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**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 THE  QUARTERLY PERIOD ENDED: JUNE 30, 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  ̈

 

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  ̈

 

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“large accelerated filer,” “accelerated filer” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. 

 
| Large  accelerated filer  ̈                | Accelerated  filer  ̈         |
|------------------------------------------------|-----------------------------------|
|                                           |                              |
| Non-accelerated  filer x                       | Smaller  reporting company  ̈ |
| (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  ̈ NO x

 

Novoting or non-voting common equity of the registrant’s were held bynon-affiliates of the registrant as of June 30, 2009.  As of August 4, 2009, all member unitswere owned by Sally Investment Holdings LLC, a wholly-owned subsidiary of SallyBeauty 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 |       | 31       |
| ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT  MARKET RISK                                 |       | 50       |
| ITEM 4. CONTROLS AND PROCEDURES                                                                     |       | 51       |
|                                                                                                |       |     |
| PART II  — OTHER INFORMATION                                                              |
|                                                                                                |
| ITEM  1. LEGAL PROCEEDINGS                                                                          |       | 52       |
| ITEM  1A. RISK FACTORS                                                                              |       | 52       |
| ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND  USE OF PROCEEDS                                |       | 53       |
| ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                             |       | 53       |
| ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                        |       | 53       |
| ITEM  5. OTHER INFORMATION                                                                          |       | 53       |
| ITEM 6.  EXHIBITS                                                                                   |       | 54       |

 

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Since November 16, 2006, Sally Holdings LLC,which we refer to as “Sally Holdings,” a limited liability company organizedunder the laws of the State of Delaware, is 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 beneficially ownedby Sally Investment, and all of the interests of Sally Investment arebeneficially owned by Sally Beauty. Prior to November 16, 2006, Sally Holdings was a Delawarecorporation named “Sally Holdings, Inc.” and was a wholly-owned subsidiaryof Alberto-Culver Company, which we refer to as “Alberto-Culver.” On November 16,2006, Sally Holdings, Inc. was converted to a Delaware limited liabilitycompany, was renamed “Sally Holdings LLC” and became a wholly-owned subsidiaryof Sally Investment and an indirect subsidiary of Sally Beauty in connectionwith the separation of Sally Holdings’ business from Alberto-Culver. Alloperations of Sally Investment and Sally Beauty are conducted through SallyHoldings and its consolidated subsidiaries.

 

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

 

Statementsin this report which are not purely historical facts or which depend uponfuture events may be forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,”“project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” orsimilar expressions may also identify such forward-looking statements.

 

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

 

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

·                  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 ourmanufacturers;

·                  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. 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 Capitaland Sally Beauty being holding companies, with no operations of their own, anddepending 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 of Sally Beauty’slargest stockholder differing from the interests of other holders of SallyBeauty’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, 2008, 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 June 30,2009 and September 30, 2008, our consolidated statements of earnings forthe three and nine months ended June 30, 2009 and 2008 and ourconsolidated statements of cash flows for the nine months ended June 30,2009 and 2008.  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 Holdings, Inc. in connection with ourseparation from the Alberto-Culver Company (“Alberto-Culver”).  In these financial statements and elsewherein this Quarterly Report on Form 10-Q, we refer to these transactions asthe Separation Transactions.  See theCompany’s Annual Report on Form 10-K for the fiscal year ended September 30,2008 for additional information about the Separation Transactions.

 

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

(Unaudited)

 
| ** **                                            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **June 30,**      | ** ** | **June 30,**     | ** ** |
| ** **                                            | ** ** | **2009**               | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net  sales                                            |       | $                      | 673,337    |                  | $          | 676,830 |   | $ | 1,960,424 |   | $ | 1,975,963 |   |
| Cost  of products sold and distribution expenses      |       | 355,492                |       | 361,764               |       | 1,036,923 |   | 1,056,304 |   |
| Gross  profit                                         |       | 317,845                |       | 315,066               |       | 923,501 |   | 919,659 |   |
| Selling,  general and administrative expenses **(a)** |       | 222,039                |       | 224,816               |       | 662,050 |   | 666,528 |   |
| Depreciation  and amortization                        |       | 11,642                 |       | 11,806                |       | 34,860 |   | 35,379 |   |
| Operating  earnings                                   |       | 84,164                 |       | 78,444                |       | 226,591 |   | 217,752 |   |
| Interest  expense, net **(b)**                        |       | 31,063                 |       | 29,671                |       | 102,694 |   | 123,797 |   |
| Earnings  before provision for income taxes      |       | 53,101                 |       | 48,773                |       | 123,897 |   | 93,955 |   |
| Provision  for income taxes                           |       | 20,246                 |       | 18,147                |       | 48,096 |   | 34,203 |   |
| Net  earnings                                         |       | $                      | 32,855     |                  | $          | 30,626 |   | $ | 75,801 |   | $ | 59,752 |   |

 

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(a)                                  Selling,general and administrative expenses include share-based compensation of $1.4million and $1.3 million for the three months ended June 30, 2009 and2008, and $6.3 million and $8.3 million for the nine months ended June 30,2009 and 2008, respectively.

 

(b)                                 Interestexpense is net of interest income of $0.1 million and $0.2 million for thethree months ended June 30, 2009 and 2008, and $0.3 million and $0.6million for the nine months ended June 30, 2009 and 2008, respectively.Interest expense includes non-cash income of $2.5 million and $7.6 million forthe three months ended June 30, 2009 and 2008 of marked-to-marketadjustments related to certain interest rate swaps, and non-cash income of $1.7million and non-cash expense of $6.6 million related to these adjustments forthe nine months ended June 30, 2009 and 2008, respectively.

 

Theaccompanying condensed notes, together with the Notes to Consolidated FinancialStatements contained in the Company’s Annual Report on Form 10-K for the fiscalyear ended September 30, 2008, are an integral part of these financialstatements.

 

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

 
| ** **                                                                                                                              | ** ** | **June 30,********2009** | ** ** | **September  30,********2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                              | ** ** | **(Unaudited)**               | ** ** | ** **                     | ** ** |
| **Assets**                                                                                                                              |       |                          |       |                           |       |
| Current assets:                                                                                                                         |       |                          |       |                           |       |
| Cash and cash equivalents                                                                                                               |       | $                             | 105,942    |                           | $          | 99,788 |   |
| Trade accounts receivable, less allowance for  doubtful accounts of $2,265 at June 30, 2009 and $2,702 at  September 30, 2008 |       | 39,234                        |       | 44,481                         |       |
| Other receivables                                                                                                                       |       | 23,386                        |       | 21,596                         |       |
| Inventories                                                                                                                             |       | 559,559                       |       | 598,195                        |       |
| Prepaid expenses                                                                                                                        |       | 20,895                        |       | 19,449                         |       |
| Deferred income tax assets                                                                                                              |       | 20,837                        |       | 20,772                         |       |
| Total current assets                                                                                                                    |       | 769,853                       |       | 804,281                        |       |
| Property and equipment, net of accumulated  depreciation of $257,040 at June 30, 2009 and $243,185 at  September 30, 2008     |       | 149,096                       |       | 156,260                        |       |
| Goodwill                                                                                                                                |       | 422,654                       |       | 424,963                        |       |
| Intangible assets, net of accumulated amortization  of $22,736 at June 30, 2009 and $18,203 at September 30, 2008             |       | 80,191                        |       | 85,434                         |       |
| Other assets                                                                                                                            |       | 41,626                        |       | 54,720                         |       |
| Total assets                                                                                                                            |       | $                             | 1,463,420  |                           | $          | 1,525,658 |   |
| **Liabilities and Member’s Deficit**                                                                                               |       |                          |       |                           |       |
| Current liabilities:                                                                                                                    |       |                          |       |                           |       |
| Current maturities of long-term debt                                                                                                    |       | $                             | 1,323      |                           | $          | 100,601 |   |
| Accounts payable                                                                                                                        |       | 207,595                       |       | 171,962                        |       |
| Accrued expenses                                                                                                                        |       | 137,536                       |       | 154,529                        |       |
| Due to Sally Beauty                                                                                                                     |       | 21,016                        |       | 17,243                         |       |
| Income taxes                                                                                                                            |       | 4,007                         |       | 11,386                         |       |
| Total current liabilities                                                                                                               |       | 371,477                       |       | 455,721                        |       |
| Long-term debt                                                                                                                          |       | 1,695,794                     |       | 1,724,684                      |       |
| Other liabilities                                                                                                                       |       | 31,428                        |       | 23,708                         |       |
| Deferred income tax liabilities                                                                                                         |       | 32,764                        |       | 37,941                         |       |
| Total liabilities                                                                                                                       |       | 2,131,463                     |       | 2,242,054                      |       |
| Stock options subject to redemption                                                                                                     |       | 5,535                         |       | 5,884                          |       |
| Member’s deficit:                                                                                                                  |       |                          |       |                           |       |
|                                                                                                                                    |       |                          |       |                           |       |
| Member’s deficit                                                                                                                   |       | (655,168                      | )          | (730,969                       | )          |
|                                                                                                                                    |       |                          |       |                           |       |
| Accumulated other comprehensive (loss) income                                                                                           |       | (18,410                       | )          | 8,689                          |       |
| Total member’s deficit                                                                                                             |       | (673,578                      | )          | (722,280                       | )          |
| Total liabilities and member’s deficit                                                                                             |       | $                             | 1,463,420  |                           | $          | 1,525,658 |   |

 

Theaccompanying condensed notes, together with the Notes to Consolidated FinancialStatements contained in the Company’s Annual Report on Form 10-K for the fiscalyear ended September 30, 2008, are an integral part of these financial statements.

 

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

(Unaudited)

 
| ** **                                                                                           | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                           | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| **Cash Flows from Operating  Activities:**                                                           |       |                                |       |   |   |
| Net earnings                                                                                         |       | $                                   | 75,801     |   | $ | 59,752 |   |
| Adjustments to reconcile net earnings to net cash  provided by operating activities:                 |       |                                |       |   |   |
| Depreciation and amortization                                                                        |       | 34,860                              |       | 35,379 |   |
| Share-based compensation expense (net of deferred  tax benefit of $1,800 in 2009 and $2,068 in 2008) |       | 4,536                               |       | 6,184 |   |
| Amortization of deferred financing costs                                                             |       | 6,289                               |       | 6,360 |   |
| Excess tax shortfall (benefit) from share-based  compensation                                        |       | 204                                 |       | (253 | ) |
| Net (gain) loss on disposal of leaseholds and other  property                                        |       | (66                                 | )          | 146 |   |
| Loss on extinguishment of debt                                                                       |       | 715                                 |       | — |   |
| Deferred income taxes                                                                                |       | 2,819                               |       | 2,902 |   |
| Changes in (exclusive of effects of acquisitions):                                                   |       |                                |       |   |   |
| Trade accounts receivable                                                                            |       | 3,986                               |       | 6,381 |   |
| Other receivables                                                                                    |       | (2,255                              | )          | (3,319 | ) |
| Inventories                                                                                          |       | 30,683                              |       | (30,121 | ) |
| Prepaid expenses                                                                                     |       | (1,835                              | )          | (5,606 | ) |
| Other assets                                                                                         |       | 571                                 |       | (2,672 | ) |
| Accounts payable and accrued expenses                                                                |       | 23,889                              |       | (35,878 | ) |
| Income taxes                                                                                         |       | (6,858                              | )          | 3,116 |   |
| Due to Sally Beauty                                                                                  |       | (2,911                              | )          | (6,414 | ) |
| Other liabilities                                                                                    |       | (5,972                              | )          | 9,290 |   |
| Net cash provided by operating activities                                                            |       | 164,456                             |       | 45,247 |   |
| **Cash Flows from Investing  Activities:**                                                           |       |                                |       |   |   |
| Capital expenditures                                                                                 |       | (26,290                             | )          | (35,727 | ) |
| Proceeds from sale of property and equipment                                                         |       | 147                                 |       | 255 |   |
| Acquisitions, net of cash acquired                                                                   |       | (1,987                              | )          | (48,201 | ) |
| Net cash used by investing activities                                                                |       | (28,130                             | )          | (83,673 | ) |
| **Cash Flows from Financing  Activities:**                                                           |       |                                |       |   |   |
| Change in book cash overdraft                                                                        |       | (1,586                              | )          | 5,008 |   |
| Proceeds from issuance of long-term debt                                                             |       | 95,104                              |       | 394,334 |   |
| Repayments of long-term debt                                                                         |       | (223,267                            | )          | (366,619 | ) |
| Excess tax (shortfall) benefit from share-based  compensation                                        |       | (204                                | )          | 253 |   |
| Net cash (used) provided by financing activities                                                     |       | (129,953                            | )          | 32,976 |   |
| Effect of foreign exchange rate changes on cash and  cash equivalents                                |       | (219                                | )          | 902 |   |
| Net increase (decrease) in cash and cash  equivalents                                                |       | 6,154                               |       | (4,548 | ) |
| Cash and cash equivalents, beginning of period                                                       |       | 99,788                              |       | 38,272 |   |
| Cash and cash equivalents, end of period                                                             |       | $                                   | 105,942    |   | $ | 33,724 |   |
|                                                                                                 |       |                                |       |   |   |
| **Supplemental Cash Flow  Information:**                                                             |       |                                |       |   |   |
| Cash paid for:                                                                                       |       |                                |       |   |   |
| Interest                                                                                             |       | $                                   | 116,995    |   | $ | 131,078 |   |
| Income taxes                                                                                         |       | $                                   | 5,205      |   | $ | 6,013 |   |

 

Theaccompanying condensed notes, together with the Notes to Consolidated FinancialStatements contained in the Company’s Annual Report on Form 10-K for the fiscalyear ended September 30, 2008, are an integral part of these financialstatements.

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

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

##### *** ***

Description of Business

 

Sally Holdings LLC (“Sally Holdings” or the “Company”)is a wholly-owned subsidiary of Sally Investment Holdings LLC (“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, the United Kingdom andcertain other countries in Europe. Additionally, the Company distributesprofessional beauty products to salons and professional cosmetologists throughits Beauty Systems Group (“BSG”) store operations and a commissioned directsales force that calls on salons in the U.S., Canada, the United Kingdom andcertain other countries in Europe, and to franchises in the southern andsouthwestern U.S. and in Mexico through the operations of its subsidiaryArmstrong McCall, L.P. (“Armstrong McCall”). Certain beauty products sold byBSG and Armstrong McCall are sold through exclusive territory agreements withthe manufacturers of the products.

 

In November 2006, the stockholders ofAlberto-Culver approved a plan to separate its consumer products business andits Sally Beauty Supply/BSG distribution business into two separate,publicly-traded companies. Sally Holdings, Inc. was a wholly-ownedsubsidiary of Alberto-Culver until November 16, 2006, when it wasconverted to a Delaware limited liability company, was renamed “Sally HoldingsLLC,” and became an indirect wholly-owned subsidiary of Sally Beauty. SallyBeauty was formed in June 2006 and became the accounting successor companyto Sally Holdings, Inc. upon the completion of the SeparationTransactions. Please see the Company’s Annual Report on Form 10-K for thefiscal year ended September 30, 2008 for more information about theSeparation 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 30,2008 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 June 30, 2009 and September 30,2008, the consolidated results of operations for the three and nine monthsended June 30, 2009 and 2008 and the consolidated cash flows for the ninemonths ended June 30, 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 and, prior to November 16, 2006, Sally Holdings, Inc.

 

##### ***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 30,2008.  The Company adheres to the sameaccounting policies in the preparation of its interim

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

financialstatements.  As permitted under GAAP,interim accounting for certain expenses, including income taxes, is based onfull year assumptions.  Such amounts areexpensed in full in the year incurred. For interim financial reporting purposes, income taxes are recordedbased upon estimated annual effective income tax rates.

 

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.

 

The Company’s financial instruments consist of cashand cash equivalents, trade and other accounts receivable, accounts payable,interest rate swap agreements and long-term debt. There were no significantchanges in the methods and significant assumptions used to estimate the fairvalue of the Company’s financial instruments since September 30, 2008.

 

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.

 

The aggregate fair value of all interest rate swap agreements held at June 30,2009 was a net liability of $19.7 million, consisting of $5.9 million includedin accrued expenses and $13.8 million included in other liabilities. Fair value amounts reported for the swapagreements are based on third-party information and were determined usingproprietary models based upon well-recognized financial principles andreasonable estimates about relevant future market conditions. Please see*Recent Accounting Pronouncement*s below.

 

At June 30, 2009,the fair value of the Company’s long-term debt (including capital leases) wasapproximately $1,630.2 million while the carrying amount in the Company’sconsolidated balance sheet was $1,697.1 million. The fair values of the Company’slong-term borrowings are based on quoted market prices where available or, ifnot available, based on discounted future cash flows using current marketinterest rates.

 

##### ***Recent Accounting Pronouncements***

##### *** ***

In May 2009, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 165, *Subsequent Events*(“SFAS 165”). SFAS 165 establishes standards of accounting for and disclosureof transactions and events that occur after the balance sheet date but beforethe financial statements are issued. This statement requires the disclosure,among other things, of the date through which an entity has evaluatedsubsequent events and whether that date is the date the financial statementswere issued or the date the financial statements were available to be issued.SFAS 165 must be applied prospectively for interim and annual periods endedafter June 15, 2009. Accordingly, the Company adopted the provisions ofSFAS 165 effective for the quarter ended June 30, 2009. In connectiontherewith, the Company has evaluated all material transactions and eventsthrough August 05, 2009, the date this Quarterly Report was filed with theSEC.

 

The Company adopted theprovisions of SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities,*an Amendment of FASBStatement No. 133 (“SFAS 161”) effective on January 1, 2009. SFAS No. 133,*Accounting for Derivative Instruments and Hedging Activities*(“SFAS 133”), establishes, among other things, the disclosure requirements forderivative instruments and for hedging activities. SFAS 161 amended andexpanded those disclosures to also require qualitative disclosures about areporting entity’s objectives and strategies for using derivative instruments,quantitative disclosures about the fair value of and gains and losses onderivative instruments and disclosures about any credit-risk-related contingentfeatures contained in the derivative instruments.  SFAS 161 also requires companies to discloseinformation about how derivatives and related hedges are accounted for underSFAS 133 and how the hedges affect the entity’s financial position, financialperformance and cash flows, including the location and amounts of derivativeinstruments in the entity’s financial statements.

 

As required by SFAS 133,as amended, the Company records all derivative instruments on its balance sheetat fair value.  The accounting for changes in the fair value of derivativeinstruments depends on the intended use of the derivative, whether the Companyhas elected to designate a derivative instrument in a hedging relationship andapply hedge accounting and whether the hedging relationship has satisfied thecriteria necessary to apply hedge accounting. Derivative instruments designatedand qualifying as a hedge of the exposure to variability in expected futurecash flows, or other types of forecasted transactions, are considered cash flowhedges. Hedge accounting generally provides for the matching of the timing ofgain or loss recognition on the hedging instrument with the recognition of theimpact on earnings of the hedged transaction or transactions. The Company mayfrom time to time enter into derivative contracts that are intended to hedgecertain economic risks even though hedge accounting

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

does not apply or theCompany elects not to apply hedge accounting to such derivative contracts.Please see Note 8 for more details about the Company’s derivative instrumentsand hedging activities as of June 30, 2009.

