**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

----

**FORM 10-Q**

----

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

**FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 2007**

**-OR-**

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

----

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

 

**3001 Colorado Boulevard**

**Denton, Texas 76210**

(Address of principalexecutive offices)

**(940) 898-7500**

(Registrants’ telephonenumber, including area code)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports) and (2) has been subject to such filing requirements for the past90 days.  YES  o    NO   x

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. Large acceleratedfiler    o    Accelerated filer  o   Non-accelerated filer  x

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

1

----

**TABLE OFCONTENTS**
|                                 | Page                                                                                        |
|---------------------------------|---------------------------------------------------------------------------------------------|
|                            |                                                                                        |
|                            |                                                                                        |
| PART I - FINANCIAL  INFORMATION |                                                                                        |
|                            |                                                                                        |
| ITEM 1.                         | FINANCIAL STATEMENTS                                                                        | 4 |
| ITEM 2.                         | MANAGEMENT’S DISCUSSION  AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 27 |
| ITEM 3.                         | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 | 46 |
| 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                                | 62 |
| ITEM 3.                         | DEFAULTS UPON  SENIOR SECURITIES                                                            | 62 |
| ITEM 4.                         | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS                                        | 62 |
| ITEM 5.                         | OTHER INFORMATION                                                                           | 62 |
| ITEM  6.                        | EXHIBITS                                                                                    | 62 |

 

2

----

Sally Holdings LLC, whichwe refer to as “Sally Holdings”, a limited liability company organized underthe laws of the State of Delaware, is a wholly-owned subsidiary of SallyInvestment Holdings LLC, which we refer to as “Sally Investment”, a wholly-owned subsidiary of Sally Beauty Holdings,Inc., which we refer to as  “Sally Beauty”,since November 16, 2006. 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.  Prior to November 16, 2006, Sally Holdingswas a Delaware corporation named “Sally Holdings, Inc.” and was a wholly-ownedsubsidiary of Alberto-Culver Company, which we refer to “Alberto-Culver”. OnNovember 16, 2006, Sally Holdings, Inc. was converted to a Delaware limitedliability company, was renamed “Sally Holdings LLC” and became a wholly-ownedsubsidiary of Sally Investment and an indirect subsidiary of Sally Beauty inconnection with the separation of Sally Holdings’ business from Alberto-Culver.All operations of Sally Investment and Sally Beauty are conducted through SallyHoldings and its consolidated subsidiaries. Sally Capital Inc., a Delaware corporation which we refer to as “SallyCapital”, is a wholly-owned subsidiary of Sally Holdings and does not have anyassets or operations of any kind.

In this report, references to “Sally Holdings”, “theCompany”, “our company”, “we”, “our”, “ours” and “us” refer to Sally HoldingsLLC and its consolidated subsidiaries for periods after the separation fromAlberto-Culver and to Sally Holdings, Inc. and its consolidated subsidiariesfor periods prior to the separation from Alberto-Culver unless otherwiseindicated or context otherwise requires.

Cautionary Notice Regarding Forward-LookingStatements

Statements in this report which are not purelyhistorical facts or which depend upon future events may be forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, asamended.  Words such as “anticipate,” “believe,”“estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,”“should,” “will,” “would,” or similar expressions may also identify suchforward-looking statements.

Readers are cautioned not to place unduereliance on forward-looking statements as such statements speak only as of thedate 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 theforward-looking statements, including, but not limited to, risks anduncertainties related to: Sally Beauty’s limited history as a stand-alonecompany; the preparedness of our accounting and other management systems tomeet financial reporting and other requirements; the representativeness of ourhistorical consolidated financial information with respect to our futurefinancial position, results of operations or cash flows; realizing the anticipatedbenefits of our separation from Alberto-Culver; since our separation from Alberto-Culver, our inability to achieve thebenefits of scale that were achieved by Alberto-Culver prior to our separationfrom Alberto-Culver; being a holding company with no operations of our own, anddepending on our subsidiaries for cash; the highly competitive nature of thebeauty products distribution industry; anticipating changes in consumerpreferences and buying trends or to manage our product lines and inventory; ourdependence upon manufacturers; products sold by us being found to be defectivein labeling or content; compliance with laws and regulations or becomingsubject to additional or more stringent laws and regulations; productdiversion; successfully identifying acquisition candidates or successfullycompleting desirable acquisitions; integration of businesses acquired in thefuture; opening and operating new stores profitably; protecting ourintellectual property rights, specifically our trademarks; obtaining theconsent of third parties under our contracts; conducting business ininternational markets; disruption in our information technology systems;natural disasters or acts of terrorism; our substantial indebtedness; thepossibility that we may incur substantial additional debt; restrictions andlimitations in the agreements and instruments governing our debt; generatingthe significant amount of cash needed to service all of our debt andrefinancing all or a portion of our indebtedness or obtaining additional financing;changes in interest rates increasing the cost of servicing our debt orincreasing our interest expense due to our interest rate swap agreements; theshare distribution of Alberto-Culver common stock in our separation fromAlberto-Culver not constituting a tax-free distribution; actions taken bycertain large shareholders of Sally Beauty adversely affecting the tax-freenature of the share distribution of Alberto-Culver common stock; significantrestrictions on Sally Beauty’s ability to issue equity securities; the votingpower of Sally Beauty’s largest stockholder discouraging third partyacquisitions of Sally Beauty at a premium; the interests of Sally Beauty’slargest stockholder differing from the interests of other holders of SallyBeauty’s common stock; and the operational and financial performance of theArmstrong McCall business.

3

----

Additional factors that could cause actualevents or results to differ materially from the events or results described inthe forward-looking statements can be found in Part II, Item 1A. “Risk Factors”of this report.  Consequently, allforward-looking statements in this release are qualified by the factors, risksand uncertainties contained therein.  Weassume no obligation to publicly update or revise any forward-lookingstatements.

**PART I – FINANCIAL INFORMATION**

# **Item 1.****                                   FinancialStatements.**

The following financial statements as of June30, 2007 and for the three and nine months ended June 30, 2007 are those ofSally Holdings LLC and its consolidated subsidiaries.  The following statements of financialposition as of September 30, 2006 and results of operations and cash flows forthe three and nine months ended June 30, 2006 are of Sally Holdings, Inc.,which was a wholly-owned subsidiary of Alberto-Culver until November 16, 2006when it was converted to a Delaware limited liability company, was renamed “SallyHoldings LLC” and became an indirect wholly-owned subsidiary of Sally Beauty inconnection with the separation of our business from Alberto-Culver.  Sally Beauty was formed on June 16, 2006 inconnection with the separation of our business from Alberto-Culver.  Sally Capital is a wholly-owned subsidiary ofSally Holdings and does not have any assets or operations of any kind.

4

----

**SALLY HOLDINGS LLC ANDSUBSIDIARIES**

Consolidated Statementsof Earnings

(In thousands)

(Unaudited)
|                                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| ** **                                                | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                                 |       | $                                | 634,880    |                            |       | $ | 599,534 |   |   |   |   | $ | 1,874,035 |   |   | $ | 1,766,990 |   |   |
| Cost of products sold  and distribution expenses          |       |                             | 343,993    |                            |       |   | 323,127 |   |   |   |   |   | 1,015,638 |   |   |   | 953,756 |   |   |
| Gross profit                                              |       |                             | 290,887    |                            |       |   | 276,407 |   |   |   |   |   | 858,397 |   |   |   | 813,234 |   |   |
| Selling, general and  administrative expenses **(1) (2)** |       |                             | 219,646    |                            |       |   | 202,487 |   |   |   |   |   | 642,042 |   |   |   | 595,356 |   |   |
| Depreciation and  amortization                            |       |                             | 10,765     |                            |       |   | 9,414 |   |   |   |   |   | 30,580 |   |   |   | 28,088 |   |   |
| Sales-based service fee  charged by Alberto-Culver        |       |                             | —     |                            |       |   | 7,151 |   |   |   |   |   | 3,779 |   |   |   | 21,568 |   |   |
| Transaction expenses**(3)**                               |       |                             | 18         |                            |       |   | 34,532 |   |   |   |   |   | 21,502 |   |   |   | 39,275 |   |   |
| Operating  earnings                                       |       |                             | 60,458     |                            |       |   | 22,823 |   |   |   |   |   | 160,494 |   |   |   | 128,947 |   |   |
| Interest expense, net **(4)**                             |       |                             | 36,832     |                            |       |   | (197 | ) |   |   |   |   | 98,882 |   |   |   | 295 |   |   |
| Earnings before  provision for                            |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| income taxes                                              |       |                             | 23,626     |                            |       |   | 23,020 |   |   |   |   |   | 61,612 |   |   |   | 128,652 |   |   |
| Provision for income  taxes                               |       |                             | 8,971      |                            |       |   | 8,469 |   |   |   |   |   | 30,999 |   |   |   | 49,122 |   |   |
| Net earnings                                              |       | $                                | 14,655     |                            |       | $ | 14,551 |   |   |   |   | $ | 30,613 |   |   | $ | 79,530 |   |   |

 

(1)          Selling, general and administrativeexpenses include allocated overhead costs from Alberto-Culver of $0.0 millionand $3.4 million and share-based compensation of $3.8 million and $1.0 millionfor the three months ended June 30, 2007 and 2006, respectively.

(2)          Selling, general and administrativeexpenses include allocated overhead costs from Alberto-Culver of $1.0 millionand $10.7 million and share-based compensation of $10.0 million and $4.1million for the nine months ended June 30, 2007 and 2006, respectively.

(3)          Transaction expenses are one-time chargesassociated with the separation from Alberto-Culver in the three and nine monthsended June 30, 2007 and one-time charges associated with the termination of theagreement with Regis Corporation (“Regis”) that called for the Company to mergewith a subsidiary of Regis in a tax-free transaction in the three and ninemonths ended June 30, 2006.

(4)          Interest expense, net of interest incomeof $0.1 million and $0.5 million for the three months ended June 30, 2007 and2006; net of interest income of $1.5 million and $1.0 million for the ninemonths ended June 30, 2007 and 2006; includes $4.0 million and $3.3 million offair market value income adjustment for marked to market interest rate swapsfor the three and nine months ended June 30, 2007, respectively.

Earnings per 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 LLC have been owned by Sally Investment, awholly-owned subsidiary of Sally Beauty.

The accompanying condensed notes are an integral part of thesefinancial statements.

5

----

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

Consolidated Balance Sheets

(In thousands)
|                                                                            | ** ** | **June 30,** | ** **         | **September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------|--------------------|------------------------|------------|
| ** **                                                                 | ** ** | **2007**          | ** **         | **2006**               | ** ** |
| **Assets**                                                                 | ** ** | **(Unaudited)**   | ** **         | ** **             | ** ** |
| Current assets:                                                            |       |              |               |                   |       |   |   |   |   |
| Cash and cash  equivalents                                                 |       | $                 | 32,339             |                   |       | $ | 107,571 |   |   |
| Trade accounts  receivable, less allowance for doubtful accounts of $2,551 |       |              |               |                   |       |   |   |   |   |
| and $2,246 at  June 30, 2007 and September 30, 2006, respectively          |       |              | 47,337             |                   |       |   | 45,462 |   |   |
| Other  receivables                                                         |       |              | 18,526             |                   |       |   | 21,228 |   |   |
| Inventories                                                                |       |              | 560,491            |                   |       |   | 574,983 |   |   |
| Prepaid expenses                                                           |       |              | 18,212             |                   |       |   | 10,255 |   |   |
| Due from  Alberto-Culver                                                   |       |              | —             |                   |       |   | 463 |   |   |
| Deferred income  tax assets                                                |       |              | 10,501             |                   |       |   | 10,327 |   |   |
| Total current  assets                                                      |       |              | 687,406            |                   |       |   | 770,289 |   |   |
| Property and equipment,  net of accumulated depreciation of $208,995 and   |       |              |               |                   |       |   |   |   |   |
| $187,089 at June  30, 2007 and September 30, 2006, respectively            |       |              | 146,329            |                   |       |   | 142,735 |   |   |
| Goodwill                                                                   |       |              | 408,759            |                   |       |   | 364,693 |   |   |
| Intangible assets, net  of accumulated amortization of $10,343 and $8,195  |       |              |               |                   |       |   |   |   |   |
| at June 30, 2007  and September 30, 2006, respectively                     |       |              | 51,613             |                   |       |   | 53,238 |   |   |
| Other assets                                                               |       |              | 65,557             |                   |       |   | 7,886 |   |   |
| Total assets                                                               |       | $                 | 1,359,664          |                   |       | $ | 1,338,841 |   |   |
| **Liabilities and Member’s /  Stockholder’s (Deficit) Equity**   |       |              |               |                   |       |   |   |   |   |
| Current liabilities:                                                       |       |              |               |                   |       |   |   |   |   |
| Current  maturities of long-term debt                                      |       | $                 | 17,121             |                   |       | $ | 503 |   |   |
| Accounts payable                                                           |       |              | 162,287            |                   |       |   | 176,623 |   |   |
| Accrued expenses                                                           |       |              | 136,548            |                   |       |   | 114,056 |   |   |
| Due to Sally  Beauty                                                       |       |              | 7,992              |                   |       |   | — |   |   |
| Income taxes                                                               |       |              | 2,783              |                   |       |   | — |   |   |
| Total current  liabilities                                                 |       |              | 326,731            |                   |       |   | 291,182 |   |   |
| Long-term debt                                                             |       |              | 1,790,977          |                   |       |   | 621 |   |   |
| Other liabilities                                                          |       |              | 12,903             |                   |       |   | 11,953 |   |   |
| Deferred income tax  liabilities                                           |       |              | 23,674             |                   |       |   | 21,590 |   |   |
| Total  liabilities                                                         |       |              | 2,154,285          |                   |       |   | 325,346 |   |   |
|                                                                       |       |              |               |                   |       |   |   |   |   |
| Stock options subject  to redemption                                       |       |              | 7,058              |                   |       |   | 7,528 |   |   |
|                                                                       |       |              |               |                   |       |   |   |   |   |
| Member’s /  Stockholder’s (deficit) equity:                      |       |              |               |                   |       |   |   |   |   |
| Common stock, no  par value. Authorized 1,000 shares; issued and           |       |              |               |                   |       |   |   |   |   |
| outstanding  1,000 shares at September 30, 2006                            |       |              | —   |                   |       |   | — |   |   |
| Additional  paid-in capital                                                |       |              | —   |                   |       |   | 62,172 |   |   |
| Retained  earnings                                                         |       |              | —   |                   |       |   | 927,512 |   |   |
| Member’s deficit:                                                     |       |              |               |                   |       |   |   |   |   |
| Member’s deficit                                                      |       |              | (827,846           | )                      |       |   |   |   |   |
| Accumulated  other comprehensive income – foreign                     |       |              |               |                   |       |   |   |   |   |
| currency  translation                                                      |       |              | 26,167             |                   |       |   | 16,283 |   |   |
| Total  member’s/stockholder’s (deficit) equity                   |       |              | (801,679           | )                      |       |   | 1,005,967 |   |   |
| Total  liabilities and member’s/stockholder’s (deficit) equity   |       | $                 | 1,359,664          |                   |       | $ | 1,338,841 |   |   |

 

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

The accompanying condensed notes are an integral part of thesefinancial statements.

6

----

**SALLY HOLDINGS LLC ANDSUBSIDIARIES**

Consolidated Statementsof Cash Flows

(In thousands)

(Unaudited)
|                                                                              | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| **Cash Flows from Operating  Activities:**                                   |       |                                               |       |   |   |   |   |   |   |
| Net earnings                                                                 |       | $                                                  | 30,613     |   |   | $ | 79,530 |   |   |
| Adjustments to  reconcile net earnings to net                                |       |                                               |       |   |   |   |   |   |   |
| cash provided by  operating activities:                                      |       |                                               |       |   |   |   |   |   |   |
| Depreciation and  amortization                                               |       |                                               | 30,580     |   |   |   | 28,088 |   |   |
| Share-based  compensation expense (net of deferred tax benefit of $3,853 and |       |                                               |       |   |   |   |   |   |   |
| $1,434 in 2007  and 2006, respectively)                                      |       |                                               | 6,190      |   |   |   | 2,663 |   |   |
| Excess tax  benefit from share-based compensation                            |       |                                               | (470       | ) |   |   | — |   |   |
| Net loss on  disposal of leaseholds and other property                       |       |                                               | 1,339      |   |   |   | 724 |   |   |
| Deferred income  taxes                                                       |       |                                               | 5,591      |   |   |   | (354 | ) |   |
| Changes in  (exclusive of effects of acquisitions):                          |       |                                               |       |   |   |   |   |   |   |
| Trade accounts  receivable                                                   |       |                                               | 6,123      |   |   |   | (2,487 | ) |   |
| Other  receivables                                                           |       |                                               | 2,980      |   |   |   | 837 |   |   |
| Inventories                                                                  |       |                                               | 44,895     |   |   |   | (24,563 | ) |   |
| Prepaid expenses                                                             |       |                                               | (4,413     | ) |   |   | (264 | ) |   |
| Other assets                                                                 |       |                                               | 1,862      |   |   |   | 45 |   |   |
| Accounts payable  and accrued expenses                                       |       |                                               | (1,442     | ) |   |   | (4,795 | ) |   |
| Income taxes                                                                 |       |                                               | 1,204      |   |   |   | — |   |   |
| Due from  Alberto-Culver                                                     |       |                                               | 463        |   |   |   | 32,268 |   |   |
| Due to Sally  Beauty                                                         |       |                                               | (2,789     | ) |   |   | — |   |   |
| Other  liabilities                                                           |       |                                               | 5,927      |   |   |   | (1,645 | ) |   |
| Net cash  provided by operating activities                                   |       |                                               | 128,653    |   |   |   | 110,047 |   |   |
| **Cash Flows from Investing  Activities:**                                   |       |                                               |       |   |   |   |   |   |   |
| Capital  expenditures                                                        |       |                                               | (35,656    | ) |   |   | (21,904 | ) |   |
| Proceeds from  sale of property and equipment                                |       |                                               | 8,344      |   |   |   | 532 |   |   |
| Acquisitions,  net of cash acquired                                          |       |                                               | (70,310    | ) |   |   | (22,008 | ) |   |
| Net cash used by  investing activities                                       |       |                                               | (97,622    | ) |   |   | (43,380 | ) |   |
| **Cash Flows from Financing  Activities:**                                   |       |                                               |       |   |   |   |   |   |   |
| Change in book  cash overdraft                                               |       |                                               | (6,515     | ) |   |   | (6,193 | ) |   |
| Proceeds from  issuance of long-term debt                                    |       |                                               | 2,137,985  |   |   |   | 529 |   |   |
| Repayments of  long-term debt                                                |       |                                               | (331,007   | ) |   |   | (401 | ) |   |
| Proceeds related  to notes with affiliated companies                         |       |                                               | —     |   |   |   | 15,230 |   |   |
| Payments related  to notes with affiliated companies                         |       |                                               | —     |   |   |   | (31,880 | ) |   |
| Debt issuance  costs                                                         |       |                                               | (58,816    | ) |   |   | — |   |   |
| Excess tax  benefit from share-based compensation                            |       |                                               | 470        |   |   |   | — |   |   |
| Distributions to  Sally Beauty.                                              |       |                                               | (1,809,739 | ) |   |   | — |   |   |
| Distributions to  Alberto-Culver                                             |       |                                               | (39,471    | ) |   |   | (5,616 | ) |   |
| Excess tax  benefit from exercises of Alberto-Culver stock options           |       |                                               | —     |   |   |   | 369 |   |   |
| Net cash used by  financing activities                                       |       |                                               | (107,093   | ) |   |   | (27,962 | ) |   |
| Effect of foreign  exchange rate changes on cash and cash equivalents        |       |                                               | 830        |   |   |   | (289 | ) |   |
| Net (decrease)  increase in cash and cash equivalents                        |       |                                               | (75,232    | ) |   |   | 38,416 |   |   |
| Cash and cash  equivalents, beginning of period                              |       |                                               | 107,571    |   |   |   | 38,612 |   |   |
| Cash and cash equivalents, end of period                                     |       | $                                                  | 32,339     |   |   | $ | 77,028 |   |   |

 

The accompanying condensed notes are an integral part of thesefinancial statements.

7

----

**SALLY HOLDINGS LLC ANDSUBSIDIARIES**

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

Nine Months Ended June30, 2007

(In thousands, exceptshare data)

(Unaudited)
|                                     | ** ** | **Number of** | ** ** | ** **     | ** ** |
|-------------------------------------|------------|--------------------|------------|----------------|------------|
| ** **                          | ** ** | **Shares**         | ** ** | **Dollars**    | ** ** |
| ** **                          | ** ** | ** **         | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | **Total** | ** ** |
| ** **                          | ** ** | **Common**         | ** ** | **Additional** | ** ** | ** ** | ** ** | ** ** | ** ** | **Other** | ** ** | **Member’s /** | ** ** |
| ** **                          | ** ** | **Stock**          | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Member’s** | ** ** | **Comprehensive** | ** ** | **Stockholder’s** | ** ** |
| ** **                          | ** ** | **Outstanding**    | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **(Deficit)** | ** ** | **Income** | ** ** | **(Deficit) Equity** | ** ** |
| Balance at September 30,  2006      |       |               | 1,000      |           |       | $ | 62,172 |   |   | $ | 927,512 |   |   | $ | — |   |   | $ | 16,283 |   |   | $ | 1,005,967 |   |   |
| Comprehensive income:               |       |               |       |           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  earnings                       |       |               | —     |           |       |   | — |   |   |   | — |   |   |   | 30,613 |   |   |   | — |   |   |   | 30,613 |   |   |
| Foreign  currency translation       |       |               | —     |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 9,884 |   |   |   | 9,884 |   |   |
| Total  comprehensive income         |       |               | —     |           |       |   | — |   |   |   | — |   |   |   | 30,613 |   |   |   | 9,884 |   |   |   | 40,497 |   |   |
| Adjustment to equity  contribution  |       |               | —     |           |       |   | — |   |   |   | — |   |   |   | 1,067 |   |   |   | — |   |   |   | 1,067 |   |   |
| Retirement of common  stock         |       |               | (1,000     | )              |       |   | (1 | ) |   |   | — |   |   |   | 1 |   |   |   | — |   |   |   | — |   |   |
| Distributions to  Alberto-Culver    |       |               | —     |           |       |   | — |   |   |   | — |   |   |   | (39,471 | ) |   |   | — |   |   |   | (39,471 | ) |   |
| Conversion to member’s  equity |       |               | —     |           |       |   | (62,171 | ) |   |   | (927,512 | ) |   |   | 989,683 |   |   |   | — |   |   |   | — |   |   |
| Distributions to Sally  Beauty      |       |               | —     |           |       |   | — |   |   |   | — |   |   |   | (1,809,739 | ) |   |   | — |   |   |   | (1,809,739 | ) |   |
| Balance at June 30, 2007            |       |               | —     |           |       | $ | — |   |   | $ | — |   |   | $ | (827,846 | ) |   | $ | 26,167 |   |   | $ | (801,679 | ) |   |

 

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

The accompanying condensed notes are an integral part of thesefinancial statements.

8

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

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

Description of Business

Sally Holdings LLC (the “Company”) is a wholly-owned subsidiary of SallyInvestment Holdings LLC (“Sally Investment”), a wholly-owned subsidiary ofSally Beauty Holdings, Inc. (“Sally Beauty”). All of the interests of Sally Holdings are beneficially owned by SallyInvestment, and all of the interests of Sally Investment are beneficially ownedby Sally Beauty.  The Company was awholly-owned subsidiary of Alberto-Culver Company (“Alberto-Culver”) untilNovember 16, 2006 when it was converted to a Delaware limited liabilitycompany, was renamed “Sally Holdings LLC” and became a wholly-owned subsidiaryof Sally Investment and an indirect subsidiary of Sally Beauty in connectionwith the separation of its business from Alberto-Culver.  The Company and its consolidated subsidiariessell professional beauty supplies, primarily through its Sally Beauty Supplyretail stores, in the United States, Puerto Rico, Mexico, Japan, Canada, UnitedKingdom and certain other European countries. Additionally, the Company distributes professional beauty products tosalons and professional cosmetologists through its Beauty Systems Group (“BSG”)store operations and a commissioned direct sales force that calls on salons inthe United States and portions of Canada and certain European countries and tofranchises in the southern and southwestern United States and Mexico throughits Armstrong McCall, L.P. (“Armstrong McCall”) operations.  The beauty products sold by BSG and ArmstrongMcCall are primarily sold through exclusive territory agreements with themanufacturers of the products.

On November 10, 2006, the stockholders of Alberto-Culver approved a planto separate its consumer products business and its Sally Beauty Supply/BSGdistribution business into two separate, publicly traded companies.  The separation was completed on November 16,2006.  The transactions were effectedpursuant to an Investment Agreement dated as of June 19, 2006, amongAlberto-Culver and certain of its subsidiaries, including Sally Holdings, Inc.,and CDRS Acquisition LLC (“CDRS”).  SallyBeauty became the accounting successor company to Sally Holdings, Inc. upon thecompletion of the transactions.  TheCompany incurred transaction expenses as a result of the separation.  See the Company’s registration statement, on Form S-4/A, asfiled with the Securities and Exchange Commission on July 26, 2007, foradditional information about the separation.

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.  See “Note 10” for further information.

Basis of Presentation

The consolidated interim financial statements included herein areunaudited and have been prepared by the Company pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”).  Certain information and note disclosuresnormally included in annual financial statements prepared in accordance withgenerally accepted accounting principles have been condensed or omittedpursuant to those rules and regulations, although the Company believes that thedisclosures made are adequate to make the information not misleading.  The consolidated interim financial statementsinclude the accounts of the Company and its subsidiaries.  In the opinion of management, these condensedconsolidated financial statements reflect all adjustments which are of a normalrecurring nature and which are necessary to present fairly the consolidatedfinancial position as of June 30, 2007, the results of operations for the threeand nine month periods ended June 30, 2007 and 2006, and cash flows for thenine months ended June 30, 2007 and 2006. The results of operations for the three and nine months ended June 30,2007 are not necessarily indicative of the results that may be expected for theentire fiscal year.  All significantinter-company accounts and transactions have been eliminated in consolidation.

