**UNITED STATES********SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2008**

 

**-OR-**

 

**o****         TRANSITION REPORT PURSUANTTO 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)                               |

 

**3001Colorado Boulevard**

**Denton,Texas 76210**

(Address ofprincipal executive offices)

 

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

 

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

 

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

 

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

 

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

 

 No voting or non-voting common equity of theregistrants was held by non-affiliates of the registrants as of March 31,2008.  As of May  5, 2008, allmember units were owned by Sally Investment Holdings LLC, a wholly-ownedsubsidiary of Sally Beauty Holdings, Inc.

 

 

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**TABLEOF CONTENTS**

 
| ** **                                                                                          | **Page** |
|-----------------------------------------------------------------------------------------------------|----------|
|                                                                                                |     |
| PART I –  FINANCIAL INFORMATION                                                           |     |
|                                                                                                |     |
| ITEM 1. FINANCIAL STATEMENTS                                                                        | 5        |
| ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 28       |
| ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES  ABOUT MARKET RISK                            | 45       |
| ITEM 4. CONTROLS AND PROCEDURES                                                                     | 46       |
|                                                                                                |     |
| PART II  – OTHER INFORMATION                                                              |     |
|                                                                                                |     |
| ITEM  1. LEGAL PROCEEDINGS                                                                          | 47       |
| ITEM  1A. RISK FACTORS                                                                              | 47       |
| ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND  USE OF PROCEEDS                                | 47       |
| ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                             | 47       |
| ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                        | 48       |
| ITEM  5. OTHER INFORMATION                                                                          | 48       |
| ITEM 6. EXHIBITS                                                                                    | 48       |

 

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Since November 16,2006, Sally Holdings LLC, a limited liability company organized under the lawsof the State of Delaware (“Sally Holdings”), has been a wholly-owned subsidiaryof Sally Investment Holdings LLC (“Sally Investment”), which is a wholly-ownedsubsidiary of Sally Beauty Holdings, Inc., (“Sally Beauty”). All of the interestsof Sally Holdings are beneficially owned by Sally Investment, and all of theinterests of Sally Investment are beneficially owned by Sally Beauty.  Prior to November 16, 2006, SallyHoldings was a Delaware corporation named “Sally Holdings, Inc.” and was awholly-owned subsidiary of Alberto-Culver Company, which we refer to as “Alberto-Culver.”On November 16, 2006, Sally Holdings, Inc. was converted to aDelaware limited liability company, was renamed “Sally Holdings LLC” and becamea wholly-owned subsidiary of Sally Investment and an indirect subsidiary ofSally Beauty in connection with the separation of Sally Holdings’ business fromAlberto-Culver. All operations of Sally Investment and Sally Beauty areconducted through Sally Holdings and its consolidated subsidiaries.  Sally Capital Inc., a Delaware corporationwhich we refer to as “Sally Capital,” is a wholly-owned subsidiary of SallyHoldings and does not have any assets or operations of any kind.

 

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

 

Cautionary NoticeRegarding Forward-Looking Statements

 

Statements in this reportwhich are not purely historical facts or which depend upon future events may beforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended.  Wordssuch as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,”“target,” “can,” “could,” “may,” “should,” “will,” “would,” or similarexpressions may also identify such forward-looking statements.

 

Readers are cautioned notto place undue reliance on forward-looking statements as such statements speakonly as of the date they were made. Any forward-looking statements involverisks and uncertainties that could cause actual events or results to differmaterially from the events or results described in the forward-lookingstatements, including, but not limited to, risks and uncertainties related to:

 

·             Sally Beauty’slimited history as a stand-alone company;

 

·             thepreparedness of our accounting and other management systems to meet financialreporting and other requirements and the upgrade of our existing financialreporting system;

 

·             therepresentativeness ofour historical consolidated financial information with respect to our futurefinancial position, results of operations or cash flows;

 

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

 

·             since our separation from Alberto-Culver,our inability to achieve the benefits of scale that were achieved byAlberto-Culver prior to our separation from Alberto-Culver;

 

·             Sally Capital and Sally Beauty beingholding companies with no operations of their own, and depending on theirsubsidiaries for cash;

 

·             the highly competitive and consolidatingnature of the beauty products distribution industry;

 

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

 

·             our dependence upon manufacturers who maybe unwilling or unable to continue to supply products to us;

 

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

 

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

 

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·             product diversion;

 

·             the operational and financial performanceof our Armstrong McCall business;

 

·             the success of our new Internet-basedbusiness;

 

·             successfully identifying acquisitioncandidates or successfully completing desirable acquisitions;

 

·             integration of businesses acquired in thefuture;

 

·             opening and operating new storesprofitably;

 

·             the success of our cost control plans;

 

·             protecting our intellectual propertyrights, specifically our trademarks;

 

·             conducting business in internationalmarkets;

 

·             disruption in our information technologysystems;

 

·             natural disasters or acts of terrorism;

 

·             our substantial indebtedness;

 

·             the possibility that we may incursubstantial additional debt;

 

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

 

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

 

·             changes in interest rates increasing thecost of servicing our debt or increasing our interest expense due to ourinterest rate swap agreements;

 

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

 

·             actions taken by certain largeshareholders of Sally Beauty adversely affecting the tax-free nature of theshare distribution of Alberto-Culver common stock;

 

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

 

·             the voting power of Sally Beauty’slargest stockholder discouraging third party acquisitions of Sally Beauty at apremium; and

 

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

 

Additional factors thatcould cause actual events or results to differ materially from the events orresults described in the forward-looking statements can be found in our AnnualReport on Form 10-K for the fiscal year ended September 30, 2007, asfiled with the Securities and Exchange Commission. The events described in theforward-looking statements might not occur or might occur to a different extentor at a different time than we have described. As a result, our actual resultsmay differ materially from the results contemplated by these forward-lookingstatements. We assume no obligation to publicly update or revise anyforward-looking statements.

 

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# **PART I– FINANCIAL INFORMATION**

#  

# **Item1.  Financial Statements.**

#  

The following are ourconsolidated balance sheets as of March 31, 2008 and September 30,2007; our consolidated statements of earnings for the three and six months endedMarch 31, 2008 and 2007 and our consolidated statements of cash flows forthe six months ended March 31, 2008 and 2007.  On November 16, 2006, Sally Holdings, Inc.was converted to a Delaware limited liability company, was renamed “SallyHoldings LLC” and became an indirect wholly owned subsidiary of Sally BeautyHoldings, Inc. in connection with our separation from the Alberto-CulverCompany (“Alberto-Culver”).  In thesefinancial statements and elsewhere in this Quarterly Report on Form 10-Q,we refer to these transactions as the Separation Transactions.  See the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2007 for additional informationabout the Separation Transactions. Sally Capital is a wholly-owned subsidiaryof Sally Holdings and does not have assets or operations of any kind.

 

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

(Unaudited)

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                        | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** |
| ** **                                        | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                         |       | $                                | 643,346    |                           | $          | 609,276 |   | $ | 1,299,133 |   | $ | 1,239,155 |   |
| Cost of products sold and distribution expenses   |       | 344,922                          |       | 326,258                        |       | 694,540 |   | 671,645 |   |
| Gross profit                                      |       | 298,424                          |       | 283,018                        |       | 604,593 |   | 567,510 |   |
| Selling, general and administrative expenses (a)  |       | 218,817                          |       | 210,139                        |       | 441,712 |   | 422,396 |   |
| Depreciation and amortization                     |       | 11,821                           |       | 10,025                         |       | 23,573 |   | 19,815 |   |
| Sales-based service fee charged by Alberto-Culver |       | —                           |       | —                         |       | — |   | 3,779 |   |
| Transaction expenses(b)                           |       | —                           |       | 27                             |       | — |   | 21,484 |   |
| Operating earnings                                |       | 67,786                           |       | 62,827                         |       | 139,308 |   | 100,036 |   |
| Interest expense, net (c)                         |       | 47,642                           |       | 42,947                         |       | 94,125 |   | 62,050 |   |
| Earnings before provision for income taxes        |       | 20,144                           |       | 19,880                         |       | 45,183 |   | 37,986 |   |
| Provision for income taxes                        |       | 6,364                            |       | 7,624                          |       | 16,057 |   | 22,028 |   |
| Net earnings                                      |       | $                                | 13,780     |                           | $          | 12,256 |   | $ | 29,126 |   | $ | 15,958 |   |

 

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(a)                                  Selling, generaland administrative expenses include allocated overhead costs fromAlberto-Culver of $1.0 million for the six months ended March 31, 2007;and share-based compensation of $1.5 million and $0.6 million for the threemonths ended March 31, 2008 and 2007, and $6.9 million and $6.3 millionfor the six months ended March 31, 2008 and 2007, respectively.

 

(b)                                 Transactionexpenses are one-time charges associated with the separation fromAlberto-Culver.

 

(c)                                  Interest expenseis net of interest income of $0.2 million and $0.3 million for the three monthsended March 31, 2008 and 2007; and $0.4 million and $1.3 million for thesix months ended March 31, 2008 and 2007, respectively; and includesexpense of $8.6 million and $1.7 million of marked-to-market adjustmentsrelated to interest rate swaps for the three months ended March 31, 2008and 2007; and expense of $14.3 million and $0.7 million related to theseadjustments for the six months ended March 31, 2008 and 2007,respectively.

 

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

 

The accompanyingcondensed notes, together with the Notes to Consolidated Financial Statementscontained in the Company’s Annual Report on Form 10-K for the fiscal yearended September 30, 2007, are an integral part of these financialstatements.

 

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

 
| ** **                                                                                                                              | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                              | ** ** | **2008**           | ** ** | **2007**               | ** ** |
| ** **                                                                                                                              | ** ** | **(Unaudited)**    | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                              |       |               |       |                   |       |
| Current assets:                                                                                                                         |       |               |       |                   |       |
| Cash and cash equivalents                                                                                                               |       | $                  | 31,420     |                   | $          | 38,272 |   |
| Trade accounts receivable, less allowance for doubtful accounts of  $2,388 at March 31, 2008 and $2,564 at September 30, 2007 |       | 46,131             |       | 51,409                 |       |
| Other receivables                                                                                                                       |       | 23,764             |       | 22,194                 |       |
| Inventories                                                                                                                             |       | 590,574            |       | 569,404                |       |
| Prepaid expenses                                                                                                                        |       | 14,708             |       | 15,375                 |       |
| Deferred income tax assets                                                                                                              |       | 18,333             |       | 15,291                 |       |
| Total current assets                                                                                                                    |       | 724,930            |       | 711,945                |       |
| Property and equipment, net of accumulated depreciation of $232,727 at  March 31, 2008 and $215,826 at September 30, 2007     |       | 159,466            |       | 154,068                |       |
| Goodwill                                                                                                                                |       | 417,463            |       | 406,623                |       |
| Intangible assets, net of accumulated amortization of $14,984 at  March 31, 2008 and $11,904 at September 30, 2007            |       | 69,441             |       | 70,505                 |       |
| Other assets                                                                                                                            |       | 57,040             |       | 61,120                 |       |
| Total assets                                                                                                                            |       | $                  | 1,428,340  |                   | $          | 1,404,261 |   |
| **Liabilities and Member’s Deficit**                                                                                               |       |               |       |                   |       |
| Current liabilities:                                                                                                                    |       |               |       |                   |       |
| Current maturities of long-term debt                                                                                                    |       | $                  | 20,848     |                   | $          | 17,147 |   |
| Accounts payable                                                                                                                        |       | 158,360            |       | 176,660                |       |
| Accrued expenses                                                                                                                        |       | 147,846            |       | 153,671                |       |
| Due to Sally Beauty                                                                                                                     |       | 11,111             |       | 18,864                 |       |
| Income taxes                                                                                                                            |       | 3,950              |       | 3,712                  |       |
| Total current liabilities                                                                                                               |       | 342,115            |       | 370,054                |       |
| Long-term debt                                                                                                                          |       | 1,768,919          |       | 1,758,594              |       |
| Other liabilities                                                                                                                       |       | 33,155             |       | 18,828                 |       |
| Deferred income tax liabilities                                                                                                         |       | 31,902             |       | 30,553                 |       |
| Total liabilities                                                                                                                       |       | 2,176,091          |       | 2,178,029              |       |
| Stock options subject to redemption                                                                                                     |       | 6,170              |       | 6,549                  |       |
| Member’s deficit:                                                                                                                  |       |               |       |                   |       |
| Member’s deficit:                                                                                                                  |       | (785,713           | )          | (814,839               | )          |
| Accumulated other comprehensive income – foreign currency translation                                                              |       | 31,792             |       | 34,522                 |       |
| Total member’s deficit                                                                                                             |       | (753,921           | )          | (780,317               | )          |
| Total liabilities and member’s deficit                                                                                             |       | $                  | 1,428,340  |                   | $          | 1,404,261 |   |

 

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

 

The accompanyingcondensed notes, together with the Notes to Consolidated Financial Statementscontained in the Company’s Annual Report on Form 10-K for the fiscal yearended September 30, 2007, are an integral part of these financialstatements.

 

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

(Unaudited)

 
| ** **                                                                                                          | ** ** | **Six Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| **Cash Flows from Operating Activities:**                                                                           |       |                                               |       |   |   |
| Net earnings                                                                                                        |       | $                                                  | 29,126     |   | $ | 15,958 |   |
| Adjustments to reconcile net earnings to net cash provided by  operating activities:                                |       |                                               |       |   |   |
| Depreciation and amortization                                                                                       |       | 23,573                                             |       | 19,815 |   |
| Share-based compensation expense (net of deferred tax benefit of  $2,117 and $2,349 in 2008 and 2007, respectively) |       | 4,788                                              |       | 3,915 |   |
| Amortization of deferred financing costs                                                                            |       | 4,247                                              |       | 3,220 |   |
| Excess tax benefit from share-based compensation                                                                    |       | (264                                               | )          | (308 | ) |
| Net loss on disposal of leaseholds and other property                                                               |       | 213                                                |       | 910 |   |
| Deferred income taxes                                                                                               |       | 648                                                |       | 3,832 |   |
| Changes in (exclusive of effects of acquisitions):                                                                  |       |                                               |       |   |   |
| Trade accounts receivable                                                                                           |       | 5,374                                              |       | 6,825 |   |
| Other receivables                                                                                                   |       | (1,773                                             | )          | 1,713 |   |
| Inventories                                                                                                         |       | (20,490                                            | )          | 35,663 |   |
| Prepaid expenses                                                                                                    |       | 553                                                |       | (2,485 | ) |
| Other assets                                                                                                        |       | (24                                                | )          | (792 | ) |
| Accounts payable and accrued expenses                                                                               |       | (25,153                                            | )          | (635 | ) |
| Income taxes                                                                                                        |       | 280                                                |       | 2,745 |   |
| Due from Alberto-Culver                                                                                             |       | —                                             |       | 463 |   |
| Due to Sally Beauty                                                                                                 |       | (15,037                                            | )          | (1,231 | ) |
| Other liabilities                                                                                                   |       | 14,558                                             |       | 7,543 |   |
| Net cash provided by operating activities                                                                           |       | 20,619                                             |       | 97,151 |   |
| **Cash Flows from Investing Activities:**                                                                           |       |                                               |       |   |   |
| Capital expenditures                                                                                                |       | (25,699                                            | )          | (18,822 | ) |
| Proceeds from sale of property and equipment                                                                        |       | 162                                                |       | 95 |   |
| Acquisitions, net of cash acquired                                                                                  |       | (17,445                                            | )          | (69,215 | ) |
| Net cash used by investing activities                                                                               |       | (42,982                                            | )          | (87,942 | ) |
| **Cash Flows from Financing Activities:**                                                                           |       |                                               |       |   |   |
| Change in book cash overdraft                                                                                       |       | —                                             |       | (4,204 | ) |
| Proceeds from issuance of long-term debt                                                                            |       | 244,235                                            |       | 2,037,100 |   |
| Repayments of long-term debt                                                                                        |       | (230,001                                           | )          | (207,643 | ) |
| Debt issuance costs                                                                                                 |       | —                                             |       | (58,816 | ) |
| Excess tax benefit from share-based compensation                                                                    |       | 264                                                |       | 308 |   |
| Distributions to Sally Beauty                                                                                       |       | —                                             |       | (1,810,149 | ) |
| Distributions to Alberto-Culver                                                                                     |       | —                                             |       | (39,471 | ) |
| Net cash provided (used) by financing activities                                                                    |       | 14,498                                             |       | (82,875 | ) |
| Effect of foreign exchange rate changes on cash and cash equivalents                                                |       | 1,013                                              |       | 72 |   |
| Net decrease in cash and cash equivalents                                                                           |       | (6,852                                             | )          | (73,594 | ) |
| Cash and cash equivalents, beginning of period                                                                      |       | 38,272                                             |       | 107,571 |   |
| Cash and cash equivalents, end of period                                                                            |       | $                                                  | 31,420     |   | $ | 33,977 |   |

 

The accompanyingcondensed notes, together with the Notes to Consolidated Financial Statementscontained in the Company’s Annual Report on Form 10-K for the fiscal yearended September 30, 2007, are an integral part of these financialstatements.

