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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****                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

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

 

**-OR-**

 

**o****                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**CommissionFile No. 333-144427**

 

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**SALLYHOLDINGS LLC**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

 

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

 

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

 

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

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

 

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

 

Novoting or non-voting common equity of the registrant’s were held bynon-affiliates of the registrant as of March 31, 2009.  As of May 1, 2009, all member units wereowned by Sally Investment Holdings LLC, a wholly-owned subsidiary of SallyBeauty Holdings, Inc.

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**TABLE OF CONTENTS**

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|                                                                                                 |   | **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                                 |   | 52       |
| 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 beneficiallyowned by 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;

 

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

 

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

 

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

 

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

 

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

 

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

 

·             product diversion tomass retailers;

 

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

 

·             the success of ournew Internet-based business;

 

·             successfullyidentifying acquisition candidates or successfully completing desirableacquisitions;

 

·             integratingbusinesses acquired in the future;

 

·             opening and operatingnew stores profitably;

 

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

 

·             the success of ourcost control plans;

 

·             protecting ourintellectual property rights, specifically our trademarks;

 

·             conducting businessoutside the United States;

 

·             disruption in ourinformation technology systems;

 

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·             natural disasters oracts of terrorism;

 

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

 

·             Sally Capital andSally Beauty being holding companies, with no operations of their own, anddepending on their subsidiaries for cash;

 

·             our substantialindebtedness;

 

·             the possibility thatwe may incur substantial additional debt;

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·             the interests ofSally Beauty’s largest stockholder differing from the interests of otherholders of Sally Beauty’s common stock.

 

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 March 31,2009 and September 30, 2008; our consolidated statements of earnings forthe three and six months ended March 31, 2009 and 2008 and ourconsolidated statements of cash flows for the six months ended March 31,2009 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** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                       | ** ** | **March 31,**     | ** ** | **March 31,**   | ** ** |
| ** **                                       | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                                        |       | $                      | 641,511    |                 | $          | 643,346 |   | $ | 1,287,087 |   | $ | 1,299,133 |   |
| Cost of products sold and distribution expenses  |       | 339,399                |       | 344,922              |       | 681,431 |   | 694,540 |   |
| Gross profit                                     |       | 302,112                |       | 298,424              |       | 605,656 |   | 604,593 |   |
| Selling, general and administrative expenses (a) |       | 216,474                |       | 218,817              |       | 440,011 |   | 441,712 |   |
| Depreciation and amortization                    |       | 11,471                 |       | 11,821               |       | 23,218 |   | 23,573 |   |
| Operating earnings                               |       | 74,167                 |       | 67,786               |       | 142,427 |   | 139,308 |   |
| Interest expense, net (b)                        |       | 31,958                 |       | 47,642               |       | 71,631 |   | 94,125 |   |
| Earnings before provision for income taxes  |       | 42,209                 |       | 20,144               |       | 70,796 |   | 45,183 |   |
| Provision for income taxes                       |       | 16,470                 |       | 6,364                |       | 27,850 |   | 16,057 |   |
| Net earnings                                     |       | $                      | 25,739     |                 | $          | 13,780 |   | $ | 42,946 |   | $ | 29,126 |   |
|                                                  |            |                        |            |                      |            |  |  |  |  |  |  |  |  |  |

 

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(a)           Selling, general andadministrative expenses include share-based compensation of $1.4 million and$1.5 million for the three months ended March 31, 2009 and 2008 and $4.9million and $6.9 million for the six months ended March 31, 2009 and 2008,respectively.

 

(b)           Interest expense is netof interest income of $0.1 million and $0.2 million for the three months ended March 31,2009 and 2008 and $0.2 million and $0.4 million for the six months ended March 31,2009 and 2008, respectively. Interest expense includes income of $2.2 millionof marked-to-market adjustments related to interest rate swaps for the threemonths ended March 31, 2009 and expenses of $8.6 million ofmarked-to-market adjustments related to interest rate swaps for the threemonths ended March 31, 2008; and expenses of $0.8 million and $14.3million related to these adjustments for the six months ended March 31,2009 and 2008, respectively.

 

The accompanying condensed notes, together with theNotes to Consolidated Financial Statements contained in the Company’s AnnualReport on Form 10-K for the fiscal year ended September 30, 2008, arean integral part of these financial statements.

 

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

 
| ** **                                                                                                                              | ** ** | **March 31,  2009** | ** ** | **September  30,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                                                                                                              | ** ** | **(Unaudited)**          | ** ** | ** **               | ** ** |
| **Assets**                                                                                                                              | ** ** | ** **               | ** ** | ** **               | ** ** |
| Current assets:                                                                                                                         |       |                     |       |                     |       |
| Cash and cash equivalents                                                                                                               |       | $                        | 104,678    |                     | $          | 99,788 |   |
| Trade accounts receivable, less allowance for doubtful accounts of $2,112  at March 31, 2009 and $2,702 at September 30, 2008 |       | 36,391                   |       | 44,481                   |       |
| Other receivables                                                                                                                       |       | 30,578                   |       | 21,596                   |       |
| Inventories                                                                                                                             |       | 538,816                  |       | 598,195                  |       |
| Prepaid expenses                                                                                                                        |       | 16,259                   |       | 19,449                   |       |
| Deferred income tax assets                                                                                                              |       | 20,871                   |       | 20,772                   |       |
| Total current assets                                                                                                                    |       | 747,593                  |       | 804,281                  |       |
| Property and equipment, net of accumulated depreciation of $246,783  at March 31, 2009 and $243,185 at September 30, 2008     |       | 146,610                  |       | 156,260                  |       |
| Goodwill                                                                                                                                |       | 410,731                  |       | 424,963                  |       |
| Intangible assets, net of accumulated amortization of $21,134 at March 31,  2009 and $18,203 at September 30, 2008            |       | 78,815                   |       | 85,434                   |       |
| Other assets                                                                                                                            |       | 47,571                   |       | 54,720                   |       |
| Total assets                                                                                                                            |       | $                        | 1,431,320  |                     | $          | 1,525,658 |   |
| **Liabilities and Member’s Deficit**                                                                                               |       |                     |       |                     |       |
| Current liabilities:                                                                                                                    |       |                     |       |                     |       |
| Current maturities of long-term debt                                                                                                    |       | $                        | 14,470     |                     | $          | 100,601 |   |
| Accounts payable                                                                                                                        |       | 185,729                  |       | 171,962                  |       |
| Accrued expenses                                                                                                                        |       | 146,845                  |       | 154,529                  |       |
| Due to Sally Beauty                                                                                                                     |       | 27,891                   |       | 17,243                   |       |
| Income taxes                                                                                                                            |       | 4,782                    |       | 11,386                   |       |
| Total current liabilities                                                                                                               |       | 379,717                  |       | 455,721                  |       |
| Long-term debt                                                                                                                          |       | 1,712,310                |       | 1,724,684                |       |
| Other liabilities                                                                                                                       |       | 36,123                   |       | 23,708                   |       |
| Deferred income tax liabilities                                                                                                         |       | 28,600                   |       | 37,941                   |       |
| Total liabilities                                                                                                                       |       | 2,156,750                |       | 2,242,054                |       |
| Stock options subject to redemption                                                                                                     |       | 5,623                    |       | 5,884                    |       |
| Member’s deficit:                                                                                                                  |       |                     |       |                     |       |
|                                                                                                                                    |       |                     |       |                     |       |
| Members’ deficit                                                                                                                   |       | (688,023                 | )          | (730,969                 | )          |
|                                                                                                                                    |       |                     |       |                     |       |
| Accumulated other comprehensive (loss) income                                                                                           |       | (43,030                  | )          | 8,689                    |       |
| Total member’s deficit                                                                                                             |       | (731,053                 | )          | (722,280                 | )          |
| Total liabilities and member’s deficit                                                                                             |       | $                        | 1,431,320  |                     | $          | 1,525,658 |   |

 

The accompanying condensed notes, together with theNotes to Consolidated Financial Statements contained in the Company’s AnnualReport on Form 10-K for the fiscal year ended September 30, 2008, arean integral part of these financial statements.

 

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

(Unaudited)

 
| ** **                                                                                           | ** ** | **Six Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                           | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| **Cash Flows from Operating Activities:**                                                            |       |                                |       |   |   |
| Net earnings                                                                                         |       | $                                   | 42,946     |   | $ | 29,126 |   |
| Adjustments to reconcile net earnings to net cash provided by  operating activities:                 |       |                                |       |   |   |
| Depreciation and amortization                                                                        |       | 23,218                              |       | 23,573 |   |
| Share-based compensation expense (net of deferred tax benefit of  $1,365 in 2009 and $2,117 in 2008) |       | 3,527                               |       | 4,788 |   |
| Amortization of deferred financing costs                                                             |       | 4,201                               |       | 4.247 |   |
| Excess tax shortfall (benefit) from share-based compensation                                         |       | 226                                 |       | (264 | ) |
| Net (gain) loss on disposal of leaseholds and other property                                         |       | (18                                 | )          | 213 |   |
| Deferred income taxes                                                                                |       | 1,036                               |       | 648 |   |
| Changes in (exclusive of effects of acquisitions):                                                   |       |                                |       |   |   |
| Trade accounts receivable                                                                            |       | 5,761                               |       | 5,374 |   |
| Other receivables                                                                                    |       | (10,108                             | )          | (1,773 | ) |
| Inventories                                                                                          |       | 39,716                              |       | (20,490 | ) |
| Prepaid expenses                                                                                     |       | 1,735                               |       | 553 |   |
| Other assets                                                                                         |       | 801                                 |       | (24 | ) |
| Accounts payable and accrued expenses                                                                |       | 17,972                              |       | (25,153 | ) |
| Income taxes                                                                                         |       | (5,886                              | )          | 280 |   |
| Due to Sally Beauty                                                                                  |       | 5,495                               |       | (15,037 | ) |
| Other liabilities                                                                                    |       | (6,038                              | )          | 14,558 |   |
| Net cash provided by operating activities                                                            |       | 124,584                             |       | 20,619 |   |
| **Cash Flows from Investing Activities:**                                                            |       |                                |       |   |   |
| Capital expenditures                                                                                 |       | (16,789                             | )          | (25,699 | ) |
| Proceeds from sale of property and equipment                                                         |       | 66                                  |       | 162 |   |
| Acquisitions, net of cash acquired                                                                   |       | (1,987                              | )          | (17,445 | ) |
| Net cash used by investing activities                                                                |       | (18,710                             | )          | (42,982 | ) |
| **Cash Flows from Financing Activities:**                                                            |       |                                |       |   |   |
| Change in book cash overdraft                                                                        |       | (1,633                              | )          | — |   |
| Proceeds from issuance of long-term debt                                                             |       | 94,639                              |       | 244,235 |   |
| Repayments of long-term debt                                                                         |       | (192,995                            | )          | (230,001 | ) |
| Excess tax (shortfall) benefit from share-based compensation                                         |       | (226                                | )          | 264 |   |
| Net cash (used) provided by financing activities                                                     |       | (100,215                            | )          | 14,498 |   |
| Effect of foreign exchange rate changes on cash and cash equivalents                                 |       | (769                                | )          | 1,013 |   |
| Net increase (decrease) in cash and cash equivalents                                                 |       | 4,890                               |       | (6,852 | ) |
| Cash and cash equivalents, beginning of period                                                       |       | 99,788                              |       | 38,272 |   |
| Cash and cash equivalents, end of period                                                             |       | $                                   | 104,678    |   | $ | 31,420 |   |
|                                                                                                 |       |                                |       |   |   |
| **Supplemental Cash Flow Information:**                                                              |       |                                |       |   |   |
| **Cash paid for:**                                                                                   |       |                                |       |   |   |
| **Interest**                                                                                         |       | $                                   | 68,976     |   | $ | 76,698 |   |
| **Income taxes**                                                                                     |       | $                                   | 4,109      |   | $ | 3,016 |   |

#####  

The accompanyingcondensed notes, together with the Notes to Consolidated Financial Statementscontained in the Company’s Annual Report on Form 10-K for the fiscal yearended September 30, 2008, are an integral part of these financialstatements.

 

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Sally Holdings LLCand Subsidiaries

##### ***Condensed Notes to ConsolidatedFinancial Statements***

#####  

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

##### *** ***

Description of Business

 

Sally Holdings LLC (“Sally Holdings”) is awholly-owned subsidiary of Sally Investment Holdings LLC (“Sally Investment”),a wholly-owned subsidiary of Sally Beauty. All of the interests of Sally Holdings are beneficially owned by SallyInvestment, and all of the interests of Sally Investment are beneficially ownedby 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.  TheCompany and its consolidated subsidiaries sell professional beauty supplies,primarily through its Sally Beauty Supply retail stores in the U.S., PuertoRico, Mexico, Canada, Japan, the United Kingdom and certain other countries inEurope. Additionally, the Company distributes professional beauty products tosalons and professional cosmetologists through its Beauty Systems Group (“BSG”)store operations and a commissioned direct sales force that calls on salons inthe U.S., Canada, the United Kingdom and certain other countries in Europe, andto franchises in the southern and southwestern U.S. and in Mexico through theoperations of its subsidiary Armstrong McCall, L.P. (“Armstrong McCall”).Certain beauty products sold by BSG and Armstrong McCall are sold throughexclusive territory agreements with the manufacturers of the products.

 

In November 2006, the stockholders ofAlberto-Culver approved a plan to separate its consumer products business andits Sally Beauty Supply/BSG distribution business into two separate,publicly-traded companies. 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 ourparent, Sally Beauty.  See the Company’sAnnual 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 March 31, 2009 and September 30,2008, the consolidated results of operations for the three and six months endedMarch 31, 2009 and 2008, and the consolidated cash flows for the sixmonths ended March 31, 2009 and 2008.

 

All references in these notes to “management” are to the management ofSally Holdings. All references in these notes to the “Company” are to SallyHoldings LLC 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 financialstatements.  As permitted under GAAP,interim accounting for certain expenses, including income taxes, 

 

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Sally Holdings LLCand Subsidiaries

##### ***Condensed Notes to ConsolidatedFinancial Statements***

 

are based on full yearassumptions.  Such amounts are expensedin full in the year incurred.  Forinterim financial reporting purposes, income taxes are recorded based uponestimated 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.

 

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

##### *** ***

The Company adopted theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 161,*Disclosures about Derivative Instruments andHedging Activities, an Amendment of FASB Statement No. 133* (“SFAS161”) effective on January 1, 2009. SFAS No. 133,*Accountingfor Derivative Instruments and Hedging Activities*(“SFAS 133”),establishes, among other things, the disclosure requirements for derivativeinstruments and for hedging activities. SFAS 161 amended and expanded those disclosures to also requirequalitative disclosures about the objectives and strategies for usingderivative instruments, quantitative disclosures about the fair value of andgains and losses on derivative instruments and disclosures aboutcredit-risk-related contingent features 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 does not apply or theCompany elects not to apply hedge accounting to such derivative contracts.Please see Note 7 for more details about the Company’s derivative instruments andhedging activities as of March 31, 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.   SFAS157 defines “fair value” as the price that would be received to sell an assetor paid to transfer a liability in the principal or most advantageous market inan orderly transaction between market participants on the measurementdate.  SFAS 157 establishes a three-levelhierarchy for measuring fair value and requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value.

 

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

 

Level 1  – Unadjusted quoted prices in active markets for identical assets orliabilities

 

Level 2 – Unadjustedquoted prices in active markets for similar assets or liabilities; orunadjusted quoted prices for identical or similar assets or liabilities inmarkets that are not active; or inputs other than quoted prices that areobservable for the asset or liability; or inputs that are derived principallyfrom or corroborated by observable market data

 

Level 3  – Unobservable inputs for the asset or liability

 

The Company measurescertain financial assets and liabilities at fair value on a recurring basis,including interest rate swaps.  Althoughthe Company has determined that the majority of the inputs used to value itsinterest rate swaps fall within Level 2 of the valuation hierarchy, the creditvaluation adjustments associated with its interest rate

 

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Sally Holdings LLCand Subsidiaries

##### ***Condensed Notes to ConsolidatedFinancial Statements***

 

swaps utilize Level 3inputs, such as estimates of current credit spreads to assess the likelihood ofdefault by the Company or a counterparty. However, at March 31, 2009, theCompany has assessed the relative significance of such estimates to the overallvaluation of our interest rate swaps and has concluded that the Company’svaluation inputs as a whole predominantly fall in the Level 2 hierarchy. Inaccordance with SFAS 157, the Company categorized certain of its financialassets and liabilities based on priority of the inputs to the valuationtechnique for the instruments, as follows (in thousands):

 
| ** **                         | ** ** | **As of March 31, 2009** | ** ** |
|------------------------------------|------------|-------------------------------|------------|
| ** **                         | ** ** | **Total**                     | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Liabilities                        |       |                          |       |   |   |   |   |   |   |
| Hedged interest rate swaps (1)     |       | $                             | 18,592     |   |   |   | $ | 18,592 |   |   |   |
| Non-hedged interest rate swaps (1) |       | 8,447                         |       |   |   | 8,447 |   |   |   |
| Total                              |       | $                             | 27,039     |   |   |   | $ | 27,039 |   |   |   |

 

----

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

 

In October 2008, theFinancial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”)FAS No. 157-3, *Determining the Fair Valueof a Financial Asset When the Market for That Asset Is Not Active* (“FAS157-3”), which clarifies the application of SFAS 157. FAS 157-3 was effectiveupon issuance and its adoption did not have a material impact on the Company’sfinancial statements.

 

In April 2009, theFASB issued FSP-FAS No. 157-4,  *Determining Fair Value When the Volume and Level of Activity for theAsset or Liability Have Significantly Decreased and Identifying TransactionsThat Are Not Orderly*(“FAS 157-4”). This FSP provides guidance to determining fair values when there is noactive market or where the price inputs available represent distressed salestransactions. As allowed by FAS 157-4, the Company early-adopted the provisionsof FAS 157-4 and its adoption did not have a material effect on the Company’sconsolidated financial position, results of operations or cash flows.