9

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

These consolidated interim financial statements shouldbe read in conjunction with the financial statements and notes thereto includedin the Company’s registrationstatement, on Form S-4/A, as filed with the Securities and Exchange Commissionon July 26, 2007.  The Companyadheres to the same accounting policies in preparation of interim financialstatements.  As permitted under generallyaccepted accounting principles, interim accounting for certain expenses,including income taxes, are based on full year assumptions.  Such amounts are expensed in full in the yearincurred.  For interim financialreporting purposes, income taxes are recorded based upon estimated annualeffective income tax rates.

**2.     Member’s / Stockholder’s(Deficit) / Equity**

At June 30, 2007, the Company had a member’s deficitas a result of distributions to Sally Beauty and Alberto-Culver.  In connection with the separation fromAlberto-Culver, the Company received the proceeds from the issuance of the debtand contributed cash of approximately $1,809.7 million to Sally Beauty toenable it to make the dividend payments to existing stockholders in accordancewith the  separation agreements enteredinto in connection with the separation transaction.  The distribution to Alberto-Culver was theresult of settlement of the inter-company agreement with Alberto-Culver, whichwas treated as a dividend, thereby decreasing member’s equity by $39.5 million.

At September 30, 2006 the additional paid-in capitaland the retained earnings were part of the stockholder’s equity of SallyHoldings, Inc. and its subsidiaries.  OnNovember 16, 2006, in connection with the separation from Alberto-Culver andthe Limited Liability Company Agreement of Sally Holdings LLC, entered into byAlberto-Culver, Sally Holdings, Inc. contributed its stockholder’s equity toSally Holdings LLC, thereby converting stockholder’s equity into member’sequity.

See “Note 7” for a discussion of other comprehensive income.

**3.     Share-Based Payments**

TheCompany accounts for stock option and stock awards in accordance withSFAS 123 (Revised 2004), *Share-BasedPayment*‘SFAS 123 (R).’ Accordingly, the Company measures thecost of employee services received in exchange for an award of equityinstruments based on the grant-date fair value of the award and recognizescompensation expense on a straight-line basis over the vesting period or to thedate a participant becomes eligible for retirement, if earlier.  During the third quarters of fiscal 2007 andfiscal 2006, total compensation cost charged against income and included in selling, general and administrativeexpenses for share-based payment arrangements was $3.8 million and $1.0million, respectively, and the total income tax benefit recognized in theCompany’s income statement from these plans was $1.5 million and $0.3 million,respectively.  During the first ninemonths of fiscal 2007 and fiscal 2006, total compensation cost charged againstincome and included in selling, generaland administrative expenses for share-based payment arrangements was$10.0 million and $4.1 million, respectively, and the total income tax benefitrecognized in the Company’s income statement from these plans was $3.9 millionand $1.4 million, respectively.

Prior to November 16, 2006, the Company was a subsidiary ofAlberto-Culver and had no stock option plans of its own; however, certainemployees of the Company had been granted stock options under stock optionplans of Alberto-Culver.  Alberto-Culvertreated the separation transaction as though it constituted a change in controlfor purposes of Alberto-Culver’s stock option and stock award plans.  As a result, in accordance with the terms ofthese plans, all outstanding stock options and stock awards of Alberto-Culver,including those held by the Company’s employees, became fully vested uponcompletion of the transactions on November 16, 2006.  Due to the separation from Alberto-Culver,the Company recorded a charge at that time equal to the amount of futurecompensation expense of approximately $5.3 million that would have beenrecognized in subsequent periods as the stock options and restricted shares forthe Company’s employees vested over the original vesting periods.  Upon completion of the transaction separatingthe Company from Alberto-Culver, all outstanding Alberto-Culver stock optionsheld by 

10

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

employees of the Company became options to purchase shares of SallyBeauty’s common stock.

Since November 16, 2006, the Company has been a subsidiary of SallyBeauty and has no share based plans of its own; however, certain employees ofthe Company have been granted stock options and share awards under the plans ofSally Beauty.

As a result of the separation, the Employee Stock Option Plan of 2003,the 2003 Stock Option Plan for Non-Employee Directors and the 2003 RestrictedStock Plan that were previously plans of Alberto-Culver became plans of SallyBeauty.

During the third quarter of fiscal year 2007, Sally Beauty adopted the2007 Omnibus Incentive Plan, a new share-based plan, which allows for theissuance of up to 10 million shares of Sally Beauty’s common stock.  Additionally, Sally Beauty grantedapproximately 2.4 million stock options to the Company’s employees during thethird quarter of fiscal year 2007.  Uponissuance of such grants, the Company recognized accelerated share-basedcompensation expense of $2.3 million in connection with certain employees whoare currently retirement eligible and eligible to continue vesting awards uponretirement under the terms of the 2007 Omnibus Incentive Plan.

Each option has an exercise price which equals 100% of the market priceof Sally Beauty’s stock on the date of grant and generally has a maximum termof 10 years.  Options generally vestratably over a four year period and are subject to forfeiture until the fouryear vesting period is complete.

Stock Options

Activity for Sally Beauty’s stock options issued tothe Company’s employees under Sally Beauty’s option plans as of June 30, 2007and changes during the nine months then ended is as follows (options inthousands):
|                                    | ** ** | ** **         | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **    | ** ** |
|------------------------------------|------------|--------------------|------------|---------------|------------|-----------------|------------|---------------|------------|
| ** **                         | ** ** | ** **         | ** ** | **Weighted-** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                         | ** ** | **Number of** | ** ** | **Average**   | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                         | ** ** | **Outstanding**    | ** ** | **Exercise**  | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                         | ** ** | **Options**        | ** ** | **Price**     | ** ** | **Term**        | ** ** | **Value**     | ** ** |
| Outstanding at  September 30, 2006 |       | 1,969              |       | $             | 37.47      |            |       |          |       |   |   |   |   |   |   |
| Shares conversion (1)              |       | 1,073              |       |          | 2.00       |            |       |          |       |   |   |   |   |   |   |
| Granted                            |       | 5,112              |       |          | 9.54       |            |       |          |       |   |   |   |   |   |   |
| Exercised                          |       | (607               | )          |          | 11.26      |            |       |          |       |   |   |   |   |   |   |
| Forfeited or expired               |       | (337               | )          |          | 10.91      |            |       |          |       |   |   |   |   |   |   |
|                               |       |               |       |          |       |            |       |          |       |   |   |   |   |   |   |
| Outstanding at  June 30, 2007      |       | 7,210              |       | $             | 7.00       |            |       |          | 8.8        |   |   | $ | 17,217 |   |   |
|                               |       |               |       |          |       |            |       |          |       |   |   |   |   |   |   |
| Exercisable at June 30,  2007      |       | 2,421              |       | $             | 2.00       |            |       |          | 7.3        |   |   | $ | 16,945 |   |   |

 

(1)          Perthe Employee Matters Agreement, in connection with the separation, options topurchase shares of Alberto-Culver’s stock, which were held by the Company’semployees, were converted into options to purchase shares of Sally Beauty’sstock.  In order to maintain the sameintrinsic value as before the separation, all of Sally Beauty’s stock optionsthat were converted from Alberto-Culver were adjusted accordingly.

The following table summarizes information about stockoptions, held by our employees, under Sally Beauty’s option plans at June 30,2007:

11

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements
|                                     | ** ** | **Options Outstanding**                             | ** ** | **Options Exercisable**                         | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|------------------------------------------------------|------------|
| **Range of  Exercise  Prices** | ** ** | **Number  Outstanding at  June 30, 2007** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  Exercisable at  June 30, 2007** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| $2.00                               |       |                                                     | 2,421      |                                                 |       |   | 7.3 |   |   |   | $ 2.00 |   |   |   | 2,421 |   |   |   | $ 2.00 |   |   |
| $7.70 – 9.66                   |       |                                                     | 4,789      |                                                 |       |   | 9.6 |   |   |   | 9.53 |   |   |   | — |   |   |   |   |   |   |
|  Total                         |       |                                                     | 7,210      |                                                 |       |   | 8.8 |   |   |   | $ 7.00 |   |   |   | 2,421 |   |   |   | $ 2.00 |   |   |

 

The Company uses the Black-Scholes option-pricingmethod to value the Sally Beauty stock options for each stock optionaward.  Using this option-pricing model,the fair value of each stock option award is estimated on the date ofgrant.  The fair value of Sally Beauty’sstock option awards, which generally vest ratably over a four year period, isexpensed on a straight-line basis over the vesting period of the stock optionsor to the date a participant becomes eligible for retirement, if earlier.

The weighted average assumptions relating to thevaluation of Sally Beauty’s stock options for the nine months ended June 30,2007 and June 30, 2006 are as follows:
|                          | ** ** | **Nine Months Ended**      | ** ** |
|--------------------------|------------|--------------------------------------|------------|
| ** **               | ** ** | **June 30, 2007 **(1) | ** ** | **June 30, 2006 **(2) | ** ** |
| ** **               | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Expected lives  (years)  |       | 5.0                                  |       | 3.5 - 4.5 |   |
|                     |       |                                 |       |   |   |
| Expected  volatility     |       | 34.0% - 35.0                         | %          | 20.0 | % |
|                     |       |                                 |       |   |   |
| Risk-free  interest rate |       | 4.4% - 4.6                           | %          | 4.2% – 5.0 | % |
|                     |       |                                 |       |   |   |
| Dividend yield           |       | 0.0                                  | %          | 1.0 | % |

 

(1)          Assumptionsare based on Sally Beauty’s future expectations and not taking into accounthistorical assumptions of Alberto-Culver’s common stock.

(2)          Assumptionswere calculated based on Sally Beauty being a wholly-owned subsidiary ofAlberto-Culver and using historical assumptions of Alberto-Culver, such asexpected volatility and dividend yield of Alberto-Culver’s common stock at thetime.

The expected life of options represents the period oftime that the options granted are expected to be outstanding and is based onhistorical experience of employees of the Company that have been granted stockoptions under stock option plans of Alberto-Culver. Expected volatility for thenine months ended June 30, 2007 is derived by using the average volatility ofsimilar companies compared to Sally Beauty since it is not practicable toestimate Sally Beauty’s expected volatility due to a lack of history. Therisk-free interest rate is based on the zero-coupon U.S. Treasury issue as ofthe date of the grant. Since Sally Beauty does not expect to pay dividends, thedividend yield is 0%.

The weighted average fair value of Sally Beauty’s stock options issuedto the Company’s employees at the date of grant in the nine months ended June30, 2007 and 2006 was $3.64 and $9.48 per option, respectively.  The total intrinsic value of optionsexercised after the separation from Alberto-Culver during the nine months endedJune 30, 2007 was $3.3 million, the total cash received from these optionexercises was $0.9 million and the tax benefit realized for the tax deductionsfrom these option exercises was $1.2 million.

At June 30, 2007, approximately $10.8 million of total unrecognizedcompensation cost related to non-vested stock option awards is expected to berecognized over the vesting period of 4 years.

12

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

# Stock Awards

As a subsidiary of Sally Beauty, the Company has noemployee stock award plans; however, certain employees of the Company have beengranted stock awards under the Alberto-Culver’s 2003 Restricted Stock Plan (the“RSP”), which became the plan of Sally Beauty upon the separation.  A stock award is an award of shares of SallyBeauty’s common stock that is subject to time-based vesting during a specifiedperiod.  Stock awards are independent ofoption grants and are generally subject to forfeiture if employment terminatesprior to the vesting of the awards. Participants have full voting and dividend rights with respect to sharesof stock awards.

The RSP provides for the grant of stock awards for upto 900,000 shares of Sally Beauty’s common stock to key employees (includingofficers and directors who are also employees) of the Company.  Stock awards issued under the RSP generallyvest ratably over a five year period and are subject to forfeiture until thefive year vesting period is complete.

The Company expenses the cost of the stock awards, which is determinedto be the fair market value of the stock award at the date of grant, on astraight-line basis over the vesting period. For these purposes, the fair market value of the stock award isdetermined based on the closing price of Sally Beauty’s common stock on thegrant date.

Activity for SallyBeauty stock awards issued to the Company’s employees for the nine months endedJune 30, 2007 (shares in thousands):
|                                   | ** ** | ** **         | ** ** | ** **          | ** ** | **Weighted**  | ** ** |
|-----------------------------------|------------|--------------------|------------|---------------------|------------|---------------|------------|
| ** **                        | ** ** | ** **         | ** ** | **Weighted**        | ** ** | **Average**   | ** ** |
| ** **                        | ** ** | ** **         | ** ** | **Average**         | ** ** | **Remaining** | ** ** |
| ** **                        | ** ** | **Number of** | ** ** | **Fair Value** | ** ** | **Vesting**   | ** ** |
| **Stock Awards**             | ** ** | **Shares**         | ** ** | **Per Share**  | ** ** | **Term**      | ** ** |
| ** **                        | ** ** | ** **         | ** ** | ** **          | ** ** | **(Years)**   | ** ** |
|                              |       |               |       |                |       |          |       |   |
| Non-vested at  September 30, 2006 |       | -                  |       |                | $          | -             |       |   |   |
| Granted                           |       | 350                |       |                | 8.10       |          |       |   |
| Vested                            |       | -                  |       |                | -          |          |       |   |
| Forfeited                         |       | -                  |       |                | -          |          |       |   |
| Non-vested at June 30,  2007      |       | 350                |       |                | $          | 8.10          |       | 4.5 |   |

 

During the nine months ended June 30, 2007, no stockawards vested.  The remainingunrecognized compensation cost related to unvested stock awards at June 30,2007 was $2.6 million and the weighted average period of time over which thiscost will be recognized is 4.5 years.

**4.     Long-Term Debt**

In connection with the separation from Alberto-Culver on November 16,2006, the Company and certain other subsidiaries of Sally Beauty incurred$1,850.0 million of indebtedness by drawing on a revolving (asset-basedlending) facility in an amount equal to $70.0 million, entered into two termloan facilities (term loans A and B) in an aggregate amount of $1,070.0million, and issued senior notes in an aggregate amount of $430.0 million andsenior subordinated notes in an aggregate amount of $280.0 million.

The term loan facilities and asset-based lending facility are secured bysubstantially all of the assets of the Company, those of Sally Investment,those of the Company’s domestic subsidiaries and, in the case of the revolving(asset-based lending) facility, those of the Company’s Canadiansubsidiaries.  The term loan 

13

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

facilities may be prepaid at the Company’s option at any time withoutpremium or penalty and are subject to mandatory prepayment in an amount equalto 50% of excess cash flow (as defined in the underlying agreements) for anyfiscal year (commencing in fiscal year 2008), unless a specified leverage ratiois met, and 100% of the proceeds of specified asset sales that are notreinvested in the business or applied to repay borrowings under the asset-basedlending credit facility.

##### The senior notes and senior subordinated notes are unsecured obligationsof the issuers and are guaranteed on a senior basis (in the case of the seniornotes) and on a senior subordinated basis (in the case of the seniorsubordinated notes) by each material domestic subsidiary of the Company.  The senior notes and the senior subordinatednotes carry optional redemption features whereby the Company has the option toredeem the notes on or before November 15, 2010 and November 15, 2011,respectively, at par plus a premium, plus accrued and unpaid interest, and onor after November 15, 2010 and November 15, 2011, respectively, at par plus apremium declining ratably to par, plus accrued and unpaid interest.

Details of the debt issued on November 16, 2006 are as follows (inthousands):
|                              | ** ** | **Amount as** | ** ** | **Maturity**           | ** ** | ** **   | ** ** |
|------------------------------|------------|--------------------|------------|------------------------|------------|--------------|------------|
| ** **                   | ** ** | **of June**   | ** ** | **dates**              | ** ** | **Interest** | ** ** |
| ** **                   | ** ** | **30, 2007**  | ** ** | **(Fiscal year)** | ** ** | **rates**    | ** ** |
| Revolving credit  facilities |       | $                  | 39,700     |                   | 2012       |         |       | (i) | PRIME  and up to 0.50% or; |   |   |
|                         |       |               |       |                   |       |         | (ii)       | LIBOR  plus (1.00% to 1.50%) |   |   |
| Term loan A                  |       | 144,375            |       | 2012                   |       |         | (i)        | PRIME  plus (1.00% to 1.50%) or; |   |   |
|                         |       |               |       |                   |       |         | (ii)       | LIBOR  plus (2.00% to 2.50%) |   |   |
| Term loan B                  |       | 913,100            |       | 2014                   |       |         | (i)        | PRIME  plus (1.25% to 1.50%) or; |   |   |
|                         |       |               |       |                   |       |         | (ii)       | LIBOR  plus (2.25% to 2.50%) |   |   |
|                         | Total      |               | $          | 1,097,175              |       |         |       |   |   |   |   |   |
|                         |       |               |       |                   |       |         |       |   |   |   |
| Senior notes                 |       | $                  | 430,000    |                   | 2015       |         |       |   | 9.25% |   |   |
| Senior subordinated  notes   |       | 280,000            |       | 2017                   |       |         |       | 10.50% |   |   |
|                         | Total      |               | $          | 710,000                |       |         |       |   |   |   |   |   |

 

On November 24, 2006, the Company entered into two interest rate swapagreements relating to $500.0 million of the $1,070.0 million term loans A andB due in 2012 and 2014, respectively. See “Note 5” for further information on the interest rate swapagreements.

Maturities of the long-term debt issued on November 16, 2006 for thenext five fiscal years are as follows (in thousands):

| Year ending September 30: |       |   |      |
|---------------------------|------------|--------|-----------|
|                      | 2007       |   |      | $ | 4,175 |   |
|                      | 2008       |   |      | 16,700 |   |
|                      | 2009       |   |      | 24,200 |   |
|                      | 2010       |   |      | 24,200 |   |
|                      | 2011       |   |      | 39,200 |   |
|                      | Thereafter |   |      | 1,698,700 |   |
|                      |       | $      | 1,807,175 |   |

 

Note: Maturities schedule is for the debt issued on November 16, 2006and does not include capital leases of $0.9 million and any payments that maybe required as part of an excess cash flow test under the terms of the termloan.

**5.  Interest Rate Swaps**

14

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

On November 24, 2006, the Company entered into two interest rate swapagreements with notional amounts of $150.0 million and $350.0 million.  These agreements expire on November 24, 2008and 2009, respectively.  These agreementsallow the Company to convert a portion of its variable rate interest to a fixedrate at 4.9975% plus (2.00% to 2.50%) and 4.94% plus (2.00% to 2.50%),respectively.  These interest rate swapagreements relate to $500.0 million of the $1,070.0 million term loans A and Bdue in 2012 and 2014, respectively, to manage the Company’s cash flow riskassociated with changing interest rates. Under the swap agreements, the Company willpay fixed rates of 4.9975% plus (2.00% to 2.50%) and 4.94% plus (2.00% to 2.50%) on a quarterly basis in exchange for receiving floating rate paymentsbased on the three-month LIBOR rate.

The Company utilizes interest rate swaps to managethe cash flow risk associated with changing interest rates and accounts forthem under Statement of Financial Accounting Standards No. 133, “Accounting forDerivative Instruments and Hedging Activities”, as amended (“SFAS 133”). SFAS133 requires that all derivatives be marked to market (fair value). The Companydoes not purchase or hold any derivative instruments for trading purposes. Theinterest rate swap agreements do not currently qualify as hedges and,therefore, the change in fair value of the interest rate swap agreements, whichare adjusted quarterly, are recorded in the results of operations. The fairvalue of the swap agreements at June 30, 2007 was recorded as an asset ofapproximately $3.3 million.

Fair value estimates presented for the swapagreements are based on third-party information and were determined usingproprietary models based upon well-recognized financial principles andreasonable estimates about relevant future market conditions.

The counter-parties to these swap instruments arelarge financial institutions which the Company believes are of high qualitycreditworthiness. While the Company may be exposed to potential losses due tothe credit risk of nonperformance by these counter-parties, such losses are notanticipated.

The marked to market impact of the swap arrangements on interest expensewas a decrease of approximately $4.0 million and $3.3 million in the three andnine months ended June 30, 2007, respectively. However,changes in the fair value of the interest rate swap agreements will eitherincrease or decrease the Company’s net interest expense and therefore mayaffect the Company’s profitability.

**6.     Goodwilland Other Intangibles**

The change in the carrying amounts of goodwill by operating segment forthe nine months ended June 30, 2007 is as follows (in thousands):
|                                               | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------|------------|
| Balance at September  30, 2006                |       | $                             | 10,160     |                           |       | $         | 354,533    |   |   | $ | 364,693 |   |   |
| Additions, net  of purchase price adjustments |       |                          | 38,091     |                           |       |      | 2,556      |   |   |   | 40,647 |   |   |
| Foreign currency  translation                 |       |                          | 1,139      |                           |       |      | 2,280      |   |   |   | 3,419 |   |   |
| Balance at June 30,  2007                     |       | $                             | 49,390     |                           |       | $         | 359,369    |   |   | $ | 408,759 |   |   |

 

The following table provides the gross carrying value and accumulatedamortization for intangible assets with indefinite lives and intangible assetssubject to amortization by operating segment at June 30, 2007 (in thousands):
|                                          | ** ** | **Sally Beauty** | ** ** | **Beauty Systems** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|-----------------------|------------|-------------------------|------------|------------|------------|
| ** **                               | ** ** | **Supply**            | ** ** | **Group**               | ** ** | **Total**  | ** ** |
| Balance at June  30, 2007:               |       |                  |       |                    |       |       |       |   |   |   |   |   |   |
| Intangible assets with indefinite lives: |       |                  |       |                    |       |       |       |   |   |   |   |   |   |
| Trade names                              |       | $                     | 713        |                    |       | $          | 34,794     |   |   | $ | 35,507 |   |   |

 

15

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements
|                                             | ** ** | **Sally Beauty** | ** ** | **Beauty Systems** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|-------------------------|------------|------------|------------|
| ** **                                  | ** ** | **Supply**            | ** ** | **Group**               | ** ** | **Total**  | ** ** |
| Other intangibles                           |       |                  | —     |                    |       |       | 6,053      |   |   |   | 6,053 |   |   |
| Total                                       |       |                  | 713        |                    |       |       | 40,847     |   |   |   | 41,560 |   |   |
| Intangible  assets subject to amortization: |       |                  |       |                    |       |       |       |   |   |   |   |   |   |
| Gross carrying amount                       |       |                  | —     |                    |       |       | 20,396     |   |   |   | 20,396 |   |   |
| Accumulated amortization                    |       |                  | —     |                    |       |       | (10,343    | ) |   |   | (10,343 | ) |   |
| Net value                                   |       |                  | —     |                    |       |       | 10,053     |   |   |   | 10,053 |   |   |
| Total intangible  assets, net               |       |                  | $          | 713                     |       |       |       | $ | 50,900 |   |   |   | $ | 51,613 |   |   |
|                                             |            |                       |            |                         |            |            |            |  |  |  |  |  |  |  |  |  |

 

**7.     ComprehensiveIncome**

Comprehensive income consists of net earnings and foreign currencytranslation adjustments as follows for the three and nine months ended June 30,2007 and 2006 (in thousands):
|                                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                           | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                           | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net earnings                                                         |       | $                                | 14,655     |                            | $          | 14,551 |   | $ | 30,613 |   | $ | 79,530 |   |
| Other comprehensive income adjustments-foreign  currency translation |       | 9,148                            |       | 5,115                           |       | 9,884 |   | 4,769 |   |
| Comprehensive income                                                 |       | $                                | 23,803     |                            | $          | 19,666 |   | $ | 40,497 |   | $ | 84,299 |   |

 

**8.     Acquisitions**

On February 15, 2007, the Company entered intoand completed an Agreement for the Sale and Purchase of the Entire Issued ShareCapital of Chapelton 21 Limited (the “Agreement”), a private company limited byshares and incorporated in Scotland (“Salon Services”) by and among OgeeLimited, an indirect subsidiary of the Company, and the registered shareholdersof Salon Services. Pursuant to the Agreement, the Company acquired all of theissued share capital of Salon Services for an aggregate cash purchase price ofapproximately £30.0 million, or approximately $59.0 million, subjectto certain adjustments. In addition, the Company extinguished approximately£2.0 million of Salon Services’ debt. The Agreement containsrepresentations, warranties and covenants that are customary to transactions ofthis nature. Salon Services, through its direct and indirect subsidiariesincluding Salon Services (Hair and Beauty Supplies) Ltd., supplies professionalhair and beauty products primarily to salon and spa operators and independenthair and beauty professionals in the United Kingdom, Germany, Ireland andSpain.

In connection with the Company’s acquisition andoperation of Salon Services, the Company’s subsidiaries financed the purchaseprice through a draw down of approximately $57.0 million under itsexisting revolving (asset-based) credit facilities.  Certain funds are being held in escrow insupport of the sellers’ representations, warranties and covenants.  We expect that the final valuation of theacquired assets and liabilities will be completed by fiscal year end.

**9.     BusinessSegments**

The Company’s business is organized into two separatesegments: (i) Sally Beauty Supply, a domestic and international chain of cashand carry retail stores, which offers professional beauty supplies to bothsalon professionals and retail customers, and (ii) BSG, a full service beautysupply distributor, which offers professional brands of beauty productsdirectly to salons through its own sales force and professional only stores inexclusive geographical territories in North America and parts of Europe.

16

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

In connection with the separation from Alberto-Culver,the Company’s management evaluated the structure of its internal organizationto identify and separate the costs incurred at the corporate level from thebusiness units as well as costs incurred that benefit both the Sally BeautySupply and BSG segments.  Accordingly,management has defined its reportable segments to report separately from theCompany’s shared corporate expenses, and has revised the comparable periods inthe prior year for comparability purposes.

