SALLY BEAUTY HOLDINGS, INC. The following section discusses management's view of the financial condition as ofSeptember 30, 2019 and 2018, and the results of operations and cash flows for the three fiscal years in the period endedSeptember 30, 2019 , ofSally Beauty . This section should be read in conjunction with the audited consolidated financial statements ofSally Beauty and the related notes included elsewhere in this Annual Report. This Management's Discussion and Analysis of Financial Condition and Results of Operations section may contain forward-looking statements. See "Cautionary Notice Regarding Forward-Looking Statements" and "Risk Factors" for a discussion of the uncertainties, risks and assumptions associated with these forward-looking statements that could cause results to differ materially from those reflected in such forward-looking statements.
Highlights of the Fiscal Year Ended
• Consolidated net sales for the fiscal year ended September 30, 2019 ,
decreased $56.2 million , or 1.4%, to $3,876.4 million , compared to the
prior fiscal year. Consolidated net sales for the fiscal year ended
September 30, 2019 , include a negative impact from changes in foreign
currency exchange rates of $31.9 million , or 0.8% ofconsolidated net
sales;
• Consolidated same store sales increased 0.3% and consolidated
e-commerce sales increased by 29.4% compared to the prior fiscal year;
• Consolidated gross profit for the fiscal year ended
decreased by $33.9 million , or 1.7%, to $1,910.5 million ,compared to
the prior fiscal year. Gross margin decreased 10 basis points to 49.3%
for the fiscal year ended September 30, 2019 , compared to the prior
fiscal year;
• Consolidated operating earnings for the fiscal year ended
2019, increased $31.9 million , or 7.5%, to $458.5 million ,compared to
the prior fiscal year. Operating margin increased 100 basispoints to
11.8% for the fiscal year ended September 30, 2019 , compared to the
prior fiscal year;
• Consolidated net earnings increased
million, compared to the prior fiscal year;
• Diluted earnings per share for the fiscal year ended
2019, were $2.26 compared to $2.08 for the prior fiscal year;
• Cash provided by operations was $320.4 million for the fiscal year
ended September 30, 2019 , compared to $372.7 million for the prior
fiscal year;
• During the year, we strategically paid down an additional $115.0
million aggregate principle of our term loan B and repurchased
approximately $64.8 million aggregate principal amount of our 2023 and
2025 senior notes;
• We repurchased and retired approximately 3.6 million shares of our
common stock under the 2017 Share Repurchase Program at anaggregate
cost of $46.6 million ; and
• In
Data's card services business to launch a private label credit card for
both SBS and BSG to benefit our retail and professional customers.
Business Strategy Update
We continue to make solid progress against our transformation as we play to win
by focusing on hair color and hair care, improve our retail fundamentals,
advance our digital commerce capabilities and drive cost out of the business. As
part of this effort, we made progress on our supply chain modernization effort,
reduced our debt levels, and rolled out new e-commerce tools such as the Sally
Beauty Supply app.
During the year, we began rolling out a new point-of-sale system in both SBS and BSG nationwide, which will allow our store associates to better serve our customers.
In
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and concentrated distribution center, which we anticipate opening by March 2020 .
Additionally, we identified a location and signed a lease agreement for a new
distribution center that will service operations in Ghent, Belgium .
