margin |       | 47.3                                | %          | 47.0 | % | 0.3 | % |   |   |

###  

### ***Net Sales***

###  

Consolidated net sales increased by $59.3 million, or 9.2%, for thethree months ended December 31, 2009 compared to the three months ended December31, 2008. Company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $48.2 million, or 7.5%, and sales frombusinesses acquired in the preceding 12 months contributed a net increase ofapproximately $14.3 million, or 2.2%, to consolidated sales, while other saleschannels experienced minor declines compared to the three months ended December31, 2008. Sales through our BSG franchise-based businesses declined byapproximately $1.8 million, or 0.3%, primarily due to lower trade showactivity; and sales through our BSG distributor sales consultants declinedapproximately $1.2 million, or 0.2%. Consolidated net sales for the threemonths ended December 31, 2009, are inclusive of approximately $9.1 million inpositive impact from changes in foreign exchange rates.

 

*Sally Beauty Supply*.  Net sales for Sally Beauty Supply increasedby $27.8 million, or 6.8%, for the three months ended December 31, 2009compared to the three months ended December 31, 2008.  In the Sally Beauty Supply segment,company-operated stores that have been open for at least 14 months contributedan increase of approximately $36.3 million, or 8.8%, while incremental sales ofbusinesses acquired in the preceding 12 months contributed approximately $8.2million less, or 2.0%, to net sales for the three months ended December 31,2009 than in the three months ended December 31, 2008. Other sales channelsexperienced minor declines compared to the three months ended December 31,2008. Net sales for Sally Beauty Supply for the three months ended December 31,2009, are inclusive of approximately $5.3 million in positive impact fromchanges in foreign exchange rates.

 

*Beauty Systems Group*. Net sales for BSG increased by $31.5 million, or 13.4%, for the threemonths ended December 31, 2009 compared to the three months ended December 31,2008. Company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $11.9 million, or 5.1%, and sales frombusinesses acquired in the preceding 12 months contributed an increase ofapproximately $22.5 million, or 9.6%, to net sales, while other sales channelsexperienced minor declines compared to the three months ended December 31,2008. Sales through our franchise-based businesses declined by approximately$1.8 million, or 0.8%, and sales through distributor sales consultants declinedapproximately $1.2 million, or 0.5%. Net sales for BSG for the three monthsended December 31, 2009 are inclusive of approximately $3.9 million in positiveimpact from changes in foreign exchange rates.

 

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#### ***GrossProfit***

#### ** **

Consolidated gross profit increased by $29.7 million, or 9.8%, for thethree months ended December 31, 2009 compared to the three months ended December31, 2008, principally due to higher sales volume in both business segments andimproved gross margins in the Sally Beauty Supply segment as more fullydescribed below.

 

*Sally Beauty Supply*. Sally BeautySupply’s gross profit increased by $17.3 million, or 8.1%, for the three monthsended December 31, 2009 compared to the three months ended December 31, 2008,principally as a result of a higher sales volume and improved grossmargins.  Sally Beauty Supply’s grossprofit as a percentage of net sales increased to 52.5% for the three monthsended December 31, 2009 compared to 51.9% for the three months ended December 31,2008. This increase was the result of low-cost sourcing initiatives and a shiftin product and customer mix (including an increase in sales of exclusive-labelproducts and other higher-margin products). This increase also reflects afavorable impact from changes in foreign exchange rates.

 

*Beauty Systems Group*.  BSG’s gross profit increased by $12.3million, or 13.6%, for the threemonths ended December 31, 2009 compared to the three months ended December 31, 2008, principallyas a result of higher sales volume.  Thisincrease also reflectsa favorable impact from changes in foreign exchange rates. BSG’s grossprofit as a percentage of net sales was 38.6% for both the three months ended December 31, 2009andthe threemonths ended December 31, 2008.

 

#### ***Selling,General and Administrative Expenses***

#### ** **

Consolidated selling, general and administrative expenses increased by$25.2 million, or 11.3%, to $248.7 million for the three months ended December 31,2009 compared to $223.5 million for the three months ended December 31, 2008.Selling, general and administrative expenses, as a percentage of net sales,were 35.3% for the three months ended December 31, 2009 compared to 34.6% forthe three months ended December 31, 2008. This increase was attributable toincremental expenses (including employee compensation, rent and otheroccupancy-related expenses) resulting from stores opened and from businessesacquired in the preceding 12 months, as well as higher share-based compensationexpense of $1.4 million, higher advertising expenses in the Sally Beauty Supplysegment of $2.8 million and acquisition-related expenses of $0.4 million.Please see “Recent Accounting Pronouncements” below for more information aboutthe Company’s treatment of acquisition-related expenses.

 

#### ***Depreciation and Amortization***

#### ** **

Consolidated depreciationand amortization was $11.9 million for three months ended December 31, 2009compared to $11.7 million for the three months ended December 31, 2008. Thisincrease reflects the incremental expenses associated with businesses acquiredin the last 12 months and depreciation related to capital expenditures mainlyin connection with store openings in both operating segments, partially offsetby the impact of assets becoming fully depreciated in the preceding 12 months.

