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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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**x****                             ****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 2008**

 

**-OR-**

 

**o****                                ****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

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

 

**3001 Colorado Boulevard**

**Denton, Texas 76210**

(Address of principal executive offices)

 

Registrants’ telephone number, including areacode:**(940) 898-7500**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports) and (2) has been subject tosuch filing requirements for the past 90 days. YES  x   NO  o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act.)    YES  o    NO  x

 

Novoting or non-voting common equity of the registrants was held bynon-affiliates of the registrants as of June 30, 2008.  As of August 4, 2008, all member unitswere owned by Sally Investment Holdings LLC, a wholly-owned subsidiary of SallyBeauty Holdings, Inc.

 

 

 

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**TABLE OF CONTENTS**

 
| ** ** | ** ** | **Page** |
|------------|------------|----------|

 
| PART I  – FINANCIAL INFORMATION |                                                                                        |
|-------------------------------------------|---------------------------------------------------------------------------------------------|
|                                      |                                                                                        |   |
| ITEM 1.                                   | FINANCIAL STATEMENTS                                                                        | 5 |
| ITEM 2.                                   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 29 |
| ITEM 3.                              | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 | 45 |
| ITEM 4.                                   | CONTROLS AND  PROCEDURES                                                                    | 47 |
|                                      |                                                                                        |   |
| PART II – OTHER INFORMATION     |                                                                                        |
|                                      |                                                                                        |
| ITEM 1.                                   | LEGAL PROCEEDINGS                                                                           | 48 |
| ITEM  1A.  RISK FACTORS              | 48                                                                                          |
| ITEM 2.                                   | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                | 48 |
| ITEM 3.                                   | DEFAULTS  UPON SENIOR SECURITIES                                                            | 48 |
| ITEM 4.                                   | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        | 49 |
| ITEM 5.                                   | OTHER INFORMATION                                                                           | 49 |
| ITEM 6.                                   | EXHIBITS                                                                                    | 49 |

 

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SinceNovember 16, 2006, Sally Holdings LLC, a limited liability companyorganized under the laws of the State of Delaware (“Sally Holdings”), has beena wholly-owned subsidiary of Sally Investment Holdings LLC (“Sally Investment”),which is a wholly-owned subsidiary of Sally Beauty Holdings, Inc., (“SallyBeauty”). All of the interests of Sally Holdings are beneficially owned bySally Investment, and all of the interests of Sally Investment are beneficiallyowned by Sally Beauty.  Prior to November 16,2006, Sally Holdings was a Delaware corporation named “Sally Holdings, Inc.”and was a wholly-owned subsidiary of Alberto-Culver Company, which we refer toas “Alberto-Culver.” On November 16, 2006, Sally Holdings, Inc. wasconverted to a Delaware limited liability company, was renamed “Sally HoldingsLLC” and became a wholly-owned subsidiary of Sally Investment and an indirectsubsidiary of Sally Beauty in connection with the separation of Sally Holdings’business from Alberto-Culver. All operations of Sally Investment and SallyBeauty are conducted through Sally Holdings and its consolidatedsubsidiaries.  Sally Capital Inc., aDelaware corporation which we refer to as “Sally Capital,” is a wholly-ownedsubsidiary of Sally Holdings and does not have any assets or operations of anykind.

 

Inthis report, references to the “Company,” “Sally Holdings,” “our company,” “we,”“our,” “ours” and “us” refer to Sally Holdings LLC and its consolidatedsubsidiaries for periods after the separation from Alberto-Culver and to SallyHoldings, Inc. and its consolidated subsidiaries for periods prior to theseparation from Alberto-Culver unless otherwise indicated or the contextotherwise requires.

 

CautionaryNotice 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.

 

Readersare cautioned not to place undue reliance on forward-looking statements as suchstatements speak only as of the date they were made. Any forward-lookingstatements involve risks and uncertainties that could cause actual events orresults to differ materially from the events or results described in the forward-lookingstatements, including, but not limited to, risks and uncertainties related to:

 

·             SallyBeauty’s limited history as a stand-alone company;

 

·             the preparedness of our accounting and othermanagement systems to meet financial reporting and other requirements and theupgrade of our existing financial reporting system;

 

·             the representativeness of our historicalconsolidated financial information with respect to our future financialposition, results of operations or cash flows;

 

·              realizing the anticipated benefits of ourseparation from Alberto-Culver;

 

·             our inability to achieve the benefits ofscale that were achieved by Alberto-Culver prior to our separation fromAlberto-Culver;

 

·             Sally Capital and Sally Beauty being holdingcompanies with no operations of their own, and depending on their subsidiariesfor cash;

 

·             the highly competitive nature of, and theincreasing consolidation of, the beauty products distribution industry;

 

·             anticipating changes in consumer preferencesand buying trends or to manage our product lines and inventory;

 

·             our dependence upon manufacturers who may be unwillingor unable to continue to supply products to us;

 

·             products sold by us being found to bedefective in labeling or content;

 

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·             compliance with laws and regulations, orbecoming subject to additional or more stringent laws and regulations;

 

·             product diversion to mass retailers;

 

·             the operational and financial performance ofour Armstrong McCall, L.P. business;

 

·             the success of our new Internet-basedbusiness;

 

·             successfully identifying acquisitioncandidates or successfully completing desirable acquisitions;

 

·             integrating businesses acquired in thefuture;

 

·             opening and operating new stores profitably;

 

·             the success of our cost control plans;

 

·             protecting our intellectual property rights,specifically our trademarks;

 

·             conducting business in international markets;

 

·             disruption in our information technologysystems;

 

·             natural disasters or acts of terrorism;

 

·             our substantial indebtedness;

 

·             the possibility that we may incur substantialadditional debt;

 

·             restrictions and limitations in theagreements and instruments governing our debt;

 

·             generating the significant amount of cashneeded to service all of our debt and refinancing all or a portion of ourindebtedness or obtaining additional financing;

 

·             changes in interest rates increasing the costof servicing our debt or increasing our interest expense due to our interestrate swap agreements;

 

·             the share distribution of Alberto-Culvercommon stock in our separation from Alberto-Culver not constituting a tax-freedistribution;

 

·             actions taken by certain large shareholdersof Sally Beauty adversely affecting the tax-free nature of the share distributionof Alberto-Culver common stock;

 

·             significant restrictions on Sally Beauty’sability to issue equity securities;

 

·             the voting power of Sally Beauty’s largeststockholder discouraging third party acquisitions of Sally Beauty at a premium;and

 

·             the interests of Sally Beauty’s largeststockholder differing from the interests of other holders of Sally Beauty’scommon stock.

 

Additionalfactors that could cause actual events or results to differ materially from theevents or results described in the forward-looking statements can be found inour Annual Report on Form 10-K for the fiscal year ended September 30,2007, as filed with the Securities and Exchange Commission (the “SEC”). Theevents described in the forward-looking statements might not occur or mightoccur to a different extent or at a different time than we have described. As aresult, our actual results may differ materially from the results contemplatedby these forward-looking statements. We assume no obligation to publicly updateor revise any forward-looking statements.

 

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# **PART I – FINANCIAL INFORMATION**

 

# **Item 1.  Financial Statements.**

 

Thefollowing are our consolidated balance sheets as of June 30, 2008 and September 30,2007; our consolidated statements of earnings for the three and nine monthsended June 30, 2008 and 2007 and our consolidated statements of cash flowsfor the nine months ended June 30, 2008 and 2007.  On November 16, 2006, Sally Holdings, Inc.was converted to a Delaware limited liability company, was renamed “SallyHoldings LLC” and became an indirect wholly owned subsidiary of Sally BeautyHoldings, Inc. in connection with our separation from the Alberto-CulverCompany (“Alberto-Culver”).  In thesefinancial statements and elsewhere in this Quarterly Report on Form 10-Q,we refer to these transactions as the “Separation Transactions.”  See the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2007 for additional informationabout the Separation Transactions. Sally Capital is a wholly-owned subsidiaryof Sally Holdings and does not have assets or operations of any kind.

 

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

(Unaudited)

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| ** **                                         | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                          |       | $                                | 676,830    |                            | $          | 634,880 |   | $ | 1,975,963 |   | $ | 1,874,035 |   |
| Cost of products sold and distribution  expenses   |       | 361,764                          |       | 343,993                         |       | 1,056,304 |   | 1,015,638 |   |
| Gross profit                                       |       | 315,066                          |       | 290,887                         |       | 919,659 |   | 858,397 |   |
| Selling, general and administrative  expenses (a)  |       | 224,816                          |       | 219,646                         |       | 666,528 |   | 642,042 |   |
| Depreciation and amortization                      |       | 11,806                           |       | 10,765                          |       | 35,379 |   | 30,580 |   |
| Sales-based service fee charged by  Alberto-Culver |       | —                           |       | —                          |       | — |   | 3,779 |   |
| Transaction expenses(b)                            |       | —                           |       | 18                              |       | — |   | 21,502 |   |
| Operating earnings                                 |       | 78,444                           |       | 60,458                          |       | 217,752 |   | 160,494 |   |
| Interest expense, net (c)                          |       | 29,671                           |       | 36,832                          |       | 123,797 |   | 98,882 |   |
| Earnings before provision for income taxes         |       | 48,773                           |       | 23,626                          |       | 93,955 |   | 61,612 |   |
| Provision for income taxes                         |       | 18,147                           |       | 8,971                           |       | 34,203 |   | 30,999 |   |
| Net earnings                                       |       | $                                | 30,626     |                            | $          | 14,655 |   | $ | 59,752 |   | $ | 30,613 |   |

 

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(a)                                 Selling, general and administrative expensesinclude allocated overhead costs from Alberto-Culver of $1.0 million for thenine months ended June 30, 2007; and share-based compensation of $1.3million and $3.8 million for the three months ended June 30, 2008 and2007, and $8.3 million and $10.0 million for the nine months ended June 30,2008 and 2007, respectively.

 

(b)                                 Transaction expenses are one-time chargesassociated with the separation from Alberto-Culver.

 

(c)                                  Interest expense is net of interest income of$0.2 million and $0.2 million for the three months ended June 30, 2008 and2007; and $0.6 million and $1.5 million for the nine months ended June 30,2008 and 2007, respectively; and includes income of $7.6 million and $4.0million of marked-to-market adjustments related to interest rate swaps for thethree months ended June 30, 2008 and 2007; and expense of $6.6 million andincome of $3.3 million related to interest rate swap adjustments for the ninemonths ended June 30, 2008 and 2007, respectively.

 

Earningsper share is not presented since prior to November 16, 2006,Alberto-Culver owned all shares of issued and outstanding common stock of SallyHoldings, Inc.  Since November 16,2006, all member units of Sally Holdings have been owned by Sally Investment, awholly-owned subsidiary of Sally Beauty.

 

The accompanying condensed notes, togetherwith the Notes to Consolidated Financial Statements contained in the Company’sAnnual Report on Form 10-K for the fiscal year ended September 30, 2007, are anintegral part of these financial statements.

 

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**SALLY HOLDINGS LLC ANDSUBSIDIARIES**Consolidated Balance Sheets(In thousands)

 
| ** **                                                                                                                              | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                                              | ** ** | **2008**          | ** ** | **2007**               | ** ** |
| ** **                                                                                                                              | ** ** | **(Unaudited)**   | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                              | ** ** | ** **        | ** ** | ** **             | ** ** |
| Current assets:                                                                                                                         |       |              |       |                   |       |
| Cash and cash equivalents                                                                                                               |       | $                 | 33,724     |                   | $          | 38,272 |   |
| Trade accounts receivable, less allowance  for doubtful accounts of $2,388 at June 30, 2008 and $2,564 at  September 30, 2007 |       | 46,791            |       | 51,409                 |       |
| Other receivables                                                                                                                       |       | 25,482            |       | 22,194                 |       |
| Inventories                                                                                                                             |       | 610,241           |       | 569,404                |       |
| Prepaid expenses                                                                                                                        |       | 21,323            |       | 15,375                 |       |
| Deferred income tax assets                                                                                                              |       | 21,502            |       | 15,291                 |       |
| Total current assets                                                                                                                    |       | 759,063           |       | 711,945                |       |
| Property and equipment, net of accumulated  depreciation of $239,382 at June 30, 2008 and $215,826 at  September 30, 2007     |       | 161,220           |       | 154,068                |       |
| Goodwill                                                                                                                                |       | 450,355           |       | 406,623                |       |
| Intangible assets, net of accumulated  amortization of $16,041 at June 30, 2008 and $11,904 at  September 30, 2007            |       | 68,977            |       | 70,505                 |       |
| Other assets                                                                                                                            |       | 60,025            |       | 61,120                 |       |
| Total assets                                                                                                                            |       | $                 | 1,499,640  |                   | $          | 1,404,261 |   |
| ** **                                                                                                                              |       |              |       |                   |       |
| **Liabilities  and Member’s Deficit**                                                                                              |       |              |       |                   |       |
| Current liabilities:                                                                                                                    |       |              |       |                   |       |
| Current maturities of long-term debt                                                                                                    |       | $                 | 24,135     |                   | $          | 17,147 |   |
| Accounts payable                                                                                                                        |       | 174,861           |       | 176,660                |       |
| Accrued expenses                                                                                                                        |       | 137,670           |       | 153,671                |       |
| Due to Sally Beauty                                                                                                                     |       | 21,118            |       | 18,864                 |       |
| Income taxes                                                                                                                            |       | 6,788             |       | 3,712                  |       |
| Total current liabilities                                                                                                               |       | 364,572           |       | 370,054                |       |
| Long-term debt                                                                                                                          |       | 1,783,926         |       | 1,758,594              |       |
| Other liabilities                                                                                                                       |       | 27,246            |       | 18,828                 |       |
| Deferred income tax liabilities                                                                                                         |       | 37,422            |       | 30,553                 |       |
| Total liabilities                                                                                                                       |       | 2,213,166         |       | 2,178,029              |       |
| Stock options subject to redemption                                                                                                     |       | 6,134             |       | 6,549                  |       |
| Member’s deficit:                                                                                                                  |       |              |       |                   |       |
| Member’s deficit                                                                                                                   |       | (755,087          | )          | (814,839               | )          |
|                                                                                                                                    |       |              |       |                   |       |
| Accumulated other comprehensive income                                                                                                  |       | 35,427            |       | 34,522                 |       |
| Total member’s deficit                                                                                                             |       | (719,660          | )          | (780,317               | )          |
| Total liabilities and member’s deficit                                                                                             |       | $                 | 1,499,640  |                   | $          | 1,404,261 |   |

 

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

 

The accompanying condensed notes, togetherwith the Notes to Consolidated Financial Statements contained in the Company’sAnnual Report on Form 10-K for the fiscal year ended September 30, 2007, are anintegral part of these financial statements.

 

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

(Unaudited)

 
| ** **                                                                                                          | ** ** | **Nine Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| **Cash  Flows from Operating Activities:**                                                                          |       |                                               |       |   |   |
| Net earnings                                                                                                        |       | $                                                  | 59,752     |   | $ | 30,613 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities:                                |       |                                               |       |   |   |
| Depreciation and amortization                                                                                       |       | 35,379                                             |       | 30,580 |   |
| Share-based compensation expense (net of  deferred tax benefit of $2,068 and $3,853 in 2008 and 2007, respectively) |       | 6,184                                              |       | 6,190 |   |
| Amortization of deferred financing costs                                                                            |       | 6,360                                              |       | 5,287 |   |
| Excess tax benefit from share-based  compensation                                                                   |       | (253                                               | )          | (470 | ) |
| Net loss on disposal of leaseholds and  other property                                                              |       | 146                                                |       | 1,339 |   |
| Deferred income taxes                                                                                               |       | 2,902                                              |       | 5,591 |   |
| Changes in (exclusive of effects of  acquisitions):                                                                 |       |                                               |       |   |   |
| Trade accounts receivable                                                                                           |       | 6,381                                              |       | 6,123 |   |
| Other receivables                                                                                                   |       | (3,319                                             | )          | 2,980 |   |
| Inventories                                                                                                         |       | (30,121                                            | )          | 44,895 |   |
| Prepaid expenses                                                                                                    |       | (5,606                                             | )          | (4,413 | ) |
| Other assets                                                                                                        |       | (2,672                                             | )          | (3,425 | ) |
| Accounts payable and accrued expenses                                                                               |       | (35,878                                            | )          | (1,442 | ) |
| Income taxes                                                                                                        |       | 3,116                                              |       | 1,204 |   |
| Due from Alberto-Culver                                                                                             |       | —                                             |       | 463 |   |
| Due to Sally Beauty                                                                                                 |       | (6,414                                             | )          | (2,789 | ) |
| Other liabilities                                                                                                   |       | 9,290                                              |       | 5,927 |   |
| Net cash provided by operating activities                                                                           |       | 45,247                                             |       | 128,653 |   |
| **Cash  Flows from Investing Activities:**                                                                          |       |                                               |       |   |   |
| Capital expenditures                                                                                                |       | (35,727                                            | )          | (35,656 | ) |
| Proceeds from sale of property and  equipment                                                                       |       | 255                                                |       | 8,344 |   |
| Acquisitions, net of cash acquired                                                                                  |       | (48,201                                            | )          | (70,310 | ) |
| Net cash used by investing activities                                                                               |       | (83,673                                            | )          | (97,622 | ) |
| **Cash  Flows from Financing Activities:**                                                                          |       |                                               |       |   |   |
| Change in book cash overdraft                                                                                       |       | 5,008                                              |       | (6,515 | ) |
| Proceeds from issuance of long-term debt                                                                            |       | 394,334                                            |       | 2,137,985 |   |
| Repayments of long-term debt                                                                                        |       | (366,619                                           | )          | (331,007 | ) |
| Debt issuance costs                                                                                                 |       | —                                             |       | (58,816 | ) |
| Excess tax benefit from share-based  compensation                                                                   |       | 253                                                |       | 470 |   |
| Distributions to Sally Beauty                                                                                       |       | —                                             |       | (1,809,739 | ) |
| Distributions to Alberto-Culver                                                                                     |       | —                                             |       | (39,471 | ) |
| Net cash provided (used) by financing  activities                                                                   |       | 32,976                                             |       | (107,093 | ) |
| Effect of foreign exchange rate changes on  cash and cash equivalents                                               |       | 902                                                |       | 830 |   |
| Net decrease in cash and cash equivalents                                                                           |       | (4,548                                             | )          | (75,232 | ) |
| Cash and cash equivalents, beginning of  period                                                                     |       | 38,272                                             |       | 107,571 |   |
| Cash and cash equivalents, end of period                                                                            |       | $                                                  | 33,724     |   | $ | 32,339 |   |

 

The accompanying condensed notes, togetherwith the Notes to Consolidated Financial Statements contained in the Company’sAnnual Report on Form 10-K for the fiscal year ended September 30, 2007, are anintegral part of these financial statements.