 

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, withearly adoption permitted for periods ending after March 15, 2009. TheCompany’s adoption of FAS No. 107-1/APB 28-1, effective January 1,2009, did not have a material effect on the Company’s consolidated financialposition, results of operations or cash flows.

 

Effective on October 1,2008, the Company also adopted the provisions of SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities- including an amendment of FASB Statement No. 115* (“SFAS159”), which permits entities to choose to measure certain financial assets andliabilities at fair value. The Company elected not to measure at fair value anyadditional assets or liabilities that were not already measured at fair valueprior to such adoption.  As a result, theadoption of SFAS 159 did not have an impact on the Company’s consolidatedfinancial position, results of operations or cash flows.

 

We have not yet adoptedand are currently assessing any potential effect of the pronouncementsdiscussed below on our consolidated financial statements.

 

In June 2008, theEmerging Issues Task Force reached consensus on Emerging Issues Task ForceIssue No. 08-3, *Accounting by Lesseesfor Nonrefundable Maintenance Deposits* (“EITF 08-3”). Under EITF08-3, lessees should account for nonrefundable maintenance deposits as depositassets if it is probable that maintenance activities will occur and the depositis therefore realizable. Amounts on deposit that are not probable of being usedto fund future maintenance activities should be expensed. EITF 08-3 iseffective for fiscal years beginning after December 15, 2008. Earlyapplication is not permitted.

 

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 

 

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Sally Holdings LLCand Subsidiaries

##### ***Condensed Notes to ConsolidatedFinancial Statements***

 

used to determine theuseful life of a recognized intangible asset under SFAS No. 142, *Goodwill and Other Intangible Assets* (“SFAS 142”). Theobjective of the Staff Position is to improve the consistency between theuseful life of a recognized intangible asset under SFAS 142 and the periodof expected cash flows used to measure the fair value of the asset under SFAS No. 141(Revised 2007): *Business Combinations* (“SFAS 141R”)and other GAAP. FAS 142-3 is effective for fiscal years beginning after December 15,2008. Early application is not permitted.

 

In December 2007, the FASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated FinancialStatements, an amendment to ARB No. 51* (“SFAS 160”), whichrequires, among other things, that the noncontrolling interest (previouslyreferred to as minority interest) in a consolidated subsidiary’s equity bereported as a component of equity separate from the parent’s interest and thatnet income or loss attributable to the noncontrolling interest be included inconsolidated net income on the face of the income statement. In addition,purchases and sales of equity interests that do not result in a change incontrol will be accounted for as equity transactions and, upon a loss ofcontrol, the interest sold, as well as any interest retained, will be recordedat fair value with any gain or loss recognized in earnings. SFAS 160 iseffective for fiscal years, and interim periods within those fiscal years,beginning on or after December 15, 2008. Early application is not permitted.

 

In December 2007, the FASB issued SFAS141(Revised 2007), *Business Combinations*(“SFAS 141R”). Among other things, SFAS 141R generally requires that anacquirer recognize the assets acquired and liabilities assumed measured attheir “full fair values” on the acquisition date. This practice replaces thepractice, under predecessor SFAS 141: *Business Combinations,*of allocating the cost of an acquisition to the individual assets acquired andliabilities assumed 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.

 

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 must also be appliedprospectively to business combinations consummated on or after the first annualreporting period beginning 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 March 31,** | ** ** | **Six Months Ended March 31,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                     | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net earnings                                   |       | $                                               | 25,739     |                                          | $          | 13,780 |   | $ | 42,946 |   | $ | 29,126 |   |
| Other comprehensive income (loss) adjustments: |       |                                            |       |                                          |       |   |   |   |   |
| Foreign currency translation adjustments (a)   |       | (7,227                                          | )          | 1,726                                         |       | (39,510 | ) | (2,730 | ) |
| Deferred loss on interest rate swaps (b)       |       | (1,336                                          | )          | —                                        |       | (12,209 | ) | — |   |
| Comprehensive income (loss)                    |       | $                                               | 17,176     |                                          | $          | 15,506 |   | $ | (8,773 | ) | $ | 26,396 |   |

 

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

(b)         Amounts are net of income taxes of $0.7million for the three months ended March 31, 2009 and $7.7 million for thesix months ended March 31, 2009.

 

##### ***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.

 

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Sally Holdings LLCand Subsidiaries

##### ***Condensed Notes to ConsolidatedFinancial Statements***

 

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 inexchange for an award of equity instruments based on the grant-date fair valueof the award and recognizes compensation expense on a straight-line basis overthe vesting period or to the date a participant becomes eligible forretirement, if earlier. During fiscal year 2007, Sally Beauty adopted the  Sally Beauty Holdings 2007 Omnibus IncentivePlan (the “2007 Plan”), a share-based compensation plan which allows for theissuance of up to 10.0 million shares of Sally Beauty’s common stock.

 

Sally Beauty granted approximately 2.7 million and 2.6million stock options to the Company’s employees and consultants during the sixmonths ended March 31, 2009 and 2008, respectively, under the 2007 Plan.Upon issuance of such grants, the Company recognized accelerated share-basedcompensation expense of $2.0 million and $3.1 million in the first quarter offiscal years 2009 and 2008, respectively, in connection with certain retirementeligible employees who are eligible to continue vesting awards upon retirementunder 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  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Share-based compensation expense                               |       | $                                      | 1,424      |                                 | $          | 1,458 |   | $ | 4,892 |   | $ | 6,905 |   |
| Income tax benefit related to share-based compensation expense |       | $                                      | 43         |                                 | $          | 152 |   | $ | 1,365 |   | $ | 2,117 |   |

 

## **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 six months ended March 31, 2009:

 
| ** **                             | ** ** | **Number of  Outstanding  Options (in  Thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  Years)** | ** ** | **Aggregate  Intrinsic  Value (in  Thousands)** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------------------|------------|
| Outstanding at September 30, 2008 |       | 8,138                                               |       | $                                      | 7.99       |                                                            |       |                                            |       |   |
| Granted                                |       | 2,707                                               |       | 5.23                                   |       |                                                            |       |                                            |       |
| Exercised                              |       | (124                                                | )          | 2.00                                   |       |                                                            |       |                                            |       |
| Forfeited or expired                   |       | (322                                                | )          | 8.64                                   |       |                                                            |       |                                            |       |
| Outstanding at March 31, 2009     |       | 10,399                                              |       | $                                      | 7.32       |                                                            | 8.2        |                                            | $          | 5,966 |   |
|                                   |       |                                                |       |                                   |       |                                                            |       |                                            |       |
| Exercisable at March 31, 2009     |       | 3,906                                               |       | $                                      | 6.94       |                                                            | 7.1        |                                            | $          | 4,770 |   |

 

The following table summarizes information about stockoptions held by the Company’s employees and consultants under Sally Beauty’soption plans at March 31, 2009:

 

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Sally Holdings LLCand Subsidiaries

##### ***Condensed Notes to ConsolidatedFinancial Statements***

 
| ** **                      | ** ** | **Options Outstanding**                                           | ** ** | **Options Exercisable**                                          | ** ** |
|---------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| **Range of  Exercise   Prices** | ** ** | **Number  Outstanding   at March 31,  2009 (in  Thousands)** | ** ** | **Weighted  Average  Remaining   Contractual  Term (in  Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable  at March 31,  2009 (in  Thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $2.00                           |       | 1,296                                                             |       | 5.3                                                              |       | $ | 2.00 |   | 1,296 |   | $ | 2.00 |   |
| $4.79 – 9.66               |       | 9,103                                                             |       | 8.6                                                              |       | 8.08 |   | 2,610 |   | 9.40 |   |
| Total                           |       | 10,399                                                            |       | 8.2                                                              |       | $ | 7.32 |   | 3,906 |   | $ | 6.94 |   |

 

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:

 
| ** **              | ** ** | **Six Months Ended March 31,** | ** ** |
|-------------------------|------------|-------------------------------------|------------|
| ** **              | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| Expected lives (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 expect to pay dividends,the dividend yield is 0%.

 

The weighted average fair value of the Sally Beautystock options issued, in the six months ended March 31, 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 six months ended March 31, 2009 was $0.2 million.  Cash proceeds from these option exercises were$0.3 million and the tax benefit realized for the tax deductions from theseoption exercises was $0.1 million.

 

At March 31, 2009, approximately $11.9 million oftotal unrecognized compensation costs related to non-vested stock option awardsare expected to be recognized over the weighted average period of 2.8 years.

 

## **Stock Awards**

##  

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

##### *** ***

As a subsidiary of Sally Beauty, the Company has noemployee stock award plans; however certain employees and consultants of theCompany have been granted restricted stock awards under Sally Beauty’s stockaward plans. A restricted stock award is an award of shares of Sally Beauty’scommon stock (which have full voting rights but are restricted with regards tosale or transfer), the restrictions over which lapse ratably over a specifiedperiod of time (generally 5 years). Restricted stock awards are independent ofstock option grants and are generally subject to forfeiture if employmentterminates prior to these restrictions lapsing, subject to certain retirementprovisions of the 2007 Plan.

 

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Sally Holdings LLCand Subsidiaries

##### ***Condensed Notes to ConsolidatedFinancial Statements***

 

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 awards for the six months ended March 31,2009:

 
| **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 March 31, 2009     |       | 358                                   |       | $                                           | 7.30       |                                                       | 3.8        |   |

 

At March 31, 2009, approximately $2.4 million oftotal unrecognized compensation costs related to non-vested restricted stockawards are expected to be recognized over the weighted average period of 3.8years.

 

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

##### *** ***

The change in the carrying amounts of goodwill by operating segment forthe six months ended March 31, 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 |       | 398                      |       | 221                       |       | 619       |       |
| Foreign currency translation                 |       | (6,944                   | )          | (7,907                    | )          | (14,851   | )          |
| Balance at March 31, 2009               |       | $                        | 58,642     |                      | $          | 352,089   |       | $ | 410,731 |   |

 

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 March 31, 2009 (inthousands):

 
| ** **                                 | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|--------------------------|------------|---------------------------|------------|-----------|------------|
| Balance at March 31, 2009             |       |                     |       |                      |       |      |       |
| Intangible assets with indefinite lives:   |       |                     |       |                      |       |      |       |
| Trade names                                |       | $                        | 18,225     |                      | $          | 33,424    |       | $ | 51,649 |   |
| Other intangibles                          |       | —                   |       | 6,053                     |       | 6,053     |       |
| Total                                      |       | 18,225                   |       | 39,477                    |       | 57,702    |       |
| Intangible assets subject to amortization: |       |                     |       |                      |       |      |       |
| Gross carrying amount                      |       | 6,505                    |       | 35,742                    |       | 42,247    |       |
| Accumulated amortization                   |       | (1,758                   | )          | (19,376                   | )          | (21,134   | )          |
| Net value                                  |       | 4,747                    |       | 16,366                    |       | 21,113    |       |
| Total intangible assets, net               |       | $                        | 22,972     |                      | $          | 55,843    |       | $ | 78,815 |   |

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

Amortization expense was $1.4 million and $1.2 million for the threemonths ended March 31, 2009 and 2008, and $2.9 million and $3.1 millionfor the six months ended March 31, 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. The term loan facilities may be prepaid at our option atany time without premium or penalty and are subject to mandatory prepayment inan amount equal to 50% of excess cash flow (as defined in the agreementgoverning the term loan facilities) for any fiscal year (commencing in fiscalyear 2008) unless a specified leverage ratio is met. In January 2009, theCompany made a mandatory repayment on the term loan facilities in the amount of$16.7 million. Amounts paid pursuant to said provision may be applied, at theoption of the Company, against minimum loan repayments otherwise required overthe twelve month period following any such payment, under the terms of the loanagreement. Additionally, borrowings under the term loan facility would besubject to mandatory prepayment in an amount equal to 100% of the proceeds ofspecified asset sales that are not reinvested in the business or applied torepay borrowings under the ABL facility.

 

The senior notes and seniorsubordinated notes are unsecured obligations of the issuers and are jointly andseverally guaranteed on a senior basis (in the case of the senior notes) and ona senior subordinated basis (in the case of the senior subordinated notes) byeach material domestic subsidiary of the Company. Furthermore, theagreements underlying the Company’s credit facilities contain terms, whichsignificantly restrict the ability of Sally Holdings and its subsidiaries topay dividends or otherwise transfer assets to Sally Beauty. Please see theCompany’s Annual Report on Form 10-K for the fiscal year ended September 30,2008 for additional information about the Company’s long-term debt.

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

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

 
| ** **                   | ** ** | **As of March  31, 2009** | ** ** | **Maturity  dates  (Fiscal  Year)** | ** ** | **Interest Rates**                                    | ** **                                       |
|------------------------------|------------|---------------------------|------------|-------------------------------------|------------|-------------------------------------------------------|--------------------------------------------------|
| ABL facility                 |       | $                         | —     |                                |       |                                                  | (i)   Prime  plus up to 0.50% or; |   |
|                         |       |                      |       |                                |       | (ii)   LIBOR plus (1.00% to 1.50%)     |                                             |
| Term Loan A                  |       | 120,902                   |       | 2013                                |       | (i)   Prime  plus (1.00% to 1.50%) or; |                                             |
|                         |       |                      |       |                                |       | (ii)   LIBOR plus (2.00% to 2.50%)     |                                             |
| Term Loan B                  |       | 892,954                   |       | 2014                                |       | (i)   Prime  plus (1.25% to 1.50%) or; |                                             |
|                         |       |                      |       |                                |       | (ii)   LIBOR plus (2.25% to 2.50%)     |                                             |
| Other (a)                    |       | 2,372                     |       | 2009-2014                           |       | 4.05%  to 7.00%                                       |                                             |
| Total                        |       | $                         | 1,016,228  |                                |       |                                                  |                                             |   |
|                         |       |                      |       |                                |       |                                                  |                                             |
| Senior notes                 |       | $                         | 430,000    |                                | 2015       |                                                  | 9.25%                                            |   |
| Senior subordinated notes    |       | 280,000                   |       | 2017                                |       | 10.50%                                                |                                             |
| Total                        |       | $                         | 710,000    |                                |       |                                                  |                                             |   |
|                         |       |                      |       |                                |       |                                                  |                                             |
| Capitalized leases and other |       | $                         | 552        |                                |       |                                                  |                                             |   |
| Less: current portion        |       | (14,470                   | )          |                                |       |                                                  |                                             |
| Total long-term debt         |       | $                         | 1,712,310  |                                |       |                                                  |                                             |   |

 

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(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                     |       | $          | 2,200      |   |
| 2010                     |       | 24,781     |       |
| 2011                     |       | 39,617     |       |
| 2012                     |       | 84,503     |       |
| 2013                     |       | 9,380      |       |
| Thereafter               |       | 1,565,747  |       |
|                     |       | $          | 1,726,228  |   |
| Capital leases and other |       | 552        |       |
| Less: current portion    |       | (14,470    | )          |
| Total                    |       | $          | 1,712,310  |   |

 

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 governing our debt contain materiallimitations on our and our subsidiaries’ ability to pay dividends and otherrestricted payments to our indirect 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 March 31, 2009, ourconsolidated interest coverage ratio exceeded 2.0 to 1.0.  Further, the aggregate amount of restrictedpayments we are able to make is limited pursuant to various baskets ascalculated pursuant to the credit agreement and indentures.

 

The agreements governing our ABL facility generally permit the makingof distributions and certain other restricted payments so long as 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 

 

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Table of Contents

 

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

since the date of the Separation Transactions, together with theaggregate cash amount paid in acquisitions since said date, of not greater than$50.0 million, together with certain other exceptions.  As of March 31, 2009, borrowingavailability under the ABL facility exceeded $60.0 million.  As of March 31, 2009, the net assets ofus and our consolidated subsidiaries that were unrestricted from transfer underour credit arrangements totaled $201.6 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 Sally Holdings, by the use ofinterest rate swaps.  The Company usesinterest rate swaps, as part of its overall economic risk management strategyto add stability to the interest payments due in connection with its term loanobligations. Interest payments related to the term loans are impacted bychanges in LIBOR. Interest rate swap agreements involve the periodic receipt bythe Company of amounts based on a variable rate in exchange for the Companymaking payments based on a fixed rate over the term of the interest rate swapagreements without exchange of the underlying notional amount. At March 31,2009, the Company did not purchase or hold any other derivative instruments orhold any derivative 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 anaggregate notionalamount of $300 million. These interest rate swap agreements are designated and qualify aseffective cash flow hedges, in accordance with SFAS 133.  Accordingly, changes in the fair value ofderivatives designated and qualifying as cash flow hedges are recorded quarterly,net of income tax, in accumulated other comprehensive (loss) income (“OCI”)until the hedged obligation is settled or the swap agreements expire, whicheveris earlier. Any hedge ineffectiveness, as this term is used in SFAS 133, isrecognized in net interest expense in our consolidated statements of earnings.No hedge ineffectiveness on cash flow hedges was recognized during the three orsix month periods ended March 31, 2009. Please see the Company’s AnnualReport on 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 six month periods ended March 31, 2009, netinterest expense of $2.3 million and $3.0 million, respectively, resulted fromsuch reclassifications.  During thetwelve months ending March 31, 2010, the Company estimates that anadditional $7.5 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. Inconnection with the Separation Transactions, effective November 2006, theCompany entered into four interest rate swap agreements with an aggregatenotional amount of $500 million. Interest rate swap agreements with an aggregatenotional amount of $150 million expired in November 2008 and interest rateswap agreements with a notional amount of $350 million expire in November 2009.These interest rate swap agreements are not designated as hedges and,accordingly, the changes in fair value of these interest rate swap agreements(which are adjusted quarterly) are recorded in net interest expense in ourstatements of earnings. Please see the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2008 for additional informationabout the Company’s interest rate swap agreements.