 

#### ***OperatingEarnings***

#### ** **

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

 
| ** **                        | ** ** | **Three  Months Ended December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **2009**                             | ** ** | **2008** | ** ** | **Increase** | ** ** |
| Operating Earnings:               |       |                                 |       |   |   |   |   |   |   |
| Segment operating  profit:        |       |                                 |       |   |   |   |   |   |   |
| Sally Beauty Supply               |       | $                                    | 71,106     |   | $ | 65,286 |   | $ | 5,820 |   | 8.9 | % |
| BSG                               |       | 25,597                               |       | 20,236 |   | 5,361 |   | 26.5 | % |
| Segment operating  profit         |       | 96,703                               |       | 85,522 |   | 11,181 |   | 13.1 | % |
| Unallocated expenses              |       | (19,295                              | )          | (13,794 | ) | 5,501 |   | 39.9 | % |
| Share-based  compensation expense |       | (4,823                               | )          | (3,468 | ) | 1,355 |   | 39.1 | % |
| Operating earnings                |       | $                                    | 72,585     |   | $ | 68,260 |   | $ | 4,325 |   | 6.3 | % |

 

Consolidated operating earnings increased by $4.3 million, or 6.3%, to$72.6 million for three months ended December 31, 2009 compared to $68.3million for the three months ended December 31, 2008. The increase inconsolidated operating earnings was due primarily to an increase in theoperating profits of both segments, partially offset by higher unallocatedcorporate expenses and share-based compensation expense, as discussed below.Operating earnings, as a percentage of net sales, were 10.3% for the threemonths ended December 31, 2009 compared to 10.6% for the three months ended December31, 2008.

 

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*Sally Beauty Supply*.  Sally Beauty Supply’s segment operatingearnings increased by $5.8 million, or 8.9%, to $71.1 million for three monthsended December 31, 2009 compared to $65.3 million for the three months ended December31, 2008.  The increase in Sally BeautySupply’s segment operating earnings was primarily a result of increased samestore sales volume and improved gross margins, partially offset by higheradvertising costs of approximately $2.8 million and the incremental costsrelated to approximately 87 additional company-operated stores (stores openedor acquired during the past twelve months) operating during the three monthsended December 31, 2009.  Segmentoperating earnings, as a percentage of net sales, were 16.2% for the threemonths ended December 31, 2009 compared to 15.9% for the three months ended December31, 2008. The increase in Sally Beauty Supply’s operating earnings as apercentage of segment net sales was primarily a result of gross marginimprovements, partially offset by an increase in advertising costs as apercentage of segment sales.

 

*Beauty Systems Group*.  BSG’s segment operating earnings increased by$5.4 million, or 26.5%, to $25.6 million for the three months ended December 31,2009 compared to $20.2 million for the three months ended December 31, 2008.Segment operating earnings, as a percentage of net sales, increased to 9.6% forthe three months ended December 31, 2009 compared to 8.6% for the three monthsended December 31, 2008. The increase in BSG operating earnings was due to increasedsame store sales volume, the incremental operating earnings of businessesacquired, and to ongoing cost reduction initiatives (including cost savingsrealized from the warehouse optimization program that began in the fiscal year2007).

 

*Unallocated expenses.*Unallocated expenses, which representcorporate costs (such as payroll, employee benefits and travel expenses forcorporate staff, certain professional fees and corporate governance expenses)that have not been charged to our operating segments, increased by $5.5million, or 39.9%, to $19.3 million for the three months ended December 31,2009 compared to $13.8 million for the three months ended December 31, 2008.This increase was due primarily to higher employee compensation andcompensation-related expenses of approximately $2.4 million, unfavorablecurrency transactions of approximately $1.5 million resulting from intercompanynotes not permanently invested, other corporate expenses of approximately $0.8million related primarily to recent upgrades to our information technologysystems, and acquisition-related expenses of approximately $0.4 million(representing legal, professional fees and other expenses).

 

#### ***Share-basedCompensation Expense.***Total compensation cost charged againstincome for share-based compensation arrangements increased $1.4 million to $4.8million for the three months ended December 31,2009 compared to $3.5million for the three months ended December 31,2008. This increase was due tothe higher fair value at the grant date of stock option awards during the threemonths ended December 31, 2009 compared to stock option awards during the threemonths ended December 31, 2008.

#### ** **

#### ***NetInterest Expense***

#### ** **

Net interest expensedecreased $11.2 million to $28.5 million for the three months ended December 31,2009 compared to $39.7 million for the three months ended December 31,2008.  Net interest expense for the threemonths ended December 31, 2008 is net of interest income of $0.1 million. Thedecrease in net interest expense was primarily attributable to a $5.4 millionfavorable change in the fair value of certain interest rate swaps (please seeNote 7 of the Condensed Notes to Consolidated Financial Statements), to loweroutstanding principal balances on our ABL facility and senior term loans and tolower prevailing LIBOR interest rates.