The Company does not sell between segments.  Segment data for the three and nine monthsended June 30, 2007 and 2006 is as follows (in thousands):
|                                                    | ** **                                  | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|----------------------------------------------------|---------------------------------------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                         | ** **                                  | **2007**                                        | ** ** | **2006**                                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales:                                         |                                        |                                            |       |                                           |       |   |   |   |   |
| Sally Beauty  Supply                               |                                        | $                                               | 402,920    |                                           | $          | 356,975 |   | $ | 1,156,684 |   | $ | 1,060,015 |   |
| Beauty Systems  Group                              |                                        | 231,960                                         |       | 242,559                                        |       | 717,351 |   | 706,975 |   |
|                                               | Total net sales                             |                                            | $          | 634,880                                        |       | $ | 599,534 | $ | 1,874,035 | $ | 1,766,990 |   |
| Earnings before  provision for income taxes:       |                                        |                                            |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                |                                        | $                                               | 67,070     | $                                              | 59,169     |   | $ | 201,825 |   | $ | 179,670 |   |
| Beauty Systems  Group                              |                                        | 15,391                                          |       | 24,865                                         |       | 48,168 |   | 69,265 |   |
| Segment operating earnings                         |                                        | 82,461                                          |       | 84,034                                         |       | 249,993 |   | 248,935 |   |
| Unallocated  corporate expenses******(1)**         |                                        | (21,985                                         | )          | (19,528                                        | )          | (64,218 | ) | (59,145 | ) |
| Sales-based  service fee charged by Alberto-Culver |                                        | —                                          |       | (7,151                                         | )          | (3,779 | ) | (21,568 | ) |
| Transaction  expenses **(2)**                      |                                        | (18                                             | )          | (34,532                                        | )          | (21,502 | ) | (39,275 | ) |
| Interest  expense, net of interest income          |                                        | (36,832                                         | )          | 197                                            |       | (98,882 | ) | (295 | ) |
|                                               | Earnings before provision for  income taxes |                                            | $          | 23,626                                         |       | $ | 23,020 |   | $ | 61,612 |   | $ | 128,652 |   |

 

(1)          Unallocated expenses consistof corporate and shared costs. The amounts include $0.0 million and $3.4million of overhead charges allocated from Alberto-Culver and share-basedcompensation of $3.8 million and $1.0 million for the three months ended June30, 2007 and 2006, respectively; and $1.0 million and $10.7 million of overheadcharges allocated from Alberto-Culver and share-based compensation of $10.0million and $4.1 million for the nine months ended June 30, 2007 and 2006,respectively.

 

(2)          Transaction expenses areone-time charges associated with the separation from Alberto-Culver in thethree and nine months ended June 30, 2007 and one-time charges associated withthe termination of the agreement with Regis that called for the Company tomerge with a subsidiary of Regis in a tax-free transaction in the three andnine months ended June 30, 2006.

**10.  Related Party Transaction**

On January 1, 2007, the Company entered into anagreement with Sally Beauty under which the Company agreed to provide certaingeneral and administrative services to Sally Beauty including accounting,finance, payroll, legal and tax sharing services. The cost of these services,which were based on a percentage of certain key employees’ salaries andbenefits, is approximately $88,000 per month. The cost of these services may not necessarily be indicative of thecosts which would be incurred by the Company as an independent stand aloneentity.  The cost of these services toSally Beauty was $0.5 million for the nine months ended June 30, 2007.

The Company has entered into a tax sharing agreementwith its parent, Sally Beauty.  Inaccordance with this tax sharing agreement, Sally Beauty shall cause each ofits subsidiaries that are eligible to be a member 

17

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated Financial Statements

of the relevant combined tax group to join in filing acombined tax 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.

Where allowed by current tax law, the Company isincluded in the consolidated income tax returns filed by Sally Beauty.  The Company’s provision for income taxes isrecorded on the basis of filing a separate income tax return.  Income taxes currently payable or receivableunder the consolidated income tax returns are paid to or received from SallyBeauty.

**11.  RecentAccounting Pronouncements**

In July 2006, the Financial Accounting Standards Board (“FASB”) issuedFASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies theaccounting for the uncertainty in income taxes recognized by prescribing arecognition threshold that a tax position is required to meet before beingrecognized in the financial statements. It also provides guidance onderecognition, classification, interest and penalties, interim periodaccounting and disclosure. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006.  The Company iscurrently assessing the effect of this pronouncement on the Company’sconsolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (“SFAS 157”), which defines fair value, establishes a frameworkfor measuring fair value in generally accepted accounting principles, andexpands disclosures about fair value measurements. SFAS 157 is effective infiscal years beginning after November 15, 2007. The Company is currently assessing the effect of this pronouncement onthe Company’s consolidated financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB108”), which provides interpretive guidance on how the effects of the carryoveror reversal of prior year misstatements should be considered in quantifying acurrent year misstatement. The Company implemented the provisions of SAB 108during the first quarter of fiscal 2007 and it did not have a material impacton the Company’s financial position, results of operations or cash flows.

In February 2007, the FASB issued SFAS No. 159, *“*The Fair Value Option for FinancialAssets and Financial Liabilities – including an amendment of FASB Statement No.115*”*(“SFAS 159”). * *SFAS159 permits entities to choose to measure many financial instruments andcertain other items at fair value that are not currently required to bemeasured at fair value, with unrealized gains and losses related to thesefinancial instruments reported in earnings at each subsequent reporting date.SFAS 159 is effective as of the beginning of an entity’s first fiscal year thatbegins after November 15, 2007. The Company is currently assessing the effectof this pronouncement on the Company’s consolidated financial statements.

**12.  Guarantor and Non-GuarantorCondensed Consolidated Financial Statements**

The following condensed consolidating financial information presents theCondensed Consolidated Balance Sheet as of June 30, 2007 and September 30,2006, the Condensed Consolidated Statement of Earnings for the three and ninemonths ended June 30, 2006 and June 30, 2007 and the Condensed ConsolidatedStatement of Cash Flows for the nine months ended June 30, 2006 and June 30,2007 of (a) Sally Holdings LLC or “the Parent”; (b) Sally Capital, Inc. or “Co-Issuer”(c) the guarantor subsidiaries; (d) the non-guarantor subsidiaries; (e)elimination entries necessary to consolidate the Parent with the guarantor andnon-guarantor subsidiaries; and (f) the Company on a consolidated basis.

Investments in subsidiaries are accounted for using the equity methodfor purposes of the consolidating presentation. The principle elimination entries relate to investments in subsidiariesand intercompany balances and transactions. Separate financial statements and other disclosures with respect to the

18

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated FinancialStatements

subsidiary guarantors 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 andunconditional.  Additionally,substantially all of the assets of the guarantor subsidiaries are pledged underthe term loan facilities and the revolving (asset-based lending) facility andconsequently may not be available to satisfy the claims of general creditors.

**SALLY HOLDINGS LLC ANDSUBSIDIARIES**

**Condensed Consolidated BalanceSheetJune 30, 2007**

**(In thousands)**

**(Unaudited)**
|                                                                             | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings LLC  & Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-------------------------------------------------------|------------|
| **Assets**                                                                  | ** ** | ** ** | ** ** | ** **    | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **                                            | ** ** |
| Cash and cash  equivalents                                                  |       | $          | 10         |          | $          | —            |       | $                                 | 7,375      |             | $          | 24,954                                                |       | — |   | $ | 32,339 |   |
| Trade  accounts and other receivables, less allowance for doubtful accounts |       | 212        |       | —        |       | 45,728                      |       | 19,923                            |       | —           |       | 65,863                                                |       |
| Due from affiliates                                                         |       | 139,415    |       | —        |       | 10,666                      |       | 13,010                            |       | (163,091)        |       | —                                                |       |
| Inventories                                                                 |       | —     |       | —        |       | 433,126                     |       | 127,365                           |       | —           |       | 560,491                                               |       |
| Prepaid expenses                                                            |       | 44         |       | —        |       | 6,597                       |       | 11,571                            |       | —           |       | 18,212                                                |       |
| Deferred  income tax assets                                                 |       | —     |       | —        |       | 13,746                      |       | (3,245)                           |       | —           |       | 10,501                                                |       |
| Property  and equipment, net                                                |       | —     |       | —        |       | 109,835                     |       | 36,494                            |       | —           |       | 146,329                                               |       |
| Investment in  Subsidiaries                                                 |       | 831,999    |       | —        |       | 245,911                     |       | —                            |       | (1,077,910)      |       | —                                                |       |
| Goodwill  and other intangible assets, net                                  |       | —     |       | —        |       | 356,697                     |       | 103,675                           |       | —           |       | 460,372                                               |       |
| Other assets                                                                |       | 57,928     |       | —        |       | 1,886                       |       | 5,743                             |       | —           |       | 65,557                                                |       |
| Total assets                                                                |       | $          | 1,029,608  |          | $          | —                      |       | $                                 | 1,231,567  |             | $          | 339,490                                               |       | $ | (1,241,001) |   | $ | 1,359,664 |   |
| **Liabilities and Member’s (Deficit) Equity**                          | ** ** | ** ** | ** ** | ** **    | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **                                            | ** ** |
| Current maturities of  long—term debt                                  |       | $          | 16,700     |          | $          | —                      |       | $                                 | 242        |             | $          | 179                                                   |       | $ | — |   | $ | 17,121 |   |
| Accounts payable                                                            |       | —     |       | —        |       | 123,321                     |       | 38,966                            |       | —           |       | 162,287                                               |       |
| Due to affiliates                                                           |       | —     |       | —        |       | 132,999                     |       | 30,092                            |       | (163,091)        |       | —                                                |       |
| Accrued expenses                                                            |       | 17,054     |       | —        |       | 98,677                      |       | 20,817                            |       | —           |       | 136,548                                               |       |
| Due to Sally Beauty                                                         |       | 1,759      |       | —        |       | 5,615                       |       | 618                               |       | —           |       | 7,992                                                 |       |
| Income taxes payable                                                        |       | —     |       | —        |       | 1,536                       |       | 1,247                             |       | —           |       | 2,783                                                 |       |
| Long—term debt                                                         |       | 1,790,475  |       | —        |       | 382                         |       | 120                               |       | —           |       | 1,790,977                                             |       |
| Other liabilities                                                           |       | —     |       | —        |       | 10,734                      |       | 2,169                             |       | —           |       | 12,903                                                |       |
| Deferred  income tax liabilities                                            |       | (1,759)    |       | —        |       | 26,062                      |       | (629)                             |       | —           |       | 23,674                                                |       |
| Total  liabilities                                                          |       | 1,824,229  |       | —        |       | 399,568                     |       | 93,579                            |       | (163,091)        |       | 2,154,285                                             |       |
| Stock  options subject to redemption                                        |       | 7,058      |       | —        |       | —                      |       | —                            |       | —           |       | 7,058                                                 |       |
| Total  member’s (deficit) equity                                       |       | (801,679)  |       | —        |       | 831,999                     |       | 245,911                           |       | (1,077,910)      |       | (801,679)                                             |       |
| Total liabilities and  member’s (deficit) equity                       |       | $          | 1,029,608  |          | $          | —                      |       | $                                 | 1,231,567  |             | $          | 339,490                                               |       | $ | (1,241,001) |   | $ | 1,359,664 |   |

 

19

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated FinancialStatements

**SALLYHOLDINGS, INC. AND SUBSIDIARIES**

**(AWholly-Owned Subsidiary of Alberto-Culver Company)**

**Condensed ConsolidatedBalance Sheet**

**Yearended September 30, 2006**

**(Inthousands)**
|                                                                  | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally Holdings, Inc.  & Subsidiaries** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-------------------------------------------------------------|------------|
| **Assets**                                                       |       |       |       |          |       |                        |       |                              |       |             |       |                                                        |       |
| Cash and cash  equivalents                                       |       | $          | 53,792     |          | $          | —                      |       | $                                 | 36,634     |             | $          | 17,145                                                      |       | $ | — |   | $ | 107,571 |   |
| Trade accounts receivable, less allowance for  doubtful accounts |       | —     |       | —        |       | 37,243                      |       | 8,219                             |       | —           |       | 45,462                                                      |       |
| Other  receivables                                               |       | 38         |       | —        |       | 17,487                      |       | 3,703                             |       | —           |       | 21,228                                                      |       |
| Due from  affiliates                                             |       | 293,209    |       | —        |       | 81,388                      |       | 12,775                            |       | (387,372)        |       | —                                                      |       |
| Inventories                                                      |       | —     |       | —        |       | 479,122                     |       | 95,861                            |       | —           |       | 574,983                                                     |       |
| Prepaid expenses and other assets                                |       | —     |       | —        |       | 8,338                       |       | 10,266                            |       | —           |       | 18,604                                                      |       |
| Deferred income tax assets                                       |       | —     |       | —        |       | 13,549                      |       | (3,222)                           |       | —           |       | 10,327                                                      |       |
| Property and equipment, net                                      |       | —     |       | —        |       | 113,892                     |       | 28,843                            |       | —           |       | 142,735                                                     |       |
| Investment in  subsidiaries                                      |       | 658,928    |       | —        |       | 78,697                      |       | —                            |       | (737,625)        |       | —                                                      |       |
| Goodwill and other intangible assets, net                        |       | —     |       | —        |       | 357,696                     |       | 60,235                            |       | —           |       | 417,931                                                     |       |
| Total assets                                                     |       | $          | 1,005,967  |          | $          | —                      |       | $                                 | 1,224,046  |             | $          | 233,825                                                     |       | $ | (1,124,997) |   | $ | 1,338,841 |   |
| **Liabilities  and Stockholder’s Equity**                   | ** ** | ** ** | ** ** | ** **    | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **                                                  | ** ** |
| Accounts payable                                                 |       | $          | —     |          | $          | —                      |       | $                                 | 147,556    |             | $          | 29,067                                                      |       | $ | — |   | $ | 176,623 |   |
| Due to  affiliates                                               |       | —     |       | —        |       | 279,820                     |       | 107,552                           |       | (387,372)        |       | —                                                      |       |
| Accrued expenses                                                 |       | —     |       | —        |       | 98,057                      |       | 15,999                            |       | —           |       | 114,056                                                     |       |
| Long—term debt, including current maturities                |       | —     |       | —        |       | 603                         |       | 521                               |       | —           |       | 1,124                                                       |       |
| Other  liabilities                                               |       | —     |       | —        |       | 9,122                       |       | 2,831                             |       | —           |       | 11,953                                                      |       |
| Deferred income tax liabilities                                  |       | —     |       | —        |       | 22,432                      |       | (842)                             |       | —           |       | 21,590                                                      |       |
| Total liabilities                                                |       | —     |       | —        |       | 557,590                     |       | 155,128                           |       | (387,372)        |       | 325,346                                                     |       |
| Stock options subject to redemption                              |       | —     |       | —        |       | 7,528                       |       | —                            |       | —           |       | 7,528                                                       |       |
| Total  stockholder’s equity                                 |       | 1,005,967  |       | —        |       | 658,928                     |       | 78,697                            |       | (737,625)        |       | 1,005,967                                                   |       |
| Total  liabilities and stockholder’s equity                 |       | $          | 1,005,967  |          | $          | —                      |       | $                                 | 1,224,046  |             | $          | 233,825                                                     |       | $ | (1,124,997) |   | $ | 1,338,841 |   |

 

20

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated FinancialStatements

**SALLY HOLDINGS LLC ANDSUBSIDIARIES**

**Condensed Consolidated Statementof EarningsThree months ended June 30, 2007**

**(In thousands)**

**(Unaudited)**
|                                                     | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings LLC  & 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 (losses) before provision for income taxes |       | (37,265)   |       | —        |       | 58,999                      |       | 1,892                             |       | —           |       | 23,626                                                |       |
| Provision 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 |   |

 

21

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated FinancialStatements

**SALLY HOLDINGS, INC. ANDSUBSIDIARIES**

**Condensed Consolidated Statementof EarningsThree months ended June 30, 2006**

**(In thousands)**

**(Unaudited)**
|                                                     | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings, Inc.  & Subsidiaries** | ** ** |
|-----------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|---------------------------------------------------------------|------------|
|                                                |       |       |       |          |       |                        |       |                              |       |             |       |                                                          |       |
| Net sales                                           |       | $          | —     |          | $          | —                      |       | $                                 | 524,040    |             | $          | 75,494                                                        |       | $ | — |   | $ | 599,534 |   |
| Related party  sales                                |       | —     |       | —        |       | 403                         |       | —                            |       | (403)            |       | —                                                        |       |
| Cost of products sold and distribution expenses     |       | —     |       | —        |       | 281,572                     |       | 41,958                            |       | (403)            |       | 323,127                                                       |       |
| Gross profit                                        |       | —     |       | —        |       | 242,871                     |       | 33,536                            |       | —           |       | 276,407                                                       |       |
| Selling, general and administrative expenses        |       | —     |       | —        |       | 170,101                     |       | 32,386                            |       | —           |       | 202,487                                                       |       |
| Depreciation and  amortization                      |       | —     |       | —        |       | 7,640                       |       | 1,774                             |       | —           |       | 9,414                                                         |       |
| Sales-based service fee charged by Alberto-Culver   |       | —     |       | —        |       | 8,043                       |       | (892)                             |       | —           |       | 7,151                                                         |       |
| Transaction  expenses                               |       | 34,532     |       | —        |       | —                      |       | —                            |       | —           |       | 34,532                                                        |       |
| Operating earnings                                  |       | (34,532)   |       | —        |       | 57,087                      |       | 268                               |       | —           |       | 22,823                                                        |       |
| Interest income                                     |       | (5,109)    |       | —        |       | (303)                       |       | (101)                             |       | 5,025            |       | (488)                                                         |       |
| Interest expense                                    |       | —     |       | —        |       | 4,395                       |       | 921                               |       | (5,025)          |       | 291                                                           |       |
| Earnings (losses) before provision for income taxes |       | (29,423)   |       | —        |       | 52,995                      |       | (552)                             |       | —           |       | 23,020                                                        |       |
| Provision for  income taxes                         |       | 1,789      |       | —        |       | 5,747                       |       | 933                               |       | —           |       | 8,469                                                         |       |
| Equity in earnings of subsidiaries (net of tax)     |       | 45,763     |       | —        |       | (1,485)                     |       | —                            |       | (44,278)         |       | —                                                        |       |
| Net earnings                                        |       | $          | 14,551     |          | $          | —                      |       | $                                 | 45,763     |             | $          | (1,485)                                                       |       | $ | (44,278) |   | $ | 14,551 |   |

 

22

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated FinancialStatements

**SALLY HOLDINGS LLC ANDSUBSIDIARIES**

**Condensed Consolidated Statementof EarningsNine months ended June 30, 2007**

**(In thousands)**

**(Unaudited)**
|                                                | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally Holdings   LLC  & 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                                  |       | (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 (losses) before provision for income taxes |       | (118,027)  |       | —        |       | 163,837                     |       | 15,802                            |       | —           |       | 61,612                                                      |       |
| Provision 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  (losses)                              |       | $          | 30,613     |          | $          | —                      |       | $                                 | 112,017    |             | $          | 10,271                                                      |       | $ | (122,288) |   | $ | 30,613 |   |

 

23

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated FinancialStatements

**SALLY HOLDINGS, INC. ANDSUBSIDIARIES**

**Condensed Consolidated Statementof EarningsNine months ended June 30, 2006**

**(In thousands)**

**(Unaudited)**
|                                                | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally   Holdings, Inc.**

**& Subsidiaries** | ** ** |
|-----------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-------------------------------------------------------------------|------------|
|                                                |       |       |       |          |       |                        |       |                              |       |             |       |                                                              |       |
| Net sales                                           |       | $          | —     |          | $          | —                      |       | $                                 | 1,551,406  |             | $          | 215,584                                                           |       | $ | — |   | $ | 1,766,990 |   |
| Related party  sales                                |       | —     |       | —        |       | 1,457                       |       | —                            |       | (1,457)          |       | —                                                            |       |
| Cost of products sold and distribution expenses     |       | —     |       | —        |       | 832,412                     |       | 122,801                           |       | (1,457)          |       | 953,756                                                           |       |
| Gross profit                                        |       | —     |       | —        |       | 720,451                     |       | 92,783                            |       | —           |       | 813,234                                                           |       |
| Selling, general and administrative expenses        |       | 3          |       | —        |       | 515,293                     |       | 80,060                            |       | —           |       | 595,356                                                           |       |
| Depreciation and  amortization                      |       | —     |       | —        |       | 22,799                      |       | 5,289                             |       | —           |       | 28,088                                                            |       |
| Sale-based service fee charged by Alberto-Culver    |       | —     |       | —        |       | 21,568                      |       | —                            |       | —           |       | 21,568                                                            |       |
| Transaction  expenses                               |       | 39,275     |       | —        |       | —                      |       | —                            |       | —           |       | 39,275                                                            |       |
| Operating earnings                                  |       | (39,278)   |       | —        |       | 160,791                     |       | 7,434                             |       | —           |       | 128,947                                                           |       |
| Interest income                                     |       | (16,632)   |       | —        |       | (644)                       |       | (299)                             |       | 16,538           |       | (1,037)                                                           |       |
| Interest expense                                    |       | —     |       | —        |       | 15,245                      |       | 2,625                             |       | (16,538)         |       | 1,332                                                             |       |
| Earnings (losses) before provision for income taxes |       | (22,646)   |       | —        |       | 146,190                     |       | 5,108                             |       | —           |       | 128,652                                                           |       |
| Provision for  income taxes                         |       | 5,821      |       | —        |       | 41,454                      |       | 1,847                             |       | —           |       | 49,122                                                            |       |
| Equity in earnings of subsidiaries (net of tax)     |       | 107,997    |       | —        |       | 3,261                       |       | —                            |       | (111,258)        |       | —                                                            |       |
| Net earnings                                        |       | $          | 79,530     |          | $          | —                      |       | $                                 | 107,997    |             | $          | 3,261                                                             |       | $ | (111,258) |   | $ | 79,530 |   |

 

24

----

Sally Holdings LLC and Subsidiaries

Condensed Notes to Consolidated FinancialStatements

**SALLY HOLDINGS LLC ANDSUBSIDIARIES**

**Condensed Consolidated Statementof Cash FlowsNine months ended June 30, 2007**

**(In thousands)**

**(Unaudited)**
|                                                                   | ** ** | **Parent**  | ** ** | **Co-  Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally Holdings,   LLC  & Subsidiaries** | ** ** |
|------------------------------------------------------------------------|------------|-------------|------------|-----------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                             | ** ** | ** **  | ** ** | ** **      | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **                                                   | ** ** |
| **Net  cash provided by operating activities**                         |       | $           | 46,363     |            | $          | —                      |       | $                                 | 486        |             | $          | 81,804                                                       |       | $ | — |   | $ | 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)                                                     |       |
| Excess tax benefit from share-based compensation                       |       | —      |       | —          |       | 470                         |       | —                            |       | —           |       | 470                                                          |       |
| Distributions to Sally Beauty                                          |       | (1,809,739) |       | —          |       | —                      |       | —                            |       | —           |       | (1,809,739)                                                  |       |
| Distributions to Alberto-Culver                                        |       | (39,471)    |       | —          |       | —                      |       | —                            |       | —           |       | (39,471)                                                     |       |
| Net cash used by  financing activities                                 |       | (100,851)   |       | —          |       | (6,024)                     |       | (218)                             |       | —           |       | (107,093)                                                    |       |
| Effect of foreign exchange rate changes on cash and  cash equivalents  |       | 706         |       | —          |       | (268)                       |       | 392                               |       | —           |       | 830                                                          |       |
| Net increase (decrease) 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 |   |

 

25

----

**SALLY HOLDINGS, INC. ANDSUBSIDIARIES**

**Condensed Consolidated Statementof Cash FlowsNine months ended June 30, 2006**

**(In thousands)**

**(Unaudited)**
|                                                                   |       | Parent     |       | Co-  Issuer |       | Guarantor  Subsidiaries |       | Non-  Guarantor  Subsidiaries |       | Eliminations |       | Sally    Holdings, Inc.  & Subsidiaries |       |
|------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------------------|------------|-------------------------------|------------|--------------|------------|---------------------------------------------|------------|
| **Net  cash provided by operating activities**                         |       | $          | 5,435      |        | $          | —                  |       | $                             | 76,246     |         | $          | 28,366                                      |       | $ | — |   | $ | 110,047 |   |
| **Cash  Flows from Investing Activities:**                             | ** ** | ** ** | ** ** | ** **  | ** ** | ** **              | ** ** | ** **                    | ** ** | ** **   | ** ** | ** **                                  | ** ** |
| Capital expenditures and proceeds from sale of  property and equipment |       | —     |       | —      |       | (18,358)                |       | (3,014)                       |       | —       |       | (21,372)                                    |       |
| Acquisitions, net of cash acquired                                     |       | —     |       | —      |       | (4,248)                 |       | (17,760)                      |       | —       |       | (22,008)                                    |       |
| Net cash used by investing activities                                  |       | —     |       | —      |       | (22,606)                |       | (20,774)                      |       | —       |       | (43,380)                                    |       |
| **Cash  Flows from Financing Activities:**                             | ** ** | ** ** | ** ** | ** **  | ** ** | ** **              | ** ** | ** **                    | ** ** | ** **   | ** ** | ** **                                  | ** ** |
| Change in book cash overdraft                                          |       | —     |       | —      |       | (6,193)                 |       | —                        |       | —       |       | (6,193)                                     |       |
| Proceeds from issuance of long-term debt                               |       | —     |       | —      |       | 264                     |       | 265                           |       | —       |       | 529                                         |       |
| Repayments of long-term debt                                           |       | —     |       | —      |       | (200)                   |       | (201)                         |       | —       |       | (401)                                       |       |
| Proceeds related to notes with affiliates                              |       | —     |       | —      |       | 15,230                  |       | —                        |       | —       |       | 15,230                                      |       |
| Payments related to notes with affiliates                              |       | —     |       | —      |       | (31,880)                |       | —                        |       | —       |       | (31,880)                                    |       |
| Distributions to Alberto-Culver                                        |       | —     |       | —      |       | (5,616)                 |       | —                        |       | —       |       | (5,616)                                     |       |
| Excess tax benefit from exercises of Alberto-Culver                    |       | —     |       | —      |       | 369                     |       | —                        |       | —       |       | 369                                         |       |
| Net cash provided by (used by) financing activities                    |       | —     |       | —      |       | (28,026)                |       | 64                            |       | —       |       | (27,962)                                    |       |
| Effect of foreign exchange rate changes on cash and  cash equivalents  |       | (307)      |       | —      |       | 1,725                   |       | (1,707)                       |       | —       |       | (289)                                       |       |
| Net decrease in cash and cash equivalents                              |       | 5,128      |       | —      |       | 27,339                  |       | 5,949                         |       | —       |       | 38,416                                      |       |
| Cash and cash equivalents, beginning of period                         |       | 62         |       | —      |       | 29,019                  |       | 9,531                         |       | —       |       | 38,612                                      |       |
| Cash and cash equivalents, end of period                               |       | $          | 5,190      |        | $          | —                  |       | $                             | 56,358     |         | $          | 15,480                                      |       | $ | — |   | $ | 77,028 |   |

 

26

----

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

The following sectiondiscusses management’s view of the operations and financial condition of SallyHoldings, LLC (“Sally Holdings”), a wholly-owned subsidiary of Sally InvestmentHoldings LLC (“Sally Investment”), a wholly-owned subsidiary of Sally BeautyHoldings, Inc. (“Sally Beauty”), and its consolidated 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.  The financial condition as of September 30,2006 and results of operations for the three and nine months ended June 30,2006 and cash flows for the nine months ended June 30, 2006 are of SallyHoldings, Inc.  Sally Holdings, Inc. wasa wholly owned subsidiary of Alberto-Culver until November 16, 2006 when it wasconverted to a Delaware limited liability company, was renamed “Sally HoldingsLLC,” and became an indirect wholly owned subsidiary of Sally Beauty inconnection with the separation transactions. Sally Capital Inc., a Delaware corporation which we refer to as “SallyCapital”, is a wholly-owned subsidiary of Sally Holdings and does not have anyassets or operations of any kind. This section should be read in conjunctionwith the audited consolidated financial statements of Sally Holdings and therelated notes included in our registration statement, on Form S-4/A, as filed with the Securities andExchange Commission on July 26, 2007.  This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contains forward-lookingstatements. See “Cautionary Notice Regarding Forward-Looking Statements” abovefor a discussion of the uncertainties, risks and assumptions associated withthese forward-looking statements that could cause results to differ materiallyfrom those reflected in such forward-looking statements.