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

##### ***1. Descriptionof Business and Basis of Presentation***

 

Descriptionof Business

 

SallyHoldings is a wholly-owned subsidiary of Sally Investment, a wholly-ownedsubsidiary of Sally Beauty.  All of theinterests of Sally Holdings are beneficially owned by Sally Investment and allof the interests of Sally Investment are beneficially owned by Sally Beauty.Sally Holdings was a wholly-owned subsidiary of Alberto-Culver until November 16,2006 when it was converted to a Delaware limited liability company, was renamed“Sally Holdings LLC” and became a wholly-owned subsidiary of Sally Investmentand an indirect subsidiary of Sally Beauty in connection with the separation ofits business from Alberto-Culver. The Company and its consolidated subsidiariessell professional beauty supplies, primarily through their Sally Beauty Supplyretail stores, in the U.S., Puerto Rico, Mexico, Canada, Japan, the UnitedKingdom and certain other countries in Europe. Additionally, the Companydistributes professional beauty products to salons and professionalcosmetologists through its Beauty Systems Group (“BSG”) store operations and acommissioned direct sales force that calls on salons in the U.S., Canada, theUnited Kingdom and certain other countries in Europe, and to franchises in thesouthern and southwestern U.S. and Mexico through the operations of itssubsidiary Armstrong McCall, L.P. (“Armstrong McCall”). Certain beauty productssold by BSG and Armstrong McCall are sold through exclusive territoryagreements with the manufacturers of the products.

 

OnNovember 16, 2006, pursuant to an investment agreement amongAlberto-Culver and certain of its subsidiaries, including Sally Holdings, Inc.,and CDRS Acquisition LLC (“CDRS”), Alberto-Culver separated its consumerproducts business and its Sally Beauty Supply/BSG distribution business intotwo separate, publicly-traded companies through the SeparationTransactions.  Sally Holdings was awholly-owned subsidiary of Alberto-Culver until the Separation Transactions,when it was converted to a Delaware limited liability company, was renamed “SallyHoldings LLC” and became an indirect wholly-owned subsidiary of SallyBeauty.  Sally Beauty was formed on June 16,2006, and became the accounting successor company to Sally Holdings upon thecompletion of the Separation Transactions. See Sally Holding’s Annual Report on Form 10-K for the fiscal yearended September 30, 2007 for more information about the SeparationTransactions.

 

Allreferences in these notes to “management” are to the management of SallyHoldings. All references in these notes to the “Company” are to Sally HoldingsLLC and, prior to November 16, 2006, to Sally Holdings, Inc.

 

Inthe ordinary course of business, the Company performs certain administrativeservices on behalf of Sally Beauty. These services arecharged to Sally Beauty and netted against the amount due to Sally Beauty.  In addition, we have entered into a taxsharing agreement and we file consolidated tax returns with our parent, SallyBeauty.  See the Company’s Annual Reporton Form 10-K for the fiscal year ended September 30, 2007 for moreinformation about related parties.

 

Basisof Presentation

 

Theconsolidated interim financial statements included herein are unaudited andhave been prepared by the Company pursuant to the rules and regulations ofthe SEC.  Certain information and notedisclosures normally included in annual financial statements prepared inaccordance with generally accepted accounting principles (“GAAP”) have beencondensed or omitted pursuant to those rules and regulations, although theCompany believes that the disclosures made are adequate to make the informationnot misleading.  The consolidated interimfinancial statements include the accounts of the Company and itssubsidiaries.  All significantinter-company accounts and transactions have been eliminated in consolidation.In the opinion of management, these consolidated financial statements reflectall adjustments which are of a normal, recurring nature and which are necessaryto present fairly the consolidated financial position as of June 30, 2008and September 30, 2007, the consolidated results of operations for thethree and nine months ended June 30, 2008 and 2007 and the consolidatedcash flows for the nine months ended 

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

June 30,2008 and 2007.  The results of operationsfor these interim periods are not necessarily indicative of the results thatmay be expected for any subsequent quarter or period or the entire fiscal year.

 

Theseconsolidated interim financial statements should be read in conjunction withthe financial statements and notes thereto included in the Company’s AnnualReport on Form 10-K for the fiscal year ended September 30,2007.  The Company adheres to the sameaccounting policies in preparation of interim financial statements.  As permitted under GAAP, interim accountingfor certain expenses, including income taxes, are based on full yearassumptions.  Such amounts are expensedin full in the fiscal year incurred. For interim financial reporting purposes,income taxes are recorded based upon estimated annual effective income taxrates.

 

Certainamounts for prior periods have been reclassified to conform to the currentperiod’s presentation.

 

##### ***2.Share-Based Payments***

 

TheCompany measures the cost of employee services received in exchange for anaward of equity instruments based on the grant-date fair value of the award andrecognizes compensation expense on a straight-line basis over the vestingperiod or to the date a participant becomes eligible for retirement, ifearlier.

 

TheCompany is an indirect wholly-owned subsidiary of Sally Beauty and has noshare-based plans of its own; however, certain employees of the Company havebeen granted stock options and share awards under the plans of Sally Beauty.

 

Duringfiscal year 2007, Sally Beauty adopted the 2007 Omnibus Incentive Plan (the “2007Plan”), a share-based compensation plan, which allows for the issuance of up to10.0 million shares of Sally Beauty’s common stock. During the first quarter offiscal year 2008, Sally Beauty granted approximately 2.6 million stock optionsto the Company’s employees under the 2007 Plan. Upon the issuance of suchgrants, the Company recognized accelerated share-based compensation expense of$3.1 million in connection with certain retirement eligible employees who areeligible to continue vesting awards upon retirement under the terms of the 2007Plan.

 

Priorto November 16, 2006, the Company was a subsidiary of Alberto-Culver andhad no share-based compensation plans of its own; however, certain employees ofthe Company had been granted stock options and stock awards under share-basedcompensation plans of Alberto-Culver. Alberto-Culver treated the SeparationTransactions as though they constituted a change in control for purposes ofAlberto-Culver’s stock options and stock awards. As a result, in accordancewith the terms of these plans, all outstanding stock options and stock awardsof Alberto-Culver, including those held by the Company’s employees, becamefully vested upon completion of the Separation Transactions on November 16,2006. Due to the Separation Transactions, the Company recorded a charge, duringthe first quarter of fiscal year 2007, equal to the amount of futurecompensation expense of approximately $5.3 million that would have beenrecognized in subsequent periods as the stock options and stock awards for theCompany’s employees vested over the original vesting periods. Upon completionof the Separation Transactions, all outstanding Alberto-Culver stock optionsand stock awards held by employees of the Company became options to purchaseshares of Sally Beauty’s common stock.

 

Thefollowing table presents the total compensation cost charged against income andincluded in selling, general and administrative expenses for share-basedcompensation arrangements and the related tax benefits recognized in thestatements of earnings (in thousands):

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 
| ** **                                                                | ** ** | **Three Months Ended June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                | ** ** | **2008**                                            | ** ** | **2007 (b)**                                  | ** ** | **2008 (a)** | ** ** | **2007 (b)** | ** ** |
| Share-based compensation expense                                          |       | $                                                   | 1,347      |                                               | $          | 3,779 |   | $ | 8,252 |   | $ | 10,043 |   |
| Income tax benefit (expense) related to  share-based compensation expense |       | $                                                   | (49        | )                                                  | $          | 1,504 |   | $ | 2,068 |   | $ | 3,853 |   |

 

----

(a)          Share-based compensation expense includes $3.1 million of acceleratedexpense related to certain retirement eligible employees who are eligible tocontinue vesting awards upon retirement under the terms of the 2007 Plan forthe nine months ended June 30, 2008.

 

(b)         Share-basedcompensation expense includes $5.3 million of accelerated expense related tothe separation from Alberto-Culver for the nine months ended June 30, 2007and $2.3 million of accelerated expense related to certain retirement eligibleemployees who are eligible to continue vesting awards upon retirement for thethree and the nine months ended June 30, 2007.

 

## **Stock Options**

 

Eachoption has an exercise price that equals 100% of the market price of SallyBeauty’s common stock on the date of grant and generally has a maximum term of10 years. Options generally vest ratably over a four year period and aresubject to forfeiture until the four year vesting period is complete.

 

Thefollowing table presents a summary of the activity for Sally Beauty’s stockoptions issued to the Company’s employees for the nine months ended June 30,2008:

 
| ** **                             | ** ** | **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, 2007 |       | 6,724                                                         |       | $                                      | 7.33       |                                                                 |       |                                                 |       |   |
| Granted                                |       | 2,598                                                         |       | 8.79                                   |       |                                                                 |       |                                                 |       |
| Exercised                              |       | (307                                                          | )          | 2.00                                   |       |                                                                 |       |                                                 |       |
| Forfeited or expired                   |       | (737                                                          | )          | 8.81                                   |       |                                                                 |       |                                                 |       |
| Outstanding at June 30, 2008      |       | 8,278                                                         |       | $                                      | 7.85       |                                                                 | 8.3        |                                                 | $          | 7,406 |   |
|                                   |       |                                                          |       |                                   |       |                                                                 |       |                                                 |       |
| Exercisable at June 30, 2008      |       | 2,728                                                         |       | $                                      | 4.98       |                                                                 | 7.0        |                                                 | $          | 7,406 |   |

 

Thefollowing table summarizes information about stock options held by the Company’semployees under Sally Beauty’s option plans at June 30, 2008:

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 
| ** **                              | ** ** | **Options Outstanding**                                                  | ** ** | **Options Exercisable**                                         | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  Outstanding at  June 30, 2008  (in Thousands)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable at  June 30, 2008  (in  Thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $ 2.00                             |       | 1,660                                                                         |       | 6.0                                                                  |       | $ | 2.00 |   | 1,660 |   | $ | 2.00 |   |
| $ 7.79 – 9.66                 |       | 6,618                                                                         |       | 8.9                                                                  |       | 9.32 |   | 1,068 |   | 9.61 |   |
| Total                                   |       | 8,278                                                                         |       | 8.3                                                                  |       | $ | 7.85 |   | 2,728 |   | $ | 4.98 |   |

 

TheCompany uses the Black-Scholes option pricing method to value Sally Beauty’sstock options for each stock option award. Using this option pricing model, thefair value of each stock option award is estimated on the date of grant. Thefair value of Sally Beauty’s stock option awards, which generally vest ratablyover a four year period, is expensed on a straight-line basis over the vestingperiod of the stock options or to the date a participant becomes eligible forretirement, if earlier.

 

Theweighted average assumptions relating to the valuation of Sally Beauty’s stockoptions are as follows:

 
| ** **              | ** ** | **Nine Months Ended June 30,** | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| Expected lives (years)  |       | 5.0                                                |       | 5.0 |   |
| Expected volatility     |       | 37.5                                               | %          | 41.2 - 41.9 | % |
| Risk-free interest rate |       | 4.0                                                | %          | 4.4 - 4.6 | % |
| Dividend yield          |       | 0.0                                                | %          | 0.0 | % |

 

Theexpected life of options represents the period of time that the options grantedare expected to be outstanding and is based on historical experience ofemployees of the Company that have been granted stock options under stockoption plans of Alberto-Culver prior to the Separation Transactions. Theexpected volatility is derived by using the average volatility of Sally Beautyand similar companies since it is not practicable to estimate Sally Beauty’sexpected volatility on a stand alone basis due to a lack of 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%.

 

Theweighted average fair value of the Sally Beauty stock options issued to Companyemployees at the date of grant in the nine months ended June 30, 2008 and2007 was $3.46 and $4.11 per option, respectively. The total intrinsic value ofoptions exercised during the nine months ended June 30, 2008 was $1.8million.  The total cash received fromthese option exercises was $0.6 million and the tax benefit realized for thetax deductions from these option exercises was $0.7 million.

 

AtJune 30, 2008, approximately $11.4 million of total unrecognizedcompensation expense related to non-vested stock option awards is expected tobe recognized over the weighted average period of 2.9 years.

 

## **Stock Awards**

 

##### ***Restricted StockAwards***

 

Arestricted stock award is an award of shares of Sally Beauty’s common stockthat is subject to time-based vesting during a specified period. Restrictedstock awards are independent of option grants and are generally subject toforfeiture if employment terminates prior to the vesting of the awards.Participants have full voting and dividend rights with respect to shares ofrestricted stock awards.

 

TheCompany expenses the cost of the restricted stock awards, which is determinedto be the fair market value of the restricted stock award at the date of grant,on a straight-line basis over the vesting period 

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

(generally5 years). For these purposes, the fair market value of the restricted stockaward is determined based on the closing price of Sally Beauty’s common stockon the grant date.

 

Thefollowing table presents a summary of the activity for Sally Beauty’srestricted stock awards for the nine months ended June 30, 2008:

 
| **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, 2007 |       | 350                                             |       | $                                                          | 8.10       |                                                                 |       |   |
| Granted                               |       | 106                                             |       | 8.78                                                       |       |                                                                 |       |
| Vested                                |       | (70                                             | )          | 8.10                                                       |       |                                                                 |       |
| Forfeited                             |       | (120                                            | )          | 7.70                                                       |       |                                                                 |       |
| Non-vested at June 30, 2008      |       | 266                                             |       | $                                                          | 8.55       |                                                                 | 3.9        |   |

 

AtJune 30, 2008, approximately $2.0 million of total unrecognizedcompensation expense related to non-vested restricted stock awards is expectedto be recognized over the weighted average period of 3.9 years.

 

##### ***3.   Long-Term Debt***

 

Inconnection with the Separation Transactions on November 16, 2006, theCompany 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) issuing senior notes in an aggregate amount of$430.0 million and senior subordinated notes in an aggregate amount of $280.0million.

 

Theterm loan facilities and the ABL facility are secured by substantially all ofthe Company’s assets, those of Sally Investment, those of the Company’sdomestic subsidiaries and, in the case of the ABL facility, those of theCompany’s Canadian subsidiaries. The term loan facilities may be prepaid at theCompany’s option at any time without premium or penalty and are subject tomandatory prepayment in an amount equal to 50% of excess cash flow (as definedin the agreement governing the term loan facilities) for any fiscal year(commencing in fiscal year 2008) unless a specified leverage ratio is met and100% of the proceeds of specified asset sales that are not reinvested in thebusiness are applied to repay borrowings under the ABL facility.

 

Thesenior notes and senior subordinated notes (collectively, the “Notes”) areunsecured obligations of Sally Holdings and its co-issuer Sally Capital and areguaranteed on a senior basis (in the case of the senior notes) and on a seniorsubordinated basis (in the case of the senior subordinated notes) by eachmaterial domestic subsidiary of Sally Holdings (other than the co-issuer).Furthermore, the terms of the debt agreements significantly restrict theability of Sally Holdings to pay dividends or otherwise transfer assets.  Please see the Company’s Annual Report on Form 10-Kfor fiscal year ended September 30, 2007 for additional information aboutthe Company’s long-term debt.

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

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

 
| ** **                   | ** ** | **June 30, 2008** | ** ** | **Maturity dates  (Fiscal Year)** | ** ** | **Interest Rates**                          | ** **                           |
|------------------------------|------------|-----------------------------|------------|---------------------------------------------|------------|--------------------------------------------------|--------------------------------------|
| ABL facility                 |       | $                           | 52,308     |                                        | 2012       |                                             | (i)   PRIME and up to 0.50% or; |   |
|                         |       |                        |       |                                        |       | (ii)   LIBOR (a) plus (1.00% to 1.50%) |                                 |
| Term Loan A                  |       | 136,875                     |       | 2013                                        |       | (i)  PRIME  plus (1.00% to 1.50%) or;       |                                 |
|                         |       |                        |       |                                        |       | (ii)   LIBOR plus (2.00% to 2.50%)          |                                 |
| Term Loan B                  |       | 903,900                     |       | 2014                                        |       | (i)   PRIME plus (1.25% to 1.50%) or;       |                                 |
|                         |       |                        |       |                                        |       | (ii)LIBOR plus (2.25% to 2.50%)                  |                                 |
| Other (b)                    |       | 4,163                       |       | 2009-2014                                   |       | 4.05% to  7.0%                                   |                                 |
| Total                        |       | $                           | 1,097,246  |                                        |       |                                             |                                 |   |
|                         |       |                        |       |                                        |       |                                             |                                 |
| Senior notes                 |       | $                           | 430,000    |                                        | 2015       |                                             | 9.25%                                |   |
| Senior subordinated notes    |       | 280,000                     |       | 2017                                        |       | 10.50%                                           |                                 |
| Total                        |       | $                           | 710,000    |                                        |       |                                             |                                 |   |
|                         |       |                        |       |                                        |       |                                             |                                 |
| Capitalized leases and other |       | $                           | 815        |                                        |       |                                             |                                 |   |
| Less: current portion        |       | (24,135                     | )          |                                        |       |                                             |                                 |
| Total long-term debt         |       | $                           | 1,783,926  |                                        |       |                                             |                                 |   |

 

----

(a)          LondonInterbank Offered Rate (“LIBOR”)

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

 

Maturitiesof the Company’s long-term debt are as follows (in thousands):

 

| **Fiscal Year:**    | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| 2008                     |       | $          | 4,175      |   |
| 2009                     |       | 25,646     |       |
| 2010                     |       | 25,738     |       |
| 2011                     |       | 39,542     |       |
| 2012                     |       | 136,864    |       |
| Thereafter               |       | 1,575,281  |       |
|                     |       | $          | 1,807,246  |   |
| Capital leases and other |       | 815        |       |
| Less: current portion    |       | (24,135    | )          |
| Total                    |       | $          | 1,783,926  |   |

 

##### ***4.   Interest Rate Swaps***

 

TheCompany utilizes interest rate swaps to manage the cash flow risk associatedwith changing interest rates related to its term loans. The Company does notpurchase or hold any derivative instruments for trading or speculativepurposes.