 

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

#### ** **

Provision for incometaxes was $16.8 million during the three months ended December 31, 2009compared to $11.4 million for the three months ended December 31, 2008.  Income taxes for the interim periods ended December31, 2009 and 2008 have been included in the accompanying financial statementson the basis of an estimated annual effective rate.  The estimated annual effective tax rate(excluding discrete items) is 37.6% for the fiscal year 2010 compared to theactual tax rate of 39.0% for the full fiscal year 2009.  The decrease in the estimated annualeffective tax rate primarily relates to a decrease in the losses subject tovaluation allowances.

 

The actual tax rate forthe three months ended December 31, 2009 exceeds the estimated annual effectivetax rate (excluding discrete items) for fiscal year 2010 primarily because ofthe discrete tax items recorded in the three months ended December 31, 2009.

 

#### ***NetEarnings***

#### ** **

As a result of theforegoing, consolidated net earnings increased by $10.2 million, or 59.0%, to$27.4 million for the three months ended December 31, 2009 compared to $17.2million for the three months ended December 31, 2008. Net earnings, as apercentage of net sales, were 3.9% for the three months ended December 31, 2009compared to 2.7% for the three months ended December 31, 2008.

 

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## **Financial Condition**

##  

##### ***December 31, 2009 Compared to September 30,2009***

##### *** ***

Working capital (currentassets less current liabilities) at December 31, 2009 was $331.1 millioncompared to $315.9 million at September 30, 2009, representing an increase of$15.2 million. The ratio of current assets to current liabilities was 1.84 to1.00 at December 31, 2009 compared to 1.79 to 1.00 at September 30, 2009. Theincrease in working capital reflects an increase of $9.9 million in currentassets and a decrease of $5.2 million in current liabilities.  The increase in current assets as of December31, 2009 includes an increase of $19.5 million in inventory levels and anincrease of $12.2 million in other receivables, partially offset by a reductionof $22.7 million in cash and cash equivalents. The decrease in current liabilities as of December 31, 2009 includes areduction of $25.2 million in accrued expenses, partially offset by an increaseof $14.2 million due to Sally Beauty.

 

Inventories increased $19.5 million to $579.2 million at December 31,2009 compared to $559.7 million at September 30, 2009 due primarily to theeffect of stores opened and businesses acquired in the preceding 12 months andto the effect of foreign currency translation adjustments of approximately $0.5million. Other receivables increased $12.2 million to $36.3 million at December31, 2009 compared to $24.1 million at September 30, 2009 due primarily toaccrued vendor rebates and the effect of businesses acquired.

 

Accrued expenses decreased $25.2 million to $128.6 million at December 31,2009 compared to $153.8 million at September 30, 2009 due primarily to thetiming of payments of interest on long-term debt. The amount due to SallyBeauty increased $14.2 million to $36.2 million at December 31, 2009 comparedto $22.0 million at September 30, 2009 due primarily to an increase in thefederal income tax liability of the Company and its consolidated subsidiaries,partially offset by corporate expenses (such as corporate income tax, board ofdirector expenses and public company expenses) and other corporate expenditurespaid on behalf of our indirect parent Sally Beauty.

 

Long-term debt, including current portion, increased $13.7 million to$1,691.2 million at December 31, 2009 compared to $1,677.5 million at September30, 2009 due primarily to the pre-acquisition indebtedness, including capitalleases, of Sinelco.

 

Total member’s deficit, for the three months ended December31, 2009, decreased by $29.8 million primarily as a result of net earnings of$27.4 million and cumulative translation adjustments of $1.6 million.

 

## **Liquidity andCapital 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. Please see our AnnualReport on Form 10-K for the fiscal year ended September 30, 2009 for additionalinformation on liquidity and capital resources.

 

Following the completion of the SeparationTransactions, we are highly leveraged and a substantial portion of ourliquidity needs will arise from debt service on indebtedness incurred primarilyin connection with the Separation Transactions and from funding the costs ofoperations, working capital and capital expenditures. As a holding company, wedepend on our subsidiaries to distribute funds to us so that we may pay ourobligations and expenses. Please see “Risk Factors—Risks Relating to OurBusiness,” and “—Risks Relating to Our Substantial Indebtedness” in Item 1A ofour Annual Report on Form 10-K for the fiscal year ended September 30, 2009.

 

The senior term loan facilities may be prepaid at theoption of the Company at any time without premium or penalty and are subject tomandatory prepayment in an amount equal to 50% of excess cash flow (as definedin the agreement governing the term loan facilities) for any fiscal year unlessa specified leverage ratio is met. In January 2009, the Company made mandatoryprepayments on the senior term loan facilities in the aggregate amount of $16.7million and made mandatory prepayments in the aggregate amount of $22.3 millionin January 2010. Amounts paid pursuant to said provision may be applied, at theoption of the Company, against minimum loan repayments otherwise required of usover the twelve-month period following any such payment under the terms of theloan agreement.