 

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

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

#####  

Descriptionof Business

 

SallyHoldings LLC (“Sally Holdings” or the “Company”) is a wholly-owned subsidiaryof Sally Investment Holdings LLC (“Sally Investment”), a wholly-ownedsubsidiary of Sally Beauty Holdings, Inc. (“Sally Beauty”).  All of the interests of Sally Holdings arebeneficially owned by Sally Investment, and all of the interests of SallyInvestment are beneficially owned by Sally Beauty. Sally Holdings was awholly-owned subsidiary of Alberto-Culver until November 16, 2006 when itwas converted to a Delaware limited liability company, was renamed “SallyHoldings LLC” and became a wholly-owned subsidiary of Sally Investment and anindirect subsidiary of Sally Beauty in connection with the separation of itsbusiness from Alberto-Culver. The Company and its consolidated subsidiariessell professional beauty supplies, primarily through its Sally Beauty Supplyretail stores, in the U.S., Puerto Rico, Mexico, Canada, Japan, United Kingdomand certain other countries in Europe. Additionally, the Company distributesprofessional beauty products to salons and professional cosmetologists throughits Beauty Systems Group (“BSG”) store operations and a commissioned directsales force that calls on salons in the U.S., Canada, United Kingdom andcertain other countries in Europe, and to franchises in the southern andsouthwestern U.S. and Mexico through the operations of its subsidiary ArmstrongMcCall, L.P. (“Armstrong McCall”). Certain beauty products sold by BSG andArmstrong McCall are sold through exclusive territory agreements with themanufacturers of the products.

 

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

 

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

 

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

 

Basisof Presentation

 

Theconsolidated interim financial statements included herein are unaudited andhave been prepared by the Company pursuant to the rules and regulations ofthe Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annualfinancial statements prepared in accordance with generally accepted accountingprinciples (“GAAP”) have been condensed or omitted pursuant to those rules andregulations, although the Company believes that the disclosures made areadequate to make the information not misleading.  The consolidated interim financial statementsinclude the accounts of the Company and its subsidiaries.  All significant inter-company accounts andtransactions have been eliminated in consolidation. In the opinion ofmanagement, these consolidated financial statements reflect all adjustmentswhich are of a normal recurring nature and which are necessary to presentfairly the consolidated financial position as of March 31, 2008 and September 30,2007, the consolidated results of operations for the three and six months endedMarch 31, 2008 and 2007, and the consolidated cash flows for the sixmonths ended March 31, 2008 and 2007. The results of operations for these interim periods are not necessarilyindicative of the results that may be expected for the entire fiscal year.

 

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

 

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

Suchamounts are expensed in full in the year incurred. For interim financialreporting purposes, income taxes are recorded based upon estimated annualeffective income tax rates.

 

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

 

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

#####  

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

 

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

 

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

 

Priorto November 16, 2006, the Company was a subsidiary of Alberto-Culver andhad no share-based compensation plans of its own; however, certain employees ofthe Company had been granted stock options and stock awards under share-basedcompensation plans of Alberto-Culver. Alberto-Culver treated the Separation Transactionsas though they constituted a change in control for purposes of Alberto-Culver’sstock options and stock awards. 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 Separation Transactions on November 16, 2006. Due to theSeparation Transactions, the Company recorded a charge during the first quarterof fiscal year 2007 equal to the amount of future compensation expense ofapproximately $5.3 million that would have been recognized in subsequentperiods as the stock options and stock awards for the Company’s employeesvested over the original vesting periods. Upon completion of the SeparationTransactions, all outstanding Alberto-Culver stock options and stock awardsheld by employees of the Company became options to purchase shares of SallyBeauty’s common stock.

 

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

 
| ** **                                                      | ** ** | **Six Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                      | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| ** **                                                      | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Share-based compensation expense                                |       | $                                                  | 6,905      | (a) | $ | 6,264 | (b) |
| Income tax benefit related to share-based  compensation expense |       | $                                                  | 2,117      |   | $ | 2,349 |   |

 

----

(a)                                  Includes $3.1 million of accelerated expenserelated to certain retirement eligible employees who are eligible to continuevesting awards upon retirement under the terms of the 2007 plan.

 

(b)                                 Includes $5.3 million of accelerated expenserelated to the separation from Alberto-Culver.

 

10

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

## Stock Options

##  

Eachoption has an exercise price that equals 100% of the market price of SallyBeauty’s stock on the date of grant and generally has a maximum term of 10years. Options generally vest ratably over a four year period and are subjectto forfeiture until the four year vesting period is complete.

 

Thefollowing table presents a summary of the activity for Sally Beauty’s stockoptions issued to the Company’s employees for the six months ended March 31,2008:

 
| ** **                             | ** ** | **Number of  Outstanding  Options (in  Thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  Years)** | ** ** | **Aggregate  Intrinsic  Value (in  Thousands)** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Outstanding at September 30, 2007 |       | 6,724                                                         |       | $                                      | 7.33       |                                                                 |       |                                                 |       |   |
| Granted                                |       | 2,598                                                         |       | 8.79                                   |       |                                                                 |       |                                                 |       |
| Exercised                              |       | (259                                                          | )          | 2.00                                   |       |                                                                 |       |                                                 |       |
| Forfeited or expired                   |       | (68                                                           | )          | 9.10                                   |       |                                                                 |       |                                                 |       |
| Outstanding at March 31, 2008     |       | 8,995                                                         |       | $                                      | 7.89       |                                                                 | 8.6        |                                                 | $          | 8,372 |   |
|                                   |       |                                                          |       |                                   |       |                                                                 |       |                                                 |       |
| Exercisable at March 31, 2008     |       | 2,888                                                         |       | $                                      | 5.07       |                                                                 | 7.3        |                                                 | $          | 8,372 |   |

 

Thefollowing table summarizes information about stock options held by the Company’semployees under Sally Beauty’s option plans at March 31, 2008:

 
| ** **                              | ** ** | **Options Outstanding**                                                   | ** ** | **Options Exercisable**                                         | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  Outstanding at  March 31, 2008  (in Thousands)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable at  March 31,  2008 (in  Thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $2.00                                   |       | 1,709                                                                          |       | 6.3                                                                  |       | $ | 2.00 |   | 1,709 |   | $ | 2.00 |   |
| $7.70 – 9.66                       |       | 7,286                                                                          |       | 9.1                                                                  |       | 9.27 |   | 1,179 |   | 9.53 |   |
| Total                                   |       | 8,995                                                                          |       | 8.6                                                                  |       | $ | 7.89 |   | 2,888 |   | $ | 5.07 |   |

 

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

 

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

 
| ** **              | ** ** | **Six Months Ended March 31,** | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| Expected lives (years)  |       | 5.0                                                |       | 5.0 |   |
| Expected volatility     |       | 37.5                                               | %          | 41.9 | % |
| Risk-free interest rate |       | 4.0                                                | %          | 4.4 | % |
| Dividend yield          |       | 0.0                                                | %          | 0.0 | % |

 

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

 

11

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

zero-couponU.S. Treasury issue as of the date of the grant. Since Sally Beauty does notexpect to pay dividends, the dividend yield is 0%.

 

Theweighted average fair value of the Sally Beauty stock options issued to Companyemployees at the date of grant in the six months ended March 31, 2008 and2007 was $3.46 and $4.07 per option, respectively. The total intrinsic value ofoptions exercised during the six months ended March 31, 2008 was $1.6million.  The total cash received fromthese option exercises was $0.5 million and the tax benefit realized for thetax deductions from these option exercises was $0.6 million.

 

AtMarch 31, 2008, approximately $12.6 million of total unrecognized compensationcost related to non-vested stock option awards is expected to be recognizedover the weighted average period of 3.2 years.

 

## Stock Awards

##  

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

#####  

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

 

TheCompany expenses the cost of the restricted stock awards, which is determinedto be the fair market value of the restricted stock award at the date of grant,on a straight-line basis over the vesting period. For these purposes, the fairmarket value of the restricted stock award is determined based on the closingprice of Sally Beauty’s common stock on the grant date.

 

Thefollowing table presents a summary of the activity for Sally Beauty’srestricted stock awards for the six months ended March 31, 2008:

 
| **Restricted Stock Awards** | ** ** | **Number of  Shares (In  Thousands)** | ** ** | **Weighted  Average Fair  Value Per Share** | ** ** | **Weighted  Average  Remaining  Vesting Term (In  Years)** | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| Non-vested at September 30, 2007 |       | 350                                             |       | $                                                          | 8.10       |                                                                 |       |   |
| Granted                               |       | 106                                             |       | 8.78                                                       |       |                                                                 |       |
| Vested                                |       | (70                                             | )          | 8.10                                                       |       |                                                                 |       |
| Forfeited                             |       | —                                          |       | —                                                     |       |                                                                 |       |
| Non-vested at March 31, 2008     |       | 386                                             |       | $                                                          | 8.29       |                                                                 | 4.1        |   |

 

AtMarch 31, 2008, approximately $2.1 million of total unrecognizedcompensation cost related to non-vested restricted stock awards is expected tobe recognized over the weighted average period of 4.1 years.

 

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

#####  

Inconnection with the Separation Transactions on November 16, 2006, theCompany and certain subsidiaries incurred $1,850.0 million of indebtedness by (i) drawingon a revolving (asset-based lending) facility (the “ABL facility”) in an amountequal to $70.0 million, (ii) entering into two term loan facilities (termloans A and B) in an aggregate amount of $1,070.0 million, and (iii) issuingsenior notes in an aggregate amount of $430.0 million and senior subordinatednotes in an aggregate amount of $280.0 million.

 

Theterm loan facilities and the ABL facility are secured by substantially all ofthe Company’s assets, those of Sally Investment, those of the Company’sdomestic subsidiaries and, in the case of the ABL facility, those of theCompany’s Canadian subsidiaries. The term loan facilities may be prepaid at theCompany’s option at any time without premium or penalty and are subject tomandatory prepayment in an amount equal to 50% of excess cash flow (as definedin the agreement governing the term loan facilities) for any fiscal year(commencing in fiscal year

 

12

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

2008)unless a specified leverage ratio is met and 100% of the proceeds of specifiedasset sales that are not reinvested in the business or applied to repayborrowings under the ABL facility.

 

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

 

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

 
| ** **                   | ** ** | **March 31,  2008** | ** ** | **Maturity dates  (Fiscal Year)** | ** ** | **Interest Rates**                    | ** **                          |
|------------------------------|------------|--------------------------|------------|---------------------------------------------|------------|--------------------------------------------|-------------------------------------|
| ABL facility                 |       | $                        | 33,878     |                                        | 2012       |                                       | (i)  PRIME and up to 0.50% or; |   |
|                         |       |                     |       |                                        |       | (ii) LIBOR  (a) plus (1.00% to 1.50%) |                                |
|                         |       |                     |       |                                        |       |                                       |                                |
| Term Loan A                  |       | 138,750                  |       | 2013                                        |       | (i)  PRIME plus (1.00% to 1.50%) or;  |                                |
|                         |       |                     |       |                                        |       | (ii) LIBOR  plus (2.00% to 2.50%)          |                                |
|                         |       |                     |       |                                        |       |                                       |                                |
| Term Loan B                  |       | 906,200                  |       | 2014                                        |       | (i)  PRIME plus (1.25% to 1.50%) or;  |                                |
|                         |       |                     |       |                                        |       | (ii) LIBOR  plus (2.25% to 2.50%)          |                                |
| Total                        |       | $                        | 1,078,828  |                                        |       |                                       |                                |   |
|                         |       |                     |       |                                        |       |                                       |                                |
| Senior notes                 |       | $                        | 430,000    |                                        | 2015       |                                       | 9.25%                               |   |
| Senior subordinated notes    |       | 280,000                  |       | 2017                                        |       | 10.50%                                     |                                |
| Total                        |       | $                        | 710,000    |                                        |       |                                       |                                |   |
|                         |       |                     |       |                                        |       |                                       |                                |
| Capitalized leases and other |       | $                        | 939        |                                        |       |                                       |                                |   |
| Less: current portion        |       | (20,848                  | )          |                                        |       |                                       |                                |
| Total long-term debt         |       | $                        | 1,768,919  |                                        |       |                                       |                                |   |

 

----

(a) London InterbankOffered Rate (“LIBOR”)

 

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

 
| **Fiscal Year:**    | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| 2008                     |       | $          | 8,350      |   |
| 2009                     |       | 24,200     |       |
| 2010                     |       | 24,200     |       |
| 2011                     |       | 39,200     |       |
| 2012                     |       | 118,078    |       |
| Thereafter               |       | 1,574,800  |       |
|                     |       | $          | 1,788,828  |   |
| Capital leases and other |       | 939        |       |
| Less: current portion    |       | (20,848    | )          |
| Total                    |       | $          | 1,768,919  |   |

 

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

#####  

In connection with the Separation Transactions,during November 2006, the Company entered into two interest rate swapagreements. The Company does not purchase or hold any derivative instrumentsfor trading purposes. The interest rate swap agreements do not currentlyqualify as hedges and, therefore, the change in fair value of the interest rateswap agreements, which are adjusted quarterly, are recorded in the results ofoperations. The fair value of the swap agreements was a liability ofapproximately $17.3 million at March 31, 2008. The liability consists ofapproximately $2.5 million included in accrued expenses and $14.8 millionincluded in other liabilities on the consolidated balance sheet.  Please see the Company’s Annual Report on Form 10-Kfor fiscal year ended September 30, 2007 for additional information onthese interest rate swap agreements.

 

13

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

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 instrumentsare large financial institutions which the Company believes are of high qualitycreditworthiness. While the Company may be exposed to potential losses due tothe credit risk of non-performance by these counter-parties, such losses arenot anticipated.

 

Themarked-to-market impact of the swap arrangements on interest expense was anincrease of approximately $8.6 million and $1.7 million for the three monthsended March 31, 2008 and 2007, respectively; and approximately $14.3million and $0.7 million for the six months ended March 31, 2008 and 2007,respectively.

 

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

#####  

Thechange in the carrying amounts of goodwill by operating segment for the sixmonths ended March 31, 2008 is as follows (in thousands):

 
| ** **                                    | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------|------------|
| Balance at September 30, 2007            |       | $                             | 44,548     |                           | $          | 362,075   |       | $ | 406,623 |   |
| Additions, net of purchase price  adjustments |       | 2,347                         |       | 10,634                         |       | 12,981    |       |
| Foreign currency translation                  |       | (582                          | )          | (1,559                         | )          | (2,141    | )          |
| Balance at March 31, 2008                |       | $                             | 46,313     |                           | $          | 371,150   |       | $ | 417,463 |   |

 

Thefollowing table provides the gross carrying value and accumulated amortizationfor intangible assets with indefinite lives and intangible assets subject toamortization by operating segment at March 31, 2008 (in thousands):

 
| ** **                                 | ** ** | **Sally Beauty  Supply** | ** ** | **Beauty Systems  Group** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------|------------|
| Balance at March 31, 2008:            |       |                          |       |                           |       |      |       |
| Intangible assets with indefinite lives:   |       |                          |       |                           |       |      |       |
| Trade names                                |       | $                             | 15,345     |                           | $          | 34,738    |       | $ | 50,083 |   |
| Other intangibles                          |       | —                        |       | 6,053                          |       | 6,053     |       |
| Total                                      |       | 15,345                        |       | 40,791                         |       | 56,136    |       |
| Intangible assets subject to amortization: |       |                          |       |                           |       |      |       |
| Gross carrying amount                      |       | 540                           |       | 27,749                         |       | 28,289    |       |
| Accumulated amortization                   |       | (72                           | )          | (14,912                        | )          | (14,984   | )          |
| Net value                                  |       | 468                           |       | 12,837                         |       | 13,305    |       |
| Total intangible assets, net               |       | $                             | 15,813     |                           | $          | 53,628    |       | $ | 69,441 |   |

 

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

#####  

Comprehensiveincome consists of net earnings and foreign currency translation adjustments asfollows for the three and six months ended March 31, 2008 and 2007 (inthousands):

 
| ** **                                                           | ** ** | **Three Months Ended March 31,** | ** ** | **Six Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                             | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net earnings                                                         |       | $                                                    | 13,780     |                                               | $          | 12,256 |   | $ | 29,126 |   | $ | 15,958 |   |
| Other comprehensive income  adjustments-foreign currency translation |       | 1,726                                                |       | 1,457                                              |       | (2,730 | ) | 736 |   |
| Comprehensive income                                                 |       | $                                                    | 15,506     |                                               | $          | 13,713 |   | $ | 26,396 |   | $ | 16,694 |   |

 

14

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

**7.   Income Taxes**

 

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

 

TheSeparation Transactions were intended to qualify as a reorganization under Section 368(a)(1)(D) ofthe Code and a distribution eligible for non-recognition under Sections 355(a) and361(c) of the Internal Revenue Code of 1986, as amended (the “Code”). Inconnection with the share distribution of Alberto-Culver common stock in theSeparation Transactions, Sally Beauty received: (i) a private letterruling from the IRS; and (ii) an opinion of Sidley Austin LLP, counsel toAlberto-Culver, in each case, to the effect that the transactions qualify as areorganization under Section 368(a)(1)(D) of the Code and a distributioneligible for non-recognition under Sections 355(a) and 361(c) of theCode. Certain internal restructurings also occurred at or immediately prior tothe Separation Transactions. As a result of the internal restructurings andSeparation Transactions, Sally Beauty inherited the federal tax identificationnumber of the old Alberto-Culver parent for U.S. federal income tax purposes.