 

Inconnection with the Separation Transactions, effective November 24, 2006,the Company entered into two interest rate swap agreements with an aggregatenotional amount of $500 million.  Theseagreements allow the Company to convert a portion of its variable interest rateobligations to a fixed rate obligation with interest rates ranging from 6.940%to 7.4975%.  These interest rate swapagreements do not qualify as hedges and, therefore, the change in the fairvalue of these interest rate swap agreements, which are adjusted quarterly, arerecorded in net interest expense in the Company’s results of operations. Thefair value of these swap agreements was a liability of approximately $9.7million at June 30, 2008.  Themarked-to-market impact of these swap arrangements on net interest expense wasa decrease of approximately $7.6 million and $4.0 million for the three monthsended June 30, 2008 and 2007, 

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

respectively;and an increase of approximately $6.6 million and a decrease of approximately$3.3 million for the nine months ended June 30, 2008 and 2007,respectively.  Please see the Company’sAnnual Report on Form 10-K for the fiscal year ended September 30,2007 for additional information about these interest rate swap agreements.

 

EffectiveMay 27, 2008, the Company entered into two interest rate swap agreementswith an aggregate notional amount of $300 million (each agreement in thenotional amount of $150 million).  Theseagreements expire on May 31, 2012 and allow the Company to convert aportion of its variable interest rate obligations to a fixed rate obligationwith interest rates ranging from 5.568% to 6.090%.  These interest rate swap agreements aredesignated as effective cash flow hedges, consistent with Statement ofFinancial Accounting Standards No. 133, *Accountingfor Derivative Instruments and Hedging Activities*(“SFAS 133”).  Adjustments to reflect the change in the fairvalues of these interest rate swap agreements, which are adjusted quarterly,are recorded, net of income tax, in accumulated other comprehensive incomeuntil the hedged obligation is settled or the swap agreements expire, whicheveris earlier.  Any ineffectiveness isrecognized in net interest expense.  Thefair value of these hedged swap agreements was an asset of approximately $3.6million at June 30, 2008.

 

Fairvalue estimates used for the swap agreements held by the Company are based onthird-party information and were determined using proprietary models based uponwell-recognized financial principles and reasonable estimates about relevantfuture market conditions.

 

Thecounter-parties to all interest rate swap instruments are large financialinstitutions which the Company believes are of high quality creditworthiness.While the Company may be exposed to potential losses due to the credit risk ofnon-performance by these counter-parties, such losses are not anticipated.

 

Theaggregate fair value of all interest rate swap agreements held at June 30,2008 was a net liability of $6.1 million, consisting of $1.3 million includedin accrued expenses, $8.4 million in other liabilities, and $3.6 millionincluded in other assets.

 

##### ***5.   Goodwill and Other Intangibles***

 

Thechange in the carrying amounts of goodwill by operating segment for the ninemonths ended June 30, 2008 is as follows (in thousands):

 
| ** **                                    | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------|------------|
| Balance at September 30, 2007            |       | $                             | 44,548     |                           | $          | 362,075   |       | $ | 406,623 |   |
| Additions, net of purchase price  adjustments |       | 34,383                        |       | 10,634                         |       | 45,017    |       |
| Foreign currency translation                  |       | 39                            |       | (1,324                         | )          | (1,285    | )          |
| Balance at June 30, 2008                 |       | $                             | 78,970     |                           | $          | 371,385   |       | $ | 450,355 |   |

 

Thefollowing table provides the gross carrying value and accumulated amortizationfor intangible assets with indefinite lives and intangible assets subject toamortization by operating segment at June 30, 2008 (in thousands):

 

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Sally Holdings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 
| ** **                                 | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------|------------|
| Balance at June 30, 2008:             |       |                          |       |                           |       |      |       |
| Intangible assets with indefinite lives:   |       |                          |       |                           |       |      |       |
| Trade names                                |       | $                             | 15,402     |                           | $          | 34,757    |       | $ | 50,159 |   |
| Other intangibles                          |       | —                        |       | 6,053                          |       | 6,053     |       |
| Total                                      |       | 15,402                        |       | 40,810                         |       | 56,212    |       |
| Intangible assets subject to amortization: |       |                          |       |                           |       |      |       |
| Gross carrying amount                      |       | 4,006                         |       | 24,800                         |       | 28,806    |       |
| Accumulated amortization                   |       | (763                          | )          | (15,278                        | )          | (16,041   | )          |
| Net value                                  |       | 3,243                         |       | 9,522                          |       | 12,765    |       |
| Total intangible assets, net               |       | $                             | 18,645     |                           | $          | 50,332    |       | $ | 68,977 |   |

 

Amortizationexpense was $1.1 million and $0.7 million for the three months ended June 30,2008 and 2007 and $4.1 million and $2.1 million for the nine months ended June 30,2008 and 2007, respectively. There have been no material changes to the Company’sfuture amortization expense schedule since September 30, 2007.

 

##### ***6.   Comprehensive Income***

 

Comprehensiveincome consists of net earnings, foreign currency translation adjustments, anddeferred gains on interest rate swaps as follows (in thousands):

 
| ** **                                                  | ** ** | **Three Months Ended June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net earnings                                                |       | $                                                   | 30,626     |                                               | $          | 14,655 |   | $ | 59,752 |   | $ | 30,613 |   |
| Other comprehensive income adjustments:                     |       |                                                |       |                                               |       |   |   |   |   |
| Foreign currency translation adjustments                    |       | 1,425                                               |       | 9,148                                              |       | (1,305 | ) | 9,884 |   |
| Deferred gains on interest rate swaps, net  of income taxes |       | 2,210                                               |       | —                                             |       | 2,210 |   | — |   |
| Comprehensive income                                        |       | $                                                   | 34,261     |                                               | $          | 23,803 |   | $ | 60,657 |   | $ | 40,497 |   |

 

**7.   Income Taxes**

 

SallyBeauty and its subsidiaries file income tax returns in the U.S. federaljurisdiction as well as in various foreign and most state jurisdictions.

 

TheSeparation Transactions 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 IRS; and (ii) an opinion of Sidley Austin LLP,counsel to Alberto-Culver, in each case, to the effect that the transactionsqualify as a reorganization under Section 368(a)(1)(D) of the Codeand a distribution eligible for non-recognition under Sections 355(a) and361(c) of the Code. 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.

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

Atax allocation agreement was signed as part of the Separation Transactions. Theagreement provides generally that Sally Beauty is responsible for itspre-separation income tax liabilities, calculated on a stand-alone basis, andAlberto-Culver is responsible for the remainder.

 

Inaddition, as the successor entity to Alberto-Culver after the SeparationTransactions, Sally Beauty relies upon the prior year federal income taxreturns of Alberto-Culver, and accounting methods established therein, forcertain calculations that affect our current U.S. federal income tax liability.

 

Inthe event 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 with Alberto-Culver. There can beno assurance that Alberto-Culver would be able to fulfill its indemnificationobligations to Sally Beauty under the tax allocation agreement ifAlberto-Culver was determined to be responsible for these taxes thereunder. TheCompany has entered into a tax sharing agreement with its parent, SallyBeauty.  In accordance with thisagreement, Sally Beauty shall cause each of its subsidiaries that are eligibleto be a member of the relevant combined tax group to join in filing aconsolidated return with respect to each jurisdiction for all tax years forwhich such subsidiary is eligible to do so under the applicable tax law.  Sally Beauty shall make all payments to theapplicable taxing authority of all combined taxes that the relevant combinedtax group is required to pay.

 

Whereallowed by current tax law, the Company is included in the consolidated incometax returns filed by Sally Beauty.  TheCompany’s provision for income taxes is recorded on the basis of filing aseparate income tax return.  Income taxescurrently payable or receivable under the consolidated income tax returns arepaid to or received from Sally Beauty.

 

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

 

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

 

SallyBeauty and the Company classify and recognize interest and penalties accruedrelated to unrecognized tax benefits in income tax expense.    The total amount of accrued interest andpenalties as of October 1, 2007 was $1.0 million.

 

Forthe twelve months following the date of adoption of FIN 48, managementanticipates that it is reasonably possible for the amount of unrecognizedbenefits (including interest accruals) to be increased by $2.5 million as aresult of additional federal, state, and foreign tax positions.  This amount includes $1.0 million of taxpositions for which the ultimate deductibility is highly certain but for whichthere is uncertainty about the timing of such deductibility.  Because of the impact of the deferred taxaccounting, other than interest, the disallowance of the shorter deductibilityperiod would not affect the annual effective tax rate but would accelerate thepayment of cash to the taxing authority to an earlier period.

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

TheInternal Revenue Service (“IRS”) has previously audited the consolidatedfederal income tax returns of Alberto-Culver through the fiscal year ending September 30,2004. The Company has not recorded a reserve for Alberto-Culver relatedliability because the Company believes any exposure is immaterial.

 

TheIRS has initiated an examination of Sally Beauty’s consolidated federal incometax returns for the tax years ended September 30, 2005 and 2006, thus ourstatute remains open from the year ended September 30, 2005 forward.  Our European subsidiaries are impacted byvarious statutes of limitations, which are generally open from 2004 forward.The statute of limitations on our Canadian operations is open from 2004forward.  Generally, states’ statutes inthe United States are open for tax reviews from 2002 forward.

 

##### ***8.   Business Segments***

 

TheCompany’s business is organized into two separate segments: (i) SallyBeauty Supply, a domestic and international chain of cash and carry retailstores, which offers professional beauty supplies to both salon professionalsand retail customers, and (ii) BSG, including its franchise-based businessArmstrong McCall, which is a full service beauty supply distributor, offeringprofessional brands of beauty products directly to salons through its own salesforce and professional only stores (including franchise stores) in generallyexclusive geographical territories in North America and parts of Europe.

 

TheCompany does not sell between segments. Segment data for the three and nine months ended June 30, 2008 and2007 is as follows (in thousands):

 
| ** **                                         | ** ** | **Three months ended   June 30,** | ** ** | **Nine months ended   June 30,** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                         | ** ** | **2008**                                              | ** ** | **2007**                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales:                                         |       |                                                  |       |                                                 |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                                                     | 427,965    |                                                 | $          | 403,525 |   | $ | 1,243,594 |   | $ | 1,157,649 |   |
| BSG                                                |       | 248,865                                               |       | 231,355                                              |       | 732,369 |   | 716,386 |   |
| Total net sales                                    |       | $                                                     | 676,830    |                                                 | $          | 634,880 |   | $ | 1,975,963 |   | $ | 1,874,035 |   |
| Earnings before provision for income taxes:        |       |                                                  |       |                                                 |       |   |   |   |   |
| Segment operating earnings:                        |       |                                                  |       |                                                 |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                                                     | 72,927     |                                                 | $          | 66,324 |   | $ | 212,389 |   | $ | 199,532 |   |
| BSG                                                |       | 21,827                                                |       | 14,952                                               |       | 60,799 |   | 46,271 |   |
| Total segment operating earnings                   |       | 94,754                                                |       | 81,276                                               |       | 273,188 |   | 245,803 |   |
| Unallocated corporate expenses (1)                 |       | (14,963                                               | )          | (17,021                                              | )          | (47,184 | ) | (49,985 | ) |
| Share-based compensation expense                   |       | (1,347                                                | )          | (3,779                                               | )          | (8,252 | ) | (10,043 | ) |
| Sales-based service fee charged by  Alberto-Culver |       | —                                                |       | —                                               |       | — |   | (3,779 | ) |
| Transaction expenses (2)                           |       | —                                                |       | (18                                                  | )          | — |   | (21,502 | ) |
| Interest expense, net of interest income           |       | (29,671                                               | )          | (36,832                                              | )          | (123,797 | ) | (98,882 | ) |
| Earnings before provision for income taxes         |       | $                                                     | 48,773     |                                                 | $          | 23,626 |   | $ | 93,955 |   | $ | 61,612 |   |

 

----

(1)          Unallocated expenses consist of corporate andshared costs. The amounts include $0.0 million and $1.0 million of overheadcharges allocated from Alberto-Culver for the nine months ended June 30,2008 and 2007, respectively.

 

(2)          Transaction expenses are one-time chargesassociated with the separation from Alberto-Culver on November 16, 2006.

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

###### **9.  Recent AccountingPronouncements**

 

Weare currently assessing the effect of the pronouncements discussed below on ourconsolidated financial statements.

 

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

 

InApril 2008, the FASB issued Staff Position FAS No. 142-3, *Determination of the Useful Life of Intangible Assets*(“FAS 142-3”). FAS 142-3 amends the factors that should be considered indeveloping renewal or extension assumptions used to determine the useful lifeof a recognized intangible asset under SFAS No. 142, *Goodwill and Other Intangible Assets* (“SFAS 142”).The objective of this FSP is to improve the consistency between the useful lifeof a recognized intangible asset under SFAS 142 and the period of expectedcash 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 beginningafter December 15, 2008. Early application is not permitted.

 

InMarch 2008, the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and Hedging Activities, anAmendment of FASB Statement No. 133* (“SFAS 161”). SFAS 161requires companies to provide qualitative disclosures about the objectives andstrategies for using derivatives, quantitative data about the fair value of andgains and losses on derivative contracts, and details of credit-risk-relatedcontingent features in their hedged positions. The statement also requires companies to disclose more information aboutthe location and amounts of derivative instruments in financial statements; howderivatives and related hedges are accounted for under SFAS 133, *Accounting for Derivative Instruments and HedgingActivities*; and how the hedges affect the entity’s financialposition, financial performance and cash flows. SFAS 161 is effective forperiods beginning after November 15, 2008. We expect the adoption of thisstatement will not have a material impact on our consolidated financialstatements.

 

InDecember 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 interest 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 periods on or after December 15, 2008.

 

InDecember 2007, the FASB, issued SFAS 141R. Among other things, SFAS 141Rgenerally requires that an acquirer recognize the assets acquired andliabilities assumed measured at their “full fair values” on the acquisitiondate. This practice replaces the practice, under predecessor SFAS 141: *Business Combinations,* of allocating thecost of an acquisition to the individual assets acquired and liabilitiesassumed based on their relative estimated fair values.  SFAS 141R further requires thatacquisition-related costs be recognized separately from the related acquisition.SFAS 141R is effective for periods beginning on or after December 15,2008.

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

In February 2007, the FASB issued SFASNo. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities - including an amendment ofFASB Statement No. 115* (“SFAS 159”). SFAS 159 permits entitiesto choose to measure many financial instruments and certain other items at fairvalue that are not currently required to be measured at fair value, withunrealized gains and losses related to these financial instruments reported inearnings at each subsequent reporting date. SFAS 159 is effective for fiscalyears beginning after November 15, 2007. 

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*, (“SFAS 157”),which defines fair value, establishes a framework for measuring fair valueunder GAAP, and expands disclosures about fair value measurements.SFAS 157 is effective for fiscal years beginning after November 15,2007. In November 2007, the FASB provided a one year deferral for theimplementation of SFAS 157 for other nonfinancial assets and liabilities.

 

###### **10.  Guarantor and Non-GuarantorCondensed Consolidated Financial Statements**

 

Thefollowing condensed consolidating financial information presents the CondensedConsolidated Balance Sheets as of June 30, 2008 and September 30,2007, the Condensed Consolidated Statement of Earnings for the three and ninemonths ended June 30, 2008 and 2007, and the Condensed ConsolidatedStatement of Cash Flows for the nine months ended June, 30 2008 and 2007 of (a) SallyHoldings or “Parent”; (b) Sally Capital Inc. or “Co-Issuer” (c) theguarantor subsidiaries; (d) the non-guarantor subsidiaries; (e) eliminationentries necessary to consolidate the Parent with the guarantor andnon-guarantor subsidiaries; and (f) the Parent on a consolidated basis.