 

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

 

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There can be no assurance that our business willgenerate sufficient cash flows from operations, that anticipated net salesgrowth and operating improvements will be realized or that future borrowingswill be available under our ABL facility in an amount sufficient to enable usto service our indebtedness or to fund our other liquidity needs. In addition,our ability to meet our debt service obligations and liquidity needs aresubject to certain risks, which include, but are not limited to, increases incompetitive activity, the loss of key suppliers, rising interest rates, theloss of key personnel, the ability to execute our business strategy and generaleconomic conditions. Please see “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the yearended September 30, 2009.

 

We utilize our ABL facilityfor the issuance of letters of credit, as well as to manage normal fluctuationsin operational cash flow. In that regard, we may from time to time draw fundsunder the revolving credit facility for general corporate purposes includingacquisitions and interest payments due on our indebtedness.  The funds drawn on individual occasions duringthe three months ended December 31, 2009, have varied in amounts of up to $30.0**million, with total amounts outstandingranging from zero up to $43.7 million. The amounts drawn are generally paiddown with cash provided by our operating activities.

 

As of December 31, 2009, wehad $328.9 million available for additional borrowings under our ABL facility,subject to borrowing base limitations, as reduced by outstanding letters ofcredit.

 

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

 

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

 

Under the agreements andindentures governing the term loan facilities and the notes, we may not makecertain restricted payments to Sally Beauty if a default then exists under thecredit agreement or the indentures or if our consolidated interest coverageratio is less than 2.0 to 1.0 at the time of the making of such restrictedpayment.  As of December 31, 2009, ourconsolidated interest coverage ratio exceeded 2.0 to 1.0.  Further, the aggregate amount of restrictedpayments we are able to make is limited pursuant to various baskets as calculatedpursuant to the credit agreement and indentures.

 

The agreements governing our ABL facility generallypermit the making of distributions and certain other restricted payments solong as borrowing availability under the facility equals or exceeds $60.0million.  If borrowing availability fallsbelow this amount, we may nevertheless make restricted payments to Sally Beautyin the aggregate since the date of the Separation Transactions, together withthe aggregate cash amount paid in acquisitions since said date, of not greaterthan $50.0 million, together with certain other exceptions.  As of December 31, 2009, borrowingavailability under the ABL facility exceeded $60.0 million. As of December 31,2009, the net assets of the Company and its consolidated subsidiaries that wereunrestricted from transfer under our credit arrangements totaled $240.9million, subject to certain adjustments**.**

 

On December 16, 2009, the Company acquired Sinelco, awholesale distributor of professional beauty products based in Ronse, Belgium,for approximately €25.5 million (approximately $37.1 million). Sinelco servesover 1,500 customers through a product catalog and website and has salesoffices in Belgium, France and Italy. Goodwill of $17.6 million was recorded asa result of this acquisition. We funded this acquisition with cash fromoperations and borrowings under our ABL facility. Such borrowings were repaidon or before December 31, 2009.

 

Our primary source of cash has been from fundsprovided by operating activities and borrowings under our ABL facility for thethree months ended December 31, 2009 and 2008. Historically, our primary use ofcash has been for acquisitions, capital expenditures and repayments of debt.The following table shows our sources and uses of funds for the three monthsended December 31, 2009 and 2008 (in thousands):

 

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| ** **                                                     | ** ** | **Three Months Ended****December 31,** | ** **           |
|----------------------------------------------------------------|------------|----------------------------------------|----------------------|
| ** **                                                     | ** ** | **2009**                               | ** **           | **2008** | ** ** |
| Net cash provided by operating activities                      |       | $                                      | 19,736               |   | $ |      31,286 |   |
| Net cash used by investing activities                          |       | (42,456                                | )                    | (10,123 | ) |
| Net cash used by financing activities                          |       | (349                                   | )                    | (8,127 | ) |
| Effect of foreign exchange rates on cash and cash  equivalents |       | 411                                    |                 | (207 | ) |
| Net (decrease) increase in cash and cash  equivalents          |       | $                                      |    (22,658 | ) | $ |      12,829 |   |

 

*NetCash Provided by Operating Activities*

 

Net cash provided by operating activities(which excludes cash used for acquisitions completed during the period) duringthe three months ended December 31, 2009 decreased by $11.6 million to $19.7 millioncompared to $31.3 million during the three months ended December 31, 2008. Thedecrease was primarily due to changes in inventory levels of approximately$17.1 million and in accounts payable and accrued expenses of approximately$23.5 million, partially offset by changes in trade accounts receivable of $9.1million, in other liabilities of $7.2 million and amount due to Sally Beauty of$3.8 million. This decrease is also net of an improvement in earnings ofapproximately $10.2 million for the three months ended December 31, 2009 comparedto the three months ended December 31, 2008.

 

*NetCash Used by Investing Activities*

 

Net cash used by investing activities duringthe three months ended December 31, 2009 increased by $32.3 million to $42.5 millioncompared to $10.1 million during the three months ended December 31, 2008.  This increase was primarily due to anincrease of $28.6 million in cash used for acquisitions and a $3.7 millionincrease in capital expenditures (primarily as a result of more store openings)for the three months ended December 31, 2009 compared to the three months endedDecember 31, 2008.