 

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

 

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

 

Inthe event an additional U.S. federal income tax liability related to the periodprior to the Separation Transactions were determined, Sally Beauty and theCompany will be jointly and severally liable for these taxes, and there can beno assurance that Alberto-Culver would be able to fulfill its indemnificationobligations to the Company under the tax allocation agreement if Alberto-Culverwas determined to be responsible for these taxes thereunder. The Company hasentered into a tax sharing agreement with its parent, Sally Beauty.  In accordance with this agreement, SallyBeauty shall cause each of its subsidiaries that are eligible to be a member ofthe relevant combined tax group to join in filing a consolidated return withrespect to each jurisdiction for all tax years for which such subsidiary is eligibleto do so under the applicable tax law. Sally Beauty shall make all payments to the applicable taxing authorityof all combined taxes that the relevant combined tax group is required to pay.

 

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

 

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

 

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

 

15

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

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

 

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

 

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

 

TheIRS has contacted Sally Beauty regarding an examination for the tax years ended2005 and 2006, thus our statute remains open from the year ended September 30,2005, forward.  Our European subsidiariesare impacted by various statutes of limitations, which are generally open from2004 forward. The statute of limitations on our Canadian operations is openfrom 2004 forward.  Generally, states’statutes in the United States are open for tax reviews from 2002 forward.

 

16

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

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

#####  

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

 

TheCompany does not sell between segments. Segment data for the three and six months ended March 31, 2008 and2007 is as follows (in thousands):

 
| ** **                                         | ** ** | **Three months ended  March 31,** | ** ** | **Six months ended  March 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                         | ** ** | **2008**                                         | ** ** | **2007**                                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                         | ** ** | ** **                                       | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales:                                         |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                                                | 406,065    |                                           | $          | 382,176 |   | $ | 815,629 |   | $ | 754,125 |   |
| BSG                                                |       | 237,281                                          |       | 227,100                                        |       | 483,504 |   | 485,030 |   |
| Total net sales                                    |       | $                                                | 643,346    |                                           | $          | 609,276 |   | $ | 1,299,133 |   | $ | 1,239,155 |   |
| Earnings before provision for income taxes:        |       |                                             |       |                                           |       |   |   |   |   |
| Segment operating earnings:                        |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                |       | $                                                | 67,819     |                                           | $          | 67,714 |   | $ | 139,462 |   | $ | 133,208 |   |
| BSG                                                |       | 17,942                                           |       | 12,597                                         |       | 38,972 |   | 31,319 |   |
| Total segment operating earnings                   |       | 85,761                                           |       | 80,311                                         |       | 178,434 |   | 164,527 |   |
| Unallocated corporate expenses (1)                 |       | (16,517                                          | )          | (16,900                                        | )          | (32,221 | ) | (32,964 | ) |
| Share-based compensation expense                   |       | (1,458                                           | )          | (557                                           | )          | (6,905 | ) | (6,264 | ) |
| Sales-based service fee charged by  Alberto-Culver |       | —                                           |       | —                                         |       | — |   | (3,779 | ) |
| Transaction expenses (2)                           |       | —                                           |       | (27                                            | )          | — |   | (21,484 | ) |
| Interest expense, net of interest income           |       | (47,642                                          | )          | (42,947                                        | )          | (94,125 | ) | (62,050 | ) |
| Earnings before provision for income taxes         |       | $                                                | 20,144     |                                           | $          | 19,880 |   | $ | 45,183 |   | $ | 37,986 |   |

 

----

| (1)    |   | Unallocated  expenses consist of corporate and shared costs. The amounts include $0.0  million and $1.0 million of overhead charges allocated from Alberto-Culver  for the six months ended March 31, 2008 and 2007, respectively. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                    |
| (2)    |   | Transaction  expenses are one-time charges associated with the separation from  Alberto-Culver on November 16, 2006.                                                                                                               |

 

17

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

###### **9.   Recent Accounting Pronouncements**

######  

InMarch 2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”)No. 161, *Disclosures about DerivativeInstruments and Hedging Activities, an Amendment of FASB Statement No. 133*(“SFAS 161”). SFAS 161 requires companies to provide qualitative disclosuresabout the objectives and strategies for using derivatives, quantitative dataabout the fair value of and gains and losses on derivative contracts, anddetails of credit-risk-related contingent features in their hedgedpositions.  The statement also requires companiesto disclose more information about the location and amounts of derivativeinstruments in financial statements; how derivatives and related hedges areaccounted for under SFAS 133, *Accounting forDerivative Instruments and Hedging Activities*; and how the hedgesaffect the entity’s financial position, financial performance and cash flows.SFAS 161 is effective for periods beginning after November 15, 2008. Weexpect the adoption of this statement will not have a material impact on ourconsolidated financial statements.

 

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

 

InDecember 2007, the FASB, issued SFAS No. 141 (Revised 2007): *Business Combinations* (“SFAS 141R”). Amongother things, SFAS 141R generally requires that an acquirer recognize theassets acquired and liabilities assumed measured at their “full fair values” onthe acquisition date. This practice replaces the practice, under predecessorSFAS 141: *Business Combinations,*of allocating the cost of an acquisition to the individual assets acquired andliabilities assumed based on their relative estimated fair values.  SFAS 141R further requires that acquisition-relatedcosts be recognized separately from the related acquisition. SFAS 141R iseffective in periods beginning on or after December 15, 2008. We arecurrently assessing the effect of this pronouncement on our consolidatedfinancial statements.

 

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

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*, (“SFAS 157”),which defines fair value, establishes a framework for measuring fair value inGAAP, and expands disclosures about fair value measurements. SFAS 157 iseffective in fiscal years beginning after November 15, 2007. In November 2007,the FASB provided a one year deferral for the implementation of SFAS 157 forother nonfinancial assets and liabilities. We are currently assessing theeffect of this pronouncement on our consolidated financial statements.

 

18

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

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

######  

Thefollowing condensed consolidating financial information presents the CondensedConsolidated Balance Sheets as of March 31, 2008 and September 30,2007, the Condensed Consolidated Statement of Earnings for the three and sixmonths ending March 31, 2008 and 2007, and the Condensed ConsolidatedStatement of Cash Flows for the six months ended March, 31 2008 and 2007 of (a) SallyHoldings LLC or “Parent”; (b) Sally Capital Inc. or “Co-Issuer” (c) theguarantor subsidiaries; (d) the non-guarantor subsidiaries; (e) eliminationentries necessary to consolidate the Parent with the guarantor andnon-guarantor subsidiaries; and (f) the Parent on a consolidated basis.

 

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

 

19

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Balance SheetMarch 31, 2008**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                  | ** ** | **Parent** | ** ** | **Co-  Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings  LLC  &  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-----------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-----------------------------------------------|------------|
| **Assets**                                                                  | ** ** | ** ** | ** ** | ** **      | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **                                    | ** ** |
| Cash and cash equivalents                                                   |       | $          | 14         |            | $          | —                      |       | $                                 | 11,948     |             | $          | 19,458                                        |       | $ | — |   | $ | 31,420 |   |
| Trade accounts and other receivables, less  allowance for doubtful accounts |       | —     |       | —          |       | 50,161                      |       | 19,734                            |       | —           |       | 69,895                                        |       |
| Due from affiliates                                                         |       | 67,847     |       | —          |       | 10,461                      |       | 5,039                             |       | (83,347          | )          | —                                        |       |
| Inventories                                                                 |       | —     |       | —          |       | 463,314                     |       | 127,260                           |       | —           |       | 590,574                                       |       |
| Prepaid expenses                                                            |       | 90         |       | —          |       | 8,497                       |       | 6,121                             |       | —           |       | 14,708                                        |       |
| Deferred income tax assets                                                  |       | 1,787      |       | —          |       | 19,715                      |       | (3,169                            | )          | —           |       | 18,333                                        |       |
| Property and equipment, net                                                 |       | —     |       | —          |       | 121,266                     |       | 38,200                            |       | —           |       | 159,466                                       |       |
| Investment in subsidiaries                                                  |       | 963,740    |       | —          |       | 253,737                     |       | —                            |       | (1,217,477       | )          | —                                        |       |
| Goodwill and other intangible assets, net                                   |       | —     |       | —          |       | 372,140                     |       | 114,764                           |       | —           |       | 486,904                                       |       |
| Other assets                                                                |       | 46,953     |       | —          |       | 1,568                       |       | 8,519                             |       | —           |       | 57,040                                        |       |
| Total assets                                                                |       | $          | 1,080,431  |            | $          | —                      |       | $                                 | 1,312,807  |             | $          | 335,926                                       |       | $ | (1,300,824 | ) | $ | 1,428,340 |   |
| **Liabilities and Member’s (Deficit) Equity**                          |       |       |       |            |       |                        |       |                              |       |             |       |                                          |       |
| Accounts payable                                                            |       | $          | —     |            | $          | —                      |       | $                                 | 123,146    |             | $          | 35,214                                        |       | $ | — |   | $ | 158,360 |   |
| Due to affiliates                                                           |       | —     |       | —          |       | 78,809                      |       | 4,538                             |       | (83,347          | )          | —                                        |       |
| Accrued expenses                                                            |       | 35,801     |       | —          |       | 89,400                      |       | 22,645                            |       | —           |       | 147,846                                       |       |
| Due to Sally Beauty                                                         |       | —     |       | —          |       | 11,111                      |       | —                            |       | —           |       | 11,111                                        |       |
| Income taxes                                                                |       | —     |       | —          |       | 473                         |       | 3,477                             |       | —           |       | 3,950                                         |       |
| Long-term debt                                                              |       | 1,777,550  |       | —          |       | 488                         |       | 11,729                            |       | —           |       | 1,789,767                                     |       |
| Other liabilities                                                           |       | 14,831     |       | —          |       | 16,513                      |       | 1,811                             |       | —           |       | 33,155                                        |       |
| Deferred income tax liabilities                                             |       | —     |       | —          |       | 29,127                      |       | 2,775                             |       | —           |       | 31,902                                        |       |
| Total liabilities                                                           |       | 1,828,182  |       | —          |       | 349,067                     |       | 82,189                            |       | (83,347          | )          | 2,176,091                                     |       |
| Stock options subject to redemption                                         |       | 6,170      |       | —          |       | —                      |       | —                            |       | —           |       | 6,170                                         |       |
| Total member’s (deficit) equity                                        |       | (753,921   | )          | —          |       | 963,740                     |       | 253,737                           |       | (1,217,477       | )          | (753,921                                      | )          |
| Total liabilities and member’s (deficit)  equity                       |       | $          | 1,080,431  |            | $          | —                      |       | $                                 | 1,312,807  |             | $          | 335,926                                       |       | $ | (1,300,824 | ) | $ | 1,428,340 |   |

 

20

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Balance Sheet**

**September 30, 2007**

**(In thousands)**

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

 

21

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Sally Holdings LLC andSubsidiaries

Condensed Notes toConsolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of EarningsThree months ended March 31, 2008**

**(In thousands)**

**(Unaudited)**

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

 

22

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Sally Holdings LLC andSubsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of EarningsThree months ended March 31, 2007**

**(In thousands)**

**(Unaudited)**

** **
| ** **                                         | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally  Holdings LLC  & Subsidiaries** | ** ** |
|----------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-------------------------------------------------------|------------|
| Net sales                                          |       | $          | —     |          | $          | —                      |       | $                                 | 514,032    |             | $          | 95,244                                                |       | $ | — |   | $ | 609,276 |   |
| Related party sales                                |       | —     |       | —        |       | 577                         |       | —                            |       | (577             | )          | —                                                |       |
| Cost of products sold and distribution  expenses   |       | —     |       | —        |       | 273,621                     |       | 53,214                            |       | (577             | )          | 326,258                                               |       |
| Gross profit                                       |       | —     |       | —        |       | 240,988                     |       | 42,030                            |       | —           |       | 283,018                                               |       |
| Selling, general and administrative expenses       |       | (298       | )          | —        |       | 175,650                     |       | 34,787                            |       | —           |       | 210,139                                               |       |
| Depreciation and amortization                      |       |       |       | —        |       | 7,693                       |       | 2,332                             |       | —           |       | 10,025                                                |       |
| Transaction Expenses                               |       | 27         |       | —        |       | —                      |       | —                            |       | —           |       | 27                                                    |       |
| Operating earnings                                 |       | 271        |       | —        |       | 57,645                      |       | 4,911                             |       | —           |       | 62,827                                                |       |
| Interest income                                    |       | 2,471      |       | —        |       | (190                        | )          | (152                              | )          | (2,469           | )          | (340                                                  | )          |
| Interest expense                                   |       | 43,100     |       | —        |       | (2,191                      | )          | (91                               | )          | 2,469            |       | 43,287                                                |       |
| Earnings (loss) before provision for income  taxes |       | (45,300    | )          | —        |       | 60,026                      |       | 5,154                             |       | —           |       | 19,880                                                |       |
| Provision (benefit) for income taxes               |       | (18,723    | )          | —        |       | 25,620                      |       | 727                               |       | —           |       | 7,624                                                 |       |
| Equity in earnings of subsidiaries (net of  tax)   |       | 38,833     |       | —        |       | 4,427                       |       | —                            |       | (43,260          | )          | —                                                |       |
| Net earnings                                       |       | $          | 12,256     |          | $          | —                      |       | $                                 | 38,833     |             | $          | 4,427                                                 |       | $ | (43,260 | ) | $ | 12,256 |   |

 

23

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Sally Holdings LLC andSubsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of EarningsSix months ended March 31, 2008**

**(In thousands)**

**(Unaudited)**

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

 

24

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Sally Holdings LLC andSubsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of EarningsSix months ended March 31, 2007**