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes 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 March 31, 2009 (inthousands):

 

**Tabular Disclosure of Fair Values of DerivativeInstruments**

 
| ** **                                                              | ** ** | **Asset Derivatives**         | ** ** | **Liability Derivatives**     | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                              | ** ** | **As of March 31, 2009** | ** ** | **As of March 31, 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 | ** ** | $ | 18,592 | (1) |
| Total derivatives designated as hedging instruments under SFAS 133      |       |                          |       | $                             | —     |   |   |   | $ | 18,592 |   |
|                                                                    |       |                          |       |                          |       |   |   |   |   |
| Derivatives not designated as hedging instruments under SFAS 133:       |       |                          |       |                          |       |
| Interest Rate Swaps                                                     |       | Prepaid expenses              |       | $                             | —     |   | Accrued expenses |   | $ | 8,447 |   |
| Total derivatives not designated as hedging instruments under SFAS  133 |       |                          |       | $                             | —     |   |   |   | $ | 8,447 |   |

 

----

(1)          At March 31, 2009, the Company estimates thatapproximately $7.5 million of the fair value of these derivative financialinstruments will settle within the twelve months ending March 31, 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 Derivative Instruments**

 
| ** **                                                              | ** ** | **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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Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

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

 

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

**Three Months Ended March 31, 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                                           |       | $                                                                                                    | (1,336     | )                                                                                                    | Interest  expense, net |                                                                                                   | $          | (2,345                                                                                                                                       | )          | 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                                               |       | $                                                                   | (541       | ) |
|                                                                        |            |                                                                      |            |                                                                     |            |  |

 

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

**Six Months Ended March 31, 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                                           |       | $                                                                                                    | (12,209    | )                                                                                                    | Interest  expense, net |                                                                                                   | $          | (3,013                                                                                                                                         | )          | 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                                               |       | $                                                                   | (6,187     | ) |
|                                                                        |            |                                                                      |            |                                                                     |            |  |

 

**Credit-risk-related ContingentFeatures**

 

The agreements governing the Company’s interest rateswaps contain provisions pursuant to which the Company could be declared indefault on its interest rate swap obligations in the event the Companydefaulted under certain terms of the loan documents governing the Company’s ABLfacility. As of March 31, 2009, the fair value of interest rate swaps in aliability position related to these agreements was $27.0 million. As of March 31,2009, the Company was under no obligation to post and had not posted anycollateral related to these agreements. If the Company breached any of theseprovisions, it would be required to settle its obligations under the agreementsat their termination value of $29.6 million, including accrued interest andother termination costs.

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

Thecounterparties to all 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 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 our interestrate swaps, we could incur substantial financial losses. However, at thepresent 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 March 31,2009, 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 offersprofessional beauty supplies to both salon professionals and retail customersand (ii) BSG, including its franchise-based business Armstrong McCall, afull service beauty supply distributor which offers professional brands ofbeauty products directly to salons through its own sales force and professionalonly stores (including franchise stores) in generally exclusive geographical territories inNorth America and parts of Europe.

 

Sales between segments, which were eliminated in consolidation, werenot material during any of the periods ended March 31, 2009 and 2008.  Segment data for the three and six monthsended March 31, 2009 and 2008 is as follows 

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

(in thousands):

 
| ** **                                  | ** ** | **Three months ended  March 31,** | ** ** | **Six months ended  March 31,** | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
|                                        | ** ** | **2009**                               | ** ** | **2008(2)**                          | ** ** | **2009** | ** ** | **2008(2)** | ** ** |
| Net sales:                                  |       |                                   |       |                                 |       |   |   |   |   |
| Sally Beauty Supply                         |       | $                                      | 412,338    |                                 | $          | 406,065 |   | $ | 822,875 |   | $ | 815,629 |   |
| BSG                                         |       | 229,173                                |       | 237,281                              |       | 464,212 |   | 483,504 |   |
| Total net sales                             |       | $                                      | 641,511    |                                 | $          | 643,346 |   | $ | 1,287,087 |   | $ | 1,299,133 |   |
| Earnings before provision for income taxes: |       |                                   |       |                                 |       |   |   |   |   |
| Segment operating profit:                   |       |                                   |       |                                 |       |   |   |   |   |
| Sally Beauty Supply                         |       | $                                      | 70,379     |                                 | $          | 67,911 |   | $ | 135,665 |   | $ | 139,644 |   |
| BSG                                         |       | 20,359                                 |       | 17,942                               |       | 40,595 |   | 38,972 |   |
| Total segment operating profit              |       | 90,738                                 |       | 85,853                               |       | 176,260 |   | 178,616 |   |
| Unallocated corporate expenses (1)          |       | (15,147                                | )          | (16,609                              | )          | (28,941 | ) | (32,403 | ) |
| Share-based compensation expense            |       | (1,424                                 | )          | (1,458                               | )          | (4,892 | ) | (6,905 | ) |
| Interest expense, net of interest income    |       | (31,958                                | )          | (47,642                              | )          | (71,631 | ) | (94,125 | ) |
| Earnings before provision for income taxes  |       | $                                      | 42,209     |                                 | $          | 20,144 |   | $ | 70,796 |   | $ | 45,183 |   |

 

----

(1)     Unallocated expenses consistof corporate and shared costs.

(2)     Certain amounts for priorperiods have been 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 March 31,2009 and September 30, 2008, the Condensed Consolidated Statements ofEarnings for the three and six months ended March 31, 2009 and 2008, andthe Condensed Consolidated Statements of Cash Flows for the three and sixmonths ended March 31, 2009 and 2008 of: (i) Sally Holdings LLC, or “theParent;” (ii) the guarantor subsidiaries; (iii) the non-guarantorsubsidiaries; (iv) elimination entries necessary to consolidate the Parentwith the guarantor and non-guarantor subsidiaries; and (v) the Parent on aconsolidated basis.

 

Investments in subsidiaries are accounted for using theequity 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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Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Condensed Consolidating Balance Sheet

March 31, 2009

(In thousands)

(Unaudited)

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings  LLC &  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|----------------------------------|------------|------------------|------------|---------------------------------------------------|------------|
| **Assets**                                                                  |       |       |       |                        |       |                             |       |             |       |                                              |       |
| Cash and cash equivalents                                                   |       | $          | 19         |                        | $          | 88,901                           |       | $                | 15,758     |                                              | $          | — |   | $ | 104,678 |   |
| Trade accounts and other receivables, less allowance for doubtful  accounts |       | —     |       | 51,518                      |       | 15,451                           |       | —           |       | 66,969                                            |       |
| Due from affiliates                                                         |       | —     |       | 116,359                     |       | 4,180                            |       | (120,539         | )          | —                                            |       |
| Inventories                                                                 |       | —     |       | 429,238                     |       | 109,578                          |       | —           |       | 538,816                                           |       |
| Prepaid expenses                                                            |       | 151        |       | 8,931                       |       | 7,177                            |       | —           |       | 16,259                                            |       |
| Deferred income tax assets                                                  |       | 2,968      |       | 21,251                      |       | (3,348                           | )          | —           |       | 20,871                                            |       |
| Property and equipment, net                                                 |       | —     |       | 116,301                     |       | 30,309                           |       | —           |       | 146,610                                           |       |
| Investment in subsidiaries                                                  |       | 1,108,872  |       | 232,784                     |       | —                           |       | (1,341,656       | )          | —                                            |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | 369,097                     |       | 120,449                          |       | —           |       | 489,546                                           |       |
| Other assets                                                                |       | 38,531     |       | 1,309                       |       | 7,731                            |       | —           |       | 47,571                                            |       |
| Total assets                                                                |       | $          | 1,150,541  |                        | $          | 1,435,689                        |       | $                | 307,285    |                                              | $          | (1,462,195 | ) | $ | 1,431,320 |   |
|                                                                        |       |       |       |                        |       |                             |       |             |       |                                              |       |
| **Liabilities and Member’s (Deficit) Equity**                          |       |       |       |                        |       |                             |       |             |       |                                              |       |
| Accounts payable                                                            |       | $          | —     |                        | $          | 149,408                          |       | $                | 36,321     |                                              | $          | — |   | $ | 185,729 |   |
| Due to affiliates                                                           |       | 101,500    |       | 4,180                       |       | 14,859                           |       | (120,539         | )          | —                                            |       |
| Accrued expenses                                                            |       | 37,084     |       | 90,961                      |       | 18,800                           |       | —           |       | 146,845                                           |       |
| Due to Sally Beauty                                                         |       | —     |       | 27,891                      |       | —                           |       | —           |       | 27,891                                            |       |
| Income taxes                                                                |       | 5,727      |       | 468                         |       | (1,413                           | )          | —           |       | 4,782                                             |       |
| Long-term debt                                                              |       | 1,723,855  |       | 272                         |       | 2,653                            |       | —           |       | 1,726,780                                         |       |
| Other liabilities                                                           |       | 18,593     |       | 16,431                      |       | 1,099                            |       | —           |       | 36,123                                            |       |
| Deferred income tax liabilities                                             |       | (10,788    | )          | 37,206                      |       | 2,182                            |       | —           |       | 28,600                                            |       |
| Total liabilities                                                           |       | 1,875,971  |       | 326,817                     |       | 74,501                           |       | (120,539         | )          | 2,156,750                                         |       |
| Stock options subject to redemption                                         |       | 5,623      |       | —                      |       | —                           |       | —           |       | 5,623                                             |       |
| Total member’s (deficit) equity                                        |       | (731,053   | )          | 1,108,872                   |       | 232,784                          |       | (1,341,656       | )          | (731,053                                          | )          |
| Total liabilities and member’s (deficit) equity                        |       | $          | 1,150,541  |                        | $          | 1,435,689                        |       | $                | 307,285    |                                              | $          | (1,462,195 | ) | $ | 1,431,320 |   |

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes 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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Table ofContents

 

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of EarningsThree months ended March 31, 2009

(In thousands)

(Unaudited)

** **
| ** **                                          | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings LLC** | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **& Subsidiaries**  | ** ** |
| ** **                                          | ** ** | ** ** | ** ** | ** **       | ** ** | ** **          | ** ** | ** **       | ** ** | ** **              | ** ** |
| Net sales                                           |       | $          | —     |             | $          | 538,932             |       | $                | 102,579    |                    | $          | — |   | $ | 641,511 |   |
| Related party sales                                 |       | —     |       | 663              |       |                |       | (663             | )          |                    |       |
| Cost of products sold and distribution expenses     |       | —     |       | 282,300          |       | 57,762              |       | (663             | )          | 339,399                 |       |
| Gross profit                                        |       | —     |       | 257,295          |       | 44,817              |       | —           |       | 302,112                 |       |
| Selling, general and administrative expenses        |       | 134        |       | 172,761          |       | 43,579              |       | —           |       | 216,474                 |       |
| Depreciation and amortization                       |       |       |       | 8,697            |       | 2,774               |       | —           |       | 11,471                  |       |
| Operating earnings (loss)                           |       | (134       | )          | 75,837           |       | (1,536              | )          |             |       | 74,167                  |       |
| Interest income                                     |       |       |       | (49              | )          | (7                  | )          | —           |       | (56                     | )          |
| Interest expense                                    |       | 31,865     |       | 85               |       | 64                  |       | —           |       | 32,014                  |       |
| Earnings (losses) before provision for income taxes |       | (31,999    | )          | 75,801           |       | (1,593              | )          |             |       | 42,209                  |       |
| Provision (benefit) for income taxes                |       | (13,417    | )          | 31,670           |       | (1,783              | )          | —           |       | 16,470                  |       |
| Equity in earnings of subsidiaries (net of tax)     |       | 44,321     |       | 190              |       | —              |       | (44,511          | )          | —                  |       |
| Net earnings                                        |       | $          | 25,739     |             | $          | 44,321              |       | $                | 190        |                    | $          | (44,511 | ) | $ | 25,739 |   |

 

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Table ofContents

 

Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of EarningsThree months ended March 31, 2008

(In thousands)

(Unaudited)

** **
| ** **                                          | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings LLC** | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **& Subsidiaries**  | ** ** |
| ** **                                          | ** ** | ** ** | ** ** | ** **       | ** ** | ** **          | ** ** | ** **       | ** ** | ** **              | ** ** |
| Net sales                                           |       | $          | —     |             | $          | 529,707             |       | $                | 113,639    |                    | $          | — |   | $ | 643,346 |   |
| Related party sales                                 |       | —     |       | 645              |       | —              |       | (645             | )          | —                  |       |
| Cost of products sold and distribution expenses     |       | —     |       | 283,796          |       | 61,771              |       | (645             | )          | 344,922                 |       |
| Gross profit                                        |       | —     |       | 246,556          |       | 51,868              |       |             |       | 298,424                 |       |
| Selling, general and administrative expenses        |       | 153        |       | 174,926          |       | 43,738              |       |             |       | 218,817                 |       |
| Depreciation and amortization                       |       | —     |       | 8,577            |       | 3,244               |       |             |       | 11,821                  |       |
| Operating earnings (loss)                           |       | (153       | )          | 63,053           |       | 4,886               |       |             |       | 67,786                  |       |
| Interest income                                     |       | —     |       | (21              | )          | (180                | )          |             |       | (201                    | )          |
| Interest expense                                    |       | 47,693     |       | 100              |       | 50                  |       |             |       | 47,843                  |       |
| Earnings (losses) before provision for income taxes |       | (47,846    | )          | 62,974           |       | 5,016               |       |             |       | 20,144                  |       |
| Provision (benefit) for income taxes                |       | (18,693    | )          | 24,065           |       | 992                 |       |             |       | 6,364                   |       |
| Equity in earnings of subsidiaries (net of tax)     |       | 42,933     |       | 4,024            |       | —              |       | (46,957          | )          | —                  |       |
| Net earnings                                        |       | $          | 13,780     |             | $          | 42,933              |       | $                | 4,024      |                    | $          | (46,957 | ) | $ | 13,780 |   |

 

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Table of Contents

 

Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

**SALLY HOLDINGSLLC AND SUBSIDIARIES**

CondensedConsolidating Statement of Earnings

Six months ended March 31,2009

(In thousands)

(Unaudited)

** **
| ** **                                          | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings LLC** | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **& Subsidiaries**  | ** ** |
| ** **                                          | ** ** | ** ** | ** ** | ** **       | ** ** | ** **          | ** ** | ** **       | ** ** | ** **              | ** ** |
| Net sales                                           |       | $          | —     |             | $          | 1,065,376           |       | $                | 221,711    |                    | $          | — |   | $ | 1,287,087 |   |
| Related party sales                                 |       | —     |       | 1,440            |       | —              |       | (1,440           | )          | —                  |       |
| Cost of products sold and distribution expenses     |       | —     |       | 557,856          |       | 125,015             |       | (1,440           | )          | 681,431                 |       |
| Gross profit                                        |       | —     |       | 508,960          |       | 96,696              |       |             |       | 605,656                 |       |
| Selling, general and administrative expenses        |       | 343        |       | 349,414          |       | 90,254              |       |             |       | 440,011                 |       |
| Depreciation and amortization                       |       |       |       | 17,736           |       | 5,482               |       |             |       | 23,218                  |       |
| Operating earnings (loss)                           |       | (343       | )          | 141,810          |       | 960                 |       |             |       | 142,427                 |       |
| Interest income                                     |       | —     |       | (111             | )          | (93                 | )          |             |       | (204                    | )          |
| Interest expense                                    |       | 71,512     |       | 153              |       | 170                 |       |             |       | 71,835                  |       |
| Earnings (losses) before provision for income taxes |       | (71,855    | )          | 141,768          |       | 883                 |       |             |       | 70,796                  |       |
| Provision (benefit) for income taxes                |       | (30,146    | )          | 59,201           |       | (1,205              | )          |             |       | 27,850                  |       |
| Equity in earnings of subsidiaries (net of tax)     |       | 84,655     |       | 2,088            |       | —              |       | (86,743          | )          | —                  |       |
| Net earnings                                        |       | $          | 42,946     |             | $          | 84,655              |       | $                | 2,088      |                    | $          | (86,743 | ) | $ | 42,946 |   |

 

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Table ofContents

 

Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Statement of Earnings

Six months ended March 31,2008

(In thousands)

(Unaudited)

** **
| ** **                                        | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings LLC** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **& Subsidiaries**  | ** ** |
|                                              | ** ** | ** ** | ** ** | ** **       | ** ** | ** **          | ** ** | ** **       | ** ** | ** **              | ** ** |
| Net sales                                         |       | $          | —     |             | $          | 1,054,438           |       | $                | 244,695    |                    | $          | — |   | $ | 1,299,133 |   |
| Related party sales                               |       | —     |       | 1,417            |       | —              |       | (1,417           | )          | —                  |       |
| Cost of products sold and distribution expenses   |       | —     |       | 561,621          |       | 134,336             |       | (1,417           | )          | 694,540                 |       |
| Gross profit                                      |       | —     |       | 494,234          |       | 110,359             |       |             |       | 604,593                 |       |
| Selling, general and administrative expenses      |       | 388        |       | 352,537          |       | 88,787              |       |             |       | 441,712                 |       |
| Depreciation and amortization                     |       |       |       | 17,336           |       | 6,237               |       |             |       | 23,573                  |       |
| Operating earnings (loss)                         |       | (388       | )          | 124,361          |       | 15,335              |       |             |       | 139,308                 |       |
| Interest income                                   |       | —     |       | (35              | )          | (386                | )          |             |       | (421                    | )          |
| Interest expense                                  |       | 94,285     |       | 208              |       | 53                  |       |             |       | 94,546                  |       |
| Earnings (loss) before provision for income taxes |       | (94,673    | )          | 124,188          |       | 15,668              |       |             |       | 45,183                  |       |
| Provision (benefit) for income taxes              |       | (36,987    | )          | 48,313           |       | 4,731               |       |             |       | 16,057                  |       |
| Equity in earnings of subsidiaries (net of tax)   |       | 86,812     |       | 10,937           |       | —              |       | (97,749          | )          | —                  |       |
| Net earnings                                      |       | $          | 29,126     |             | $          | 86,812              |       | $                | 10,937     |                    | $          | (97,749 | ) | $ | 29,126 |   |