Results of Operations
Key Operating Metrics
The following table sets forth, for the periods indicated, information
concerning key measures we rely on to assess our operating performance (dollars
in thousands):
2019 vs 2018 2018 vs 2017
Fiscal Year Ended September 30, Amount % Amount %
2019 2018 2017 Change Change Change Change
Net sales:
SBS $ 2,293,094 $ 2,333,838 $ 2,345,116 $ (40,744 ) (1.7 )% $ (11,278 ) (0.5 )%
BSG 1,583,317 1,598,727 1,593,201 (15,410 ) (1.0 )% 5,526 0.3 %
Consolidated $ 3,876,411 $ 3,932,565 $ 3,938,317 $ (56,154 ) (1.4 )% $ (5,752 ) (0.1 )%
Gross profit:
SBS $ 1,272,263 $ 1,292,725 $ 1,303,976 $ (20,462 ) (1.6 )% $ (11,251 ) (0.9 )%
BSG 638,279 651,688 660,919 (13,409 ) (2.1 )% (9,231 ) (1.4 )%
Consolidated $ 1,910,542 $ 1,944,413 $ 1,964,895 $ (33,871 ) (1.7 )% $ (20,482 ) (1.0 )%
Segment gross margin:
SBS 55.5 % 55.4 % 55.6 % 10 bps (20 ) bps
BSG 40.3 % 40.8 % 41.5 % (50 ) bps (70 ) bps
Consolidated 49.3 % 49.4 % 49.9 % (10 ) bps (50 ) bps
Net earnings:
Segment operating earnings:
SBS $ 366,412 $ 362,853 $ 385,407 $ 3,559 1.0 % $ (22,554 ) (5.9 )%
BSG 239,572 240,225 254,691 (653 ) (0.3 )% (14,466 ) (5.7 )%
Segment operating
earnings 605,984 603,078 640,098 2,906 0.5 % (37,020 ) (5.8 )%
Unallocated expenses
and restructuring (a)
(b) (147,511 ) (176,489 ) (161,501 ) 28,978 (16.4 )% (14,988 ) 9.3 %
Consolidated operating
earnings 458,473 426,589 478,597 31,884 7.5 % (52,008 ) (10.9 )%
Interest expense 96,309 98,162 132,899 (1,853 ) (1.9 )% (34,737 ) (26.1 )%
Earnings before
provision for income
taxes 362,164 328,427 345,698 33,737 10.3 % (17,271 ) (5.0 )%
Provision for income
taxes 90,541 70,380 130,622 20,161 28.6 % (60,242 ) (46.1 )%
Net earnings $ 271,623 $ 258,047 $ 215,076 $ 13,576 5.3 % $ 42,971 20.0 %
Number of stores at end-of-period (including franchises):
SBS 3,695 3,761 3,782 (66 ) (1.8 )% (21 ) (0.6 )%
BSG 1,366 1,395 1,368 (29 ) (2.1 )% 27 2.0 %
Consolidated 5,061 5,156 5,150 (95 ) (1.8 )% 6 0.1 %
Same store sales growth (decline)
SBS 0.4 % (1.5 )% (1.6 )% 190 bps 10 bps
BSG 0.2 % (1.5 )% 1.3 % 170 bps (280 ) bps
Consolidated 0.3 % (1.5 )% (0.7 )% 180 bps (80 ) bps
(a) Unallocated expenses represent certain corporate costs (such as payroll,
share-based compensation, employee benefits and travel expense for corporate
staff, certain professional fees and corporate governance expenses) that have
not been charged to our segments and are included in selling, general and
administrative expenses in our consolidated statements of earnings. For the
fiscal year 2018, unallocated expenses reflect expenses of
connection with the data security incidents.
(b) Restructuring charges relate to the supply chain modernization plan, 2018
Restructuring Plan and the 2017 Restructuring Plan.
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The Fiscal Year Ended
SBS. The decrease in net sales for SBS was primarily driven by the following (in thousands):
Foreign currency exchange$ (27,395 ) Stores outside same store sales (18,040 ) Same store sales 4,578 Other (a) 113 Total$ (40,744 )
(a) Other consists of non-store sales, which include catalog and internet
sales of our
SBS experienced lower unit volume, including lower customer traffic and the impact of fewer company-operated stores, partially offset by a positive impact from increase in average unit prices, resulting from price increases and a promotional efficiency effort (which reduced promotions that provided 'free' units, such as Buy One, Get One offers).
BSG. The decrease in net sales for BSG was driven by the following (in thousands):
Distributor sales consultants$ (12,092 ) Foreign currency exchange (4,534 ) Same store sales 1,722 Other (a) (506 ) Total$ (15,410 ) (a) Other consists of stores outside same store sales and sales to our franchisees. BSG experienced a decrease in unit volume, including from the impact of fewer company-operated stores, partially offset by an increase in average unit prices (resulting primarily from the introduction of certain third-party brands with higher average unit prices in the preceding 12 months).