**(In thousands)**

**(Unaudited)**

** **
| ** **                                         | ** ** | **Parent** | ** ** | **Co-Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally Holdings  LLC  & Subsidiaries** | ** ** |
|----------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|--------------------------------------------------|------------|
| Net sales                                          |       | $          | —     |          | $          | —                      |       | $                                 | 1,051,071  |             | $          | 188,084                                          |       | $ | — |   | $ | 1,239,155 |   |
| Related party sales                                |       | —     |       | —        |       | 1,242                       |       | —                            |       | (1,242           | )          | —                                           |       |
| Cost of products sold and distribution  expenses   |       | —     |       | —        |       | 568,180                     |       | 104,707                           |       | (1,242           | )          | 671,645                                          |       |
| Gross profit                                       |       | —     |       | —        |       | 484,133                     |       | 83,377                            |       | —           |       | 567,510                                          |       |
| Selling, general and administrative  expenses      |       | (193       | )          | —        |       | 358,032                     |       | 64,557                            |       | —           |       | 422,396                                          |       |
| Depreciation and amortization                      |       | —     |       | —        |       | 15,370                      |       | 4,445                             |       | —           |       | 19,815                                           |       |
| Sales-based service fee charged by  Alberto-Culver |       | —     |       | —        |       | 3,779                       |       | —                            |       | —           |       | 3,779                                            |       |
| Transaction expenses                               |       | 21,484     |       | —        |       | —                      |       | —                            |       | —           |       | 21,484                                           |       |
| Operating earnings (loss)                          |       | (21,291    | )          | —        |       | 106,952                     |       | 14,375                            |       | —           |       | 100,036                                          |       |
| Interest income                                    |       | (3,423     | )          |          |       | (330                        | )          | (289                              | )          | 2,689            |       | (1,353                                           | )          |
| Interest expense                                   |       | 62,894     |       | —        |       | 2,444                       |       | 754                               |       | (2,689           | )          | 63,403                                           |       |
| Earnings (loss) before provision for income  taxes |       | (80,762    | )          | —        |       | 104,838                     |       | 13,910                            |       | —           |       | 37,986                                           |       |
| Provision (benefit) for income taxes               |       | (24,924    | )          | —        |       | 42,944                      |       | 4,008                             |       | —           |       | 22,028                                           |       |
| Equity in earnings of subsidiaries (net of  tax)   |       | 71,796     |       | —        |       | 9,902                       |       | —                            |       | (81,698          | )          | —                                           |       |
| Net earnings                                       |       | $          | 15,958     |          | $          | —                      |       | $                                 | 71,796     |             | $          | 9,902                                            |       | $ | (81,698 | ) | $ | 15,958 |   |

 

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Sally Holdings LLC andSubsidiaries

CondensedNotes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of Cash FlowsSix months ended March 31, 2008**

**(In thousands)**

**(Unaudited)**

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

 

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Sally Holdings LLC andSubsidiaries

Condensed Notes to Consolidated Financial Statements

 

**SALLY HOLDINGS LLC AND SUBSIDIARIES**

**Condensed Consolidated Statement of Cash FlowsSix months ended March 31, 2007**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Co-  Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Sally Holdings   LLC  & Subsidiaries** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|-----------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|-------------------------------------------------------------|------------|
| **Net cash (used) provided by operating  activities**                  |       | $          | (260,808   | )               | $          | —                      |       | $                                 | 198,109    |             | $          | 159,850                                                     |       | $ | — |   | $ | 97,151 |   |
| **Cash Flows from Investing Activities:**                              |       |       |       |            |       |                        |       |                              |       |             |       |                                                        |       |
|                                                                   |       |       |       |            |       |                        |       |                              |       |             |       |                                                        |       |
| Capital expenditures and proceeds from sale  of property and equipment |       | —     |       | —          |       | (13,440                     | )          | (5,287                            | )          | —           |       | (18,727                                                     | )          |
| Acquisitions, net of cash acquired                                     |       | —     |       | —          |       | (5,484                      | )          | (63,731                           | )          | —           |       | (69,215                                                     | )          |
| Net cash used by investing activities                                  |       | —     |       | —          |       | (18,924                     | )          | (69,018                           | )          | —           |       | (87,942                                                     | )          |
| **Cash Flows from Financing Activities:**                              |       |       |       |            |       |                        |       |                              |       |             |       |                                                        |       |
|                                                                   |       |       |       |            |       |                        |       |                              |       |             |       |                                                        |       |
| Change in book cash overdraft                                          |       | —     |       | —          |       | (4,204                      | )          | —                            |       | —           |       | (4,204                                                      | )          |
| Proceeds from issuance of long-term debt                               |       | 2,036,843  |       | —          |       | 250                         |       | 7                                 |       | —           |       | 2,037,100                                                   |       |
| Repayments of long-term debt                                           |       | (207,323   | )          | —          |       | (159                        | )          | (161                              | )          | —           |       | (207,643                                                    | )          |
| Debt issuance Costs                                                    |       | (58,816    | )          | —          |       | —                      |       | —                            |       | —           |       | (58,816                                                     | )          |
| Proceeds related to notes with affiliates                              |       | 287,548    |       | —          |       | 60,038                      |       | —                            |       | (347,586         | )          | —                                                      |       |
| Payments related to notes with affiliates                              |       | —     |       | —          |       | (268,400                    | )          | (79,186                           | )          | 347,586          |       | —                                                      |       |
| Distributions to Sally Beauty                                          |       | (1,810,149 | )          | —          |       | —                      |       | —                            |       | —           |       | (1,810,149                                                  | )          |
| Distributions to Alberto-Culver                                        |       | (39,471    | )          | —          |       | —                      |       | —                            |       | —           |       | (39,471                                                     | )          |
| Excess tax benefit from share-based  compensation                      |       | —     |       | —          |       | 308                         |       | —                            |       | —           |       | 308                                                         |       |
| Net cash (used) provided by financing  activities                      |       | 208,632    |       | —          |       | (212,167                    | )          | (79,340                           | )          | —           |       | (82,875                                                     | )          |
| Effect of foreign exchange rate changes on  cash and cash equivalents  |       | 705        |       | —          |       | (271                        | )          | (362                              | )          | —           |       | 72                                                          |       |
| Net (decrease) increase in cash and cash  equivalents                  |       | (51,471    | )          | —          |       | (33,253                     | )          | 11,130                            |       | —           |       | (73,594                                                     | )          |
| Cash and cash equivalents, beginning of  period                        |       | 53,792     |       | —          |       | 36,634                      |       | 17,145                            |       | —           |       | 107,571                                                     |       |
| Cash and cash equivalents, end of period                               |       | $          | 2,321      |            | $          | —                      |       | $                                 | 3,381      |             | $          | 28,275                                                      |       | $ | — |   | $ | 33,977 |   |

 

27

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# **Item2.  Management****’s Discussion and Analysis of Financial Condition and Results ofOperations.**

#  

The following section discusses management’s view of the financialcondition, results of operations and cash flows of Sally Holdings LLC, awholly-owned subsidiary of Sally Investment Holdings LLC, a wholly-ownedsubsidiary of Sally Beauty Holdings, Inc., and its consolidatedsubsidiaries. All of the interests of Sally Holdings are beneficially owned bySally Investment and all of the interests of Sally Investment are beneficiallyowned by Sally Beauty. This section should be read in conjunction with theaudited consolidated financial statements and the related notes included in ourAnnual Report on Form 10-K for the fiscal year ended September 30,2007, as well as the Risk Factors section of that Annual Report, andinformation contained elsewhere in this Quarterly Report, including theconsolidated financial statements and condensed notes to those statements.  This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contain forward-lookingstatements. See “Cautionary Notice Regarding Forward-Looking Statements,”included at the beginning of this Quarterly Report, for a discussion of theuncertainties, risks and assumptions associated with these forward-lookingstatements that could cause results to differ materially from those reflectedin such forward-looking statements.

 

**Highlights For the First Six Months of Fiscal Year2008**

 

·                  Our net sales for thesix months ended March 31, 2008 increased $60.0 million, or 4.8%, to$1,299.1 million compared to the six months ended March 31, 2007;

·                  Our sales for storesthat have been open for at least 14 months as of the balance sheet date, whichwe refer to as same store sales, increased 2.4%, while operations acquiredduring the last twelve months contributed a 2.9% increase in sales. Theseincreases were partly offset by the anticipated lower sales of L’Oreal brandproducts in the first four months of fiscal year 2008, resulting from thechanges in the L’Oreal distribution agreement as reported in fiscal year 2007;

·                  Our consolidated grossprofit for the six months ended March 31, 2008 increased 6.5% to $604.6million compared to the six months ended March 31, 2007. As a percentageof net sales, gross profit for the six months ended March 31, 2008increased to 46.5% from 45.8% compared to the six months ended March 31,2007;

·                  Our consolidatedoperating earnings for the six months ended March 31, 2008 increased $39.3million, or 39.3%, to $139.3 million compared to the six months ended March 31,2007. As a percentage of net sales, operating earnings were 10.7% for the sixmonths ended March 31, 2008 compared to 8.1% for the six months ended March 31,2007;

·                  Sally Beauty Supply andBeauty Systems Group, which we refer to as BSG, opened 45 and 31 net stores,respectively, in the first half of fiscal year 2008;.

·                  We acquired certainassets and the distribution rights in four states from two distributors ofGoldwell/KMS products and began distributing these products in 12 additionalstates;

·                  We acquired certainassets and the distribution rights from a distributor of Joico and ISO productsin California, Arizona and southern Nevada and certain assets and distributionrights in southern and central Texas from a distributor of Paul Mitchellproducts; and

·                  We are in the secondyear of our 2-year program to consolidate warehouses and reduce administrativeexpenses of the BSG segment.

 

## **Overview**

##  

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

#####  

We are the largest distributor of professional beauty supplies in theU.S. based on store count. We operate primarily through two business units,Sally Beauty Supply and BSG. Through Sally Beauty Supply and BSG, we operate amulti-channel platform of 3,450 stores and supply 194 franchised stores inNorth America as well as selected European countries and Japan, as of March 31,2008. Within BSG, we also have one of the largest networks of professionaldistributor sales consultants in North America, with approximately 1,000professional distributor sales consultants who sell directly to salons andsalon professionals.  We provide ourcustomers with a wide variety of leading third-party branded andexclusive-label professional beauty supplies, including hair care products,styling appliances, skin and nail care products and other beauty items. SallyBeauty Supply stores target retail consumers and salon professionals, while BSGexclusively targets salons and salon professionals. For the six months ended March 31,2008, our consolidated net sales and operating earnings were$1,299.1 million and $139.3 million, respectively.

 

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Sally Beauty Supply is the largest open-line distributor ofprofessional beauty supplies in the U.S. based on store count. As of March 31,2008, Sally Beauty Supply operated 2,716 company-operated stores and supplied23 franchised stores (all outside the U.S.), with 2,289 stores located in theU.S. (including Puerto Rico), and the remainder in Mexico, Canada, Japan,United Kingdom and certain other countries in Europe. Sally Beauty Supply storesaverage approximately 1,700 square feet and are primarily located instrip shopping centers. The product selection in Sally Beauty Supply storesranges between 5,000 and 7,800 stock keeping units (“SKUs”) of beauty products,and includes products for hair care, nail care, beauty sundries and appliances,targeting retail consumers and salon professionals. Sally Beauty Supply storescarry leading third-party brands such as Clairol, Revlon and Conair, as well asan extensive selection of exclusive-label merchandise.

 

We believe BSG is the largest full-service distributor of professionalbeauty supplies in the U.S. As of March 31, 2008, BSG operated734 company-operated stores, supplied 171 franchised stores through ourfranchise-based business and had a sales force of approximately 1,000professional distributor sales consultants selling exclusively to salons andsalon professionals in 47 U.S. states and portions of Canada, Mexico andcertain European countries. BSG stores average approximately 2,700 squarefeet and are primarily located in secondary strip shopping centers. Through BSG’slarge store base and sales force, BSG is able to access a significant portionof the highly fragmented U.S. salon market. The product selection in BSGstores, ranging between 3,500 and 9,700 SKUs of beauty products, includes haircare, nail care, beauty sundries and appliances targeting salons and salonprofessionals. BSG carries leading professional beauty product brands, intendedfor use in salons and for resale by the salon to consumers. Certain BSGproducts are sold under exclusive distribution agreements with suppliers,whereby BSG is designated as the sole distributor for a product line withincertain geographic territories.

 

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

 

We operate within the large and growing U.S. professional beautysupply industry. Potential growth in the industry is expected to be driven byincreases in hair color, hair loss prevention and hair styling products. Webelieve the following key industry and business trends and characteristics willinfluence our business and our financial results going forward:

 

·             *Highlevel of customer fragmentation.*  TheU.S. salon market is highly fragmented with over 225,000salons. Given the fragmented and small-scale nature of the salon industry,we believe that salon operators will continue to depend on full-service/exclusivedistributors and open-line channels for a majority of their beauty supplypurchases.

 

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

 

·             *IncreasingUse of Exclusive-Label Products.*  We offer abroad range of private label and control label products, which we generallyrefer to collectively as “exclusive-label products.” Private label products arebrands for which we own or license the trademark and, in some instances, theformula. Control label products are brands that are owned by the manufacturer,but for which we have been granted sole distribution rights. Generally, ourexclusive-label products have higher gross margins than the leading third-partybranded products and we believe this area offers potential growth.

 

·             *InternationalGrowth Strategies. *A keyelement of our growth strategy depends on our ability to capitalize on growthin the international marketplace and to grow our current level of non-U.S.operations.  On May 7, 2008, weacquired Pro-Duo, N.V., a 40-store beauty supply chain located in Belgium,France and Spain for 19.3 million Euros, or approximately $29.8 million,subject to certain adjustments.  Totalrevenues for Pro-Duo were approximately $31 million for the fiscal year ended June 30,2007.  The acquisition was funded through$29.8 million in cash and borrowings on our asset-based revolving loan facility(“ABL”) and the assumption of 2.7 million Euros, or approximately $4.0 million,of debt from Pro-Duo.  This acquisitionfurthers our expansion plans within the European Union and is an importantphase of Sally Beauty Supply’s international growth initiative.  We intend to continue to identify andevaluate non-U.S. acquisition targets

 

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and are actively considering expansion into South America.  Our ability to grow our non-U.S. operations,integrate our new non-U.S. acquisitions and to successfully pursue additionalnon-U.S. acquisitions may be affected by business, legal, regulatory andeconomic risks.  Please see “Risk Factors– We may not be able to successfully identify acquisition candidates...” “If weacquire any businesses in the future...” and “Our ability to conduct business ininternational markets...” in Item 1A of our Annual Report on Form 10-K forthe fiscal year ended September 30, 2007.

 

·             *Continuingconsolidation.*  There is continuing consolidationamong professional beauty product distributors and professional beauty productmanufacturers. We plan to continue to examine ways in which we can benefit fromthis trend, including reviewing opportunities to shift business fromcompetitive distributors to the BSG network as well as seeking opportunisticvalue-added acquisitions. We believe that suppliers are increasingly likely tofocus on larger distributors and retailers with broader scale and retailfootprint. We also believe that we are well positioned to capitalize on thistrend as well as participate in the ongoing consolidation at thedistributor/retail level. However, changes often occur in our relationshipswith suppliers that may materially affect the net sales and operating earningsof our business segments. Consolidation among suppliers could exacerbate theeffects of these relationship changes and could increase pricing pressures. Forexample, as we announced in December 2006, our largest supplier, L’Oreal,moved a material amount of revenue out of the BSG nationwide distributionnetwork and into competitive regional distribution networks. More recently, L’Orealalso announced the acquisitions of distributors competing with BSG in the southeasternand west coast of the U.S. and of a supplier (Pureology) that does notcurrently do business with BSG.  As aresult, L’Oreal is entering into direct competition with BSG. If L’Orealacquired other distributors or suppliers that conduct significant business withBSG, we could lose that revenue as well. There can be no assurance that therewill not be further loss of revenue over time by BSG (including within itsfranchise-based business) due to potential losses of additional L’Oreal relatedproducts as well as from the increased competition from L’Oreal-affiliateddistribution networks.  Please see “RiskFactors – The beauty products distribution industry is highly competitive andis consolidating” and “We depend upon manufacturers” in Item 1A of our AnnualReport on Form 10-K for the fiscal year ended September 30, 2007.

 

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

 

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

 

·             *Controllingexpenses*. Another important aspect of our business is our ability to controlcosts, especially in our BSG business segment by right-sizing the business(including some targeted reductions-in-force) and maximizing the efficiency ofour structure. In fiscal year 2007, in response to the loss of L’Oreal relatedrevenue discussed above, BSG’s sales force was reduced and the remainingaffected distributor sales consultants were offered certain compensationrelated incentives to stay with BSG as BSG has sought and continues to seek toreplace lost L’Oreal revenue. We also continue to study our distributionfunction as we seek to rationalize our infrastructure.  BSG has substantially completed a storere-branding project that repositioned all of its North Americancompany-operated stores under a common name and store identity,

 

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CosmoProf. This project is expected to provide brand consistency, saveon advertising and promotional costs and allow for a more focused marketingstrategy. During fiscal year 2007, we began implementing a two-year capitalspending program to consolidate warehouses and reduce administrative expensesrelated to BSG’s distribution network optimization program. For the fiscal year2008, we project capital expenditures to be approximately $15 million andrelated expenses to be approximately $4 million.  For the three and six months ended March 31,2008, related expenses for new facility costs, moving expenses, facilityclosures and severance costs totaled $1.3 million and $1.6 million,respectively. We believe that annual savings from this program could beapproximately $10 million beginning in fiscal 2009.  Please see “Risk Factors – We are not certainthat our ongoing cost control plans will continue to be successful” in Item 1Aof our Annual Report on Form 10-K for the fiscal year ended September 30,2007.