 

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

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Balance SheetJune 30, 2008**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **          | ** ** | ** **       | ** ** | **Sally**                | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|--------------------------|------------|
| ** **                                                                  | ** ** | ** ** | ** ** | **Co-**    | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Holdings  LLC  &** | ** ** |
| ** **                                                                  | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **Subsidiaries**         | ** ** |
| **Assets**                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **          | ** ** | ** **       | ** ** | ** **               | ** ** |
| Cash and cash equivalents                                                   |       | $          | 5,021      |       | $          | —           |       | $                   | 4,730      |             | $          | 23,973                   |       | $ | — |   | $ | 33,724 |   |
| Trade accounts and other receivables, less  allowance for doubtful accounts |       | —     |       | —     |       | 49,960           |       | 22,313              |       | —           |       | 72,273                   |       |
| Due from affiliates                                                         |       | 9,065      |       | —     |       | 13,214           |       | 5,284               |       | (27,563          | )          | —                   |       |
| Inventories                                                                 |       | —     |       | —     |       | 467,259          |       | 142,982             |       | —           |       | 610,241                  |       |
| Prepaid expenses                                                            |       | 137        |       | —     |       | 10,627           |       | 10,559              |       | —           |       | 21,323                   |       |
| Deferred income tax assets                                                  |       | 1,787      |       | —     |       | 19,715           |       | —              |       | —           |       | 21,502                   |       |
| Property and equipment, net                                                 |       | —     |       | —     |       | 120,956          |       | 40,264              |       | —           |       | 161,220                  |       |
| Investment in subsidiaries                                                  |       | 1,043,287  |       | —     |       | 291,272          |       | —              |       | (1,334,559       | )          | —                   |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | —     |       | 371,821          |       | 147,511             |       | —           |       | 519,332                  |       |
| Other assets                                                                |       | 49,905     |       | —     |       | 1,465            |       | 8,655               |       | —           |       | 60,025                   |       |
| Total assets                                                                |       | $          | 1,109,202  |       | $          | —           |       | $                   | 1,351,019  |             | $          | 401,541                  |       | $ | (1,362,122 | ) | $ | 1,499,640 |   |
| **Liabilities and Member’s (Deficit) Equity**                          |       |       |       |       |       |             |       |                |       |             |       |                     |       |
| Accounts payable                                                            |       | $          | 5,008      |       | $          | —           |       | $                   | 116,675    |             | $          | 53,178                   |       | $ | — |   | $ | 174,861 |   |
| Due to affiliates                                                           |       | —     |       | —     |       | 21,805           |       | 5,758               |       | (27,563          | )          | —                   |       |
| Accrued expenses                                                            |       | 15,374     |       | —     |       | 94,292           |       | 28,004              |       | —           |       | 137,670                  |       |
| Due to Sally Beauty                                                         |       | —     |       | —     |       | 21,118           |       | —              |       | —           |       | 21,118                   |       |
| Income taxes                                                                |       | —     |       | —     |       | 992              |       | 5,796               |       | —           |       | 6,788                    |       |
| Long-term debt                                                              |       | 1,793,975  |       | —     |       | 439              |       | 13,647              |       | —           |       | 1,808,061                |       |
| Other liabilities                                                           |       | 8,371      |       | —     |       | 17,921           |       | 954                 |       | —           |       | 27,246                   |       |
| Deferred income tax liabilities                                             |       | —     |       | —     |       | 34,490           |       | 2,932               |       | —           |       | 37,422                   |       |
| Total liabilities                                                           |       | 1,822,728  |       | —     |       | 307,732          |       | 110,269             |       | (27,563          | )          | 2,213,166                |       |
| Stock options subject to redemption                                         |       | 6,134      |       | —     |       | —           |       | —              |       | —           |       | 6,134                    |       |
| Total member’s (deficit) equity                                        |       | (719,660   | )          | —     |       | 1,043,287        |       | 291,272             |       | (1,334,559       | )          | (719,660                 | )          |
| Total liabilities and member’s (deficit)  equity                       |       | $          | 1,109,202  |       | $          | —           |       | $                   | 1,351,019  |             | $          | 401,541                  |       | $ | (1,362,122 | ) | $ | 1,499,640 |   |

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

**SALLYHOLDINGS LLC AND SUBSIDIARIES**

**CondensedConsolidated Balance Sheet**

**September 30,2007**

**(Inthousands)**

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

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of EarningsThree months ended June 30, 2008**

**(In thousands)**

**(Unaudited)**

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

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of EarningsThree months ended June 30, 2007**

**(In thousands)**

**(Unaudited)**

** **
| ** **                                         | ** ** | ** ** | ** ** | ** **    | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally  Holdings LLC ** | ** ** |
|----------------------------------------------------|------------|------------|------------|---------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------------------------|------------|
| ** **                                         | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **& Subsidiaries**        | ** ** |
| Net sales                                          |       | $          | —     |          | $          | —           |       | $                   | 517,920    |             | $          | 116,960                            |       | $ | — |   | $ | 634,880 |   |
| Related party sales                                |       | —     |       | —        |       | 623              |       |                |       | (623             | )          |                               |       |
| Cost of products sold and distribution  expenses   |       | —     |       | —        |       | 278,312          |       | 66,304              |       | (623             | )          | 343,993                            |       |
| Gross profit                                       |       | —     |       | —        |       | 240,231          |       | 50,656              |       |             |       | 290,887                            |       |
| Selling, general and administrative  expenses      |       | 384        |       | —        |       | 172,966          |       | 46,296              |       |             |       | 219,646                            |       |
| Depreciation and amortization                      |       | —     |       |          |       | 8,191            |       | 2,574               |       |             |       | 10,765                             |       |
| Transaction Expenses                               |       | 18         |       | —        |       | —           |       |                |       |             |       | 18                                 |       |
| Operating earnings                                 |       | (402       | )          | —        |       | 59,074           |       | 1,786               |       |             |       | 60,458                             |       |
| Interest income                                    |       | (1         | )          | —        |       | (19              | )          | (169                | )          |             |       | (189                               | )          |
| Interest expense                                   |       | 36,864     |       | —        |       | 94               |       | 63                  |       |             |       | 37,021                             |       |
| Earnings (loss) before provision for income  taxes |       | (37,265    | )          | —        |       | 58,999           |       | 1,892               |       |             |       | 23,626                             |       |
| Provision (benefit) for income taxes               |       | (11,699    | )          | —        |       | 19,147           |       | 1,523               |       |             |       | 8,971                              |       |
| Equity in earnings of subsidiaries (net of  tax)   |       | 40,221     |       | —        |       | 369              |       |                |       | (40,590          | )          |                               |       |
| Net earnings                                       |       | $          | 14,655     |          | $          | —           |       | $                   | 40,221     |             | $          | 369                                |       | $ | (40,590 | ) | $ | 14,655 |   |

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of EarningsNine months ended June 30, 2008**

**(In thousands)**

**(Unaudited)**

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

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of EarningsNine months ended June 30, 2007**

**(In thousands)**

**(Unaudited)**

 
| ** **                                         | ** ** | ** ** | ** ** | ** **    | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally Holdings  LLC ** | ** ** |
|----------------------------------------------------|------------|------------|------------|---------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------------------------|------------|
| ** **                                         | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **& Subsidiaries**        | ** ** |
| Net sales                                          |       | $          | —     |          | $          | —           |       | $                   | 1,568,991  |             | $          | 305,044                            |       | $ | — |   | $ | 1,874,035 |   |
| Related party sales                                |       | —     |       | —        |       | 1,865            |       | —              |       | (1,865           | )          | —                             |       |
| Cost of products sold and distribution  expenses   |       | —     |       | —        |       | 846,492          |       | 171,011             |       | (1,865           | )          | 1,015,638                          |       |
| Gross profit                                       |       | —     |       | —        |       | 724,364          |       | 134,033             |       | —           |       | 858,397                            |       |
| Selling, general and administrative  expenses      |       | 191        |       | —        |       | 530,998          |       | 110,853             |       | —           |       | 642,042                            |       |
| Depreciation and amortization                      |       | —     |       | —        |       | 23,561           |       | 7,019               |       | —           |       | 30,580                             |       |
| Sales-based service fee charged by Alberto-Culver  |       | —     |       | —        |       | 3,779            |       | —              |       | —           |       | 3,779                              |       |
| Transaction expenses                               |       | 21,502     |       | —        |       | —           |       | —              |       | —           |       | 21,502                             |       |
| Operating earnings (loss)                          |       | (21,693    | )          | —        |       | 166,026          |       | 16,161              |       | —           |       | 160,494                            |       |
| Interest income                                    |       | (3,424     | )          |          |       | (349             | )          | (458                | )          | 2,689            |       | (1,542                             | )          |
| Interest expense                                   |       | 99,758     |       | —        |       | 2,538            |       | 817                 |       | (2,689           | )          | 100,424                            |       |
| Earnings (loss) before provision for income  taxes |       | (118,027   | )          | —        |       | 163,837          |       | 15,802              |       | —           |       | 61,612                             |       |
| Provision (benefit) for income taxes               |       | (36,623    | )          | —        |       | 62,091           |       | 5,531               |       | —           |       | 30,999                             |       |
| Equity in earnings of subsidiaries (net of  tax)   |       | 112,017    |       | —        |       | 10,271           |       | —              |       | (122,288         | )          | —                             |       |
| Net earnings                                       |       | $          | 30,613     |          | $          | —           |       | $                   | 112,017    |             | $          | 10,271                             |       | $ | (122,288 | ) | $ | 30,613 |   |

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of Cash FlowsNine months ended June 30, 2008**

**(In thousands)**

**(Unaudited)**

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

 

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SallyHoldings LLC and Subsidiaries

Condensed Notes to ConsolidatedFinancial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of Cash FlowsNine months ended June 30, 2007**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                             | ** ** | ** ** | ** ** | **Co-**    | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | **Sally Holdings  LLC ** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------------------------|------------|
| ** **                                                             | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**    | ** ** | **Eliminations** | ** ** | **& Subsidiaries**        | ** ** |
| **Net cash (used) provided by operating activities**                   |       | $          | (241,185   | )          | $          | —           |       | $                   | 208,848    |             | $          | 160,990                            |       | $ | — |   | $ | 128,653 |   |
| **Cash Flows from Investing Activities:**                              |       |       |       |       |       |             |       |                |       |             |       |                               |       |
| Capital expenditures and proceeds from sale  of property and equipment |       | —     |       | —     |       | (18,347          | )          | (8,965              | )          | —           |       | (27,312                            | )          |
| Acquisitions, net of cash acquired                                     |       | —     |       | —     |       | (5,106           | )          | (65,204             | )          | —           |       | (70,310                            | )          |
| Net cash used by investing activities                                  |       | —     |       | —     |       | (23,453          | )          | (74,169             | )          | —           |       | (97,622                            | )          |
| **Cash Flows from Financing Activities:**                              |       |       |       |       |       |             |       |                |       |             |       |                               |       |
| Change in book cash overdraft                                          |       | —     |       | —     |       | (6,515           | )          | —              |       | —           |       | (6,515                             | )          |
| Proceeds from issuance of long-term debt                               |       | 2,138,181  |       | —     |       |             |       | (196                | )          | —           |       | 2,137,985                          |       |
| Repayments of long-term debt                                           |       | (331,006   | )          | —     |       | 21               |       | (22                 | )          | —           |       | (331,007                           | )          |
| Debt issuance costs                                                    |       | (58,816    | )          | —     |       | —           |       | —              |       | —           |       | (58,816                            | )          |
| Proceeds related to notes with affiliates                              |       | 287,548    |       | —     |       | 60,038           |       | —              |       | (347,586         | )          | —                             |       |
| Payments related to notes with affiliates                              |       | —     |       | —     |       | (268,400         | )          | (79,186             | )          | 347,586          |       | —                             |       |
| Distributions to Sally Beauty                                          |       | (1,809,739 | )          | —     |       | —           |       | —              |       | —           |       | (1,809,739                         | )          |
| Distributions to Alberto-Culver                                        |       | (39,471    | )          | —     |       | —           |       | —              |       | —           |       | (39,471                            | )          |
| Excess tax benefit from share-based  compensation                      |       | —     |       | —     |       | 470              |       | —              |       | —           |       | 470                                |       |
| Net cash (used) provided by financing  activities                      |       | 186,697    |       | —     |       | (214,386         | )          | (79,404             | )          | —           |       | (107,093                           | )          |
| Effect of foreign exchange rate changes on  cash and cash equivalents  |       | 706        |       | —     |       | (268             | )          | 392                 |       | —           |       | 830                                |       |
| Net (decrease) increase in cash and cash  equivalents                  |       | (53,782    | )          | —     |       | (29,259          | )          | 7,809               |       | —           |       | (75,232                            | )          |
| Cash and cash equivalents, beginning of  period                        |       | 53,792     |       | —     |       | 36,634           |       | 17,145              |       | —           |       | 107,571                            |       |
| Cash and cash equivalents, end of period                               |       | $          | 10         |       | $          | —           |       | $                   | 7,375      |             | $          | 24,954                             |       | $ | — |   | $ | 32,339 |   |

 

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

 

The following section discusses management’sview of the financial condition, results of operations and cash flows of SallyHoldings LLC, a wholly-owned subsidiary of Sally Investment Holdings LLC, awholly-owned subsidiary of Sally Beauty Holdings, Inc., and itsconsolidated subsidiaries. All of the interests of Sally Holdings arebeneficially owned by Sally Investment and all of the interests of SallyInvestment are beneficially owned by Sally Beauty. This section should be readin conjunction with the audited consolidated financial statements and therelated notes included in our Annual Report on Form 10-K for the fiscalyear ended September 30, 2007, as well as the Risk Factors section of thatAnnual Report, and information contained elsewhere in this Quarterly Report,including the consolidated financial statements and condensed notes to thosestatements.  This Management’s Discussionand Analysis of Financial Condition and Results of Operations containsforward-looking statements. See “Cautionary Notice Regarding Forward-LookingStatements,” included at the beginning of this Quarterly Report, for adiscussion of the uncertainties, risks and assumptions associated with theseforward-looking statements that could cause results to differ materially fromthose reflected in such forward-looking statements.

 

**Highlights For the First NineMonths of Fiscal Year 2008**

 

·                  Our net salesfor the nine months ended June 30, 2008 increased $101.9 million, or 5.4%,to $1,976.0 million compared to the nine months ended June 30, 2007;

 

·                  Our sales forstores that have been open for at least 14 months as of the balance sheet date,which we refer to as same store sales, increased 2.8% for the nine months endedJune 30, 2008, while operations acquired during the last twelve monthscontributed a 1.8% increase in sales. These increases were partly offset by theanticipated lower sales of L’Oreal brand products in the first four months offiscal year 2008, resulting from the changes in the L’Oreal distributionagreement as reported in fiscal year 2007;

 

·                  Ourconsolidated gross profit for the nine months ended June 30, 2008increased 7.1% to $919.7 million compared to the nine months ended June 30,2007. As a percentage of net sales, gross profit for the nine months ended June 30,2008 increased to 46.5% from 45.8% compared to the nine months ended June 30,2007;

 

·                  Ourconsolidated operating earnings for the nine months ended June 30, 2008increased $57.3 million, or 35.7%, to $217.8 million compared to the ninemonths ended June 30, 2007. As a percentage of net sales, operatingearnings were 11.0% for the nine months ended June 30, 2008 compared to8.6% for the nine months ended June 30, 2007;

 

·                  Sally BeautySupply and Beauty Systems Group, which we refer to as BSG, opened 67 and 41 netstores, respectively, in the first nine months of fiscal year 2008;

 

·                  We acquiredPro-Duo, N.V. (“Pro-Duo”), a 40-store beauty supply chain located in Belgium,France and Spain for €19.3 million (approximately $29.8 million plus certaincapitalized costs) subject to certain adjustments, which we financedsubstantially with borrowings under our ABL facility and the assumption of €2.7million, or approximately $4 million, of debt from Pro-Duo;

 

·                  We acquiredcertain assets and the distribution rights in four states from two distributorsof Goldwell/KMS products and began distributing these products in 12 additionalstates; acquired certain assets and the distribution rights from a distributorof Joico and ISO products in California, Arizona and southern Nevada; andacquired certain assets and distribution rights in southern and central Texasfrom a distributor of Paul Mitchell products; and

 

·                  We are in theprocess of completing our 2-year program to consolidate warehouses and reduceadministrative expenses of the BSG segment and anticipate completion of theprogram in the first half of fiscal year 2009.

 

## **Overview**

 

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

 

We are the largest distributor of professionalbeauty supplies in the U.S. based on store count. We operate primarily throughtwo business units, Sally Beauty Supply and BSG. Through Sally Beauty Supplyand BSG, we operate a multi-channel platform of 3,520 stores and supply 196franchised stores in North America as well as selected European countries andJapan, as of June 30, 2008. Within BSG, we also have one of the largestnetworks of professional distributor sales consultants in North America, withover 1,000 professional distributor sales consultants who sell directly tosalons and salon professionals.  Weprovide our customers with a wide variety of 

 

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leading third-party branded and exclusive-labelprofessional beauty supplies, including hair care products, styling appliances,skin and nail care products and other beauty items. Sally Beauty Supply storestarget retail consumers and salon professionals, while BSG exclusively targetssalons and salon professionals. For the nine months ended June 30, 2008,our consolidated net sales and operating earnings were $1,976.0 millionand $217.8 million, respectively.

 

Sally Beauty Supply is the largest open-linedistributor of professional beauty supplies in the U.S. based on storecount. As of June 30, 2008, Sally Beauty Supply operated 2,776company-operated stores and supplied 25 franchised stores (all outside theU.S.), with 2,307 stores located in the U.S. (including Puerto Rico), and theremainder in Mexico, Canada, Japan, the United Kingdom and certain othercountries in Europe. Sally Beauty Supply stores averageapproximately 1,700 square feet and are primarily located in stripshopping centers. The product selection in Sally Beauty Supply stores rangesbetween 5,000 and 7,800 stock keeping units, or “SKUs,” of beauty products, andincludes products for hair care, nail care, beauty sundries and appliances,targeting retail consumers and salon professionals. Sally Beauty Supply storescarry leading third-party brands such as Clairol, Revlon and Conair, as well asan extensive selection of exclusive-label merchandise.

 

We believe BSG is the largest full-servicedistributor of professional beauty supplies in the U.S. As of June 30,2008, BSG operated 744 company-operated stores, supplied 171 franchisedstores through our franchise-based business and had a sales force of over 1,000professional distributor sales consultants selling exclusively to salons andsalon professionals in 47 U.S. states and portions of Canada, Mexico andcertain European countries. BSG stores average approximately2,700 square feet and are primarily located in secondary strip shoppingcenters. Through BSG’s large store base and sales force, BSG is able to accessa significant portion of the highly fragmented U.S. salon market. Theproduct selection in BSG stores, ranging between 3,500 and 9,700 SKUs of beautyproducts, includes hair care, nail care, beauty sundries and appliancestargeting salons and salon professionals. BSG carries leading professionalbeauty product brands, intended for use in salons and for resale by the salonto consumers. Certain BSG products are sold under exclusive distributionagreements with suppliers, whereby BSG is designated as the sole distributorfor a product line within certain geographic territories.

 

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

 

We operate within the large and growingU.S. professional beauty supply industry. Potential growth in the industryis expected to be driven by increases in hair color, hair loss prevention andhair styling products, offset by lower sales of electrical products during moredifficult economic periods. We believe the following key industry and businesstrends and characteristics will influence our business and our financialresults going forward:

 

·             *High level of customer fragmentation.*  The U.S. salon marketis highly fragmented with over 225,000 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.*  Salonprofessionals primarily rely on just-in-time inventory due to capitalconstraints and a lack of warehouse and shelf space at salons.  In addition, booth renters, who comprise asignificant percentage of total U.S. salon professionals, are often responsiblefor purchasing their own supplies. Historically, booth renters havesignificantly increased as a percentage of total salon professionals and weexpect this trend to continue. Given their smaller individual purchases andrelative lack of financial resources, booth renters are likely to be dependenton frequent trips to professional beauty supply stores, like BSG and SallyBeauty Supply.  These factors are key todriving demand for conveniently located professional beauty supply stores.