 

The Company adopted theprovisions of SFAS No. 157, *Fair Value Measurements*(“SFAS 157”), as it relates to its financial instruments, effective on October 1,2008.  SFAS 157 defines fair value,establishes a framework for measuring fair value and expands disclosures aboutfair value measurements. This statement does not require any new fair valuemeasurements; rather, it amends other accounting pronouncements that require orpermit fair value measurements.  SFAS 157defines “fair value” as the price that would be received to sell an asset orpaid to transfer a liability in the principal or most advantageous market in anorderly transaction between market participants on the measurement date.  SFAS 157 establishes a three-level hierarchyfor measuring fair value and requires an entity to maximize the use ofobservable inputs and minimize the use of unobservable inputs when measuringfair value.

 

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

 

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

 

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

 

Level 3 - Unobservable inputs for the asset orliability

 

The Company measurescertain financial assets and liabilities at fair value on a recurring basis,including interest rate swaps. The Company has determined that the majority ofthe inputs used to value its interest rate swaps fall within Level 2 of thevaluation hierarchy.

 

In accordance with SFAS157, the Company categorized certain of its financial assets and liabilitiesbased on priority of the inputs to the valuation technique for the instruments,as follows (in thousands):

 
| ** **                          | ** ** | **As of June 30, 2009** | ** ** |
|-------------------------------------|------------|------------------------------|------------|
| ** **                          | ** ** | **Total**                    | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Liabilities                         |       |                         |       |   |   |   |   |   |   |
| Long-term  debt (1)                 |       | $                            | 1,630,195  |   |   |   | $ | 1,630,195 |   |   |   |
| Hedged  interest rate swaps (1)     |       | 13,759                       |       |   |   | 13,759 |   |   |   |
| Non-hedged  interest rate swaps (1) |       | 5,940                        |       |   |   | 5,940 |   |   |   |
| Total                               |       | $                            | 1,649,894  |   |   |   | $ | 1,649,894 |   |   |   |

 

----

(1) Fair valuecalculated using internal models based on market observable inputs, includingmarket interest rates.

 

In April 2009, theFASB issued FSP-FAS No. 107-1 and APB 28-1, *Disclosures about Fair Value of Financial Instruments* (“FAS No. 107-1/APB 28-1”).This FSP extends to interim periods certain disclosures about fair value offinancial instruments for publicly traded companies and amends APB Opinion No. 28,*Interim Financial**Reporting,*to require those disclosures insummarized financial information at interim reporting periods. This FSP iseffective for interim reporting periods ending after June 15, 2009. TheCompany’s adoption of FAS No. 107-1/APB 28-1 did not have a materialeffect on the Company’s consolidated financial position, results of operationsor cash flows.

 

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

 

In June 2009, theFASB issued SFAS No. 168, *The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples,* a replacement of SFAS No. 162 (“SFAS 168”). SFAS168 identifies the previously issued accounting standards that are consideredauthoritative generally accepted accounting principles in

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

the U.S., repeals SFAS No. 162,*The Hierarchy of Generally Accounting Principles,*and replaces all previously issued accounting pronouncements of the FASB, andits predecessor rule-making bodies, with the FASB Accounting StandardsCodification. SFAS 168 is effective prospectively for reporting periods endingafter September 15, 2009.

 

In April 2008, theFASB issued FSP-FAS No. 142-3, *Determination of theUseful Life of Intangible Assets* (“FAS 142-3”). FAS 142-3 amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, *Goodwill and OtherIntangible Assets* (“SFAS 142”). The objective of the StaffPosition is to improve the consistency between the useful life of a recognizedintangible asset under SFAS 142 and the period of expected cash flows usedto measure the fair value of the asset under SFAS No. 141 (Revised 2007): *Business Combinations* (“SFAS 141R”) and other GAAP. FAS142-3 is effective for fiscal years beginning after December 15, 2008.Early application is not permitted.

 

In December 2007, the FASB issued SFAS No. 141(Revised2007), *Business Combinations* (“SFAS 141R”).Among other things, SFAS 141R generally requires that an acquirer recognize theassets acquired and liabilities assumed measured at their “full fair values” onthe acquisition date. This practice replaces the practice, under predecessorSFAS 141: *Business Combinations,* of allocating thecost of an acquisition to the individual assets acquired and liabilitiesassumed based on their relative estimated fair values.  SFAS 141R further requires thatacquisition-related costs be recognized separately from the relatedacquisition. SFAS 141R must be applied prospectively to business combinationsconsummated on or after the first annual reporting period beginning on or afterDecember 15, 2008.  Earlyapplication is not permitted.

 

InApril 2009, the FASB issued FSP-FAS No. 141(R)-1,*****Accounting for AssetsAcquired and Liabilities Assumed in a Business Combination That Arise fromContingencies* (“FAS 141(R)-1”). This FSP amends and clarifies SFAS141R and applies to assets acquired and liabilities assumed that arise fromcontingencies in a business combination. FAS 141(R)-1 must also be applied prospectively to businesscombinations consummated on or after the first annual reporting periodbeginning on or after December 15, 2008. Early application is not permitted.

 

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

##### *** ***

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

 
| ** **                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                       | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net  earnings                                    |       | $                                              | 32,855     |                                          | $          | 30,626 |   | $ | 75,801 |   | $ | 59,752 |   |
| Other  comprehensive income (loss) adjustments:  |       |                                           |       |                                          |       |   |   |   |   |
| Foreign  currency translation adjustments (a)    |       | 21,653                                         |       | 1,425                                         |       | (17,857 | ) | (1,305 | ) |
| Deferred  (gain) loss on interest rate swaps (b) |       | 2,968                                          |       | 2,210                                         |       | (9,241 | ) | 2,210 |   |
| Comprehensive  income                            |       | $                                              | 57,476     |                                          | $          | 34,261 |   | $ | 48,703 |   | $ | 60,657 |   |

 

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(a)               There were no income tax amounts relatedto foreign currency translation adjustments recorded in other comprehensiveincome (loss) for the three and nine months ended June 30, 2009 and 2008.

(b)              Amounts are net of income tax expense of$1.9 million and $1.4 million for the three months ended June 30, 2009 and2008, and an income tax benefit of $5.8 million and income tax expense of $1.4million for the nine months ended June 30, 2009 and 2008, respectively.

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

##### ***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 stock awardplans, which we refer to as share-based payment plans, in accordance withSFAS 123(R), *Share-Based Payment*. Accordingly,the Company measures the cost of employee services received in exchange for anaward of equity instruments based on the grant-date fair value of the award andrecognizes compensation expense on a straight-line basis over the vestingperiod or to the date a participant becomes eligible for retirement, ifearlier. During 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 2.7 million and 2.6million stock options to the Company’s employees and consultants during thenine months ended June 30, 2009 and 2008, respectively, under the 2007Plan. Upon issuance of such grants, the Company recognized acceleratedshare-based compensation expense of $2.0 million and $3.1 million in the firstquarter of fiscal years 2009 and 2008, respectively, in connection with certainretirement eligible employees who are eligible to continue vesting awards uponretirement under the terms of the 2007 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  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                      | ** ** | **2009**                              | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Share-based  compensation expense                               |       | $                                     | 1,444      |                                 | $          | 1,347 |   | $ | 6,336 |   | $ | 8,252 |   |
| Income  tax benefit related to share-based compensation expense |       | $                                     | 435        |                                 | $          | (49 | ) | $ | 1,800 |   | $ | 2,068 |   |

 

## **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 are generally subject to forfeiture until the four yearvesting period is complete, subject to certain retirement provisions of the2007 Plan.

 

The following table presents a summary of the activityfor Sally Beauty’s stock options issued to the Company’s employees andconsultants for the nine months ended June 30, 2009:

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 
| ** **                             | ** ** | **Number  of  Outstanding  Options (in  thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  years)** | ** ** | **Aggregate  Intrinsic  Value (in  thousands)** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------------------|------------|
| Outstanding at September 30, 2008 |       | 8,138                                                |       | $                                      | 7.99       |                                                            |       |                                            |       |   |
| Granted                                |       | 2,707                                                |       | 5.23                                   |       |                                                            |       |                                            |       |
| Exercised                              |       | (177                                                 | )          | 2.00                                   |       |                                                            |       |                                            |       |
| Forfeited or expired                   |       | (445                                                 | )          | 8.55                                   |       |                                                            |       |                                            |       |
| Outstanding at June 30, 2009      |       | 10,223                                               |       | $                                      | 7.34       |                                                            | 7.9        |                                            | $          | 8,399 |   |
|                                   |       |                                                 |       |                                   |       |                                                            |       |                                            |       |
| Exercisable at June 30, 2009      |       | 3,814                                                |       | $                                      | 6.99       |                                                            | 6.9        |                                            | $          | 5,421 |   |

 

The following table summarizes information about SallyBeauty’s stock options held by the Company’s employees and consultants underSally Beauty’s option plans at June 30, 2009:

 
| ** **                      | ** ** | **Options  Outstanding**                                        | ** ** | **Options  Exercisable**                                        | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| **Range  of  Exercise  Prices** | ** ** | **Number  Outstanding  at June 30,  2009 (in  thousands)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable  at June 30,  2009 (in  thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $2.00                           |       | 1,243                                                           |       | 5.0                                                             |       | $ | 2.00 |   | 1,243 |   | $ | 2.00 |   |
| $4.79 – 9.66               |       | 8,980                                                           |       | 8.3                                                             |       | 8.08 |   | 2,571 |   | 9.40 |   |
| Total                           |       | 10,223                                                          |       | 7.9                                                             |       | $ | 7.34 |   | 3,814 |   | $ | 6.99 |   |

 

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:

 
| ** **                 | ** ** | **Nine Months Ended June 30,** | ** ** |
|----------------------------|------------|-------------------------------------|------------|
| ** **                 | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| Expected  lives (in years) |       | 5.0                                 |       | 5.0 |   |
| Expected  volatility       |       | 47.9                                | %          | 37.5 | % |
| Risk-free  interest rate   |       | 2.6                                 | %          | 4.0 | % |
| 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 history.The risk-free interest rate is based on the zero-coupon U.S. Treasury issue asof the date of the grant. Since Sally Beauty does not currently expect to paydividends, the dividend yield is 0%.

 

The weighted average fair value of the Sally Beautystock options issued, in the nine months ended June 30, 2009 and 2008 tothe Company’s employees and consultants at the date of grant was $2.33 and$3.46 per option, respectively. The total intrinsic value of options exercisedduring the nine months ended June 30, 2009 was $0.5

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

million.  Cashproceeds from these option exercises were $0.5 million and the tax benefitrealized for the tax deductions from these option exercises was $0.2 million.

 

At June 30, 2009, approximately $10.6 million oftotal unrecognized compensation costs related to non-vested stock option awardsare expected to be recognized over the weighted average period of 2.5 years.

 

## **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 of the 2007 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 nine months ended June 30, 2009:

 
| **Restricted Stock Awards**           | ** ** | **Number  of  Shares (in  thousands)** | ** ** | **Weighted  Average Fair  Value Per Share** | ** ** | **Weighted  Average  Remaining  Vesting Term  (in years)** | ** ** |
|---------------------------------------|------------|----------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------------|------------|
| Non-vested at September 30, 2008 |       | 296                                    |       | $                                           | 8.44       |                                                       | 3.8        |   |
| Granted                               |       | 123                                    |       | 5.17                                        |       |                                                       |       |
| Vested                                |       | (61                                    | )          | 8.54                                        |       |                                                       |       |
| Forfeited                             |       | —                                 |       | —                                      |       |                                                       |       |
| Non-vested at June 30, 2009      |       | 358                                    |       | $                                           | 7.30       |                                                       | 3.6        |   |

 

At June 30, 2009, approximately $2.2 million oftotal unrecognized compensation costs related to non-vested restricted stockawards are expected to be recognized over the weighted average period of 3.6years.

 

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

##### *** ***

The change in the carrying amounts of goodwill by operating segment forthe nine months ended June 30, 2009 is as follows (in thousands):

 
| ** **                                    | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|---------------------------|------------|-----------|------------|
| Balance  at September 30, 2008           |       | $                        | 65,188     |                      | $          | 359,775   |       | $ | 424,963 |   |
| Additions,  net of purchase price adjustments |       | 3,983                    |       | 243                       |       | 4,226     |       |
| Foreign  currency translation                 |       | (2,572                   | )          | (3,963                    | )          | (6,535    | )          |
| Balance  at June 30, 2009                |       | $                        | 66,599     |                      | $          | 356,055   |       | $ | 422,654 |   |

 

The following table provides the gross carrying value and accumulatedamortization for intangible assets with indefinite lives and intangible assetssubject to amortization by operating segment at June 30, 2009 (inthousands):

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 
| ** **                                  | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|--------------------------|------------|---------------------------|------------|-----------|------------|
| Balance  at June 30, 2009              |       |                     |       |                      |       |      |       |
| Intangible  assets with indefinite lives:   |       |                     |       |                      |       |      |       |
| Trade  names                                |       | $                        | 20,179     |                      | $          | 33,928    |       | $ | 54,107 |   |
| Other  intangibles                          |       | —                   |       | 5,700                     |       | 5,700     |       |
| Total                                       |       | 20,179                   |       | 39,628                    |       | 59,807    |       |
| Intangible  assets subject to amortization: |       |                     |       |                      |       |      |       |
| Gross  carrying amount                      |       | 6,871                    |       | 36,249                    |       | 43,120    |       |
| Accumulated  amortization                   |       | (2,020                   | )          | (20,716                   | )          | (22,736   | )          |
| Net  value                                  |       | 4,851                    |       | 15,533                    |       | 20,384    |       |
| Total  intangible assets, net               |       | $                        | 25,030     |                      | $          | 55,161    |       | $ | 80,191 |   |

 

Amortization expense was $1.6 million and $1.1 million for the threemonths ended June 30, 2009 and 2008, and $4.5 million and $4.1 million forthe nine months ended June 30, 2009 and 2008, respectively. There havebeen no material changes to the Company’s future amortization expense schedulesince September 30, 2008.

 

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

##### *** ***

In connection with the Separation Transactions on November 16,2006, the Company and certain of its subsidiaries incurred $1,850.0 million ofindebtedness by (i) drawing on a revolving (asset-based lending) facility(the “ABL facility”) in an amount equal to $70.0 million, (ii) enteringinto two term loan facilities (term loans A and B) in an aggregate amount of$1,070.0 million and (iii) together (jointly and severally) with anotherof Sally Beauty’s indirect subsidiaries, Sally Capital Inc., issuing seniornotes in an aggregate amount of $430.0 million and senior subordinated notes inan 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. During the nine months ended June 30, 2009, theCompany made scheduled payments in the aggregate amount of $6.1 million on itssenior term loans. The senior term loan facilities may be prepaid at the optionof the Company at any time without premium or penalty and are subject tomandatory repayment 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 amandatory repayment on the senior term loan facilities in the amount of $16.7million. 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 repayment in an amount equal to 100% of the proceeds ofspecified asset sales that are not reinvested in the business or applied to repayborrowings under the ABL facility.

 

During the nine months ended June 30, 2009, theCompany also made optional repayments in the aggregate amount of $25.0 millionon its senior term loans. In addition, in May 2009, the Companyrepurchased $5.0 million in par value of its 10.5% senior subordinated notes(due in November 2016) for approximately $5.0 million, plus accruedinterest. In connection with the mandatory and optional repayments made duringthe nine months ended June 30, 2009, the Company recorded losses onextinguishment of debt in the aggregate amount of $0.7 million, which areincluded in net interest expense in the Company’s consolidated statements ofearnings.

 

The senior notes and seniorsubordinated notes are unsecured obligations of the issuers and are 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

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

Report on Form 10-K for the fiscal year ended September 30,2008, for additional information about the Company’s long-term debt.

 

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

 
| ** **                   | ** **   | **As of  June 30, 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                  |         | 105,407                       |       | Nov - 2012          |       | (i)                 | Prime plus (1.00% to  1.50%) or; |   |
|                         | * *     | * *                      |       |                |       | (ii)                | LIBOR plus (2.00% to 2.50%)      |   |
| Term Loan B                  |         | 883,449                       |       | Nov - 2013          |       | (i)                 | Prime plus (1.25% to  1.50%) or; |   |
|                         | * *     | * *                      |       |                |       | (ii)                | LIBOR plus (2.25% to 2.50%)      |   |
| Other (a)                    |         | 2,677                         |       | 2009-2014           |       |                | 4.05% to 7.00%                   |   |
| Total                        |         | $                             | 991,533    |                |       |                |                             |   |   |
|                         | *** *** | *** ***                  |       |                |       |                |                             |   |
| Senior notes                 |         | $                             | 430,000    |                | Nov - 2014 |                |                             | 9.25% |   |
| Senior subordinated notes    |         | 275,000                       |       | Nov - 2016          |       |                | 10.50%                           |   |
| Total                        |         | $                             | 705,000    |                |       |                |                             |   |   |
|                         | *** *** | *** ***                  |       |                |       |                |                             |   |
| Capitalized leases and other |         | $                             | 584        |                |       |                |                             |   |   |
| Less: current portion        |         | (1,323                        | )          |                |       |                |                             |   |
| Total long-term debt         |         | $                             | 1,695,794  |                |       |                |                             |   |   |

 

----

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

 

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

 
| **Fiscal Year:**          | ** ** | ** ** | ** ** |
|---------------------------|------------|------------|------------|
| 2009                      |       | $          | 864        |   |
| 2010                      |       | 1,364      |       |
| 2011                      |       | 39,640     |       |
| 2012                      |       | 84,520     |       |
| 2013                      |       | 9,390      |       |
| Thereafter                |       | 1,560,755  |       |
|                      |       | $          | 1,696,533  |   |
| Capital leases  and other |       | 584        |       |
| Less: current  portion    |       | (1,323     | )          |
| Total                     |       | $          | 1,695,794  |   |

 

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 June 30, 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 ascalculated pursuant to the credit agreement and indentures.

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

The agreements governing our ABL facility generally permit the makingof distributions and certain other restricted payments so long as borrowingavailability under the facility equals or exceeds $60.0 million. If borrowingavailability falls below this amount, we may nevertheless make restrictedpayments to Sally Beauty in the aggregate since the date of the SeparationTransactions, together with the aggregate cash amount paid in acquisitionssince said date, of not greater than $50.0 million, together with certain otherexceptions.  As of June 30, 2009,borrowing availability under the ABL facility exceeded $60.0 million.  As of June 30, 2009, the net assets ofus and our consolidated subsidiaries that were unrestricted from transfer underour credit arrangements totaled $213.6 million, subject to certain 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 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.Interest payments related to the term loans are impacted by changes in LIBOR.Interest rate swap agreements involve the periodic receipt by the Company ofamounts based on a variable rate in exchange for the Company making paymentsbased on a fixed rate over the term of the interest rate swap agreements,without exchange of the underlying notional amount. At June 30, 2009, theCompany did not purchase or hold any other derivative instruments or hold anyderivative instruments for trading or speculative purposes.