 

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

 

·             *Changesto our information technology systems*.  As our operations grow in both size andscope, we will continuously need to improve and upgrade our information systemsand infrastructure while maintaining the reliability and integrity of oursystems and infrastructure.  Theexpansion of our systems and infrastructure will require us to commitsubstantial financial, operational and technical resources in advance of anyincrease in the volume of our business, with no assurance that the volume ofbusiness will increase.  For example,beginning in fiscal year 2008, we are upgrading our financial reporting system,our distribution information systems (in connection with our capital spendingprogram to consolidate warehouses, as discussed above), implementing newwarehouse information systems at our Armstrong McCall, L.P. (“Armstrong McCall”)warehouse, implementing Customer Relationship Management (“CRM”) programs forour Sally Beauty Supply Stores, upgrading our AS400 iSeries servers, andimplementing a new point-of-sale system for tracking customer sales.  These and any other required upgrades to ourinformation systems and information technology (or new technology), now or inthe future, will require that our management and resources be diverted from ourcore business to assist in completion of these projects. There can be noassurance that the time and resources our management will need to devote tothese upgrades, service outages or delays due to the installation of any new orupgraded technology (and customer issues therewith), or the impact on thereliability of our data from any new or upgraded technology will not have amaterial adverse effect on our financial reporting, business, financialcondition or results of operations. Please see “Risk Factors – We may be adversely affected by anydisruption in our information technology systems” in Item 1A of our AnnualReport on Form 10-K for the fiscal year ended September 30, 2007.

 

·             *Relationshipswith suppliers*.  We donot manufacture the brand name or exclusive-label products we sell, and insteadpurchase our products from manufacturers. We depend upon a limited number ofmanufacturers for a significant percentage of the products we sell, and ourrelationships with these suppliers change often.  Please see the next section, Relationshipswith suppliers, for more information on this trend.

 

***Relationships with suppliers***

 

Most of the net sales of Sally Beauty Supply and BSG are generatedthrough retail stores with respect to the Sally Beauty Supply business, andboth professional only stores and professional distribution sales consultantswith respect to the BSG business. 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 of sales are generated through franchiseesor sub-distributors (primarily in Europe), which also buy products directlyfrom Sally Beauty Supply or BSG for resale. Sally Beauty Supply/BSG and theirsuppliers are dependent on each other for the distribution of beauty products.As is typical in distribution businesses, these relationships are subject tochange from time to time (including the expansion or loss of distributionrights in various geographies and the addition or loss of products lines).Changes in our relationships with suppliers occur often, and could positivelyor negatively impact our net sales and operating profits. For example, duringthe second quarter of 2007, Farouk Systems, Inc. (“Farouk Systems”)terminated its distribution

 

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agreement with us. Subsequently, effective July 2007, BSG storesand professional distributor sales consultants were once again given approvalto distribute Farouk Systems products in an expanded distribution area.

 

On December 19, 2006, we announced that: (i) BSG, other thanits Armstrong 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 in its stores on an exclusive basis (effective January 1, 2007) inthose geographic areas within the U.S. in which BSG had distributionrights, and (ii) BSG’s Armstrong McCall division would not retain therights to distribute Redken professional products through its franchises. In aneffort to replace these rights, BSG entered into long-term agreements with L’Orealunder which, as of January 1, 2007, BSG had non-exclusive rights todistribute the same L’Oreal professional products in its stores that itpreviously had exclusive rights to in its stores and through its salesconsultants. Armstrong McCall retained its exclusive rights to distributeMatrix professional products in its territories.

 

In fiscal year 2007, we adopted a plan to mitigate the negative effectsresulting from unfavorable changes in our relationships with suppliers, such asL’Oreal, which includes the following steps: (i) adding new products toreplace lines with our distributor sales consultants; (ii) adding newproduct lines to our BSG stores; (iii) expanding existing product linesinto new territories; and (iv) managing costs to maximize the efficiencyof the BSG structure (in fiscal year 2007 we undertook a right-sizing of theBSG business, including some targeted reductions-in-force). Although we arefocused on developing new revenue and cost management initiatives, there can beno assurance that our efforts will partially or completely offset the loss ofthese distribution rights. See “*RiskFactors—We depend upon manufacturers who may be unable to provide products ofadequate quality or who may be unwilling to continue to supply products to us*”contained in Item 1A of our Annual Report on Form 10-K for the fiscal yearended September 30, 2007.

 

Regarding other suppliers, during fiscal year 2007 and the six monthsended March 31, 2008, our expansion of the BSG segment included theacquisition of certain assets, and the award of distribution rights, whichallow us to distribute, or expand the distribution of, Paul Mitchell, Joico andISO products in various markets, as well as a number of other brands, inadditional segments of the marketplace. We expect to gain certain otherdistribution rights over time through either further awards or by acquisitionsof existing distributors.

 

## In addition, on February 25,2008, we disclosed in a Current Report on Form 8-K that L’Oreal USA S/D, Inc.(“L’Oreal”) filed a lawsuit in California state court naming, among others, SDHair, Ltd. and Hair of Nevada, LLC (collectively, “SD Hair”), franchisees ofour subsidiary Armstrong McCall division (“AMLP”) of our BSG business unit, asdefendants.  The suit alleges, among other things, that SD Hair hasbreached its franchise agreement with AMLP by diverting (selling) Matrixbranded products to unauthorized buyers, and that L’Oreal is entitled to makeclaims against SD Hair under the franchise agreement as a third-partybeneficiary of that agreement.  The suit also alleges, among other issues,that SD Hair induced AMLP to breach its agreement to distribute Matrix brandedproducts in some unspecified manner.** **Asof February 25, 2008, neither the Company nor any of its subsidiaries(including AMLP) was a defendant in the lawsuit filed by L’Oreal.  On March 24, 2008, however, SD Hair filed a cross-complaint inthe same case naming AMLP and BSG as cross-defendants, seeking, among otherthings,, i) declaratory relief from BSG and AMLP in the form of a judicialfinding that****SD Hair is not inbreach of its franchise agreement and that L’Oreal has no rights as athird-party beneficiary to SD Hair’s franchise agreement, and ii) injunctiverelief in the form of a judicial order compelling AMLP and BSG to takeappropriate legal action against L’Oreal to enforce SD Hair’s claimed rightsunder AMLP’s Matrix distribution agreement.  We have answered thecross-complaint; however no monetary relief is being sought by SD Hair.

##  

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

#####  

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

 

32

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## **Resultsof Operations**

##  

The following table shows the condensed results of operations of ourbusiness for the three and six months ended March 31, 2008 and 2007 (inthousands):

 
| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                         | ** ** | **2007**                                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | $643,346                                         |       | $609,276                                       |       | $1,299,133 |   | $1,239,155 |   |
| Cost of products sold and distribution  expenses |       | 344,922                                          |       | 326,258                                        |       | 694,540 |   | 671,645 |   |
| Gross profit                                     |       | 298,424                                          |       | 283,018                                        |       | 604,593 |   | 567,510 |   |
| Total other operating costs and  expenses        |       | 230,638                                          |       | 220,191                                        |       | 465,285 |   | 467,474 |   |
| Operating earnings                               |       | 67,786                                           |       | 62,827                                         |       | 139,308 |   | 100,036 |   |
| Interest expense, net                            |       | 47,642                                           |       | 42,947                                         |       | 94,125 |   | 62,050 |   |
| Earnings before provision for income  taxes      |       | 20,144                                           |       | 19,880                                         |       | 45,183 |   | 37,986 |   |
| Provision for income taxes                       |       | 6,364                                            |       | 7,624                                          |       | 16,057 |   | 22,028 |   |
| Net earnings                                     |       | $13,780                                          |       | $12,256                                        |       | $29,126 |   | $15,958 |   |

 

The following table shows the condensed results of operations of ourbusiness for the three and six months ended March 31, 2008 and 2007,expressed as a percentage of net sales for each respective period shown:

 
| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                         | ** ** | **2007**                                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | 100.0                                            | %          | 100.0                                          | %          | 100.0 | % | 100.0 | % |
| Cost of products sold and distribution  expenses |       | 53.6                                             | %          | 53.5                                           | %          | 53.5 | % | 54.2 | % |
| Gross profit                                     |       | 46.4                                             | %          | 46.5                                           | %          | 46.5 | % | 45.8 | % |
| Total other operating costs and  expenses        |       | 35.9                                             | %          | 36.2                                           | %          | 35.8 | % | 37.7 | % |
| Operating earnings                               |       | 10.5                                             | %          | 10.3                                           | %          | 10.7 | % | 8.1 | % |
| Interest expense, net                            |       | 7.4                                              | %          | 7.0                                            | %          | 7.2 | % | 5.0 | % |
| Earnings before provision for income  taxes      |       | 3.1                                              | %          | 3.3                                            | %          | 3.5 | % | 3.1 | % |
| Provision for income taxes                       |       | 1.0                                              | %          | 1.3                                            | %          | 1.3 | % | 1.8 | % |
| Net earnings                                     |       | 2.1                                              | %          | 2.0                                            | %          | 2.2 | % | 1.3 | % |

 

33

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#####  

##### ***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  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                         | ** ** | **2007(1)**                                    | ** ** | **2008** | ** ** | **2007 (1)** | ** ** |
| Net sales:                                                 |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       | $                                                | 406,065    |                                           | $          | 382,176 |   | $ | 815,629 |   | $ | 754,125 |   |
| BSG                                                        |       | 237,281                                          |       | 227,100                                        |       | 483,504 |   | 485,030 |   |
|                                                       |       | $                                                | 643,346    |                                           | $          | 609,276 |   | $ | 1,299,133 |   | $ | 1,239,155 |   |
| Gross Profit                                               |       | $                                                | 298,424    |                                           | $          | 283,018 |   | $ | 604,593 |   | $ | 567,510 |   |
| Gross profit margin                                        |       | 46.4                                             | %          | 46.5                                           | %          | 46.5 | % | 45.8 | % |
| Selling, general and administrative  expenses              |       | $                                                | 218,817    |                                           | $          | 210,139 |   | $ | 441,712 |   | $ | 422,396 |   |
| Depreciation and amortization                              |       | $                                                | 11,821     |                                           | $          | 10,025 |   | $ | 23,573 |   | $ | 19,815 |   |
| Earnings before provision for income  taxes:               |       |                                             |       |                                           |       |   |   |   |   |
| Segment operating profit:                                  |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       | $                                                | 67,819     |                                           | $          | 67,714 |   | $ | 139,462 |   | $ | 133,208 |   |
| BSG                                                        |       | 17,942                                           |       | 12,597                                         |       | 38,972 |   | 31,319 |   |
| Segment operating profit                                   |       | 85,761                                           |       | 80,311                                         |       | 178,434 |   | 164,527 |   |
| Unallocated expenses                                       |       | (16,517                                          | )          | (16,900                                        | )          | (32,221 | ) | (32,964 | ) |
| Share-based compensation expense                           |       | (1,458                                           | )          | (557                                           | )          | (6,905 | ) | (6,264 | ) |
| Sales-based service fee charged by  Alberto-Culver         |       | —                                           |       | —                                         |       | — |   | (3,779 | ) |
|                                                       |       |                                             |       |                                           |       |   |   |   |   |
| Transaction expenses                                       |       | —                                           |       | (27                                            | )          | — |   | (21,484 | ) |
| Operating earnings                                         |       | 67,786                                           |       | 62,827                                         |       | 139,308 |   | 100,036 |   |
| Interest expense, net of interest  income                  |       | (47,642                                          | )          | (42,947                                        | )          | (94,125 | ) | (62,050 | ) |
| Earnings before provision for income  taxes                |       | $                                                | 20,144     |                                           | $          | 19,880 |   | $ | 45,183 |   | $ | 37,986 |   |
| Segment operating profit margin:                           |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 16.7                                             | %          | 17.7                                           | %          | 17.1 | % | 17.7 | % |
| BSG                                                        |       | 7.6                                              | %          | 5.5                                            | %          | 8.1 | % | 6.5 | % |
| Consolidated operating profit margin                       |       | 10.5                                             | %          | 10.3                                           | %          | 10.7 | % | 8.1 | % |
| Number of stores at end-of-period  (including franchises): |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       |                                             |       |                                           |       | 2,739 |   | 2,642 |   |
| BSG                                                        |       |                                             |       |                                           |       | 905 |   | 847 |   |
| Total                                                      |       |                                             |       |                                           |       | 3,644 |   | 3,489 |   |
| Same store sales growth (2)                                |       |                                             |       |                                           |       |   |   |   |   |
| Sally Beauty Supply                                        |       | 1.4                                              | %          | 1.6                                            | %          | 0.9 | % | 2.5 | % |
| BSG                                                        |       | 6.9                                              | %          | 11.2                                           | %          | 7.2 | % | 10.6 | % |
| Consolidated                                               |       | 2.8                                              | %          | 3.8                                            | %          | 2.4 | % | 4.4 | % |

 

----

|   | (1) | Certain amounts for prior periods have been  reclassified to conform to the current period’s presentation.                     |
|--------|-----|-------------------------------------------------------------------------------------------------------------------------------------|
|   | (2) | Same stores are defined as company-operated  stores that have been open for at least 14 months as of the last day of  a month. |

 

34

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***Comparison of the Three Months EndedMarch 31, 2008 and 2007***

 

The table below presents net sales, gross profit and gross profitmargin data for each reportable segment (in thousands).

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **Increase (Decrease)** | ** ** |
| Net sales:                       |       |                                                 |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                                    | 406,065    |   | $ | 382,176 |   | $ | 23,889 |   | 6.3 | % |
| BSG                              |       | 237,281                                              |       | 227,100 |   | 10,181 |   | 4.5 | % |
| Consolidated net sales           |       | $                                                    | 643,346    |   | $ | 609,276 |   | $ | 34,070 |   | 5.6 | % |
|                             |       |                                                 |       |   |   |   |   |   |   |
| Gross profit:                    |       |                                                 |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                                    | 207,337    |   | $ | 196,837 |   | $ | 10,500 |   | 5.3 | % |
| BSG                              |       | 91,087                                               |       | 86,181 |   | 4,906 |   | 5.7 | % |
| Consolidated gross profit        |       | $                                                    | 298,424    |   | $ | 283,018 |   | $ | 15,406 |   | 5.4 | % |
|                             |       |                                                 |       |   |   |   |   |   |   |
| Gross profit margin:             |       |                                                 |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | 51.1                                                 | %          | 51.5 | % | (0.4 | )% |   |   |
| BSG                              |       | 38.4                                                 | %          | 37.9 | % | 0.5 | % |   |   |
| Consolidated gross profit margin |       | 46.4                                                 | %          | 46.5 | % | (0.1 | )% |   |   |

###  

### ***Net Sales***

###  

Consolidated net sales increased $34.1 million, or 5.6% for the threemonths ended March 31, 2008 as compared to the three months ended March 31,2007.  The net sales increase was drivenby same store sales growth of 2.8%, acquisitions, which contributedapproximately $10.7 million, or 1.8%, approximately $10.8 million in net salesfrom new stores (155 net new stores opened during the last twelve months) andapproximately $2.4 million, or 0.4% in positive impact from foreign exchangerates. In addition, net sales continue to be positively impacted by theintroduction of new BSG product lines. These increases were offset, in part, bylower L’Oreal product sales resulting from contractual changes during fiscalyear 2007 of approximately $9.3 million and a loss of approximately $3.0million of lower-margin franchise-based products in the BSG segment.

 

*Sally Beauty Supply*.  Net sales for Sally Beauty Supply increased$23.9 million, or 6.3% for the three months ended March 31, 2008 ascompared to the three months ended March 31, 2007.  The net sales increase was driven by samestore sales growth of 1.4%, incremental sales from acquisitions (principallySalon Services U.K. acquired in February 2007) of approximately $10.7million, or 2.8% and net sales from new stores (97 net new stores opened duringthe last twelve months) of approximately $6.1 million, or 1.6%.  Same store sales were positively impacted bycontinued growth of exclusive label products and certain merchandise categoriessuch as hair extensions and an increase in promotional sales.  These positive impacts were offset, in part,by a continued decline in same store number of transactions and by a generallyweak retail selling environment in the U.S. during the three months ended March 31,2008 as well as a negative impact of foreign exchange rates of 0.3%.