## **Overview**

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

We are the largest distributor of professional beauty supplies in theU.S. based on store count.  We operateprimarily through two business units, Sally Beauty Supply and Beauty SystemsGroup, which we refer to as “BSG.” Through Sally Beauty Supply and BSG, we operated a multi-channelplatform of 3,341 stores and supplied 195 franchised stores in North America aswell as selected European countries and Japan, as of June 30, 2007.  Within BSG, we also have one of the largestnetworks of professional distributor sales consultants in North America, withapproximately 1,000 professional distributor sales consultants who selldirectly to salons and salon professionals. We provide our customers with a wide variety of leading third-partybranded and private label professional beauty supplies, including hair careproducts, styling appliances, skin and nail care products and other beautyitems. Sally Beauty Supply stores target retail consumers and salonprofessionals, while BSG exclusively targets salons and salon professionals.

Sally Beauty Supply is the largest open-line distributor ofprofessional beauty supplies in the U.S. based on store count.  As of June 30, 2007, Sally Beauty Supplyoperated 2,652 company-owned retail stores and supplied 24 franchise storesacquired in the Salon Services acquisition, 2,218 of which are located in theU.S. and the remainder in the United Kingdom and certain other countries inEurope, Canada, Puerto Rico, Mexico and Japan. Sally Beauty Supply storesaverage 1,700 square feet and are primarily located in strip shopping centers.  The product selection in Sally Beauty Supplystores ranges between 5,600 and 7,600 SKU’s of beauty products, and includesproducts for hair care, nail care, beauty sundries and appliances, targetingretail consumers and salon professionals. Sally Beauty Supply stores carryleading third-party brands such as Clairol, Revlon and Conair, as well as anextensive selection of private label merchandise.

We believe BSG is the largest full-service distributor of professionalbeauty supplies in the U.S.  As ofJune 30, 2007, BSG operated 689 company-owned stores, supplied 171franchised stores and had a sales force of approximately 1,000 professionaldistributor sales consultants selling exclusively to salons and salonprofessionals in 45 U.S. states and portions of Canada, Mexico and certainEuropean countries. BSG stores average 2,800 square feet and are primarilylocated in secondary strip shopping centers. Through BSG’s large store base and sales force, BSG is able to access asignificant portion of the highly fragmented U.S. salon market.  The product selection in BSG stores, rangingbetween 4,000 and 9,400 SKU’s of beauty products, includes hair care, nailcare, beauty sundries and appliances targeting salons and salon professionals.BSG carries leading professional beauty product brands intended for use insalons and for resale by the salons to consumers. Certain BSG products are soldunder exclusive distribution agreements with suppliers, whereby BSG isdesignated as the sole distributor for a product line within certain geographicterritories.

27

----

In connection with the separation from Alberto-Culver, our managementevaluated the structure of its internal organization to identify and separatethe costs incurred by us at the corporate level as well as costs incurred by usthat benefit both the Sally Beauty Supply and BSG segments.  Accordingly, management has defined itsreportable segments as Sally Beauty Supply and BSG, less these corporate andshared costs, and has revised the comparable quarter in the prior year for comparabilitypurposes.

### ***Business Trends***

We operate within the large and growing U.S. professional beauty supplyindustry. Potential growth in the industry is expected to be driven byincreases in hair color, hair loss prevention and hair styling products.  Our results of operations are dependent uponthe following trends, events and uncertainties, some of which are beyond ourcontrol:

·                  *High level of customer fragmentation*.  The U.S. salon market is highly fragmentedwith over 230,000 salons in the U.S. Given the fragmented and small-scale nature of the salon industry, webelieve that salon operators will continue to depend on full service/exclusivedistributors and open-line channels for a majority of their beauty supplypurchases.

·                  *Growth in booth renting*. Booth renters are responsible for purchasing their own supplies.Historically, booth renters have significantly increased as a percentage oftotal salon professionals and we expect this trend to continue. Given theirsmaller individual purchases and relative lack of financial resources, boothrenters are likely to be dependent on frequent trips to professional beautysupply stores, like BSG and Sally Beauty Supply.

·                  *Increasing Use of Private*-*LabelProducts*.   We offer a broadrange of private label and control label products, which we generally refer tocollectively as “private label products.” Private label products are brands for which we own the trademark and insome instances the formula. Control label products are brands that are owned bythe manufacturer for which we have been granted sole distribution rights.Generally, our private label products have higher gross margins than theleading third-party branded products and we believe this area offerssignificant potential growth.

·                  *Frequent re-stocking needs*. Salon professionals primarily rely on just-in-time inventory due tocapital constraints and a lack of warehouse and shelf space at salons.  These factors are key to driving demand forconveniently located professional beauty supply stores.

·                  *Continuing consolidation*. There is continuing consolidation among professional beauty productdistributors and professional beauty product manufacturers.  We plan to continue to examine ways in whichwe can benefit from this trend, including reviewing opportunities to shiftbusiness from competitive distributors to the BSG network as other suppliersseek to lessen their reliance on distribution of their products through acompetitor’s network, as more fully described below.  We also intend to seek opportunisticvalue-added acquisitions that strategically fit with our current distributionnetwork, product offerings, and longer-term growth and profitabilityplans.  We believe that suppliers areincreasingly likely to focus on larger distributors and retailers with broaderscale and retail footprint.  We alsobelieve that we are well-positioned to capitalize on this trend as well asparticipate in the ongoing consolidation at the distributor / retail level.However, changes often occur in our relationships with suppliers that canmaterially affect the net sales and operating earnings of our businesssegments.

In addition, consolidation among suppliers could exacerbate the effectsof these relationship changes and could increase pricing pressures.  As we announced in December 2006, our largestsupplier, the Professional Products Division of L’Oreal USA S/D, Inc., which werefer to as “L’Oreal,” has moved a material amount of revenue out of the BSGnationwide distribution network and into competitive regional distributionnetworks.  More recently, L’Oreal hasalso announced the acquisition of two distributors competitive with BSG in thesoutheastern U.S. and the west coast markets. As a result, L’Oreal is entering into direct competition with BSG andthere can be no assurance that there will not be further revenue losses overtime at BSG, due to potential losses of additional L’Oreal related products aswell as from the increased competition from L’Oreal-affiliated distributionnetworks. In addition, L’Oreal has announced the acquisition of a supplier(Pureology) that does not currently do business with BSG.  If L’Oreal acquired a supplier that didconduct business with BSG, we could lose that revenue as well.  See “Risk 

28

----

Factors-We depend upon manufacturers who may be unable to provideproducts of adequate quality or who may be unwilling to continue to supplyproducts to us,” in Part II, Item 1A. of this report.

·                  *High level of competition*. Sally Beauty Supply competes with other domestic and internationalbeauty product wholesale and retail outlets, including local and regionalcash-and-carry beauty supply stores, professional-only beauty supply stores,salons, mass merchandisers, drug stores and supermarkets, as well as sellers onthe Internet and salons retailing hair care items. BSG competes with otherdomestic and international beauty product wholesale and retail suppliers andmanufacturers selling professional beauty products directly to salons andindividual salon professionals.  We alsoface competition from authorized and unauthorized retailers and Internet sitesoffering professional salon-only products. The increasing availability of unauthorized professional salon productsin large format retail stores such as drug stores, grocery stores and otherscould have a negative impact on our business.

·                  *Changing demographic and consumer trends*.  The aging baby-boomer population is expectedto drive future growth in professional beauty supply sales through an increasein the usage of hair color and hair-loss products.  Additionally, continuously changingfashion-related trends that drive new hair styles are expected to result incontinued demand for hair styling products. Changes in consumer tastes and fashion trends can have an impact on ourfinancial performance.  Our continuedsuccess depends in large part on our ability to anticipate, gauge and react ina timely and effective manner to changes in consumer spending patterns andpreferences for beauty products. If we are unable to anticipate and respond totrends in the market for beauty products and changing consumer demands, ourbusiness could suffer.

·                  *Controlling expenses*. Another important aspect of our business is our ability to controlcosts, especially in our BSG business by right-sizing the business (includingsome targeted reductions-in-force) and maximizing the efficiency of ourstructure.  In response to the loss of L’Orealrelated revenue discussed below, BSG made certain changes with its distributorsales consultants.  BSG’s sales force wasreduced and the remaining affected distributor sales consultants were offeredcertain compensation related incentives to stay with the Company as BSG seeksto replace lost L’Oreal revenue. BSG is also implementing a store re-brandingproject that will reposition all of its North American company-owned storesunder a common name and store identity, CosmoProf.  This project is expected to provide brandconsistency, save on advertising and promotional costs and allow for a morefocused marketing strategy.  Further, wecontinue to study our distribution function as we seek to rationalize ourinfrastructure.   During the remainder offiscal 2007, we plan to continue implementing a two-year $19.0 million capitalspending program to consolidate warehouses and reduce administrative expensesrelated to BSG’s distribution network optimization program.  We currently believe that this plan couldproduce significant annual expense savings of approximately $10.0 millionwithin the next two years.

·                  *Relationships with suppliers*.  We do not manufacture thebrand name or private label products we sell, and instead purchase our productsfrom manufacturers. We depend upon a limited number of manufacturers for asignificant percentage of the products we sell, and our relationships with thesesuppliers change often.   Please see thenext section for more information on this trend.

### ***Relationships With Suppliers***

Most of the net sales of Sally Beauty Supply are generated throughretail stores.  Most of the net sales ofBSG are generated through both professional only stores and professionaldistributor sales consultants. In addition, BSG has a number of franchiseeslocated primarily in the south and southwestern portions of the U.S. and inMexico, which buy products directly from BSG for resale in their assignedterritories.  A very small percentage ofsales are generated through sub-distributors (primarily in Europe), which alsobuy products directly from BSG for resale in their assigned territories. SallyBeauty Supply / BSG and their suppliers are dependent on each other for thedistribution of beauty products.  As istypical in distribution businesses, these relationships are subject to changefrom time to time (including the expansion or loss of distribution rights invarious geographies and the addition or loss of products lines).  Changes in our relationships with suppliersoccur often and could positively or negatively impact our net sales andoperating earnings. For example, our net sales and operating earnings werenegatively affected in fiscal year 2005 by the decision of certain suppliers ofthe BSG business to begin selling their products directly to salons in mostmarkets. Subsequently, in fiscal year 2006 one of those suppliers agreed toallow BSG to once again, sell its product lines in BSG stores.

29

----

On December 19, 2006, we announced that (1) BSG, other than itsArmstrong McCall division, would not retain its rights to distribute theprofessional products of L’Oreal through its distributor sales consultants(effective January 30, 2007, with exclusivity ending December 31, 2006) or inits stores on an exclusive basis (effective January 1, 2007) in thosegeographic areas within the U.S. in which BSG currently has distributionrights, and (2) BSG’s Armstrong McCall division would not retain the rights todistribute Redken professional products through its franchises.  In an effort to replace these rights, BSGentered 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 in its storesand through its sales consultants. Armstrong McCall retained its exclusive rights to distribute Matrixprofessional products in its territories.

We plan to mitigate the negative effects resulting from unfavorablechanges in our relationships with suppliers, such as L’Oreal, by taking thefollowing steps: (i) adding new products to replace lines with our distributorsales consultants, (ii) adding new product lines to our BSG stores, (iii)expanding existing product lines into new territories and, (iv) managing coststo maximize the efficiency of the BSG structure (in the third quarter of 2007we continued a right-sizing of the BSG business, including some targetedreductions-in-force). Although we are focused on developing new revenue and oncost management initiatives, there can be no assurance that our efforts willpartially or completely offset the loss of these distribution rights.   In addition, BSG’s loss of distributionrights through its distributor sales consultants, as well as the loss ofexclusive rights to distribute L’Oreal products in its stores, has resulted inmargin pressure on BSG’s remaining L’Oreal revenues, and this pressure iscurrently projected to continue during the remainder of fiscal 2007.  See “Risk Factors-We depend uponmanufacturers who may be unable to provide products of adequate quality or whomay be unwilling to continue to supply products to us,” in Part II, Item 1A. ofthis report.

Previously, we had estimated that the loss of the L’Oreal distributionrights described above would negatively impact our consolidated revenue byapproximately $110.0 million for the last nine months of fiscal 2007.  Of this projected $110.0 million, it wasassumed that the distributor sales consultant channel would lose approximately$20.0 million of ancillary, non-L’Oreal business.  However, during the third quarter of 2007,sales of non-L’Oreal brands continued to exceed prior-year levels in the impacteddistributor sales consultants channel and were also up in the storeschannel.  In addition, one of our keystrategies in dealing with the loss of the L’Oreal distribution rights has beento attempt to shift a portion of the L’Oreal purchases by BSG customerspreviously served by the distributor sales consultants to our BSG stores. Wedid not significantly shift a portion of L’Oreal purchases by BSG customerspreviously served by the distribution sales consultants to stores for the thirdquarter of 2007, and we no longer expect to do so in the future.

Regarding other suppliers, BSG continues to expand the P&GProfessional Care product lines including Wella, Sebastian and Graham Webb intoadditional geographies for BSG stores and distributor sales consultants.   As of June 30, 2007, BSG had 15 stores inFlorida and plans to open an additional 20 net new stores in that state byJanuary 2008.  Although Farouk Systemsterminated its agreement with BSG during the second fiscal quarter, BSG storesand DSCs once again have been given approval to distribute Farouk Systemsproducts since July, with an expanded distribution area that initially includes30 states.  Additionally, BSG enteredinto an agreement during the third quarter with KPSS to distribute the Goldwell/KMSbrands in 28 states.  BSG expects to gainthese distribution rights over time through either expirations or acquisitionsfrom existing distributors.

### ***Recent Acquisitions***

On February 15, 2007, we entered into and completed an Agreementfor the Sale and Purchase of the Entire Issued Share Capital of Chapelton 21Limited (the “Agreement”), a private company limited by shares and incorporatedin Scotland, which we refer to as “Salon Services,” by and among Ogee Limited,an indirect subsidiary of ours, and the registered shareholders of SalonServices. Pursuant to the Agreement, we acquired all of the issued sharecapital of Salon Services for an aggregate cash purchase price of approximately£30.0 million, or approximately $59.0 million, subject to certainadjustments. In addition, we extinguished approximately £2.0 million ofSalon Services’ debt. The Agreement contains representations, warranties andcovenants that are customary to transactions of this nature. Salon Services,through its direct and indirect subsidiaries including Salon Services (Hair andBeauty Supplies) Ltd., supplies professional hair and beauty products primarilyto salon and spa operators and independent hair and beauty professionals in theUnited Kingdom, Germany, Ireland and Spain.

30

----

In connection with our acquisition and operation of Salon Services, oursubsidiaries financed the purchase price through a draw down of approximately$57.0 million under our revolving (asset-based lending) facility, which werefer to as our “ABL facility”.  Certainfunds are being held in escrow in support of the sellers’ representations,warranties and covenants and regulatory compliance matters.  We expect that the final valuation of theacquired assets and liabilities will be completed by fiscal year end.

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

On November 16, 2006, we separated from Alberto-Culver, pursuant to aninvestment agreement, dated as of June 19, 2006, as amended, among us,Alberto-Culver, CDRS Acquisition LLC, which we refer to as “CDRS” and others.  See our registration statement, on Form S-4/A, asfiled with the Securities and Exchange Commission on July 26, 2007 foradditional information about our separation from Alberto-Culver.

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

#### ***Share-Based Payments***

Prior to November 16, 2006, we were a subsidiaryof Alberto-Culver and had no stock option plans of our own; however, certain ofour employees had been granted stock options under stock option plans ofAlberto-Culver.  In connection with theseparation from Alberto-Culver, the transaction constituted a change in controlfor purposes of Alberto-Culver’s stock option and stock award plans.  As a result, in accordance with the terms ofthese plans, all outstanding stock options and stock awards of Alberto-Culver,including those held by our employees, became fully vested upon completion ofthe transactions on November 16, 2006. During the nine months ended June 30, 2007, we recorded a charge equalto the amount of future compensation expense of approximately $5.3 million thatwould have been recognized in subsequent periods had these stock options andrestricted shares for our employees vested over the original vesting periods.Upon completion of the transaction separating us from Alberto-Culver, alloutstanding Alberto-Culver stock options held by our employees became optionsto purchase shares of Sally Beauty’s common stock.

Since November 16, 2006, we have been a subsidiary of Sally Beauty andhave had no share based plans of our own; however, certain employees have beengranted stock options and share awards under the plans of Sally Beauty.  As a result of the separation, the EmployeeStock Option Plan of 2003, the 2003 Stock Option Plan for Non-EmployeeDirectors and the 2003 Restricted Stock Plan that were previously plans of Alberto-Culverbecame plans of Sally Beauty.

Duringthe third quarters of fiscal 2007 and fiscal 2006, total compensation costcharged against income andincluded in selling, general and administrative expenses, for share-basedpayment arrangements was $3.8 million, which included $2.3 million of accelerated expense relatedto certain of our employees who are currently retirement eligible andeligible to continue vesting awards upon retirement under the terms of the 2007Omnibus Incentive Plan, and $1.0 million, respectively, and the total incometax benefit recognized in the income statement from these plans was $1.5million and $0.3 million, respectively. During the first nine months of fiscal 2007 and fiscal 2006, totalcompensation cost charged against income andincluded in selling, general and administrative expenses for share-basedpayment arrangements was $10.0 million and $4.1 million, respectivelyand the total income tax benefit recognized in the income statement from theseplans was $3.9 million and $1.4 million, respectively.

### ***Results of Operations***

The following table shows the results of operations of our business forthe three and nine months ended June 30, 2007 and 2006, expressed as apercentage of net sales for the respective periods:

31

----

 
|                                                  | ** ** | Three Months Ended  June 30, | ** ** | **Nine Months Ended  June 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                    | ** ** | **2006**                                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                   |       | 100.0%                                      |       | 100.0%                                         |       | 100.0% |   | 100.0% |   |
| Cost of products  sold and distribution expenses |       | 54.2%                                       |       | 53.9%                                          |       | 54.2% |   | 54.0% |   |
| Gross profit                                     |       | 45.8%                                       |       | 46.1%                                          |       | 45.8% |   | 46.0% |   |
| Total other  costs and expenses                  |       | 36.3%                                       |       | 42.3%                                          |       | 37.2% |   | 38.7% |   |
| Operating  earnings                              |       | 9.5%                                        |       | 3.8%                                           |       | 8.6% |   | 7.3% |   |
| Interest  expense, net                           |       | 5.8%                                        |       | 0.0%                                           |       | 5.3% |   | 0.0% |   |
| Earnings before  provision for income taxes      |       | 3.7%                                        |       | 3.8%                                           |       | 3.3% |   | 7.3% |   |
| Provision for  income taxes                      |       | 1.4%                                        |       | 1.3%                                           |       | 1.7% |   | 2.8% |   |
| Net earnings                                     |       | 2.3%                                        |       | 2.5%                                           |       | 1.6% |   | 4.5% |   |

 

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

The following table sets forth, for the periods indicated, informationconcerning key measures we rely on to gauge our operating performance (dollarsin thousands):
|                                                   | ** ** | **Three Months Ended June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                            | ** ** | **2006**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales:                                        |       |                                                |       |                                               |       |   |   |   |   |
| Sally Beauty Supply                               |       | $                                                   | 402,920    |                                               | $          | 356,975 |   | $ | 1,156,684 |   | $ | 1,060,015 |   |
| Beauty Systems Group                              |       | 231,960                                             |       | 242,559                                            |       | 717,351 |   | 706,975 |   |
|                                              |       | $                                                   | 634,880    |                                               | $          | 599,534 |   | $ | 1,874,035 |   | $ | 1,766,990 |   |
| Gross Profit                                      |       | $                                                   | 290,887    |                                               | $          | 276,407 |   | $ | 858,397 |   | $ | 813,234 |   |
| Gross profit  margin                              |       | 45.8%                                               |       | 46.1%                                              |       | 45.8% |   | 46.0% |   |
| Selling, general  and administrative expenses     |       | $                                                   | 219,646    |                                               | $          | 202,487 |   | $ | 642,042 |   | $ | 595,356 |   |
|                                              |       |                                                |       |                                               |       |   |   |   |   |
| Operating  earnings:                              |       |                                                |       |                                               |       |   |   |   |   |
| Sally Beauty Supply                               |       | $                                                   | 67,070     |                                               | $          | 59,169 |   | $ | 201,825 |   | $ | 179,670 |   |
| Beauty Systems Group                              |       | 15,391                                              |       | 24,865                                             |       | 48,168 |   | 69,265 |   |
| Segment operating earnings                        |       | 82,461                                              |       | 84,034                                             |       | 249,993 |   | 248,935 |   |
| Unallocated corporate and shared costs            |       | (21,985                                             | )          | (19,528                                            | )          | (64,218 | ) | (59,145 | ) |
| Sales based service fee charged by Alberto-Culver |       | —                                              |       | (7,151                                             | )          | (3,779 | ) | (21,568 | ) |
| Transaction expenses                              |       | (18                                                 | )          | (34,532                                            | )          | (21,502 | ) | (39,275 | ) |
| Operating earnings                                |       | 60,458                                              |       | 22,823                                             |       | 160,494 |   | 128,947 |   |
| Interest expense, net of interest income          |       | (36,832                                             | )          | 197                                                |       | (98,882 | ) | (295 | ) |
| Earnings before provision for income taxes        |       | $                                                   | 23,626     |                                               | $          | 23,020 |   | $ | 61,612 |   | $ | 128,652 |   |
| Segment  operating earnings margin:               |       |                                                |       |                                               |       |   |   |   |   |
| Sally Beauty Supply                               |       | 16.6%                                               |       | 16.6%                                              |       | 17.4% |   | 16.9% |   |
| Beauty Systems Group                              |       | 6.6%                                                |       | 10.3%                                              |       | 6.7% |   | 9.8% |   |
| Consolidated  operating earnings margin           |       | 9.5%                                                |       | 3.7%                                               |       | 8.6% |   | 7.3% |   |
|                                              |       |                                                |       |                                               |       |   |   |   |   |
| Number of retail  stores (end-of-period):         |       |                                                |       |                                               |       |   |   |   |   |
| Sally Beauty Supply                               |       |                                                |       |                                               |       |   |   |   |   |
| Company-owned stores                              |       |                                                |       |                                               |       | 2,652 |   | 2,494 |   |
| Franchise stores                                  |       |                                                |       |                                               |       | 24 |   | — |   |
| Total Sally Beauty Supply                         |       |                                                |       |                                               |       | 2,676 |   | 2,494 |   |
| Beauty Systems Group                              |       |                                                |       |                                               |       |   |   |   |   |
| Company-owned stores                              |       |                                                |       |                                               |       | 689 |   | 661 |   |
| Franchise stores                                  |       |                                                |       |                                               |       | 171 |   | 163 |   |
| Total Beauty Systems Group                        |       |                                                |       |                                               |       | 860 |   | 824 |   |
| Total                                             |       |                                                |       |                                               |       | 3,536 |   | 3,318 |   |
|                                              |       |                                                |       |                                               |       |   |   |   |   |
| Comparable store  sales growth******(1)**         |       |                                                |       |                                               |       |   |   |   |   |
| Sally Beauty Supply                               |       | 3.4%                                                |       | 1.0%                                               |       | 2.8% |   | 2.2% |   |
| Beauty Systems Group                              |       | 9.2%                                                |       | 5.6%                                               |       | 10.1% |   | 2.9% |   |
| Consolidated                                      |       | 4.8%                                                |       | 2.1%                                               |       | 4.5% |   | 2.4% |   |

 

32

----

(1)          Comparable stores are definedas company-owned stores that have been open for at least 14 months as of thelast day of a month.