Gross Profit
SBS. SBS's gross profit decreased as a result of lower sales, partially offset by a higher gross margin. The higher gross margin reflects improved gross margins in ourU.S. and Canadian operations, from price increases and promotional efficiency efforts, partially offset by weaker gross margins in our European operations. BSG. BSG's gross profit decreased as a result of lower sales and a lower gross margin. The decrease in the gross margin was primarily a result of challenges related to the ongoing merchandising transformation.
Selling, General and Administrative Expenses
Consolidated. Consolidated selling, general and administrative expenses decreased primarily as a result of lower compensation and compensation-related expenses, lower advertising expenses, no expenses related to the data security incidents and the positive impact from changes in foreign currency exchange rates. This decrease was partially offset by higher facility expenses and expenses related to our information technology systems. SBS. SBS's selling, general and administrative expenses decreased$24.0 million , or 2.6% for the fiscal year endedSeptember 30, 2019 . This decrease was primarily as a result of the impact of the 2018 Restructuring Plan, our recently implemented field structure realignment and store labor hour optimization initiatives (net of labor rate inflation), the positive impact from changes in the foreign currency exchange rate of approximately$11.3 million and lower advertising expense of$6.7 million . This decrease was partially offset by higher facility costs of$2.3 million and the impact of the reduction of an estimated casualty loss related to hurricanes of$2.4 million during fiscal year 2018.
BSG. BSG's selling, general and administrative expenses decreased
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Plan, lower sales commissions of $3.5 million , lower advertising expenses of
$2.9 million and a positive impact from changes in foreign currency exchange
rate of approximately $1.4 million .
Unallocated. Unallocated selling, general and administrative expenses increased
$5.3 million , or 3.7%, for the fiscal year ended September 30, 2019 . This
increase is primarily a result of higher expenses related to our information
technology systems and no comparable positive adjustments related to our
actuarially determined insurance liabilities in the current year compared to
$6.9 million in the prior year. These increases were partially offset by no
expenses related to the data security incidents compared to $7.9 million in the
prior year.
Restructuring
For the fiscal year ended September 30, 2019 , we recognized a $8.4 million gain
resulting from the sale of our secondary headquarters and fulfillment center in
Denton, Texas , and our Marinette, Wisconsin , fulfillment center in connection
with the supply chain modernization plan, partially offset by charges of $7.7
million in connection with our supply chain modernization plan and the 2018
Restructuring Plan. For the fiscal year ended September 30, 2018 , we incurred
restructuring charges of approximately $33.6 million in connection with the 2018
Restructuring Plan. See Note 18 of the Notes to Consolidated Financial
Statements included in Item 8 of this Annual Report for more information about
our restructuring plans.
Interest Expense
Interest expense decreased as a result of fewer borrowings under the ABL
facility during the current fiscal year and lower outstanding principal balances
on our senior notes and term loan B. This decrease was partially offset by a
higher interest rate on our term loan B variable tranche.
Provision for Income Taxes
For the fiscal year endedSeptember 30, 2019 and 2018, our effective tax rate was 25.0% and 21.4%, respectively. The increase in the effective tax rate was due primarily to the impact ofU.S. Tax Reform in the prior year, partially offset by a decrease in our federal statutory tax rate this year to 21.0% compared to 24.5% in the prior year. See Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about the impact of theU.S. Tax Reform on our consolidated financial statements.
The Fiscal Year Ended
SBS. The decrease in net sales for SBS was primarily driven by a decrease in same store sales of approximately$23.7 million and lower net sales from new company-operated stores of approximately$17.9 million , partially offset by the positive impact from changes in foreign currency exchange rates of approximately$30.1 million . SBS experienced lower unit volume, including lower customer traffic, partially offset by a positive impact from an increase in average unit prices, resulting primarily from select price increases in certain geographical areas of theU.S. and a change in product mix (to higher-priced products) resulting from shifts in customer preferences. BSG. The increase in net sales for BSG was driven by the impact of the Chalut acquisition, net of the impact of Peerless sales in the prior year now included in same store sales, of approximately$10.1 million , the positive impact from changes in foreign currency exchange rates of approximately$3.0 million and higher net sales from other sales channels of approximately$7.2 million , partially offset by decreases in sales by our DSCs of approximately$11.1 million and same store sales of approximately$3.8 million . Net sales from other sales channels include sales from new company-operated stores, sales to our franchisees and sales by our DSCs. BSG experienced an increase in average unit prices (resulting primarily from the introduction of certain third-party brands with higher average unit prices in the preceding 12 months), partially offset by a decrease in unit volume (notwithstanding the impact of incremental sales from 28 company-operated stores opened or acquired during the last 12 months). In addition, we were impacted by vendor supply chain issues that negatively affected BSG's net sales by approximately$13 million . - 29 - --------------------------------------------------------------------------------
Gross Profit
SBS. SBS's gross profit decreased as a result of lower sales and a lower gross margin. This decrease reflects a change in geographic sales mix, as a result of lower-margin non-U.S. sales making up a greater portion of total segment sales, and higher coupon redemption, compared to the prior fiscal year. BSG. BSG's gross profit decreased as a result of a lower gross margin, partially offset by higher sales. BSG's gross margin decrease was driven by opportunistic purchases that were not repeated from the prior year and lower vendor allowances.