 

*Beauty Systems Group*.  Net sales for BSG increased $10.2 million, or4.5% for the three months ended March 31, 2008 as compared to the threemonths ended March 31, 2007.  Thenet sales increase was driven by same store sales growth of 6.9%, approximately$4.6 million, or 2.0% in net sales from new stores (58 net new stores openedduring the last twelve months) and approximately $3.7 million or 1.6% inpositive impact from foreign exchange rates. In addition, BSG net salescontinued to be positively impacted by the introduction of new product lines.These increases were offset, in part, by lower L’Oreal product sales resultingfrom contractual changes during fiscal year 2007 of approximately $9.3 millionand a loss of approximately $3.0 million of lower-margin franchise-basedproducts.

 

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

####  

Consolidated gross profit increased $15.4 million, or 5.4% for thethree months ended March 31, 2008 as compared to the three months ended March 31,2007, principally due to revenue from acquired businesses in Sally BeautySupply and improved gross margins in BSG.

 

35

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*Sally Beauty Supply*. Sally Beauty Supply’sgross profit increased $10.5 million, or 5.3% for the three months ended March 31,2008, as compared to the three months ended March 31, 2007, principally asa result of acquired businesses and increased unit sales volume.  Sally Beauty Supply’s gross profit as apercent of net sales, however, decreased by 0.4% for the three months ended March 31,2008 as compared to the three months ended March 31, 2007, principally asa result of the dilutive impact of the additional acquisition-related revenuesof the Sally international business, which typically have lower margins, and anincrease in planned promotional sales in the U.S. and higher freight costs.This decrease was partially offset by a shift in product mix including, amongother things, continued increase in sales of exclusive-label products and grossprofit margin increases on certain products as well as improved internationalbusiness margin, apart from acquired businesses.

 

#### *BeautySystems Group*.  BSG’sgross profit increased $4.9 million, or 5.7% for the three months ended March 31,2008 as compared to the three months ended March 31, 2007, principally asa result of increased unit sales volume in the U.S. and Canada, offset byapproximately $1.0 million of warehouse optimization costs. BSG’s gross profitas a percentage of net sales increased by 0.5% for the three months ended March 31,2008 as compared to the three months ended March 31, 2007 primarily due tomargin pressure from lower-margin business in our franchise-based businessduring the three months ended March 31, 2007 that was not repeated duringthe three months ended March 31, 2008.

####  

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

####  

Consolidated selling, general and administrative expenses increased $8.7million, or 4.1% to $218.8 million for the three months ended March 31,2008 compared to $210.1 million for the three months ended March 31, 2007.This increase is attributable principally to expenses directly associated withthe increased sales volume, unit growth and acquisitions, including increasedrent expense of approximately $2.3 million, and additional share-basedcompensation expense of approximately $1.0 million. These increases werepartially offset by lower sales commissions and advertising expense.  Selling, general and administrative expensefor the three months ended March 31, 2008 also includes approximately $0.9million in BSG retention incentives for distributor sales consultants due tothe L’Oreal contractual changes reported during fiscal year 2007.  As a percentage of net sales, selling,general and administrative expenses were 34.0% for the three months ended March 31,2008 compared to 34.5% for the three months ended March 31, 2007.

 

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

####  

Consolidated depreciation and amortization increased $1.8 million, or17.9%, to $11.8 million for three months ended March 31, 2008 compared to$10.0 million for the three months ended March 31, 2007.  The increase was primarily due to theamortization of intangible assets associated with acquisitions and the capitalexpenditures for unit growth of both operating segments.

 

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

####  

Consolidated operating earnings increased $5.0 million, or 7.9%, to$67.8 million for the three months ended March 31, 2008 compared to $62.8million for the three months ended March 31, 2007. Operating earnings, asa percentage of net sales, were 10.5% for the three months ended March 31,2008 compared to 10.3% for the three months ended March 31, 2007. Theincrease in consolidated operating earnings was primarily due to increases ingross profit in both operating segments, offset by increased selling, generaland administrative expenses.

 

*Sally Beauty Supply*.  Sally Beauty Supply’s segment operatingearnings increased $0.1 million to $67.8 million for the three months ended March 31,2008 compared to $67.7 million for the three months ended March 31, 2007.Segment operating earnings, as a percentage of net sales, were 16.7% for thethree months ended March 31, 2008 compared to 17.7% for the three monthsended March 31, 2007.  Sally BeautySupply’s segment operating earnings margins were adversely impacted by plannedpromotions and advertising by the Sally’s U.S. based business, higher freightcosts and the dilutive effect of the incremental acquisition-related Sallyinternational business, as this is generally a lower operating earnings marginbusiness.

 

*Beauty Systems Group*.  BSG’s segment operating earnings increased$5.3 million, or 42.4%, to $17.9 million for the three months ended March 31,2008 compared to $12.6 million for the three months ended March 31, 2007.Segment operating earnings, as a percentage of net sales, were 7.6% for thethree months ended March 31, 2008 compared to 5.5% for the three monthsended March 31, 2007.  BSG’s segmentoperating earnings were positively impacted by improvement in gross profitmargins and the Company’s initiatives to increase non-L’Oreal sales.  In

 

36

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addition, BSG segment operating earnings reflect lower selling, generaland administrative expenses, principally sales commissions and advertisingexpenses.  These improvements wereoffset, in part, by the operating expenses attributable to stores opened orbusinesses acquired in the twelve month period ending on March 31, 2008 aswell as by warehouse optimization expenses of $1.7 million (includingdepreciation) in the three months ended March 31, 2008.

 

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

 

Interest expense, net of interest income of $0.2 million, was $47.6million for the three months ended March 31, 2008 compared to $42.9million, net of interest income of $0.3 million, for the three months ended March 31,2007.  Net interest expense reflectsnon-cash expense of $8.6 million and $1.7 million of marked-to-market adjustmentsfor the interest rate swaps, as described in Note 4 of the Condensed Notes toConsolidated Financial Statements, for the three months ended March 31,2008 and 2007, respectively.

 

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

####  

Provision for income taxes was $6.4 million during the three monthsended March 31, 2008 compared to $7.6 million for the three months ended March 31,2007.  Income taxes for the interimperiods ended March 31, 2008 and March 31, 2007 have been included inthe accompanying financial statements on the basis of an estimated annualeffective rate.  The estimated annualeffective tax rate (excluding discrete items) is 35.7% for fiscal year 2008compared to 37.4% for fiscal year 2007. The reduction in the estimated annual effective tax rate primarilyrelates to the reduced impact of permanent items on higher earnings and areduction in foreign statutory tax rates.

 

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

####  

As a result of the foregoing, consolidated net earnings increased $1.5million, to $13.8 million for the three months ended March 31, 2008compared to $12.3 million for the three months ended March 31, 2007. Netearnings, as a percentage of net sales, were 2.1% for the three months ended March 31,2008 compared to 2.0% for the three months ended March 31, 2007.

 

***Comparison of the Six Months Ended March 31,2008 and 2007***

 

The table below presents net sales, gross profit and gross profitmargin data for each reportable segment (in thousands).

 
| ** **                       | ** ** | **Six Months Ended March 31,** | ** ** |
|----------------------------------|------------|----------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                           | ** ** | **2007** | ** ** | **Increase (Decrease)** | ** ** |
| Net sales:                       |       |                                               |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                                  | 815,629    |   | $ | 754,125 |   | $ | 61,504 |   | 8.2 | % |
| BSG                              |       | 483,504                                            |       | 485,030 |   | (1,526 | ) | (0.3 | )% |
| Consolidated net sales           |       | $                                                  | 1,299,133  |   | $ | 1,239,155 |   | $ | 59,978 |   | 4.8 | % |
|                             |       |                                               |       |   |   |   |   |   |   |
| Gross profit:                    |       |                                               |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | $                                                  | 418,876    |   | $ | 385,842 |   | $ | 33,034 |   | 8.6 | % |
| BSG                              |       | 185,717                                            |       | 181,668 |   | 4,049 |   | 2.2 | % |
| Consolidated gross profit        |       | $                                                  | 604,593    |   | $ | 567,510 |   | $ | 37,083 |   | 6.5 | % |
|                             |       |                                               |       |   |   |   |   |   |   |
| Gross profit margin:             |       |                                               |       |   |   |   |   |   |   |
| Sally Beauty Supply              |       | 51.4                                               | %          | 51.2 | % | 0.2 | % |   |   |
| BSG                              |       | 38.4                                               | %          | 37.5 | % | 0.9 | % |   |   |
| Consolidated gross profit margin |       | 46.5                                               | %          | 45.8 | % | 0.7 | % |   |   |

###  

### ***Net Sales***

 

Consolidated net sales increased $60.0 million or 4.8% for the sixmonths ended March 31, 2008 as compared to the six months ended March 31,2007.  The net sales increase is attributableto same store sales growth of 2.4%, acquisitions, which contributedapproximately $35.9 million or 2.9%, approximately $23.1 million in net salesfrom new stores (155 net new stores opened during the last twelve months) andapproximately $6.3 million, or 0.5% in positive impact from foreign exchangerates.  These increases were offset, inpart, by lower L’Oreal product sales resulting from contractual changes duringfiscal year 2007 of approximately $37.1 million and the loss of

 

37

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approximately $12.1 million of lower-margin franchise-based products inthe BSG segment.

 

*Sally Beauty Supply.*  Net sales for Sally Beauty Supply increased$61.5 million or 8.2% for the six months ended March 31, 2008 as comparedto the six months ended March 31, 2007. The net sales increasedprincipally from same stores sales growth of 0.9%, incremental sales fromacquisitions of approximately $35.9 million, or 4.8%, net sales from new stores(97 net new stores opened during the last twelve months) of approximately $13.1million, or 1.7% and an increase in promotional sales.  Same store sales were positively impacted bycontinued growth of exclusive-label products and certain merchandise categoriessuch as hair extensions and negatively impacted by a decline in same storenumber of transactions and by a generally weak retail selling environment inthe U.S during the six months ended March 31, 2008 and a 0.2% decline fromthe effect of foreign exchange rates.

 

*Beauty Systems Group*.  Net sales for BSG decreased $1.5 million or0.3% for the six months ended March 31, 2008 as compared to the six monthsended March 31, 2007.  The net salesdecreased principally as a result of lower L’Oreal product sales ofapproximately $37.1 million resulting from contractual changes during fiscalyear 2007 and a reduction in sales of certain lower-margin franchise-basedproducts of approximately $12.1 million. These decreases were offset, in part,by a same store sales growth of 7.2%, approximately $10.0 million, or 2.1% innet sales from new stores (58 net new stores opened during the last twelvemonths) and approximately $7.7 million, or 1.6% in positive impact from foreignexchange rates. In addition, BSG net sales were positively impacted by theintroduction of new product lines.

 

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

####  

Consolidated gross profit increased $37.1 million, or 6.5% for the sixmonths ended March 31, 2008 as compared to the six months ended March 31,2007, principally due to acquisitions for Sally Beauty Supply and improvedgross margins in both operating segments.

 

*Sally Beauty Supply.* Sally Beauty Supply’sgross profit increased $33.0 million or 8.6% for the six months ended March 31,2008 as compared to the six months ended March 31, 2007, principally as aresult of acquisitions and increased unit sales volume.  Sally Beauty Supply’s gross profit as apercent of net sales increased to 51.4% for the six months ended March 31,2008 compared to 51.2% for the six months ended March 31, 2007,principally as a result of a shift in product mix including, among otherthings, continued increase in sales of exclusive-label products and grossprofit margin increases on certain products. This increase was partially offset by the dilutive impact of theadditional acquisition-related revenues of Sally’s international business(which typically has lower margins), higher freight costs and an increase inpromotional sales in the U.S.

 

*Beauty Systems Group.* BSG’s gross profitincreased $4.0 million, or 2.2% for the six months ended March 31, 2008 ascompared to the six months ended March 31, 2007, principally as a resultof increased unit sales volume and net of incurring approximately $1.4 millionof warehouse optimization costs. BSG’s gross profit as a percentage of net salesincreased to 38.4% for the six months ended March 31, 2008 compared to37.5% for the six months ended March 31, 2007 primarily due to marginpressure from lower-margin business in our franchise-based business during thesix months ended March 31, 2007 that was not repeated during the sixmonths ended March 31, 2008, as well as a shift in revenue mix during thesix months ended March 31, 2008 towards higher store sales volume versusdistributor sales consultants’ revenues, as stores generally having a highergross profit margin.

 

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

####  

Consolidated selling, general and administrative expenses increased$19.3 million, or 4.6%, to $441.7 million for the six months ended March 31,2008 compared to $422.4 million for the six months ended March 31,2007.   This increase is attributableprincipally to expenses directly associated with the increased sales volume,unit growth and the effects of acquisitions, including increased rent expenseof approximately $5.3 million. Selling, general and administrative expense forthe six months ended March 31, 2008 includes approximately $1.5 millionfor BSG retention incentives for distributor sales consultants due to the L’Orealcontractual changes reported during fiscal year 2007.  Selling, general and administrative expenses,as a percentage of net sales, were 34.0% for the six months ended March 31,2008 and 34.1% for the six months ended March 31, 2007.  These increases were partially offset by a$1.0 million decrease in expenses from the inclusion in the results for the sixmonths ended March 31, 2007, of allocated overhead charges fromAlberto-Culver prior to the Separation Transactions, with no comparable chargesin the six months ended March 31, 2008 and by lower sales commissions ofapproximately $2.4 million as well as a reduction in advertising expense ofapproximately $2.0 million.

 

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

####  

Consolidated depreciation and amortization increased $3.8 million, or19.0%, to $23.6 million for six months ended March 31, 2008 compared to$19.8 million for the six months ended March 31, 2007.  The increase was primarily due to theamortization of intangible assets associated with acquisitions and the capitalexpenditures for unit growth of both operating segments.

 

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

####  

The sales-based service fee charged by Alberto-Culver was $3.8 millionfor the six months ended March 31, 2007 with no comparable expense for thesix months ended March 31, 2008 as a result of the cancellation of theagreement in connection with the Separation Transactions.

 

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

####  

We recorded $21.5 million in expenses related to the SeparationTransactions for the six months ended March 31, 2007.  These expenses were for fees allocated to usby Alberto-Culver, for severance payments to certain former officers and forother professional fees.  We did notincur any comparable expenses related to the Separation Transactions in the sixmonths ended March 31, 2008.

 

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

####  

Consolidated operating earnings increased $39.3 million or 39.3% to$139.3 million for the six months ended March 31, 2008 compared to $100.0million for the six months ended March 31, 2007. Operating earnings, as apercentage of net sales, were 10.7% for the six months ended March 31,2008 compared to 8.1% for the six months ended March 31, 2007.  The increase in consolidated operatingearnings was primarily due to increased gross profit by both operating segmentsas well as the non-recurrence of fees incurred during the six months ended March 31,2007 of $21.5 million in connection with the Separation Transactions.

 

*Sally Beauty Supply.*  Sally Beauty Supply’s segment operatingearnings increased $6.3 million, or 4.7%, to $139.5 million for the six monthsended March 31, 2008 compared to $133.2 million for the six months ended March 31,2007. Segment operating earnings, as a percentage of net sales, were 17.1% forthe six months ended March 31, 2008 compared to 17.7% for the six monthsended March 31, 2007.  Sally BeautySupply’s segment operating earnings margins were adversely impacted bypromotions and increased advertising by the Sally U.S. based business, higherfreight costs and the dilutive effect of the incremental acquisition-relatedSally international business, as this is generally a lower operating earningsmargin business.

 

*Beauty Systems Group*.  BSG’s segment operating earnings increased$7.7 million, or 24.4%, to $39.0 million for the six months ended March 31,2008 compared to $31.3 million for the six months ended March 31, 2007.Segment operating earnings, as a percentage of net sales, were 8.1% for the sixmonths ended March 31, 2008 compared to 6.5% for the six months ended March 31,2007.  BSG’s segment operating earningswere positively impacted by improvement in gross profit margins and the Company’sinitiatives to increase non-L’Oreal sales as well as lower selling, general andadministrative expenses, principally sales commissions and advertising expenses.  In addition, operating earnings were improvedfrom the non-recurrence of consulting fees and expenses related to the L’Orealcontractual changes incurred for the six months ended March 31, 2007.  These improvements were offset, in part, bythe operating expenses attributable to stores opened or businesses acquired inthe twelve month period ending on March 31, 2008 as well as by warehouseoptimization expenses of $2.1 million (including depreciation), in the sixmonths ended March 31, 2008.