 

**DesignatedCash Flow Hedges of Interest Rate Risk**

 

Effective May 2008,the Company entered into two interest rate swap agreements with an aggregate notional amount of $300 million. These interest rate swap agreements are designated and qualify as effectivecash flow hedges in accordance with SFAS 133. Accordingly, changes in the fair value of derivatives designated andqualifying as cash flow hedges are recorded quarterly, net of income tax, inaccumulated other comprehensive (loss) income (“OCI”) until the hedgedobligation is settled or the swap agreements expire, whichever is earlier. Anyhedge ineffectiveness, as this term is used in SFAS 133, is recognized in netinterest expense in our consolidated statements of earnings. No hedgeineffectiveness on cash flow hedges was recognized during the three or ninemonth periods ended June 30, 2009. Please see the Company’s Annual Reporton Form 10-K for the fiscal year ended September 30, 2008 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 and nine month periods ended June 30, 2009, netinterest expense of $2.4 million and $5.4 million, respectively, resulted fromsuch reclassifications.  During thetwelve months ending June 30, 2010, the Company estimates that anadditional $8.2 million of the amount reported in OCI will be reclassified intointerest expense.

 

**Non-designatedCash Flow Hedges of Interest Rate Risk**

 

Interest rate swaps not designated as hedges are usedto manage the Company’s exposure to interest rate movements but do not meet thehedge accounting requirements of SFAS 133. In connection with the Separation Transactions,effective November 2006, the Company entered into four interest rate swapagreements with an aggregate notional amount of $500 million. Interest rate swap agreements with anaggregate notional amount of $150 million expired in November 2008 andinterest rate swap agreements with a notional amount of $350 million expire in November 2009. These interest rate swap agreements are notdesignated as hedges and, accordingly, the changes in fair value of theseinterest rate swap agreements (which are adjusted quarterly) are recorded innet interest expense in our statements of earnings. Please see the Company’s Annual Report onForm 10-K for the fiscal year ended September 30, 2008 for additionalinformation about the Company’s interest rate swap agreements.

 

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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 June 30, 2009 (inthousands):

 

**Tabular Disclosure of Fair Values of DerivativeInstruments**

 
| ** **                                                              | ** ** | **Asset Derivatives**        | ** ** | **Liability Derivatives**    | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                              | ** ** | **As of June 30, 2009** | ** ** | **As of June 30, 2009** | ** ** |
| ** **                                                              | ** ** | **Balance Sheet  Location**  | ** ** | **Fair Value**               | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** | ** ** |
| Derivatives designated as hedging instruments under  SFAS 133:          |       |                         |       |                         |       |   |   |   |   |
| Interest Rate Swaps                                                     |       | Prepaid  expenses            |       | $                            | —     |   | Accrued  expenses |   | $ | — |   |
| Interest Rate Swaps                                                     |       | Other  assets                |       | $                            | —     |   | Other  liabilities |   | $ | 13,759 | **(1)** |
| Total derivatives designated as hedging instruments  under SFAS 133     |       |                         |       | $                            | —     |   |   |   | $ | 13,759 |   |
|                                                                    |       |                         |       |                         |       |   |   |   |   |
| Derivatives not designated as hedging instruments  under SFAS 133:      |       |                         |       |                         |       |   |   |   |   |
| Interest Rate Swaps                                                     |       | Prepaid  expenses            |       | $                            | —     |   | Accrued  expenses |   | $ | 5,940 |   |
| Total derivatives not designated as hedging  instruments under SFAS 133 |       |                         |       | $                            | —     |   |   |   | $ | 5,940 |   |

 

----

(1)          At June 30, 2009, theCompany estimates that approximately $8.2 million of the fair value of thesederivative financial instruments will settle within the twelve months ending June 30,2010.

 

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, 2008 (inthousands):

 

**Tabular Disclosure of Fair Values of DerivativeInstruments**

 
| ** **                                                              | ** ** | **Asset Derivatives**             | ** ** | **Liability Derivatives**         |       |
|-------------------------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                                                              | ** ** | **As of September 30, 2008** | ** ** | **As of September 30, 2008** |       |
| ** **                                                              | ** ** | **Balance Sheet  Location**       | ** ** | **Fair Value**                    | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** |   |
| Derivatives designated as hedging instruments under  SFAS 133:          |       |                              |       |                              |       |   |   |   |   |
| Interest Rate Swaps                                                     |       | Prepaid  expenses                 |       | $                                 | —     |   | Accrued  expenses |   | $ | — |   |
| Interest Rate Swaps                                                     |       | Other  assets                     |       | $                                 | 1,302      |   | Other  liabilities |   | $ | — |   |
| Total derivatives designated as hedging instruments  under SFAS 133     |       |                              |       | $                                 | 1,302      |   |   |   | $ | — |   |
|                                                                    |       |                              |       |                              |       |   |   |   |   |
| Derivatives not designated as hedging instruments  under SFAS 133:      |       |                              |       |                              |       |   |   |   |   |
| Interest Rate Swaps                                                     |       | Prepaid  expenses                 |       | $                                 | —     |   | Accrued  expenses |   | $ | 487 |   |
| Interest Rate Swaps                                                     |       | Other  assets                     |       | $                                 | —     |   | Other  liabilities |   | $ | 7,167 |   |
| Total derivatives not designated as hedging  instruments under SFAS 133 |       |                              |       | $                                 | —     |   |   |   | $ | 7,654 |   |

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

The tables below presentthe effect of the Company’s derivative financial instruments on the statementsof earnings for the three and nine months ended June 30, 2009 (inthousands):

 

**Tabular Disclosure of the Effect of DerivativeInstruments on the Statement of Earnings for theThree Months Ended June 30, 2009**

 
| **Derivatives  in SFAS  133 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                                            |       | $                                                                                                     | 2,968      |                                                                                                  | Interest  expense, net |                                                                                                    | $          | (2,397                                                                                                                                        | )          | Interest expense, net                                                                                                                           |       | $ | — |   |
|                                                                |            |                                                                                                       |            |                                                                                                       |                        |                                                                                                         |            |                                                                                                                                               |            |                                                                                                                                                 |            |  |  |  |

 
| **Derivatives Not Designated as Hedging  Instruments Under SFAS 133** | ** ** | **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                                                                             |       | $                                                                                            | (964       | )          |       |       |       |   |
|                                                                                                          |            |                                                                                                    |            |                                                                                              |            |            |            |            |            |  |

 

**Tabular Disclosure of the Effect of DerivativeInstruments on the Statement of Earnings for theNine Months Ended June 30, 2009**

 
| **Derivatives  in SFAS  133 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                                            |       | $                                                                                                     | (9,241     | )                                                                                                     | Interest  expense, net |                                                                                                    | $          | (5,410                                                                                                                                          | )          | Interest expense, net                                                                                                                           |       | $ | — | ** ** |
|                                                                |            |                                                                                                       |            |                                                                                                       |                        |                                                                                                         |            |                                                                                                                                                 |            |                                                                                                                                                 |            |  |  |  |

 
| **Derivatives  Not Designated as Hedging  Instruments Under SFAS 133** | ** ** | **Location  of Gain or  (Loss) Recognized  in Income on  Derivative** | ** ** | **Amount  of  Gain or (Loss)  Recognized in  Income on  Derivative** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Interest Rate Swaps                                                    |       | Interest  expense, net                                                |       | $                                                                    | (7,152     | )          | ** ** | ** ** | ** ** | ** ** |
|                                                                        |            |                                                                       |            |                                                                      |            |            |            |            |            |  |

 

**Credit-risk-related ContingentFeatures**

 

The agreements governing the Company’s interest rateswaps contain provisions pursuant to which the Company could be declared in defaulton its interest rate swap obligations in the event the Company defaulted undercertain terms of the loan documents governing the Company’s ABL facility. As ofJune 30, 2009, the fair value of interest rate swaps in a liabilityposition related to these agreements was $19.7 million. As of June 30,2009, the Company was under no obligation to post and had not posted anycollateral related to these agreements. If the Company 

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

breached any of these provisions, it would be requiredto settle its obligations under the agreements at their termination value of$22.0 million, including accrued interest and other termination costs.

 

Thecounterparties toall our interest rate swap instruments are deemed by theCompany to be of substantial resources and strong creditworthiness. However,these transactions result in exposure to credit risk in the event of default bya counterparty. The recent financial crisis affecting the banking systems andfinancial markets has resulted in many well-known financial institutionsbecoming less creditworthy or having diminished liquidity, which could exposeus to an increased level of counterparty risk. In the event that a counterparty defaults in its obligation under ourinterest rate swaps, we could incur substantial financial losses. However, atthe present time, no such losses are deemed probable.

 

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. From time to time, the Company may enter into derivative instruments,such as foreign currency swaps, intended to fix the amount of certain foreignassets and obligations relative to its functional currency. At June 30,2009, the Company did not have any such derivative instruments.

 

**8. Income Taxes**

 

**SallyBeauty and its subsidiaries, including the Company, file income tax returns inthe U.S. federal jurisdiction and most state jurisdictions, as well as invarious foreign jurisdictions.**

 

The SeparationTransactions were intended to qualify as a reorganization under Section 368(a)(1)(D) ofthe Internal Revenue Code of 1986, as amended (the “Code”) and a distributioneligible for non-recognition under Sections 355(a) and 361(c) of theCode. In connection with the share distribution of Alberto-Culver common stockin the Separation Transactions, Sally Beauty received: (i) a privateletter ruling from the Internal Revenue Service (“IRS”) and (ii) anopinion of Sidley Austin LLP, counsel to Alberto-Culver, in each case, to theeffect that the transactions qualify as a reorganization under Section 368(a)(1)(D) ofthe Code and a distribution eligible for non-recognition under Sections 355(a) and361(c) of the Code. Certain internal restructurings also occurred at orimmediately prior to the Separation Transactions. As a result of the internalrestructurings and Separation Transactions, Sally Beauty inherited the federaltax identification number of the old Alberto-Culver parent for U.S. federalincome tax purposes.

 

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 would 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 affectour current U.S. federal income tax liability.

 

The IRS examination ofthe Company’s consolidated federal income tax returns for the tax years ended September 30,2005 and 2006 were concluded with no adjustments required.

 

##### ***9.   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 offers professionalbeauty supplies to both salon professionals and retail customers and (ii) BSG,including its franchise-based business Armstrong McCall, a full service beautysupply distributor which offers professional brands of beauty products directlyto salons through its own sales force and professional only stores (includingfranchise stores) in generally exclusive geographical territories inNorth America and parts of Europe.

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

Sales between segments, which were eliminated in consolidation, werenot material during any of the periods ended June 30, 2009 and 2008.  Segment data for the three and nine monthsended June 30, 2009 and 2008 is as follows (in thousands):

 
| ** **                                   | ** ** | **Three months ended********June 30,** | ** ** | **Nine months ended********June 30,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2009**                                    | ** ** | **2008 (2)**                               | ** ** | **2009** | ** ** | **2008 (2)** | ** ** |
| Net  sales:                                  |       |                                        |       |                                       |       |   |   |   |   |
| Sally  Beauty Supply                         |       | $                                           | 434,732    |                                       | $          | 427,965 |   | $ | 1,257,607 |   | $ | 1,243,594 |   |
| BSG                                          |       | 238,605                                     |       | 248,865                                    |       | 702,817 |   | 732,369 |   |
| Total  net sales                             |       | $                                           | 673,337    |                                       | $          | 676,830 |   | $ | 1,960,424 |   | $ | 1,975,963 |   |
| Earnings  before provision for income taxes: |       |                                        |       |                                       |       |   |   |   |   |
| Segment  operating profit:                   |       |                                        |       |                                       |       |   |   |   |   |
| Sally  Beauty Supply                         |       | $                                           | 76,748     |                                       | $          | 73,021 |   | $ | 212,413 |   | $ | 212,665 |   |
| BSG                                          |       | 25,632                                      |       | 21,827                                     |       | 66,227 |   | 60,799 |   |
| Total  segment operating profit              |       | 102,380                                     |       | 94,848                                     |       | 278,640 |   | 273,464 |   |
| Unallocated  corporate expenses **(1)**      |       | (16,772                                     | )          | (15,057                                    | )          | (45,713 | ) | (47,460 | ) |
| Share-based  compensation expense            |       | (1,444                                      | )          | (1,347                                     | )          | (6,336 | ) | (8,252 | ) |
| Interest  expense, net of interest income    |       | (31,063                                     | )          | (29,671                                    | )          | (102,694 | ) | (123,797 | ) |
| Earnings  before provision for income taxes  |       | $                                           | 53,101     |                                       | $          | 48,773 |   | $ | 123,897 |   | $ | 93,955 |   |

 

----

(1)          Unallocatedexpenses consist of corporate and shared costs.

(2)          Certain amounts for prior periods havebeen reclassified to conform to the current period’s presentation.

 

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

 

The following condensed consolidating financialinformation presents the Condensed Consolidated Balance Sheets as of June 30,2009 and September 30, 2008, the Condensed Consolidated Statements ofEarnings for the three and nine months ended June 30, 2009 and 2008, andthe Condensed Consolidated Statements of Cash Flows for the nine months ended June 30,2009 and 2008 of: (i) Sally Holdings, or “the Parent;” (ii) theguarantor subsidiaries; (iii) the non-guarantor subsidiaries; (iv) eliminationentries necessary to consolidate the Parent with the guarantor andnon-guarantor subsidiaries; and (v) the Parent on a consolidated 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 generalcreditors.

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Condensed Consolidating Balance Sheet

June 30, 2009

(In thousands)

(Unaudited)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings  LLC &  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|---------------------------------------------------|------------|
| **Assets**                                                                  |       |       |       |                        |       |                              |       |             |       |                                              |       |
| Cash and cash equivalents                                                   |       | $          | 66         |                        | $          | 89,436                            |       | $                | 16,440     |                                              | $          | — |   | $ | 105,942 |   |
| Trade accounts and other receivables, less allowance for doubtful  accounts |       | —     |       | 46,274                      |       | 16,346                            |       | —           |       | 62,620                                            |       |
| Due from affiliates                                                         |       | —     |       | 189,557                     |       | 7,272                             |       | (196,829         | )          | —                                            |       |
| Inventories                                                                 |       | —     |       | 437,175                     |       | 122,384                           |       | —           |       | 559,559                                           |       |
| Prepaid expenses                                                            |       | 147        |       | 8,337                       |       | 12,411                            |       | —           |       | 20,895                                            |       |
| Deferred income tax assets                                                  |       | 2,968      |       | 21,251                      |       | (3,382                            | )          | —           |       | 20,837                                            |       |
| Property and equipment, net                                                 |       | —     |       | 114,261                     |       | 34,835                            |       | —           |       | 149,096                                           |       |
| Investment in subsidiaries                                                  |       | 1,184,751  |       | 253,110                     |       | —                            |       | (1,437,861       | )          | —                                            |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | 367,830                     |       | 135,015                           |       | —           |       | 502,845                                           |       |
| Other assets                                                                |       | 35,715     |       | 1,352                       |       | 4,559                             |       | —           |       | 41,626                                            |       |
| Total assets                                                                |       | $          | 1,223,647  |                        | $          | 1,528,583                         |       | $                | 345,880    |                                              | $          | (1,634,690 | ) | $ | 1,463,420 |   |
|                                                                        |       |       |       |                        |       |                              |       |             |       |                                              |       |
| **Liabilities and Member’s (Deficit) Equity**                          |       |       |       |                        |       |                              |       |             |       |                                              |       |
| Accounts payable                                                            |       | $          | 47         |                        | $          | 159,399                           |       | $                | 48,149     |                                              | $          | — |   | $ | 207,595 |   |
| Due to affiliates                                                           |       | 172,279    |       | 7,272                       |       | 17,278                            |       | (196,829         | )          | —                                            |       |
| Accrued expenses                                                            |       | 17,280     |       | 99,197                      |       | 21,059                            |       | —           |       | 137,536                                           |       |
| Due to Sally Beauty                                                         |       | —     |       | 21,016                      |       | —                            |       | —           |       | 21,016                                            |       |
| Income taxes                                                                |       | 4,246      |       | 231                         |       | (470                              | )          | —           |       | 4,007                                             |       |
| Long-term debt                                                              |       | 1,693,856  |       | 227                         |       | 3,034                             |       | —           |       | 1,697,117                                         |       |
| Other liabilities                                                           |       | 13,759     |       | 16,540                      |       | 1,129                             |       | —           |       | 31,428                                            |       |
| Deferred income tax liabilities                                             |       | (9,777     | )          | 39,950                      |       | 2,591                             |       | —           |       | 32,764                                            |       |
| Total liabilities                                                           |       | 1,891,690  |       | 343,832                     |       | 92,770                            |       | (196,829         | )          | 2,131,463                                         |       |
| Stock options subject to redemption                                         |       | 5,535      |       | —                      |       | —                            |       | —           |       | 5,535                                             |       |
| Total member’s (deficit) equity                                        |       | (673,578   | )          | 1,184,751                   |       | 253,110                           |       | (1,437,861       | )          | (673,578                                          | )          |
| Total liabilities and member’s (deficit) equity                        |       | $          | 1,223,647  |                        | $          | 1,528,583                         |       | $                | 345,880    |                                              | $          | (1,634,690 | ) | $ | 1,463,420 |   |

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Condensed Consolidating Balance Sheet