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidating Statement of Cash Flows

Six months ended March 31,2009

(In thousands)

(Unaudited)

 
| ** **                                                                 | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally Holdings LLC** | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------------|------------|
| ** **                                                                 | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **& Subsidiaries** | ** ** |
| **Net cash provided by operating activities**                              |       | $          | 97,753     |             | $          | 16,966              |       | $                | 9,865      |                   | $          | — |   | $ | 124,584 |   |
| ** **                                                                 |       |       |       |             |       |                |       |             |       |                   |       |
| **Cash Flows from Investing Activities:**                                  |       |       |       |             |       |                |       |             |       |                   |       |
| ** **                                                                 |       |       |       |             |       |                |       |             |       |                   |       |
| Capital expenditures, net of proceeds from sale of property and  equipment |       | —     |       | (11,829          | )          | (4,894              | )          | —           |       | (16,723                | )          |
| Acquisitions, net of cash acquired                                         |       | —     |       | (1,280           | )          | (707                | )          | —           |       | (1,987                 | )          |
|                                                                       |       |       |       |             |       |                |       |             |       |                   |       |
| Net cash used by investing activities                                      |       | —     |       | (13,109          | )          | (5,601              | )          | —           |       | (18,710                | )          |
|                                                                       |       |       |       |             |       |                |       |             |       |                   |       |
| **Cash Flows from Financing Activities:**                                  |       |       |       |             |       |                |       |             |       |                   |       |
| ** **                                                                 |       |       |       |             |       |                |       |             |       |                   |       |
| Change in book cash overdraft                                              |       | (1,633     | )          | —           |       | —              |       | —           |       | (1,633                 | )          |
| Proceeds from issuance of long-term debt                                   |       | 94,639     |       | —           |       | —              |       | —           |       | 94,639                 |       |
| Repayments of long-term debt                                               |       | (192,385   | )          | (114             | )          | (496                | )          | —           |       | (192,995               | )          |
| Excess tax provision from share-based compensation                         |       | —     |       | (226             | )          | —              |       | —           |       | (226                   | )          |
|                                                                       |       |       |       |             |       |                |       |             |       |                   |       |
| Net cash used by financing activities                                      |       | (99,379    | )          | (340             | )          | (496                | )          | —           |       | (100,215               | )          |
|                                                                       |       |       |       |             |       |                |       |             |       |                   |       |
| Effect of foreign exchange rate changes on cash and cash equivalents       |       | —     |       | —           |       | (769                | )          | —           |       | (769                   | )          |
|                                                                       |       |       |       |             |       |                |       |             |       |                   |       |
| Net (decrease) increase in cash and cash equivalents                       |       | (1,626     | )          | 3,517            |       | 2,999               |       | —           |       | 4,890                  |       |
|                                                                       |       |       |       |             |       |                |       |             |       |                   |       |
| Cash and cash equivalents, beginning of period                             |       | 1,645      |       | 85,384           |       | 12,759              |       | —           |       | 99,788                 |       |
|                                                                       |       |       |       |             |       |                |       |             |       |                   |       |
| Cash and cash equivalents, end of period                                   |       | $          | 19         |             | $          | 88,901              |       | $                | 15,758     |                   | $          | — |   | $ | 104,678 |   |

 

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Sally Holdings LLCand Subsidiaries

Condensed Notes toConsolidated Financial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

CondensedConsolidated Statement of Cash Flows

Six months ended March 31,2008

(In thousands)

(Unaudited)

 
| ** **                                                            | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | ** **       | ** ** | **Sally Holdings, LLC** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|------------------|------------|-------------------|------------|------------------|------------|-------------------------|------------|
| ** **                                                            | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations** | ** ** | **& Subsidiaries**  | ** ** |
| **Net cash (used) provided by operating activities**                  |       | $          | (22,338    | )                | $          | 57,400            |       | $                | (14,443    | )                       | $          | — |   | $ | 20,619 |   |
| ** **                                                            |       |       |       |             |       |              |       |             |       |                    |       |
| **Cash Flows from Investing Activities:**                             |       |       |       |             |       |              |       |             |       |                    |       |
| ** **                                                            |       |       |       |             |       |              |       |             |       |                    |       |
| Capital expenditures and proceeds from sale of property and equipment |       | —     |       | (20,639          | )          | (4,898            | )          | —           |       | (25,537                 | )          |
| Acquisitions, net of cash acquired                                    |       | —     |       | (14,874          | )          | (2,571            | )          | —           |       | (17,445                 | )          |
| Net cash used by investing activities                                 |       | —     |       | (35,513          | )          | (7,469            | )          | —           |       | (42,982                 | )          |
|                                                                  |       |       |       |             |       |              |       |             |       |                    |       |
| **Cash Flows from Financing Activities:**                             |       |       |       |             |       |              |       |             |       |                    |       |
| ** **                                                            |       |       |       |             |       |              |       |             |       |                    |       |
| Change in book cash overdraft                                         |       | —     |       | —           |       | —            |       | —           |       | —                  |       |
| Proceeds from issuance of long-term debt                              |       | 232,564    |       | —           |       | 11,671            |       | —           |       | 244,235                 |       |
| Repayments of long-term debt                                          |       | (229,738   | )          | —           |       | (263              | )          | —           |       | (230,001                | )          |
| Excess tax benefit from share-based compensation                      |       | —     |       | 264              |       | —            |       | —           |       | 264                     |       |
|                                                                  |       |       |       |             |       |              |       |             |       |                    |       |
| Distributions received (paid)                                         |       | 19,519     |       | (19,519          | )          | —            |       | —           |       | —                  |       |
|                                                                  |       |       |       |             |       |              |       |             |       |                    |       |
| Net cash provided (used) by financing activities                      |       | 22,345     |       | (19,255          | )          | 11,408            |       | —           |       | 14,498                  |       |
|                                                                  |       |       |       |             |       |              |       |             |       |                    |       |
| Effect of foreign exchange rate changes on cash and cash equivalents  |       | —     |       | —           |       | 1,013             |       | —           |       | 1,013                   |       |
|                                                                  |       |       |       |             |       |              |       |             |       |                    |       |
| Net (decrease) increase in cash and cash equivalents                  |       | 7          |       | 2,632            |       | (9,491            | )          | —           |       | (6,852                  | )          |
|                                                                  |       |       |       |             |       |              |       |             |       |                    |       |
| Cash and cash equivalents, beginning of period                        |       | 7          |       | 9,316            |       | 28,949            |       | —           |       | 38,272                  |       |
|                                                                  |       |       |       |             |       |              |       |             |       |                    |       |
| Cash and cash equivalents, end of period                              |       | $          | 14         |             | $          | 11,948            |       | $                | 19,458     |                    | $          | — |   | $ | 31,420 |   |

 

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# **Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

# ** **

The following sectiondiscusses management’s view of the financial condition, results of operationsand cash flows of Sally Holdings LLC, a wholly-owned subsidiary of SallyInvestment Holdings LLC, or Sally Investment, a wholly-owned subsidiary ofSally Beauty Holdings, Inc., or SallyBeauty, and its consolidated subsidiaries.All of the interests of Sally Holdings are beneficially owned by SallyInvestment, and all of the interests of Sally Investment are beneficially ownedby 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 financial statements and condensed notes to those statements. ThisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contains forward-looking statements. See “Cautionary NoticeRegarding 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.

 

**Highlights For the First Six Months of Fiscal Year 2009:**

 

·                  Oursame store sales increased by 1.1% for the six months ended March 31, 2009(while increasing 2.1 % for the three months ended March 31, 2009);

·                  Ourconsolidated net sales for the six months ended March 31, 2009, decreasedby $12.0 million, or 0.9%, to $1,287.1 million compared to $1,299.1 million forthe six months ended March 31, 2008;

·                  Netsales reported for the six months ended March 31, 2009, reflectapproximately $50.9 million, or 3.9%, in negative impact from changes inforeign exchange rates;

·                  Ourconsolidated gross profit for the six months ended March 31, 2009,increased $1.1 million, or 0.2%, to $605.7 million compared to $604.6 millionfor the six months ended March 31, 2008. As a percentage of net sales,gross profit increased 52 basis points to 47.1% for the six months ended March 31,2009, compared to 46.5% for the six months ended March 31, 2008;

·                  Ourconsolidated operating earnings for the six months ended March 31, 2009,increased $3.1 million, or 2.2%, to $142.4 million compared to $139.3 millionfor the six months ended March 31, 2008. As a percentage of net sales, operating earnings increased to 11.1% forthe six months ended March 31, 2009, compared to 10.7% for the six monthsended March 31, 2008;

·                  Netearnings increased $13.8 million, or 47.4%, to $42.9 million for the six monthsended March 31, 2009, compared to $29.1 million for the six months ended March 31,2008; and

·                  Cashprovided by operations increased by $104.0 million to $124.6 millionfor the six months ended March 31, 2009, compared to $20.6 millionfor the six months ended March 31, 2008.

 

**Overview**

 

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

##### *** ***

We arethe largest distributor of professional beauty supplies in the U.S. based onstore count. We operate primarily through two business units, Sally BeautySupply and BSG. Through Sally Beauty Supply and BSG (which operates storesunder the CosmoProf service mark), we operated a multi-channel platform of3,618 stores and supplied 189 franchised stores in North America, as well as incertain European countries and Japan, as of March 31, 2009. Within BSG, wealso have one of the largest networks of professional distributor salesconsultants in North America, with approximately 961 professional distributorsales consultants who sell directly to salons and salon professionals.  We provide our customers with a wide varietyof leading third-party branded and exclusive-label professional beautysupplies, including hair care products, styling appliances, skin and nail care productsand other beauty items. Sally Beauty Supply stores target retail consumers andsalon professionals, while BSG exclusively targets salons and salonprofessionals. For the six months ended March 31, 2009, our net sales andoperating earnings were $1,287.1 million and $142.4 million,respectively.

 

Webelieve that Sally Beauty Supply is the largest open-line distributor ofprofessional beauty supplies in the U.S. based on store count. As of March 31,2009, Sally Beauty Supply operated 2,847 company-operated retail stores andsupplied 26 franchised stores (all located outside the U.S.). Of these stores,2,325 are located in the U.S. (with the remainder in the United Kingdom andcertain other countries in Europe, Canada, Puerto Rico, Mexico and Japan). SallyBeauty Supply stores average 1,700 square feet and are primarilylocated in strip shopping centers. The 

 

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productselection in Sally Beauty Supply stores ranges between 5,000 and 8,000 SKUs ofbeauty products and includes products for hair care, skin and nail care, beautysundries and electrical appliances targeting retail consumers and salonprofessionals. Sally Beauty Supply stores carry leading third-party brands suchas Clairol, Revlon and Conair, as well as an extensive selection ofexclusive-label merchandise.

 

Webelieve that BSG is the largest full-service distributor of professional beautysupplies in the U.S. As of March 31, 2009, BSG had771 company-operated stores, supplied 163 franchised stores and had asales force of approximately 961 professional distributor sales consultantsselling exclusively to salons and salon professionals in substantially allstates in the U.S. and in portions of Canada, Mexico and certain Europeancountries. BSG stores average 2,700 square feet and are primarilylocated in secondary strip shopping centers. Through BSG’s large store base andsales force, BSG is able to access a significant portion of the highlyfragmented U.S. salon channel. The product selection in BSG stores,ranging between 4,000 and 9,600 SKUs of beauty products, includes hair care andcolor, skin and nail care, beauty sundries and electrical appliances targetingsalons and salon professionals. BSG carries leading professional beauty productbrands intended for use in salons and for resale by the salon to consumers.Certain BSG products are sold under exclusive distribution agreements withsuppliers, whereby BSG is designated as the sole distributor for a product linewithin certain geographic territories.

 

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

##### *** ***

Weoperate within the large and growing U.S. professional beauty supplyindustry. Potential growth in the industry is expected to be driven byincreases in hair color, hair loss prevention and hair styling products, offsetby lower sales of electrical products during periods of prolonged economicslowdown. We believe the following key industry and business trends and characteristicswill influence our business and our financial 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 uponmanufacturers who may be unable to provide products of adequate quality or whomay be unwilling to continue to supply products to us” in Item 1A of our AnnualReport on Form 10-K for the fiscal year ended September 30, 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.

 

·             *International GrowthStrategies. *A key element of our growth strategy dependson our ability to capitalize on growth in the international marketplace and togrow our current level of non-U.S. operations. 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 

 

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Limited, a private company based in Scotland with almost 100 storeslocated in the United Kingdom, Ireland, Germany, France and Spain, which werefer to as Salon Services.  Theseacquisitions furthered our expansion plans in Europe, a significant part ofSally Beauty Supply’s international growth initiative.  We intend to continue to identify andevaluate non-U.S. acquisition targets and are actively considering expansioninto South America.  Our ability to growour non-U.S. operations, integrate our new non-U.S. acquisitions andsuccessfully pursue additional non-U.S. acquisitions may be affected bybusiness, legal, regulatory and economic risks. Please see “Risk Factors - Wemay not be able to successfully identify acquisition candidates and completedesirable acquisitions,” “If we acquire any businesses in the future they couldprove difficult to integrate, disrupt our business or have an adverse effect onour results of operations” and “Our ability to conduct business ininternational marketplaces may be affected by legal, regulatory and economicrisks” in Item 1A of our Annual Report on Form 10-K for the fiscal yearended September 30, 2008.

 

·             *Continuing consolidation.*  There is continuing consolidation among professional beautyproduct distributors and professional beauty product manufacturers. We plan tocontinue to examine ways in which we can benefit from this trend, includingreviewing opportunities to shift business from competitive distributors to theBSG network as well as seeking opportunistic, value-added acquisitions whichcomplement our long-term growth strategy. We believe that suppliers areincreasingly likely to focus on larger distributors and retailers with abroader scale and retail footprint. We also believe that we are well positionedto capitalize on this trend as well as participate in the ongoing consolidationat the distributor/retail level. However, changes often occur in ourrelationships with suppliers that may materially affect the net sales andoperating earnings of our business segments. Consolidation among supplierscould exacerbate the effects of these relationship changes and could increasepricing pressures. For example, as we announced in December 2006, ourlargest supplier, L’Oreal, moved a material amount of revenue out of the BSGnationwide distribution network and into competitive regional distributionnetworks. More recently, L’Oreal acquired distributors competing with BSG inthe southeastern and west coast of the U.S. and a supplier that does notcurrently do business with BSG.  As a result, L’Oreal directly competeswith BSG in certain geographic areas. If L’Oreal acquired other distributors orsuppliers that conduct significant business with BSG we could lose relatedrevenue. There can be no assurance that there will not be further loss ofrevenue over time by BSG (including within its franchise-based business) due topotential losses of additional products (both from L’Oreal and from othersuppliers) as well as from the increased competition from L’Oreal-affiliateddistribution networks. Please see “Relationships with Suppliers” and “RiskFactors - The beauty products distribution industry is highly competitive andis consolidating” and “We depend upon manufacturers who may be unable toprovide products of adequate quality or who may be unwilling to continue tosupply products to us” in Item 1A of our Annual Report on Form 10-K forthe fiscal year ended September 30, 2008.

 

·             *High level of competition.*  Sally Beauty Supply competes with other domestic andinternational beauty product wholesale and retail outlets, including local andregional open-line beauty supply stores, professional-only beauty supplystores, salons, mass merchandisers, drug stores and supermarkets, as well assellers on the Internet and salons retailing hair care items. BSG competes withother domestic and international beauty product wholesale and retail suppliersand manufacturers selling professional beauty products directly to salons andindividual salon professionals. We also face competition from authorized andunauthorized retailers and internet sites offering professional salon-onlyproducts. The increasing availability of unauthorized professional salonproducts in large format retail stores such as drug stores, grocery stores andothers could also have a negative impact on our business.

 

·             *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 savings from this program could range between $5million and $7 million in fiscal year 2009 and annualized savings of $10million beginning in fiscal year 

 

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2010.  In addition, duringthe fiscal 2009 first quarter we implemented a temporary hiring freeze for allpersonnel, deferred merit increases for upper management and institutedvariable expense reductions related to benefits and payroll related costs.  Please see “Risk Factors — We are not certainthat our ongoing cost control plans will continue to be successful” in Item 1Aof our Annual Report on 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.

 

·             *Changesto our information technology systems*.  As our operations grow in bothsize and scope, we will continuously need to improve and upgrade ourinformation systems and infrastructure while maintaining the reliability andintegrity of our systems and infrastructure. The expansion of our systems and infrastructure will require us tocommit substantial financial, operational and technical resources in advance ofany increase in the volume of our business, with no assurance that the volumeof business will increase.  For example,in fiscal year 2008 we upgraded our Lawson financial reporting system and, infiscal year 2009, are upgrading our distribution information systems (inconnection with our capital spending program to consolidate warehouses, as discussedabove), are upgrading our AS400 iSeries servers and are planning toinstall Hyperion software to enhance our financial reporting system. These andany other required upgrades to our information systems and informationtechnology (or new technology), now or in the future, will require that ourmanagement and resources be diverted from our core business to assist incompletion of these projects. There can be no assurance that the time andresources our management will need to devote to these upgrades, service outagesor delays due to the installation of any new or upgraded technology (andcustomer issues therewith), or the impact on the reliability of our data fromany new or upgraded technology will not have a material adverse effect on ourfinancial reporting, business, financial condition or results ofoperations.  Please see “Risk Factors —We may be adversely affected by any disruption in our information technologysystems” in Item 1A of our Annual Report on Form 10-K for the fiscal yearended September 30, 2008.

 

·             *Relationshipswith suppliers*.  We do not manufacture the brand name orexclusive-label products we sell, and instead purchase our products frommanufacturers. We depend upon a limited number of manufacturers for asignificant percentage of the products we sell, and our relationships withthese suppliers change often.  Please see“Relationships with Suppliers.”