### ***Description of Revenues and Expenses***

*Net Sales*. Our net sales consist primarily of the following:

·                  *Sally Beauty Supply.* Sally Beauty Supplygenerates net sales primarily by selling products through its stores to bothprofessional and retail customers.  SallyBeauty Supply sells hair care, hair color, skin and nail care products,electrical appliances and other beauty related accessories.  Because nearly 40% of our U.S. Sally BeautySupply revenues come from private or control label brands, most of these sameproducts are generally not sold in most other retail stores and are not sold inour BSG business.  Various factorsinfluence Sally Beauty Supply’s net sales including local competition, productassortment and availability, price, hours of operation and marketing andpromotional activity. Sally Beauty Supply’s product assortment and sales aregenerally not seasonal in nature.

·                  *Beauty Systems Group.* BSG generates netsales by selling products to salon professionals and independent styliststhrough company-owned and franchised stores, as well as through its network ofprofessional distributor sales consultants. BSG sells hair care, hair color products, skin and nail care products,electrical appliances and other beauty related accessories.  These products are not sold directly to thegeneral public and are generally not the same products as those sold in ourSally Beauty Supply stores.  Variousfactors influence BSG’s net sales, including product breadth and availability,competitive activity, relationships with suppliers, new product introductionsand price. BSG’s product assortment and sales are not seasonal in nature.

*Cost of Products Sold and Distribution Expenses*.  Cost of products sold and distributionexpenses consist of the cost to purchase merchandise from suppliers, lessrebates and allowances, and certain overhead expenses including purchasingcosts, freight from distribution centers to stores and handling costs in thedistribution centers.  Cost of productssold and distribution expenses are also affected by inventory shrinkage, whichrepresents products that are lost, stolen or damaged.

*Selling, General and Administrative Expenses*.  Selling, general and administrative expensesconsist primarily of share-based compensation, store personnel costs,commissions paid to professional distributor sales consultants, benefits,utilities, property maintenance, advertising, rent, insurance, freight anddistribution expenses for delivery to customers and corporate administrativecosts.

*Sales-based Service Fee. * Prior to the separation from Alberto-Culver,we were charged a sales-based service fee under the consulting, businessdevelopment and advisory services agreement between certain of our subsidiariesand Alberto-Culver.  Following theseparation from Alberto-Culver, the arrangements giving rise to this fee fromAlberto-Culver were terminated and the related charges have ceased.  We believe that had we been a stand-alonecompany, we would have not incurred a comparable expense.

*Transaction Expenses*.  For the fiscal year 2007, transactionexpenses are costs associated with the separation from Alberto-Culver and areprimarily payments to Alberto-Culver as defined in the separationagreements.  In addition, we recognizedseverance costs for two executives and certain professional fees related to theseparation from Alberto-Culver.  Forfiscal year 2006, transaction expenses are related to the termination of theagreement with Regis Corporation, which we refer to as “Regis,” that called forus to merge with a subsidiary of Regis in a tax-free transaction.  This proposed transaction was terminated inApril 2006 and we expensed approximately $41.5 million ($27.2 million aftertaxes) in fees associated with the termination.

33

----

### **Results ofOperations**

### ***Comparison of the Three Months Ended June 30, 2007 and 2006***

#### ***Net Sales***

Consolidated net sales increased $35.4 million, or 5.9%, to $634.9million for the three months ended June 30, 2007 compared to $599.5 million forthe same period in 2006.  This increase was primarily the result ofcomparable store sales growth of 4.8% and the acquisitions of Salon Success, aU.K based distributor of professional beauty products, and SalonServices.  Salon Success contributed an incremental $5.0 million ofrevenue and Salon Services contributed $25.9 million of revenue during thethree months ended June 30, 2007. We acquired Salon Success during the thirdquarter of fiscal 2006 and Salon Services during the second quarter of fiscal2007.

*Sally Beauty Supply*. Net sales for Sally Beauty Supply increased $45.9 million, or 12.9%, to$402.9 million for the three months ended June 30, 2007 compared to$357.0 million for the same period in 2006. Net sales increased primarilydue to a 7.3% increase resulting from the Salon Services acquisition, whichcontributed $25.9 million of revenue during the three months ended June 30,2007.  Revenues also increased due to 83 net new stores opened during thelast twelve months (July, 2006 through June, 2007, excluding acquisitions) andfrom a comparable store sales growth of 3.4%.

*Beauty Systems Group*. Net sales for BSG decreased $10.6 million, or 4.4%, to $232.0 millionfor the three months ended June 30, 2007 compared to $242.6 million forthe same period in 2006.  Net sales of our U.S. operations decreased dueto a decline of 31.3% in sales by BSG professional distributor salesconsultants, caused primarily by the loss of L’Oreal revenue, partially offsetby revenue increases with other suppliers.  BSG also experienced a declinein sales at its franchised-based business.  These declines were mostlyoffset by comparable store sales growth of 9.2% and an incremental $5.0 millionof revenues from the acquisition of Salon Success.  Sales for third fiscalquarter of 2007 were impacted by changes in the L’Oreal distribution agreement,resulting in the loss of approximately $30.0 million in sales of L’Orealproducts compared to the same months in fiscal 2006.

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

Consolidated gross profit increased $14.5 million, or 5.2%, to $290.9million for the three months ended June 30, 2007 compared to $276.4 million forthe same period in 2006. Consolidated gross profit, as a percentage of netsales, was 45.8% for the three months ended June 30, 2007 compared to 46.1% forthe prior year period.  Gross profit margins were down 30 basis pointsduring the third fiscal quarter of 2007 as compared to the same period in 2006due to higher gross profit margins from Sally Beauty Supply offset by lowergross profit margins from BSG.  Gross profit margins for Sally BeautySupply were helped, in part, by a continued increase in sales of private labelproducts.  Gross profit margins for BSG were hurt, in part, by marginpressure on certain products and replacing L’Oreal product sales with otherproducts at lower margins.  BSG’s loss ofstore exclusivity in the distribution of L’Oreal products is anticipated toresult in sustained margin pressure on all L’Oreal products sold through itsstore network. BSG gross margins during the third quarter of 2007 includedmargin pressures at BSG’s franchise-based business.

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

Consolidated selling, general and administrative expenses increased$17.1 million, or 8.5%, to $219.6 million for the three months ended June 30,2007 compared to $202.5 million for the same period in 2006.  Theseexpenses, as a percentage of net sales, were 34.6% for the three months endedJune 30, 2007 compared to 33.8% for the prior year period.  The increasein expense is partly attributable to selling and administrative expensesassociated with the unit growth of the Sally Beauty Supply and BSG businesses,$2.7 million in non-recurring costs associated with the realignment,right-sizing and retention incentives of our BSG business (based uponacquisition integration and previously-disclosed changes in its L’Orealcontract); acquisitions and an incremental expense for legal, audit andprofessional fees primarily due to expenses as a new public company.  Additionally, selling, general and administrativeexpenses for the third quarter of 2007 also included $3.7 million ofshare-based compensation expense, which includes $2.3 million of acceleratedexpenses related to certain employees who are currently retirement eligible andeligible to continue vesting awards upon retirement under the terms of the 2007Omnibus 

34

----

Incentive Plan, compared to $1.0 million of share-based compensationexpense in the third quarter of 2006.

#### ***Sales-based Service Fee Charged by Alberto-Culver***

The sales-based service fee charged to us by Alberto-Culver declined to$0.0 million for the three months ended June 30, 2007 from $7.2 million for thethree months ended June 30, 2006 due to the cancellation of the consulting,business development and advisory services agreement between certain of oursubsidiaries and Alberto-Culver which we entered into in connection with theseparation from Alberto-Culver.

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

We recorded minimal expenses related to the transaction separating usfrom Alberto-Culver for the three months ended June 30, 2007.  During thethree months ended June 30, 2006, we recorded $34.5 million in expenses relatedto the termination of the agreement with Regis that called for us to merge witha subsidiary of Regis in a tax-free transaction.

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

Consolidated operating earnings increased by $37.7 million, or 165.4%,to $60.5 million for the three months ended June 30, 2007 compared to $22.8million for the same period in 2006. Operating earnings, as a percentage of netsales, were 9.5% for the three months ended June 30, 2007 compared to 3.8% forthe same period in 2006.  The increase in consolidated operating earningswas primarily due to the expenses incurred as a result of the terminatedtransaction with Regis in 2006 and the elimination of service fees charged byAlberto-Culver due to the separation in 2007.  We do not allocate theseexpenses to our operating segments and these expenses are not reflected in thesegment operating earnings of Sally Beauty Supply and BSG discussed below.

*Sally Beauty Supply*. Sally Beauty Supply’s segment operating earnings increased $7.9 million, or13.4%, to $67.1 million for the three months ended June 30, 2007 compared to$59.2 million for the same period in 2006. Segment operating earnings, as apercentage of net sales, was 16.6% for the three months ended June 30, 2007compared to 16.6% for the same period in 2006.  Sally Beauty Supplyoperating earnings were positively impacted by growth in the number of storesas well as a gross margin improvement caused by a continued shift in productand customer mix partially offset by additional international revenue at loweroperating margins.

*Beauty Systems Group*.  BSG’ssegment operating earnings decreased $9.5 million, or 38.1%, to $15.4 millionfor the three months ended June 30, 2007 compared to $24.9 million for the sameperiod in 2006, in part, due to an increase in selling, general andadministrative expenses, while also experiencing lower gross profit margins ona slight decrease in sales volume.  Grossprofit margins declined partially as a result of a change in the mix ofproducts sold.  BSG also experienced gross margin declines in certainproducts as well as a decline in the profitability of its franchise-basedbusiness during the quarter.  In addition, BSG incurred $2.3 million ofadditional expenses related to the retention of its professional distributorsales consultants, and $0.4 million related to the realignment of the BSG salesforce and the closure of a warehouse during the third quarter of fiscal2007.  Segment operating earnings, as a percentage of net sales, was 6.6%for the three months ended June 30, 2007 compared to 10.3% for the same periodin 2006.

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

Interest expense, net of interest income, was $36.8 million and ($0.2) millionfor the three months ended June 30, 2007 and 2006, respectively.  Theincrease in interest expense was primarily attributable to the interestassociated with the new debt incurred on November 16, 2006.  The interest expense was partially offset by interestincome of $0.1 million and $0.5 million for the three months ended June 30,2007 and 2006, respectively.  Interest expense includes a marked to marketfair value income adjustment for interest rate swaps of $4.0 million for thethree months ended June 30, 2007.

35

----

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

Provision for income taxes was $9.0 million during the three monthsended June 30, 2007 compared to $8.5 million for the same period of2006.   Income taxes for interimperiods are included in the accompanying financial statements on the basis ofan estimated annual effective rate.  In determining the estimated annualeffective tax rate, we have excluded the tax effect of one-time charges relatedto the separation from Alberto-Culver.  The current estimated annual effectivetax rate excluding these charges is 36.9% for 2007 compared to 38.2% for 2006.

#### **Net Earnings**

As a result of the foregoing, consolidated net earnings decreased $0.1million, or 0.7%, to $14.7 million for the three months ended June 30, 2007compared to $14.6 million for the same period in 2006. Net earnings, as apercentage of net sales, were 2.3% for the three months ended June 30, 2007compared to 2.5% for the three months ended June 30, 2006.  Net earningswere reduced as a result of the expenses related to the transaction separatingus from Alberto-Culver and increased interest expense associated with the debtincurred.

### ***Comparison of the Nine Months Ended June 30, 2007 and 2006***

#### ***Net Sales***

Consolidated net sales increased $107.0 million, or 6.1%, to $1,874.0million for the nine months ended June 30, 2007 compared to $1,767.0 millionfor the same period in 2006.  This increase was primarily the result ofcomparable store sales growth of 4.5% and the acquisition of Salon Success andSalon Services.  Salon Success contributed an incremental $20.7 million ofrevenue and Salon Services contributed $39.4 million of revenue during the ninemonths ended June 30, 2007. We acquired Salon Success during the third quarterof 2006 and Salon Services during the second quarter of 2007.

*Sally Beauty Supply*. Net sales for Sally Beauty Supply increased $96.7 million, or 9.1%, to $1,156.7million for the nine months ended June 30, 2007 compared to $1,060.0 millionfor the same period in 2006. Net sales increased primarily due to a 3.7%increase resulting from the Salon Services acquisition, which contributed $39.4million of revenue during the nine months ended June 30, 2007, the opening of83 net new stores over the last twelve months (July, 2006 through June, 2007, excludingacquisitions) and a comparable store sales growth of 2.8%, which includesa decline in same store number of transactions.

*Beauty Systems Group*. Net sales for BSG increased $10.4 million, or 1.5%, to $717.4 million for thenine months ended June 30, 2007 compared to $707.0 million for the same periodin 2006.  Net sales increased due to a comparable store sales growth of10.1% and an incremental $20.7 million of revenues from the acquisition ofSalon Success.  The BSG same store sales increases were partially offsetby a decline of 19.2% in sales by BSG professional distributor salesconsultants, caused primarily by the loss of L’Oreal revenue, offset by revenueincreases with other suppliers.  BSG also experienced a decline in salesat its franchised-based business.

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

Consolidated gross profit increased $45.2 million, or 5.6%, to $858.4million for the nine months ended June 30, 2007 compared to $813.2 million forthe same period in 2006. Consolidated gross profit, as a percentage of net sales,was 45.8% for the nine months ended June 30, 2007 compared to 46.0% for theprior year period.  Gross profit margins declined slightly during thefirst nine months of 2007 due to lower gross profit margins at BSG, partiallyoffset by higher gross profit margins at Sally Beauty Supply.  Grossprofit margins for Sally Beauty Supply increased, in part, because of acontinued increase in sales of higher margin private label products and highermargin customer mix.  Gross profit margins for BSG declined, in part,because of the loss of L’Oreal revenues being partially replaced with lowermargin product sales and lower margins on certain products.

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

Consolidated selling, general and administrative expenses increased$46.6 million, or 7.8%, to $642.0 million for the 

36

----

nine months ended June 30, 2007 compared to $595.4 million for the sameperiod in 2006.  These expenses, as a percentage of net sales, were 34.3%for the nine months ended June 30, 2007 compared to 33.7% for the prior yearperiod. The increase in expense is partly attributable to selling andadministrative costs associated with the unit growth of the Sally Beauty Supplyand BSG businesses, costs associated with the realignment of our BSG business,acquisitions, and additional expenses at our corporate support center. Additionally, selling, general and administrative expenses for the first ninemonths of fiscal 2007 includes $10.0 million of share-based compensationexpense, including $2.3 million of accelerated expenses related to certainemployees who are currently retirement eligible and eligible to continuevesting awards upon retirement under the terms of the 2007 Omnibus IncentivePlan and $5.3 million of expenses related to early vesting of equity awards asa result of the separation transaction from the Alberto-Culver Company,compared to $4.1 million for the first nine months of fiscal 2006.

#### ***Sales-based Service Fee Charged by Alberto-Culver***

The sales-based service fee charged to us by Alberto-Culver declined to$3.8 million for the nine months ended June 30, 2007 from $21.6 million for thenine months ended June 30, 2006 due to the cancellation of the consulting,business development and advisory services agreement between certain of oursubsidiaries and Alberto-Culver which we entered into in connection with theseparation from Alberto-Culver.

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

We recorded $21.5 million in expenses related to the transactionseparating us from Alberto-Culver for the nine months ended June 30, 2007. The expenses were for fees allocated to us by Alberto-Culver and for theseverance payments to Mr. Renzulli, former Chairman of Sally Holdings, Inc, ascalled for in the separation agreement from Alberto-Culver, of approximately$20.0 million, as well as severance payments to Mr. Robinson, former ChiefFinancial Officer and Treasurer, prior to his retirement, of approximately $0.9million, and for other professional fees.  During the nine months endedJune 30, 2006, we recorded $39.3 million in expenses related to the terminatedtransaction with Regis.

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

Consolidated operating earnings increased by $31.6 million, or 24.5%,to $160.5 million for the nine months ended June 30, 2007 compared to $128.9million for the same period in 2006. Operating earnings, as a percentage of netsales, were 8.6% for the nine months ended June 30, 2007 compared to 7.3% forthe same period in 2006.  The increase in consolidated operating earningswas primarily due to the expenses incurred as a result of the transactionseparating us from Alberto-Culver being less than the expenses we recognized in2006 related to the proposed but terminated Regis transaction.  We do notallocate these expenses to our operating segments and these expenses are notreflected in the segment operating earnings of Sally Beauty Supply and BSGdiscussed below.

*Sally Beauty Supply*. Sally Beauty Supply’s segment operating earnings increased $22.1 million, or12.3%, to $201.8 million for the nine months ended June 30, 2007 compared to $179.7million for the same period in 2006. Segment operating earnings, as apercentage of net sales, was 17.4% for the nine months ended June 30, 2007compared to 16.9% for the same period in 2006.  Sally Beauty Supplyoperating earnings were positively impacted by growth in the number of storesas well as a gross margin improvement caused by a continued shift toward highermargin retail customers and higher margin private label products.

*Beauty Systems Group*. BSG’s segment operating earnings decreased $21.1 million, or 30.4%, to $48.2million for the nine months ended June 30, 2007 compared to $69.3 million forthe same period in 2006, in part, due to an increase in selling, general andadministrative expenses, while also experiencing slightly lower gross profitmargins on an increased sales volume. Gross profit margins declined primarily as a result of a higher level ofsales volume in a particular channel that traditionally has carried lowmargins, the loss of L’Oreal related revenue being partially replaced withlower margin products, and gross margin declines in certain products.  BSG’sfranchise-based business also experienced a decline in profitability for thenine months ended June 30, 2007.  In addition, BSG incurred approximately$5.8 million of expenses related to the closure of a warehouse and expensesrelated to the realignment of the BSG sales force, which includes $3.4 millionrelated to the retention of its professional distributor sales consultantsduring the first three quarters of fiscal 2007.  Segment operatingearnings, as a percentage of net sales, was 6.7% for the nine months ended June30, 2007 compared to 9.8% for the same period in 2006.

37

----

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

Interest expense, net of interest income, was $98.9 million and $0.3million for the nine months ended June 30, 2007 and 2006, respectively. The increase in interest expense was primarily attributable to the interestassociated with the new debt incurred on November 16, 2006.  The interest expense was partially offset byinterest income of $1.5 million and $1.0 million for the nine months ended June30, 2007 and 2006, respectively.  Interest expense includes a marked tomarket fair value income adjustment for interest rate swaps of $3.3 million forthe nine months ended June 30, 2007.

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

Provision for income taxes was $31.0 million during the nine monthsended June 30, 2007 compared to $49.1 million for the same period of2006.   Income taxes for interimperiods are included in the accompanying financial statements on the basis ofan estimated annual effective rate.  In determining the estimated annualeffective tax rate, we have excluded the tax effect of one-time charges relatedto the separation from Alberto-Culver.  The estimated annual effective taxrate excluding these charges is 36.9% for 2007 compared to 38.2% for 2006.

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

As a result of the foregoing, consolidated net earnings decreased $48.9million, or 61.5%, to $30.6 million for the nine months ended June 30, 2007compared to $79.5 million for the same period in 2006. Net earnings, as apercentage of net sales, were 1.6% for the nine months ended June 30, 2007compared to 4.5% for the nine months ended June 30, 2006.  Net earningswere reduced as a result of the expenses related to the transaction separatingus from Alberto-Culver and increased interest expense associated with the debtincurred.

## **FinancialCondition**

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

Working capital (current assets less current liabilities) at June 30,2007 was $360.7 million compared to $479.1 million at September 30, 2006,representing a decrease of $118.4 million. The resulting ratio of current assets to current liabilities was 2.10 to1.00 at June 30, 2007 compared to 2.65 to 1.00 at September 30, 2006.  The decrease in working capital was impactedas current assets declined while current liabilities increased.  Current assets were impacted by a $78.2million reduction in cash associated with the payment of fees and the transferof cash to Alberto-Culver in connection with the separation and an $8.4 milliondecline in inventory levels, offset by an increase in the prepayment of certainexpenses.  The increase in currentliabilities was primarily impacted by the addition of the current maturities oflong-term debt, which are amounts due over the next twelve months, incurred onNovember 16, 2006 or approximately $16.7 million, and $17.1 million of interestthat has been accrued at June 30, 2007. These increases, along with an increase in taxes, which had previously beenpaid by Alberto-Culver, exceeded a reduction in accounts payable, having beenimpacted by the decline in inventory purchases.   A reduction in working capital is part ofthe Company’s business strategy to minimize the amount of capital employed inthe business while maximizing the related operating profits.

Other assets at June 30, 2007 were $65.6 million compared to $7.9million at September 30, 2006, representing an increase of $57.7 million.  This increase was primarily due to the costsassociated with the debt, which will be amortized as interest expense over theterm of the debt.

Goodwill at June 30, 2007 increased by $44.1 million to $408.8 millioncompared to $364.7 million at September 30, 2006 primarily as a result of theacquisition in the United Kingdom and a smaller acquisition in Ireland.

Accrued expenses increased by $22.4 million to $136.5 million at June30, 2007 compared to $114.1 million at September 30, 2006.  This increase was a result of $17.1 millionof interest expense related to the new debt incurred on November 16, 2006 and$13.4 million for health and worker’s compensation insurance previouslyprovided by Alberto-Culver, offset by $9.3 million of payments against variousincentive and benefit plans and adjustments to various incentive plans.

38

----

Total member’s / stockholder’s (deficit) equity decreased mainly as aresult of the distribution to Sally Beauty of $1,809.7 million, which enabledSally Beauty to pay a special dividend payment of approximately $2,342.1million called for under the separation agreement from Alberto-Culver.  In addition, we paid $39.5 million toAlberto-Culver as a result of settlement of the inter-company agreement.

### **Liquidity and Capital Resources**

We broadly define liquidity as our ability to generate sufficient cashflow from operating activities to meet our obligations and commitments. Inaddition, liquidity includes the ability to obtain appropriate debt and equityfinancing and to convert into cash those assets that are no longer required tomeet existing strategic and financial objectives.  Therefore, liquidity cannot be consideredseparately from capital resources that consist of current or potentiallyavailable funds for use in achieving long-range business objectives and meetingdebt service commitments.

Our primary source of cash over the past three years has been from fundsprovided by operating activities and, for the nine months ended June 30, 2007,from borrowings.  The primary uses ofcash during the past three years were for acquisitions and capital expendituresand, for the nine months ended June 30, 2007, for the cash dividend paid inconnection with our separation from Alberto-Culver.  The following table shows our sources anduses of cash for the nine months ended June 30, 2007 and 2006 (in thousands):
|                                                       | ** ** | **Nine Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                            | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| Net cash  provided by operating activities            |       | $                                                  | 128,653    |   | $ | 110,047 |   |
| Net cash used by  investing activities                |       | (97,622                                            | )          | (43,380 | ) |
| Net cash used by  financing activities                |       | (107,093                                           | )          | (27,962 | ) |
| Effect of  foreign exchange rate changes              |       | 830                                                |       | (289 | ) |
| Net (decrease) increase  in cash and cash equivalents |       | $                                                  | (75,232    | ) | $ | 38,416 |   |

 

### ***Net Cash Provided by Operating Activities***

Net cash provided by operating activities in the nine months ended June30, 2007 increased by $18.7 million to $128.7 million compared to $110.0million during the nine months ended June 30, 2006.  The increase was primarily due to a reductionin cash used for inventory as we reduced our inventory levels, partially offsetby less net income due to transaction expenses and payments against taxliabilities.  These tax liabilities werepaid by Alberto-Culver in 2006 and were included in the inter-company account.  Operating cash also increased due to thetiming of collections from customers and vendors, offset by prepayments ofinsurance as we assumed responsibility from Alberto-Culver for liability andworker’s compensation coverage.

### ***Net Cash Used by Investing Activities***

Net cash used by investing activities in the nine months ended June 30,2007 increased by $54.2 million to $97.6 million compared to $43.4 million inthe nine months ended June 30, 2006, primarily due to capital expenditures fornew stores and remodels and the acquisition of Salon Services.  During the third quarter of fiscal 2007,capital expenditures include $7.6 million paid to exercise an operating leasepurchase option of a warehouse building that was subsequently sold for $8.0million, which proceeds are included in the proceeds from sale of property andequipment.

### ***Net Cash Used by Financing Activities***

Net cash used by financing activities in the nine months ended June 30,2007 increased by $79.1 million to $107.1 million compared to $28.0 millionduring the nine months ended June 30, 2006, primarily due to distributions toAlberto-Culver and costs associated with the separation from Alberto-Culver,including debt issuance costs and distribution to Sally Beauty to pay the cashdividend, offset by proceeds from issuance of debt.

39

----

### ***Liquidity Following our Separation from Alberto-Culver***

In connection with our separation from Alberto-Culver, we,(a) entered into senior secured term loan facilities (which we refer to assenior term loans) under which we borrowed approximately $1,070.0 million atclosing, (b) issued approximately $430.0 million principal amount of seniornotes and $280.0 million principal amount of senior subordinated notes (whichwe refer to as the Notes) and (c) entered into a $400.0 millionasset-backed senior secured loan facility (which we refer to as the ABLfacility), subject to borrowing base limitations, of which approximately $70.0million was drawn at closing.  Weincurred aggregate indebtedness in connection with the transactions ofapproximately $1,850.0 million.  Proceedsfrom this new debt and the $575.0 million equity investment by CD&RParallel Fund VI, L.P., which we refer to as the “CDR investors,” into SallyBeauty were used to pay a $25.00 per share cash dividend to holders of recordof Alberto-Culver shares as of the record date for the separationtransaction.  See our registration statement, on Form S-4/A, asfiled with the Securities and Exchange Commission on July 26, 2007, and “RiskFactors—Risks Relating to Our Substantial Indebtedness,” in Part II, Item 1A.of this report for additionalinformation about the separation from Alberto-Culver.