September 30, 2008

(In thousands)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings  LLC &  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|---------------------------------------------------|------------|
| **Assets**                                                                  |       |       |       |                        |       |                              |       |             |       |                                              |       |
| Cash and cash equivalents                                                   |       | $          | 1,645      |                        | $          | 85,384                            |       | $                | 12,759     |                                              | $          | — |   | $ | 99,788 |   |
| Trade accounts and other receivables, less allowance for doubtful  accounts |       | —     |       | 45,631                      |       | 20,446                            |       | —           |       | 66,077                                            |       |
| Due from affiliates                                                         |       | 36,219     |       | 15,389                      |       | 15,860                            |       | (67,468          | )          | —                                            |       |
| Inventories                                                                 |       | —     |       | 465,319                     |       | 132,876                           |       | —           |       | 598,195                                           |       |
| Prepaid expenses                                                            |       | 113        |       | 10,532                      |       | 8,804                             |       | —           |       | 19,449                                            |       |
| Deferred income tax assets                                                  |       | 2,968      |       | 21,251                      |       | (3,447                            | )          | —           |       | 20,772                                            |       |
| Property and equipment, net                                                 |       | —     |       | 120,051                     |       | 36,209                            |       | —           |       | 156,260                                           |       |
| Investment in subsidiaries                                                  |       | 1,064,199  |       | 272,094                     |       | —                            |       | (1,336,293       | )          | —                                            |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | 370,178                     |       | 140,219                           |       | —           |       | 510,397                                           |       |
| Other assets                                                                |       | 44,034     |       | 1,612                       |       | 9,074                             |       | —           |       | 54,720                                            |       |
| Total assets                                                                |       | $          | 1,149,178  |                        | $          | 1,407,441                         |       | $                | 372,800    |                                              | $          | (1,403,761 | ) | $ | 1,525,658 |   |
|                                                                        |       |       |       |                        |       |                              |       |             |       |                                              |       |
| **Liabilities and Member’s (Deficit) Equity**                          |       |       |       |                        |       |                              |       |             |       |                                              |       |
| Accounts payable                                                            |       | $          | 1,633      |                        | $          | 120,917                           |       | $                | 49,412     |                                              | $          | — |   | $ | 171,962 |   |
| Due to affiliates                                                           |       | —     |       | 52,079                      |       | 15,389                            |       | (67,468          | )          | —                                            |       |
| Accrued expenses                                                            |       | 31,503     |       | 100,678                     |       | 22,348                            |       | —           |       | 154,529                                           |       |
| Due to Sally Beauty                                                         |       | 474        |       | 16,769                      |       | —                            |       | —           |       | 17,243                                            |       |
| Income taxes                                                                |       | 5,727      |       | 476                         |       | 5,183                             |       | —           |       | 11,386                                            |       |
| Long-term debt                                                              |       | 1,821,600  |       | 386                         |       | 3,299                             |       | —           |       | 1,825,285                                         |       |
| Other liabilities                                                           |       | 7,163      |       | 15,436                      |       | 1,109                             |       | —           |       | 23,708                                            |       |
| Deferred income tax liabilities                                             |       | (2,526     | )          | 36,501                      |       | 3,966                             |       | —           |       | 37,941                                            |       |
| Total liabilities                                                           |       | 1,865,574  |       | 343,242                     |       | 100,706                           |       | (67,468          | )          | 2,242,054                                         |       |
| Stock options subject to redemption                                         |       | 5,884      |       | —                      |       | —                            |       | —           |       | 5,884                                             |       |
| Total member’s (deficit) equity                                        |       | (722,280   | )          | 1,064,199                   |       | 272,094                           |       | (1,336,293       | )          | (722,280                                          | )          |
| Total liabilities and member’s (deficit) equity                        |       | $          | 1,149,178  |                        | $          | 1,407,441                         |       | $                | 372,800    |                                              | $          | (1,403,761 | ) | $ | 1,525,658 |   |

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of Earnings

Three months endedJune 30, 2009

(In thousands)

(Unaudited)

 
| ** **                                             | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** **    | **Sally********Holdings LLC** | ** ** |
|--------------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|---------------|-------------------------------|------------|
| ** **                                             | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** **    | **&  Subsidiaries**       | ** ** |
| ** **                                             | ** ** | ** ** | ** ** | ** **       | ** ** | ** **          | ** ** | ** **       | ** **    | ** **                    | ** ** |
| Net sales                                              |       | $          | —     |             | $          | 557,884             |       | $                |  115,453 |                          | $          | — |   | $ | 673,337 |   |
| Related party sales                                    |       | —     |       | 701              |       |                |       | (701             | )             | —                        |       |
| Cost of products sold and distribution expenses        |       | —     |       | 288,788          |       | 67,405              |       | (701             | )             | 355,492                       |       |
| Gross profit                                           |       | —     |       | 269,797          |       | 48,048              |       | —           |          | 317,845                       |       |
| Selling, general and administrative expenses           |       | 130        |       | 178,141          |       | 43,768              |       | —           |          | 222,039                       |       |
| Depreciation and amortization                          |       | —     |       | 8,792            |       | 2,850               |       | —           |          | 11,642                        |       |
| Operating earnings (loss)                              |       | (130       | )          | 82,864           |       | 1,430               |       | —           |          | 84,164                        |       |
| Interest income                                        |       | —     |       | (60              | )          | (57                 | )          | —           |          | (117                          | )          |
| Interest expense                                       |       | 30,982     |       | 122              |       | 76                  |       | —           |          | 31,180                        |       |
| Earnings (losses) before provision for income taxes    |       | (31,112    | )          | 82,802           |       | 1,411               |       | —           |          | 53,101                        |       |
| Provision (benefit) for income taxes                   |       | (8,735     | )          | 26,242           |       | 2,739               |       | —           |          | 20,246                        |       |
| Equity in earnings (loss) of subsidiaries, net of  tax |       | 55,232     |       | (1,328           | )          | —              |       | (53,904          | )             | —                        |       |
| Net earnings (loss)                                    |       | $          | 32,855     |             | $          | 55,232              |       | $                | (1,328        | )                             | $          | (53,904 | ) | $ | 32,855 |   |

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of Earnings

Three months endedJune 30, 2008

(In thousands)

(Unaudited)

 
| ** **                                        | ** ** | ** ** | ** **   | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** **    | **Sally********Holdings LLC** | ** ** |
|---------------------------------------------------|------------|------------|--------------|------------------|------------|---------------------|------------|------------------|---------------|-------------------------------|------------|
| ** **                                        | ** ** | **Parent** | ** **   | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** **    | **&  Subsidiaries**       | ** ** |
| ** **                                        | ** ** | ** ** | ** **   | ** **       | ** ** | ** **          | ** ** | ** **       | ** **    | ** **                    | ** ** |
| Net sales                                         |       | $          |  — |             | $          |  546,353       |       | $                |  130,477 |                          | $          |  — |   | $ |  676,830 |   |
| Related party sales                               |       | —     |         | 729              |       | —              |       | (729             | )             | —                        |       |
| Cost of products sold and distribution expenses   |       | —     |         | 291,451          |       | 71,042              |       | (729             | )             | 361,764                       |       |
| Gross profit                                      |       | —     |         | 255,631          |       | 59,435              |       | —           |          | 315,066                       |       |
| Selling, general and administrative expenses      |       | 181        |         | 176,708          |       | 47,927              |       | —           |          | 224,816                       |       |
| Depreciation and amortization                     |       | —     |         | 8,851            |       | 2,955               |       | —           |          | 11,806                        |       |
| Operating earnings (loss)                         |       | (181       | )            | 70,072           |       | 8,553               |       | —           |          | 78,444                        |       |
| Interest income                                   |       | —     |         | (35              | )          | (118                | )          | —           |          | (153                          | )          |
| Interest expense                                  |       | 29,492     |         | 117              |       | 215                 |       | —           |          | 29,824                        |       |
| Earnings (loss) before provision for income taxes |       | (29,673    | )            | 69,990           |       | 8,456               |       | —           |          | 48,773                        |       |
| Provision (benefit) for income taxes              |       | (12,010    | )            | 28,214           |       | 1,943               |       | —           |          | 18,147                        |       |
| Equity in earnings of subsidiaries (net of tax)   |       | 48,289     |         | 6,513            |       | —              |       | (54,802          | )             | —                        |       |
| Net earnings                                      |       | $          | 30,626       |             | $          | 48,289              |       | $                | 6,513         |                          | $          | (54,802 | ) | $ | 30,626 |   |

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of Earnings

Nine months ended June 30,2009

(In thousands)

(Unaudited)

 
| ** **                                          | ** ** | ** ** | ** **   | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally********Holdings LLC** | ** ** |
|-----------------------------------------------------|------------|------------|--------------|------------------|------------|---------------------|------------|------------------|------------|-------------------------------|------------|
| ** **                                          | ** ** | **Parent** | ** **   | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **&  Subsidiaries**       | ** ** |
| Net sales                                           |       | $          |  — |             | $          | 1,623,260           |       | $                | 337,164    |                          | $          |  — |   | $ | 1,960,424 |   |
| Related party sales                                 |       | —     |         | 2,141            |       | —              |       | (2,141           | )          | —                        |       |
| Cost of products sold and distribution expenses     |       | —     |         | 846,644          |       | 192,420             |       | (2,141           | )          | 1,036,923                     |       |
| Gross profit                                        |       | —     |         | 778,757          |       | 144,744             |       | —           |       | 923,501                       |       |
| Selling, general and administrative expenses        |       | 473        |         | 527,555          |       | 134,022             |       | —           |       | 662,050                       |       |
| Depreciation and amortization                       |       | —     |         | 26,528           |       | 8,332               |       | —           |       | 34,860                        |       |
| Operating earnings (loss)                           |       | (473       | )            | 224,674          |       | 2,390               |       | —           |       | 226,591                       |       |
| Interest income                                     |       | —     |         | (171             | )          | (150                | )          | —           |       | (321                          | )          |
| Interest expense                                    |       | 102,494    |         | 275              |       | 246                 |       | —           |       | 103,015                       |       |
| Earnings (losses) before provision for income taxes |       | (102,967   | )            | 224,570          |       | 2,294               |       | —           |       | 123,897                       |       |
| Provision (benefit) for income taxes                |       | (38,881    | )            | 85,443           |       | 1,534               |       | —           |       | 48,096                        |       |
| Equity in earnings of subsidiaries (net of tax)     |       | 139,887    |         | 760              |       | —              |       | (140,647         | )          | —                        |       |
| Net earnings                                        |       | $          | 75,801       |             | $          | 139,887             |       | $                | 760        |                          | $          | (140,647 | ) | $ | 75,801 |   |

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Statement of Earnings

Nine months ended June 30,2008

(In thousands)

(Unaudited)

 
| ** **                                        | ** ** | ** ** | ** **   | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally********Holdings LLC** | ** ** |
|---------------------------------------------------|------------|------------|--------------|------------------|------------|---------------------|------------|------------------|------------|-------------------------------|------------|
| ** **                                        | ** ** | **Parent** | ** **   | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **&  Subsidiaries**       | ** ** |
| ** **                                        | ** ** | ** ** | ** **   | ** **       | ** ** | ** **          | ** ** | ** **       | ** ** | ** **                    | ** ** |
| Net sales                                         |       | $          |  — |             | $          | 1,600,791           |       | $                | 375,172    |                          | $          |  — |   | $ | 1,975,963 |   |
| Related party sales                               |       | —     |         | 2,146            |       | —              |       | (2,146           | )          | —                        |       |
| Cost of products sold and distribution expenses   |       | —     |         | 853,072          |       | 205,378             |       | (2,146           | )          | 1,056,304                     |       |
| Gross profit                                      |       | —     |         | 749,865          |       | 169,794             |       | —           |       | 919,659                       |       |
| Selling, general and administrative expenses      |       | 569        |         | 529,245          |       | 136,714             |       | —           |       | 666,528                       |       |
| Depreciation and amortization                     |       |       |         | 26,187           |       | 9,192               |       | —           |       | 35,379                        |       |
| Operating earnings (loss)                         |       | (569       | )            | 194,433          |       | 23,888              |       | —           |       | 217,752                       |       |
| Interest income                                   |       | —     |         | (70              | )          | (503                | )          | —           |       | (573                          | )          |
| Interest expense                                  |       | 123,777    |         | 325              |       | 268                 |       | —           |       | 124,370                       |       |
| Earnings (loss) before provision for income taxes |       | (124,346   | )            | 194,178          |       | 24,123              |       | —           |       | 93,955                        |       |
| Provision (benefit) for income taxes              |       | (48,997    | )            | 76,527           |       | 6,673               |       | —           |       | 34,203                        |       |
| Equity in earnings of subsidiaries (net of tax)   |       | 135,101    |         | 17,450           |       | —              |       | (152,551         | )          | —                        |       |
| Net earnings                                      |       | $          | 59,752       |             | $          | 135,101             |       | $                | 17,450     |                          | $          | (152,551 | ) | $ | 59,752 |   |

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of Cash Flows

Nine months ended June 30,2009

(In thousands)

(Unaudited)

 
| ** **                                                                 | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings  LLC** | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|--------------------------|------------|
| ** **                                                                 | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **&  Subsidiaries**  | ** ** |
|                                                                       |       |       |       |             |       |                |       |             |       |                     |       |
| **Net cash provided by operating  activities**                             |       | $          | 127,734    |             | $          | 22,839              |       | $                | 13,883     |                     | $          | — |   | $ | 164,456 |   |
| ** **                                                                 |       |       |       |             |       |                |       |             |       |                     |       |
| **Cash Flows from Investing  Activities:**                                 |       |       |       |             |       |                |       |             |       |                     |       |
| ** **                                                                 |       |       |       |             |       |                |       |             |       |                     |       |
| Capital expenditures, net of proceeds from sale of  property and equipment |       | —     |       | (17,144          | )          | (8,999              | )          | —           |       | (26,143                  | )          |
| Acquisitions, net of cash acquired                                         |       | —     |       | (1,280           | )          | (707                | )          | —           |       | (1,987                   | )          |
| Net cash used by investing activities                                      |       | —     |       | (18,424          | )          | (9,706              | )          | —           |       | (28,130                  | )          |
|                                                                       |       |       |       |             |       |                |       |             |       |                     |       |
| **Cash Flows from Financing Activities:**                                  |       |       |       |             |       |                |       |             |       |                     |       |
|                                                                       |       |       |       |             |       |                |       |             |       |                     |       |
| Change in book cash overdraft                                              |       | (1,586     | )          | —           |       | —              |       | —           |       | (1,586                   | )          |
| Proceeds from issuance of long-term debt                                   |       | 94,637     |       | —           |       | 467                 |       | —           |       | 95,104                   |       |
| Repayments of long-term debt                                               |       | (222,364   | )          | (159             | )          | (744                | )          | —           |       | (223,267                 | )          |
| Tax shortfall from share-based compensation                                |       | —     |       | (204             | )          | —              |       | —           |       | (204                     | )          |
| Net cash used by financing activities                                      |       | (129,313   | )          | (363             | )          | (277                | )          | —           |       | (129,953                 | )          |
| Effect of foreign exchange rate changes on cash and  cash equivalents      |       | —     |       | —           |       | (219                | )          | —           |       | (219                     | )          |
|                                                                       |       |       |       |             |       |                |       |             |       |                     |       |
| Net (decrease) increase in cash and cash  equivalents                      |       | (1,579     | )          | 4,052            |       | 3,681               |       | —           |       | 6,154                    |       |
| Cash and cash equivalents, beginning of period                             |       | 1,645      |       | 85,384           |       | 12,759              |       | —           |       | 99,788                   |       |
|                                                                       |       |       |       |             |       |                |       |             |       |                     |       |
| Cash and cash equivalents, end of period                                   |       | $          | 66         |             | $          | 89,436              |       | $                | 16,440     |                     | $          | — |   | $ | 105,942 |   |

 

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SallyHoldings LLC and Subsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Statement of Cash Flows

Nine months ended June 30,2008

(In thousands)

(Unaudited)

 
| ** **                                                             | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings,  LLC** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|---------------------------|------------|
| ** **                                                             | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **&  Subsidiaries**   | ** ** |
| **Net cash (used) provided by  operating activities**                  |       | $          | (33,780    | )                | $          | 53,469              |       | $                | 25,558     |                      | $          | — |   | $ | 45,247 |   |
| ** **                                                             |       |       |       |             |       |                |       |             |       |                      |       |
| **Cash Flows from Investing  Activities:**                             |       |       |       |             |       |                |       |             |       |                      |       |
| ** **                                                             |       |       |       |             |       |                |       |             |       |                      |       |
| Capital expenditures and proceeds from sale of  property and equipment |       | —     |       | (28,804          | )          | (6,668              | )          | —           |       | (35,472                   | )          |
| Acquisitions, net of cash acquired                                     |       | —     |       | (14,874          | )          | (33,327             | )          | —           |       | (48,201                   | )          |
| Net cash used by investing activities                                  |       | —     |       | (43,678          | )          | (39,995             | )          | —           |       | (83,673                   | )          |
|                                                                   |       |       |       |             |       |                |       |             |       |                      |       |
| **Cash Flows from Financing  Activities:**                             |       |       |       |             |       |                |       |             |       |                      |       |
| ** **                                                             |       |       |       |             |       |                |       |             |       |                      |       |
| Change in book cash overdraft                                          |       | —     |       | 5,008            |       | —              |       | —           |       | 5,008                     |       |
| Proceeds from issuance of long-term debt                               |       | 376,285    |       | 72               |       | 17,977              |       | —           |       | 394,334                   |       |
| Repayments of long-term debt                                           |       | (357,010   | )          | (191             | )          | (9,418              | )          | —           |       | (366,619                  | )          |
| Excess tax benefit from share-based compensation                       |       | —     |       | 253              |       | —              |       | —           |       | 253                       |       |
| Distributions received (paid)                                          |       | 19,519     |       | (19,519          | )          | —              |       | —           |       | —                    |       |
| Net cash provided (used) by financing activities                       |       | 38,794     |       | (14,377          | )          | 8,559               |       | —           |       | 32,976                    |       |
| Effect of foreign exchange rate changes on cash and  cash equivalents  |       | —     |       | —           |       | 902                 |       | —           |       | 902                       |       |
|                                                                   |       |       |       |             |       |                |       |             |       |                      |       |
| Net (decrease) increase in cash and cash  equivalents                  |       | 5,014      |       | (4,586           | )          | (4,976              | )          | —           |       | (4,548                    | )          |
| Cash and cash equivalents, beginning of period                         |       | 7          |       | 9,316            |       | 28,949              |       | —           |       | 38,272                    |       |
|                                                                   |       |       |       |             |       |                |       |             |       |                      |       |
| Cash and cash equivalents, end of period                               |       | $          | 5,021      |             | $          | 4,730               |       | $                | 23,973     |                      | $          | — |   | $ | 33,724 |   |

 

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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 30,2008, 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 Nine Months of Fiscal Year 2009:**

·                  Our same store sales increased by 1.6%for the nine months ended June 30, 2009;

·                  Our consolidated net sales for the ninemonths ended June 30, 2009, decreased by $15.5 million, or 0.8%, to$1,960.4 million compared to $1,976.0 million for the nine months ended June 30,2008;

·                  Net sales reported for the nine monthsended June 30, 2009, reflect approximately $72.9 million, or 3.7%, innegative impact from changes in foreign exchange rates;

·                  Our consolidated gross profit for thenine months ended June 30, 2009, increased $3.8 million, or 0.4%, to$923.5 million compared to $919.7 million for the nine months ended June 30,2008. As a percentage of net sales, gross profit increased 60 basis points to47.1% for the nine months ended June 30, 2009, compared to 46.5% for thenine months ended June 30, 2008;

·                  Our consolidated operating earnings forthe nine months ended June 30, 2009, increased $8.8 million, or 4.1%, to$226.6 million compared to $217.8 million for the nine months ended June 30,2008.  As a percentage of net sales,operating earnings increased to 11.6% for the nine months ended June 30,2009, compared to 11.0% for the nine months ended June 30, 2008;

·                  Net earnings increased $16.0 million, or26.9%, to $75.8 million for the nine months ended June 30, 2009, comparedto $59.8 million for the nine months ended June 30, 2008; and

·                  Cash provided by operations increased by$119.2 million to $164.5 million for the nine months ended June 30,2009, compared to $45.2 million for the nine months ended June 30,2008.