 

*NetCash Used by Financing Activities*

 

Net cash used by financing activities duringthe three months ended December 31, 2009 decreased by $7.8 million to cash usedof $0.3 million compared to $8.1 million during the three months ended December31, 2008.  The decrease was primarily dueto scheduled payments of $6.1 million under the senior term loans during thethree months ended December 31, 2008, without comparable payments during thethree months ended December 31, 2009.

 

**Capital Requirements**

 

During the three months ended December 31,2009, capital expenditures were $12.1 million. For fiscal year 2010, weanticipate total capital expenditures in the range of approximately $45.0 millionto $50.0 million, excluding acquisitions. We expect that capital expenditureswill be primarily for the addition of new stores and the remodeling, expansionand/or relocation of existing stores in the ordinary course of our business aswell as certain corporate projects.

 

**Contractual Obligations**

 

There have been nomaterial changes outside the ordinary course of business in any of ourcontractual obligations since September 30, 2009.

 

**Off-Balance Sheet FinancingArrangements**

 

We had no off-balance sheet financingarrangements other than operating leases incurred in the ordinary course ofbusiness, as well as outstanding letters of credit related to inventorypurchases and self insurance programs which totaled $14.3 million and $13.4million at December 31, 2009 and September 30, 2009, respectively.

 

**Inflation**

 

We believe that inflation currently does nothave a material effect on our results of operations.

 

**Critical Accounting Policies andEstimates**

 

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

 

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Our critical accounting policies, asdescribed in our Annual Report on Form 10-K for the fiscal year ended September30, 2009, include but are not limited to the valuation of inventories, vendorconcessions, retention of risk, income taxes and share-based payments. Therehave been no material changes to our critical accounting policies, estimates orassumptions since September 30, 2009.

 

As required by ASC 815,*Derivatives and Hedging*, as amended, the Company recordsall derivative instruments on its balance sheet at fair value.  The accounting for changes in the fair valueof derivative instruments depends on the intended use of the derivative,whether the Company has elected to designate a derivative instrument in ahedging relationship and apply hedge accounting and whether the hedgingrelationship has satisfied the criteria necessary to apply hedge accounting.Derivative instruments designated and qualifying as a hedge of the exposure tovariability in expected future cash flows, or other types of forecastedtransactions, are considered cash flow hedges. Hedge accounting generallyprovides for the matching of the timing of gain or loss recognition on thehedging instrument with the recognition of the impact on earnings of the hedgedtransaction or transactions. The Company may from time to time enter intoderivative contracts that are intended to hedge certain economic risks eventhough hedge accounting does not apply or the Company elects not to apply hedgeaccounting to such derivative contracts.

 

In the fiscal year 2009,the Company adopted the provisions of ASC 820 as it relates to its financialinstruments.  ASC 820, as amended,establishes a three-level hierarchy for measuring fair value and requires anentity to maximize the use of observable inputs and minimize the use ofunobservable inputs when measuring fair value. This valuation hierarchy isbased upon the transparency of inputs to the valuation of an asset or liabilityon the measurement date.  The threelevels of that hierarchy are defined as follows:

 

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

 

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

 

Level 3 - Unobservable inputs for the asset orliability

 

The Company measurescertain financial instruments at fair value on a recurring basis, includinginterest rate swaps and foreign currency options. In accordance with ASC 820,the Company categorized certain of its financial assets and liabilities basedon priority of the inputs to the valuation technique for the instruments, asfollows (in thousands):

 
| ** **                      | ** ** | **As of December 31, 2009** | ** ** |
|---------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **Total**                   | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Assets                          |       |                        |       |   |   |   |   |   |   |
| Foreign  currency options (b)   |       | $                           | 131        |   |   |   | $ | 131 |   |   |   |
| Total  assets                   |       | $                           | 131        |   |   |   | $ | 131 |   |   |   |
|                            |       |                        |       |   |   |   |   |   |   |
| Liabilities                     |       |                        |       |   |   |   |   |   |   |
| Long-term  debt (a)             |       | $                           | 1,685,198  |   | $ | 739,106 |   | $ | 946,092 |   |   |   |
| Hedged  interest rate swaps (b) |       | 14,004                      |       | — |   | 14,004 |   |   |   |
| Total  liabilities              |       | $                           | 1,699,202  |   | $ | 739,106 |   | $ | 960,096 |   |   |   |

 

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(a)          Long-term debt, which is carried at amortized cost inthe Company’s financial statements, is valued using internal models based onmarket observable inputs, except for the senior and senior subordinated notes.The senior and senior subordinated notes are valued using quoted market pricesfor such debt securities.

(b)         Interest rate swaps and foreign currency options arevalued using internal models based on market observable inputs, includingmarket interest rates and foreign currency exchange rates, as appropriate.Please see Note 7 of the Condensed Notes to Consolidated Financial Statementscontained in Item 1 of this report for more information about the Company’sforeign currency options.