 

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

##### *** ***

Mostof our net sales are generated through retail stores with respect to the SallyBeauty Supply business, and both professional only stores and professionaldistribution sales consultants with respect to the BSG business. In addition,BSG has a number of franchisees located primarily in the south and southwesternportions of the U.S. and in Mexico, which buy products directly from BSG forresale in their assigned territories. A very small percentage of sales aregenerated through franchisees or sub-distributors (primarily in Europe), whichalso buy products directly from Sally Beauty Supply or BSG for resale. SallyBeauty Supply/BSG and their suppliers are dependent on each other for thedistribution of beauty products. As is typical in distribution businesses,these relationships are subject to change from time to time (including theexpansion or loss of distribution rights in various geographies and theaddition or loss of product lines).

 

Sincewe purchase products from many manufacturers on an at-will basis, undercontracts which can generally be terminated without cause upon 90 days’notice or less or which expire without express rights of renewal, suchmanufacturers could discontinue sales to us at any time or upon the expirationof the distribution period. Some of our contracts with manufacturers may beterminated by such manufacturers if we fail to meet specified minimum purchaserequirements. In such cases, we do not have contractual assurances of continuedsupply, pricing or access to new products and vendors may change the terms uponwhich they sell. Infrequently, a supplier will seek to terminate a distributionrelationship through legal action.

 

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Changesin our relationships with suppliers occur often and could positively ornegatively impact our net sales and operating profits. For example, during thesecond quarter of fiscal year 2007, Farouk Systems, Inc., or FaroukSystems, terminated its distribution agreement with us. Subsequently, effectiveJuly 2007,BSG stores and professional distributor sales consultants wereonce again given approval to distribute Farouk Systems products with anexpanded distribution area. In the first quarter of fiscal 2009, Farouk Systemsagain terminated its distribution agreement with BSG. The agreement throughwhich our Armstrong McCall franchisees are supplied is currently unaffected bythis event. In December 2006, we announced the loss of certain L’Orealdistribution rights, including (among other things) distribution rightsthrough our BSG distributor sales consultants and the loss of exclusive rightsto distribute L’Oreal products in our BSG stores. As discussed above, L’Orealhas entered into direct competition with BSG and there can be no assurance thatthere will not be further revenue losses over time at BSG due to potentiallosses of additional L’Oreal related products as well as from the increasedcompetition from L’Oreal-affiliated distribution networks. BSG has entered intolong-term agreements with L’Oreal under which, as of January 1, 2007, BSGhad non-exclusive rights to distribute the same L’Oreal professional productsin its stores that it previously had exclusive rights to distribute in itsstores and through its sales consultants. Armstrong McCall retained itsexclusive rights to distribute L’Oreal’s Matrix professional products in itsterritories. Although we have focused on developing new revenue and costmanagement initiatives to mitigate the negative effects resulting fromunfavorable changes in our supplier relationships, there can be no assurancethat our efforts will continue to completely offset the loss of these or otherdistribution rights. Please see “Risk Factors*—* We depend upon manufacturers who may be unable to provide productsof adequate quality or who may be unwilling to continue to supply products tous” in Item 1A of our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2008.

 

Weexpect to continue to expand our product line offerings and to gain additionaldistribution rights over time through either further negotiation with suppliersor 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.

 

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

##### *** ***

InNovember 2006, pursuant to an investment agreement among Alberto-Culverand certain of its subsidiaries, including Sally Holdings, and CDRS AcquisitionLLC (“CDRS”), Alberto-Culver separated its consumer products business and itsSally Beauty Supply/BSG distribution business into two separate,publicly-traded companies.  SallyHoldings was a wholly-owned subsidiary of Alberto-Culver until the SeparationTransactions, when it was converted to a Delaware limited liability company,was renamed Sally Holdings LLC and became an indirect wholly-owned subsidiaryof Sally Beauty.  Sally Beauty was formedin June 2006 and became the accounting successor company to Sally Holdingsupon the completion of the Separation Transactions.  See the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2008 for more information aboutthe Separation Transactions.

 

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

##### *** ***

*Interest Rate Swap Agreements*

 

TheCompany is exposed to a wide variety of risks, including risks arising fromchanging economic conditions. The Company manages its exposure to certaineconomic risks (including liquidity, credit risk and changes in interest rates)primarily (a) by closely managing its cash flows from operating andinvesting activities and the amounts and sources of its debt obligations; (b) byassessing periodically the creditworthiness of its business partners; and (c) bythe use of interest rate swaps.  TheCompany uses interest rate swaps as part of its overall economic riskmanagement strategy to add stability to the interest payments due in connectionwith its term loan obligations. Interest payments related to the term loans areimpacted by changes in LIBOR. Interest rate swap agreements involve theperiodic receipt by the Company of amounts based on a variable rate in exchangefor the Company making payments based on a fixed rate over the term of theagreements without exchange of the underlying notional amount. At March 31,2009, the Company did not purchase or hold any other derivative instruments orhold any derivative instruments for trading or speculative purposes.

 

Thecounterparties are deemed to be of substantial resources and strongcreditworthiness. However, these transactions result in exposure to creditrisks in the event of default by a counterparty. The current financial crisisaffecting the banking systems and financial markets has resulted in manywell-known financial institutions becoming less creditworthy or havingdiminished liquidity which could expose us to an increased level of

 

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counterparty risk. In the event that a counterparty defaults in its obligation under ourinterest rate swaps, we could incur substantial financial loss. At March 31,2009, the aggregate fair value of all our interest rate swaps was a netliability of $27.0 million.

 

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 swap agreementswith an aggregate notional amount of $300 million. These interest rate swapagreements are designated as effective hedges, consistent with Statement ofFinancial Accounting Standards No. 133, *Accountingfor Derivative Instruments and Hedging Activities*.  Adjustments to reflect the change in the fairvalues of these interest rate swap agreements are recorded in accumulated othercomprehensive (loss) income until the hedged obligation is settled or the swapagreements expire, whichever is earlier. Any ineffectiveness is recognized in net interest expense in ourconsolidated statements of earnings. Please see “Item 3—Quantitative andQualitative Disclosures about Market Risk—Interest rate risk” and Note 12 ofthe “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 six months ended March 31,2009 and 2008 (in thousands):

 
| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                       | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                                        |       | $                                      | 641,511    |                                 | $          | 643,346 |   | $ | 1,287,087 |   | $ | 1,299,133 |   |
| Cost of  products sold and distribution expenses |       | 339,399                                |       | 344,922                              |       | 681,431 |   | 694,540 |   |
| Gross profit                                     |       | 302,112                                |       | 298,424                              |       | 605,656 |   | 604,593 |   |
| Total other operating costs and expenses         |       | 227,945                                |       | 230,638                              |       | 463,229 |   | 465,285 |   |
| Operating earnings                               |       | 74,167                                 |       | 67,786                               |       | 142,427 |   | 139,308 |   |
| Interest expense, net                            |       | 31,958                                 |       | 47,642                               |       | 71,631 |   | 94,125 |   |
| Earnings before provision for income taxes       |       | 42,209                                 |       | 20,144                               |       | 70,796 |   | 45,183 |   |
| Provision for income taxes                       |       | 16,470                                 |       | 6,364                                |       | 27,850 |   | 16,057 |   |
| Net earnings                                     |       | $                                      | 25,739     |                                 | $          | 13,780 |   | $ | 42,946 |   | $ | 29,126 |   |

 

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

 
| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                       | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                                        |       | 100.0                                  | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
| Cost of products sold and distribution  expenses |       | 52.9                                   | %          | 53.6                                 | %          | 52.9 | % | 53.5 | % |
| Gross profit                                     |       | 47.1                                   | %          | 46.4                                 | %          | 47.1 | % | 46.5 | % |
| Total other operating costs and expenses         |       | 35.5                                   | %          | 35.9                                 | %          | 36.0 | % | 35.8 | % |
| Operating earnings                               |       | 11.6                                   | %          | 10.5                                 | %          | 11.1 | % | 10.7 | % |
| Interest expense, net                            |       | 5.0                                    | %          | 7.4                                  | %          | 5.6 | % | 7.2 | % |
| Earnings before provision for income taxes       |       | 6.6                                    | %          | 3.1                                  | %          | 5.5 | % | 3.5 | % |
| Provision for income taxes                       |       | 2.6                                    | %          | 1.0                                  | %          | 2.2 | % | 1.3 | % |
| Net earnings                                     |       | 4.0                                    | %          | 2.1                                  | %          | 3.3 | % | 2.2 | % |

#####  

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

##### *** ***

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

 
| ** **                                                 | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                 | ** ** | **2009**                                         | ** ** | **2008(a)**                                    | ** ** | **2009** | ** ** | **2008(a)** | ** ** |
| Net sales:                                                 |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       | $                                                | 412,338    |                                           | $          | 406,065 |   | $ | 822,875 |   | $ | 815,629 |   |
| BSG                                                        |       | 229,173                                          |       | 237,281                                        |       | 464,212 |   | 483,504 |   |
| Total                                                      |       | $                                                | 641,511    |                                           | $          | 643,346 |   | $ | 1,287,087 |   | $ | 1,299,133 |   |
| Gross Profit                                               |       | $                                                | 302,112    |                                           | $          | 298,424 |   | $ | 605,656 |   | $ | 604,593 |   |
| Gross profit margin                                        |       | 47.1                                             | %          | 46.4                                           | %          | 47.1 | % | 46.5 | % |
| Selling, general and administrative expenses               |       | $                                                | 216,474    |                                           | $          | 218,817 |   | $ | 440,011 |   | $ | 441,712 |   |
| Depreciation and amortization                              |       | $                                                | 11,471     |                                           | $          | 11,821 |   | $ | 23,218 |   | $ | 23,573 |   |
| Earnings before provision for income taxes:                |       |                                             |       |                                           |       |   |   |   |   |
| Segment operating profit:                                  |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       | $                                                | 70,379     |                                           | $          | 67,911 |   | $ | 135,665 |   | $ | 139,644 |   |
| BSG                                                        |       | 20,359                                           |       | 17,942                                         |       | 40,595 |   | 38,972 |   |
| Segment operating profit                                   |       | 90,738                                           |       | 85,853                                         |       | 176,260 |   | 178,616 |   |
| Unallocated expenses                                       |       | (15,147                                          | )          | (16,609                                        | )          | (28,941 | ) | (32,403 | ) |
| Share-based compensation expense                           |       | (1,424                                           | )          | (1,458                                         | )          | (4,892 | ) | (6,905 | ) |
| Operating earnings                                         |       | 74,167                                           |       | 67,786                                         |       | 142,427 |   | 139,308 |   |
| Interest expense, net of interest income                   |       | (31,958                                          | )          | (47,642                                        | )          | (71,631 | ) | (94,125 | ) |
| Earnings before provision for income taxes                 |       | $                                                | 42,209     |                                           | $          | 20,144 |   | $ | 70,796 |   | $ | 45,183 |   |
| Segment operating profit margin:                           |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 17.1                                             | %          | 16.7                                           | %          | 16.5 | % | 17.1 | % |
| BSG                                                        |       | 8.9                                              | %          | 7.6                                            | %          | 8.7 | % | 8.1 | % |
| Consolidated operating profit margin                       |       | 11.6                                             | %          | 10.5                                           | %          | 11.1 | % | 10.7 | % |
| Number of stores at end-of-period  (including franchises): |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       |                                             |       |                                           |       | 2,873 |   | 2,739 |   |
| BSG                                                        |       |                                             |       |                                           |       | 934 |   | 905 |   |
|                                                       |       |                                             |       |                                           |       | 3,807 |   | 3,644 |   |
| Same store sales growth (b)                                |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 2.0                                              | %          | 1.4                                            | %          | 0.9 | % | 0.9 | % |
| BSG                                                        |       | 2.3                                              | %          | 6.9                                            | %          | 1.5 | % | 7.2 | % |
| Consolidated                                               |       | 2.1                                              | %          | 2.8                                            | %          | 1.1 | % | 2.4 | % |

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| (a) |   | Certain  amounts for 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  March 31, 2009. |

 

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

 

### *The table belowpresents net sales, gross profit and gross profit margin data for eachreportable segment (dollars in thousands).*

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2009**                              | ** ** | **2008** | ** ** | **Increase (Decrease)** | ** ** |
| Net sales:                       |       |                                  |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                     | 412,338    |   | $ | 406,065 |   | $ | 6,273 |   | 1.5 | % |
| BSG                              |       | 229,173                               |       | 237,281 |   | (8,108 | ) | (3.4 | )% |
| Consolidated net sales           |       | $                                     | 641,511    |   | $ | 643,346 |   | $ | (1,835 | ) | (0.3 | )% |
|                             |       |                                  |       |   |   |   |   |   |   |
| Gross profit:                    |       |                                  |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                     | 214,765    |   | $ | 207,337 |   | $ | 7,428 |   | 3.6 | % |
| BSG                              |       | 87,347                                |       | 91,087 |   | (3,740 | ) | (4.1 | )% |
| Consolidated gross profit        |       | $                                     | 302,112    |   | $ | 298,424 |   | $ | 3,688 |   | 1.2 | % |
|                             |       |                                  |       |   |   |   |   |   |   |
| Gross profit margin:             |       |                                  |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | 52.1                                  | %          | 51.1 | % | 1.0 | % |   |   |
| BSG                              |       | 38.1                                  | %          | 38.4 | % | (0.3 | )% |   |   |
| Consolidated gross profit margin |       | 47.1                                  | %          | 46.4 | % | 0.7 | % |   |   |

 

### ***Net Sales***

###  

Consolidated net sales decreased by $1.8 million, or 0.3%, for thethree months ended March 31, 2009, compared to the three months ended March 31,2008. Company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $15.8 million, or 2.5%, and salesthrough certain non-store sales channels contributed an increase ofapproximately $3.2 million, or 0.5%, to consolidated sales. Other saleschannels experienced declines compared to the three months ended March 31,2008. Sales through our BSG franchise-based businesses declined byapproximately $3.1 million, or 0.5%; sales through distributor salesconsultants declined approximately $7.8 million, or 1.2%; and sales through newstores declined approximately $6.5 million, or 1.0%. Also, incremental salesfrom businesses acquired in the preceding 12 months contributed $3.5 million,or 0.5%, less to our consolidated net sales for the three months ended March 31,2009, compared to the three months ended March 31, 2008. Consolidated netsales for the three months ended March 31, 2009, are inclusive ofapproximately $26.2 million in negative impact from changes in foreign exchangerates.

 

Sally Beauty Supply.  Net salesfor Sally Beauty Supply increased by $6.3 million, or 1.5%, for the threemonths ended March 31, 2009, compared to the three months ended March 31,2008.  In the Sally Beauty Supplysegment, company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $9.4 million, or 2.3%; our non-storesales channels contributed an increase of approximately $3.2 million, or 0.8%;and sales through new stores declined approximately $2.0 million, or 0.5%.Sales of businesses acquired in the preceding 12 months contributed $4.3million less to the Sally Beauty Supply segment sales for the three monthsended March 31, 2009, compared to the three months ended March 31,2008. Net sales for Sally Beauty Supply for the three months ended March 31,2009, are inclusive of approximately $19.3 million in negative impact fromchanges in foreign exchange rates.

 

*BeautySystems Group*.  Net sales for BSG decreased by $8.1 million,or 3.4%, for the three months ended March 31, 2009, compared to the threemonths ended March 31, 2008. While company-operated stores that have beenopen for at least 14 months contributed an increase of approximately $6.4million, or 2.7%, to net sales and incremental sales from businesses acquiredin the preceding 12 months contributed $0.8 million, other sales channelsexperienced declines compared to the three months ended March 31, 2008.Sales through our franchise-based 

 

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businessesdeclined by approximately $3.1 million, or 1.3%; sales through distributorsales consultants declined approximately $7.8 million, or 3.3%; and sales throughnew stores declined approximately $4.5 million, or 1.9%. Net sales for BSG forthe three months ended March 31, 2009 are inclusive of approximately $6.9million in negative impact from changes in foreign exchange rates.

 

#### ***GrossProfit***

#### ** **

Consolidated gross profit increased by $3.7 million, or 1.2%, for thethree months ended March 31, 2009, compared to the three months ended March 31,2008, principally due to higher sales volume and improved gross margins for theSally Beauty Supply segment. This increase was partially offset by lower salesvolume and lower gross margins for the BSG segment, as more fully describedbelow.

 

Sally Beauty Supply. Sally Beauty Supply’s gross profit increased by$7.4 million, or 3.6%, for the three months ended March 31, 2009, comparedto the three months ended March 31, 2008, principally as a result ofincreased unit sales volume and improved margins.  Sally Beauty Supply’s gross profit as apercentage of net sales increased to 52.1% for the three months ended March 31,2009, compared to 51.1% for the three months ended March 31, 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).

 

*BeautySystems Group*. BSG’s gross profit decreased by $3.7 million, or 4.1%, for the three months ended March 31, 2009,compared to the three months ended March 31,2008, principally as a result of lower sales volume and slightly lowermargins.  BSG’s gross profit as apercentage of net sales decreased to 38.1% for the three months ended March 31, 2009, compared to 38.4%for the three months ended March 31,2008. The decrease in gross profit margins reflects unfavorable foreign currency transactionsand an unfavorable change in sales mix in BSG’s franchise business.

 

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

#### ** **

Consolidatedselling, general and administrative expenses decreased by $2.3 million, or1.1%, to $216.5 million for the three months ended March 31, 2009,compared to $218.8 million for the three months ended March 31, 2008.Selling, general and administrative expenses, as a percentage of net sales,were 33.7% for the three months ended March 31, 2009, compared to 34.0%for the three months ended March 31, 2008. This decrease was attributableto lower sales commissions of $1.3 million and lower unallocated corporateexpenses of $1.5 million as a result of cost control measures, partially offsetby higher advertising expenses in the Sally Beauty Supply segment of $1.2million. Selling, general and administrative expense for the three months endedMarch 31, 2008 included approximately $0.9 million for BSG retentionincentives for distributor sales consultants (resulting from the L’Oreal contractualchanges reported during fiscal year 2007) and warehouse optimization expensesof approximately $1.3 million, with no similar expenses in the three monthsended March 31, 2009.