 

·             *Increasing Use of Exclusive-Label Products.*  Weoffer a broad range of private label and control label products, which we generallyrefer to collectively as “exclusive-label products.” Private label products arebrands for which we own or license the trademark and, in some instances, theformula. Control label products are brands that are owned by the manufacturer,but for which we have been granted sole distribution rights. Generally, ourexclusive-label products have higher gross margins than the leading third-partybranded products and we believe this area offers potential growth. Please see “Anysignificant interruption in the supply of beauty supply products bymanufacturers of our products could disrupt our ability to deliver merchandiseto our stores and customers in a timely manner, which could have a materialadverse effect on our business, financial condition and results of operations”in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30,2007.

 

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·             *International Growth Strategies. *A key element of our growth strategy depends on our ability tocapitalize on growth in the international marketplace and to grow our currentlevel of non-U.S. operations.  On May 7,2008, we acquired Pro-Duo, N.V., a cash and carry retailer of both professionaland retail hair products located in Belgium, France and Spain, for €19.3million Euros (approximately $29.8 million plus certain capitalized costs)subject to certain adjustments.  Theacquisition was funded through $29.8 million in cash and borrowings on our ABLfacility and the assumption of €2.7 million, or approximately $4 million, ofdebt from Pro-Duo.  This acquisitionfurthers our expansion plans within the European Union and is an importantphase of Sally 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 and tosuccessfully pursue additional non-U.S. acquisitions may be affected bybusiness, legal, regulatory and economic risks. Please see “Risk Factors – We may not be able to successfully identifyacquisition candidates...” “If we acquire any businesses in the future...” and “Ourability to conduct business in international markets...” in Item 1A of our AnnualReport on Form 10-K for the fiscal year ended September 30, 2007.

 

·             *Continuing consolidation.*  There is continuingconsolidation among professional beauty product distributors and professionalbeauty product manufacturers. We plan to continue to examine ways in which wecan benefit from this trend, including reviewing opportunities to shiftbusiness from competitive distributors to the BSG network as well as seekingopportunistic value-added acquisitions. We believe that suppliers areincreasingly likely to focus on larger distributors and retailers with broaderscale and retail footprint. We also believe that we are well positioned tocapitalize on this trend as well as participate in the ongoing consolidation atthe distributor/retail level. However, changes often occur in our relationshipswith suppliers that may materially affect the net sales and operating earningsof our business segments. Consolidation among suppliers could exacerbate theeffects of these relationship changes and could increase pricing pressures. Forexample, as we announced in December 2006, our largest supplier, L’Oreal,moved a material amount of revenue out of the BSG nationwide distributionnetwork and into competitive regional distribution networks. More recently, L’Orealalso acquired distributors competing with BSG in the southeastern and westcoast of the U.S. and a supplier (Pureology) that does not currently do businesswith BSG.  As a result, L’Oreal directlycompetes with BSG in certain geographic areas. If L’Oreal acquired otherdistributors or suppliers that conduct significant business with BSG, we couldlose related revenue.  There can be noassurance that there will not be further loss of revenue over time by BSG(including within its franchise-based business) due to potential losses ofadditional L’Oreal-related products as well as from the increased competitionfrom L’Oreal-affiliated distribution networks. Please see “Risk Factors – The beauty products distribution industry ishighly competitive and is consolidating” and “We depend upon manufacturers whomay be unable to provide products of adequate quality or who may be unwillingto continue to supply products to us” in Item 1A of our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2007.

 

·             *High level of competition.*  Sally Beauty Supply competeswith other domestic and international beauty product wholesale and retailoutlets, including local and regional open-line beauty supply stores,professional-only beauty supply stores, salons, mass merchandisers, drug storesand supermarkets, as well as sellers on the Internet and salons retailing haircare items. BSG competes with other domestic and international beauty productwholesale and retail suppliers and manufacturers selling professional beautyproducts directly to salons and individual salon professionals. We also facecompetition from authorized and unauthorized retailers and Internet sitesoffering professional salon-only products. The increasing availability ofunauthorized professional salon products in large format retail stores such asdrug stores, grocery stores and others could also have a negative impact on ourbusiness.

 

·             *Favorable demographic and consumer trends.*  Theaging baby-boomer population is expected to drive future growth in professionalbeauty supply sales through an increase in the usage of hair color and hairloss products. Additionally, continuously changing fashion-related trends thatdrive new hair styles are expected to result in continued demand for hairstyling products. Changes in consumer tastes and fashion trends can have animpact on our financial performance. Our continued success depends in largepart on our ability to anticipate, gauge and react in a timely and effectivemanner to changes in consumer spending patterns and preferences for beautyproducts. We continuously adapt our marketing and merchandising initiatives forSally Beauty Supply.  For example, werecently signed an exclusive merchandising agreement in the U.S. and Canada forcertain hair extension products promoting Paris Hilton.** **If we are unable to anticipate andrespond to trends in the market for beauty products and changing consumer demands,our business could suffer.

 

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·             *Economic conditions.*  Weappeal to a wide demographic consumer profile and offer a broad selection ofbeauty products sold directly to retail consumers and salons and salonprofessionals. Historically, these factors have provided us with reducedexposure to a downturn in economic conditions in the countries in which weoperate.  However, a downturn in theeconomy could adversely impact consumer purchases of discretionary items suchas beauty products and salon services, particularly in our electrical productscategory. In addition, higher freight costs from the increasing cost of fuelmay continue to impact our expenses at levels that we cannot pass through toour customers.  These factors could havea material adverse effect on our business, financial condition and results ofoperations.

 

·             *Controlling expenses*. Another important aspect of our business is our ability to controlcosts, especially in our BSG business segment, by right-sizing the business(including some targeted reductions-in-force) and maximizing the efficiency ofour structure. In fiscal year 2007, in response to the loss of L’Oreal relatedrevenue discussed above, BSG’s sales force was reduced and the remainingaffected distributor sales consultants were offered certain compensationrelated incentives to stay with BSG as BSG has sought and continues to seek toreplace lost L’Oreal revenue. BSG has substantially completed a storere-branding project that repositioned all of its North Americancompany-operated stores under a common name and store identity, CosmoProf. Thisproject is expected to provide brand consistency, save on advertising andpromotional costs and allow for a more focused marketing strategy. Duringfiscal year 2007, we began implementing a two-year capital spending program toconsolidate warehouses and reduce administrative expenses related to BSG’sdistribution network optimization program. For the fiscal year 2008, we projectcapital expenditures to be approximately $15 million and related expenses to beapproximately $4.5 million. For the three and nine months ended June 30,2008, related expenses for new facility costs, moving expenses, facilityclosures and severance costs totaled $1.4 million and $3.1 million,respectively. We believe that annual savings from this program could rangebetween $8 million and $10 million beginning during fiscal year 2009.  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 30,2007.

 

·             *Opening New Stores*.  Ourfuture growth strategy depends in part, on our ability to open and profitablyoperate new stores in existing and additional geographic markets. The capitalrequirements to open a U.S. based Sally Beauty Supply or BSG store, excludinginventory, average approximately $60,000 and $75,000, respectively. However, wemay not be able to open all of the new stores we plan to open and any newstores we open may not be profitable, either of which could have a materialadverse impact on our financial condition or results of operations. Please see “RiskFactors – If we are unable to profitably open...” in Item 1A of our Annual Reporton Form 10-K for the fiscal year ended September 30, 2007.

 

·             *Changes to our information technology systems*.  As our operations grow in both size and scope,we will continuously need to improve and upgrade our information systems andinfrastructure while maintaining the reliability and integrity of our systemsand infrastructure.  The expansion of oursystems and infrastructure will require us to commit substantial financial,operational and technical resources in advance of any increase in the volume ofour business, with no assurance that the volume of business will increase.  For example, beginning in fiscal year 2008,we have upgraded our Lawson financial reporting system and are upgrading ourdistribution information systems (in connection with our capital spendingprogram to consolidate warehouses, as discussed above), implementing CustomerRelationship Management, or “CRM,” programs for our Sally Beauty Supply Stores,upgrading our AS400 iSeries servers, and implementing a new point-of-salesystem for tracking customer sales. These and any other required upgrades to our information systems andinformation technology (or new technology), now or in the future, will requirethat our management and resources be diverted from our core business to assistin completion of these projects. There can be no assurance that the time andresources our management will need to devote to these upgrades, service outagesor delays due to the installation of any new or upgraded technology (andcustomer issues therewith), or the impact on the reliability of our data fromany new or upgraded technology will not have a material adverse effect on ourfinancial reporting, business, financial condition or results 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, 2007.

 

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·                  *Relationships with suppliers*. We do not manufacture the brand name or exclusive-label products wesell, and instead purchase our products from manufacturers. We depend upon alimited number of manufacturers for a significant percentage of the products wesell, and our relationships with these suppliers change often.  Please see the next section, Relationshipswith suppliers, for more information on this trend.

 

***Relationshipswith suppliers***

 

Most of the net sales of Sally Beauty Supplyand BSG are generated through retail stores with respect to the Sally BeautySupply 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 andthrough our online e-commerce site. Sally Beauty Supply, BSG and theirsuppliers are dependent on each other for the distribution of beauty products.As is typical in distribution businesses, these relationships are subject tochange from time to time (including the expansion or loss of distributionrights in various geographies and the addition or loss of product lines) andour distribution agreements with suppliers are generally cancelable by eitherparty with limited notice. Changes in our relationships with suppliers occuroften, and could positively or negatively impact our net sales and operatingprofits. For example, during the second quarter of 2007, Farouk Systems, Inc.,or “Farouk Systems,” terminated its distribution agreement with us.Subsequently, effective July 2007, BSG stores and professional distributorsales consultants were once again given approval to distribute Farouk Systemsproducts in an expanded distribution area.

 

In December 2006, we announced the loss ofcertain L’Oreal distribution rights, including (among other things)  distribution rights through our BSGdistributor sales consultants and the loss of exclusive rights to distribute L’Orealproducts in our BSG stores.  These losseshave resulted in margin pressure on BSG’s remaining L’Oreal revenues, and thispressure is currently projected to continue into fiscal year 2009. As discussedabove, L’Oreal has entered into direct competition with BSG and there can be noassurance that there will not be further revenue losses over time at BSG due topotential losses of additional L’Oreal related products as well as from theincreased competition from L’Oreal-affiliated distribution networks. BSG hasentered into long-term agreements with L’Oreal under which, as of January 1,2007, BSG had non-exclusive rights to distribute the same L’Oreal professionalproducts in its stores that it previously had exclusive rights to distribute inits stores and through its sales consultants. Armstrong McCall retained itsexclusive rights to distribute Matrix professional products in its territories.Although we have focused on developing new revenue and cost managementinitiatives to mitigate the negative effects resulting from unfavorable changesin our supplier relationships, there can be no assurance that our efforts willcontinue to completely offset the loss of these or other distribution rights.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” contained in Item 1A ofour Annual Report on Form 10-K for the fiscal year ended September 30,2007.

 

Regarding other suppliers, during fiscal year2007 and the nine months ended June 30, 2008, our expansion of the BSGsegment included the acquisition of certain assets, and the award ofdistribution rights, which allow us to distribute, or expand the distributionof, Paul Mitchell, Joico and ISO products in various markets, as well as anumber of other brands, in additional segments of the marketplace. We expect togain certain other distribution rights over time through either further awardsor by targeted acquisitions of existing distributors.

 

Inaddition, on February 25, 2008, we disclosed in a Current Report on Form 8-Kthat L’Oreal USA S/D, Inc. (“L’Oreal”) filed a lawsuit in the SuperiorCourt of the State of California in and for the County of San Diego — CentralDivision naming, among others, SD Hair, Ltd. and Hair of Nevada, LLC(collectively, “SD Hair”), franchisees of our subsidiary Armstrong McCalldivision (“AMLP”) of our BSG business unit, as defendants.  The suitalleges, among other things, that SD Hair has breached its franchise agreementwith AMLP by diverting (selling) Matrix branded products to unauthorizedbuyers, and that L’Oreal is entitled to make claims against SD Hair under thefranchise agreement as a third-party beneficiary of that agreement.  Thesuit also alleges, among other issues, that SD Hair induced AMLP to breach itsagreement to distribute Matrix branded products in some unspecified manner.  As of February 25, 2008,neither we nor any of our subsidiaries (including AMLP) were a defendant in thelawsuit filed by L’Oreal.  On March 24, 2008, however, SD Hair fileda cross-complaint in the same case naming AMLP and BSG as cross-defendants,seeking, among other things, i) declaratory relief from BSG and AMLP in theform of a judicial finding that SDHair is not in breach of its franchise agreement and that L’Oreal has no rightsas a third-party beneficiary to SD Hair’s franchise agreement, and ii)injunctive relief in the form of a judicial order compelling AMLP and BSG totake appropriate legal action against L’Oreal to enforce SD Hair’s 

 

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claimedrights under AMLP’s Matrix distribution agreement.  We have answered thecross-complaint. No monetary relief is being sought by SD Hair.

 

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

 

On November 16, 2006, pursuant to aninvestment agreement among Alberto-Culver and certain of its subsidiaries,including Sally Holdings, and CDRS, Alberto-Culver separated its consumerproducts business and its Sally Beauty Supply/BSG distribution business intotwo separate, publicly-traded companies. Sally Holdings was a wholly-owned subsidiary of Alberto-Culver until theSeparation Transactions, when it was converted to a Delaware limited liabilitycompany, was renamed Sally Holdings LLC and became an indirect wholly-ownedsubsidiary of Sally Beauty.  Sally Beautywas formed on June 16, 2006 and became the accounting successor company toSally Holdings upon the completion of the Separation Transactions.  Please see the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2007 for more information aboutthe Separation Transactions.

 

## **Results ofOperations**

 

The following table shows the condensed resultsof operations of our business for the three and nine months ended June 30,2008 and 2007 (in thousands):

 
| ** **                                       | ** ** | **Three Months Ended June  30,** | ** ** | **Nine Months Ended June  30,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                        | ** ** | **2007**                                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | $                                               | 676,830    |                                           | $          | 634,880 |   | $ | 1,975,963 |   | $ | 1,874,035 |   |
| Cost of products sold and  distribution expenses |       | 361,764                                         |       | 343,993                                        |       | 1,056,304 |   | 1,015,638 |   |
| Gross profit                                     |       | 315,066                                         |       | 290,887                                        |       | 919,659 |   | 858,397 |   |
| Total other operating costs  and expenses        |       | 236,622                                         |       | 230,429                                        |       | 701,907 |   | 697,903 |   |
| Operating earnings                               |       | 78,444                                          |       | 60,458                                         |       | 217,752 |   | 160,494 |   |
| Interest expense, net                            |       | 29,671                                          |       | 36,832                                         |       | 123,797 |   | 98,882 |   |
| Earnings before provision for  income taxes      |       | 48,773                                          |       | 23,626                                         |       | 93,955 |   | 61,612 |   |
| Provision for income taxes                       |       | 18,147                                          |       | 8,971                                          |       | 34,203 |   | 30,999 |   |
| Net earnings                                     |       | $                                               | 30,626     |                                           | $          | 14,655 |   | $ | 59,752 |   | $ | 30,613 |   |

 

The following table shows the condensed resultsof operations of our business for the three and nine months ended June 30,2008 and 2007, expressed as a percentage of net sales for each respectiveperiod shown:

 
| ** **                                       | ** ** | **Three Months Ended June  30,** | ** ** | **Nine Months Ended   June 30,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                        | ** ** | **2007**                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | 100.0                                           | %          | 100.0                                                | %          | 100.0 | % | 100.0 | % |
| Cost of products sold and  distribution expenses |       | 53.4                                            | %          | 54.2                                                 | %          | 53.5 | % | 54.2 | % |
| Gross profit                                     |       | 46.6                                            | %          | 45.8                                                 | %          | 46.5 | % | 45.8 | % |
| Total other operating costs  and expenses        |       | 35.0                                            | %          | 36.3                                                 | %          | 35.5 | % | 37.2 | % |
| Operating earnings                               |       | 11.6                                            | %          | 9.5                                                  | %          | 11.0 | % | 8.6 | % |
| Interest expense, net                            |       | 4.4                                             | %          | 5.8                                                  | %          | 6.3 | % | 5.3 | % |
| Earnings before provision for  income taxes      |       | 7.2                                             | %          | 3.7                                                  | %          | 4.7 | % | 3.3 | % |
| Provision for income taxes                       |       | 2.7                                             | %          | 1.4                                                  | %          | 1.7 | % | 1.7 | % |
| Net earnings                                     |       | 4.5                                             | %          | 2.3                                                  | %          | 3.0 | % | 1.6 | % |

 

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##### ***Key Operating Metrics***

 