Selling, General and Administrative Expenses
Consolidated. Consolidated selling, general and administrative expenses increased primarily as a result of the negative impact from changes in foreign currency exchange rates, the impact from the Chalut acquisition, higher expenses related to the data security incidents and higher facility expenses. These increases were partially offset by a reduction of estimated casualty loss and no comparable casualty loss this fiscal year, positive impact from gift card breakage, positive adjustments to actuarially determined insurance liabilities and cost reduction initiatives, related to our restructuring plans. Consolidated selling, general and administrative expenses, as a percentage of net sales, increased 50 basis points to 37.7% for the fiscal year endedSeptember 30, 2018 . SBS. SBS's selling, general and administrative expenses increased primarily as a result of the negative impact from changes in the foreign currency exchange rate of approximately$13.2 million , higher facility expense of$5.0 million and higher advertising expense of$2.0 million . These increases were partially offset by the impact of the reduction of prior year's estimated casualty loss, in connection with natural disasters that occurred in the fourth quarter of our fiscal year 2017, and no comparable casualty losses this fiscal year, in the aggregate, of$6.5 million and by positive impact from gift card breakage of$2.1 million in the current fiscal year.
BSG. BSG's selling, general and administrative expenses increased primarily as a
result of the incremental operating expenses associated with Chalut of
Unallocated. Unallocated selling, general and administrative expenses increased$4.1 million , or 2.9%, for the fiscal year endedSeptember 30, 2018 . This increase includes expenses related to the previously disclosed data security incidents of$7.9 million and higher professional fees of$1.7 million . See Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about the data security incidents. This increase was partially offset by lower compensation and compensation-related expenses of$4.3 million primarily due to the results of the 2018 Restructuring Plan. In addition, for our actuarially determined insurance liabilities, we recorded net positive adjustments of$6.9 million in fiscal year 2018 as a result of a decrease in our estimated future payments, compared to positive adjustments of$5.7 million in fiscal year 2017.
Restructuring Charges
Restructuring charges increased$10.9 million for the fiscal year endedSeptember 30, 2018 . During the fiscal year endedSeptember 30, 2018 , we incurred restructuring charges of approximately$33.6 million in connection with the 2018 Restructuring Plan, including severance and related expenses of approximately$15.6 million , consulting expenses of$10.9 million and other costs of$7.1 million . During the fiscal year endedSeptember 30, 2017 , we incurred restructuring charges of approximately$22.7 million in connection with the 2017 Restructuring Plan, including severance and related expenses of$12.1 million , facility closure expenses of$6.7 million and other expenses of$3.9 million . See Note 18 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about our restructuring plans.
Interest Expense
Interest expense decreased as a result of a loss on extinguishment of debt of$28.0 million in the prior fiscal year, compared to$0.9 million in the current fiscal year. These losses were the result of our redemption of certain senior notes inJuly 2017 with the proceeds from the term loan B with lower interest rates in the prior fiscal year and from the repricing of the variable-rate tranche of the term loan B in the current fiscal year. The lower interest rate on the - 30 -
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term loan B reduced interest expense by
Provision for Income Taxes
The provision for income taxes was$70.4 million and$130.6 million , resulting in an effective tax rate of 21.4% and 37.8%, for the fiscal year endedSeptember 30, 2018 and 2017, respectively. The decrease in the effective tax rate was due primarily to the impact of theU.S. Tax Reform. More specifically, we recognized a provisional income tax benefit of$37.7 million in connection with the revaluation of our deferred income tax assets and liabilities, including a benefit related to the adoption of income tax method changes of$2.7 million , and a provisional income tax charge of$11.7 million for federal and state income taxes applicable to accumulated but undistributed earnings of our foreign operations. See Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information about the impact of theU.S. Tax Reform on our consolidated financial statements.