Followingthe completion of our separation from Alberto-Culver, we are highlyleveraged and a substantial portion of our liquidity needs will arise from debtservice on indebtedness incurred in connection with the transactions and fromfunding the costs of operations, working capital and capital expenditures.Ongoing liquidity needs are expected to be funded by net cash provided byoperating activities and borrowings under the ABL facility. The ABL facilityprovides for senior secured revolving loans up to a maximum aggregate principalamount of $400.0 million, subject to borrowing base limitations.  Extensions of credit under the ABL facilityare limited by a borrowing base calculated periodically based upon specifiedpercentages of the value of eligible inventory and eligible accountsreceivables, subject to certain reserves and other adjustments.  Our ability to obtain liquidity from theissuance of additional public or private equity is severely limited until atleast two years have passed from the completion of our separation from Alberto-Culverbecause issuance of Sally Beauty common stock may cause the Alberto-Culvershare distribution to be taxable to Sally Beauty and its stockholders underSection 355(e) of the Internal Revenue Code.  See “Risk Factors-Risks Relating to the Tax Treatment of our Separationfrom Alberto-Culver and Relating to Our Largest Stockholder,” in Part II, Item1A. of this report.

Theagreements and instruments governing our debt contain restrictions andlimitations that could significantly impact our ability to operate ourbusiness.*** ***For instance, the agreementsgoverning our senior term loans contain covenants that, among other things, restrictour and our subsidiaries’ ability to:

·    disposeof assets;

·    incuradditional indebtedness (including guarantees of additional indebtedness);

·    paydividends, repurchase stock or make other distributions;

·    make voluntary prepayments on the Notes ormake amendments to the terms thereof;

·    prepaycertain other debt or amend specific debt agreements;

·    createliens on assets;

·    makeinvestments (including joint ventures);

·    engagein mergers, consolidations or sales of all or substantially all of our assets;

·    engagein certain transactions with affiliates; and

·    permitrestrictions on our subsidiaries ability to pay dividends.

Theindentures governing the senior notes and senior subordinated notes alsocontain restrictive covenants that, among other things, limit our ability andthe ability of our restricted subsidiaries to:

40

----

·    disposeof assets;

·    incuradditional indebtedness (including guarantees of additional indebtedness);

·    paydividends, repurchase stock or make other distributions;

·    prepaysubordinated debt;

·    createliens on assets (which, in the case of the senior subordinated notes, would belimited in applicability to liens securing pari passu or subordinatedindebtedness);

·    makeinvestments (including joint ventures);

·    engagein mergers, consolidations or sales of all or substantially all of our assets;

·    engagein certain transactions with affiliates; and

· permit restrictions on our subsidiaries abilityto pay dividends.

TheABL facility contains covenants that, among other things, restrict our and oursubsidiaries’ ability to:

·    changeour line of business;

·    engage in certain mergers, consolidations andtransfers of all or substantially all of our assets;

·    make certain dividends, stock repurchases andother distributions;

·    make acquisitions of all of the business orassets of, or stock representing beneficial ownership of, any person;

·    dispose of certain assets;

·    make voluntary prepayments on the Notes ormake amendments to the terms thereof;

·    prepay certain other debt or amend specificdebt agreements;

·    change our fiscal year or the fiscal year ofour direct parent; and

·    create or incur negative pledges.

The agreements governing the senior secured term loanfacilities contain a covenant requiring us and our subsidiaries to comply withmaximum consolidated secured leverage ratio levels, which will decline overtime.  The consolidated secured leverageratio will be tested quarterly, with a maximum ratio of 5.25 for the fourquarter period ending June 30, 2007.  Theconsolidated secured leverage ratio is a ratio of (A) net consolidated secureddebt to (B) Consolidated EBITDA, as defined in the agreement governing thesenior term loan facility.

The ABL facility contains a covenant requiring us andour subsidiaries to maintain a fixed-charge coverage ratio of at least 1.0 to1.0 when availability under the ABL facility falls below $40.0 million. Thefixed-charge coverage ratio is defined as the ratio of (A) EBITDA (as definedin the ABL facility, or “Credit Agreement EBITDA”), less unfinanced capitalexpenditures to (B) fixed charges (as included in the definition of thefixed-charge coverage ratio in the agreement governing the ABL facility). TheABL facility uses fixed amounts for Credit Agreement EBITDA for periodspreceding our separation from Alberto-Culver.

For purposes of calculating either the consolidatedsecured leverage ratio or the fixed-charge coverage ratio, Consolidated EBITDAand Credit Agreement EBITDA are measured on a last-four-quarters basis.Accordingly, the 

41

----

calculation can bedisproportionately affected by a particularly strong or weak quarter and maynot be comparable to the measure for any previous or subsequent four-quarterperiod.

Failure to comply with the consolidated securedleverage ratio covenant under the senior secured term loan facilities wouldresult in a default under such facilities. Failure to comply with thefixed-charge coverage ratio covenant (if and when applicable) under the ABLfacility would result in a default under such facility. Either such a defaultcould also result in a default under the other facility or facilities, as thecase may be, and the notes. Absent a waiver or an amendment from our lendersand note holders, such defaults could permit the acceleration of allindebtedness under the ABL facility, senior secured term loan facilities andthe notes, which would have a material adverse effect on our results ofoperations, financial position and cash flows.

Consolidated EBITDA and Credit Agreement EBITDA arenot recognized measurements under accounting principles generally accepted inthe United States of America, or “GAAP,” and should not be considered as asubstitute for financial performance and liquidity measures determined inaccordance with GAAP, such as net income, operating income or operating cashflow. In addition, because other companies may calculate EBITDA differently,Consolidated EBITDA and Credit Agreement EBITDA likely will not be comparableto EBITDA or similarly titled measures reported by other companies.

We believe that we are currently in compliance withthe agreements and instruments governing our debt, including our financialcovenants.  Our ability to comply withthese covenants in future periods will depend on our ongoing financial andoperating performance, which in turn will be subject to economic conditions andto financial, market and competitive factors, many of which are beyond ourcontrol. Our ability to comply with these covenants in future periods will alsodepend substantially on the pricing of our products, our success atimplementing cost reduction initiatives and our ability to successfullyimplement our overall business strategy. See “Risk Factors—Risks Relating to Our Substantial Indebtedness” inPart II of Item 1A. of this report.

Based upon the current level of operations andanticipated growth, we anticipate that existing cash balances, funds generatedby operations and funds available under the ABL facility will be sufficient tomeet our working capital requirements and to finance capital expenditures,excluding acquisitions, over the next twelve months. However, our ability tomeet our debt service obligations and other capital requirements, includingcapital expenditures, will depend upon our future performance which, in turn,will be subject to general economic, financial, capital markets, business,competitive, legislative, regulatory and other conditions, many of which arebeyond our control.

There can be no assurance that our business will generate sufficientcash flows from operations, that anticipated net sales growth and operatingimprovements will be realized or that future borrowings will be available underthe ABL facility in an amount sufficient to enable us to service ourindebtedness or to fund our other liquidity needs. In addition, our ability tomeet our debt service obligations and liquidity needs are subject to certainrisks, which include, but are not limited to, restrictions on Sally Beauty’sability to issue public or private equity for at least two years after ourseparation from Alberto-Culver, increases in competitive activity, the loss ofkey suppliers, rising interest rates, the loss of key personnel, the ability toexecute our business strategy and general economic conditions.  See “Risk Factors” in Part II, Item 1A. ofthis report.

Our ability to pay obligations and expenses will be subject to ouroperating results, cash requirements and financial condition and our compliancewith covenants and financial ratios related to our existing or futureindebtedness. See “Risk Factors—Risks Relating to Our Substantial Indebtedness,”in Part II, Item 1A. of this report.

**Contractual Obligations**

Our contractual cash obligations have substantially changed as a resultof the transaction separating us from Alberto-Culver. Under the terms of theinvestment agreement entered into in connection with our separation fromAlberto-Culver, we incurred approximately $1.85 billion of new debt. We havematerial contractual cash obligations related to the principal and interestpayments for this new debt.  See “Note 4”of the condensed notes to consolidated financial statements included elsewherein this report for further detail on the debt and future minimum payments.  On November 24, 2006, the Company enteredinto interest rate swaps to manage our risk associated with changing interestrates.  See “Note 5” of the condensednotes to consolidated financial statements included elsewhere in this 

42

----

report for further information on the interest rate swaps and see PartII, Item 1A. “Risk Factors” of this report, for risks associated with theinterest rate swaps.

## **Off-BalanceSheet Financing Arrangements**

At June 30, 2007 and 2006, 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, which totaled $2.6 million and $1.4 million, respectively.

## **CriticalAccounting Policies and Estimates**

The preparation of financial statements in conformity with GAAP requiresus to make estimates and assumptions that affect the reported amounts ofassets, liabilities, revenues and expenses in the financial statements.  Actual results may differ from theseestimates. We believe these estimates and assumptions are reasonable.  We consider accounting policies to becritical when they require us to make assumptions about matters that are highlyuncertain at the time the accounting estimate is made and when differentestimates that our management reasonably could have used have a material effecton the presentation of our financial condition, changes in financial conditionor results of operations.

Our critical accounting policies relate to the valuation of inventories,vendor allowances, income taxes and share-based payments.

### ***Valuation of Inventories***

When necessary, we provide allowances to adjust the carrying value ofinventories to the lower of cost or market, including costs to sell or dispose,and for estimated inventory shrinkage. Inventories are stated at the lower ofcost (first in, first out method) or market (net realizable value). Estimatesof the future demand for our products and changes in stock-keeping units aresome of the key factors used by our management in assessing the net realizablevalue of inventories. We estimate inventory shrinkage based on historicalexperience.  Actual results differingfrom these estimates could significantly affect our inventories and cost ofproducts sold and distribution expenses.

### ***Vendor Allowances***

We account for cash consideration received from vendors under EmergingIssues Task Force (EITF) 02-16, Accounting by a Customer (Including a Reseller)for Certain Consideration Received from a Vendor, which we refer to as “EITF02-16.”  EITF 02-16 states that cashconsideration received by a customer is presumed to be a reduction of the costof sales unless it is for an asset or service or a reimbursement of a specific,incremental, identifiable cost incurred by the customer in selling the vendor’sproducts.  The majority of cashconsideration we receive is considered to be a reduction of the cost of salesand is allocated to cost of products sold and distribution expenses as therelated inventory is sold. We consider the facts and circumstances of thevarious contractual agreements with vendors in order to determine theappropriate classification of amounts received in the statements of earnings.We record cash consideration expected to be received from vendors in otherreceivables.  These receivables arerecorded at the amount we believe will be collected based on the provisions ofthe programs in place and are computed by estimating the point in time that wehave completed our performance under the agreements and the amountsearned.  These receivables could besignificantly affected if actual results differ from management’s expectations.

### ***Income Taxes***

We record tax provisions in our consolidated financial statements basedon an estimation of current income tax liabilities.  The development of these provisions requiresjudgments about tax issues, potential outcomes and timing. If we prevail in taxmatters for which provisions have been established or are required to settlematters in excess of established provisions, our effective tax rate for aparticular period could be significantly affected.

Deferred income taxes are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofassets and liabilities and their respective tax bases. Deferred tax assets and 

43

----

liabilities are measured using enacted tax rates expected to apply totaxable income in the years in which temporary differences are estimated to berecovered or settled. We believe that it is more likely than not that resultsof future operations will generate sufficient taxable income to realize our deferredtax assets, net of the valuation allowance currently recorded. In the future,if we determine that certain deferred tax assets will not be realizable, therelated adjustments could significantly affect our effective tax rate at thattime.

We have entered into a tax sharing agreement with Sally Beauty pursuantto which Sally Beauty has agreed to cause each of its subsidiaries that areeligible to be a member of the relevant combined tax group to join in filing acombined tax return with respect to each jurisdiction for all tax years forwhich such subsidiary is eligible to do so under the applicable tax law andSally Beauty shall make all payments to the applicable taxing authority of allcombined taxes that the relevant combined tax group is required to pay.

Where allowed by current tax law, we are included in the consolidatedincome tax returns filed by Sally Beauty, yet our provision for income taxes isrecorded on the basis of filing a separate income tax return.  Income taxes currently payable or receivableunder the consolidated income tax returns are paid to or received from SallyBeauty.

We are currently in the process of reconciling all tax balancestransferred from Alberto-Culver and expect to complete the process in thefourth quarter of fiscal 2007.  To date,we have not identified any necessary reconciling adjustments.

### ***Share-Based Payments***

Effective October 1, 2005, we adopted SFAS 123 (Revised 2004), *Share-Based Payment*‘SFAS 123 (R).’to account for stock options and stock awards, using the modified prospectivemethod. Under this method, compensation expense is recognized for new stockoption grants and stock awards beginning in fiscal year 2006 and for theunvested portion of outstanding stock options that were granted prior to theadoption of SFAS No. 123 (R). We recognize compensation expense on astraight-line basis over the vesting period or to the date a participantbecomes eligible for retirement, if earlier.

The amount of stock option expense is determined based on the fair valueof each stock option grant, which is estimated on the date of grant using theBlack-Scholes option pricing model with the following assumptions: expectedlife, volatility, risk-free interest rate and dividend yield.  The expected life of stock options representsthe period of time that the stock options granted are expected to beoutstanding. We estimate the expected life based on historical exercise trends.We estimate expected volatility by using the industry sector that Sally Beautybelongs to for the expected volatility of Sally Beauty’s share price since itis not practicable to estimate due to Sally Beauty’s lack of history.  The risk-free interest rate is based on thezero-coupon U.S. Treasury issue at the date of the grant for the expected lifeof the stock options.  The dividend yieldrepresents Sally Beauty’s anticipated cash dividend over the expected life ofthe stock options.  The amount of stockoption expense recorded is significantly affected by these estimates. Inaddition, we record stock option expense based on an estimate of the totalnumber of stock options expected to vest, which requires us to estimate futureforfeitures. We use historical forfeiture experience as a basis for thisestimate.  Actual forfeitures differingfrom these estimates could significantly affect the timing of the recognitionof stock option expense. We have based all these estimates on the assumptionsmade by Sally Beauty as of June 30, 2007. Our estimates for future periods may be based on different assumptionsand accordingly may differ.

## ***Related Party Transaction***

On January 1, 2007, weentered into an agreement with Sally Beauty under which we agreed to providecertain general and administrative services to Sally Beauty includingaccounting, finance, payroll, legal and tax sharing services. The cost of theseservices, which were based on a percentage of certain key employees’ salariesand benefits, is approximately $88,000 per month.  The cost of these services may notnecessarily be indicative of the costs which would be incurred by us as anindependent stand alone entity.  The costof these services to Sally Beauty was $0.5 million for the nine months endedJune 30, 2007.

We have entered into a tax sharing agreement and wefile consolidated tax returns with our parent, Sally Beauty.  See “Income Taxes” in Part I, Item 2 of thisreport for further information.

44

----

## **RecentAccounting Pronouncements**

In July 2006, the Financial Accounting Standards Board (“FASB”) issuedFASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109,” which we refer to as “FIN 48.” FIN48 clarifies the accounting for the uncertainty in income taxes recognized byprescribing a recognition threshold that a tax position is required to meetbefore being recognized in the financial statements. It also provides guidanceon derecognition, classification, interest and penalties, interim periodaccounting and disclosure. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006.  We are currentlyassessing the effect of this pronouncement on our consolidated financialstatements.

In September 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements,” which we refer to as “SFAS 157,” which defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.SFAS 157 is effective in fiscal years beginning after November 15, 2007.  We are currently assessing the effect of thispronouncement on our consolidated financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108,which we refer to as “SAB 108,” which provides interpretive guidance on how theeffects of the carryover or reversal of prior year misstatements should beconsidered in quantifying a current year misstatement. We implemented theprovisions of SAB 108 during the first quarter of fiscal 2007 and it did nothave a material impact on our financial position, results of operations or cashflows.

In February 2007, the FASB issued SFAS No. 159, *“*The Fair Value Option for FinancialAssets and Financial Liabilities - including an amendment of FASBStatement No. 115,*”*which werefer to as “SFAS 159.”  SFAS 159 permitsentities to choose to measure many financial instruments and certain otheritems at fair value that are not currently required to be measured at fairvalue, with unrealized gains and losses related to these financial instrumentsreported in earnings at each subsequent reporting date. SFAS 159 is effectiveas of the beginning of an entity’s first fiscal year that begins after November15, 2007. We are currently assessing the effect of this pronouncement on ourconsolidated financial statements.

45

----

# **Item 3. Quantitative and Qualitative Disclosuresabout Market Risk.**

As a multinational corporation, we are subject to certain market risksincluding foreign currency fluctuations, interest rates and government actions.We consider a variety of practices to manage these market risks, including,when deemed appropriate, the occasional use of derivative financialinstruments.

### ***Foreign currency exchange rate risk***

We are exposed to potential gains or losses from foreign currencyfluctuations affecting net investments and earnings denominated in foreigncurrencies. Our primary exposures are to changes in exchange rates for the U.S.dollar versus the British pound sterling, Canadian dollar, Euro and Mexicanpeso. Our various currency exposures at times offset each other providing anatural hedge against currency risk. Fluctuations in U.S. dollar exchange rateswithin the range of the rates for the nine months ended June 30, 2007 and 2006did not have a material effect on our financial condition and results of operations.  We do not use derivative financialinstruments to manage foreign currency exchange rate risk.

### ***Interest rate risk***

As a result of the debt financing incurred in connection with ourseparation from Alberto-Culver, we are subject to interest rate market risk inconnection with our long-term debt.  Theprincipal interest rate exposure relates to amounts borrowed under our seniorsecured term loan facilities and ABL facility. We incurred approximately $1.14billion of indebtedness with variable interest rates under our senior term loanfacility and ABL facility at the time of our separation fromAlberto-Culver.  A change in theestimated interest rate on the $1.10 billion of current borrowings under thesenior secured term loan facilities and the ABL facility up or down by 1/8%will increase or decrease earnings before provision for income taxes byapproximately $1.4 million on an annual basis, without considering the effectof any interest rate swap agreements we may have from time to time.

We are sensitive to interest rate fluctuations. In order to enhance ourability to manage risk relating to cash flow and interest rate exposure, we mayfrom time to time enter into and maintain derivative instruments, such asinterest rate swap agreements, for periods consistent with the relatedunderlying exposures. In addition, the agreements underlying our senior securedterm loan facilities require that we and/or certain of our other subsidiarieshedge a portion of our floating interest rate exposure for a specified period.

On November 24, 2006, we entered into two interest rate swap agreementswith a notional amount of $150.0 million and $350.0 million, respectively.  These agreements expire on November 24, 2008and 2009, respectively.  The agreementsallow us to convert a portion of our variable rate interest to a fixed rate of4.9975% plus (2.00% to 2.50%) and 4.94% plus (2.00% to 2.50%),respectively.   As discussed in Part II, “Item1A. Risk Factors”, changes in the fair value of these interest rate swapagreements driven by interest rate changes will increase or decrease our netinterest expense and may therefore affect our profitability.

## ***Credit risk***

We are exposed to credit risk on certain assets, primarily cashequivalents, short-term investments and accounts receivable.  The credit risk associated with cashequivalents and short-term investments is mitigated by our policy of investingin a diversified portfolio of securities with high credit ratings.

We provide credit to customers in the ordinary course of business andperform ongoing credit evaluations. We believe that our broad customer basemitigates our exposure to concentrations of credit risk with respect to tradereceivables. We believe our allowance for doubtful accounts is sufficient tocover customer credit risks.

46

----

**Item 4.Controls and Procedures.**

*Controls Evaluation and Related CEO and CFO Certifications.*  Ourmanagement, with the participation of our principal executive officer, who alsoserves as the principal executive officer of Sally Capital (“CEO”) andprincipal financial officer, who also serves as the principal financial officerof Sally Capital  (“CFO”), conducted anevaluation of the effectiveness of the design and operation of our disclosurecontrols and procedures as of the end of the period covered by this report. Thecontrols evaluation was conducted by our Disclosure Committee, comprised ofsenior representatives from our finance, accounting, internal audit, and legaldepartments under the supervision of our CEO.

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

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

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

*Conclusions regarding Disclosure Controls.*  Basedon the required evaluation of our disclosure controls and procedures, our CEOand CFO have concluded that, as of June 30, 2007, we maintain disclosurecontrols and procedures that are effective in providing reasonable assurancethat information required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms, and that suchinformation is accumulated and communicated to our management, including ourCEO and CFO, as appropriate to allow timely decisions regarding requireddisclosure.

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

47

----

**PARTII – OTHER INFORMATION**

# **Item 1.  LegalProceedings.**

There were no material legal proceedings pending against us or oursubsidiaries, as of June 30, 2007. We are involved in various claims andlawsuits incidental to the conduct of our business in the ordinary course. Wecarry insurance coverage in such amounts in excess of our self-insuredretention as we believe to be reasonable under the circumstances and that mayor may not cover any or all of our liabilities in respect of claims andlawsuits. We do not believe that the ultimate resolution of these matters willhave a material adverse impact on our consolidated financial position, cashflows or results of operations.

We are subject to a number of U.S., federal, state and local laws andregulations, as well as the laws and regulations applicable in each othermarket in which we do business.  Theselaws and regulations govern, among other things, the composition, packaging,labeling and safety of the products we sell and the methods we use to sellthese products.  We believe that we arein material compliance with such laws and regulations, although no assurancecan be provided that this will remain true going forward.

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

**Risks Relating to Our Business**

***We have a very limited history as a stand-alonecompany and may be unable to make the changes necessary to operate effectively.***

Werecently separated from Alberto-Culver and became an indirect subsidiary ofSally Beauty, an independent publicly-traded company. There can be no assurancethat our separation from Alberto-Culver and the resulting absence of itsgeneral administrative assistance will not have an adverse impact on ourbusiness, financial condition and results of operations. Apart from a limitednumber of services to be provided to us on a transitional basis, Alberto-Culverhas no obligation to provide financial, operational or organizationalassistance to us or any of our subsidiaries.

***The accounting and other management systemsand resources of Sally Beauty, our ultimate parent, may not be adequatelyprepared to meet the financial reporting and other requirements to which SallyBeauty is subject following our separation from Alberto-Culver.***

Ourfinancial results previously were included within the consolidated results ofAlberto-Culver, and the reporting and control systems were appropriate forthose of subsidiaries of a public company. However, neither we nor any of oursubsidiaries was directly subject to reporting and other requirements of theExchange Act. Sally Beauty, as an independent publicly-traded company, is nowdirectly subject to reporting and other obligations under the Exchange Act.These reporting and other obligations place significant demands on themanagement and administrative and operational resources, including accountingresources, of Sally Beauty, us and our subsidiaries. As a public company, SallyBeauty incurs significant legal, accounting, and other expenses that it did notincur as a private company while a subsidiary of Alberto-Culver.  As a result of our recent offer to exchangecertain of our unregistered senior notes and senior subordinated notes fromregistered notes, which we refer to as the exchange offers, we have becomesubject to reporting and other obligations under the Exchange Act. Under SECrules and regulations, our compliance costs have increased and are likely toincrease further.

SallyBeauty, as a public company, is subject to rules adopted by the SEC pursuant toSection 404 of the Sarbanes-Oxley Act of 2002, which will require Sally Beautyto include in its annual report on Form 10-K its management’s report on, andassessment of, the effectiveness of its internal controls over financialreporting. Such a report will first be required with respect to Sally Beauty’sannual report for the fiscal year ending September 30, 2007. As a result of theexchange offers, we have also become subject to these same rules such that themanagement report requirement will first apply to our annual report for thefiscal year ending September 30, 2008. If Sally Beauty or we fail to properlyassess and/or achieve and maintain the adequacy of its or our internalcontrols, as the case may be, there is 

48

----

a riskthat Sally Beauty or we will not comply with all of the requirements imposed bySection 404. Moreover, effective internal controls are necessary to helpprevent financial fraud. Any of these possible outcomes could result in anadverse reaction in the financial marketplace due to a loss of investorconfidence in the reliability of the financial statements of Sally Beauty orour company, which ultimately could harm our business.

Tocomply with these requirements, Sally Beauty, we and our subsidiaries areupgrading our systems, including information technology, implementingadditional financial and management controls, reporting systems and proceduresand have hired additional legal, accounting and finance staff. If additionalupgrades to our financial and management controls, reporting systems,information technology and procedures are required under the financial reportingrequirements and other rules that apply to reporting companies, now and in thefuture, our management and resources may need to be devoted to assist incompliance with those requirements.

***Our historical consolidated financialinformation contained in this report does not represent our future financialposition, results of operations or cash flows nor does it reflect what ourfinancial position, results of operations or cash flows would have been as aseparate public company during the periods presented.***

Ourhistorical consolidated financial information included in this report is notrepresentative of our future financial position, results of operations or cashflows nor does it reflect what our financial position, results of operations orcash flows would have been as the subsidiary of a public company independentfrom Alberto-Culver during the periods presented. This is primarily because:

·Ourhistorical consolidated financial information reflects allocation of expensesfrom Alberto-Culver. Those allocations may be different from the comparableexpenses we would have incurred as a separate company.

·Ourworking capital requirements were historically satisfied as part ofAlberto-Culver’s corporate-wide cash management policies. In connection withour separation from Alberto-Culver, we incurred a large amount of indebtednessand assumed significant debt service costs. As a result, our cost of debt andcapitalization are significantly different from that reflected in ourhistorical consolidated financial information for periods prior to ourseparation from Alberto-Culver.

·Asa result of our separation from Alberto-Culver, there have been significantchanges in our cost structure, including the costs of establishing anappropriate accounting and reporting system, debt service obligations and othercosts of being a stand-alone company.

***We may not be able to realize theanticipated benefits of our separation from Alberto-Culver on a timely basis orat all.***

The success of ourseparation from Alberto-Culver depends, in part, on our ability to realize theanticipated benefits of the separation. These anticipated benefits includeincreased brand and product recognition as a result of our increased ability toengage in more aggressive marketing and advertising campaigns following theelimination of difficulties arising from our businesses’ competition with thecustomers and suppliers of Alberto-Culver’s consumer products business and thepotential for increased operating earnings of our business expected to resultfrom allowing us to focus our attention and resources on our business andcustomers. We cannot assure you these benefits will occur or that we will beable to achieve growth in the future comparable to our businesses’ recenthistorical sales and earnings growth.