 

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**Recent Accounting Pronouncements**

 

In December 2007, the FASB revised theaccounting standards for business combinations. This new standard (currentlycontained in ASC 805), among other things, generally requires that an acquirerrecognize the assets acquired and liabilities assumed measured at their “fullfair values” on the acquisition date. This practice replaced the practice,under predecessor accounting standards, of allocating the cost of anacquisition to the individual assets acquired and liabilities assumed based ontheir relative estimated fair values. This new standard further requires that acquisition-related costs berecognized separately from the related acquisition. This standard must beapplied prospectively to business combinations consummated on or after thefirst annual reporting period beginning on or after December 15, 2008 and,accordingly, the Company adopted it during the first quarter of the fiscal year2010. Selling, general and administrative expenses for the three months ended December31, 2009 includes approximately $0.4 million of expenses related toacquisitions.

 

In April 2008, the FASB amended ASC 350, *Intangibles and Other* (“ASC 350”). This new accountingstandard, currently contained in ASC 350-30-35, specifically amends the factorsthat should be considered in developing renewal or extension assumptions usedto determine the useful life of a recognized intangible asset. The objective ofthis amendment is to improve the consistency between the useful life of arecognized intangible asset and the period of expected cash flows used tomeasure the fair value of the asset. This new standard is effective for fiscalyears beginning after December 15, 2008 and, accordingly, the Company adoptedit during the first quarter of the fiscal year 2010. The adoption of thisstandard did not have a material effect on the Company’s consolidated financialposition, results of operations or cash flows.

 

In August 2009, the FASB issued AccountingStandards Update 2009-05 which amended ASC 820 as it relates to the measurementof liabilities at fair value, effective for interim reporting periods beginningafter August 26, 2009. More specifically, this amendment provided clarificationfor liabilities in which a quoted price in an active market for an identicalliability is not available. The Company adopted this amendment during the firstquarter of the fiscal year 2010. The adoption of this amendment did not have amaterial effect on the Company’s consolidated financial position, results ofoperations or cash flows.

 

We have not yet adopted and are currentlyassessing any potential effect of the following pronouncement on ourconsolidated financial statements:

 

In January 2010, the FASBissued Accounting Standards Update 2010-06 which amends ASC 820 as it relatesto certain disclosures of fair value measurements. The new standard willrequire, among other things, (a) disclosure of the sensitivity of an entity’sfair value measurements using Level 3 inputs to changes in such inputs, (b) areconciliation of changes in such fair value measurements and (c) disclosure oftransfers between fair value measurements using Level 1 and 2 inputs, if any.The new standard is effective for interim reporting periods beginning after December15, 2009.

 

**Item 3.  Quantitative and Qualitative Disclosures AboutMarket Risk.**

 

As a multinational corporation, we aresubject to certain market risks including foreign currency fluctuations,interest rates and government actions. We consider a variety of practices tomanage these market risks, including, when deemed appropriate, the occasionaluse of derivative financial instruments.

 

**Foreign currency exchange raterisk**

 

We are exposed to potential gains or lossesfrom foreign 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, theCanadian dollar, the Euro, the Chilean peso, and the Mexican peso. Our variousforeign currency exposures at times offset each other providing a natural hedgeagainst foreign currency risk. For fiscal year 2009, 2008 and 2007, approximately16%, 18% and 16%, respectively, of our sales were made in currencies other thanthe U.S. dollar. Consolidated net sales for the three months ended December 31,2009, are inclusive of approximately $9.1 million in positive impact fromchanges in foreign currency exchange rates. In addition, for the three monthsended December 31, 2009, other comprehensive income reflects $1.6 million inforeign currency translation adjustments. Fluctuations in the U.S. dollarexchange rates did not otherwise have a material effect on our consolidatedfinancial condition and consolidated results of operations.

 

As a result of the Company’s acquisition ofSinelco on December 16, 2009, the Company, through Sinelco, uses foreigncurrency options to manage the exposure to certain foreign currencies inconnection with Sinelco’s purchases of merchandise. These foreign currencyoption agreements are not designated as hedges and do not meet

 

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the hedge accounting requirements of ASC 815.Accordingly, the changes in fair value of thesederivative instruments (which are adjusted quarterly) are recorded in selling,general and administrative expenses in our consolidated statements of earnings.During the three months ended December 31, 2009, these derivative instrumentsdid not have a material impact in results of operations or cash flows.

 

A 10% increase or decrease in the exchange rates forthe U.S. dollar versus the foreign currencies to which we have exposure wouldhave impacted consolidated net sales by approximately 1.7% in the three monthsended December 31, 2009 and would have impacted consolidated net assets by 2.6%at December 31, 2009.

 

**Interest rate risk**

 

As a result of the debt financing incurred inconnection with the Separation Transactions, we are subject to interest ratemarket risk in connection with our long-term debt. The principal interest rateexposure relates to amounts borrowed under the term loans and the ABL facility.Based on the approximately $968.9 million of aggregate borrowings under theCompany’s term loans and the ABL facility as of December 31, 2009, a change inthe estimated interest rate up or down by 1/8% would increase or decreaseearnings before provision for income taxes by approximately $1.2 million on anannual basis, without considering the effect of any interest rate swapagreements we may have from time to time.