Liquidity and Capital Resources
We are highly leveraged and a substantial portion of our liquidity needs will arise from debt service on our outstanding indebtedness and from funding the costs of operations, working capital, capital expenditures and opportunistic share repurchases. Working capital (current assets less current liabilities) increased$43.6 million to$707.5 million atSeptember 30, 2019 , compared to$663.9 million atSeptember 30, 2018 , resulting primarily from the reduction in accounts payable and accrued liabilities and the increase in vendor receivables included in accounts receivable, other. The ratio of current assets to current liabilities was 2.55 to 1.00 atSeptember 30, 2019 , compared to 2.35 to 1.00 atSeptember 30, 2018 . AtSeptember 30, 2019 , cash and cash equivalents were$71.5 million . Based upon the current level of operations and anticipated growth, we anticipate that existing cash balances (excluding certain amounts permanently invested in connection with foreign operations), funds expected to be generated by operations and funds available under the ABL facility will be sufficient to meet our working capital requirements, potential acquisitions, finance anticipated capital expenditures, including information technology upgrades and store remodels, debt repayment and opportunistic share repurchases over the next 12 months. For the foreseeable future, we will prioritize needed investments in our business that we believe will deliver value for shareholders, and will consider measured debt repayment within our ratings guidance as well as opportunistic share repurchases. We utilize our ABL facility for the issuance of letters of credit, for certain working capital and liquidity needs and to manage normal fluctuations in our operational cash flow. In that regard, we may from time to time draw funds under the ABL facility for general corporate purposes including funding of capital expenditures, acquisitions, interest payments due on our indebtedness, paying down other debt and share repurchases. During the fiscal year endedSeptember 30, 2019 , the weighted average interest rate on our borrowings under the ABL facility was 4.64%. The amounts drawn are generally paid down with cash provided by our operating activities. As ofSeptember 30, 2019 , 2018,Sally Holdings had$482.0 million available for borrowings under the ABL facility, subject to borrowing base limitations, as reduced by$18.0 million in outstanding letters of credit. Share Repurchase Programs During the fiscal years endedSeptember 30, 2019 , 2018 and 2017, we repurchased and subsequently retired approximately 3.6 million shares, 10.0 million shares and 16.1 million shares, respectively, of our common stock under the 2017 Share Repurchase Program or the 2014 Share Repurchase Program at a cost of$46.6 million ,$165.9 million and$346.1 million , respectively. We funded these share repurchases with cash from operations and borrowings under the ABL facility. As ofSeptember 30, 2019 , we had approximately$787.5 million of additional share repurchase authorization remaining under the 2017 Share Repurchase Program.
Historical Cash Flows
For the fiscal years 2019, 2018 and 2017, our primary sources of cash have been
funds provided by operating activities and, when necessary, borrowings under our
ABL facility, as appropriate. The primary non-operating uses of cash during the
past three years were for share repurchases, debt service and capital
expenditures.
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The following table shows our sources and uses of cash for the periods presented
(in thousands):
Fiscal Year Ended September 30,
2019 2018 Change 2018 2017 Change
Net cash provided by operating
activities $ 320,415 $ 372,661 $ (52,246 ) $ 372,661 $ 343,286 $ 29,375
Net cash used by investing
activities (95,867 ) (95,313 ) (554 ) (95,313 ) (89,625 ) (5,688 )
Net cash used by financing
activities (229,308 ) (263,282 ) 33,974 (263,282 ) (277,303 ) 14,021
Effect of foreign currency
exchange rate
changes on cash and cash
equivalents (1,040 ) (530 ) (510 ) (530 ) 779 (1,309 )
Net increase (decrease) in
cash
and cash equivalents $ (5,800 ) $ 13,536 $ (19,336 ) Net Cash Provided by Operating Activities
Net cash provided by operating activities decreased for the fiscal year ended
Net cash provided by operating activities increased for the fiscal year endedSeptember 30, 2018 , compared to the fiscal year endedSeptember 30, 2017 , primarily due to favorable cash impact of improved net earnings and accrued liabilities, partially offset by the unfavorable impact by deferred taxes and merchandise purchases.