 

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

#### ** **

Consolidateddepreciation and amortization decreased to $11.5 million for three months endedMarch 31, 2009, compared to $11.8 million for the three months ended March 31,2008, due to a favorable impact from changes in foreign exchange rates,partially offset by the expenses associated with businesses acquired in thelast twelve months and depreciation related to capital expenditures mainly inconnection with store openings in both operating segments.

 

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#### ***OperatingEarnings***

#### ** **

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

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2009**                              | ** ** | **2008** | ** ** | **Increase (Decrease)** | ** ** |
| Operating Earnings:              |       |                                  |       |   |   |   |   |   |   |
| Segment operating profit:        |       |                                  |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                     | 70,379     |   | $ | 67,911 |   | $ | 2,468 |   | 3.6 | % |
| BSG                              |       | 20,359                                |       | 17,942 |   | 2,417 |   | 13.5 | % |
| Segment operating profit         |       | 90,738                                |       | 85,853 |   | 4,885 |   | 5.7 | % |
| Unallocated expenses             |       | (15,147                               | )          | (16,609 | ) | (1,462 | ) | (8.8 | )% |
| Share-based compensation expense |       | (1,424                                | )          | (1,458 | ) | (34 | ) | (2.3 | )% |
| Operating earnings               |       | $                                     | 74,167     |   | $ | 67,786 |   | $ | 6,381 |   | 9.4 | % |

 

Consolidated operating earnings increased by $6.4 million, or 9.4%, to$74.2 million for three months ended March 31, 2009, compared to $67.8million for the three months ended March 31, 2008. Operating earnings, asa percentage of net sales, were 11.6% for the three months ended March 31,2009, compared to 10.5% for the three months ended March 31, 2008. Theincrease in consolidated operating earnings was due primarily to an increase inthe operating profits of both segments, as discussed below.

 

Sally Beauty Supply.  SallyBeauty Supply’s segment operating earnings increased by $2.5 million, or 3.6%,to $70.4 million for three months ended March 31, 2009, compared to $67.9million for the three months ended March 31, 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 $1.2 million and incremental costs related to approximately 131additional company-operated stores operating during the three months ended March 31,2009.  Segment operating earnings, as apercentage of net sales, were 17.1% for the three months ended March 31,2009, compared to 16.7% for the three months ended March 31, 2008. Theincrease in Sally Beauty Supply’s operating earnings as a percentage of segmentnet sales was primarily a result of gross margin improvements, partially offsetby an increase in advertising costs as a percentage of segment sales andcontinued softer sales in some of the segment’s international operations.

 

Beauty Systems Group.  BSG’ssegment operating earnings increased by $2.4 million, or 13.5%, to $20.4million for the three months ended March 31, 2009, compared to $17.9million for the three months ended March 31, 2008. Segment operatingearnings, as a percentage of net sales, increased to 8.9% for the three monthsended March 31, 2009, compared to 7.6% for the three months ended March 31,2008. This increase was due to lower segment selling and administrative costs,partially offset by the decline in segment sales and gross profit, as discussedabove.

 

*Unallocatedexpenses*. Unallocatedexpenses, which represent corporate costs (such as payroll, employee benefitsand travel expenses for corporate staff, certain professional fees andcorporate governance expenses) that have not been charged to our operatingsegments decreased by $1.5 million, or 8.8%, to $15.1 million for the threemonths ended March 31, 2009, compared to $16.6 million for the threemonths ended March 31, 2008. This decrease was due primarily to lower corporateexpenses resulting from cost-saving initiatives as well as to lower currencytranslation losses resulting from intercompany notes not permanently invested.

 

*Share-based Compensation Expense*.Total compensation cost charged against income for share-based compensationarrangements was $1.4 million and $1.5 million for the three months ended March 31,2009 and 2008, respectively.

 

#### **Net Interest Expense**

#### ** **

Interestexpense, net of interest income of $0.1 million, was $32.0 million for thethree months ended March 31, 2009, compared to $47.6 million, net ofinterest income of $0.2 million, for the three months ended March 31,2008.  The decrease in interest expensewas primarily attributable to a $10.8 million change in the fair value ofcertain interest rate swaps (please see Note 8 of the Condensed Notes toConsolidated Financial Statements) and to lower prevailing interest rates onour ABL and senior term loan facilities and lower outstanding principalbalances on our senior term loans, partially offset by higher outstandingborrowings under our ABL facility as discussed in “Liquidity and CapitalResources” below.

 

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

#### ** **

Provisionfor income taxes was $16.5 million during the three months ended March 31,2009, compared to $6.4 million for the three months ended March 31,2008.  Income taxes for the interimperiods ended March 31, 2009 and

 

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March 31,2008 have been included in the accompanying financial statements on the basisof an estimated annual effective rate. The estimated annual effective tax rate (excluding discrete items) is37.9% for fiscal year 2009, compared to 35.7% for fiscal year 2008.  The increase in the estimated annualeffective tax rate primarily relates to a reduction in earnings in low taxjurisdictions and a reduction in favorable permanent items triggered by lowerforeign earnings.

 

For the three months ended March 31,2009, the actual tax rate exceeds the estimated annual effective tax ratebecause of losses recorded in the three months ended March 31, 2009 forentities for which a valuation allowance is required.

 

#### ***NetEarnings***

#### ** **

Asa result of the foregoing, consolidated net earnings increased by $12.0million, or 86.8%, to $25.7 million for the three months ended March 31,2009, compared to $13.8 million for the three months ended March 31, 2008.Net earnings, as a percentage of net sales, were 4.0% for the three monthsended March 31, 2009, compared to 2.1% for the three months ended March 31,2008.

 

***The Six Months Ended March 31,2009 compared to the Six Months Ended March 31, 2008***

 

### *The table belowpresents net sales, gross profit and gross profit margin data for eachreportable segment (dollars in thousands).*

 
| ** **                       | ** ** | **Six Months Ended March 31,** | ** ** |
|----------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **2009**                            | ** ** | **2008** | ** ** | **Increase (Decrease)** | ** ** |
| Net sales:                       |       |                                |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                   | 822,875    |   | $ | 815,629 |   | $ | 7,246 |   | 0.9 | % |
| BSG                              |       | 464,212                             |       | 483,504 |   | (19,292 | ) | (4.0 | )% |
| Consolidated net sales           |       | $                                   | 1,287,087  |   | $ | 1,299,133 |   | $ | (12,046 | ) | (0.9 | )% |
|                             |       |                                |       |   |   |   |   |   |   |
| Gross profit:                    |       |                                |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                   | 427,693    |   | $ | 418,876 |   | $ | 8,817 |   | 2.1 | % |
| BSG                              |       | 177,963                             |       | 185,717 |   | (7,754 | ) | (4.2 | )% |
| Consolidated gross profit        |       | $                                   | 605,656    |   | $ | 604,593 |   | $ | 1,063 |   | 0.2 | % |
|                             |       |                                |       |   |   |   |   |   |   |
| Gross profit margin:             |       |                                |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | 52.0                                | %          | 51.4 | % | 0.6 | % |   |   |
| BSG                              |       | 38.3                                | %          | 38.4 | % | (0.1 | )% |   |   |
| Consolidated gross profit margin |       | 47.1                                | %          | 46.5 | % | 0.6 | % |   |   |

 

### ***Net Sales***

###  

Consolidated net sales decreased by $12.0 million, or 0.9%, for the sixmonths ended March 31, 2009, compared to the six months ended March 31,2008. Company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $32.3 million, or 2.5%, and salesthrough certain non-store sales channels contributed an increase ofapproximately $7.5 million, or 0.6%, to consolidated sales. Other saleschannels experienced declines compared to the six months ended March 31,2008. Sales through our BSG franchise-based businesses declined byapproximately $8.8 million, or 0.7%; sales through our BSG distributor salesconsultants declined approximately $13.2 million, or 1.0%; and sales throughnew stores declined approximately $13.1 million, or 1.0%. In addition,incremental sales from businesses acquired in the preceding 12 monthscontributed $16.8 million less to our consolidated net sales for the six monthsended March 31, 2009, compared to the six months 

 

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ended March 31, 2008. Consolidated net sales for the six monthsended March 31, 2009, are inclusive of approximately $50.9 million innegative impact from changes in foreign exchange rates.

 

Sally Beauty Supply.  Net salesfor Sally Beauty Supply increased by $7.2 million, or 0.9%, for the six monthsended March 31, 2009, compared to the six months ended March 31,2008.  In the Sally Beauty Supplysegment, company-operated stores that have been open for at least 14 monthscontributed an increase of approximately $21.7 million, or 2.7%, while ournon-store sales channels contributed an increase of approximately $7.5 million,or 0.9%. Sales of businesses acquired in the preceding 12 months contributed$18.6 million less to the Sally Beauty Supply segment sales for the six monthsended March 31, 2009, compared to the six months ended March 31, 2008and sales through new stores declined approximately $3.4 million, or 0.4%. Netsales for Sally Beauty Supply for the six months ended March 31, 2009, areinclusive of approximately $36.4 million in negative impact from changes inforeign exchange rates.

 

*BeautySystems Group*.  Net sales for BSG decreased by $19.3 million,or 4.0%, for the six months ended March 31, 2009, compared to the sixmonths ended March 31, 2008. While company-operated stores that have beenopen for at least 14 months contributed an increase of approximately $10.6million, or 2.2%, to net sales and incremental sales from businesses acquiredin the preceding 12 months contributed $1.8 million, other sales channelsexperienced declines compared to the six months ended March 31, 2008.Sales through our franchise-based businesses declined by approximately $8.8million, or 1.8%; sales through distributor sales consultants declinedapproximately $13.2 million, or 2.7%; and sales through new stores declinedapproximately $9.7 million, or 2.0%. Net sales for BSG for the six months endedMarch 31, 2009, are inclusive of approximately $14.5 million in negativeimpact from changes in foreign exchange rates.

 

#### ***GrossProfit***

#### ** **

Consolidated gross profit increased by $1.1 million or 0.2% for the sixmonths ended March 31, 2009, compared to the six months ended March 31,2008, principally due to higher sales volume and improved gross margins for theSally Beauty Supply segment. This increase was partially offset by lower salesvolume and lower gross margins for the BSG segment, as more fully describedbelow.

 

Sally Beauty Supply. Sally Beauty Supply’s gross profit increased by$8.8 million or 2.1% for the six months ended March 31, 2009, compared tothe six months ended March 31, 2008, principally as a result of increasedunit sales volume and improved margins. Sally Beauty Supply’s gross profit as a percentage of net salesincreased to 52.0% for the six months ended March 31, 2009, compared to51.4% for the six months ended March 31, 2008. This increase was theresult of recent marketing efforts, low-cost sourcing initiatives and a shiftin product mix (including an increase in sales of exclusive-label products andother higher-margin products).

 

*BeautySystems Group*. BSG’s gross profit decreased by $7.8 million or 4.2% for the six months ended March 31, 2009, comparedto the six months ended March 31,2008, principally as a result of lower sales volume and slightly lowersegment gross margins. BSG’s gross profit as a percentage of net salesdecreased to 38.3% for the six monthsended March 31, 2009, compared to 38.4% for the six months ended March 31, 2008. The decrease in grossprofit margins reflects unfavorableforeign currency transactions and an unfavorable change in sales mix inBSG’s franchise business.

 

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

#### ** **

Consolidated selling, general and administrative expenses decreased by$1.7 million, or 0.4%, to $440.0 million for the six months ended March 31,2009, compared to $441.7 million for the six months ended March 31,2008.   Selling, general andadministrative expenses, as a percentage of net sales, were 34.2% for the sixmonths ended March 31, 2009, compared to 34.0% for the six months ended March 31,2008. The 0.4% decrease in selling, general and administrative expenses wasattributable to lower share-based compensation of $2.0 million and otherunallocated corporate expenses as a result of cost control measures of $3.5million, partially offset by the incremental expenses related to businessesacquired in the last twelve months as well as to an increase in advertisingexpenses of approximately $2.8 million. Selling, general and administrativeexpense for the six months ended March 31, 2008 included approximately$1.5 million for BSG retention incentives for distributor sales consultants(resulting from the L’Oreal contractual changes reported during fiscal year2007) and warehouse optimization expenses of approximately $1.6 million, withno similar expenses in the six months ended March 31, 2009.

 

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

#### ** **

Consolidateddepreciation and amortization decreased to $23.2 million for six months ended March 31,2009, compared to $23.6 million for the six months ended March 31, 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.

 

#### ***OperatingEarnings***

#### ** **

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

 
| ** **                       | ** ** | **Six Months Ended March 31,** | ** ** |
|----------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **2009**                            | ** ** | **2008** | ** ** | **Increase (Decrease)** | ** ** |
| Operating Earnings:              |       |                                |       |   |   |   |   |   |   |
| Segment operating profit:        |       |                                |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                   | 135,665    |   | $ | 139,644 |   | $ | (3,979 | ) | (2.8 | )% |
| BSG                              |       | 40,595                              |       | 38,972 |   | 1,623 |   | 4.2 | % |
| Segment operating profit         |       | 176,260                             |       | 178,616 |   | (2,356 | ) | (1.3 | )% |
| Unallocated expenses             |       | (28,941                             | )          | (32,403 | ) | (3,462 | ) | 10.7 | % |
| Share-based compensation expense |       | (4,892                              | )          | (6,905 | ) | (2,013 | ) | 29.2 | % |
| Operating earnings               |       | $                                   | 142,427    |   | $ | 139,308 |   | $ | 3,119 |   | 2.2 | % |

 

Consolidated operating earnings increased by $3.1 million, or 2.2%, to$142.4 million for six months ended March 31, 2009, compared to $139.3million for the six months ended March 31, 2008. Operating earnings, as apercentage of net sales, were 11.1% for the six months ended March 31,2009, compared to 10.7% for the six months ended March 31, 2008. Theincrease in consolidated operating earnings was due primarily to a decline inunallocated expenses and share-based compensation expense; offset in part by adecline in the Sally Beauty Supply’s operating profits, as discussedbelow.  Consolidated operating earningsfor the six months ended March 31, 2009, are inclusive of approximately$0.9 million in negative impact from changes in foreign exchange rates.

 

*Sally Beauty Supply*.  Sally Beauty Supply’s segment operatingearnings decreased $4.0 million, or 2.8%, to $135.7 million for six monthsended March 31, 2009, compared to $139.6 million for the six months ended March 31,2008.  The decrease in Sally BeautySupply’s segment operating earnings was primarily a result of higheradvertising costs of approximately $2.8 million and incremental costs relatedto approximately 131 additional company-operated stores operating during thesix months ended March 31, 2009. Segment operating earnings, as a percentage of net sales, were 16.5% forthe six months ended March 31, 2009, compared to 17.1% for the six monthsended March 31, 2008. The decrease in Sally Beauty Supply’s segmentoperating earnings as a percentage of segment net sales was primarily a resultof higher advertising costs as a percentage of segment net sales and continuedsofter sales in some of the segment’s international operations.

 

*Beauty Systems Group*.  BSG’s segment operating earnings increased$1.6 million, or 4.2%, to $40.6 million for the six months ended March 31,2009, compared to $39.0 million for the six months ended March 31, 2008.Segment operating earnings, as a percentage of net sales, were 8.7% for the sixmonths ended March 31, 2009, compared to 8.1% for the six months ended March 31,2008. This increase was due primarily to a decline in segment operatingexpenses resulting from cost-saving initiatives, partially offset by lowersegment gross profit, as discussed above. BSG’s segment operating earnings alsoreflect, for the six months ended March 31, 2008, approximately $1.5million for retention incentives for distributor sales consultants (resultingfrom the L’Oreal contractual changes reported during fiscal year 2007). Segmentoperating earnings for the six months ended March 31, 2009, are inclusiveof approximately $1.3 million in negative impact from changes in foreignexchange rates.

 

*Unallocatedexpenses.*Unallocatedexpenses, which represent corporate costs (such as payroll, employee benefitsand travel expenses for corporate staff, certain professional fees andcorporate governance expenses) that have not been charged to our operatingsegments decreased by $3.5 million, or 10.7%, to $28.9 million for the sixmonths ended March 31, 2009, compared to $32.4 million for the six monthsended March 31, 2008. This decrease was due primarily to lower corporateexpenses resulting from cost-saving initiatives as well as to lower currencytranslation losses resulting from intercompany notes not permanently invested.

 

#### ***Share-basedCompensation Expense.***For the sixmonths ended March 31, 2009, total compensation cost charged against income forshare-based compensation arrangements was $4.9 million, compared to $6.9million for the six months ended March 31,2008. This decrease was due toa decline in the fair value per share of options awarded in 

 

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#### **the period ended March 31, 2009, compared tooptions awarded in the period ended March 31, 2008.  For**the sixmonths ended March 31, 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 six months ended March 31, 2009 and 2008, the Sally Beauty granted toour employees and consultants approximately 2.7 million and 2.6 million stockoptions, respectively.

#### ** **

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

#### ** **

Interestexpense, net of interest income of $0.2 million, was $71.6 million for the sixmonths ended March 31, 2009, compared to $94.1 million, net of interestincome of $0.4 million, for the six months ended March 31, 2008.  The decrease in interest expense wasprimarily attributable to a $13.5 million change in the fair value of certaininterest rate swaps (please see Note 8 of the Condensed Notes to ConsolidatedFinancial Statements) and to lower prevailing interest rates on our ABL andsenior term loans facilities and lower outstanding principal balances on oursenior term loans, partially offset by higher outstanding borrowings under ourABL facility as discussed in “Liquidity and Capital Resources” below.