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

 
| ** **                                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended June  30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                        | ** ** | **2007****(1)**                                | ** ** | **2008** | ** ** | **2007 ****(1)** | ** ** |
| Net  sales:                                                |       |                                            |       |                                           |       |   |   |   |   |
| Sally  Beauty Supply                                       |       | $                                               | 427,965    |                                           | $          | 403,525 |   | $ | 1,243,594 |   | $ | 1,157,649 |   |
| BSG                                                        |       | 248,865                                         |       | 231,355                                        |       | 732,369 |   | 716,386 |   |
|                                                       |       | $                                               | 676,830    |                                           | $          | 634,880 |   | $ | 1,975,963 |   | $ | 1,874,035 |   |
| Gross  Profit                                              |       | $                                               | 315,066    |                                           | $          | 290,887 |   | $ | 919,659 |   | $ | 858,397 |   |
| Gross  profit margin                                       |       | 46.6                                            | %          | 45.8                                           | %          | 46.5 | % | 45.8 | % |
| Selling,  general and administrative expenses              |       | $                                               | 224,816    |                                           | $          | 219,646 |   | $ | 666,528 |   | $ | 642,042 |   |
| Depreciation  and amortization                             |       | $                                               | 11,806     |                                           | $          | 10,765 |   | $ | 35,379 |   | $ | 30,580 |   |
| Earnings  before provision for income taxes:               |       |                                            |       |                                           |       |   |   |   |   |
| Segment  operating profit:                                 |       |                                            |       |                                           |       |   |   |   |   |
| Sally  Beauty Supply                                       |       | $                                               | 72,927     |                                           | $          | 66,324 |   | $ | 212,389 |   | $ | 199,532 |   |
| BSG                                                        |       | 21,827                                          |       | 14,952                                         |       | 60,799 |   | 46,271 |   |
| Segment  operating profit                                  |       | 94,754                                          |       | 81,276                                         |       | 273,188 |   | 245,803 |   |
| Unallocated  expenses                                      |       | (14,963                                         | )          | (17,021                                        | )          | (47,184 | ) | (49,985 | ) |
| Share-based  compensation expense                          |       | (1,347                                          | )          | (3,779                                         | )          | (8,252 | ) | (10,043 | ) |
| Sales-based  service fee charged by Alberto-Culver         |       | —                                          |       | —                                         |       | — |   | (3,779 | ) |
| Transaction  expenses                                      |       | —                                          |       | (18                                            | )          | — |   | (21,502 | ) |
| Operating  earnings                                        |       | 78,444                                          |       | 60,458                                         |       | 217,752 |   | 160,494 |   |
| Interest  expense, net of interest income                  |       | (29,671                                         | )          | (36,832                                        | )          | (123,797 | ) | (98,882 | ) |
| Earnings  before provision for income taxes                |       | $                                               | 48,773     |                                           | $          | 23,626 |   | $ | 93,955 |   | $ | 61,612 |   |
| Segment  operating profit margin:                          |       |                                            |       |                                           |       |   |   |   |   |
| Sally  Beauty Supply                                       |       | 17.0                                            | %          | 16.4                                           | %          | 17.1 | % | 17.2 | % |
| BSG                                                        |       | 8.8                                             | %          | 6.5                                            | %          | 8.3 | % | 6.5 | % |
| Consolidated  operating profit margin                      |       | 11.6                                            | %          | 9.5                                            | %          | 11.0 | % | 8.6 | % |
| Number  of stores at end-of-period (including franchises): |       |                                            |       |                                           |       |   |   |   |   |
| Sally  Beauty Supply                                       |       |                                            |       |                                           |       | 2,801 |   | 2,676 |   |
| BSG                                                        |       |                                            |       |                                           |       | 915 |   | 860 |   |
| Total                                                      |       |                                            |       |                                           |       | 3,716 |   | 3,536 |   |
| Same  store sales growth (2)                               |       |                                            |       |                                           |       |   |   |   |   |
| Sally  Beauty Supply                                       |       | 2.1                                             | %          | 3.4                                            | %          | 1.3 | % | 2.8 | % |
| BSG                                                        |       | 7.2                                             | %          | 9.2                                            | %          | 7.2 | % | 10.1 | % |
| Consolidated                                               |       | 3.4                                             | %          | 4.8                                            | %          | 2.8 | % | 4.5 | % |

 

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|   | (1) | Certain amounts for prior periods have been  reclassified to conform to the current period’s presentation.                     |
|--------|-----|-------------------------------------------------------------------------------------------------------------------------------------|
|   | (2) | 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. |

 

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***The ThreeMonths Ended June 30, 2008 compared to the Three Months Ended June 30,  2007***

 

The table below presents net sales, grossprofit and gross profit margin data for each reportable segment (dollars inthousands).

 
| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                            | ** ** | **2007** | ** ** | **Increase (Decrease)** | ** ** |
| Net  sales:                       |       |                                                |       |   |   |   |   |   |   |
| Sally  Beauty Supply              |       | $                                                   | 427,965    |   | $ | 403,525 |   | $ | 24,440 |   | 6.1 | % |
| BSG                               |       | 248,865                                             |       | 231,355 |   | 17,510 |   | 7.6 | % |
| Consolidated  net sales           |       | $                                                   | 676,830    |   | $ | 634,880 |   | $ | 41,950 |   | 6.6 | % |
|                              |       |                                                |       |   |   |   |   |   |   |
| Gross  profit:                    |       |                                                |       |   |   |   |   |   |   |
| Sally  Beauty Supply              |       | $                                                   | 218,093    |   | $ | 202,539 |   | $ | 15,554 |   | 7.7 | % |
| BSG                               |       | 96,973                                              |       | 88,348 |   | 8,625 |   | 9.8 | % |
| Consolidated  gross profit        |       | $                                                   | 315,066    |   | $ | 290,887 |   | $ | 24,179 |   | 8.3 | % |
|                              |       |                                                |       |   |   |   |   |   |   |
| Gross  profit margin:             |       |                                                |       |   |   |   |   |   |   |
| Sally  Beauty Supply              |       | 51.0                                                | %          | 50.2 | % | 0.8 | % |   |   |
| BSG                               |       | 39.0                                                | %          | 38.2 | % | 0.8 | % |   |   |
| Consolidated  gross profit margin |       | 46.6                                                | %          | 45.8 | % | 0.8 | % |   |   |

###  

### ***NetSales***

 

Consolidated net sales increased $42.0 million,or 6.6% for the three months ended June 30, 2008 as compared to the threemonths ended June 30, 2007.  The netsales increase was driven principally by same store sales growth of 3.4%, whichcontributed approximately $17.1 million, or 2.7%; approximately $10.5 millionin sales from new stores (180 net new stores operating during the last twelvemonths); and approximately $7.0 million, or 1.1%, in sales from acquiredbusinesses; and approximately $0.2 million in positive impact from foreignexchange rates.  In addition, net salescontinue to be positively impacted by the introduction of new BSG productlines.

 

*Sally Beauty Supply*.  Net sales for Sally Beauty Supply increased$24.5 million, or 6.1% for the three months ended June 30, 2008 ascompared to the three months ended June 30, 2007.  The net sales increase was driven principallyby same store sales growth of 2.1%, which contributed approximately $8.3million, or 2.1%; net sales from new stores of approximately $6.1 million, or1.5% (125 net new stores operating during the last twelve months); andapproximately $7.0 million, or 1.7%, from acquisitions; offset in part byapproximately $1.4 million in negative impact from foreign exchange rates.  Same store sales were positively impacted bycontinued growth of exclusive-label products and certain merchandise categoriessuch as hair extensions and electrical products as well as an increase inpromotional sales.

 

*Beauty Systems Group*.  Net sales for BSG increased $17.5 million, or7.6% for the three months ended June 30, 2008 as compared to the threemonths ended June 30, 2007.  The netsales increase was driven principally by same store sales growth of 7.2%, whichcontributed approximately $8.8 million, or 3.8%; approximately $4.4 million, or1.9% in net sales from new stores (55 net new stores operating during the lasttwelve months); and approximately $1.6 million or 0.7% in positive impact fromforeign exchange rates. In addition, BSG net sales continued to be positivelyimpacted by the introduction of new product lines during the past twelve monthsoffset, in part, by a decline in sales of lower-margin products, in ourfranchise-based business, of approximately $3.2 million.

 

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

 

Consolidated gross profit increased $24.2million, or 8.3% for the three months ended June 30, 2008, as compared tothe three months ended June 30, 2007, principally due to improved grossmargins in both operating segments.

 

*Sally Beauty Supply*. Sally BeautySupply’s gross profit increased $15.6 million, or 7.7% for the three monthsended June 30, 2008, as compared to the three months ended June 30,2007, as a result of increased unit sales volume and gross profit marginimprovements.  Sally Beauty Supply’sgross profit as a percentage of net sales increased by 0.8% for the threemonths ended June 30, 2008, as compared to the three months ended June 30,2007, principally as a result of a shift in product mix including, among otherthings, continued increases in sales of exclusive-label

 

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products and other higher-margin products, aswell as improved international business margins. This increase was partiallyoffset by higher freight costs.

 

*Beauty Systems Group*.  BSG’s gross profit increased $8.6 million, or9.8% for the three months ended June 30, 2008, as compared to the threemonths ended June 30, 2007, principally as a result of increased unitsales volume in the U.S. and Canada. BSG’s gross profit as a percentage of netsales increased by 0.8% for the three months ended June 30, 2008, as comparedto the three months ended June 30, 2007. This was due primarily toimprovement in sales mix between store sales (with higher gross profit margin)and full service revenues during the three months ended June 30, 2008.

 

#### ***Selling, General andAdministrative Expenses***

 

Consolidated selling, general andadministrative expenses increased $5.2 million, or 2.4% to $224.8 million forthe three months ended June 30, 2008, compared to $219.6 million for thethree months ended June 30, 2007.  This increase is attributable principally to expenses directlyassociated with the increase in unit sales volume as well as from incrementalexpenses related to the opening of new stores and $2.7 million in expenses fromacquired businesses.  These increaseswere partially offset by lower sales commissions of $1.3 million and areduction of $2.4 million in share-based compensation expense.  As a percentage of net sales, selling,general and administrative expenses were 33.2% for the three months ended June 30,2008 compared to 34.6% for the three months ended June 30, 2007.

 

#### ***Depreciation andAmortization***

 

Consolidated depreciation and amortizationincreased $1.0 million, or 9.7%, to $11.8 million for three months ended June 30,2008 compared to $10.8 million for the three months ended June 30,2007.  The increase was due primarily tothe amortization of intangible assets associated with acquisitions and thecapital expenditures made to support unit growth of both operating segments.

#### *** ***

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

 

Consolidated operating earnings increased $18.0million, or 29.7%, to $78.4 million for the three months ended June 30,2008 compared to $60.5 million for the three months ended June 30, 2007.Operating earnings, as a percentage of net sales, were 11.6% for the threemonths ended June 30, 2008, compared to 9.5% for the three months ended June 30,2007.  The increase in consolidatedoperating earnings was due primarily to increases in gross profit in bothoperating segments partially offset by increased selling, general and administrativeexpenses.

 

*Sally Beauty Supply*.  Sally Beauty Supply’s segment operatingearnings increased $6.6 million to $72.9 million for the three months ended June 30,2008 compared to $66.3 million for the three months ended June 30, 2007.Segment operating earnings, as a percentage of segment net sales, were 17.0%for the three months ended June 30, 2008 compared to 16.4% for the threemonths ended June 30, 2007.  SallyBeauty Supply’s segment operating earnings margins were positively impacted bygrowth in number of stores, same store sales increases and improved productmix.

 

*Beauty Systems Group*.  BSG’s segment operating earnings increased$6.9 million, or 46.0%, to $21.8 million for the three months ended June 30,2008 compared to $14.9 million for the three months ended June 30, 2007.Segment operating earnings, as a percentage of segment net sales, were 8.8% forthe three months ended June 30, 2008 compared to 6.5% for the three monthsended June 30, 2007.  BSG’s segmentoperating earnings were positively impacted by improvement in gross profitmargins and the Company’s initiatives to increase non-L’Oreal sales.  In addition, BSG segment operating earningsreflect certain lower selling, general and administrative expenses, principallysales commissions and advertising expenses. These improvements were offset, in part, by the operating expensesattributable to stores opened or businesses acquired in the twelve month periodending on June 30, 2008 as well as by warehouse optimization projectexpenses of $1.6 million (including depreciation) in the three months ended June 30,2008.

 

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

 

Interest expense, net of interest income of$0.2 million, was $29.9 million for the three months ended June 30, 2008compared to $36.8 million, net of interest income of $0.2 million, for thethree months ended June 30, 2007. Net interest expense reflects non-cash income of $7.6 million and $4.0million resulting from marked-to-market 

 

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adjustments for certain interest rate swaps, asdescribed in Note 4 of the Condensed Notes to Consolidated FinancialStatements, for the three months ended June 30, 2008 and 2007, respectively.

 

#### ***Provision for IncomeTaxes***

 

Provision for income taxes was $18.1 millionduring the three months ended June 30, 2008 compared to $9.0 million forthe three months ended June 30, 2007. Income taxes for the interim periods ended June 30, 2008 and June 30,2007 have been included in the accompanying financial statements on the basisof an estimated annual effective rate. The estimated annual effective tax rate is 36.1% for fiscal year 2008compared to 36.9% for fiscal year 2007. The reduction in the estimated annual effective tax rate primarilyrelates to the reduced impact of permanent items on higher earnings and areduction in foreign statutory tax rates.

 

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

 

As a result of the foregoing, consolidated netearnings increased $16.0 million, to $30.6 million for the three months ended June 30,2008 compared to $14.7 million for the three months ended June 30, 2007.Net earnings, as a percentage of net sales, were 4.5% for the three monthsended June 30, 2008 compared to 2.3% for the three months ended June 30,2007.

 

***The NineMonths Ended June 30, 2008 compared to the Nine Months Ended June 30,2007***

 

The table below presents net sales, grossprofit and gross profit margin data for each reportable segment (dollars inthousands).

 
| ** **                        | ** ** | **Nine Months Ended June 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                           | ** ** | **2007** | ** ** | **Increase (Decrease)** | ** ** |
| Net  sales:                       |       |                                               |       |   |   |   |   |   |   |
| Sally  Beauty Supply              |       | $                                                  | 1,243,594  |   | $ | 1,157,649 |   | $ | 85,945 |   | 7.4 | % |
| BSG                               |       | 732,369                                            |       | 716,386 |   | 15,983 |   | 2.2 | % |
| Consolidated  net sales           |       | $                                                  | 1,975,963  |   | $ | 1,874,035 |   | $ | 101,928 |   | 5.4 | % |
|                              |       |                                               |       |   |   |   |   |   |   |
| Gross  profit:                    |       |                                               |       |   |   |   |   |   |   |
| Sally  Beauty Supply              |       | $                                                  | 636,969    |   | $ | 588,381 |   | $ | 48,588 |   | 8.3 | % |
| BSG                               |       | 282,690                                            |       | 270,016 |   | 12,674 |   | 4.7 | % |
| Consolidated  gross profit        |       | $                                                  | 919,659    |   | $ | 858,397 |   | $ | 61,262 |   | 7.1 | % |
|                              |       |                                               |       |   |   |   |   |   |   |
| Gross  profit margin:             |       |                                               |       |   |   |   |   |   |   |
| Sally  Beauty Supply              |       | 51.2                                               | %          | 50.8 | % | 0.4 | % |   |   |
| BSG                               |       | 38.6                                               | %          | 37.7 | % | 0.9 | % |   |   |
| Consolidated  gross profit margin |       | 46.5                                               | %          | 45.8 | % | 0.7 | % |   |   |

###  

### ***NetSales***

 

Consolidated net sales increased $101.9 millionor 5.4% for the nine months ended June 30, 2008 as compared to the ninemonths ended June 30, 2007.  The netsales increase was driven principally by same store sales growth of 2.8%, whichcontributed approximately $40.7 million, or 2.2%; sales from acquiredbusinesses, which contributed approximately $43.0 million, or 2.3%; net salesfrom new stores of approximately $33.6 million, or 1.8% (180 net new storesoperating during the last twelve months); and approximately $6.5 million, or 0.3%,in positive impact from foreign exchange rates. These increases were partially offset by a loss of approximately $12.6million of lower-margin franchise-based products sales in the BSG segment. Thecurrent period results also reflect lower L’Oreal product sales resulting fromcontractual changes during fiscal year 2007 of approximately $37.1 million.

 

*Sally Beauty Supply*.  Net sales for Sally Beauty Supply increased$85.9 million or 7.4% for the nine months ended June 30, 2008 as comparedto the nine months ended June 30, 2007. The net sales increased principally from same stores sales growth of1.3%, which contributed approximately $14.6 million, or 1.3%; incremental salesfrom acquisitions, which contributed approximately $43.0 million, or 3.7%; netsales from new stores of approximately $19.1 million, or 1.7% (125 net newstores operating during the last twelve months); and an increase in promotionalsales; offset in part by approximately $2.8 million in negative impact fromforeign exchange rates.  Same store saleswere positively impacted by continued growth of exclusive-label products andcertain merchandise categories such

 

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as hair extensions and negatively impacted by adecline in same store number of transactions. The current period results also reflect the impact of a challengingbusiness environment in the U.S. during the nine months ended June 30,2008.

 

*Beauty Systems Group*.  Net sales forBSG increased $16.0 million or 2.2% for the nine months ended June 30,2008 as compared to the nine months ended June 30, 2007.  The net sales increase was driven principallyby a same store sales growth of 7.2%, which contributed approximately $26.0million, or 3.6%; net sales from new stores of approximately $14.5 million, or2.0% (55 net new stores operating during the last twelve months); andapproximately $9.3 million, or 1.3%, in positive impact from foreign exchangerates.  These increases were partiallyoffset by a decline in sales of lower-margin products in our franchise-basedbusiness of approximately $12.6 million. In addition, BSG net sales were positively impacted by the introductionof new product lines.  The current periodresults also reflect lower L’Oreal product sales resulting from contractualchanges during fiscal year 2007 of approximately $37.1 million.

 

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

 

Consolidated gross profit increased $61.3million, or 7.1% for the nine months ended June 30, 2008 as compared tothe nine months ended June 30, 2007, principally due to acquisitions forSally Beauty Supply and improved gross margins in both operating segments.

 

*Sally Beauty Supply*. Sally BeautySupply’s gross profit increased $48.6 million, or 8.3%, for the nine monthsended June 30, 2008 as compared to the nine months ended June 30,2007, principally as a result of acquisitions made in 2008, increased unitsales volume and gross profit margin improvements.  Sally Beauty Supply’s gross profit as apercent of net sales increased to 51.2% for the nine months ended June 30,2008, compared to 50.8% for the nine months ended June 30, 2007,principally as a result of a shift in product mix including, among otherthings, continued increase in sales of exclusive-label products and otherhigher-margin products.  This increasewas partially offset by an increase in promotional initiatives in the U.S. andhigher freight costs.