 

**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 3,632 stores and supplied 189 franchised stores inNorth America, as well as in certain European countries, as of June 30,2009. Within BSG, we also have one of the largest networks of professionaldistributor sales consultants in North America, with approximately 931professional distributor sales consultants who sell directly to salons andsalon professionals. We provide our customers with a wide variety of leadingthird-party branded and exclusive-label professional beauty supplies, includinghair care products, styling appliances, skin and nail care products and otherbeauty items. Sally Beauty Supply stores target retail consumers and salonprofessionals, while BSG exclusively targets salons and salon professionals.For the nine months ended June 30, 2009, our net sales and operatingearnings were $1,960.4 million and $226.6 million, respectively.

 

We believe that Sally Beauty Supply is the largestopen-line distributor of professional beauty supplies in the U.S. based onstore count. As of June 30, 2009, Sally Beauty Supply operated 2,853company-operated retail stores and supplied 26 franchised stores (all locatedoutside the U.S.). Of these stores, 2,330 are located in the U.S. (with theremainder in the United Kingdom and certain other countries in Europe, Canada,Puerto Rico and Mexico). Sally Beauty Supply storesaverage 1,700 square feet and are primarily located in strip shoppingcenters. The product selection in Sally Beauty Supply stores ranges between5,000 and 8,000 SKUs of beauty products and includes products for hair care,skin and nail care, beauty sundries and electrical appliances targeting retailconsumers and

 

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salon professionals. Sally Beauty Supply stores carryleading third-party brands such as Clairol, Revlon and Conair, as well as anextensive selection of exclusive-label merchandise.

 

We believe that BSG isthe largest full-service distributor of professional beauty supplies in theU.S.  As of June 30, 2009, BSG had 779 company-operated stores,supplied 163 franchised stores and had a sales force of approximately 931professional distributor sales consultants selling exclusively to salons andsalon professionals in substantially all states in the U.S. and inportions of Canada, Mexico and certain European countries. BSG storesaverage 2,700 square feet and are primarily located in secondarystrip shopping centers. Through BSG’s large store base and sales force, BSG isable to access a significant portion of the highly fragmented U.S. salonchannel. The product selection in BSG stores, ranging between 4,000 and 9,600SKUs of beauty products, includes hair care and color, skin and nail care,beauty sundries and electrical appliances targeting salons and salonprofessionals. BSG carries leading professional beauty product brands intendedfor use in salons and for resale by the salon to consumers. Certain BSGproducts are sold under exclusive distribution agreements with suppliers,whereby BSG is designated as the sole distributor for a product line withincertain 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, offset by lower sales of electrical products duringperiods of prolonged economic slowdown. We believe the following key industryand business trends and characteristics will influence our business and ourfinancial results going forward:

 

·                  *High level of customer fragmentation.*  The U.S. salon channel ishighly fragmented with over 228,000 salons. Given the fragmented andsmall-scale nature of the salon industry, we believe that salon operators willcontinue to depend on full-service/exclusive distributors and open-linechannels for a majority of their beauty supply purchases.

 

·                  *Growth in booth renting and frequent stocking needs.*  Salon professionals primarilyrely on just-in-time inventory due to capital constraints and a lack ofwarehouse and shelf space at salons.  Inaddition, booth renters, who comprise a significant percentage of total U.S.salon professionals, 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 upon manufacturerswho may be unable to provide products of adequate quality or who may beunwilling to continue to supply products to us” in Item 1A of our Annual Reporton Form 10-K for the fiscal year ended September 30, 2008.

 

·                  *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. In May 2008, we acquired Pro-Duo, N.V., a cash and carry retailerof both professional and retail hair products with approximately 40 storeslocated in Belgium, France and Spain. In February 2007, we acquiredChapelton 21 Limited, a private company based in Scotland with almost 100stores located in the United Kingdom, Ireland, Germany, France and Spain, whichwe refer to as Salon Services.  Theseacquisitions furthered our

 

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expansion plans in Europe, a significant part of Sally Beauty Supply’sinternational growth initiative.  Weintend to continue to identify and evaluate non-U.S. acquisition targets andare actively considering expansion into South America.  Our ability to grow our non-U.S. operations,integrate our new non-U.S. acquisitions and 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, 2008.

 

·                  *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 competeswith BSG in certain geographic areas. If L’Oreal acquired other distributors orsuppliers that conduct significant business with BSG we could lose relatedrevenue. There can be no assurance that there will not be further loss ofrevenue over time by BSG (including within its franchise-based business) due topotential losses of additional products (both from L’Oreal and from othersuppliers) as well as from the increased competition from L’Oreal-affiliateddistribution networks. Please see “Risk Factors - The beauty productsdistribution industry is highly competitive and is consolidating” and “Wedepend upon manufacturers who may be unable to provide products of adequatequality or who may be unwilling to continue to supply products to us” in Item1A of our Annual Report on Form 10-K for the fiscal year ended September 30,2008.

 

·                  *Relationshipswith Suppliers.*   Sally Beauty Supply/BSG and theirsuppliers are dependent on each other for the distribution of beauty products. We do not manufacture the brand name orexclusive-label products we sell. We purchase our products from a limitednumber of manufacturers. As is typical in distribution businesses, theserelationships are subject to change from time to time (including the expansionor loss of distribution rights in various geographies and the addition or lossof product lines). Since we purchase products from many manufacturers on anat-will basis, under contracts which can generally be terminated without causeupon 90 days’ notice or less or which expire without express rights ofrenewal, such manufacturers could discontinue sales to us at any time or uponthe expiration of the distribution period. Some of our contracts withmanufacturers may be terminated by such manufacturers if we fail to meetspecified minimum purchase requirements. In such cases, we do not havecontractual assurances of continued supply, pricing or access to new productsand vendors may change the terms upon which they sell. Infrequently, a supplierwill seek to terminate a distribution relationship through legal action.Changes in our relationships with suppliers occur often and could positively ornegatively impact our net sales and operating profits. Although we focus ondeveloping new revenue and cost management initiatives to mitigate the negativeeffects resulting from unfavorable changes in our supplier relationships, therecan be no assurance that our efforts will continue to completely offset theloss of these or other distribution rights. Please see “Risk Factors*—* We depend upon manufacturers who may beunable to provide products of adequate quality or who may be unwilling tocontinue to supply products to us” in Item 1A of our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2008.

 

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 on Form 10-Kfor the fiscal year ended September 30, 2008.

 

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

 

·                  *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.

 

·                  *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.During late fiscal year 2007, we began implementing an approximately $22.0million capital spending program to consolidate warehouses and reduceadministrative expenses related to BSG’s distribution network optimizationprogram. We believe that cost savingsfrom this program could range between $5 million and $7 million infiscal year 2009 and annualized savings of $10 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, 2008.

 

·                  *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. However, in response to economic conditionsand to allow flexibility to capitalize on potential real estate revaluations inkey locations, we have slowed our new store openings. We may not be able toopen all of the new stores we plan to open and any new stores we open may notbe profitable, any of which could have a material adverse impact on ourfinancial condition or results of operations. Please see “Risk Factors — If weare unable to profitably open and operate new stores, our business, financialcondition and results of operations may be adversely affected” in Item 1A ofour Annual Report on Form 10-K for the fiscal year ended September 30,2008.

 

·                  *Changes to our information technology systems*.  As our operations grow in both size andscope, we will continuously need to improve and upgrade our information systemsand infrastructure while maintaining the reliability and integrity of oursystems and infrastructure.  Theexpansion of our systems and infrastructure will require us to commitsubstantial financial, operational and technical resources in advance of anyincrease in the volume of our business, with no assurance that the volume ofbusiness will increase.  For example, infiscal year 2009, we are upgrading our distribution information systems (inconnection with our capital spending program to consolidate warehouses, asdiscussed above), are upgrading our AS400 iSeries servers and are in theprocess of installing Hyperion software to enhance our financial reportingsystem. These and any other required upgrades to our information systems andinformation technology (or new technology), now or in the future, will requirethat our management and resources be diverted from our core business to assistin completion of these projects. There can be no assurance that the time andresources our management will need to devote to these upgrades, service outagesor delays due to the installation of any new or upgraded technology (andcustomer issues therewith), or the impact on the reliability of our data fromany new or upgraded technology will not have a material adverse effect on ourfinancial reporting, business, financial condition or results of operations.  Please see “Risk Factors — We may beadversely affected by any disruption in our information technology systems” inItem 1A of our Annual Report on Form 10-K for the fiscal year ended September 30,2008.

 

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

##### *** ***

In November 2006,pursuant to an investment agreement among Alberto-Culver and certain of itssubsidiaries, including Sally Holdings, and CDRS Acquisition LLC (“CDRS”),Alberto-Culver separated its consumer products

 

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business and its SallyBeauty Supply/BSG distribution business into two separate, publicly-tradedcompanies.  Sally Holdings was awholly-owned subsidiary of Alberto-Culver until the Separation Transactions,when it was converted to a Delaware limited liability company, was renamedSally Holdings LLC and became an indirect wholly-owned subsidiary of SallyBeauty.  Sally Beauty was formed in June 2006and became the accounting successor company to Sally Holdings upon thecompletion of the Separation Transactions. See the Company’s Annual Report on Form 10-K for the fiscal yearended September 30, 2008 for more information about the SeparationTransactions.

 

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

* *

*InterestRate Swap Agreements*

 

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 agreements without exchange of the underlyingnotional amount. At June 30, 2009, the Company did not purchase or holdany other derivative instruments or hold any derivative instruments for tradingor speculative purposes.

 

Our counterparties in these transactions are deemed tobe of substantial resources and strong creditworthiness. However, thesetransactions result in exposure to credit risks in the event of default by acounterparty. The current financial crisis affecting the banking systems andfinancial markets has resulted in many well-known financial institutionsbecoming less creditworthy or having diminished liquidity, which could exposeus to an increased level of counterparty risk. In the event that a counterparty defaults in its obligation under ourinterest rate swaps, we could incur substantial financial loss. At June 30,2009, the aggregate fair value of all our interest rate swaps was a netliability of $19.7million.

 

Effective in November 2006, the Company enteredinto four interest rate swap agreements with an aggregate notional amount of$500 million. Interest rate swap agreements with an aggregate notional amountof $150 million expired in November 2008 and interest rate swap agreementswith a notional amount of $350 million expire in November 2009. Theseinterest rate swap agreements do not currently qualify as hedges and,therefore, the change in fair value of these interest rate swap agreements isrecorded in net interest expense in our consolidated statements of earnings.

 

# **Additionally,effective in May 2008, the Company entered into two interest rate swapagreements with an aggregate notional amount of $300 million. These interestrate swap agreements are designated as effective hedges, consistent withStatement of Financial Accounting Standards (“SFAS”) No. 133, *Accounting for Derivative Instruments and Hedging Activities*.Adjustments to reflect the change in the fair values of these interest rateswap agreements are recorded in accumulated other comprehensive (loss) income,net of income tax, until the hedged obligation is settled or the swapagreements expire, whichever is earlier. Any ineffectiveness is recognized innet interest expense in our 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, 2008.**

# ** **

## **Results of Operations**

##  

The following table shows the condensed results ofoperations of our business for the three and nine months ended June 30,2009 and 2008 (in thousands):

 

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| ** **                                       | ** ** | **Three Months Ended********June 30,** | ** ** | **Nine Months Ended********June 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                    | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net  sales                                       |       | $                                           | 673,337    |                                       | $          | 676,830 |   | $ | 1,960,424 |   | $ | 1,975,963 |   |
| Cost  of products sold and distribution expenses |       | 355,492                                     |       | 361,764                                    |       | 1,036,923 |   | 1,056,304 |   |
| Gross  profit                                    |       | 317,845                                     |       | 315,066                                    |       | 923,501 |   | 919,659 |   |
| Total  other operating costs and expenses        |       | 233,681                                     |       | 236,622                                    |       | 696,910 |   | 701,907 |   |
| Operating  earnings                              |       | 84,164                                      |       | 78,444                                     |       | 226,591 |   | 217,752 |   |
| Interest  expense, net                           |       | 31,063                                      |       | 29,671                                     |       | 102,694 |   | 123,797 |   |
| Earnings  before provision for income taxes      |       | 53,101                                      |       | 48,773                                     |       | 123,897 |   | 93,955 |   |
| Provision  for income taxes                      |       | 20,246                                      |       | 18,147                                     |       | 48,096 |   | 34,203 |   |
| Net  earnings                                    |       | $                                           | 32,855     |                                       | $          | 30,626 |   | $ | 75,801 |   | $ | 59,752 |   |

 

The following table shows the condensed results ofoperations of our business for the three and nine months ended June 30,2009 and 2008, expressed as a percentage of net sales for each respectiveperiod shown:

 
| ** **                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended********June 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                              | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net  sales                                       |       | 100.0                                 | %          | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost  of products sold and distribution expenses |       | 52.8                                  | %          | 53.4                                       | %          | 52.9 | % | 53.5 | % |
| Gross  profit                                    |       | 47.2                                  | %          | 46.6                                       | %          | 47.1 | % | 46.5 | % |
| Total  other operating costs and expenses        |       | 34.7                                  | %          | 35.0                                       | %          | 35.5 | % | 35.5 | % |
| Operating  earnings                              |       | 12.5                                  | %          | 11.6                                       | %          | 11.6 | % | 11.0 | % |
| Interest  expense, net                           |       | 4.6                                   | %          | 4.4                                        | %          | 5.3 | % | 6.3 | % |
| Earnings  before provision for income taxes      |       | 7.9                                   | %          | 7.2                                        | %          | 6.3 | % | 4.7 | % |
| Provision  for income taxes                      |       | 3.0                                   | %          | 2.7                                        | %          | 2.4 | % | 1.7 | % |
| Net  earnings                                    |       | 4.9                                   | %          | 4.5                                        | %          | 3.9 | % | 3.0 | % |

 

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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********June 30,** | ** ** | **Nine Months Ended********June 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2009**                                              | ** ** | **2008(a)**                                          | ** ** | **2009** | ** ** | **2008(a)** | ** ** |
| Net  sales:                                                |       |                                                  |       |                                                 |       |   |   |   |   |
| Sally  Beauty Supply                                       |       | $                                                     | 434,732    |                                                 | $          | 427,965 |   | $ | 1,257,607 |   | $ | 1,243,594 |   |
| BSG                                                        |       | 238,605                                               |       | 248,865                                              |       | 702,817 |   | 732,369 |   |
| Total                                                      |       | $                                                     | 673,337    |                                                 | $          | 676,830 |   | $ | 1,960,424 |   | $ | 1,975,963 |   |
| Gross  profit                                              |       | $                                                     | 317,845    |                                                 | $          | 315,066 |   | $ | 923,501 |   | $ | 919,659 |   |
| Gross  profit margin                                       |       | 47.2                                                  | %          | 46.6                                                 | %          | 47.1 | % | 46.5 | % |
| Selling,  general and administrative expenses              |       | $                                                     | 222,039    |                                                 | $          | 224,816 |   | $ | 662,050 |   | $ | 666,528 |   |
| Depreciation  and amortization                             |       | $                                                     | 11,642     |                                                 | $          | 11,806 |   | $ | 34,860 |   | $ | 35,379 |   |
| Earnings  before provision for income taxes:               |       |                                                  |       |                                                 |       |   |   |   |   |
| Segment  operating profit:                                 |       |                                                  |       |                                                 |       |   |   |   |   |
| Sally  Beauty Supply                                       |       | $                                                     | 76,748     |                                                 | $          | 73,021 |   | $ | 212,413 |   | $ | 212,665 |   |
| BSG                                                        |       | 25,632                                                |       | 21,827                                               |       | 66,227 |   | 60,799 |   |
| Segment  operating profit                                  |       | 102,380                                               |       | 94,848                                               |       | 278,640 |   | 273,464 |   |
| Unallocated  expenses                                      |       | (16,772                                               | )          | (15,057                                              | )          | (45,713 | ) | (47,460 | ) |
| Share-based  compensation expense                          |       | (1,444                                                | )          | (1,347                                               | )          | (6,336 | ) | (8,252 | ) |
| Operating  earnings                                        |       | 84,164                                                |       | 78,444                                               |       | 226,591 |   | 217,752 |   |
| Interest  expense, net of interest income                  |       | (31,063                                               | )          | (29,671                                              | )          | (102,694 | ) | (123,797 | ) |
| Earnings  before provision for income taxes                |       | $                                                     | 53,101     |                                                 | $          | 48,773 |   | $ | 123,897 |   | $ | 93,955 |   |
| Segment  operating profit margin:                          |       |                                                  |       |                                                 |       |   |   |   |   |
| Sally  Beauty Supply                                       |       | 17.7                                                  | %          | 17.1                                                 | %          | 16.9 | % | 17.1 | % |
| BSG                                                        |       | 10.7                                                  | %          | 8.8                                                  | %          | 9.4 | % | 8.3 | % |
| Consolidated  operating profit margin                      |       | 12.5                                                  | %          | 11.6                                                 | %          | 11.6 | % | 11.0 | % |
| Number  of stores at end-of-period (including franchises): |       |                                                  |       |                                                 |       |   |   |   |   |
| Sally  Beauty Supply                                       |       |                                                  |       |                                                 |       | 2,879 |   | 2,801 |   |
| BSG                                                        |       |                                                  |       |                                                 |       | 942 |   | 915 |   |
|                                                       |       |                                                  |       |                                                 |       | 3,821 |   | 3,716 |   |
| Same  store sales growth (b)                               |       |                                                  |       |                                                 |       |   |   |   |   |
| Sally  Beauty Supply                                       |       | 3.2                                                   | %          | 2.1                                                  | %          | 1.7 | % | 1.3 | % |
| BSG                                                        |       | 0.6                                                   | %          | 7.2                                                  | %          | 1.2 | % | 7.2 | % |
| Consolidated                                               |       | 2.6                                                   | %          | 3.4                                                  | %          | 1.6 | % | 2.8 | % |

 

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| (a) | Certain  amounts for the prior fiscal year may have been reclassified to conform to  the current year’s presentation.                                                                                                                                                                                                    |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (b) | 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 each of the periods  ended June 30, 2009. |

 

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***The Three Months Ended June 30,2009 compared to the Three Months Ended June 30, 2008***

 

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

 
|                             |   | **Three Months Ended June30,** | * * |
|----------------------------------|--------|--------------------------------|----------|
|                             |   | **2009**                       | * * | **2008** | * * | **Increase (Decrease)** | * * |
| Net sales:                       |   |                           | * * | * * | * * | * * | * * | * * | * * |
| Sally Beauty Supply              |   | $                              | 434,732  |   | $ | 427,965 |   | $ | 6,767 |   | 1.6 | % |
| BSG                              |   | 238,605                        |     | 248,865 |   | (10,260 | ) | (4.1 | )% |
| Consolidated net sales           |   | $                              | 673,337  |   | $ | 676,830 |   | $ | (3,493 | ) | (0.5 | )% |
|                             |   |                           | * * | * * | * * | * * | * * | * * | * * |
| Gross profit:                    |   |                           | * * | * * | * * | * * | * * | * * | * * |
| Sally Beauty Supply              |   | $                              | 224,752  |   | $ | 218,093 |   | $ | 6,659 |   | 3.1 | % |
| BSG                              |   | 93,093                         |     | 96,973 |   | (3,880 | ) | (4.0 | )% |
| Consolidated gross profit        |   | $                              | 317,845  |   | $ | 315,066 |   | $ | 2,779 |   | 0.9 | % |
|                             |   |                           | * * | * * | * * | * * | * * | * * | * * |
| Gross profit margin:             |   |                           | * * | * * | * * | * * | * * | * * | * * |
| Sally Beauty Supply              |   | 51.7                           | %        | 51.0 | % | 0.7 | % |   |   |
| BSG                              |   | 39.0                           | %        | 39.0 | % | — |   |   |   |
| Consolidated gross profit margin |   | 47.2                           | %        | 46.6 | % | 0.6 | % |   |   |

###  

### ***Net Sales***

###  

Consolidated net sales decreased by $3.5 million, or 0.5%, for thethree months ended June 30, 2009, compared to the three months ended June 30,2008. Company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $13.7 million, or 2.0%, toconsolidated sales. Other sales channels experienced declines compared to thethree months ended June 30, 2008. Sales through our BSG franchise-basedbusinesses declined by approximately $2.5 million, or 0.4%, sales through ourBSG distributor sales consultants declined approximately $9.5 million, or 1.4%,and sales through new stores declined approximately $4.4 million, or 0.6%, dueto fewer store openings in the twelve-month period ended June 30, 2009,compared to the twelve-month period ended June 30, 2008. Consolidated netsales for the three months ended June 30, 2009, are inclusive ofapproximately $21.9 million in negative impact from changes in foreign exchangerates.