 

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

####  

Interest expense, net of interest income of $0.4 million, was $94.1million for the six months ended March 31, 2008 compared to $62.1 million,net of interest income of $1.3 million, for the six months ended March 31,2007.  The increase in interest expensewas primarily attributable to the interest associated with the new debtincurred on November 16, 2006.  Netinterest expense also reflects non-cash expense of $14.3 million and $0.7million of marked-to-market adjustments for the interest rate swaps, asdescribed in Note 4 of the Condensed Notes to Consolidated FinancialStatements, for the six months ended March 31, 2008 and 2007,respectively.

 

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

####  

Provision for income taxes was $16.1million during the six months endedMarch 31, 2008 compared to $22.0 million for the six months ended March 31,2007.  Income taxes for the interimperiods ended March 31, 2008 and March 31, 2007 have been included inthe accompanying financial statements on the basis of an estimated annualeffective rate.  The estimated annualeffective tax rate (excluding discrete items) is 35.7% for fiscal year 2008compared to 37.4% for fiscal year 2007. The reduction in the estimated annual effective tax rate primarilyrelates to the reduced impact of permanent items on higher earnings and areduction in foreign statutory tax rates.

 

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

 

As a result of the foregoing, consolidated net earnings increased $13.1million, to $29.1 million for the six months ended March 31, 2008 comparedto $16.0 million for the six months ended March 31, 2007. Net earnings, asa percentage of net sales, were 2.2% for the six months ended March 31,2008 compared to 1.3% for the six months ended March 31, 2007.

 

## **FinancialCondition**

##  

### ***March 31, 2008 Compared to September 30, 2007***

###  

Working capital (current assets less current liabilities) at March 31,2008 was $382.8 million compared to $341.9 million at September 30, 2007,representing an increase of $40.9 million. The resulting ratio of current assets to current liabilities was 2.12 to1.00 at March 31, 2008 compared to 1.92 to 1.00 at September 30,2007.  The increase in working capitalreflects a $13.0 million increase in current assets combined with a $27.9 decreasein current liabilities.  Current assetsreflect a $21.2 million increase in inventory levels offset, in part, by adecrease in cash and cash equivalents (see Liquidity and Capital Resourcesbelow).  The decrease in currentliabilities was primarily the result of a $24.1 million decrease in accountspayable and accrued expenses.

 

Inventories increased $21.2 million to $590.6 million at March 31,2008 compared to $569.4 million at September 30, 2007 primarily due topurchases in connection with new and expanded BSG brands, the seeding of a newBSG warehouse and the build up of certain products for Sally Beauty Supply.

 

Accounts payable decreased by $18.3 million to $158.4 million at March 31,2008 from $176.7 million at September 30, 2007 primarily due to the timingof payments related to inventory and property and equipment purchased duringthe fourth quarter of fiscal year 2007. Accrued expenses decreased by $5.9million to $147.8 million at March 31, 2008 from $153.7 million at September 30,2007 primarily due to payments of accrued interest on long-term debt.

 

Member’s deficit decreased by $26.4 million as a result of net earningsoffset in part by a decrease in accumulated other comprehensive income.Accumulated other comprehensive income - foreign currency translation decreasedby $2.7 million to $31.8 million at March 31, 2008, compared to $34.5million at September 30, 2007.

 

## **Liquidityand 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 cannotbe considered separately from capital resources that consist of current orpotentially available funds for use in achieving long-range business objectivesand meeting debt service commitments.

 

Following the completion of the Separation Transactions, we are highlyleveraged and a substantial portion of our liquidity needs will arise from debtservice on indebtedness incurred in connection with the Separation Transactionsand from funding the costs of operations, working capital and capitalexpenditures. As a holding company, we depend on our subsidiaries to distributefunds to us so that we may pay our obligations and expenses.  The ability of our subsidiaries to make suchdistributions will be subject to their operating results, cash requirements andfinancial condition. In addition, under Delaware law, the ability of our subsidiariesto make distributions to us will be limited to the extent: (i) of their

 

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surplus, or if there is no surplus, of their net earnings for thefiscal year in which the distribution is declared and/or the preceding fiscalyear, if such subsidiary is a corporation; or (ii) the fair value of theirassets exceeds their liabilities, in the case of a subsidiary that is a limitedliability company. See “Risk Factors—Risks Relating to Our Business, and —RisksRelating to Our Substantial Indebtedness” in our Annual Report on Form 10-Kfor the year ended September 30, 2007.

 

Based upon the current level of operations and anticipated growth, weanticipate that existing cash balances, funds generated by operations and fundsavailable under the ABL facility will be sufficient to meet our working capitalrequirements and to finance capital expenditures, excluding acquisitions, overthe next 12 months.

 

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, increases in competitiveactivity, the loss of key suppliers, rising interest rates, the loss of keypersonnel, the ability to execute our business strategy and general economicconditions.

 

Please see the Company’s Annual Report on Form 10-K for fiscalyear ended September 30, 2007 for additional information on liquidity andcapital resources.

 

We utilize our ABL facility for the issuance of letters of credit, aswell as to manage normal fluctuations in operational cash flow. In that regard,we may from time to time draw funds under the revolving credit facility forgeneral corporate purposes including acquisitions and interest payments due onour indebtedness.  The funds drawn on individualoccasions during the six months ended March 31, 2008 have varied inamounts of up to $35.7**million,with total amounts outstanding ranging from $2.2 million up to $86.9 million.The amounts drawn are generally outstanding for a short period of time and aregenerally paid down as cash is received from our operating activities.  As of March 31, 2008, we had $317.8million available for additional borrowings under our ABL facility, subject tobase limitations, as reduced by outstanding letters of credit.

 

During the six months ended March 31, 2008, the Company completedseveral small acquisitions at an aggregate cost of $17.4 million of which $1.6million was allocated to tangible assets acquired and $15.8 million wasallocated to intangible assets and goodwill. We utilized our ABL facility to pay for these acquisitions.    In addition, on May 7, 2008, weacquired Pro-Duo, N.V., a 40-store beauty supply chain located in Belgium,France and Spain for 19.3 million Euros, or approximately $29.8 million,subject to certain adjustments.  Theacquisition was funded through $29.8 million in cash and borrowings on our ABLand the assumption of 2.7 million Euros, or approximately $4.0 million, of debtfrom Pro-Duo.

 

Our primary source of cash has been from funds provided by operatingactivities and borrowings under our ABL facility for the six months ended March 31,2008. Historically, the primary use of cash was for acquisitions and capitalexpenditures and, for the six months ended March 31, 2007, for the specialcash distribution paid in connection with the Separation Transactions. Thefollowing table shows our sources and uses of funds for the six months ended March 31,2008 and 2007 (in thousands):

 

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| ** **                                        | ** ** | **Six Months Ended March 31,** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| Net cash provided by operating  activities        |       | $                                                  | 20,619     |   | $ | 97,151 |   |
| Net cash used by investing activities             |       | (42,982                                            | )          | (87,942 | ) |
| Net cash provided (used) by financing  activities |       | 14,498                                             |       | (82,875 | ) |
| Effect of foreign exchange rates                  |       | 1,013                                              |       | 72 |   |
| Net decrease in cash and cash  equivalents        |       | $                                                  | (6,852     | ) | $ | (73,594 | ) |

###  

### *Net Cash Provided by Operating Activities*

###  

Net cash provided by operating activities, which excludes the effectsof acquisitions, during the six months ended March 31, 2008 decreased by$76.6 million to $20.6 million compared to $97.2 million duringthe six months ended March 31, 2007. The decrease was primarily due to anincrease of approximately $56.2 million in cash used to purchase inventory anda reduction in accounts payable and accrued expenses of $24.5 million andincome taxes payable of $2.5 million. This decrease was offset, in part, by improved earnings for the sixmonths ended March 31, 2008 of approximately $13.2 million.

 

### *Net Cash Used by Investing Activities*

###  

Net cash used by investing activities during the six months ended March 31,2008 decreased by $44.9 million to $43.0 million, compared to$87.9 million during the six months ended March 31, 2007.  This decrease was primarily due to areduction in cash used for acquisitions (including approximately $57.7 millionin connection with the acquisition of Salon Services in 2007); offset in partby an increase in capital expenditures for new stores, remodeling of existingfacilities and capital spending on our BSG warehouse optimization program toconsolidate warehouses.  For the sixmonths ended March 31, 2008, the $17.4 million of cash used foracquisitions consisted primarily of goodwill and intangible assets.

 

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

###  

Net cash provided (used) by financing activities during the six monthsended March 31, 2008 increased by $97.4 million to cash provided of$14.5 million, compared to cash used of $82.9 million during the sixmonths ended March 31, 2007.  Theincrease was primarily due to the exclusion of distributions to Alberto-Culverand costs associated with the Separation Transactions, including debt issuancecosts, and special cash distribution paid in the six months ended March 31,2007.  This increase was offset, in part,by lower levels of borrowings and the absence of capital contributions duringthe six months ended March 31, 2008 compared to the six months ended March 31,2007.

 

##### **CapitalRequirements**

#####  

For fiscal year 2008, we anticipate total capital expenditures ofapproximately $60.0 million. We anticipate utilizing these capital expendituresprimarily for the addition of new stores, our BSG warehouse optimizationprogram to consolidate warehouses, the remodeling, expansion or relocation ofexisting facilities and various corporate projects. During the six months endedMarch 31, 2008, capital expenditures were approximately $25.7 million.

 

**Contractual Obligations**

 

There have been no material changes in any of our contractualobligations since September 30, 2007, other than new product purchaseobligations in the ordinary course of business in an aggregate amount of $7.3million.

 

## **Off-BalanceSheet Financing Arrangements**

##  

We had no off-balance sheet financing arrangements other than operatingleases incurred in the ordinary course of business, as well as outstandingletters of credit related to inventory purchases and self insurance programswhich totaled $12.9 million and $9.4 million at March 31, 2008 and September 30,2007, respectively.

 

## **Inflation**

##  

We believe that inflation does not currently have a material effect onour results of operations.

 

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## **CriticalAccounting Policies and Estimates**

##  

The preparation of financial statements in conformity with GAAPrequires us to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues and expenses and disclosure of contingentassets and liabilities in the financial statements. Actual results may differfrom these estimates. We believe these estimates and assumptions are reasonable.We consider accounting policies to be critical when they require us to makeassumptions about matters that are highly uncertain at the time the accountingestimate is made and when different estimates that our management reasonablycould have used have a material effect on the presentation of our financialcondition, changes in financial condition or results of operations.

 

Our critical accounting policies, as described in our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2007, relate to the valuation ofinventories, vendor allowances, retention of risk, income taxes, share-basedpayments and related party transactions. There have been no material changes toour critical accounting policies since September 30, 2007, except for theadoption of FIN 48, which is discussed in Note 7 of the Condensed Notes toConsolidated Financial Statements.

##  

## **RelatedParty Transactions**

##  

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

##  

## **RecentAccounting Pronouncements**

##  

In March 2008, the Financial Accounting Standards Board, orFASB issued Statement of Financial Accounting Standards (“SFAS”) No. 161,*Disclosures about Derivative Instruments andHedging Activities, an Amendment of FASB Statement No. 133* (“SFAS161”). SFAS 161 requires companies to provide qualitative disclosures about theobjectives and strategies for using derivatives, quantitative data about thefair value of and gains and losses on derivative contracts, and details ofcredit-risk-related contingent features in their hedged positions.  The statement also requires companies todisclose more information about the location and amounts of derivativeinstruments in financial statements; how derivatives and related hedges areaccounted for under SFAS 133, *Accounting forDerivative Instruments and Hedging Activities*; and how the hedgesaffect the entity’s financial position, financial performance and cash flows.SFAS 161 is effective for periods beginning after November 15, 2008. Weexpect the adoption of this statement will not have a material impact on ourconsolidated financial statements.

 

In December 2007, the FASB, issued SFAS No. 160, *Noncontrolling Interests in Consolidated FinancialStatements, an amendment to ARB No. 51* (“SFAS 160”), whichrequires, among other things, that the noncontrolling interest (previouslyreferred to as minority interest) in a consolidated subsidiary’s equity bereported as a component of equity separate from the parent’s interest and thatnet income or loss attributable to the noncontrolling interest be included inconsolidated net income on the face of the income statement. In addition, purchasesand sales of equity interest that do not result in a change in control will beaccounted for as equity transactions and, upon a loss of control, the interestsold, as well as any interest retained, will be recorded at fair value with anygain or loss recognized in earnings. SFAS 160 is effective for periods on orafter December 15, 2008.  We arecurrently assessing the effect of this pronouncement on our consolidatedfinancial statements.

 

In December 2007, the FASB, issued SFAS No. 141 (Revised 2007):*Business Combinations* (“SFAS 141R”).Among other things, SFAS 141R generally requires that an acquirer recognize theassets acquired and liabilities assumed measured at their fair values on theacquisitions date. This practice replaces the practice, under predecessor SFAS141: *Business Combinations,* ofallocating the cost of an acquisition to the individual assets acquired andliabilities assumed based on their relative estimated fair values.  SFAS 141R further requires thatacquisition-related costs be recognized separately from the relatedacquisition. SFAS 141R is effective in periods beginning after December 15,2008. We are currently assessing the effect of this pronouncement on ourconsolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities – including an amendment of FASB Statement No. 115*,(“SFAS 159”). SFAS 159 permits entities to choose to measure many financialinstruments and certain other items at fair value that are not currentlyrequired to

 

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be measured at fair value, with unrealized gains and losses related tothese financial instruments reported in earnings at each subsequent reportingdate. SFAS 159 is effective in fiscal years beginning after November 15,2007. We are currently assessing the effect of this pronouncement on ourconsolidated financial statements.

 

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*, (“SFAS 157”),which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS 157 is effective in fiscal years beginning after November 15,2007. In November 2007, the FASB provided a one year deferral for theimplementation of SFAS 157 for other nonfinancial assets and liabilities. Weare currently assessing the effect of this pronouncement on our consolidatedfinancial statements.

 

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# **Item 3.  Quantitative and QualitativeDisclosures About 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.

 

## **Foreigncurrency 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 theU.S. dollar versus the British pound sterling, Canadian dollar, Euro andMexican peso. Our various currency exposures at times offset each otherproviding a natural hedge against currency risk. Fluctuations inU.S. dollar exchange rates within the range of the rates for the sixmonths ended March 31, 2008 and 2007 did not have a material effect on ourfinancial condition and results of operations. We do not use derivativefinancial instruments to manage foreign currency exchange rate risk.

 

## **Interestrate risk**

## ** **

As a result of the debt financing incurred in connection with theSeparation Transactions, we are subject to interest rate market risk inconnection with our long-term debt. The principal interest rate exposurerelates to amounts borrowed under the Term Loans and the ABL facility. Based onthe approximately $1.1 billion of borrowings under the Term Loans and the ABLfacility as of March 31, 2008, a change in the estimated interest rate upor down by 1/8% will increase or decrease earnings before provision for incometaxes by approximately $1.3 million on an annual basis, without considering theeffect of 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, weand/or our other subsidiaries who are borrowers under the ABL facility may fromtime to time enter into and maintain derivative instruments, such as interestrate swap agreements, for periods consistent with the related underlyingexposures. In addition, the agreement underlying our Term Loans requires thatwe hedge a portion of our floating interest rate exposure for a specifiedperiod.

 

On November 24, 2006, we entered into two interest rate swapagreements with a notional amount of $150.0 million and $350.0 million,respectively. These agreements expire on November 24, 2008 and 2009,respectively. The agreements allow us to convert a portion of our variable rateinterest to a fixed rate of 4.9975% plus (2.00% to 2.50%) and 4.94% plus (2.00%to 2.50%), respectively.  As discussed inPart I, “Item 1A. Risk Factors” of our Annual Report on Form 10-K forthe fiscal year ended September 30, 2007, changes in the fair value ofthese interest rate swap agreements driven by interest rate changes willincrease or decrease our net interest expense and may therefore affect ourearnings.

 

## **Creditrisk**

## ** **

We are exposed to credit risk on certain assets, primarily cashequivalents, short-term investments and accounts receivable. The credit riskassociated with cash equivalents and short-term investments is mitigated by ourpolicy of investing in a diversified portfolio of securities with high creditratings.

 

We provide credit to customers in the ordinary course of business andperform ongoing credit evaluations. Our exposure to concentrations of creditrisk with respect to trade receivables is mitigated by our broad customer base.We believe our allowance for doubtful accounts is sufficient to cover customercredit risks.