***As a separate entity, we will not enjoy allof the benefits of scale that Alberto-Culver achieved with the combination ofthe consumer products business and our business.***

Priorto our separation from Alberto-Culver, Alberto-Culver benefited from the scopeand scale of the consumer products business and our business in certain areas,including, among other things, risk management, employee benefits, regulatorycompliance, administrative services and human resources. Our loss of thesebenefits as a consequence of our separation from Alberto-Culver could have anadverse effect on our business, results of operations and financial condition.For example, it is possible that some costs will be greater for us than theywere for Alberto-Culver due to the loss of volume discounts and the position ofbeing a large customer to service providers and vendors. In addition, theseparation eliminated Alberto-Culver’s diversification that resulted from 

49

----

operatingthe consumer products business of Alberto-Culver alongside our distributionbusiness which tended to mitigate financial and operations volatility. As aresult, we may experience increased volatility in terms of cash flow, operatingresults, working capital and financing requirements.

***We are a holding company, with nooperations of our own, and we depend on our subsidiaries for cash.***

We area holding company and do not have any material assets or operations other thanownership of equity interests of our subsidiaries. Our operations are conductedalmost entirely through our subsidiaries and our ability to generate cash tomeet our obligations or to pay dividends is highly dependent on the earningsof, and receipt of funds from, our subsidiaries through dividends orintercompany loans. However, none of our subsidiaries are obligated to makefunds available to us for payment of dividends. Furthermore, we and oursubsidiaries may be able to incur substantial additional indebtedness in thefuture that may severely restrict or prohibit our subsidiaries from makingdistributions, paying dividends or making loans to us.

***The beauty products distribution industryis highly competitive.***

The beauty productsdistribution industry is highly fragmented and there are few significantbarriers to entry into the markets for most of the types of products andservices we sell. Sally Beauty Supply competes with other domestic andinternational beauty product wholesale and retail outlets, including local andregional cash-and-carry beauty supply stores, professional-only beauty supplystores, salons, mass merchandisers, drug stores and supermarkets, as well assellers on the Internet and salons retailing hair care items. BSG competes withother domestic and international beauty product wholesale and retail suppliersand with manufacturers selling professional beauty products directly to salonsand individual salon professionals. The primary competitive factors in thebeauty products distribution industry are the price at which we purchaseproducts from manufacturers, quality, perceived value, consumer brand namerecognition, packaging and mix of the products we sell; customer service; theefficiency of our distribution network; and the availability of desirable storelocations. Competitive conditions may limit our ability to maintain prices or mayrequire us to reduce prices to retain business or market share. Some of ourcompetitors are larger and have greater financial and other resources than wedo, and are less leveraged than our business, and may therefore be able tospend more aggressively on advertising and promotional activities and respondmore effectively to changing business and economic conditions. In addition, wemay lose customers if our competitors that own national chains acquireadditional salons that are BSG customers or if professional beauty supplymanufacturers align themselves with other beauty product wholesale and retailsuppliers who compete with BSG. For example, as we announced in December 2006,our largest supplier, the Professional Products Division of L’Oreal USA S/D, Inc.,which we refer to as L’Oreal, has moved a material amount of revenue out of theBSG nationwide distribution network and into competitive regional distributionnetworks. More recently, L’Oreal has also announced the acquisition of adistributor competitive with BSG in the southeastern U.S. As a result, L’Orealis entering into direct competition with BSG and there can be no assurance thatthere will not be further revenue losses over time at BSG, due to potentiallosses of additional L’Oreal related products as well as from the increasedcompetition from L’Oreal-affiliated distribution networks. Our failure tocontinue to compete effectively in our markets could adversely impact ourbusiness, financial condition and results of operations.

***We may be unable to anticipate changes inconsumer preferences and buying trends or manage our product lines andinventory commensurate with consumer demand.***

Ourcontinued success depends in large part on our ability to anticipate, gauge andreact in a timely and effective manner to changes in consumer spending patternsand preferences for beauty products. If we do not anticipate and respond totrends in the market for beauty products and changing consumer demands in atimely manner, our sales may decline significantly and we may be required tomark down certain products to sell the resulting excess inventory at priceswhich can be significantly lower than the normal retail or wholesale price,which could adversely impact our business, financial condition and results of operations.In addition, we depend on our inventory management and information technologysystems in order to replenish inventories and deliver products to storelocations in response to customer demands. Any systems-related problems couldresult in difficulties satisfying the demands of customers which, in turn,could adversely affect our sales and profitability.

Theaging baby-boomer population is expected to drive future growth in professionalbeauty supply sales through an increase in the usage of hair color andhair-loss products. Additionally, continuously changing fashion-related trends 

50

----

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. If we are unable to anticipate and respondto trends in the market for beauty products and changing consumer demands, ourbusiness could suffer.

***We depend upon manufacturers who may beunable to provide products of adequate quality or who may be unwilling tocontinue to supply products to us.***

We donot manufacture the brand name or private label products we sell, and insteadpurchase our products from manufacturers and fillers. We depend on a limitednumber of manufacturers for a significant percentage of the products we sell.Sally Beauty Supply’s five largest suppliers provided it with 41.3% and 40.9%of the products Sally Beauty Supply purchased in fiscal years 2005 and 2006,respectively. BSG’s five largest suppliers provided it with 59.7% and 59.2% ofthe products BSG purchased in fiscal years 2005 and 2006, respectively.

Inaddition, since we purchase products from many manufacturers and fillers on anat-will basis, under contracts which can generally be terminated without causeupon 90 days notice or less or which expire without express rights of renewal,such manufacturers and fillers could discontinue sales to us at any time orupon the expiration of the distribution period. Some of our contracts withmanufacturers may be terminated by such manufacturers if we fail to meetspecified minimum purchase requirements. In such cases, we do not havecontractual assurances of continued supply, pricing or access to new productsand vendors may change the terms upon which they sell. We may not be able toacquire desired merchandise in sufficient quantities or on acceptable terms inthe future.

Changesin Sally Beauty Supply and BSG’s relationships with suppliers occur often, andcould positively or negatively impact the net sales and operating profits ofboth business segments. For example, net sales and operating profits of SallyBeauty Supply and BSG were negatively affected in fiscal year 2005 by thedecision of certain suppliers of the BSG business to begin selling theirproducts directly to salons in most markets. Subsequently, in fiscal year 2006one of those suppliers agreed to have BSG once again sell its product lines inBSG stores.

Inaddition, some of our suppliers may seek to decrease their reliance ondistribution intermediaries, including full service/exclusive and open-linedistributors such as BSG and Sally Beauty Supply, by promoting their owndistribution channels. If our access to supplier-provided products were to bediminished relative to our competitors, our business could be materially andadversely affected. Also, consolidation among suppliers may increase theirnegotiating leverage, thereby providing them with competitive advantages overus that may increase our costs and reduce our revenues, adversely affecting ourbusiness, financial condition and results of operations.

OnDecember 19, 2006, we announced that (1) BSG, other than its Armstrong-McCalldivision, would not retain its rights to distribute the professional productsof L’Oreal through its distributor sales consultants (effective January 30,2007, with exclusivity ending December 31, 2006) or in its stores on anexclusive basis (effective January 1, 2007) in those geographic areas withinthe U.S. in which BSG had distribution rights, and (2) BSG’s Armstrong-McCalldivision would not retain the rights to distribute  *Redken*professional products through its franchises. In an effort to replace theserights, BSG entered into long-term agreements with L’Oreal under which, as ofJanuary 1, 2007, BSG had non-exclusive rights to distribute the same *L’Oreal* professional products in itsstores that it previously had exclusive rights to in its stores and through itssales consultants. Armstrong-McCall retained its exclusive rights todistribute  *Matrix* professional products in its territories.

Previously,we had estimated that the loss of the L’Oreal distribution rights describedabove would negatively impact our consolidated revenue by approximately $110.0million for the last nine months of fiscal 2007.  Of this projected $110.0 million, it wasassumed that the distributor sales consultant channel would lose approximately$20.0 million of ancillary, non-L’Oreal business.  However, during the third quarter of 2007,sales of non-L’Oreal brands continued to exceed prior-year levels in theimpacted distributor sales consultants channel and were also up in the storeschannel.   We cannot assure you that theimpact of these developments will not adversely impact revenue to a greaterdegree than we currently expect, or that our efforts to mitigate the impact ofthese developments will be successful. If the impact of these developments isgreater than we expect or our efforts to mitigate the impact of thesedevelopments are not successful, this could have a material adverse effect onour business, financial condition or results of operations.

Manufacturersand fillers of beauty supply products are subject to certain risks that couldadversely impact their 

51

----

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

If amaterial interruption of supply occurs, or a significant supplier ceases tosupply us or materially decreases its supply to us, we may not be able toacquire products with similar quality and consumer brand name recognition asthe products we currently sell, or acquire such products in sufficientquantities to meet our customers’ demands or on favorable terms to our business,any of which could adversely impact our business, financial condition andresults of operations.

We donot control the production process for the brand name and private labelproducts we sell. In many cases, we rely on representations of manufacturersand fillers about the products we purchase for resale regarding whether suchproducts have been manufactured in accordance with applicable governmentalregulations. We may not be able to identify a defect in a product we purchasefrom a manufacturer or filler before we offer such product for resale, whichcould result in fines or other actions by government regulators, productliability claims, product recalls, harm to our credibility, impairment ofcustomer relationships or a decrease in the market acceptance of brand names,any of which could adversely affect our business, financial condition andresults of operations.

***If products sold by us are found to bedefective in labeling or content, our credibility and that of the brands wesell may be harmed, market acceptance of our products may decrease and we maybe exposed to liability in excess of our products liability insurance coverageand manufacturer indemnities.***

Oursale of certain products exposes us to potential product liability claims,recalls or other regulatory or enforcement actions initiated by federal, stateor foreign regulatory authorities or through private causes of action. Suchclaims, recalls or actions could be based on allegations that, among otherthings, the products sold by us are misbranded, contain contaminants, provideinadequate instructions regarding their use or misuse, or include inadequatewarnings concerning flammability or interactions with other substances. Claimsagainst us could also arise as a result of the misuse by purchasers of suchproducts or as a result of their use in a manner different than the intendeduse. We may be required to pay for losses or injuries actually or allegedlycaused by the products we sell and to recall any product we sell that isalleged to be or is found to be defective.

Anyactual defects or allegations of defects in products sold by us could result inadverse publicity and harm our credibility, which could adversely affect ourbusiness, financial condition and results of operations. Although we may haveindemnification rights against the manufacturers of many of the products wedistribute and rights as an “additional insured” under the manufacturers’insurance policies, it is not certain that any individual manufacturer orinsurer will be financially solvent and capable of making payment to any partysuffering loss or injury caused by products sold by us. Further, some types ofactions and penalties, including many actions or penalties imposed bygovernmental agencies and punitive damages awards, may not be remediablethrough reliance on indemnity agreements or insurance. Furthermore, potentialproduct liability claims may exceed the amount of indemnity or insurancecoverage or be excluded under the terms of an indemnity agreement or insurancepolicy. If we are forced to pay to satisfy such claims, it could have anadverse effect on our business, financial condition and results of operations.

***We could be adversely affected if we do notcomply with laws and regulations or if we become subject to additional or morestringent laws and regulations.***

We aresubject to a number of U.S. federal, state and local laws and regulations, aswell as the laws and regulations applicable in each other market in which we dobusiness. These laws and regulations govern the composition, packaging,labeling and safety of the products we sell and the methods we use to sell theproducts. Non-compliance with applicable laws and regulations of governmentalauthorities, including the Food and Drug Administration and similar authoritiesin other jurisdictions, by us or the manufacturers of the products sold by uscould result in fines, product recalls and enforcement actions or otherwiserestrict our ability to market certain products, which could 

52

----

adverselyaffect our business, financial condition and results of operations. The lawsand regulations applicable to us or manufacturers of the products sold by usmay become more stringent. Continued legal compliance could require the reviewand possible reformulation or relabeling of certain products, as well as thepossible removal of some products from the market altogether. Legal compliancecould also lead to considerably higher internal regulatory costs. Manufacturersmay try to recover some or all of any increased costs of compliance byincreasing the prices at which we purchase products and we may not be able torecover some or all of such increased cost in our own prices to our customers.We are also subject to state and local laws that affect ourfranchisor-franchisee relationships. Increased compliance costs and the loss ofsales of certain products due to more stringent or new laws and regulationscould adversely affect our business, financial condition and results ofoperations.

Lawsand regulations impact our business in many areas that have no direct relationto the products we sell. For example, as a reporting company following theexchange offers, we will be subject to a number of laws and regulations relatedto the issuance and sale of our securities. Another area of intense regulationis that of the relationships we have with our employees, including compliancewith many different wage/hour and nondiscrimination related regulatory schemes.Violation of any of the laws or regulations governing our business and the assertionof individual or class-wide claims could have an adverse effect on ourbusiness, financial condition and results of operations.

***Product diversion could have an adverseimpact on our revenues.***

Themajority of the products that BSG sells are meant to be used exclusively bysalons and individual salon professionals or are meant to be sold exclusivelyby the purchasers, such as salons, to their retail consumers. However, despiteBSG’s efforts to prevent diversion, incidents of product diversion occur, wherebyBSG products are sold by these purchasers (and possibly by other bulkpurchasers such as franchisees) to middlemen and general merchandise retailers.The retailers, in turn, sell such products to consumers. The diverted productmay be old, tainted or damaged and sold through unapproved outlets, all ofwhich could diminish the value of the brand. Diversion could result in lowernet sales for BSG should consumers choose to purchase diverted products fromretailers rather than purchasing from BSG customers, or choose other productsaltogether because of the perceived loss of brand prestige.

Productdiversion is generally prohibited under BSG supplier contracts and we may beunder a contractual obligation to stop selling to salons, salon professionalsand other bulk purchasers who engage in product diversion. Our investigationand enforcement of anti-diversion policies may result in reduced sales to ourcustomer base, thereby decreasing our revenues. In addition, if we fail to stopdiversion as required, our supplier contracts could be adversely affected oreven terminated.

***BSG’s financial results are affected by thefinancial results of BSG’s franchised-based business (Armstrong McCall).***

BSGreceives revenue in the form of products purchased by Armstrong McCallfranchisees. Accordingly, a portion of BSG’s financial results is to an extentdependent upon the operational and financial success of these franchisees,including their implementation of BSG’s strategic plans. If sales trends oreconomic conditions worsen for Armstrong McCall’s franchisees, their financialresults may worsen. When Armstrong McCall divests company-owned stores,Armstrong McCall is often required to remain responsible for lease payments forthese stores to the extent that the relevant franchisees default on theirleases. Additionally, if Armstrong McCall franchisees fail to renew theirfranchise agreements, or if Armstrong McCall fails to meet its obligationsunder its franchise agreements or vendor distribution agreements or is requiredto restructure its franchise agreements in connection with such renewal, itcould result in decreased revenues for BSG.

***We may not be able to successfully identifyacquisition candidates or successfully complete desirable acquisitions.***

In thepast several years, we have completed several significant acquisitions, themajority of which were for the BSG business. We intend to continue to pursueadditional acquisitions in the future. Our business has in the past activelyreviewed acquisition prospects that would complement its existing lines ofbusiness, increase the size and geographic scope of its operations or otherwiseoffer growth and operating efficiency opportunities. There can be no assurancethat we will be able to identify suitable acquisition candidates.

53

----

If suitable candidatesare identified, sufficient funds may not be available to make suchacquisitions. We compete against many other companies, some of which are largerand have greater financial and other resources than we do. Increased competitionfor acquisition candidates could result in fewer acquisition opportunities andhigher acquisition prices. In addition, the amount of equity that Sally Beautycan issue to make acquisitions or raise additional capital will be severelylimited for at least two years following our separation from Alberto-Culver,which will make equity generally unavailable to fund acquisitions. Also,because we are highly leveraged and the agreements governing our indebtednesscontain limits on our ability to incur additional debt, we may be unable tofinance acquisitions that would increase our growth or improve our financialand competitive position. To the extent that debt financing is available tofinance acquisitions, our net indebtedness could be increased as a result ofany acquisitions.

***If we acquire any businesses in the future,they could prove difficult to integrate, disrupt our business or have anadverse effect on our results of operations.***

Anyacquisitions that we do make may be difficult to integrate profitably into ourbusiness and may entail numerous risks, including:

·difficultiesin assimilating acquired operations, stores or products, including the loss ofkey employees from acquired businesses;

·difficultiesand costs associated with integrating and evaluating the internal controlsystems of acquired businesses;

·expensesassociated with the amortization of identifiable intangible assets;

·diversionof management’s attention from our core business;

·complyingwith foreign regulatory requirements, including multi-jurisdictionalcompetition rules;

·enforcementof intellectual property rights in some foreign countries;

·adverseeffects on existing business relationships with suppliers and customers,including the potential loss of suppliers of the acquired businesses;

·operatinginefficiencies and negative impact on profitability;

·enteringmarkets in which we have limited or no prior experience; and

·thoserelated to general economic and political conditions, including legal and otherbarriers to cross-border investment in general, or by United States companiesin particular.

Inaddition, during the acquisition process, we may fail or be unable to discoversome of the liabilities of businesses that we acquire. These liabilities mayresult from a prior owner’s noncompliance with applicable laws and regulations.Acquired businesses may also not perform as we expect or we may not be able toobtain financial improvements in acquired businesses that we may expect.

***If we are unable to profitably open andoperate new stores, our business, financial condition and results of operationsmay be adversely affected.***

Ourfuture growth depends in part on our ability to open and profitably operate newstores in existing and additional geographic markets. The capital requirementsto open a Sally Beauty Supply or BSG store, excluding inventory, averageapproximately $66,000 and $68,000, respectively. However, we may not be able toopen all of the new stores we plan to open and any new stores we open may notbe profitable, either of which could have a material adverse impact on ourfinancial condition or results of operations. There are several factors thatcould affect our ability to open and profitably operate new stores, including:

54

----

·theinability to identify and acquire suitable sites or to negotiate acceptableleases for such sites;

·proximityto existing stores that may reduce new stores’ sales;

·difficultiesin adapting our distribution and other operational and management systems to anexpanded network of stores;

·thepotential inability to obtain adequate financing to fund expansion because ofour high leverage and limitations on Sally Beauty’s ability to issue equity forat least two years following our separation from Alberto-Culver, among otherthings;

·difficultiesin obtaining any needed governmental and third-party consents, permits andlicenses needed to operate additional stores; and

·potentiallimitations on capital expenditures which may be included in financingdocuments that we enter into.

***If we are unable to protect ourintellectual property rights, specifically our trademarks, our ability tocompete could be negatively impacted.***

Thesuccess of our business depends to a certain extent upon the value associatedwith our intellectual property rights. We own certain trademark and brand namerights used in connection with our business including, but not limited to, “*Sally*,” “*SallyBeauty*,” “*Sally Beauty Supply*,”“*Sally ProCard*,” “*BSG*,” “*CosmoProf*,”“*Armstrong McCall*,” “*ion,*” “*SalonServices*” and “*Beauty Club*.”We protect our intellectual property rights through a variety of methods,including trademarks which are registered or legally protected in the UnitedStates, Canada and other countries throughout the world in which our businessoperates. We also rely on trade secret laws, in addition to confidentialityagreements with vendors, employees, consultants, and others who have access toour proprietary information. While we intend to vigorously protect ourtrademarks against infringement, we may not be successful in doing so. Inaddition, the laws of certain foreign countries may not protect ourintellectual property rights to the same extent as the laws of the UnitedStates. The costs required to protect our intellectual property rights andtrademarks are expected to continue to be substantial.

***Our ability to conduct business ininternational markets may be affected by legal, regulatory, and economic risks.***

Ourability to capitalize on growth in new international markets and to grow ormaintain our current level of operations in our existing international marketsis subject to risks associated with our international operations. These risksinclude: unexpected changes in regulatory requirements; trade barriers to someinternational markets; economic fluctuations in specific markets; potentialdifficulties in enforcing contracts, protecting assets, including intellectualproperty, and collecting receivables in certain foreign jurisdictions; anddifficulties and costs of staffing, managing and accounting for foreignoperations.

***We may be adversely affected by anydisruption in our information technology systems.***

Ouroperations are dependent upon our information technology systems, whichencompass all of our major business functions. We rely upon such informationtechnology systems to manage and replenish inventory, to fill and ship customerorders on a timely basis, to coordinate our sales activities across all of ourproducts and services and to coordinate our administrative activities. Asubstantial disruption in our information technology systems for any prolongedtime period (arising from, for example, system capacity limits from unexpectedincreases in our volume of business, outages or delays in our service) couldresult in delays in receiving inventory and supplies or filling customer ordersand adversely affect our customer service and relationships. Our systems mightbe damaged or interrupted by natural or man-made events or by computer viruses,physical or electronic break-ins and similar disruptions affecting the global Internet.There can be no assurance that such delays, problems, or costs will not have amaterial adverse effect on our financial condition, results of operations andcash flows.

55

----

***The occurrence of one or more naturaldisasters or acts of terrorism could adversely affect our operations andfinancial performance.***

Theoccurrence of one or more natural disasters or acts of terrorism could resultin physical damage to one or more of our properties, the temporary closure ofstores or distribution centers, the temporary lack of an adequate work force ina market, the temporary or long term disruption in the supply of products (or asubstantial increase in the cost of those products) from some local suppliers,the temporary disruption in the delivery of goods to our distribution centers(or a substantial increase in the cost of those deliveries), the temporaryreduction in the availability of products in our stores and/or the temporaryreduction in visits to stores by customers.

If oneor more natural disasters or acts of terrorism were to impact our business, wecould, among other things, incur significantly higher costs and longer leadtimes associated with distributing products to stores. Furthermore, insurancecosts associated with our business may rise significantly in the event of alarge scale natural disaster or act of terrorism.

**Risks Relating to Our Substantial Indebtedness**

***We have substantial debt and may incursubstantial additional debt, which could adversely affect our financial health,our ability to obtain financing in the future and our ability to react tochanges in our business.***

Inconnection with our separation from Alberto-Culver, together with certain ofour subsidiaries, we incurred approximately $1,850.0 million in debt. As ofJune 30, 2007, we had an aggregate principal amount of approximately $1,808.1million, including capital lease obligations, of outstanding debt, and a totaldebt to equity ratio of -2.26:1.00.

Oursubstantial debt could have important consequences to you. For example, it could:

·makeit more difficult for us to satisfy our obligations to our lenders, resultingin possible defaults on and acceleration of such indebtedness;

·limitour ability to obtain additional financing for working capital, capitalexpenditures, acquisitions, debt service requirements, or general corporatepurposes;

·requireus to dedicate a substantial portion of our cash flow from operations to thepayment of principal and interest on our indebtedness, thereby reducing theavailability of such cash flows to fund working capital, capital expendituresand other general corporate purposes;

·increaseour vulnerability to general adverse economic and industry conditions,including interest rate fluctuations, because a portion of our borrowings areat variable rates of interest, including borrowings under senior secured termloan facilities and our asset-backed senior secured loan facility, which werefer to collectively as the senior secured credit facilities;

·placeus at a competitive disadvantage compared to our competitors withproportionately less debt or comparable debt at more favorable interest ratesand that, as a result, may be better positioned to withstand economicdownturns;

·limitour ability to refinance indebtedness or cause the associated costs of suchrefinancing to increase; and

·limitour flexibility to adjust to changing market conditions and our ability towithstand competitive pressures, or prevent us from carrying out capitalspending that is necessary or important to our growth strategy and efforts toimprove operating margins or our business.

Any ofthe foregoing impacts of our substantial indebtedness could have a materialadverse effect on our business, financial condition and results of operations.

***Despite our current indebtedness levels, weand our subsidiaries may incur substantially more debt, including secured debt,which could further exacerbate the risks associated with our substantialindebtedness.***

We andour subsidiaries may incur substantial additional indebtedness in the future. Theterms of the instruments 

56

----

governingour indebtedness do not fully prohibit us or our subsidiaries from doing so. Asof June 30, 2007, our senior credit facilities provided us commitments foradditional borrowings of up to approximately $360.3 million under our seniorABL facility, subject to borrowing base limitations. If new debt is added toour current debt levels, the related risks that we now face would increase andwe may not be able to meet all our debt obligations. In addition, theagreements governing our senior credit facilities as well as the indenturesgoverning our senior notes and senior subordinated notes do not prevent us fromincurring obligations that do not constitute indebtedness.

***The agreements and instruments governingour debt contain restrictions and limitations that could significantly impactour ability to operate our business.***

Oursenior secured term loan facilities contain covenants that, among other things,restrict our and our subsidiaries’ ability to:

·disposeof assets;

·incuradditional indebtedness (including guarantees of additional indebtedness);

·paydividends, repurchase stock or make other distributions;

·makevoluntary prepayments on our notes or make amendments to the terms thereof;

·prepaycertain other debt or amend specific debt agreements;

·createliens on assets;

·makeinvestments (including joint ventures);

·engagein mergers, consolidations or sales of all or substantially all of our assets;

·engagein certain transactions with affiliates; and

·permitrestrictions on our subsidiaries’ ability to pay dividends.

OurABL facility, contains covenants that, among other things, restrict our and oursubsidiaries’ ability to:

·changeour line of business;

·engagein certain mergers, consolidations and transfers of all or substantially all ofour assets;

·makecertain dividends, stock repurchases and other distributions;

·makeacquisitions of all of the business or assets of, or stock representingbeneficial ownership of, any person;

·disposeof certain assets;

·prepaycertain debt or amend specific debt agreements;

·changeour fiscal year or the fiscal year of our direct parent; and

·createor incur negative pledges.

Oursenior secured term loan facilities contain a requirement that we not exceed amaximum ratio of net senior secured debt to consolidated EBITDA (as those termsare defined in the agreement governing our senior secured term loanfacilities). In addition, if we fail to maintain a specified minimum level ofborrowing capacity under our ABL facility, we will then be obligated tomaintain a specified fixed-charge coverage ratio. Our ability to comply 

57

----

withthese covenants in future periods will depend on our ongoing financial andoperating performance, which in turn will be subject to economic conditions andto financial, market and competitive factors, many of which are beyond ourcontrol. Our ability to comply with these covenants in future periods will alsodepend substantially on the pricing of our products, our success atimplementing cost reduction initiatives and our ability to successfullyimplement our overall business strategy.