 

*Beauty Systems Group*.  BSG’s gross profit increased $12.7 million,or 4.7%, for the nine months ended June 30, 2008 as compared to the ninemonths ended June 30, 2007, principally as a result of increased unitsales volume and net of approximately $1.5 million of additional warehouseoptimization costs.  BSG’s gross profitas a percentage of net sales increased to 38.6% for the nine months ended June 30,2008 compared to 37.7% for the nine months ended June 30, 2007,  due to a) margin pressure from lower-marginproducts in our franchise-based business during the nine months ended June 30,2007 that was not repeated during the nine months ended June 30, 2008, andb) a shift in revenue mix during the nine months ended June 30, 2008,towards higher store sales volume (with higher gross profit margin) versusdistributor sales consultants’ revenues.

 

#### ***Selling, General andAdministrative Expenses***

 

Consolidated selling, general andadministrative expenses increased $24.5 million, or 3.8%, to $666.5 million forthe nine months ended June 30, 2008 compared to $642.0 million for thenine months ended June 30, 2007. This increase was attributable principallyto expenses directly associated with the increase in unit sales volume,increased expenses related to the opening of new stores and to acquiredbusinesses. Selling, general and administrative expense includes approximately$2.8 million and $3.4 million, for the nine months ended June 30, 2008 and2007, respectively, of BSG retention incentives for distributor salesconsultants due to the L’Oreal contractual changes reported during fiscal year2007.  Selling, general andadministrative expenses, as a percentage of net sales, were 33.7% for the ninemonths ended June 30, 2008 compared to 34.3% for the nine months ended June 30,2007.  The expense increases werepartially offset by a $1.0 million decrease in expenses from the inclusion inthe results, for the nine months ended June 30, 2007, of allocatedoverhead charges from Alberto-Culver prior to the Separation Transactions.There were no comparable charges during the nine months ended June 30,2008.

 

#### ***Depreciation andAmortization***

 

Consolidated depreciation and amortizationincreased $4.8 million, or 15.7%, to $35.4 million for nine months ended June 30,2008 compared to $30.6 million for the nine months ended June 30,2007.  The increase was due primarily tothe amortization of intangible assets associated with acquisitions and capitalexpenditures made to support unit growth of both operating segments.

 

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#### ***Sales-based Service FeeCharged by Alberto-Culver***

 

The sales-based service fee charged byAlberto-Culver was $3.8 million for the nine months ended June 30,2007.  The nine months ended June 30,2008 had no comparable expenses as a result of the cancellation of thisagreement in connection with the Separation Transactions.

 

#### ***Transaction Expenses***

 

We recorded $21.5 million in expenses relatedto the Separation Transactions for the nine months ended June 30,2007.  These expenses were for feesallocated to us by Alberto-Culver for severance payments to certain formerofficers and for other professional fees related to the SeparationTransactions.  We did not incur anycomparable expenses related to the Separation Transactions in the nine monthsended June 30, 2008.

 

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

 

Consolidated operating earnings increased $57.3million or 35.7% to $217.8 million for the nine months ended June 30, 2008compared to $160.5 million for the nine months ended June 30, 2007.Operating earnings, as a percentage of net sales, were 11.0% for the ninemonths ended June 30, 2008 compared to 8.6% for the nine months ended June 30,2007.  The increase in consolidatedoperating earnings was due primarily to increased gross profit by bothoperating segments as well as the non-recurrence of expenses incurred duringthe nine months ended June 30, 2007 of $21.5 million in connection withthe Separation Transactions.

 

*Sally Beauty Supply*.  Sally Beauty Supply’s segment operatingearnings increased $12.9 million, or 6.4%, to $212.4 million for the ninemonths ended June 30, 2008 compared to $199.5 million for the nine monthsended June 30, 2007. Segment operating earnings, as a percentage of netsales, were 17.1% for the nine months ended June 30, 2008 compared to17.2% for the nine months ended June 30, 2007.  This small decrease in Sally Beauty Supply’ssegment operating earnings as a percentage of net sales was primarily a resultof higher freight costs.

 

*Beauty Systems Group*.  BSG’s segment operating earnings increased$14.5 million, or 31.4%, to $60.8 million for the nine months ended June 30,2008 compared to $46.3 million for the nine months ended June 30, 2007.Segment operating earnings, as a percentage of net sales, were 8.3% for thenine months ended June 30, 2008 compared to 6.5% for the nine months endedJune 30, 2007.  BSG’s segmentoperating earnings were positively impacted by improvement in gross profitmargins due to sales mix, as well as certain lower selling, general andadministrative expenses, principally sales commissions.  In addition, operating earnings were improvedfrom the non-recurrence of consulting fees and expenses related to the L’Orealcontractual changes incurred for the nine months ended June 30, 2007.  These improvements were offset, in part, bythe operating expenses attributable to stores opened and businesses acquired inthe twelve month period ending on June 30, 2008 as well as by warehouseoptimization project expenses of $3.7 million (including depreciation) in thenine months ended June 30, 2008.

#### ** **

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

 

Interest expense, net of interest income of$0.6 million, was $124.0 million for the nine months ended June 30, 2008compared to $98.9 million, net of interest income of $1.5 million, for the ninemonths ended June 30, 2007.  Theincrease in interest expense was primarily attributable to the interestassociated with the debt incurred on November 16, 2006.  Net interest expense also reflects non-cashexpense of $6.6 million and non-cash income of $3.3 million resulting frommarked-to-market adjustments for certain interest rate swaps, as described inNote 4 of the Condensed Notes to Consolidated Financial Statements, for thenine months ended June 30, 2008 and 2007, respectively.

 

#### ***Provision for IncomeTaxes***

 

Provision for income taxes was $34.2 millionduring the nine months ended June 30, 2008 compared to $31.0 million forthe nine months ended June 30, 2007. Income taxes for the interim periods ended June 30, 2008 and June 30,2007 have been included in the accompanying financial statements on the basisof an estimated annual effective rate. In determining the estimated annualeffective tax rate for fiscal year 2007, we have excluded the tax effect ofone-time charges related to the Separation Transactions. The estimated annualeffective tax rate is 36.1% for fiscal year 2008 compared to 36.9% for fiscalyear 2007.  The reduction in theestimated annual effective tax rate primarily relates to the reduced impact ofpermanent items on higher earnings and a reduction in foreign statutory tax rates.

 

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

 

As a result of the foregoing, consolidated netearnings increased $29.1 million, to $59.8 million for the nine months ended June 30,2008 compared to $30.6 million for the nine months ended June 30, 2007.Net earnings, as a percentage of net sales, were 3.0% for the nine months endedJune 30, 2008 compared to 1.6% for the nine months ended June 30,2007.

 

## **FinancialCondition**

 

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

 

Working capital (current assets less currentliabilities) at June 30, 2008 was $394.5 million compared to $341.9million at September 30, 2007, representing an increase of $52.6million.  The resulting ratio of currentassets to current liabilities was 2.08 to 1.00 at June 30, 2008 comparedto 1.92 to 1.00 at September 30, 2007. The increase in working capital reflects a $47.1 million increase incurrent assets combined with a $5.5 decrease in current liabilities.  Current assets reflect a $40.8 millionincrease in inventory levels offset, in part, by a decrease in cash and cashequivalents (see Liquidity and Capital Resources below).  The decrease in current liabilities was primarilythe result of a $17.8 million decrease in accounts payable and accruedexpenses.

 

Inventories increased $40.8 million to $610.2million at June 30, 2008 compared to $569.4 million at September 30,2007 due primarily to purchases in connection with new and expanded BSG brands,the seeding of a new BSG warehouse and increase in certain product lines forSally Beauty Supply and acquisitions.

 

Accounts payable decreased by $1.8 million to$174.9 million at June 30, 2008 from $176.7 million at September 30,2007 due primarily to the timing of payments to vendors in connection withpurchases of inventory and property plant and equipment.  Accrued expenses decreased by $16.0 millionto $137.7 million at June 30, 2008 from $153.7 million at September 30,2007 due primarily to payments of accrued interest on long-term debt.

 

Total member’s deficit decreased by $60.7million as a result of net earnings of $59.8 million and accumulated othercomprehensive income, net, of $0.9 million. Accumulated other comprehensiveincome increased due to deferred gains on hedged interest rate swaps of $2.2million (net of income tax); offset, in part, by foreign currency translationadjustments of $1.3 million to $35.4 million at June 30, 2008, compared to$34.5 million at September 30, 2007.

##  

## **Liquidityand Capital Resources**

 

We broadly define liquidity as our ability togenerate sufficient cash flow from operating activities to meet our obligationsand commitments. In addition, liquidity includes the ability to obtainappropriate debt and equity financing and to convert into cash those assetsthat are no longer required to meet existing strategic and financialobjectives. Therefore, liquidity cannot be considered separately from capitalresources that consist of current or potentially available funds for use inachieving long-range business objectives and meeting debt service commitments.

 

Following the completion of the SeparationTransactions, we are highly leveraged and a substantial portion of ourliquidity needs will arise from debt service on indebtedness incurred inconnection with the Separation Transactions and from funding the costs ofoperations, working capital and capital expenditures. As a holding company, wedepend on our subsidiaries to distribute funds to us so that we may pay ourobligations and expenses.  The ability ofour subsidiaries to make such distributions will be subject to their operatingresults, cash requirements and financial condition. In addition, under Delawarelaw, the ability of our subsidiaries to make distributions to us will belimited to the extent: (i) of their surplus, or if there is no surplus, oftheir net earnings for the fiscal year in which the distribution is declaredand/or the preceding fiscal year, if such subsidiary is a corporation; or (ii) thefair value of their assets exceeds their liabilities, in the case of asubsidiary that is a limited liability company. See “Risk Factors—RisksRelating to Our Business, and —Risks Relating to Our Substantial Indebtedness”in our Annual Report on Form 10-K for the fiscal year ended September 30,2007.

 

During the nine months ended June 30,2008, we made scheduled payments on our senior term loans in the aggregateamount of $12.5 million.

 

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Based upon our current level ofoperations and anticipated growth, we anticipate that existing cash balances,funds generated by operations and funds available under our 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 businesswill generate 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 the Company’s Annual Report on Form 10-Kfor fiscal year ended September 30, 2007 for additional information onliquidity and capital resources.

 

We utilize our ABL facility for the issuance ofletters of credit, as well as to manage normal fluctuations in operational cashflow. In that regard, we may from time to time draw funds under the revolvingcredit facility for general corporate purposes including acquisitions andinterest payments due on our indebtedness.  The funds drawn onindividual occasions during the nine months ended June 30, 2008 havevaried in amounts of up to $35.7**million,with total amounts outstanding ranging from $2.3 million up to $86.9 million.The amounts drawn are generally outstanding for a short period of time and aregenerally paid down as cash is received from our operating activities.  As of June 30, 2008, we had $306.9million available for additional borrowings under our ABL facility, subject toborrowing base limitations, as reduced by outstanding letters of credit.

 

During the nine months ended June 30,2008, the Company completed several small acquisitions, including Pro-Duo,N.V., at an aggregate cost of $48.6 million of which substantially all wasallocated to intangible assets and goodwill. We utilized our ABL facility to fund these acquisitions.  On May 7, 2008, we acquired Pro-Duo,N.V., a 40-store beauty supply chain located in Belgium, France and Spain for €19.3million (approximately $29.8 million plus certain capitalized costs) subject tocertain adjustments.  The acquisition wasfunded through $29.8 million in cash and borrowings on our ABL and theassumption of €2.7 million (approximately $4 million) of debt from Pro-Duo.

 

Our primary source of cash has been from fundsprovided by operating activities and borrowings under our ABL facility for thenine months ended June 30, 2008. Historically, the primary use of cash wasfor acquisitions and capital expenditures and, for the nine months ended June 30,2007, for the special cash distribution paid in connection with the SeparationTransactions. The following table shows our sources and uses of funds for thenine months ended June 30, 2008 and 2007 (in thousands):

 
| ** **                                        | ** ** | **Nine Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| Net  cash provided by operating activities        |       | $                                                  | 45,247     |   | $ | 128,653 |   |
| Net  cash used by investing activities            |       | (83,673                                            | )          | (97,622 | ) |
| Net  cash provided (used) by financing activities |       | 32,976                                             |       | (107,093 | ) |
| Effect  of foreign exchange rates                 |       | 902                                                |       | 830 |   |
| Net  decrease in cash and cash equivalents        |       | $                                                  | (4,548     | ) | $ | (75,232 | ) |

###  

### *Net Cash Provided by Operating Activities*

 

Net cash provided by operating activities,which excludes the effects of acquisitions, during the nine months ended June 30,2008 decreased by $83.4 million to $45.2 million compared to$128.7 million during the nine months ended June 30, 2007. Thedecrease was due primarily to an increase in cash used to purchase inventory ofapproximately $75.0 million as our inventory levels increased and a reductionin accounts payable and accrued expenses of $34.4 million.  This decrease was offset, in part, byimproved earnings for the nine months ended June 30, 2008 of approximately$29.1 million.

 

### *Net Cash Used by Investing Activities*

 

Net cash used by investing activities duringthe nine months ended June 30, 2008 decreased by $13.9 million to$83.7 million, compared to $97.6 million during the nine months endedJune 30, 2007.   This decrease wasdue

 

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primarily to a reduction in cash used foracquisitions of $22.1 million (including approximately $57.7 million inconnection with the acquisition of Salon Services in 2007); partially offset byproceeds from the sale of property and equipment in 2007 of $8.3 million.  For the nine months ended June 30, 2008,the $48.2 million of cash used for acquisitions consisted primarily of goodwilland intangible assets.

 

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

 

Net cash provided by financing activitiesduring the nine months ended June 30, 2008 increased by $140.1 million to$33.0 million, compared to cash used of $107.1 million during thenine months ended June 30, 2007. The increase was due primarily to the absence, during the nine monthsended June 30, 2008, of distributions to Alberto-Culver and costsassociated with the Separation Transactions, including debt issuance costs, andspecial cash distribution paid during the nine months ended June 30,2007.  These increases were offset, inpart, by the absence, during the nine months ended June 30, 2008, ofequity contributions and proceeds from the issuance of debt in connection withthe Separation Transactions during the nine months ended June 30, 2007.

 

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

 

For fiscal year 2008, we anticipate totalcapital expenditures to range from approximately $55.0 million to $60.0million. We anticipate utilizing these capital expenditures primarily for theaddition of new stores, our BSG warehouse optimization program to consolidatewarehouses, the remodeling, expansion or relocation of existing facilities andvarious corporate projects. During the nine months ended June 30, 2008,capital expenditures were approximately $35.7 million.

 

**Contractual Obligations**

 

There have been no material changes in any ofour contractual obligations since September 30, 2007, other than a newproduct purchase obligation in the ordinary course of business in the amount of$7.3 million.

 

## **Off-BalanceSheet Financing Arrangements**

 

We had no off-balance sheet financingarrangements other than operating leases incurred in the ordinary course ofbusiness, as well as outstanding letters of credit related to inventorypurchases and self insurance programs which totaled $11.8 million and $9.4million at June 30, 2008 and September 30, 2007, respectively.

 

## **Inflation**

 

We believe that inflation does not currentlyhave a material effect on our results of operations.

 

## **CriticalAccounting Policies and Estimates**

 

The preparation of financial statements inconformity with GAAP requires us to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expenses 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 describedin our Annual Report on Form 10-K for the fiscal year ended September 30,2007, relate to the valuation of inventories, vendor allowances, retention ofrisk, income taxes, share-based payments and related party transactions. Therehave been no material changes to our critical accounting policies since September 30,2007, except for the adoption of FIN 48, which is discussed in Note 7 of theCondensed Notes to Consolidated Financial Statements.

 

## **RelatedParty Transactions**

 

## **In the ordinary course of business, the Company performs certainadministrative services on behalf of Sally Beauty.  These services are charged to Sally Beautyand netted against the amount due to Sally Beauty.  In addition, we have entered into a taxsharing agreement and we file consolidated tax returns with our parent, SallyBeauty.  See the**

 

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## **Company’s Annual Report on Form 10-K for the fiscal year ended September 30,2007 for more information about related party transactions.**

 

## **RecentAccounting Pronouncements**

 

We are currently assessing the effect of thepronouncements discussed below on our consolidated financial statements.

 

In June 2008, the FASB Emerging IssuesTask Force reached consensus on Emerging Issues Task Force Issue No. 08-3,*Accounting by Lessees for NonrefundableMaintenance Deposits* (“EITF 08-3”). 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 FASB issued StaffPosition FAS No. 142-3, *Determinationof the Useful Life of Intangible Assets* (“FAS 142-3”). FAS 142-3amends the factors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, *Goodwill andOther Intangible Assets* (“SFAS 142”). The objective of this FSPis to improve the consistency between the useful life of a recognizedintangible asset under SFAS 142 and the period of expected cash flows usedto measure the fair value of the asset under SFAS No. 141 (Revised 2007): *Business Combinations* (“SFAS 141R”) andother GAAP. FAS 142-3 is effective for fiscal years beginning after December 15,2008. Early application is not permitted.

 

In March 2008, the Financial AccountingStandards Board, or FASB issued Statement of Financial Accounting Standards (“SFAS”)No. 161, *Disclosures about DerivativeInstruments and Hedging Activities, an Amendment of FASB Statement No. 133*(“SFAS 161”). SFAS 161 requires companies to provide qualitative disclosuresabout the objectives and strategies for using derivatives, quantitative dataabout the fair value of and gains and losses on derivative contracts, anddetails of credit-risk-related contingent features in their hedgedpositions.  The statement also requirescompanies to disclose more information about the location and amounts ofderivative instruments in financial statements; how derivatives and relatedhedges are accounted for under SFAS 133, *Accountingfor Derivative Instruments and Hedging Activities*; and how thehedges affect the entity’s financial position, financial performance and cashflows. SFAS 161 is effective for periods beginning after November 15,2008. We expect the adoption of this statement will not have a material impacton our consolidated financial statements.