 

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

#### ** **

Provisionfor income taxes was $27.9 million during the six months ended March 31,2009, compared to $16.1 million for the six months ended March 31,2008.  Income taxes for the interimperiods ended March 31, 2009 and March 31, 2008 have been included inthe accompanying financial statements on the basis of an estimated annualeffective rate.  The estimated annualeffective tax rate (excluding discrete items) is 37.9% for fiscal year 2009,compared to 35.7% for fiscal year 2008. The increase in the estimated annual effective tax rate primarilyrelates to a reduction in earnings in low tax jurisdictions and a reduction infavorable permanent items triggered by lower foreign earnings.

 

Forthe six months ended March 31, 2009, the actual tax rate exceeds theestimated annual effective tax rate because of losses recorded in the sixmonths ended March 31, 2009 for entities for which a valuation allowanceis required.

 

#### ***NetEarnings***

#### ** **

Asa result of the foregoing, consolidated net earnings increased by $13.8million, or 47.4%, to $42.9 million for the six months ended March 31,2009, compared to $29.1 million for the six months ended March 31, 2008.Net earnings, as a percentage of net sales, were 3.3% for the six months ended March 31,2009, compared to 2.2% for the six months ended March 31, 2008.

 

## **Financial Condition**

##  

##### ***March 31, 2009 Compared to September 30,2008***

##### *** ***

Workingcapital (current assets less current liabilities) at March 31, 2009 was$367.9 million, compared to $348.6 million at September 30, 2008,representing an increase of $19.3 million. The ratio of current assets tocurrent liabilities was 1.97 to 1.00 at March 31, 2009, compared to 1.76to 1.00 at September 30, 2008. The increase in working capital reflects adecrease of $76.0 million in current liabilities and a $56.7 million decreasein current assets.  The decrease incurrent assets as of March 31, 2009 includes a $59.4 million reduction ininventory levels.  The decrease incurrent liabilities as of March 31, 2009, was primarily the result of adecrease in current maturities of long-term debt of $86.1 million.

 

Inventories decreased $59.4 million to $538.8 million at March 31,2009, compared to $598.2 million at September 30, 2008 due primarily tolower purchases by us during the period ended March 31, 2009 in responseto the current economic slowdown and to the effect of foreign currencytranslation adjustments of approximately $20.0 million.

 

Current maturities of long-term debt decreased by $86.1 million to $14.5million at March 31, 2009, compared to $100.6 million at September 30,2008 due primarily to the repayment of $75.0 million of borrowings under ourABL facilities as well as repayments of principal under our senior term loanfacilities of $22.7 million (please see Liquidity and Capital Resources below).

 

Other liabilities increased by $12.4 million to $36.1 million at March 31,2009, compared to $23.7 million at September 30, 2008 due primarily to achange in the fair value of certain of our interest rate swaps.

 

Total member’s deficit increased by $8.1 million as aresult of cumulative translation adjustments of $39.5 million and deferredlosses on interest rate swaps, net of income taxes, of $12.2 million, partiallyoffset by net earnings of $42.9 million for the six months ended March 31,2009.

 

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## **Liquidity and 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 no longerrequired 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 SeparationTransactions, we are highly leveraged and a substantial portion of ourliquidity needs will arise from debt service on indebtedness incurred primarilyin connection with the Separation Transactions and from funding the costs ofoperations, working capital and capital expenditures. As a holding company, wedepend on our subsidiaries to distribute funds to us so that we may pay ourobligations and expenses. Please see “Risk Factors—Risks Relating to OurBusiness,” and “—Risks Relating to Our Substantial Indebtedness” in Item 1A ofour Annual Report on Form 10-K for the fiscal year ended September 30,2008.

 

During the six months ended March 31, 2009, wemade scheduled payments on our senior term loans in the aggregate amount of$6.1 million. The senior term loan facilities may be prepaid at our option atany time without premium or penalty and are subject to mandatory prepayment inan amount equal to 50% of excess cash flow (as defined in the agreementgoverning the term loan facilities) for any fiscal year unless a specifiedleverage ratio is met. In January 2009, we made a mandatory repayment onthe senior term loan facilities in the amount of $16.7 million. Amounts paidpursuant to said provision may be applied, at the option of the Company,against minimum loan repayments otherwise required of us over the twelve monthperiod following any such payment under the terms of the loan agreement.

 

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

 

There can be no assurance that our business willgenerate sufficient cash flows from operations, that anticipated net salesgrowth and operating improvements will be realized or that future borrowingswill be available under our ABL facility in an amount sufficient to enable usto service our indebtedness or to fund our other liquidity needs. In addition,our ability to meet our debt service obligations and liquidity needs aresubject to certain risks, which include, but are not limited to, increases incompetitive activity, the loss of key suppliers, rising interest rates, theloss of key personnel, the ability to execute our business strategy and generaleconomic conditions. Please see “Risk Factors” in Item 1A of our Annual Report on Form 10-K for theyear ended September 30, 2008.

 

We utilize ourABL facility for the issuance of letters of credit, as well as to manage normalfluctuations in operational cash flow. In that regard, we may from time to timedraw funds under the revolving credit facility for general corporate purposesincluding acquisitions and interest payments due on our indebtedness.  Thefunds drawn on individual occasions during the six months ended March 31,2009, have varied in amounts of up to $20.0**million,with total amounts outstanding ranging from zero million up to $120.0 million.The amounts drawn are generally paid down with cash provided by our operatingactivities.

 

In September 2008, weborrowed $75 million under our existing $400 million ABL facility to increaseour cash position in order to preserve our financial flexibility in light ofthe recent dislocation of the financial markets.  We repaid suchborrowings in full before March 31, 2009.****Asof March 31, 2009, we had $318.7 million available for additionalborrowings under our ABL facility, subject to borrowing base limitations, as reducedby outstanding letters of credit.

 

We may from time to timerepurchase or otherwise retire our debt (through our subsidiaries) and takeother steps to reduce our debt or otherwise improve our balance sheet. Theseactions may include open market repurchases of our notes or other retirementsof outstanding debt. The amount of debt that may be repurchased or otherwiseretired, if any, would be decided upon at the sole discretion of Sally Beauty’sBoard of Directors and will depend on market conditions, trading levels of theCompany’s debt from time to time, the Company’s cash position and otherconsiderations.

 

Weare a holding company and do not have any material assets or operations otherthan ownership of equity interests of our subsidiaries. The agreements andinstruments governing the debt of the Company and our subsidiaries contain 

 

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materiallimitations on our ability to pay dividends and other restricted payments toSally Beauty.

 

Underthe agreements and indentures governing the term loan facilities and the notes,we may not make certain restricted payments to Sally Beauty if a default thenexists under the credit agreement or the indentures or if our consolidatedinterest coverage ratio is less than 2.0 to 1.0 at the time of the making ofsuch restricted payment.  As of March 31,2009, our consolidated interest coverage ratio exceeded 2.0 to 1.0.  Further, the aggregate amount of restrictedpayments we are able to make is limited pursuant to various baskets ascalculated pursuant to the credit agreement and indentures.

 

The agreements governing our ABL facility 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 March 31, 2009, borrowingavailability under the ABL facility exceeded $60 million. As of March 31,2009, the net assets of our consolidated subsidiaries that were unrestrictedfrom transfer under our credit arrangements totaled $201.6 million, subject tocertain adjustments**.**

 

Our primary source of cash has been from fundsprovided by operating activities and borrowings under our ABL facility for thesix months ended March 31, 2009 and 2008. Historically, the primary use ofcash has been for acquisitions and capital expenditures. The following tableshows our sources and uses of funds for the six months ended March 31,2009 and 2008 (in thousands):

 
| ** **                                                     | ** ** | **Six Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                                      | ** ** | **2008** | ** ** |
| Net cash provided by operating activities                      |       | $                                             | 124,584    |   | $ | 20,619 |   |
| Net cash used by investing activities                          |       | (18,710                                       | )          | (42,982 | ) |
| Net cash (used) provided by financing  activities              |       | (100,215                                      | )          | 14,498 |   |
| Effect of foreign exchange rates on cash  and cash equivalents |       | (769                                          | )          | 1,013 |   |
| Net increase (decrease) in cash and cash  equivalents          |       | $                                             | 4,890      |   | $ | (6,852 | ) |

###  

### *Net Cash Provided byOperating Activities*

###  

Net cash provided by operating activities, whichexcludes the effects of acquisitions, during the six months ended March 31,2009 increased by $104.0 million to $124.6 million, compared to$20.6 million during the six months ended March 31, 2008. Theincrease was primarily due to a reduction of approximately $60.2 million ininventory levels, an increase in accounts payable and accrued expenses ofapproximately $43.1 million and an improvement of approximately $13.8 millionin earnings, partially offset by an decrease in other liabilities of $20.6million for the six months ended March 31, 2009, compared to the sixmonths ended March 31, 2008.

 

### *Net Cash Used byInvesting Activities*

###  

Net cash used by investing activities during the sixmonths ended March 31, 2009, decreased by $24.3 million to$18.7 million, compared to $43.0 million during the six months ended March 31,2008.  This decrease was primarily due tolower capital expenditures and a reduction in cash used for acquisitions forthe six months ended March 31, 2009, compared to the six months ended March 31,2008.

 

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

###  

# **Net cash (used)provided by financing activities during the six months ended March 31,2009, decreased by $114.7 million to cash used of $100.2 million, comparedto cash provided of $14.5 million during the six months ended March 31,2008.  The decrease was primarily due tonet borrowings of $22.5 million under our ABL facility during the six monthsended March 31, 2008, compared to net repayments of $75.0 million duringthe six months ended March 31, 2009, as well as a $16.7 million mandatoryrepayment on our term loan facilities in January 2009 (please see *Liquidity and Capital Resources* above).**

# ** **

# **Capital Requirements**

# ** **

For fiscal year 2009, we anticipate total capitalexpenditures in the range of approximately $35.0 million to $40.0 million,excluding acquisitions. We expect that capital expenditures will be primarilyfor the addition of new stores 

 

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and the remodeling, expansion and/or relocation ofexisting stores in the ordinary course of our business as well as certaincorporate projects.

 

## **Contractual Obligations**

##  

Therehave been no material changes outside the ordinary course of business in any ofour contractual obligations since September 30, 2008.

 

## **Off-Balance Sheet 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 $11.4 million and $12.1 million at March 31,2009 and September 30, 2008, respectively.

 

## **Inflation**

##  

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

 

## **Critical Accounting Policies and Estimates**

##  

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

 

Our critical accounting policies, 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**

# ** **

TheCompany adopted the provisions of Statement of Financial Accounting Standards (“SFAS”)No. 161, *Disclosures about Derivative Instruments andHedging Activities, an Amendment of FASB Statement No. 133* (“SFAS161”) effective on January 1, 2009. SFAS No. 133,*Accountingfor Derivative Instruments and Hedging Activities* (“SFAS 133”),establishes, among other things, the disclosure requirements for derivativeinstruments and for hedging activities. SFAS 161 amended and expanded those disclosures to also requirequalitative disclosures about the objectives and strategies for usingderivative instruments, quantitative disclosures about the fair value of andgains and losses on derivative instruments and disclosures aboutcredit-risk-related contingent features 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.

 

Asrequired by SFAS 133, as amended, the Company records all derivativeinstruments on its balance sheet at fair value.  The accounting forchanges in the fair value of derivative instruments depends on the intended useof the derivative, whether the Company has elected to designate a derivativeinstrument in a hedging relationship and apply hedge accounting and whether thehedging relationship has satisfied the criteria necessary to apply hedgeaccounting. Derivative instruments designated and qualifying as a hedge of theexposure to variability in expected future cash flows, or other types offorecasted transactions, are considered cash flow hedges. Hedge accountinggenerally provides for the matching of the timing of gain or loss recognitionon the hedging instrument with the recognition of the impact on earnings of thehedged transaction or transactions. The Company may from time to time enterinto derivative contracts that are intended to hedge certain economic riskseven though hedge accounting does not apply or the Company elects not to applyhedge accounting to such derivative contracts. Please see Note 7 for moredetails about the Company’s derivative instruments and hedging activities as ofMarch 31, 2009.

 

TheCompany adopted the provisions of SFAS No. 157, *Fair ValueMeasurements* (“SFAS 157”), as it relates to its financialinstruments, 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 

 

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newfair value measurements; rather, it amends other accounting pronouncements thatrequire or permit fair value measurements. SFAS 157 defines “fair value” as the price that would be received tosell an asset or paid to transfer a liability in the principal or mostadvantageous market in an orderly transaction between market participants onthe measurement date.  SFAS 157establishes a three-level hierarchy for measuring fair value and requires anentity to maximize the use of observable inputs and minimize the use ofunobservable inputs when measuring fair value.

 

Thisvaluation hierarchy is based upon the transparency of inputs to the valuationof an asset or liability on the measurement date.  The three levels of that hierarchy aredefined as follows:

 

Level1- Unadjusted quoted prices in active markets for identical assets orliabilities

 

Level2 - Unadjusted quoted prices in active markets for similar assets orliabilities; or unadjusted quoted prices for identical or similar assets orliabilities in markets that are not active; or inputs other than quoted pricesthat are observable for the asset or liability; or inputs that are derived principallyfrom or corroborated by observable market data

 

Level3 - Unobservable inputs for the asset or liability

 

TheCompany measures certain financial assets and liabilities at fair value on arecurring basis, including interest rate swaps. Although the Company has determined that the majority of the inputs usedto value its interest rate swaps fall within Level 2 of the valuationhierarchy, the credit valuation adjustments associated with its interest rateswaps utilize Level 3 inputs, such as estimates of current credit spreads toassess the likelihood of default by the Company or a counterparty. However, at March 31,2009, the Company has assessed the relative significance of such estimates tothe overall valuation of our interest rate swaps and has concluded that theCompany’s valuation inputs as a whole predominantly fall in the Level 2hierarchy. 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 March 31, 2009** | ** ** |
|------------------------------------|------------|-------------------------------|------------|
| ** **                         | ** ** | **Total**                     | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Liabilities                        |       |                          |       |   |   |   |   |   |   |
| Hedged interest rate swaps (1)     |       | $                             | 18,592     |   |   |   | $ | 18,592 |   |   |   |
| Non-hedged interest rate swaps (1) |       | 8,447                         |       |   |   | 8,447 |   |   |   |
| Total                              |       | $                             | 27,039     |   |   |   | $ | 27,039 |   |   |   |

----

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

 

InOctober 2008, the Financial Accounting Standards Board (“FASB”) issuedFASB Staff Position (“FSP”) FAS No. 157-3, *Determiningthe Fair Value of a Financial Asset When the Market for That Asset Is NotActive*(“FAS 157-3”)*,* whichclarifies the application of SFAS 157. FAS 157-3 was effective upon issuanceand its adoption did not have a material impact on the Company’s financialstatements.

 

InApril 2009, the FASB issued FSP-FAS No. 157-4, *DeterminingFair Value When the Volume and Level of Activity for the Asset or LiabilityHave Significantly Decreased and Identifying Transactions That Are Not Orderly*(“FAS157-4”).  This FSP provides guidance todetermining fair values when there is no active market or where the priceinputs available represent distressed sales transactions. As allowed by FAS157-4, the Company early-adopted the provisions of FAS 157-4 and its adoptiondid not have a material effect on the Company’s consolidated financialposition, results of operations or cash flows.

 

InApril 2009, the FASB 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, withearly adoption permitted for periods ending after March 15, 2009. TheCompany’s adoption of FAS No. 107-1/APB 28-1, effective January 1,2009, did not have a material effect on the Company’s consolidated financialposition, results of operations or cash flows.

 

Effectiveas of October 1, 2008, the Company also adopted the provisions of SFAS No. 159,*The Fair Value Option for Financial Assets andFinancial Liabilities - including an amendment of FASB Statement No. 115*,which permits 

 

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entitiesto choose to measure certain financial assets and liabilities at fair value,but elected not to measure any additional assets or liabilities at fair valuethat are not already measured at fair value prior to such adoption.  As a result, the adoption of SFAS 159 did nothave an impact on the Company’s consolidated financial position, results ofoperations or cash flows.

 

Wehave not yet adopted and are currently assessing any potential effect of thepronouncements discussed below on our consolidated financial statements.

 

InJune 2008, the Emerging Issues Task Force reached consensus onEITF 08-3, *Accounting by Lessees forNonrefundable Maintenance Deposits*. Under EITF 08-3, lessees shouldaccount for nonrefundable maintenance deposits as deposit assets if it isprobable that maintenance activities will occur and the deposit is thereforerealizable. Amounts on deposit that are not probable of being used to fundfuture maintenance activities should be expensed. EITF 08-3 is effective forfiscal years beginning after December 15, 2008. Early application is notpermitted.

 

In April 2008, the FASBissued Staff Position FAS No. 142-3, *Determination of theUseful Life of Intangible Assets*. FAS 142-3 amends the factors thatshould be considered in developing renewal or extension assumptions used todetermine the useful life of a recognized intangible asset under SFAS No. 142,*Goodwill and Other Intangible Assets*.The objective of the Staff Position is to improve the consistency between theuseful life of a recognized intangible asset under SFAS 142 and the periodof expected cash flows used to measure the fair value of the asset under SFAS No. 141(Revised 2007): *Business Combinations* and otherGAAP. FAS 142-3 is effective for fiscal years beginning after December 15,2008. Early application is not permitted.

 

In December 2007, the FASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated FinancialStatements, an amendment to ARB No. 51*, which requires, amongother things, that the noncontrolling interest (previously referred to asminority interest) in a consolidated subsidiary’s equity be reported as acomponent of equity separate from the parent’s interest and that net income orloss attributable to the noncontrolling interest be included in consolidatednet income on the face of the income statement. In addition, purchases andsales of equity interest that do not result in a change in control will beaccounted for as equity transactions and, upon a loss of control, the interestsold, as well as any interest retained, will be recorded at fair value with anygain or loss recognized in earnings. SFAS 160 is effective for fiscal years,and interim periods within those fiscal years, beginning on or after December 15,2008.  Early application is not permitted.