Net cash used by investing activities increased slightly for the fiscal year endedSeptember 30, 2019 , compared to the fiscal year endedSeptember 30, 2018 , due to an increase in capital expenditures primarily from investments in our information technology systems, partially offset by proceeds received from the sale our secondary headquarters and fulfillment center inDenton, Texas and our fulfillment center inMarinette, Wisconsin , and as a result of not having any significant acquisitions in the current year.
Net cash used by investing activities increased for the fiscal year ended
Net cash used by financing activities decreased for the fiscal year ended
Net cash used by financing activities decreased for the fiscal year ended
Long-Term Debt
AtSeptember 30, 2019 , we have$1,609.3 million in outstanding principal under a term loan B and senior notes, not including capital leases, unamortized debt issuance costs or debt discounts, in the aggregate, of$16.4 million . There were no outstanding balances under the ABL facility atSeptember 30, 2019 . See Note 11 of the Notes to Consolidated Financial Statements in Item 8 contained in this Annual Report for additional information about our debt.
We are currently in compliance with the agreements and instruments governing our debt, including our financial covenants.
Capital Requirements
During the fiscal year endedSeptember 30, 2019 , we had total capital expenditures of approximately$118.7 million , including amounts incurred but not paid of approximately$26.2 million , primarily in connection with information technology projects and store remodels and maintenance. - 32 - --------------------------------------------------------------------------------
Contractual Obligations
The following table summarizes our contractual obligations atSeptember 30, 2019 (in thousands): Payments Due by Period Less than More than 1 year 1-3 years 3-5 years 5 years Total Long-term debt obligations, including interest(a)$ 82,148 $ 162,566 $ 1,066,628 $ 733,019 $ 2,044,361 Obligations under operating 174,578 232,818 95,747 40,545 leases(b) 543,688 Purchase obligations(c) 13,553 23,412 - - 36,965 Other long-term 3,857 5,963 3,502 5,016 obligations(d)(e) 18,338 Total$ 274,136 $ 424,759 $ 1,165,877 $ 778,580 $ 2,643,352
(a) Long-term debt obligations include obligations under capital leases and
future interest payments on our debt outstanding as of
The amounts shown above do not include unamortized discount or deferred
debt issuance costs reflected in our consolidated balance sheets since
those amounts do not represent contractual obligations.
(b) The amounts reported for operating leases do not include common area
maintenance (CAM), property taxes or other executory costs. The amounts
shown above do not include immaterial contingent liabilities for operating
leases for which we are liable in the event of default by a franchisee.
(c) Purchase obligations reflect legally binding non-cancellable agreements
that are entered into by us to purchase goods or services, that specify
minimum quantities to be purchased and with fixed or variable price
provisions. Amounts shown do not reflect open purchase orders, mainly for
merchandise, to be fulfilled within one year, which are generally
cancellable or contracts that tend to be reoccurring in nature and similar
in amount year over year.
(d) Other long-term obligations, including current portion, principallyrepresent obligations under insurance and self-insurance programs. These
obligations are included in accrued liabilities and other liabilities, as
appropriate, in our consolidated balance sheets.
(e) The table above does not include an estimated
tax benefits due to uncertainty regarding the realization and timing of
the related future cash flows, if any.
The information contained in the table above with regards to our long-term debt obligations is based on the current terms of such debt obligations and does not reflect any assumptions about our ability or intent to refinance any of our debt either on or before their maturity. In the event that we refinance some or all of debt either on or before their maturity, actual payments for some of the periods shown may differ materially from the amounts reported herein. In addition, other future events, including potential increases in interest rates, could cause actual payments to differ materially from these amounts.