 

We and certain of our subsidiaries are sensitive tointerest rate fluctuations. In order to enhance our ability to manage riskrelating to cash flow and interest rate exposure, we and/or our othersubsidiaries who are borrowers under the ABL facility may from time to timeenter into and maintain derivative instruments, such as interest rate swapagreements, for periods consistent with the related underlying exposures. We donot purchase or hold any derivative instruments for speculative or tradingpurposes.

 

In November 2006, we entered into four interest rateswap agreements with an aggregate notional amount of $500 million. Interestrate swap agreements with an aggregate notional amount of $150 million expiredin November 2008 and agreements with a notional amount of $350 million expiredin November 2009. These interest rate swap agreements didnot qualify as hedges and, therefore, the change in the fair value of theseagreements, which were adjusted quarterly, were recorded in net interestexpense in the Company’s results of operations.

 

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

 

**Credit risk**

 

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

 

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

 

**Item 4.  Controls and Procedures.**

 

*Controls Evaluation and Related CEOand CFO Certifications.*  Our management, with theparticipation of our principal executive officer (“CEO”) and principalfinancial officer (“CFO”), conducted an evaluation of the effectiveness of thedesign and operation of our disclosure controls and procedures as of the end ofthe period covered by this report. The controls evaluation was conducted by ourDisclosure Committee, comprised of senior representatives from our finance,accounting, internal audit, and legal departments under the supervision of ourCEO.

 

Certifications of our CEO and our CFO, which arerequired in accordance with Rule 13a-14 of the Exchange Act, are attached asexhibits 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 certifications fora more complete understanding of the topics presented.

 

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*Limitations on the Effectiveness ofControls.*  We do not expect that our disclosure controlsand procedures will prevent all errors and all fraud. A system of controls andprocedures, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the system are met.Because of the limitations in all such systems, no evaluation can provideabsolute assurance that all control issues and instances of fraud, if any, havebeen detected. Furthermore, the design of any system of controls and proceduresis based in part upon certain assumptions about the likelihood of futureevents, and there can be no assurance that any design will succeed in achievingits stated goals under all potential future conditions, regardless of howunlikely. Because of these inherent limitations in a cost-effective system ofcontrols and procedures, misstatements or omissions due to error or fraud mayoccur 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 our AnnualReports on Form 10-K. Many of the components of our disclosure controls andprocedures are also evaluated by our internal audit department, our legaldepartment and by personnel in our finance organization. The overall goals ofthese various evaluation activities are to monitor our disclosure controls andprocedures on an ongoing basis and to maintain them as dynamic systems thatchange as conditions warrant.

 

*Conclusions regarding DisclosureControls.*  Based on the required evaluation of our disclosurecontrols and procedures, our CEO and CFO have concluded that, as of December 31,2009, we maintain disclosure controls and procedures that are effective inproviding reasonable assurance that information required to be disclosed by usin the reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and that such information is accumulated and communicated toour management, including our CEO and CFO, as appropriate to allow timelydecisions regarding required disclosure.

 

*Changes in Internal Control overFinancial Reporting.*  Duringour last fiscal quarter, there have been no changes in our internal controlover financial reporting identified in connection with the evaluation describedabove that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II — OTHERINFORMATION**

** **

**Item 1.  Legal Proceedings.**

 

There were no material legal proceedingspending against us or our subsidiaries as of December 31, 2009. We are involvedin various claims and lawsuits incidental to the conduct of our business in theordinary course. We carry insurance coverage in such amounts in excess of ourself-insured retention as we believe to be reasonable under the circumstancesand that may or may not cover any or all of our liabilities in respect ofclaims and lawsuits. We do not believe that the ultimate resolution of thesematters will have a material adverse impact on our consolidated financialposition, cash flows or results of operations.

 

We are subject to a number of U.S., federal,state and local laws and regulations, as well as the laws and regulationsapplicable in each other marketplace in which we do business. These laws andregulations govern, among other things, the composition, packaging, labeling andsafety of the products we sell, the methods we use to sell these products andthe methods we use to import these products. We believe that we are in material compliance with such laws andregulations, although no assurance can be provided that this will remain truegoing forward.

 

On February 25, 2008, Sally Beauty disclosedin a Current Report on Form 8-K that on February 21, 2008, L’Oreal filed alawsuit in the Superior Court of the State of California in and for the Countyof San Diego — Central Division naming, among others, SD Hair, Ltd. and Hair ofNevada, LLC (collectively, “SD Hair”), franchisees of our subsidiary ArmstrongMcCall division (“AMLP”) of our BSG business unit, as defendants.  The suit alleged, among other things, that SDHair breached its franchise agreement with AMLP by diverting (selling) Matrixbranded products to unauthorized buyers, and that L’Oreal is entitled to makeclaims against SD Hair under the franchise agreement as a third-partybeneficiary of that agreement.  On March 24,2008, SD Hair filed a cross-complaint in the same case naming AMLP and BSG ascross-defendants, seeking, among other things, i) declaratory relief from BSGand AMLP in the form of a judicial finding that SD Hair is not in breach of itsfranchise agreement and that L’Oreal has no rights as a third-party beneficiaryto SD Hair’s franchise agreement, and ii) injunctive relief in the form of ajudicial order compelling AMLP and BSG to take appropriate legal action againstL’Oreal to enforce SD Hair’s claimed rights under AMLP’s Matrix distributionagreement.  We have answered thecross-complaint and the lawsuit has been set for a jury trial in June of 2010.