 

In December 2007, the FASB issued SFAS No. 141(Revised 2007), *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.

 

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 must also be appliedprospectively to business combinations consummated on or after the first annualreporting period beginning on or after December 15, 2008.  Early application is not permitted.

 

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##  

# **Item 3.  Quantitativeand Qualitative Disclosures About Market Risk.**

# ** **

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

 

## **Foreign currency 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 $50.9 million, for the six monthsended March 31, 2009, such fluctuations did not have a material effect onour financial condition and net earnings for the three and six month periodsended March 31, 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 March 31, 2009 and 2008 or for the interim periodsthen ended.

 

## **Interest rate risk**

##  

As a result of the debt financing incurred inconnection with the Separation Transactions, we are subject to interest ratemarket risk in connection with our long-term debt. The principal interest rateexposure relates to amounts borrowed under the term loans and the ABL facility.Based on the approximately $1.0 billion of aggregate borrowings under theCompany’s term loans and the ABL facility as of March 31, 2009, a changein the 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 swapagreements, for periods consistent with the related underlying exposures. We donot purchase 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 March 31, 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%. These interest rate swapagreements do not currently qualify as hedges and, therefore, the change in thefair value of these interest rate swap agreements, which are adjustedquarterly, are recorded in net interest expense in the Company’s results ofoperations. As discussed in Item 1A “Risk Factors” in our Annual Report on Form 10-K for thefiscal year ended September 30, 2008, changes in the fair value ofthese interest rate swap agreements are mainly driven by interest rate changesand will increase or decrease our net interest expense and may therefore affectour earnings.

 

Effective in May 2008, we entered into twoadditional interest rate swap agreements with anaggregate notional amount of $300 million (each agreement with anotional amount of $150 million).  Theseagreements expire on May 31, 2012 and enable us to convert a portion ofour variable interest rate obligations to fixed rate obligations with interestranging from 5.818% to 6.090%.  Theseagreements are designated as effective hedges, consistent with SFAS 133, *Accounting for Derivative Instruments and Hedging Activities*.  Adjustments to reflect the change in the fairvalues 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.  Any ineffectiveness of these interest rateswaps is recognized in earnings.

 

## **Creditrisk**

##  

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

 

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

 

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# **Item4.  Controls and Procedures.**

# ** **

*Controls Evaluation 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.

 

Certificationsof our CEO and our CFO, which are required in accordance with Rule 13a-14of the Securities Exchange Act of 1934, as amended (“Exchange Act”), areattached as exhibits to this report. This “Controls and Procedures” sectionincludes the information concerning the controls evaluation referred to in thecertifications and it should be read in conjunction with the certifications fora more complete understanding of the topics presented.

 

*Limitations on the Effectiveness of Controls.*  Wedo not expect that our disclosure controls and procedures will prevent allerrors and all fraud. A system of controls and procedures, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the system are met. Because of the limitations in allsuch systems, no evaluation can provide absolute assurance that all controlissues and instances of fraud, if any, have been detected. Furthermore, thedesign of any system of controls and procedures is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions, regardless of how unlikely. Because of theseinherent limitations in a cost-effective system of controls and procedures,misstatements or omissions due to error or fraud may occur and not be detected.

 

*Scope of the Controls Evaluation.*  Theevaluation of our disclosure controls and procedures included a review of theirobjectives and design, our implementation of the controls and procedures and theeffect of the controls and procedures on the information generated for use inthis report. In the course of the evaluation, we sought to identify whether wehad any data errors, control problems or acts of fraud and to confirm thatappropriate corrective action, including process improvements, was beingundertaken if needed. This type of evaluation is performed on a quarterly basisso that conclusions concerning the effectiveness of our disclosure controls andprocedures can be reported in our Quarterly Reports on Form 10-Q and ourAnnual Reports on Form 10-K. Many of the components of our disclosurecontrols and procedures are also evaluated by our internal audit department,our legal department and by personnel in our finance organization. The overallgoals of these various evaluation activities are to monitor our disclosurecontrols and procedures on an ongoing basis, and to maintain them as dynamicsystems that change as conditions warrant.

 

*Conclusions regarding Disclosure Controls.*  Basedon the required evaluation of our disclosure controls and procedures, our CEOand CFO have concluded that, as of March 31, 2009, we maintain disclosurecontrols and procedures that are effective in providing reasonable assurancethat information 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 March 31, 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 believethat we are in material compliance with such laws and regulations, although noassurance can be provided that this will remain true going forward.

 

On February 25, 2008,Sally Beauty disclosed in a Current Report on Form 8-K that on February 21,2008, L’Oreal filed a lawsuit in the Superior Court of the State of Californiain and for the County of San Diego — Central Division naming, among others, SDHair, Ltd. and Hair of Nevada, LLC (collectively, “SD Hair”), franchisees ofour subsidiary Armstrong McCall division (“AMLP”) of our BSG business unit, asdefendants.  The suit alleged, among other things, that SD Hair breachedits franchise agreement with AMLP by diverting (selling) Matrix brandedproducts to unauthorized buyers, and that L’Oreal is entitled to make claimsagainst SD Hair under the franchise agreement as a third-party beneficiary ofthat agreement.  The suit also alleged, among other issues, that SD Hairinduced AMLP to breach its agreement to distribute Matrix branded products (the“Matrix Agreement”) in some unspecified manner.  L’Oreal’scomplaint against SD Hair was subsequently amended to delete the reference toAMLP’s breach of the Matrix Agreement as one of the specific contractualrelationships that SD Hair allegedly induced and caused to be breached.  However, the amended complaint does notdesignate which distributors are at issue, and L’Oreal has not stated on therecord whether it continues to allege that SD Hair induced and caused AMLP tobreach the Matrix Agreement.  As of May 6,2009, neither Sally Beauty nor any ofits subsidiaries (including AMLP) were a defendant in the lawsuit filed by L’Oreal.  On March 24, 2008, however, SD Hair filed a cross-complaint inthe same case naming AMLP and BSG as cross-defendants, seeking, among otherthings, i) declaratory relief from BSG and AMLP in the form of a judicialfinding that SD Hair is not inbreach of its franchise agreement and that L’Oreal has no rights as athird-party beneficiary to SD Hair’s franchise agreement, and ii) injunctiverelief in the form of a judicial order compelling AMLP and BSG to takeappropriate legal action against L’Oreal to enforce SD Hair’s claimed rightsunder AMLP’s Matrix distribution agreement.  We have answered thecross-complaint and the lawsuit has been set for a jury trial in November of2009. No monetary relief is being sought by SD Hair.

 

# **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 materialchanges from the risk factors disclosed in our Annual Report.  The risks described in that report are notthe only risks facing our company. Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/or operating results.**

##  

# **Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds.**

# ** **

(a) Notapplicable

 

(b) Notapplicable

 

(c) Notapplicable

 

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

# ** **

Not applicable

 

# **Item4.  Submission of Matters to a Vote ofSecurity 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 herein by reference from  Exhibit 2.1 to Amendment No. 3 to the Registration Statement on  Form S-4 of New Sally Holdings, Inc. (File No. 333-136259)  filed on October 10, 2006                                                                      |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.2                  |       | First  Amendment to the Investment Agreement, dated as of October 3, 2006,  among Alberto-Culver Company, New Aristotle Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and CDRS Acquisition LLC,  which is incorporated herein by reference from Exhibit 2.2 to Amendment  No. 3 to the Registration Statement on Form S-4 of New Sally  Holdings, Inc. (File No. 333-136259) filed on October 10, 2006                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.3                  |       | Second  Amendment to the Investment Agreement, dated as of October 26, 2006,  among Alberto-Culver Company, New Aristotle Company, Sally Holdings, Inc.,  New Sally Holdings, Inc. and CDRS Acquisition LLC, which is incorporated  herein by reference from Exhibit 2.02 to the Current Report on  Form 8-K of New Sally Holdings, Inc. (File No. 333-136259)  filed on October 30, 2006                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.4                  |       | Separation  Agreement, dated as of June 19, 2006, among Alberto-Culver Company,  Sally Holdings, Inc., New Sally Holdings, Inc. and New Aristotle  Holdings, Inc., which is incorporated herein by reference from  Exhibit 2.3 to Amendment No. 3 to the Registration Statement on  Form S-4 of New Sally Holdings, Inc. (File No. 333-136259)  filed on October 10, 2006                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.5                  |       | First  Amendment to the Separation Agreement, dated as of October 3, 2006,  among Alberto-Culver Company, Sally Holdings, Inc., New Sally  Holdings, Inc. and New Aristotle Holdings, Inc., which is  incorporated herein by reference from Exhibit 2.4 to Amendment  No. 3 to the Registration Statement on Form S-4 of New Sally  Holdings, Inc. (File No. 333-136259) filed on October 10, 2006                                                       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.6                  |       | Second  Amendment to the Separation Agreement, dated as of October 26, 2006,  among Alberto-Culver Company, Sally Holdings, Inc., New Sally  Holdings, Inc. and New Aristotle Holdings, Inc., which is  incorporated herein by reference from Exhibit 2.01 to the Current Report  on Form 8-K of New Sally Holdings, Inc. (File No. 333-136259)  filed on October 30, 2006                                                                                    |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.1                  |       | Certificate  of Formation of Sally Holdings LLC, which is incorporated herein by reference  to Exhibit 3.1 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                                                                                                                                                                                                                                      |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.2                  |       | Limited  Liability Company Agreement of Sally Holdings LLC, which is incorporated  herein by reference from Exhibit 3.2 to the Registration Statement on  Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally  Capital Inc. filed on July 9, 2007                                                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.3                  |       | Certificate  of Incorporation of Sally Capital Inc., which is incorporated herein by  reference from Exhibit 3.3 to the Registration Statement on  Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally  Capital Inc. filed on July 9, 2007                                                                                                                                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.4                  |       | By-Laws  of Sally Capital Inc., which is incorporated herein by reference from  Exhibit 3.4 to the Registration Statement on Form S-4 (File  No. 333-144427) of Sally Holdings LLC and Sally Capital Inc. filed on  July 9, 2007                                                                                                                                                                                                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.1                  |       | Stockholders  Agreement, dated as of November 16, 2006, by and among the Company, CDRS  Acquisition LLC, CD&R Parallel Fund VII, L.P. and the other stockholders  party thereto, which is incorporated by reference from Exhibit 4.8 to  the Current Report on Form 8-K of Sally Beauty Holdings, Inc. filed  on November 22, 2006                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.2                  |       | First  Amendment to the Stockholders Agreement, dated as of December 13, 2006,  between the Company and CDRS Acquisition LLC and Carol L. Bernick, as  representative of the other stockholders, which is incorporated herein by  reference from Exhibit 4.2 to the Annual Report on Form 10-K of  Sally Beauty Holdings, Inc. filed on December 22, 2006                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.3                  |       | Indenture,  dated as of November 16, 2006, by and among Sally Holdings LLC and Sally  Capital Inc., as Co-Issuers, the Subsidiary Guarantors from time to time  parties thereto, and Wells Fargo Bank, National Association, as Trustee,  governing the 9.25% Senior Notes due 2014, which is incorporated by reference  from Exhibit 4.1 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.4                  |       | First  Supplemental Indenture, dated as of May 30, 2007, by and among Sally  Holdings LLC and Sally Capital Inc., as co-Issuers, the Subsidiary Guarantors  named therein, and Wells Fargo Bank, National Association, as trustee,  governing the 9.25% Senior Notes due 2014, which is incorporated herein by  reference from Exhibit 4.2 from the Registration Statement on Form S-4  (File No. 333-144427) of Sally Holdings LLC and Sally Capital Inc. filed  on July 9, 2007 |

 

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| 4.5    |   | Indenture,  dated as of November 16, 2006, by and among Sally Holdings LLC and Sally  Capital Inc., as Co-Issuers, the Subsidiary Guarantors from time to time  parties thereto, and Wells Fargo Bank, National Association, as Trustee,  governing the 10.5% Senior Subordinated Notes due 2016, which is incorporated  by reference from Exhibit 4.2 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                                    |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.6    |   | First  Supplemental Indenture, dated as of May 30, 2007, by and among Sally  Holdings LLC and Sally Capital Inc., as co-Issuers, the Subsidiary Guarantors  named therein, and Wells Fargo Bank, National Association, as trustee,  governing the 10.5% Senior Subordinated Notes due 2016, which is incorporated  herein by reference from Exhibit 4.4 from the Registration Statement on  Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally  Capital Inc. filed on July 9, 2007                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.7    |   | Exchange  and Registration Rights Agreement, dated as of November 16, 2006, by and  among Sally Holdings LLC, Sally Capital Inc., the Subsidiary Guarantors  parties thereto, Merrill Lynch, Pierce, Fenner & Smith, Incorporated  and the other financial institutions named therein, relating to the 9.25%  Senior Notes due 2014, which is incorporated by reference from Exhibit 4.3  to the Current Report on Form 8-K of Sally Beauty Holdings, Inc.  filed on November 22, 2006                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.8    |   | Exchange  and Registration Rights Agreement, dated as of November 16, 2006, by and  among Sally Holdings LLC, Sally Capital Inc., the Subsidiary Guarantors parties  thereto, Merrill Lynch, Pierce, Fenner & Smith, Incorporated and the  other financial institutions named therein, relating to the 10.5% Senior  Subordinated Notes due 2016, which is incorporated by reference from  Exhibit 4.4 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.9    |   | Credit  Agreement, dated November 16, 2006, with respect to a Term Loan  Facility, by and among Sally Holdings LLC, the several lenders from time to  time parties thereto, and Merrill Lynch Capital Corporation, as  Administrative Agent and Collateral Agent, which is incorporated by reference  from Exhibit 4.5.1 to the Current Report on Form 8-K of Sally  Beauty Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.10   |   | Guarantee  and Collateral Agreement, dated as of November 16, 2006, made by Sally  Investment Holdings LLC, Sally Holdings LLC and certain subsidiaries of Sally  Holdings LLC in favor of Merrill Lynch Capital Corporation, as Administrative  Agent and Collateral Agent, which is incorporated by reference from  Exhibit 4.5.2 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.11   |   | Credit  Agreement, dated November 16, 2006, with respect to an Asset-Based Loan  Facility, among Sally Holdings LLC, Beauty Systems Group LLC, Sally Beauty  Supply LLC, any Canadian Borrower from time to time party thereto, certain  subsidiaries of Sally Holdings LLC, the several lenders from time to time  parties thereto, Merrill Lynch Capital, a division of Merrill Lynch Business  Financial Services Inc., as Administrative Agent and Collateral Agent, and  Merrill Lynch Capital Canada Inc., as Canadian Agent and Canadian Collateral  Agent, which is incorporated by reference from Exhibit 4.6.1 to the  Current Report on Form 8-K of Sally Beauty Holdings, Inc. filed on  November 22, 2006 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.12   |   | U.S.  Guarantee and Collateral Agreement, dated as of November 16, 2006, made  by Sally Investment Holdings LLC, Sally Holdings LLC and certain subsidiaries  of Sally Holdings LLC in favor of Merrill Lynch Capital, a division of  Merrill Lynch Business Financial Services Inc., as Administrative Agent and  Collateral Agent, which is incorporated by reference from Exhibit 4.6.2  to the Current Report on Form 8-K of Sally Beauty Holdings, Inc.  filed on November 22, 2006                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.13   |   | Canadian  Guarantee and Collateral Agreement, dated as of November 16, 2006, made  by Sally Beauty (Canada) Corporation, Beauty Systems Group  (Canada), Inc., Sally Beauty Canada Holdings Inc. and certain of their  respective subsidiaries in favor of Merrill Lynch Capital Canada Inc., as  Canadian Agent and Canadian Collateral Agent, which is incorporated by  reference from Exhibit 4.6.3 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on November 22, 2006                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 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   |   | Form of  Amended and Restated Severance Agreement for Executive Officers (Gary G.  Winterhalter, Michael G. Spinozzi, John R. Golliher, W. Richard Dowd, Bennie  L. Lowery, Raal H. Roos) effective as of October 3, 2008, which is  incorporated by reference from Exhibit 10.1 to the Current Report on  Form 8-K of Sally Beauty Holdings, Inc. filed on October 6,  2008                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 31.1   |   | Rule 13(a)-14(a)/15(d)-14(a) Certification  of Gary G. Winterhalter*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

 

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| 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 reviewing the agreements included asexhibits to this Quarterly Report, please remember they are included to provideyou with information regarding their terms and are not intended to provide anyother factual or disclosure information about the Company or the other partiesto the agreements. The agreements contain representations and warranties byeach of the parties to the applicable agreement. These representations andwarranties have been made solely for the benefit of the other parties to theapplicable agreement and:

 

·                  should not in allinstances be treated as categorical statements of fact, but rather as a way ofallocating the risk to one of the parties if those statements prove to beinaccurate;

·                  have beenqualified by disclosures that were made to the other party in connection withthe negotiation of the applicable agreement, which disclosures are notnecessarily reflected in the agreement;

·                  may applystandards of materiality in a way that is different from what may be viewed asmaterial to you or other investors; and

·                  were made only asof the date of the applicable agreement or such other date or dates as may bespecified in the agreement and are subject to more recent developments.

 

Accordingly,these representations and warranties may not describe the actual state ofaffairs as of the date they were made or at any other time. Additionalinformation about the Company may be found elsewhere in this filing and in theCompany’s other public filings, which are available without charge through theSEC’s website at http://www.sec.gov. Please see “Where You Can Find MoreInformation.”

 

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**SIGNATURE**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                              |                                                       |
|-----------------------------------|------------------------------------------------------------|
|                              | SALLY HOLDINGS LLC                                         |
|                              | (Registrant)                                               |
|                              |                                                       |
| Date:  May 6, 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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