 

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

 

In December 2007, the FASB issued SFAS No. 141(Revised 2007): *Business Combinations*(“SFAS 141R”). Among other things, SFAS 141R generally requires that anacquirer recognize the assets acquired and liabilities assumed measured attheir fair values on the acquisitions date. This practice replaces thepractice, under predecessor SFAS 141: *BusinessCombinations,* of allocating the cost of an acquisition to theindividual assets acquired and liabilities assumed based on their relativeestimated fair values.  SFAS 141R furtherrequires that acquisition-related costs be recognized separately from therelated acquisition. SFAS 141R is effective for periods beginning after December 15,2008.

 

In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assetsand Financial Liabilities - including an amendment of FASB Statement No. 115*,(“SFAS 159”). SFAS 159 permits entities to choose to measure many financialinstruments and certain other items at fair value that are not currentlyrequired to be measured at fair value, with unrealized gains and losses relatedto these financial instruments reported in earnings at each subsequentreporting date. SFAS 159 is effective in fiscal years beginning after November 15,2007.

 

In September 2006, the FASB issuedSFAS No. 157, *Fair ValueMeasurements*, (“SFAS 157”), which defines fair value, establishes aframework for measuring fair value under GAAP and expands disclosures aboutfair value

 

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measurements. SFAS 157 is effective forfiscal years beginning after November 15, 2007. In November 2007, theFASB provided a one year deferral for the implementation of SFAS 157 for othernonfinancial assets and liabilities.

 

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

 

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

##  

## **Foreigncurrency exchange rate risk**

 

We are exposed to potential gains or lossesfrom foreign currency fluctuations affecting net investments and earningsdenominated in foreign currencies. Our primary exposures are to changes inexchange rates for the U.S. dollar versus the British pound sterling,Canadian dollar, Euro and Mexican peso. Our various currency exposures at timesoffset each other providing a natural hedge against currency risk. Fluctuationsin U.S. dollar exchange rates within the range of the rates for the ninemonths ended June 30, 2008 and 2007 did not have a material effect on ourfinancial condition and results of operations. During these periods, we did notuse derivative financial instruments to manage foreign currency exchange raterisk.

 

## **Interestrate risk**

 

As a result of the debt financing incurred inconnection with the Separation Transactions, we are subject to interest ratemarket risk in connection with our long-term debt. The principal interest rateexposure relates to amounts borrowed under the Term Loans and our ABL facility.Based on the approximately $1.1 billion of borrowings under the Term Loans andour ABL facility as of June 30, 2008, a change in the estimated interestrate up or down by 1/8% will increase or decrease earnings before provision forincome taxes by approximately $1.3 million on an annual basis, withoutconsidering the effect of any interest rate swap agreements we may have fromtime to time.

 

We are sensitive to interest rate fluctuations.In order to enhance our ability to manage risk relating to cash flow and interestrate exposure, we and/or our other subsidiaries who are borrowers under our ABLfacility may from time to time enter into and maintain derivative instruments,such as interest rate swap agreements, for periods consistent with the relatedunderlying exposures. In addition, the agreement underlying our Term Loansrequired that we hedge a portion of our floating interest rate exposure for aspecified period.

 

Effective November 24, 2006, the Companyentered into two interest rate swap agreements with a notional amount of $150.0million and $350.0 million, respectively. These agreements expire on November 24,2008 and 2009, respectively. The agreements allow us to convert a portion ofour variable interest rate obligations to fixed rate obligations with interestrates ranging from 6.940% to 7.4975%. These interest rate swap agreements donot currently qualify as hedges and, therefore, the change in the fair value ofthese interest rate swap agreements, which are adjusted quarterly, are recordedin net interest expense in the Company’s results of operations. As discussed inPart I, “Item 1A. Risk Factors” of our Annual Report on Form 10-K forthe fiscal year ended September 30, 2007, 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 May 27, 2008, the Companyentered into two interest rate swap agreements with an aggregate notionalamount of $300 million (each agreement in the notional amount of $150million).  These agreements expire on May 31,2012 and allow us to convert a portion of our variable interest rateobligations to fixed rate obligations with interest ranging from 5.568% to6.090%.  These agreements are designatedas effective hedges, consistent with Statement of Financial AccountingStandards No. 133, *Accounting forDerivative Instruments and Hedging Activities*(“SFAS 133”).  Adjustments to reflect the change in the fairvalues of these interest rate swap agreements, which are adjusted quarterly,are recorded in accumulated other comprehensive income until the hedgedobligation is settled or the swap agreements expire, whichever is earlier.  Any ineffectiveness is recognized inearnings.

 

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## **Credit risk**

 

We are exposed to credit risk on certainassets, primarily cash equivalents, short-term investments and accountsreceivable. The credit risk associated with cash equivalents and short-terminvestments is mitigated by our policy of investing in a diversified portfolioof securities with high credit ratings.

 

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

 

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# **Item 4.  Controls and Procedures.**

 

*Controls Evaluation andRelated CEO and CFO Certifications.*  Our management, with theparticipation of our principal executive officer, who also serves as theprincipal executive officer of Sally Capital (“CEO”), and principal financialofficer, who also serves as the principal financial officer of Sally Capital (“CFO”),conducted an evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures as of the end of the period covered by thisreport. The controls evaluation was conducted by our Disclosure Committee,comprised of senior representatives from our finance, accounting, internalaudit, and legal departments under the supervision of our CEO.

 

Certifications of our CEO and our CFO, whichare required in accordance with Rule 13a-14 of the Securities Exchange Actof 1934, as amended (“Exchange Act”), are attached as exhibits to this report.This “Controls and Procedures” section includes the information concerning thecontrols evaluation referred to in the certifications, and it should be read inconjunction with the certifications for a more complete understanding of thetopics presented.

 

*Limitations on theEffectiveness of Controls.*  We do not expect that ourdisclosure controls and procedures will prevent all errors and all fraud. Asystem of controls and procedures, no matter how well conceived and operated,can provide only reasonable, not absolute, assurance that the objectives of thesystem are met. Because of the limitations in all such systems, no evaluationcan provide absolute assurance that all control issues and instances of fraud,if any, have been detected. Furthermore, the design of any system of controlsand procedures is based in part upon certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions, regardless ofhow unlikely. Because of these inherent limitations in a cost-effective systemof controls and procedures, misstatements or omissions due to error or fraudmay occur and not be detected.

 

*Scope of the ControlsEvaluation.*  The evaluation of our disclosure controls and proceduresincluded a review of their objectives and design, our implementation of thecontrols and procedures and the effect of the controls and procedures on theinformation generated for use in this report. In the course of the evaluation,we sought to identify whether we had any data errors, control problems or actsof fraud and to confirm that appropriate corrective action, including processimprovements, was being undertaken if needed. This type of evaluation isperformed on a quarterly basis so that conclusions concerning the effectivenessof our disclosure controls and procedures can be reported in our quarterlyreports on Form 10-Q and our annual reports on Form 10-K. Many of thecomponents of our disclosure controls and procedures are also evaluated by ourinternal audit department, our legal department and by personnel in our financeorganization. The overall goals of these various evaluation activities are tomonitor our disclosure controls and procedures on an ongoing basis, and tomaintain them as dynamic systems that change as conditions warrant.

 

*Conclusions regardingDisclosure Controls.*  Based on the required evaluation ofour disclosure controls and procedures, our CEO and CFO have concluded that, asof June 30, 2008, we maintain disclosure controls and procedures that areeffective in providing reasonable assurance that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to our management, including our CEO and CFO, as appropriate toallow timely decisions regarding required disclosure.

 

*Changes in Internal Controlover Financial 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**

# **Item 1.  Legal Proceedings.**

 

There were no material legal proceedingspending against us or our subsidiaries, as of June 30, 2008. We areinvolved in various claims and lawsuits incidental to the conduct of ourbusiness in the ordinary course. We carry insurance coverage in such amounts inexcess of our self-insured retention as we believe to be reasonable under thecircumstances and that may or may not cover any or all of our liabilities inrespect of claims and lawsuits. We do not believe that the ultimate resolutionof these matters will have a material adverse impact on our consolidatedfinancial position, cash flows or results of operations.

 

We are subject to a number of U.S., federal, stateand local laws and regulations, as well as the laws and regulations applicablein each other market in which we do business. These laws and regulationsgovern, among other things, the composition, packaging, labeling and safety ofthe products we sell, the methods we use to sell these products and the methodswe use to import these products.  We believe that we are in materialcompliance with such laws and regulations, although no assurance can beprovided that this will remain true going forward.

 

On February 25, 2008, we disclosed in a Current Report on Form 8-Kthat L’Oreal filed a lawsuit in the Superior Court of the State of Californiain and for the County of San Diego – Central Division naming, among others, SDHair, franchisees of AMLP as defendants.  The suit alleges, among otherthings, that SD Hair has breached its franchise agreement with AMLP bydiverting (selling) Matrix branded products to unauthorized buyers, and that L’Orealis entitled to make claims against SD Hair under the franchise agreement as athird-party beneficiary of that agreement.  The suit also alleges, amongother issues, that SD Hair induced AMLP to breach its agreement to distributeMatrix branded products in some unspecified manner.  As of February 25,2008, neither we nor any of our subsidiaries (including AMLP) were a defendantin the lawsuit filed by L’Oreal.   On March 24, 2008, however,SD Hair filed a cross-complaint in the same case naming AMLP and BSG ascross-defendants, seeking, among other things, i) declaratory relief from BSGand AMLP in the form of a judicial finding that SD Hair is not in breach of itsfranchise agreement and that L’Oreal has no rights as a third-party beneficiaryto SD Hair’s franchise agreement, and ii) injunctive relief in the form of a judicialorder compelling AMLP and BSG to take appropriate legal action against L’Orealto enforce SD Hair’s claimed rights under AMLP’s Matrix distributionagreement.  We have answered the cross-complaint. No monetary relief isbeing sought by SD Hair.

 

# **Item 1A.  Risk Factors.**

 

In addition to the otherinformation set forth in this report, you should carefully consider the factorscontained in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2007, which could materiallyaffect our business, financial condition or future results.  There have been no material changes from therisk factors disclosed in our Annual Report. The risks described in that report are not the only risks facing ourcompany.  Additional risks anduncertainties not currently known to us or that we currently deem to beimmaterial also may materially adversely affect our business, financialcondition and/or operating results.

 

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

 

(a) Not applicable

 

(b) Not applicable

 

(c) Not applicable

# ** **

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

 

Not applicable

 

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

 

Not applicable

 

# **Item 5.  Other Information.**

 

(a) Not applicable

 

(b) Not applicable

# ** **

# **Item 6. Exhibits.**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                  |       | Investment Agreement, dated as of June 19,  2006, among Alberto-Culver Company, New Aristotle Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and CDRS Acquisition LLC,  which is incorporated by reference from Exhibit 2.1 to Amendment  No. 3 to the Registration Statement on Form S-4 of New Sally  Holdings, Inc.. (File No. 333-136259) filed on October 10,  2006                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.2                  |       | First Amendment to the Investment Agreement,  dated as of October 3, 2006, among Alberto-Culver Company, New Aristotle  Company, Sally Holdings, Inc., New Sally Holdings, Inc. and CDRS  Acquisition LLC, which is incorporated by reference from Exhibit 2.2 to  Amendment No. 3 to the Registration Statement on Form S-4 of New  Sally Holdings, Inc. (File No. 333-136259) filed on  October 10, 2006 |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.3                  |       | Second Amendment to the Investment Agreement,  dated as of October 26, 2006, among Alberto-Culver Company, New  Aristotle Company, Sally Holdings, Inc., New Sally Holdings, Inc.  and CDRS Acquisition LLC, which is incorporated by reference from  Exhibit 2.02 to the Current Report on Form 8-K of New Sally  Holdings, Inc. filed on October 30, 2006                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.4                  |       | Separation Agreement, dated as of  June 19, 2006, among Alberto-Culver Company, Sally Holdings, Inc.,  New Sally Holdings, Inc. and New Aristotle Holdings, Inc., which is  incorporated by reference from Exhibit 2.3 to Amendment No. 3 to  the Registration Statement on Form S-4 of New Sally Holdings, Inc.  (File No. 333-136259) filed on October 10, 2006                                     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.5                  |       | First Amendment to the Separation Agreement,  dated as of October 3, 2006, among Alberto-Culver Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and New Aristotle  Holdings, Inc., which is incorporated by reference from Exhibit 2.4  to Amendment No. 3 to the Registration Statement on Form S-4 of New  Sally Holdings, Inc. (File No. 333-136259) filed on  October 10, 2006           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.6                  |       | Second Amendment to the Separation Agreement,  dated as of October 26, 2006, among Alberto-Culver Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and New Aristotle  Holdings, Inc., which is incorporated by reference from  Exhibit 2.01 to the Current Report on Form 8-K of New Sally  Holdings, Inc. filed on October 30, 2006                                                                    |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.1                  |       | Certificate of Formation of Sally Holdings  LLC, which is incorporated by reference to Exhibit 3.1 to the  Registration Statement on Form S-4 (File No. 333-144427) of Sally  Holdings LLC and Sally Capital Inc. filed on July 9, 2007                                                                                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.2                  |       | Limited Liability Company Agreement of Sally  Holdings LLC, which is incorporated by reference to Exhibit 3.2 to the  Registration Statement on Form S-4 (File No. 333-144427) of Sally  Holdings LLC and Sally Capital Inc. filed on July 9, 2007                                                                                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.3                  |       | Certificate of Incorporation of Sally Capital  Inc., which is incorporated by reference to Exhibit 3.3 to the  Registration Statement on Form S-4 (File No. 333-144427) of Sally  Holdings LLC and Sally Capital Inc. filed on July 9, 2007                                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.4                  |       | By-Laws of Sally Capital Inc., which is  incorporated by reference to Exhibit 3.4 to the Registration                                                                                                                                                                                                                                                                                                                                              |

 

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|   |   | Statement on Form S-4 (File  No. 333-144427) of Sally Holdings LLC and Sally Capital Inc. filed on  July 9, 2007                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.1    |   | Stockholders Agreement, dated as of  November 16, 2006, by and among Sally Beauty Holdings, Inc., CDRS  Acquisition LLC, CD&R Parallel Fund VII, L.P. and the other stockholders  party thereto, which is incorporated by reference from Exhibit 4.8 to  the Current Report on Form 8-K of Sally Beauty Holdings, Inc. filed  on November 22, 2006                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.2    |   | First Amendment to the Stockholders  Agreement, dated as of December 13, 2006, between Sally Beauty  Holdings, Inc., CDRS Acquisition LLC and Carol L. Bernick, as  representative of the other stockholders, which is incorporated herein by  reference from Exhibit 4.2 to the Annual Report on Form 10-K of  Sally Beauty Holdings, Inc. filed on December 22, 2006                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.3    |   | Indenture, dated as of November 16,  2006, by and among Sally Holdings LLC and Sally Capital Inc., as Co-Issuers, the  Subsidiary Guarantors from time to time parties thereto, and Wells Fargo  Bank, National Association, as Trustee, governing the 9.25% Senior Notes due  2014, which is incorporated by reference from Exhibit 4.1 to the Current  Report on Form 8-K of Sally Beauty Holdings, Inc. filed on  November 22, 2006                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.4    |   | First Supplemental Indenture, dated as of  May 30, 2007, by and among Sally Holdings LLC and Sally Capital Inc., as  co-Issuers, the Subsidiary Guarantors named therein, and Wells Fargo Bank,  National Association, as trustee, governing the 9.25% Senior Notes due 2014,  which is incorporated herein by reference from Exhibit 4.2 from the  Registration Statement on Form S-4 (File No. 333-144427) of Sally  Holdings LLC and Sally Capital Inc. filed on July 9, 2007                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.5    |   | Indenture, dated as of November 16,  2006, by and among Sally Holdings LLC and Sally Capital Inc., as Co-Issuers,  the Subsidiary Guarantors from time to time parties thereto, and Wells Fargo  Bank, 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                                                                             |

 

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| 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   |   | Sally Beauty Holdings, Inc. Annual  Incentive Plan, which is incorporated by reference from Exhibit 10.1 to  the Sally Holding’s Quarterly Report on Form 10-Q filed on May 8,  2008                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 31.1   |   | Rule 13(a)-14(a)/15(d)-14(a) Certification  of Gary G. Winterhalter*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 31.2   |   | Rule 13(a)-14(a)/15(d)-14(a) Certification  of Mark J. Flaherty*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 32.1   |   | Section 1350 Certification of Gary G.  Winterhalter*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 32.2   |   | Section 1350 Certification of Mark J.  Flaherty*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |

 

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*Included herewith.

 

PLEASE NOTE: It is inappropriate for investorsto assume the accuracy of any covenants, representations or warranties that maybe contained in agreements or other documents filed as exhibits to thisQuarterly Report on Form 10-Q.  Incertain instances the disclosure schedules to such agreements or documentscontain information that modifies, qualifies and creates exceptions to therepresentations, warranties and covenants. Moreover, some of therepresentations and warranties may not be complete or accurate as of aparticular date because they are subject to a contractual standard ofmateriality that is different from those generally applicable and/or were usedfor the purpose of allocating risk among the parties rather than establishingcertain matters as facts. Accordingly, you should not rely on therepresentations and warranties as characterizations of the actual state offacts at the time they were made or otherwise.

 

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**SIGNATURE**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, each registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
| Date:     August 7,  2008 |               |
|---------------------------------------------------------|--------------------|
|                                                    |               |
|                                                    |               | SALLY HOLDINGS LLC |
|                                                    |               |
|                                                    |               |
|                                                    | By:                | /s/ MARK J. FLAHERTY |
|                                                    | Name:              | Mark J. Flaherty |
|                                                    | Title:             | Senior Vice President and Chief Financial  Officer |
|                                                    |               |
| Date:     August 7,  2008 |               |
|                                                    |               |
|                                                    |               |
|                                                    | SALLY CAPITAL INC. |
|                                                    |               |
|                                                    |               |
|                                                    | By:                | /s/ MARK J. FLAHERTY |
|                                                    | Name:              | Mark J. Flaherty |
|                                                    | Title:             | Senior Vice President and Chief Financial  Officer |

 

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