 

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

 

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

 

Certifications of our CEO and our CFO, which are required in accordancewith Rule 13a-14 of the Securities Exchange Act of 1934, as amended (“ExchangeAct”), are attached as exhibits to this report. This “Controls and Procedures”section includes the information concerning the controls evaluation referred toin the certifications, and it should be read in conjunction with thecertifications for 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 March 31, 2008, we maintain disclosurecontrols and procedures that are effective in providing reasonable assurancethat information required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms, and thatsuch information is accumulated and communicated to our management, includingour CEO and CFO, as appropriate to allow timely decisions regarding requireddisclosure.

 

*Changes in Internal Control 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.

 

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** **

**PART II– OTHER INFORMATION**

** **

# **Item 1.  LegalProceedings.**

 

There were no material legal proceedings pending against us or oursubsidiaries, as of March 31, 2008. 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. These laws and regulations govern, among otherthings, the composition, packaging, labeling and safety of the products wesell, the methods we use to sell these products and the methods we use toimport these products.  We believe that we are in material compliance withsuch laws and regulations, although no assurance can be provided that this willremain true going forward.

 

## On February 25,2008, we disclosed in a Current Report on Form 8-K that L’Oreal USA S/D, Inc.(“L’Oreal”) filed a lawsuit in California state court naming, among others, SDHair, Ltd. and Hair of Nevada, LLC (collectively, “SD Hair”), franchisees ofour subsidiary Armstrong McCall division (“AMLP”) of our BSG business unit, asdefendants.  The suit alleges, among other things, that SD Hair hasbreached its franchise agreement with AMLP by diverting (selling) Matrixbranded products to unauthorized buyers, and that L’Oreal is entitled to makeclaims against SD Hair under the franchise agreement as a third-partybeneficiary of that agreement.  The suit also alleges, among other issues,that SD Hair induced AMLP to breach its agreement to distribute Matrix brandedproducts in some unspecified manner.** **Asof February 25, 2008, neither the Company nor any of its subsidiaries(including AMLP) was a defendant in the lawsuit filed by L’Oreal.  On March 24, 2008, however, SD Hair filed a cross-complaint inthe same case naming AMLP and BSG as cross-defendants, seeking, among other things,i) declaratory relief from BSG and AMLP in the form of a judicial finding that****SD Hair is not in breach of its franchiseagreement and that L’Oreal has no rights as a third-party beneficiary to SDHair’s franchise agreement, and ii) injunctive relief in the form of a judicialorder compelling AMLP and BSG to take appropriate legal action against L’Orealto enforce SD Hair’s claimed rights under AMLP’s Matrix distributionagreement.  We have answered the cross-complaint; however no monetaryrelief is being sought by SD Hair.

##  

# **Item 1A.  RiskFactors.**

 

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

##  

# **Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.**

 

(a) Not applicable

 

(b) Not applicable

 

(c) Not applicable

 

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

 

Not applicable

 

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# **Item 4. Submission of Matters to a Vote of Security Holders.**

 

Not applicable

 

# **Item 5.  OtherInformation.**

 

(a) Not applicable

 

(b) Not applicable

 

# **Item 6. Exhibits**

 
| ** ** | **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|------------|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       | 2.1                  |       | Investment Agreement, dated as of  June 19, 2006, among Alberto-Culver Company, New Aristotle Company,  Sally Holdings, Inc., New Sally Holdings, Inc. and CDRS Acquisition  LLC, which is incorporated by reference from Exhibit 2.1 to Amendment  No. 3 to the Registration Statement on Form S-4 of New Sally  Holdings, Inc.. (File No. 333-136259) filed on October 10,  2006                                                                                                                             |
|       |                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       | 2.2                  |       | First Amendment to the Investment Agreement,  dated as of October 3, 2006, among Alberto-Culver Company, New Aristotle  Company, Sally Holdings, Inc., New Sally Holdings, Inc. and CDRS  Acquisition LLC, which is incorporated by reference from Exhibit 2.2 to  Amendment No. 3 to the Registration Statement on Form S-4 of New  Sally Holdings, Inc. (File No. 333-136259) filed on  October 10, 2006                                                                                                     |
|       |                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       | 2.3                  |       | Second Amendment to the Investment Agreement,  dated as of October 26, 2006, among Alberto-Culver Company, New  Aristotle Company, Sally Holdings, Inc., New Sally Holdings, Inc.  and CDRS Acquisition LLC, which is incorporated by reference from  Exhibit 2.02 to the Current Report on Form 8-K of New Sally  Holdings, Inc. filed on October 30, 2006                                                                                                                                                              |
|       |                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       | 2.4                  |       | Separation Agreement, dated as of  June 19, 2006, among Alberto-Culver Company, Sally Holdings, Inc.,  New Sally Holdings, Inc. and New Aristotle Holdings, Inc., which is  incorporated by reference from Exhibit 2.3 to Amendment No. 3 to  the Registration Statement on Form S-4 of New Sally Holdings, Inc.  (File No. 333-136259) filed on October 10, 2006                                                                                                                                         |
|       |                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       | 2.5                  |       | First Amendment to the Separation Agreement,  dated as of October 3, 2006, among Alberto-Culver Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and New Aristotle  Holdings, Inc., which is incorporated by reference from Exhibit 2.4  to Amendment No. 3 to the Registration Statement on Form S-4 of New  Sally Holdings, Inc. (File No. 333-136259) filed on  October 10, 2006                                                                                                               |
|       |                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       | 2.6                  |       | Second Amendment to the Separation Agreement,  dated as of October 26, 2006, among Alberto-Culver Company, Sally  Holdings, Inc., New Sally Holdings, Inc. and New Aristotle  Holdings, Inc., which is incorporated by reference from  Exhibit 2.01 to the Current Report on Form 8-K of New Sally  Holdings, Inc. filed on October 30, 2006                                                                                                                                                                        |
|       |                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       | 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 Sally Beauty Holdings, Inc., and  the shareholders named therein, which is incorporated by reference from  Exhibit 2.7 to the Quarterly Report on Form 10-Q of Sally Beauty  Holdings, Inc. filed May 10, 2007 |
|       |                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       | 3.1                  |       | Certificate of Formation of Sally Holdings  LLC, which is incorporated by reference to Exhibit 3.1 to the  Registration Statement on Form S-4 (File No. 333-144427) of Sally  Holdings LLC and Sally Capital, Inc. filed on July 9, 2007                                                                                                                                                                                                                                                                                           |
|       |                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|       | 3.2                  |       | Limited Liability Company Agreement of Sally  Holdings LLC, which is incorporated by reference to Exhibit 3.2  to the Registration Statement on  Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally Capital, Inc.  filed on July 9, 2007                                                                                                                                                                                                                                                                          |

 

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|   | 3.3    |   | Certificate of Incorporation of Sally Capital  Inc., which is incorporated by reference to Exhibit 3.3  to the Registration Statement on  Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally  Capital, Inc. filed on July 9, 2007                                                                                                                                                                                                                                                           |
|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 3.4    |   | By-Laws of Sally Capital Inc., which is  incorporated by reference to Exhibit 3.4 to the Registration Statement  on Form S-4 (File No. 333-144427) of Sally Holdings LLC and Sally  Capital, Inc. filed on July 9, 2007                                                                                                                                                                                                                                                                                      |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.1    |   | Stockholders Agreement, dated as of  November 16, 2006, by and among Sally Beauty Holdings, Inc., CDRS  Acquisition LLC, CD&R Parallel Fund VII, L.P. and the other stockholders  party thereto, which is incorporated by reference from Exhibit 4.8 to  the Current Report on Form 8-K of Sally Beauty Holdings, Inc. filed  on November 22, 2006                                                                                                                                                  |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.2    |   | First Amendment to the Stockholders  Agreement, dated as of December 13, 2006, between Sally Beauty Holdings,  Inc., CDRS Acquisition LLC and Carol L. Bernick, as representative of the  other stockholders, which is incorporated herein by reference from  Exhibit 4.2 to the Annual Report on Form 10-K of Sally Beauty  Holdings, Inc. filed on December 22, 2006                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.3    |   | Indenture, dated as of November 16,  2006, by and among Sally Holdings LLC and Sally Capital Inc., as Co-Issuers,  the Subsidiary Guarantors from time to time parties thereto, and Wells Fargo  Bank, National Association, as Trustee, governing the 9.25% Senior Notes due  2014, which is incorporated by reference from Exhibit 4.1 to the Current  Report on Form 8-K of Sally Beauty Holdings, Inc. filed on  November 22, 2006                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.4    |   | First Supplemental Indenture, dated as of  May 30, 2007, by and among Sally Holdings LLC and Sally Capital Inc., as  co-Issuers, the Subsidiary Guarantors named therein, and Wells Fargo Bank,  National Association, as trustee, governing the 9.25% Senior Notes due 2014,  which is incorporated herein by reference from Exhibit 4.2 from the Registration  Statement on Form S-4 (File No. 333-144427) of Sally Holdings LLC  and Sally Capital, Inc. filed on July 9, 2007                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.5    |   | Indenture, dated as of November 16,  2006, by and among Sally Holdings LLC and Sally Capital Inc., as Co-Issuers,  the Subsidiary Guarantors from time to time parties thereto, and Wells Fargo  Bank, National Association, as Trustee, governing the 10.5% Senior  Subordinated Notes due 2016, which is incorporated by reference from  Exhibit 4.2 to the Current Report on Form 8-K of Sally Beauty  Holdings, Inc. filed on November 22, 2006                                                          |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.6    |   | First Supplemental Indenture, dated as of  May 30, 2007, by and among Sally Holdings LLC and Sally Capital Inc., as  co-Issuers, the Subsidiary Guarantors named therein, and Wells Fargo Bank,  National Association, as trustee, governing the 10.5% Senior Subordinated  Notes due 2016, which is incorporated herein by reference from  Exhibit 4.4 from the Registration Statement on Form S-4 (File  No. 333-144427) of Sally Holdings LLC and Sally Capital, Inc. filed  on July 9, 2007         |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.7    |   | Exchange and Registration Rights Agreement,  dated as of November 16, 2006, by and among Sally Holdings LLC, Sally  Capital Inc., the Subsidiary Guarantors parties thereto, Merrill Lynch,  Pierce, Fenner & Smith, Incorporated and the other financial  institutions named therein, relating to the 9.25% Senior Notes due 2014,  which is incorporated by reference from Exhibit 4.3 to the Current  Report on Form 8-K of Sally Beauty Holdings, Inc. filed on November 22,  2006              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.8    |   | Exchange and Registration Rights Agreement,  dated as of November 16, 2006, by and among Sally Holdings LLC, Sally  Capital Inc., the Subsidiary Guarantors parties thereto, Merrill Lynch,  Pierce, Fenner & Smith, Incorporated and the other financial  institutions named therein, relating to the 10.5% Senior Subordinated Notes  due 2016, which is incorporated by reference from Exhibit 4.4 to the  Current Report on Form 8-K of Sally Beauty Holdings, Inc. filed on  November 22, 2006 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.9    |   | Credit Agreement, dated November 16,  2006, with respect to a Term Loan Facility, by and among Sally Holdings LLC,  the several lenders from time to time parties thereto, and Merrill Lynch  Capital Corporation, as Administrative Agent and Collateral Agent, which is  incorporated by reference from Exhibit 4.5.1 to the Current Report on  Form 8-K of Sally Beauty Holdings, Inc. filed on November 22,  2006                                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.10   |   | Guarantee and Collateral Agreement, dated as  of November 16, 2006, made by Sally Investment                                                                                                                                                                                                                                                                                                                                                                                                                                     |

 

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|   |   |   | Holdings LLC, Sally Holdings LLC and certain  subsidiaries of Sally Holdings LLC in favor of Merrill Lynch Capital  Corporation, as Administrative Agent and Collateral Agent, which is  incorporated by reference from Exhibit 4.5.2 to the Current Report on  Form 8-K of Sally Beauty Holdings, Inc. filed on November 22,  2006                                                                                                                                                                                                                                                                                                                                                                                        |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 4.11   |   | Credit Agreement, dated November 16,  2006, with respect to an Asset-Based Loan Facility, among Sally Holdings LLC,  Beauty Systems Group LLC, Sally Beauty Supply LLC, any Canadian Borrower from  time to time party thereto, certain subsidiaries of Sally Holdings LLC, the  several lenders from time to time parties thereto, Merrill Lynch Capital, a  division of Merrill Lynch Business Financial Services Inc., as Administrative  Agent and Collateral Agent, and Merrill Lynch Capital Canada Inc., as  Canadian Agent and Canadian Collateral Agent, which is incorporated by  reference from Exhibit 4.6.1 to the Current Report on Form 8-K of  Sally Beauty Holdings, Inc. filed on November 22, 2006 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 4.12   |   | U.S. Guarantee and Collateral Agreement,  dated as of November 16, 2006, made by Sally Investment Holdings LLC,  Sally Holdings LLC and certain subsidiaries of Sally Holdings LLC in favor of  Merrill Lynch Capital, a division of Merrill Lynch Business Financial  Services Inc., as Administrative Agent and Collateral Agent, which is  incorporated by reference from Exhibit 4.6.2 to the Current Report on  Form 8-K of Sally Beauty Holdings, Inc. filed on November 22,  2006                                                                                                                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 4.13   |   | Canadian Guarantee and Collateral Agreement,  dated as of November 16, 2006, made by Sally Beauty (Canada)  Corporation, Beauty Systems Group (Canada), Inc., Sally Beauty Canada  Holdings Inc. and certain of their respective subsidiaries in favor of  Merrill Lynch Capital Canada Inc., as Canadian Agent and Canadian Collateral  Agent, which is incorporated by reference from Exhibit 4.6.3 to the  Current Report on Form 8-K of Sally Beauty Holdings, Inc. filed on  November 22, 2006                                                                                                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 4.14   |   | Intercreditor Agreement, dated as of  November 16, 2006, by and between Merrill Lynch Capital, a division of  Merrill Lynch Business Financial Services Inc., as Administrative Agent and  Collateral Agent under the Term Loan Facility, and Merrill Lynch Capital, a  division of Merrill Lynch Business Financial Services Inc., as Administrative  Agent and Collateral Agent under the Asset-Based Loan Facility, which is  incorporated by reference from Exhibit 4.7 to the Current Report on  Form 8-K of Sally Beauty Holdings, Inc. filed on November 22,  2006                                                                                                                                             |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 10.1   |   | Sally Beauty Holding, Inc. Annual  Incentive Plan*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 31.1   |   | Rule 13(a)-14(a)/15(d)-14(a) Certification  of Gary G. Winterhalter*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 31.2   |   | Rule 13(a)-14(a)/15(d)-14(a) Certification  of Mark J. Flaherty*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 32.1   |   | Section 1350 Certification of Gary G.  Winterhalter*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 32.2   |   | Section 1350 Certifications of Mark J.  Flaherty*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

 

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*Included herewith

 

PLEASE NOTE: It is inappropriate for investors to assume the accuracyof any covenants, representations or warranties that may be contained inagreements or other documents filed as exhibits to this Quarterly Report on Form 10-Q.  In certain instances the disclosure schedulesto such agreements or documents contain information that modifies, qualifiesand creates exceptions to the representations, warranties and covenants.Moreover, some of the representations and warranties may not be complete oraccurate as of a particular date because they are subject to a contractualstandard of materiality that is different from those generally applicable tostockholders and/or were used for the purpose of allocating risk among theparties rather than establishing certain matters as facts. Accordingly, youshould not rely on the representations and warranties as characterizations ofthe actual state of facts at the time they were made or otherwise.

 

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** **

**SIGNATURE**

 

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

 
| Date:  | May 8, 2008   |                                                                                          |   |
|--------|--------------------|-----------------------------------------------------------------------------------------------|--------|
|   |               |                                                                                          |   |
|   | SALLY HOLDINGS LLC |
|   |               |                                                                                          |
|   |               |                                                                                          |
|   | By:                | /s/ MARK J. FLAHERTY                                                                          |
|   | Name:              | Mark J. Flaherty                                                                              |
|   | Title:             | Vice President, Acting Chief Financial Officer, Chief Accounting  Officer and Controller      |
|   |               |                                                                                          |
| Date:  | May 8, 2008   |                                                                                          |   |
|   |               |                                                                                          |
|   | SALLY CAPITAL INC. |
|   |               |                                                                                          |
|   |               |                                                                                          |
|   | By:                | /s/ MARK J. FLAHERTY                                                                          |
|   | Name:              | Mark J. Flaherty                                                                              |
|   | Title:             | Vice President, Acting Chief Financial Officer, Chief  Accounting Officer and Controller |

 

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