 

*Sally Beauty Supply*.  Net sales for Sally Beauty Supply increasedby $6.8 million, or 1.6%, for the three months ended June 30, 2009,compared to the three months ended June 30, 2008.  In the Sally Beauty Supply segment,company-operated stores that have been open for at least 14 months contributedan increase of approximately $10.0 million, or 2.3%, and sales through newstores declined approximately $1.4 million, or 0.3%, as a result of fewer storeopenings during the nine-month period ended June 30, 2009. Net sales forSally Beauty Supply for the three months ended June 30, 2009, areinclusive of approximately $16.8 million in negative impact from changes inforeign exchange rates.

 

*Beauty Systems Group*. Net sales for BSG decreased by $10.3 million, or 4.1%, for the threemonths ended June 30, 2009, compared to the three months ended June 30,2008. While company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $3.6 million, or 1.5%, to net sales,other sales channels experienced declines compared to the three months ended June 30,2008. Sales through our franchise-based businesses declined by approximately$2.5 million, or 1.0%, sales through distributor sales consultants declinedapproximately $9.5 million, or 3.8%, and sales through new stores declinedapproximately $2.9 million, or 1.2%. Net sales for BSG for the three monthsended June 30, 2009 are inclusive of approximately $5.1 million innegative impact from changes in foreign exchange rates.

 

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#### ***Gross Profit***

 

Consolidated grossprofit increased by $2.8 million, or 0.9%, for the three months ended June 30,2009, compared to the three months ended June 30, 2008, principally due tohigher sales volume and improved gross margins for the Sally Beauty Supplysegment. This increase was partially offset by lower sales volume and lowergross margins for the BSG segment, as more fully described below.

 

*SallyBeauty Supply*. Sally Beauty Supply’s gross profit increasedby $6.7 million, or 3.1%, for the three months ended June 30, 2009,compared to the three months ended June 30, 2008, principally as a resultof a shift in product and customer mix, recent marketing efforts and low-costsourcing initiatives.  Sally BeautySupply’s gross profit as a percentage of net sales increased to 51.7% for thethree months ended June 30, 2009, compared to 51.0% for the three monthsended June 30, 2008. This increase was the result of recent marketingefforts, low-cost sourcing initiatives and a shift in product mix (including anincrease in sales of exclusive-label products and other higher-marginproducts).

 

*Beauty Systems Group*.  BSG’s gross profit decreased by $3.9 million,or 4.0%, for the threemonths ended June 30, 2009, compared to the three months ended June 30, 2008, principallyas a result of lower sales volume.  Thisdecrease reflectsunfavorable foreign currency transactions and softness in the BSG salesconsultant businesses. BSG’s gross profit as a percentage of net sales was39.0% for both thethree months ended June 30, 2009 andthe three months ended June 30, 2008.

 

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

#### ** **

Consolidatedselling, general and administrative expenses decreased by $2.8 million, or1.2%, to $222.0 million for the three months ended June 30, 2009, comparedto $224.8 million for the three months ended June 30, 2008.   Selling, general and administrativeexpenses, as a percentage of net sales, were 33.0% for the three months ended June 30,2009, compared to 33.2% for the three months ended June 30, 2008. Thisdecrease was attributable to lower sales commissions of $1.1 million andfavorable foreign currency transactions of $1.2 million, offset by higher advertisingexpenses in the Sally Beauty Supply segment of $1.9 million. Selling, generaland administrative expense for the three months ended June 30, 2008included approximately $1.3 million for BSG retention incentives fordistributor sales consultants (resulting from the L’Oreal contractual changesreported during fiscal year 2007) and warehouse optimization expenses ofapproximately $1.3 million, with no similar expenses in the three months ended June 30,2009.

 

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

#### ** **

Consolidated depreciationand amortization decreased to $11.6 million for three months ended June 30,2009, compared to $11.8 million for the three months ended June 30, 2008,due to a favorable impact from changes in foreign exchange rates, partiallyoffset by the expenses associated with businesses acquired in the last twelvemonths and depreciation related to capital expenditures mainly in connectionwith store openings in both operating segments.

 

#### ***Operating Earnings***

#### ** **

The following table sets forth, for the periods indicated,information concerning our operating earnings for each reportable segment(dollars in thousands):

 
| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **2009**                             | ** ** | **2008** | ** ** | **Increase** | ** ** |
| Operating Earnings:               |       |                                 |       |   |   |   |   |   |   |
| Segment operating  profit:        |       |                                 |       |   |   |   |   |   |   |
| Sally Beauty Supply               |       | $                                    | 76,748     |   | $ | 73,021 |   | $ | 3,727 |   | 5.1 | % |
| BSG                               |       | 25,632                               |       | 21,827 |   | 3,805 |   | 17.4 | % |
| Segment operating  profit         |       | 102,380                              |       | 94,848 |   | 7,532 |   | 7.9 | % |
| Unallocated expenses              |       | (16,772                              | )          | (15,057 | ) | 1,715 |   | 11.4 | % |
| Share-based  compensation expense |       | (1,444                               | )          | (1,347 | ) | 97 |   | 7.2 | % |
| Operating earnings                |       | $                                    | 84,164     |   | $ | 78,444 |   | $ | 5,720 |   | 7.3 | % |

 

Consolidatedoperating earnings increased by $5.7 million, or 7.3%, to $84.2 million forthree months ended June 30, 2009, compared to $78.4 million for the threemonths ended June 30, 2008. Operating earnings, as a percentage

 

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of net sales, were12.5% for the three months ended June 30, 2009, compared to 11.6% for thethree months ended June 30, 2008. The increase in consolidated operatingearnings was due primarily to an increase in the operating profits of bothsegments, as discussed below.

 

*SallyBeauty Supply*.  SallyBeauty Supply’s segment operating earnings increased by $3.7 million, or 5.1%,to $76.7 million for three months ended June 30, 2009, compared to $73.0million for the three months ended June 30, 2008.  The increase in Sally Beauty Supply’s segmentoperating earnings was primarily a result of increased same store sales volumeand improved gross margins, partially offset by higher advertising costs ofapproximately $1.9 million and the incremental costs related to approximately77 additional company-operated stores (stores opened or acquired during thepast twelve months) operating during the three months ended June 30,2009.  Segment operating earnings, as apercentage of net sales, were 17.7% for the three months ended June 30,2009, compared to 17.1% for the three months ended June 30, 2008. The increasein Sally Beauty Supply’s operating earnings as a percentage of segment netsales was primarily a result of gross margin improvements, partially offset byan increase in advertising costs as a percentage of segment sales and continuedsofter sales in some of the segment’s international operations.

 

*BeautySystems Group*.  BSG’ssegment operating earnings increased by $3.8 million, or 17.4%, to $25.6million for the three months ended June 30, 2009, compared to $21.8million for the three months ended June 30, 2008. Segment operatingearnings, as a percentage of net sales, increased to 10.7% for the three monthsended June 30, 2009, compared to 8.8% for the three months ended June 30,2008. This increase was due to lower sales commissions and other segmentselling and administrative costs, partially offset by the decline in segmentsales and gross profit, as discussed above.

 

*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 $1.7 million,or 11.4%, to $16.8 million for the three months ended June 30, 2009,compared to $15.1 million for the three months ended June 30, 2008. Thisincrease was due primarily to higher payroll related costs, professional feesand management information system upgrades, partially offset by favorablecurrency transactions resulting from intercompany notes not permanentlyinvested.

 

#### ***Share-based Compensation Expense.***Total compensation cost charged againstincome for share-based compensation arrangements was $1.4 million for the three months ended June 30, 2009 compared to $1.3 million for the threemonths ended June 30, 2008.

#### ** **

#### ***Net Interest Expense***

#### ** **

Interest expense,net of interest income of $0.1 million, was $31.1 million for the three monthsended June 30, 2009, compared to $29.7 million, net of interest income of$0.2 million, for the three months ended June 30, 2008.  The increase in interest expense wasprimarily attributable to a $5.1 million unfavorable change in the fair valueof certain interest rate swaps (please see Note 7 of the Condensed Notes toConsolidated Financial Statements), partially offset by lower prevailinginterest rates on our senior term loans and lower outstanding principalbalances on our ABL facility and senior term loans.

 

#### ***Provision for Income Taxes***

#### ** **

Provision for incometaxes was $20.2 million during the three months ended June 30, 2009,compared to $18.1 million for the three months ended June 30, 2008.  Income taxes for the interim periods ended June 30,2009 and 2008 have been included in the accompanying financial statements onthe basis of an estimated annual effective rate.  The estimated annual effective tax rate(excluding discrete items) is 38.5% for fiscal year 2009, compared to 36.1% forfiscal year 2008.  The increase in theestimated annual effective tax rate primarily relates to a reduction inearnings in low tax jurisdictions and a reduction in favorable permanent itemstriggered by lower foreign earnings.

 

For the three months ended June 30, 2009, the actual tax rate is lowerthan the estimated annual effective tax rate primarily because of lossesrecorded in the three months ended June 30, 2009 for entities for which avaluation allowance is required, and discrete items.

 

#### ***Net Earnings***

#### ** **

As a result of theforegoing, consolidated net earnings increased by $2.2 million, or 7.3%, to$32.9 million for the three months ended June 30, 2009, compared to $30.6million for the three months ended June 30, 2008. Net earnings, as apercentage of net sales, were 4.9% for the three months ended June 30,2009, compared to 4.5% for the three months ended June 30, 2008.

 

***The Nine Months Ended June 30,2009 compared to the Nine Months Ended June 30, 2008***

 

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

 

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| ** **                       | ** ** | **Nine Months Ended June 30,** | ** ** |
|----------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **2009**                            | ** ** | **2008** | ** ** | **Increase (Decrease)** | ** ** |
| Net sales:                       | * *   | * *                            | * *   | * * | * * | * * | * * | * * | * * |
| Sally Beauty Supply              |       | $                                   | 1,257,607  |   | $ | 1,243,594 |   | $ | 14,013 |   | 1.1 | % |
| BSG                              |       | 702,817                             |       | 732,369 |   | (29,552 | ) | (4.0 | )% |
| Consolidated net sales           |       | $                                   | 1,960,424  |   | $ | 1,975,963 |   | $ | (15,539 | ) | (0.8 | )% |
|                             | * *   | * *                            | * *   | * * | * * | * * | * * | * * | * * |
| Gross profit:                    | * *   | * *                            | * *   | * * | * * | * * | * * | * * | * * |
| Sally Beauty Supply              |       | $                                   | 652,445    |   | $ | 636,969 |   | $ | 15,476 |   | 2.4 | % |
| BSG                              |       | 271,056                             |       | 282,690 |   | (11,634 | ) | (4.1 | )% |
| Consolidated gross profit        |       | $                                   | 923,501    |   | $ | 919,659 |   | $ | 3,842 |   | 0.4 | % |
|                             | * *   | * *                            | * *   | * * | * * | * * | * * | * * | * * |
| Gross profit margin:             | * *   | * *                            | * *   | * * | * * | * * | * * | * * | * * |
| Sally Beauty Supply              |       | 51.9                                | %          | 51.2 | % | 0.7 | % |   |   |
| BSG                              |       | 38.6                                | %          | 38.6 | % | — |   |   |   |
| Consolidated gross profit margin |       | 47.1                                | %          | 46.5 | % | 0.6 | % |   |   |

###  

### ***Net Sales***

###  

Consolidated netsales decreased by $15.5 million, or 0.8%, for the nine months ended June 30,2009, compared to the nine months ended June 30, 2008. Company-operatedstores that have been open for at least 14 months contributed an increase ofapproximately $46.0 million, or 2.3%, and sales through certain non-store saleschannels contributed an increase of approximately $5.0 million, or 0.3%, toconsolidated sales. Other sales channels experienced declines compared to thenine months ended June 30, 2008. Sales through our BSG franchise-basedbusinesses declined by approximately $11.3 million, or 0.6%, sales through ourBSG distributor sales consultants declined approximately $22.6 million, or1.1%, and sales through new stores declined approximately $17.4 million, or0.9%, due to fewer store openings in the twelve-month period ended June 30,2009, compared to the twelve-month period ended June 30, 2008. Inaddition, incremental sales from businesses acquired in the preceding 12 monthscontributed $15.2 million less to our consolidated net sales for the ninemonths ended June 30, 2009, compared to the nine months ended June 30,2008. Consolidated net sales for the nine months ended June 30, 2009, areinclusive of approximately $72.9 million in negative impact from changes inforeign exchange rates.

 

*SallyBeauty Supply*.  Netsales for Sally Beauty Supply increased by $14.0 million, or 1.1%, for the ninemonths ended June 30, 2009, compared to the nine months ended June 30,2008.  In the Sally Beauty Supplysegment, company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $31.8 million, or 2.6%, while ournon-store sales channels contributed an increase of approximately $5.0 million,or 0.4%. Sales of businesses acquired in the preceding 12 months contributed$18.0 million less to the Sally Beauty Supply segment sales for the nine monthsended June 30, 2009, compared to the nine months ended June 30, 2008and sales through new stores declined approximately $4.8 million, or 0.4%. Netsales for Sally Beauty Supply for the nine months ended June 30, 2009, areinclusive of approximately $53.3 million in negative impact from changes inforeign exchange rates.

 

*Beauty Systems Group*. Net sales for BSG decreased by $29.6 million, or 4.0%, for the ninemonths ended June 30, 2009, compared to the nine months ended June 30,2008. While company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $14.2 million, or 1.9%, to net sales,other sales channels experienced declines compared to the nine months ended June 30,2008. Sales through our franchise-based businesses declined by approximately$11.3 million, or 1.5%, sales through distributor sales consultants declinedapproximately $22.6 million, or 3.1%, and sales through new stores declinedapproximately $12.7 million, or 1.7%. Net sales for BSG for the nine monthsended June 30, 2009, are inclusive of approximately $19.6 million innegative impact from changes in foreign exchange rates.

 

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#### ***Gross Profit***

#### ** **

Consolidated grossprofit increased by $3.8 million, or 0.4%, for the nine months ended June 30,2009, compared to the nine months ended June 30, 2008, principally due tohigher sales volume and improved gross margins for the Sally Beauty Supplysegment. This increase was partially offset by lower sales volume and lowergross margins for the BSG segment, as more fully described below.

 

*SallyBeauty Supply*. Sally Beauty Supply’s gross profit increasedby $15.5 million, or 2.4%, for the nine months ended June 30, 2009,compared to the nine months ended June 30, 2008, principally as a resultof increased unit sales volume and improved margins.  Sally Beauty Supply’s gross profit as apercentage of net sales increased to 51.9% for the nine months ended June 30,2009, compared to 51.2% for the nine months ended June 30, 2008. Thisincrease was the result of recent marketing efforts, low-cost sourcinginitiatives and a shift in product mix (including an increase in sales ofexclusive-label products and other higher-margin products).

 

*Beauty Systems Group*.  BSG’s gross profit decreased by $11.6million, or 4.1%, for the ninemonths ended June 30, 2009, compared to the nine months ended June 30, 2008, principallyas a result of lower unit sales volume. BSG’s gross profit as a percentage ofnet sales was 38.6% for both the nine months ended June 30, 2009 and the nine months ended June 30, 2008.

 

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

#### ** **

Consolidatedselling, general and administrative expenses decreased by $4.5 million, or0.7%, to $662.1 million for the nine months ended June 30, 2009, comparedto $666.5 million for the nine months ended June 30, 2008.   Selling, general and administrativeexpenses, as a percentage of net sales, were 33.8% for the nine months ended June 30,2009, compared to 33.7% for the nine months ended June 30, 2008. Thedecrease in selling, general and administrative expenses reflects lowershare-based compensation of $1.9 million, lower sales commissions of $4.0million and a decrease in other unallocated corporate expenses as a result ofcost-saving initiatives as well as favorable currency transactions resultingfrom intercompany notes not permanently invested of $1.6 million, partiallyoffset by the incremental expenses related to businesses acquired in the lasttwelve months as well as to an increase in advertising expenses ofapproximately $3.5 million. Selling, general and administrative expense for thenine months ended June 30, 2008 included approximately $2.8 million forBSG retention incentives for distributor sales consultants (resulting from theL’Oreal contractual changes reported during fiscal year 2007) and warehouseoptimization expenses of approximately $1.5 million, with no similar expensesin the nine months ended June 30, 2009.

 

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

#### ** **

Consolidated depreciationand amortization decreased to $34.9 million for the nine months ended June 30,2009, compared to $35.4 million for the nine months ended June 30, 2008,due to a favorable impact from changes in foreign exchange rates, partiallyoffset by the expenses associated with businesses acquired in the last twelvemonths and depreciation related to capital expenditures mainly in connectionwith store openings in both operating segments.