 

On July 30, 2009, SallyBeauty disclosed in a Current Report on Form 8-K that L’Oreal filed a Second AmendedComplaint in connection with the previously disclosed lawsuit describedabove.  The Second Amended Complaintalleges, among other things, that AMLP, certain of its employees and otherswere involved in selling Matrix branded products to unauthorized buyers andthat certain of its employees (and others) engaged in improper businesstransactions for personal benefit during 2005 through 2007.  L’Oreal seeks money damages, certaininjunctive relief and a declaration that L’Oreal is entitled to terminate the1981 Matrix Distributor Agreement now in effect between L’Oreal and AMLP.  None of the employees involved in theallegations are executive officers of the Company or Sally Beauty.  Substantially all of these allegations weremade known by L’Oreal to Sally Beauty prior to the filing of the Second AmendedComplaint.   L’Oreal also provided SallyBeauty with documents allegedly supporting the allegations.

 

As a result of these allegations made by L’Oreal,many of which are incorporated into the Second Amended Complaint, the AuditCommittee of the Board of Directors of Sally Beauty engaged independent specialcounsel to investigate whether certain employees engaged in improper businesstransactions for personal benefit.  Afterextensive review, the Audit Committee and independent special counsel foundinsufficient evidence to support a conclusion that employees of the Company orSally Beauty entered into improper transactions for personal benefit.

 

On September 8, 2009, AMLP and BSG filed across-complaint against L’Oreal.  In thecross-complaint, AMLP and BSG allege that L’Oreal does not have a genuineinterest in stopping diversion, and that L’Oreal’s anti-diversion policies havebeen discriminatorily applied to AMLP and BSG.  AMLP further alleges that L’Oreal is usingdiversion as a pretext to attempt to terminate the Distributor Agreement withAMLP.

 

**Items 1A.  Risk Factors.**

 

In addition to theother information set forth in this report, you should carefully consider thefactors contained in Part I, Item 1A. “Risk Factors” in our Annual Report on Form10-K for the fiscal year ended September 30, 2009, which could materiallyaffect our business, financial condition or future results.  There have been no material changes from therisk factors disclosed in our Annual Report. The risks described in that report are not the only risks facing ourcompany.  Additional risks anduncertainties not currently known to us or that we currently deem to beimmaterial also may materially adversely affect our business, financialcondition and/or operating results.

 

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**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds.**

 

(a) Not applicable

 

(b) Not applicable

 

(c) Not applicable

 

**Item 3.  Defaults Upon Senior Securities.**

 

Not applicable

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders.**

 

Not applicable

 

**Item 5.  Other Information.**

 

(a) Not applicable

 

(b) Not applicable

 

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# **Item 6. Exhibits**

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

 

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

 

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| 10.1   |   | Sally  Beauty Holdings, Inc. 2010 Omnibus Incentive Plan, which is incorporated  herein by reference from Appendix A to the Definitive Proxy Statement on  Schedule 14A of Sally Beauty Holdings, Inc. filed on December 11, 2009 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                              |
| 31.1   |   | Rule  13(a)-14(a)/15(d)-14(a) Certification of Gary G. Winterhalter*                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                              |
| 31.2   |   | Rule  13(a)-14(a)/15(d)-14(a) Certification of Mark J. Flaherty*                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 32.1   |   | Section  1350 Certification of Gary G. Winterhalter*                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                              |
| 32.2   |   | Section  1350 Certification of Mark J. Flaherty*                                                                                                                                                                                  |

 

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* Included herewith

 

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

 

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

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

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

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

 

Accordingly, theserepresentations and warranties may not describe the actual state of affairs asof the date they were made or at any other time. Additional information aboutthe Company may be found elsewhere in this filing and in the Company’s otherpublic filings, which are available without charge through the SEC’s website athttp://www.sec.gov. Please see “Where You Can Find More Information.”

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                         | SALLY  HOLDINGS LLC                                                                                           |
|------------------------------|---------------------------------------------------------------------------------------------------------------|
|                         | (Registrant)                                                                                                  |
|                         |                                                                                                          |
| Date:  February 4, 2010 |                                                                                                          |
|                         |                                                                                                          |
|                         |                                                                                                          |
|                         | By:                                                                                                           | /s/ Mark J. Flaherty |
|                         | Mark J. Flaherty                                                                                              |
|                         | Senior Vice President  and Chief Financial Officer  For the Registrant and as its Principal Financial Officer |

 

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