The indentures governingour senior notes and our senior subordinated notes contain restrictivecovenants that, among other things, limit our ability and the ability of ourrestricted subsidiaries to:

·disposeof assets;

·incuradditional indebtedness (including guarantees of additional indebtedness);

·paydividends, repurchase stock or make other distributions;

·prepaysubordinated debt;

·createliens on assets (which, in the case of the senior notes, would be limited inapplicability to liens securing pari passu or subordinated indebtedness);

·makeinvestments (including joint ventures);

·engagein mergers, consolidations or sales of all or substantially all of our assets;

·engagein certain transactions with affiliates; and

·permitour subsidiaries’ ability to pay dividends.

Therestrictions in the indentures governing our notes and the terms of our seniorcredit facilities may prevent us from taking actions that we believe would bein the best interest of our business, and may make it difficult for us tosuccessfully execute our business strategy or effectively compete withcompanies that are not similarly restricted. We may also incur future debtobligations that might subject us to additional restrictive covenants thatcould affect our financial and operational flexibility. We cannot assure youthat we will be granted waivers or amendments to these agreements if for anyreason we are unable to comply with these agreements, or that we will be ableto refinance our debt on terms acceptable to us, or at all.

Ourability to comply with the covenants and restrictions contained in our seniorcredit facilities and the indentures for our notes may be affected by economic,financial and industry conditions beyond our control. The breach of any ofthese covenants or restrictions could result in a default under either oursenior credit facilities or the indentures that would permit the applicablelenders or note holders, as the case may be, to declare all amounts outstandingthereunder to be due and payable, together with accrued and unpaid interest. Ifwe are unable to repay debt, lenders having secured obligations, such as thelenders under our senior credit facilities, could proceed against thecollateral securing the debt. In any such case, we may be unable to borrowunder our senior credit facilities and may not be able to repay the amounts dueunder our senior credit facilities and our notes. This could have seriousconsequences to our financial condition and results of operations and couldcause us to become bankrupt or insolvent.

***Our ability to generate the significantamount of cash needed to service all of our debt and our ability to refinanceall or a portion of our indebtedness or obtain additional financing depends onmany factors beyond our control.***

Ourability to make scheduled payments on, or to refinance our obligations under,our debt will depend on our financial and operating performance, which, inturn, will be subject to prevailing economic and competitive conditions and tothe financial and business factors, many of which may be beyond our control,described under “—Risks Relating to Our Business” above.

If ourcash flow and capital resources are insufficient to fund our debt serviceobligations, we may be forced to 

58

----

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

Our ABL facility willmature in 2011. Our senior secured term loan facilities consist of a term loanA maturing in 2012 and a term loan B maturing in 2013. As a result, we may berequired to refinance any outstanding amounts under our senior creditfacilities prior to the maturity dates of our notes. We cannot assure you thatwe will be able to refinance any of our indebtedness or obtain additionalfinancing, particularly because of our high levels of debt and the debtincurrence restrictions imposed by the agreements governing our debt, as wellas prevailing market conditions. In the absence of such operating results andresources, we could face substantial liquidity problems and might be requiredto dispose of material assets or operations to meet our debt service and otherobligations. Our senior credit facilities and the indentures governing our notesrestrict our ability to dispose of assets and use the proceeds from any suchdispositions. We cannot assure you we will be able to consummate those sales,or if we do, what the timing of the sales will be or whether the proceeds thatwe realize will be adequate to meet debt service obligations when due.

***An increase in interest rates wouldincrease the cost of servicing our debt and could reduce our profitability.***

Asignificant portion of our outstanding debt, including under our senior creditfacilities, bears interest at variable rates. As a result, an increase ininterest rates, whether because of an increase in market interest rates or adecrease in our creditworthiness, would increase the cost of servicing our debtand could materially reduce our profitability and cash flows. The impact ofsuch an increase would be more significant for us than it would be for someother companies because of our substantial debt.

***A decrease in interest rates would increaseour interest expense (due to our interest rates) and could reduce ourprofitability.***

Wehave entered into two interest rate swap agreements with a notional amount of$150.0 million and $350.0 million. These interest rate swap agreements relateto $500.0 million of the $1,070.0 million term loans A and B under our seniorsecured term loan facilities due in 2012 and 2013, respectively, to manage ourrisk associated with changing interest rates. We utilize interest rate swaps tomanage our financial risk associated with changing interest rates and account forthem under Statement of Financial Accounting Standards No. 133, “Accounting forDerivative Instruments and Hedging Activities,” as amended, which requires thatall derivatives be marked to market (fair value). Our current interest rateswap agreements do not qualify as hedges and therefore, the change in fairvalue of the interest rate swap agreements, which are adjusted quarterly, arerecorded in the results of operations. The marked to market impact of the swaparrangements on interest expense was a decrease of approximately $3.3 millionin the nine months ended June 30, 2007. Future changes in the fair value of the interest rate swap agreementswill continue to increase or decrease our interest expense and could have thepotential to affect our profitability.

**Risks Relating to the Tax Treatment of Our Separation fromAlberto-Culver and Relating To Sally Beauty’s Largest Stockholder**

***If the share distribution of Alberto-Culvercommon stock in the transactions separating our company  from Alberto-Culver  did not constitute a tax-free distributionunder Section 355 of the Internal Revenue Code, then we may be responsible forpayment of significant U.S. federal income taxes.***

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

59

----

Inconnection with the share distribution of Alberto-Culver common stock in theseparation, Sally Beauty received (i) a private letter ruling from the IRS and(ii) an opinion of Sidley Austin LLP, counsel to Alberto-Culver, in each case,to the effect that the transactions qualify as a reorganization under Section368(a)(1)(D) of the Internal Revenue Code and a distribution eligible fornon-recognition under Sections 355(a) and 361(c) of the Internal Revenue Code.The private letter ruling and the opinion of counsel were based, in part, onassumptions and representations as to factual matters made by, among others,Alberto-Culver, Sally Beauty and representatives of the Lavin familystockholders, as requested by the IRS or counsel, which, if incorrect, couldjeopardize the conclusions reached by the IRS and counsel. The private letterruling also did not address certain material legal issues that could affect itsconclusions, and reserved the right of the IRS to raise such issues upon asubsequent audit. Opinions of counsel neither bind the IRS nor any court, norpreclude the IRS from adopting a contrary position.

If theAlberto-Culver share distribution were not to qualify as a tax-freedistribution under Section 355 of the Internal Revenue Code, Sally Beauty wouldrecognize taxable gain equal to the excess of the fair market value of theAlberto-Culver common stock distributed to its stockholders over Sally Beauty’stax basis in the Alberto-Culver common stock.

Evenif the Alberto-Culver share distribution otherwise qualified as a tax-freedistribution under Section 355 of the Internal Revenue Code, it would result insignificant U.S. federal income tax liabilities to Sally Beauty if there is anacquisition of its stock or stock of Alberto-Culver as part of a plan or seriesof related transactions that includes the Alberto-Culver share distribution andthat results in an acquisition of 50% or more of Alberto-Culver’s or SallyBeauty’s outstanding common stock.

In theevent that Sally Beauty recognizes a taxable gain in connection with theAlberto-Culver share distribution (either (i) because the Alberto-Culver sharedistribution did not qualify as a tax-free distribution under Section 355 ofthe Internal Revenue Code or (ii) because of an acquisition by CDRS andCD&R Parallel Fund VII, L.P. of 50% or more of Alberto-Culver or SallyBeauty’s outstanding common stock as part of a plan or series of relatedtransactions that includes the Alberto-Culver share distribution), the taxablegain recognized by Sally Beauty would result in significant U.S. federal incometax liabilities to Sally Beauty. Under the Internal Revenue Code, Sally Beautywould be primarily liable for these taxes (for which Alberto-Culver may berequired to indemnify Sally Beauty under a tax allocation agreement, and therecan be no assurance that Alberto-Culver would be able to fulfill itsobligations under the tax allocation agreement if Alberto-Culver was determinedto be responsible for these taxes thereunder).

Forpurposes of determining whether the distribution of Alberto-Culver common stockto Sally Beauty’s stockholders in connection with the Alberto-Culver sharedistribution is disqualified as tax-free to Sally Beauty under the rulesdescribed in the second preceding paragraph, any acquisitions by CDRS andCD&R Parallel Fund VII, L.P. of Sally Beauty’s stock or the stock ofAlberto-Culver within two years before or after the Alberto-Culver sharedistribution are presumed to be part of a plan, although the parties may beable to rebut that presumption. For purposes of this test, the acquisition byCDRS and CD&R Parallel Fund VII, L.P. of 48% of Sally Beauty’s outstandingcommon stock on an undiluted basis that occurred in connection with ourseparation from Alberto-Culver will be treated as part of such a plan or seriesof transactions. Thus, a relatively minor additional change in the ownership ofSally Beauty common stock could trigger a significant tax liability for SallyBeauty under Section 355 of the Internal Revenue Code.

Theprocess for determining whether a prohibited change in control has occurredunder the rules is complex, inherently factual and subject to interpretation ofthe facts and circumstances of a particular case. If Alberto-Culver does notcarefully monitor its, or Sally Beauty does not carefully monitor its,compliance with these rules, this might inadvertently cause or permit aprohibited change in the ownership of Sally Beauty or of Alberto-Culver tooccur, thereby triggering Alberto-Culver’s or Sally Beauty’s respectiveobligations to indemnify the other pursuant to the tax allocation agreement,which would have a material adverse effect on Sally Beauty and/orAlberto-Culver. Sally Beauty will be primarily liable for these taxes, andthere can be no assurance that Alberto-Culver would be able to fulfill itsobligations under the tax allocation agreement if Alberto-Culver was determinedto be responsible for these taxes thereunder. In addition, these mutualindemnity obligations could discourage or prevent a third party from making aproposal to acquire Sally Beauty.

60

----

***Actions taken by the Lavin family stockholders or by CDRSand CD&R Parallel Fund VII, L.P. could adversely affect the tax-free natureof the share distribution of Alberto-Culver common stock in connection with thetransactions separating our company from Alberto-Culver.***

Sales and/or acquisitionsby the Lavin family stockholders of Sally Beauty common stock or Alberto-Culvercommon stock may adversely affect the tax-free nature of the share distributionof Alberto-Culver common stock in the transactions separating our company fromAlberto-Culver. First, with certain exceptions, sales by the Lavin familystockholders of Sally Beauty common stock or Alberto-Culver common stock at anytime after the transactions separating our company from Alberto-Culver might beconsidered evidence that the share distribution was used principally as adevice for the distribution of earnings and profits, particularly if theselling stockholder were found to have an intent to effect such sale at thetime of the share distribution. If the IRS successfully asserted that the sharedistribution was used principally as such a device, the share distributionwould not qualify as a tax-free distribution, and thus would be taxable toSally Beauty. Second, with certain exceptions, if any of the Lavin familystockholders were to sell an amount of Sally Beauty common stock that itreceived in connection with the transactions separating our company fromAlberto-Culver (or to acquire additional shares of Sally Beauty’s common stock)within the two year period following completion of the Alberto-Culver sharedistribution, and that amount of stock, if added to the common stock comprisingapproximately 48% of Sally Beauty’s outstanding common stock on an undilutedbasis that was acquired by CDRS and CD&R Parallel Fund VII, L.P. were toequal or exceed 50% of Sally Beauty’s outstanding common stock, as determinedunder the Internal Revenue Code and applicable Treasury regulations, a deemedacquisition of control of Sally Beauty in connection with the Alberto-Culvershare distribution would be presumed. If this presumption were not rebutted,Sally Beauty would be subject to significant U.S. federal income taxliabilities, which, if not reimbursed by Alberto-Culver, would have a materialadverse effect on Sally Beauty. Similarly, acquisitions by the CDRS andCD&R Parallel Fund VII, L.P. or their affiliates of Sally Beauty’s commonstock may cause a deemed acquisition of control of Sally Beauty in connectionwith the Alberto-Culver share distribution.

***Sally Beauty is affected by significant restrictions on itsability to issue equity securities following completion of the transactionsseparating our company from Alberto-Culver.***

Because of certainlimitations imposed by the Internal Revenue Code and regulations thereunder,the amount of equity that Sally Beauty can issue to make acquisitions or raiseadditional capital is severely limited and will continue to be so for at leasttwo years following completion of the transactions separating our company fromAlberto-Culver. As a result, Sally Beauty may not be able to raise even a smallamount of equity capital during that period. These limitations may restrict ourability to carry out our business objectives and to take advantage ofopportunities that could be favorable to our business. In addition, because weincurred approximately $1.85 billion in debt in connection with thosetransactions, and the instruments governing our indebtedness contain limits onour ability to incur additional debt, Sally Beauty’s inability to raise even asmall amount of equity capital at a time when we need additional capital couldhave a material adverse effect on our ability to service our debt and operateour business.

***The interests of the largest stockholder of Sally Beauty maydiffer from the interests of our note holders.***

CDRS, the largeststockholder of Sally Beauty, owns approximately 48% of the outstanding commonstock of Sally Beauty on an undiluted basis. Pursuant to a stockholders agreement entered into by Sally Beauty, CDRS,CD&R Parallel Fund VII, L.P. and the Lavin family stockholders, CDRS hasdesignated five of the initial eleven directors of Sally Beauty, and CDRS’srights to nominate certain numbers of directors will continue so long as itowns specified percentages of the common stock of Sally Beauty.  In addition, the current Chairman of SallyBeauty’s board of directors is affiliated with CDRS.  The interests of CDRS may differ from thoseof the holders of our notes in material respects.  For example, CDRS may have an interest inpursuing acquisitions, divestitures, financings, re-financings or othertransactions that, in its judgment, could enhance its overall equity portfolio,even though such transactions might involve substantial risks to holders of ournotes.  The manager of CDRS’s ultimateparent is in the business of making investments in companies, and may from timeto time in the future, acquire interests in businesses that directly orindirectly compete with certain portions of our business or are suppliers ofour customers.  Additionally, CDRS maydetermine that the disposition of some or all of its interest in Sally Beautywould be beneficial to it at a time when such disposition could be detrimentalto us and/or to the holders of our notes. Moreover, the ownership by CDRS of approximately 48% of Sally Beauty’soutstanding common stock may have

61

----

the effect ofdiscouraging offers to acquire control of Sally Beauty, which may inhibit theability of Sally Beauty to maximize stockholder value and/or us to maximize thevalue of our notes.

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

** **

# (a)Not applicable.

# (b)Not applicable.

# (c)Not applicable.

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

Not applicable.

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

Not applicable.

# **Item 5.  Other Information.**

(a) None.

# (b)None.

**Item6. Exhibits.**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                        |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.1             |       | Investment  Agreement, dated as of June 19, 2006, among Alberto-Culver Company, New Aristotle  Company, Sally Holdings, Inc., New Sally Holdings, Inc. and CDRS Acquisition  LLC, which is incorporated herein by reference from Exhibit 2.1 of the  Amendment No. 3 to the Registration Statement on Form S-4 of New Sally  Holdings, Inc. (File No. 333-136259) filed on October 10, 2006                            |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.2             |       | First Amendment  to the Investment Agreement, dated as of October 3, 2006, among  Alberto-Culver Company, New Aristotle Company, Sally Holdings, Inc., New  Sally Holdings, Inc. and CDRS Acquisition LLC, which is incorporated herein  by reference from Exhibit 2.2 of the Amendment No. 3 to the Registration  Statement on Form S-4 of New Sally Holdings, Inc. (File No. 1333-136259)  filed on October 10, 2006 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.3             |       | Second Amendment  to the Investment Agreement, dated as of October 26, 2006, among  Alberto-Culver Company, New Aristotle Company, Sally Holdings, Inc., New  Sally Holdings, Inc. and CDRS Acquisition LLC, which is incorporated herein  by reference from Exhibit 2.02 of the Current Report on Form 8-K of New Sally  Holdings, Inc. filed on October 30, 2006                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.4             |       | Separation  Agreement, dated as of June 19, 2006, among Alberto-Culver Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and New Aristotle Holdings, Inc.,  which is incorporated herein by reference from Exhibit 2.3 of the Amendment  No. 3 to the Registration Statement on Form S-4 of New Sally Holdings, Inc.  (File No. 1333-136259) filed on October 10, 2006                                          |

 

62

----

 
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.5             |       | First Amendment  to the Separation Agreement, dated as of October 3, 2006, among  Alberto-Culver Company, Sally Holdings, Inc., New Sally Holdings, Inc. and  New Aristotle Holdings, Inc., which is incorporated herein by reference from  Exhibit 2.4 of the Amendment No. 3 to the Registration Statement on Form S-4  of New Sally Holdings, Inc. (File No. 1333-136259) filed on October 10, 2006                                                                                                                  |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.6             |       | Second Amendment  to the Separation Agreement, dated as of October 26, 2006, among  Alberto-Culver Company, Sally Holdings, Inc., New Sally Holdings, Inc. and  New Aristotle Holdings, Inc., which is incorporated herein by reference from  Exhibit 2.01 of the Current Report on Form 8-K of New Sally Holdings, Inc.  filed on October 30, 2006                                                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.7             |       | Agreement for  the sale and purchase of the entire issued share capital of Chapelton 21  Limited, a private company incorporated in Scotland, dated as of February 15,  2007 by and among Ogee Limited, a company incorporated under the laws of  England and Wales and an indirect wholly-owned subsidiary of the Company, and  the shareholders named therein, which is incorporated herein by reference  from Exhibit 2.7 of the Quarterly Report on Form 10-Q of Sally Beauty  Holdings, Inc. filed on May 10, 2007 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.1             |       | Certificate of  Formation of Sally Holdings LLC, which is incorporated herein by reference  from Exhibit 3.1 of the Registration Statement on Form S-4 of Sally Holdings  LLC and Sally Capital Inc. (File No. 333-144427) filed on July 9, 2007                                                                                                                                                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.2             |       | Limited  Liability Company Agreement of Sally Holdings LLC, which is incorporated  herein by reference from Exhibit 3.2 of the Registration Statement on Form  S-4 of Sally Holdings LLC and Sally Capital Inc. (File No. 333-144427) filed  on July 9, 2007                                                                                                                                                                                                                                                            |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.3             |       | Certificate of  Incorporation of Sally Capital Inc., which is incorporated herein by  reference from Exhibit 3.3 of the Registration Statement on Form S-4 of Sally  Holdings LLC and Sally Capital Inc. (File No. 333-144427) filed on July 9,  2007                                                                                                                                                                                                                                                                   |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.4             |       | By-Laws of Sally  Capital Inc, which is incorporated herein by reference from Exhibit 3.4 of  the Registration Statement on Form S-4 of Sally Holdings LLC and Sally  Capital Inc. (File No. 333-144427) 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 of 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 of the Annual Report on Form 10-K of Sally Beauty  Holdings, Inc. filed on December 22, 2006                                                                                                                                                  |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 4.3             |       | Indenture, dated  as of November 16, 2006, by and among Sally Holdings LLC and Sally Capital  Inc., as Co-Issuers, the Subsidiary Guarantors from time to time parties thereto,  and Wells Fargo Bank, National Association, as Trustee, governing the 9.25%  Senior Notes due 2014, which is incorporated herein by reference from Exhibit  4.1 of 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,                                                                                                                                                                                                                                                                                                                        |

 

63

----

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

 

64

----

 
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|-----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|            |       | Administrative  Agent and Collateral Agent, which is incorporated herein by reference from  Exhibit 4.6.2 of the Current Report on Form 8-K of Sally Beauty Holdings,  Inc. filed on November 22, 2006                                                                                                                                                                                                                                                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.13            |       | Canadian  Guarantee and Collateral Agreement, dated as of November 16, 2006, made by  Sally Beauty (Canada) Corporation, Beauty Systems Group (Canada), Inc., Sally  Beauty Canada Holdings Inc. and certain of their respective subsidiaries in  favor of Merrill Lynch Capital Canada Inc., as Canadian Agent and Canadian  Collateral Agent, which is incorporated herein by reference from Exhibit  4.6.3 of 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 herein by reference from  Exhibit 4.7 of the Current Report on Form 8-K of Sally Beauty Holdings, Inc.  filed on November 22, 2006 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.1            |       | Sally Beauty  Holdings, Inc. Independent Director Compensation Policy, which is  incorporated herein by reference from Exhibit 10.10 of the Quarterly Report  on Form 10-Q of Sally Beauty Holdings, Inc. filed on February 9, 2007                                                                                                                                                                                                                                                                                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.2            |       | Alberto-Culver  Company Employee Stock Option Plan of 2003, which is incorporated herein by  reference from Exhibit 10.16 of the Registration Statement on Form S-4 of  Sally Holdings LLC and Sally Capital Inc. (File No. 333-144427) filed July 9,  2007                                                                                                                                                                                                                                                                                                                      |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.3            |       | Alberto-Culver  Company 2003 Stock Option Plan for Non-Employee Director, which is  incorporated herein by reference from Exhibit 10.17 of the Registration  Statement on Form S-4 of Sally Holdings LLC and Sally Capital Inc. (File No.  333-144427) filed July 9, 2007                                                                                                                                                                                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.4            |       | Alberto-Culver  Company 2003 Restricted Stock Plan, which is incorporated herein by reference  from Exhibit 10.18 of the Registration Statement on Form S-4 of Sally  Holdings LLC and Sally Capital Inc. (File No. 333-144427) filed July 9, 2007                                                                                                                                                                                                                                                                                                                               |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.5            |       | Alberto-Culver  Company 1994 Shareholder Value Incentive Plan, as Amended, which is  incorporated herein by reference from Exhibit 10.19 of the Registration  Statement on Form S-4 of Sally Holdings LLC and Sally Capital Inc. (File No.  333-144427) filed July 9, 2007                                                                                                                                                                                                                                                                                                       |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.6            |       | Alberto-Culver Company  Management Incentive Plan, which is incorporated herein by reference from  Exhibit 10.20 of the Registration Statement on Form S-4 of Sally Holdings LLC  and Sally Capital Inc. (File No. 333-144427) filed July 9, 2007                                                                                                                                                                                                                                                                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.7            |       | Sally Beauty  Holdings, Inc. Annual Incentive Plan, which is incorporated herein by  reference from Exhibit 10.21 of the Registration Statement on Form S-4 of  Sally Holdings LLC and Sally Capital Inc. (File No. 333-144427) filed on July  9, 2007                                                                                                                                                                                                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.8            |       | Form of Stock  Option Agreement for Independent Directors pursuant to the Sally Beauty  Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated herein by  reference from Exhibit 10.1 of the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on April 27, 2007                                                                                                                                                                                                                                                                                       |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.9            |       | Form of Stock  Option Agreement for Employees pursuant to the Sally Beauty Holdings, Inc.  2007 Omnibus Incentive Plan, which is incorporated herein by reference from  Exhibit 10.2 of the Current                                                                                                                                                                                                                                                                                                                                                                              |

 

65

----

 
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                     |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                |
|            |       | Report on Form  8-K of Sally Beauty Holdings, Inc. filed on April 27, 2007                                                                                                                                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                                                |
| 10.10           |       | Form of  Restricted Stock Unit Agreement for Independent Directors pursuant to the  Sally Beauty Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated  herein by reference from Exhibit 10.3 of the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on April 27, 2007 |
|            |       |                                                                                                                                                                                                                                                                                                |
| 10.11           |       | Form of  Restricted Stock Unit Agreement for Employees pursuant to the Sally Beauty  Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated herein by  reference from Exhibit 10.4 of the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on April 27, 2007             |
|            |       |                                                                                                                                                                                                                                                                                                |
| 10.12           |       | Sally Beauty  Holdings, Inc. 2007 Omnibus Incentive Plan, which is incorporated herein by  reference from Exhibit 4.4 of the Registration Statement on Form S-8 of Sally  Beauty Holdings, Inc. filed on May 3, 2007                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                |
| 10.13           |       | Statement  relating to relocation payments to John R. Golliher, President of Beauty  Systems Group LLC, which is incorporated herein by reference from Exhibit  10.13 of the Quarterly Report on Form 10-Q of Sally Beauty Holdings, Inc.  filed on August 9, 2007                                  |
|            |       |                                                                                                                                                                                                                                                                                                |
| 10.14           |       | Tax Sharing  Agreement, dated as of November 16, 2006, made and entered into by and among  Sally Beauty Holdings, Inc., Sally Investment Holdings LLC and Sally Holdings  LLC*                                                                                                                      |
|            |       |                                                                                                                                                                                                                                                                                                |
| 31.1-31.2       |       | Rule 13(a)-  14(a)/15(b)-14(a) Certifications                                                                                                                                                                                                                                                       |
|            |       |                                                                                                                                                                                                                                                                                                |
| 32.1-32.2       |       | Section 1350  Certifications                                                                                                                                                                                                                                                                        |

 

*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 to stockholdersand/or were used for the purpose of allocating risk among the parties ratherthan establishing certain matters as facts. Accordingly, you should not rely onthe representations and warranties as characterizations of the actual state offacts at the time they were made or otherwise.

66

----

SIGNATURE

Pursuant to therequirements of the Securities Exchange Act of 1934, each registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
| Date:      August 29,  2007 |               |                                              |
|------------------------------------------------------|--------------------|---------------------------------------------------|
|                                                 | SALLY HOLDINGS LLC |                                              |
|                                                 |               |                                              |
|                                                 |               |                                              |
|                                                 | By:                | /s/ David L. Rea                                  |   |
|                                                 | Name:              | David L. Rea                                      |
|                                                 | Title:             | Senior Vice President and Chief Financial Officer |
|                                                      |                    |                                                   |  |  |

 
| Date:       August 29, 2007 |               |                                              |
|------------------------------------------------------|--------------------|---------------------------------------------------|
|                                                 |               |                                              |
|                                                 |               |                                              |
|                                                 | SALLY CAPITAL INC. |
|                                                 |               |                                              |
|                                                 |               |                                              |
|                                                 | By:                | /s/ David L. Rea                                  |   |
|                                                 | Name:              | David L. Rea                                      |
|                                                 | Title:             | Senior Vice President and Chief Financial Officer |
|                                                      |                    |                                                   |  |  |

 

67

----