 

#### ***Operating Earnings***

#### ** **

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

 
| ** **                        | ** ** | **Nine Months Ended June 30,** | ** ** |
|-----------------------------------|------------|-------------------------------------|------------|
| ** **                        | ** ** | **2009**                            | ** ** | **2008** | ** ** | **Increase (Decrease)** | ** ** |
| Operating Earnings:               |       |                                |       |   |   |   |   |   |   |
| Segment operating  profit:        |       |                                |       |   |   |   |   |   |   |
| Sally Beauty Supply               |       | $                                   | 212,413    |   | $ | 212,665 |   | $ | (252 | ) | (0.1 | )% |
| BSG                               |       | 66,227                              |       | 60,799 |   | 5,428 |   | 8.9 | % |
| Segment operating  profit         |       | 278,640                             |       | 273,464 |   | 5,176 |   | 1.9 | % |
| Unallocated expenses              |       | (45,713                             | )          | (47,460 | ) | (1,747 | ) | (3.7 | )% |
| Share-based  compensation expense |       | (6,336                              | )          | (8,252 | ) | (1,916 | ) | (23.2 | )% |
| Operating earnings                |       | $                                   | 226,591    |   | $ | 217,752 |   | $ | 8,839 |   | 4.1 | % |

 

Consolidatedoperating earnings increased by $8.8 million, or 4.1%, to $226.6 million forthe nine months ended

 

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June 30,2009, compared to $217.8 million for the nine months ended June 30, 2008.Operating earnings, as a percentage of net sales, were 11.6% for the ninemonths ended June 30, 2009, compared to 11.0% for the nine months ended June 30,2008. The increase in consolidated operating earnings was due primarily to anincrease in BSG operating earnings and declines in unallocated expenses andshare-based compensation expense, offset in part by a decline in the SallyBeauty Supply’s operating profits, as discussed below.  Consolidated operating earnings for the ninemonths ended June 30, 2009, are inclusive of approximately $1.2 million innegative impact from changes in foreign exchange rates.

 

*SallyBeauty Supply*.  SallyBeauty Supply’s segment operating earnings decreased $0.3 million, or 0.1%, to$212.4 million for the nine months ended June 30, 2009, compared to $212.7million for the nine months ended June 30, 2008.  The decrease in Sally Beauty Supply’s segmentoperating earnings was primarily a result of higher advertising costs ofapproximately $4.8 million and the incremental costs related to approximately77 additional company-operated stores (stores opened or acquired during thepast twelve months) operating during the nine months ended June 30, 2009.  Segment operating earnings, as a percentageof net sales, were 16.9% for the nine months ended June 30, 2009, comparedto 17.1% for the nine months ended June 30, 2008. The decrease in SallyBeauty Supply’s segment operating earnings as a percentage of segment net saleswas primarily a result of higher advertising costs as a percentage of segmentnet sales and continued softer sales in some of the segment’s internationaloperations.

 

*BeautySystems Group*.  BSG’ssegment operating earnings increased $5.4 million, or 8.9%, to $66.2 millionfor the nine months ended June 30, 2009, compared to $60.8 million for thenine months ended June 30, 2008. Segment operating earnings, as apercentage of net sales, were 9.4% for the nine months ended June 30,2009, compared to 8.3% for the nine months ended June 30, 2008. Thisincrease was due primarily to a decline in segment operating expenses resultingfrom cost-saving initiatives, partially offset by lower segment gross profit,as discussed above. BSG’s segment operating earnings also reflect, for the ninemonths ended June 30, 2008, approximately $2.8 million for retentionincentives for distributor sales consultants (resulting from the L’Orealcontractual changes reported during fiscal year 2007). Segment operatingearnings for the nine months ended June 30, 2009, are inclusive ofapproximately $1.7 million in negative impact from changes in foreign exchangerates.

 

*Unallocated expenses.*Unallocated expenses, which representcorporate costs (such as payroll, employee benefits and travel expenses forcorporate staff, certain professional fees and corporate governance expenses)that have not been charged to our operating segments decreased by $1.7 million,or 3.7%, to $45.7 million for the nine months ended June 30, 2009,compared to $47.5 million for the nine months ended June 30, 2008. Thisdecrease was due primarily to lower corporate expenses resulting fromcost-saving initiatives as well as to favorable currency transactions resultingfrom intercompany notes not permanently invested.

 

#### ***Share-based Compensation Expense.***For the ninemonths ended June 30, 2009, total compensation cost charged against income forshare-based compensation arrangements was $6.3 million, compared to $8.3million for the nine months ended June 30,2008. This decrease was due toa decline in the fair value per share of options awarded in the period ended June 30,2009, compared to options awarded in the period ended June 30, 2008.  For the ninemonths ended June 30, 2009 and 2008, share-based compensation expense includes$2.0 million and $3.1 million, respectively, of accelerated expense related tocertain retirement eligible employees who are eligible to continue vestingawards upon retirement under the terms of the 2007 Plan.  Duringthe nine months ended June 30, 2009 and 2008, Sally Beauty granted to ouremployees and consultants approximately 2.7 million and 2.6 million stockoptions, respectively.

 

#### ***Net Interest Expense***

 

Interest expense, net ofinterest income of $0.3 million, was $102.7 million for the nine months ended June 30,2009, compared to $123.8 million, net of interest income of $0.6 million, forthe nine months ended June 30, 2008. The decrease in interest expense was primarily attributable to a $8.3million favorable change in the fair value of certain interest rate swaps(please see Note 7 of the Condensed Notes to Consolidated Financial Statements)and to lower prevailing interest rates on our ABL and senior term loanfacilities and lower outstanding principal balances on our senior term loans,partially offset by higher average outstanding borrowings under our ABLfacility as discussed in “Liquidity and Capital Resources” below.

 

#### ***Provision for Income Taxes***

 

Provision for incometaxes was $48.1 million during the nine months ended June 30, 2009,compared to $34.2 million for the nine months ended June 30, 2008.  Income taxes for the interim periods ended June 30,2009 and June 30, 2008 have been included in the accompanying financialstatements on the basis of an estimated annual effective rate.  The estimated annual effective tax rate(excluding discrete items) is 38.5% for fiscal year 2009,

 

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compared to 36.1% forfiscal year 2008.  The increase in theestimated annual effective tax rate primarily relates to a reduction inearnings in low tax jurisdictions and a reduction in favorable permanent itemstriggered by lower foreign earnings.

 

For the nine months endedJune 30, 2009, the actual tax rate exceeds the estimated annual effectivetax rate because of losses recorded in the nine months ended June 30, 2009for entities for which a valuation allowance is required.

 

#### ***Net Earnings***

 

As a result of theforegoing, consolidated net earnings increased by $16.0 million, or 26.9%, to$75.8 million for the nine months ended June 30, 2009, compared to $59.8million for the nine months ended June 30, 2008. Net earnings, as apercentage of net sales, were 3.9% for the nine months ended June 30,2009, compared to 3.0% for the nine months ended June 30, 2008.

 

## **FinancialCondition**

 

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

 

Working capital (currentassets less current liabilities) at June 30, 2009 was $398.4 million,compared to $348.6 million at September 30, 2008, representing an increaseof $49.8 million. The ratio of current assets to current liabilities was 2.07to 1.00 at June 30, 2009, compared to 1.76 to 1.00 at September 30,2008. The increase in working capital reflects a decrease of $84.2 million incurrent liabilities and a $34.4 million decrease in current assets.  The decrease in current assets as of June 30,2009 includes a $38.6 million reduction in inventory levels.  The decrease in current liabilities as of June 30,2009, was primarily the result of a decrease in current maturities of long-termdebt of $99.3 million.

 

Inventoriesdecreased $38.6 million to $559.6 million at June 30, 2009, compared to$598.2 million at September 30, 2008 due primarily to efforts toright-size inventory levels (including through lower purchases by us) duringthe period ended June 30, 2009, in response to the current economicslowdown and to the effect of foreign currency translation adjustments ofapproximately $8.4 million.

 

Current maturitiesof long-term debt decreased by $99.3 million to $1.3 million at June 30,2009, compared to $100.6 million at September 30, 2008 due primarily tothe repayment of $75.0 million of borrowings under our ABL facilities. Inaddition, this decrease reflects the current portion of certain repayments ofprincipal under our senior term loan facilities made during the nine monthsended June 30, 2009 (please see *Liquidity and CapitalResources* below).

 

Other liabilitiesincreased by $7.7 million to $31.4 million at June 30, 2009, compared to$23.7 million at September 30, 2008 due primarily to a change in the fairvalue of certain of our interest rate swaps.

 

Total member’s deficit decreased by $48.7 million as aresult of net earnings of $75.8 million for the nine months ended June 30,2009, partially offset by cumulative translation adjustments of $17.9 millionand deferred losses on interest rate swaps, net of income taxes, of $9.2million.

##  

## **Liquidityand Capital Resources**

 

We broadly define liquidity as our ability to generatesufficient cash flow from operating activities to meet our obligations andcommitments. In addition, liquidity includes the ability to obtain appropriatedebt and equity financing and to convert into cash those assets that are nolonger required to meet existing strategic and financial objectives. Therefore,liquidity cannot be considered separately from capital resources that consistof current or potentially available funds for use in achieving long-rangebusiness objectives and meeting debt service commitments. Please see our AnnualReport on Form 10-K for the fiscal year ended September 30, 2008 foradditional information on liquidity and capital resources.

 

Following the completion of the Separation Transactions,we are highly leveraged and a substantial portion of our liquidity needs willarise from debt service on indebtedness incurred primarily in connection withthe Separation Transactions and from funding the costs of operations, workingcapital and capital expenditures. As a holding company, we depend on oursubsidiaries to distribute funds to us so that we may pay our obligations andexpenses. Please see “Risk Factors—Risks Relating to Our Business,” and “—RisksRelating to Our Substantial Indebtedness” in Item 1A of our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2008.

 

During the nine months ended June 30, 2009, wemade scheduled payments in the aggregate amount of $6.1 million on its seniorterm loans.

 

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The senior term loan facilities may be prepaid at theoption of the Company at any time without premium or penalty and are subject tomandatory repayment 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 amandatory repayment on the senior term loan facilities in the amount of $16.7million. 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.

 

During the nine months ended June 30, 2009, theCompany also made optional repayments in the aggregate amount of $25.0 millionon our senior term loans. In addition, in May 2009, the Companyrepurchased $5.0 million in par value of its 10.5% senior subordinated notes(due in November 2016) for approximately $5.0 million, plus accruedinterest. In connection with the mandatory and optional repayments made duringthe nine months ended June 30, 2009, the Company recorded losses onextinguishment of debt in the aggregate amount of $0.7 million, which areincluded in net interest expense in the Company’s consolidated statements ofearnings.

 

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 financeanticipated capital expenditures and potential acquisitions over the next 12months.

 

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 theyear ended September 30, 2008.

 

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.  Thefunds drawn on individual occasions during the nine months ended June 30,2009, have varied in amounts of up to $20.0**million,with total amounts outstanding ranging from zero up to $120.0 million. Theamounts drawn are generally paid down with cash provided by our operatingactivities.

 

As of June 30, 2009, wehad $326.5 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 June 30, 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 ascalculated pursuant to the credit agreement and indentures.

 

The agreements governing our ABL facility generallypermit the making of distributions and certain other restricted payments solong as borrowing availability under the facility equals or exceeds $60million.  If borrowing availability fallsbelow this amount, we may nevertheless make restricted payments to Sally Beautyin the aggregate since the date of the Separation Transactions, together withthe aggregate cash amount paid in acquisitions since said date, of not greaterthan $50 million, together with certain other exceptions.  As of June 30, 2009, borrowing

 

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availability under the ABL facility exceeded $60million. As of June 30, 2009, the net assets of our consolidatedsubsidiaries that were unrestricted from transfer under our credit arrangementstotaled $213.6 million, subject to certain adjustments**.**

 

Our primary source of cash has been from fundsprovided by operating activities and borrowings under our ABL facility for thenine months ended June 30, 2009 and 2008. Historically, our primary use ofcash has been for acquisitions and capital expenditures. The following tableshows our sources and uses of funds for the nine months ended June 30,2009 and 2008 (in thousands):

 
| ** **                                                     | ** ** | **Nine Months Ended****June 30,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Net cash provided by operating activities                      |       | $                                                | 164,456    |   | $ | 45,247 |   |
| Net cash used by investing activities                          |       | (28,130                                          | )          | (83,673 | ) |
| Net cash (used) provided by financing activities               |       | (129,953                                         | )          | 32,976 |   |
| Effect of foreign exchange rates on cash and cash  equivalents |       | (219                                             | )          | 902 |   |
| Net increase (decrease) in cash and cash  equivalents          |       | $                                                | 6,154      |   | $ | (4,548 | ) |

###  

### *Net Cash Provided by Operating Activities*

###  

Net cash provided by operating activities, whichexcludes cash used for acquisitions completed during the period, during thenine months ended June 30, 2009, increased by $119.2 million to$164.5 million, compared to $45.2 million during the nine monthsended June 30, 2008. The increase was primarily due to a reduction ofapproximately $60.8 million in inventory levels, an increase in accountspayable and accrued expenses of approximately $59.8 million and an improvementof approximately $16.0 million in earnings, partially offset by a decrease inother liabilities of $15.3 million for the nine months ended June 30,2009, compared to the nine months ended June 30, 2008.

 

### *Net Cash Used by Investing Activities*

###  

Net cash used by investing activities during the ninemonths ended June 30, 2009, decreased by $55.5 million to$28.1 million, compared to $83.7 million during the nine months endedJune 30, 2008.  This decrease wasprimarily due to $9.4 million less in capital expenditures (primarily as aresult of fewer store openings) and a reduction of $46.2 million in cash usedfor acquisitions for the nine months ended June 30, 2009, compared to thenine months ended June 30, 2008.

###  

### *Net Cash (Used) Provided by FinancingActivities*

###  

# **Net cash (used)provided by financing activities during the nine months ended June 30,2009, decreased by $162.9 million to cash used of $130.0 million, comparedto cash provided of $33.0 million during the nine months ended June 30,2008.  The decrease was primarily due tonet borrowings of $40.9 million under our ABL facility during the nine monthsended June 30, 2008, compared to net repayments of $75.0 million duringthe nine months ended June 30, 2009. In addition, during the nine monthsended June 30, 2009, we made scheduled payments in the aggregate amount of$6.1 million, a mandatory repayment in the amount of $16.7 million and optionalrepayments in the aggregate amount of $25.0 million on our term loan facilitiesand we repurchased $5.0 million in par value of our senior subordinated notes(please see *Liquidity and Capital Resources* above).**

# ** **

# **Capital Requirements**

# ** **

For fiscal year 2009, we anticipate total capitalexpenditures in the range of approximately $37.0 million to $39.0 million,excluding acquisitions. We expect that capital expenditures will be primarilyfor the addition of new stores and the remodeling, expansion and/or relocationof existing stores in the ordinary course of our business as well as certaincorporate projects.

 

## **ContractualObligations**

##  

There have been nomaterial changes outside the ordinary course of business in any of ourcontractual obligations since September 30, 2008.

 

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## **Off-BalanceSheet Financing Arrangements**

##  

We had no off-balance sheet financing arrangementsother than operating leases incurred in the ordinary course of business, aswell as outstanding letters of credit related to inventory purchases and selfinsurance programs which totaled $12.5 million and $12.1 million at June 30,2009 and September 30, 2008, respectively.

 

## **Inflation**

##  

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

 

## **CriticalAccounting Policies and Estimates**

##  

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

 

Our critical accounting policies, as described in ourAnnual Report on Form 10-K for the fiscal year ended September 30,2008, 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, 2008.

 

# **Recent Accounting Pronouncements**

# ** **

In May 2009, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 165, *Subsequent Events* (“SFAS 165”). SFAS 165 establishesstandards of accounting for and disclosure of transactions and events thatoccur after the balance sheet date but before the financial statements areissued. This statement requires the disclosure, among other things, of the datethrough which an entity has evaluated subsequent events and whether that dateis the date the financial statements were issued or the date the financialstatements were available to be issued. SFAS 165 must be applied prospectivelyfor interim and annual periods ended after June 15, 2009. Accordingly, theCompany adopted the provisions of SFAS 165 effective for the quarter ended June 30,2009. In connection therewith, the Company has evaluated all materialtransactions and events through August 05, 2009, the date this QuarterlyReport was filed with the SEC.

 

The Company adopted theprovisions of SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133*(“SFAS 161”) effective on January 1, 2009. SFAS No. 133,*Accounting for Derivative Instruments and Hedging Activities*(“SFAS 133”), establishes, among other things, the disclosure requirements forderivative instruments and for hedging activities. SFAS 161 amended andexpanded those disclosures to also require qualitative disclosures about theobjectives and strategies for using derivative instruments, quantitativedisclosures about the fair value of and gains and losses on derivativeinstruments and disclosures about credit-risk-related contingent featurescontained in the derivative instruments. SFAS 161 also requires companies todisclose information about how derivatives and related hedges are accounted forunder SFAS 133 and how the hedges affect the entity’s financial position,financial performance and cash flows, including the location and amounts ofderivative instruments in the entity’s financial statements.

 

As required by SFAS 133,as amended, the Company records all derivative instruments on its balance sheetat fair value.  The accounting for changes in the fair value of derivativeinstruments depends on the intended use of the derivative, whether the Companyhas elected to designate a derivative instrument in a hedging relationship andapply hedge accounting and whether the hedging relationship has satisfied thecriteria necessary to apply hedge accounting. Derivative instruments designatedand qualifying as a hedge of the exposure to variability in expected futurecash flows, or other types of forecasted transactions, are considered cash flowhedges. Hedge accounting generally provides for the matching of the timing ofgain or loss recognition on the hedging instrument with the recognition of theimpact on earnings of the hedged transaction or transactions. The Company mayfrom time to time enter into derivative contracts that are intended to hedgecertain economic risks even though hedge accounting does not apply or theCompany elects not to apply hedge accounting to such derivative contracts.Please see Note 8 for more details about the Company’s derivative instrumentsand hedging activities as of June 30, 2009.

 

The Company adopted theprovisions of SFAS No. 157, *Fair Value Measurements*(“SFAS157”), as it relates to its financial instruments, effective on October 1,2008. SFAS 157 defines fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements. This statementdoes not require any new fair value measurements; rather, it amends otheraccounting pronouncements that require or permit fair value

 

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measurements. SFAS 157defines “fair value” as the price that would be received to sell an asset orpaid to transfer a liability in the principal or most advantageous market in anorderly transaction between market participants on the measurement date. SFAS157 establishes a three-level hierarchy for measuring fair value and requiresan entity to maximize the use of observable inputs and minimize the use ofunobservable 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. The three levels of that hierarchy aredefined 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 assets and liabilities at fair value on a recurring basis, includinginterest rate swaps. The Company has determined that the majority of the inputsused to value its interest rate swaps fall within Level 2 of the valuationhierarchy. In accordance with SFAS 157, the Company categorized certain of itsfinancial assets and liabilities based on priority of the inputs to thevaluation technique for the instruments, as follows (in thousands):

 
|                                     |   | **As  of June 30, 2009** |      |
|------------------------------------------|--------|-------------------------------|-----------|
|                                     |   | **Total**                     |      | **Level  1** |   | **Level  2** |   | **Level  3** |   |
| Liabilities                              |   |                          |      |   |   |   |   |   |   |
| Long-term  debt (1)                      |   | $                             | 1,630,195 |   |   |   | $ | 1,630,195 |   |   |   |
| Hedged  interest rate swaps (1)          |   | 13,759                        |      |   |   | 13,759 |   |   |   |
| Non-hedged  interest rate swaps (1) |   | 5,940                         |      |   |   | 5,940 |   |   |   |
| Total                                    |   | $                             | 1,649,894 |   |   |   | $ | 1,649,894 |   |   |   |

 

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(1) Interest rateswaps are valued using internal models based on market observable inputs,including market interest rates.

 

In April 2009, theFASB issued FSP-FAS No. 107-1 and APB 28-1, *Disclosures about Fair Value of Financial Instruments* (“FAS No. 107-1/APB 28-1”).This FSP extends to interim periods certain disclosures about fair value offinancial instruments for publicly traded companies and amends APB Opinion No. 28,*Interim Financial**Reporting,*to require those disclosures insummarized financial information at interim reporting periods. This FSP iseffective for interim reporting periods ending after June 15, 2009. TheCompany’s adoption of FAS No. 107-1/APB 28-1 did not have a materialeffect on the Company’s consolidated financial position, results of operationsor cash flows.

 

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

 

In June 2009, theFASB issued SFAS No. 168, *The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples,* a replacement of SFAS No. 162 (“SFAS 168”). SFAS168 identifies the previously issued accounting standards that are consideredauthoritative generally accepted accounting principles in the U.S., repealsSFAS No. 162, *The Hierarchy of GenerallyAccounting Principles* and replaces all previously issued accountingpronouncements of the FASB, and its predecessor rule-making bodies, with theFASB Accounting Standards Codification. SFAS 168 is effective prospectively forreporting periods ending after September 15, 2009.

 

In April 2008, theFASB issued FSP-FAS No. 142-3, *Determination of theUseful Life of Intangible Assets* (“FAS 142-3”). FAS 142-3 amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, *Goodwill and OtherIntangible Assets* (“SFAS 142”). The objective of the StaffPosition is to improve the consistency between the useful life of a recognizedintangible asset under SFAS 142 and the period of expected cash flows usedto measure the fair

 

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value of the asset underSFAS No. 141 (Revised 2007): *Business Combinations*(“SFAS 141R”) and other GAAP. FAS 142-3 is effective for fiscal years beginningafter December 15, 2008. Early application is not permitted.

 

In December 2007, the FASB issued SFAS No. 141(Revised2007), *Business Combinations* (“SFAS 141R”).Among other things, SFAS 141R generally requires that an acquirer recognize theassets acquired and liabilities assumed measured at their “full fair values” onthe acquisition date. This practice replaces the practice, under predecessorSFAS 141: *Business Combinations,* of allocating thecost of an acquisition to the individual assets acquired and liabilitiesassumed based on their relative estimated fair values. SFAS 141R furtherrequires that acquisition-related costs be recognized separately from therelated acquisition. SFAS 141R must be applied prospectively to businesscombinations consummated on or after the first annual reporting periodbeginning on or after December 15, 2008. Early application is notpermitted.

 

In April 2009, the FASBissued FSP-FAS No. 141(R)-1,*****Accounting for Assets Acquired and Liabilities Assumed in a BusinessCombination That Arise from Contingencies* (“FAS 141(R)-1”). This FSPamends and clarifies SFAS 141R and applies to assets acquired and liabilitiesassumed that arise from contingencies in a business combination. FAS 141(R)-1 mustalso be applied prospectively to business combinations consummated on or afterthe first annual reporting period beginning on or after December 15, 2008.Early application is not permitted.

 

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# **Item 3. Quantitative and Qualitative Disclosures About Market Risk.**

# ** **

As a multinational corporation, we are subject tocertain market risks including foreign currency fluctuations, interest ratesand government actions. We consider a variety of practices to manage thesemarket risks, including, when deemed appropriate, the occasional use ofderivative financial instruments.

 

## **Foreigncurrency exchange rate risk**

##  

We are exposed to potential gains or losses fromforeign currency fluctuations affecting net investments and earningsdenominated in foreign currencies. Our primary exposures are to changes inexchange rates for the U.S. dollar versus the British pound sterling,Canadian dollar, euro and Mexican peso. Our various currency exposures at timesoffset each other providing a natural hedge against currency risk. Whilefluctuations in the U.S. dollar exchange rates had a negative impact onreported consolidated sales of approximately $72.9 million, for the nine monthsended June 30, 2009, such fluctuations did not have a material effect onour financial condition and net earnings for the three and nine month periodsended June 30, 2009 and 2008. Although we may use derivative financialinstruments to manage foreign currency exchange rate risk from time to time,none were used as of June 30, 2009 and 2008 or for the interim periodsthen ended.

 

## **Interestrate risk**

##  

As a result of the debt financing incurred inconnection with the Separation Transactions, we are subject to interest ratemarket risk in connection with our long-term debt. The principal interest rateexposure relates to amounts borrowed under the term loans and the ABL facility.Based on the approximately $1.0 billion of aggregate borrowings under theCompany’s term loans and the ABL facility as of June 30, 2009, a change inthe estimated interest rate up or down by 1/8% would increase or decreaseearnings before provision for income taxes by approximately $1.3 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 swap agreements,for periods consistent with the related underlying exposures. We do notpurchase or hold any derivative instruments for speculative or tradingpurposes.

 

Effective in November 2006, we entered into fourinterest rate swap agreements with an aggregate notional amount of $500million. Interest rate swap agreements with an aggregate notional amount of$150 million expired in November 2008 and interest rate swap agreementswith a notional amount of $350 million expire in November 2009. Theagreements outstanding at June 30, 2009 enable us to convert a portion ofour variable interest rate obligations to fixed rate obligations with interestrates ranging from 7.19% to 7.44%. Theseinterest rate swap agreements do not currently qualify as hedges and, therefore,the change in the fair value of these interest rate swap agreements, which areadjusted quarterly, are recorded in net interest expense in the Company’sresults of operations. As discussed in Item 1A “RiskFactors” in our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2008, changes in the fairvalue of these interest rate swap agreements are mainly driven by interest ratechanges and will increase or decrease our net interest expense and maytherefore affect our earnings.

 

Effective in May 2008, we entered into twoadditional interest rate swap agreements with an aggregate notionalamount of $300 million (each agreement with a notional amount of $150 million).These agreements expire on May 31, 2012 and enable us to convert a portionof our variable interest rate obligations to fixed rate obligations withinterest ranging from 5.818% to 6.090%. These agreements are designated aseffective hedges, consistent with SFAS 133, *Accounting for DerivativeInstruments and Hedging Activities*. Adjustments to reflect thechange in the fair values of these interest rate swap agreements, which are adjusted quarterly, arerecorded in accumulated other comprehensive (loss) income until the hedgedobligation is settled or the swap agreements expire, whichever is earlier. Anyineffectiveness of these interest rate swaps is recognized in earnings.

 

## **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-terminvestments, if any, is largely mitigated by our policy of investing in adiversified portfolio of securities with high credit ratings.

 

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

 

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# **Item4. Controls and Procedures.**

# ** **

*ControlsEvaluation and Related CEO and CFO Certifications.*  Ourmanagement, with the participation of our principal executive officer (“CEO”)and principal financial officer (“CFO”), conducted an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this report. The controlsevaluation was conducted by our Disclosure Committee, comprised of seniorrepresentatives from our finance, accounting, internal audit, and legaldepartments under the supervision of our CEO.

 

Certifications of our CEOand our CFO, which are required in accordance with Rule 13a-14 of theSecurities Exchange Act of 1934, as amended (“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.

 

*Limitationson the Effectiveness of Controls.*  We do not expectthat our disclosure controls and procedures will prevent all errors and allfraud. A system of controls and procedures, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the system are met. Because of the limitations in all suchsystems, no evaluation can provide absolute assurance that all control issuesand instances of fraud, if any, have been detected. Furthermore, the design ofany system of controls and procedures is based in part upon certain assumptionsabout the likelihood of future events, and there can be no assurance that anydesign will succeed in achieving its stated goals under all potential futureconditions, regardless of how unlikely. Because of these inherent limitationsin a cost-effective system of controls and procedures, misstatements oromissions due to error or fraud may occur and not be detected.

 

*Scope ofthe Controls Evaluation.*  The evaluation of our disclosurecontrols and procedures included a review of their objectives and design, ourimplementation of the controls and procedures and the effect of the controlsand procedures on the information generated for use in this report. In thecourse of the evaluation, we sought to identify whether we had any data errors,control problems or acts of fraud and to confirm that appropriate correctiveaction, including process improvements, was being undertaken if needed. Thistype of evaluation is performed on a quarterly basis so that conclusionsconcerning the effectiveness of our disclosure controls and procedures can bereported in our Quarterly Reports on Form 10-Q and our Annual Reports on Form 10-K.Many of the components of our disclosure controls and procedures are alsoevaluated by our internal audit department, our legal department and bypersonnel in our finance organization. The overall goals of these variousevaluation activities are to monitor our disclosure controls and procedures onan ongoing basis, and to maintain them as dynamic systems that change as conditionswarrant.

 

*Conclusionsregarding Disclosure Controls.*  Based on therequired evaluation of our disclosure controls and procedures, our CEO and CFOhave concluded that, as of June 30, 2009, we maintain disclosure controlsand procedures that are effective in providing reasonable assurance thatinformation required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms, and thatsuch information is accumulated and communicated to our management, includingour CEO and CFO, as appropriate to allow timely decisions regarding requireddisclosure.

 

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

 

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**PART II— OTHER INFORMATION**

** **

# **Item1. Legal Proceedings.**

# ** **

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

 

We are subject to a number of U.S., federal, state andlocal laws and regulations, as well as the laws and regulations applicable ineach other market in which we do business. These laws and regulations govern,among other things, the composition, packaging, labeling and safety of theproducts we sell, the methods we use to sell these products and the methods weuse to import these products. We believe that we are in material compliancewith such laws and regulations, although no assurance can be provided that thiswill remain true going forward.

 

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 March24, 2008, SD Hair filed a cross-complaint in the same case naming AMLP and BSGas cross-defendants, seeking, among other things, i) declaratory relief fromBSG and AMLP in the form of a judicial finding that SD Hair is not in breach ofits franchise agreement and that L’Oreal has no rights as a third-partybeneficiary to SD Hair’s franchise agreement, and ii) injunctive relief in theform of a judicial order compelling AMLP and BSG to take appropriate legalaction against L’Oreal to enforce SD Hair’s claimed rights under AMLP’s Matrixdistribution agreement.  We have answeredthe cross-complaint and the lawsuit has been set for a jury trial in Novemberof 2009.

# ** **

On July 30, 2009,Sally Beauty disclosed in a Current Report on Form 8-K that L’Oreal fileda Second Amended Complaint in connection with the previously disclosed lawsuitdescribed above. The Second Amended Complaint alleges, among other things, thatAMLP, certain of its employees and others were involved inselling Matrix branded products to unauthorized buyers and that certain of itsemployees (and others) engaged in improper business transactions for personalbenefit 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. Noneof the employees involved in the allegations are executive officers of the Companyor Sally Beauty. Substantially all of these allegations were made known byL’Oreal to Sally Beauty prior to the filing of the Second Amended Complaint. L’Orealalso provided Sally Beauty with documents allegedly supporting the allegations.

 

## **As aresult of these allegations made by L’Oreal, many of which areincorporated into the Second Amended Complaint, the Audit Committee of theBoard of Directors of Sally Beauty engaged independent special counsel toinvestigate whether certain employees engaged in improper business transactionsfor personal benefit. After extensive review, the Audit Committee andindependent special counsel found insufficient evidence to support a conclusionthat employees of the Company or Sally Beauty entered into improper transactionsfor personal benefit. The Company intends to file its response to the SecondAmended Complaint and to vigorously defend itself in the lawsuit.**

##  

# **Items1A. Risk Factors.**

# ** **

## **In addition to the other information set forth in this report, youshould carefully consider the factors contained in Part I, Item 1A. “RiskFactors” in our Annual Report on Form 10-K for the fiscal year ended September 30,2008, which could materially affect our business, financial condition or futureresults. There have been no material changes from the risk factors disclosed inour Annual Report. The risks described in that report are not the only risksfacing our company. Additional risks and uncertainties not currently known tous or that we currently deem to be immaterial also may materially adverselyaffect our business, financial condition and/or operating results.**

 

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# **Item2. Unregistered Sales of Equity Securities and Use of Proceeds.**

# ** **

(a) Notapplicable

 

(b) Notapplicable

 

(c) Notapplicable

 

# **Item3. Defaults Upon Senior Securities.**

# ** **

Not applicable

 

# **Item4. Submission of Matters to a Vote of Security Holders.**

# ** **

Not applicable

 

# **Item5. Other Information.**

# ** **

(a) Notapplicable

 

(b) Notapplicable

 

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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 by reference from  Exhibit 2.1 to Amendment No. 3 to the Registration Statement on  Form S-4 of New Sally Holdings, Inc.. (File No. 333-136259)  filed on October 10, 2006                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.2                  |       | First  Amendment to the Investment Agreement, dated as of October 3, 2006,  among Alberto-Culver Company, New Aristotle Company, Sally Holdings, Inc.,  New Sally Holdings, Inc. and CDRS Acquisition LLC, which is incorporated  by reference from Exhibit 2.2 to Amendment No. 3 to the  Registration Statement on Form S-4 of New Sally Holdings, Inc.  (File No. 333-136259) filed on October 10, 2006                                                    |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.3                  |       | Second  Amendment to the Investment Agreement, dated as of October 26, 2006,  among Alberto-Culver Company, New Aristotle Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and CDRS Acquisition LLC,  which is incorporated by reference from Exhibit 2.02 to the Current  Report on Form 8-K of New Sally Holdings, Inc. filed on  October 30, 2006                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.4                  |       | Separation  Agreement, dated as of June 19, 2006, among Alberto-Culver Company,  Sally Holdings, Inc., New Sally Holdings, Inc. and New Aristotle  Holdings, Inc., which is incorporated by reference from Exhibit 2.3  to Amendment No. 3 to the Registration Statement on Form S-4 of New  Sally Holdings, Inc. (File No. 333-136259) filed on  October 10, 2006                                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.5                  |       | First  Amendment to the Separation Agreement, dated as of October 3, 2006,  among Alberto-Culver Company, Sally Holdings, Inc., New Sally  Holdings, Inc. and New Aristotle Holdings, Inc., which is  incorporated by reference from Exhibit 2.4 to Amendment No. 3 to  the Registration Statement on Form S-4 of New Sally Holdings, Inc.  (File No. 333-136259) filed on October 10, 2006                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.6                  |       | Second  Amendment to the Separation Agreement, dated as of October 26, 2006,  among Alberto-Culver Company, Sally Holdings, Inc., New Sally  Holdings, Inc. and New Aristotle Holdings, Inc., which is  incorporated by reference from Exhibit 2.01 to the Current Report on  Form 8-K of New Sally Holdings, Inc. filed on October 30, 2006                                                                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.1                  |       | Certificate  of Formation of Sally Holdings LLC, which is incorporated by reference to  Exhibit 3.1 to the Registration Statement on Form S-4 (File  No. 333-144427) of Sally Holdings LLC and Sally Capital, Inc. filed  on July 9, 2007                                                                                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.2                  |       | Limited  Liability Company Agreement of Sally Holdings LLC, which is incorporated by  reference to Exhibit 3.2 to the Registration Statement on Form S-4  (File No. 333-144427) of Sally Holdings LLC and Sally Capital, Inc.  filed on July 9, 2007                                                                                                                                                                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.1                  |       | Stockholders  Agreement, dated as of November 16, 2006, by and among Sally Beauty  Holdings, Inc., CDRS Acquisition LLC, CD&R Parallel Fund VII, L.P.  and the other stockholders party thereto, which is incorporated by reference  from Exhibit 4.8 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.2                  |       | First  Amendment to the Stockholders Agreement, dated as of December 13, 2006,  between Sally Beauty Holdings, Inc., CDRS Acquisition LLC and Carol L.  Bernick, as representative of the other stockholders, which is incorporated  herein by reference from Exhibit 4.2 to the Annual Report on Form 10-K  of Sally Beauty Holdings, Inc. filed on December 22, 2006                                                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.3                  |       | Indenture,  dated as of November 16, 2006, by and among Sally Holdings LLC and Sally  Capital Inc., as Co-Issuers, the Subsidiary Guarantors from time to time  parties thereto, and Wells Fargo Bank, National Association, as Trustee,  governing the 9.25% Senior Notes due 2014, which is incorporated by reference  from Exhibit 4.1 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.4                  |       | First  Supplemental Indenture, dated as of May 30, 2007, by and among Sally  Holdings LLC and Sally Capital Inc., as co-Issuers, the Subsidiary Guarantors  named therein, and Wells Fargo Bank, National Association, as trustee,  governing the 9.25% Senior Notes due 2014, which is incorporated herein by  reference from Exhibit 4.2 from the Registration Statement on  Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally  Capital Inc. filed on July 9, 2007 |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.5                  |       | Indenture,  dated as of November 16, 2006, by and among Sally Holdings LLC and Sally  Capital Inc., as Co-Issuers, the Subsidiary Guarantors from time to time  parties thereto, and Wells Fargo Bank,                                                                                                                                                                                                                                                                                                |

 

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

 

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| 4.13   |   | Canadian  Guarantee and Collateral Agreement, dated as of November 16, 2006, made  by Sally Beauty (Canada) Corporation, Beauty Systems Group  (Canada), Inc., Sally Beauty Canada Holdings Inc. and certain of their  respective subsidiaries in favor of Merrill Lynch Capital Canada Inc., as  Canadian Agent and Canadian Collateral Agent, which is incorporated by  reference from Exhibit 4.6.3 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on November 22, 2006                                                                  |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.14   |   | Intercreditor  Agreement, dated as of November 16, 2006, by and between Merrill Lynch  Capital, a division of Merrill Lynch Business Financial Services Inc., as  Administrative Agent and Collateral Agent under the Term Loan Facility, and  Merrill Lynch Capital, a division of Merrill Lynch Business Financial  Services Inc., as Administrative Agent and Collateral Agent under the  Asset-Based Loan Facility, which is incorporated by reference from  Exhibit 4.7 to the Current Report on Form 8-K of Sally Beauty Holdings, Inc.  filed on November 22, 2006 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.1   |   | Release  and Separation Agreement by and between Sally Beauty Holdings, Inc. and  Walter Richard Dowd, which is incorporated by reference from  Exhibit 10.2 to the Quarterly Report on From 10-Q of Sally Beauty  Holdings, Inc. filed on May 6, 2009                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.2   |   | Form of  Option Exercise Period Extension Agreement for Retired Executives, which is  incorporated by reference from Exhibit 10.3 to the Quarterly Report on  From 10-Q of Sally Beauty Holdings, Inc. filed on May 6, 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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**SIGNATURE**

 

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:  August 5,  2009 |                                                       |
|                                  |                                                       |
|                                  | 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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