Off-Balance Sheet Financing Arrangements
At
Inflation
We believe inflation did not have a material effect on our results of operations during each of the three fiscal years in the period endedSeptember 30, 2019 . However, during the past few years, in theU.S. , we have experienced an increase in labor and real estate costs (including store rent and other occupancy expenses). Employee compensation and real estate expenses represent our two most significant operating expense categories. A material increase in labor and real estate costs in the future, particularly for an extended period of time, could have a material adverse effect on our results of operations.
Critical Accounting Estimates
The preparation of our consolidated financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at each balance sheet date, reported amount of revenues and expenses
for each reporting period presented, and related disclosures of contingent
liabilities. Actual results may differ from these estimates. We believe these
estimates and assumptions are reasonable. We consider accounting policies to be
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critical when they require us to make assumptions about matters that are highly
uncertain at the time the accounting estimate is made and when different
estimates that we reasonably could have used have a material effect on the
presentation of our consolidated financial condition, changes in consolidated
financial condition or consolidated results of operations.
Our critical accounting estimates relate to the valuation of inventory, vendor rebates and concessions, retention of risk, income taxes, assessment of long-lived assets and intangible assets for impairment and share-based payments.
Valuation of Inventory
Inventory is stated at the lower of cost, determined using the first-in,
first-out ("FIFO") method, or net realizable value. In assessing the net
realizable value of inventory, we consider several key factors including
estimates of the future demand for our products, historical turn-over rates, the
age and sales history of the inventory, and historic as well as anticipated
changes in SKUs. When necessary, we adjust the carrying value of inventory for
estimated inventory shrinkage and damage. We estimate inventory shrinkage
between physical counts and product damage based upon our historical experience.
Actual results differing from these estimates could significantly affect our
inventory and cost of goods sold. Inventory shrinkage and damage expense, in the
aggregate, averaged less than 1.0% of consolidated net sales in fiscal years
2019, 2018 and 2017. A 10% increase or decrease in our estimate of inventory
shrinkage and damage at September 30, 2019 , would impact net earnings by
approximately $2.2 million .
Vendor Rebates and Concessions
We deem cash consideration received from a supplier to be a reduction of the cost of goods sold unless it is in exchange for an asset or service or a reimbursement of a specific, incremental, identifiable cost incurred by us in selling the vendor's products. The majority of cash consideration we receive is considered to be a reduction of inventory and a subsequent reduction in cost of goods sold as the related products are sold. We consider the facts and circumstances of the various contractual agreements with vendors in order to determine the appropriate classification of amounts received in our consolidated statements of earnings. We record cash consideration expected to be received from vendors in accounts receivables, other at the amount we believe will be collected. These receivables could be significantly affected if the actual amounts subsequently collected differ from our expectations. A 10% increase or decrease in these receivables atSeptember 30, 2019 , would impact net earnings by approximately$3.9 million .
Insurance
We retain a substantial portion of the risk related to employee health (primarily in theU.S. ), workers' compensation, general and product liability. However, we maintain stop-loss coverage to limit the exposure related to certain insurance risks. We base our health insurance liability estimate on trends in claim payment history, historical trends in claims incurred but not yet reported, and other components such as expected increases in medical costs, projected premium costs and the number of plan participants. Additionally, we base our estimates for workers' compensation, general and product liability on an actuarial analysis performed by an independent third-party actuary. We review our insurance liability on a regular basis and adjust our accruals accordingly. Changes in facts and circumstances may lead to a change in the estimated liability due to revisions of the estimated ultimate costs that affect our liability insurance coverage. Our liabilities could be significantly affected if actual results differ from our expectations or prior actuarial analyses. A 10% increase or decrease in our insurance liabilities atSeptember 30, 2019 , would impact net earnings by approximately$1.5 million .
The changes in our insurance liabilities were as follows (in thousands):
Fiscal Year Ended September 30,
2019 2018
Balance at beginning of period $ 19,956 $ 24,743
Self-insurance expense 63,963
66,581
Payments, net of employee contributions (63,625 ) (71,368 )
Balance at end of period $ 20,294 $ 19,956
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Income Taxes
We record income tax provisions in our consolidated financial statements based on an estimate of current income tax liabilities. The development of these provisions requires judgments about tax positions, potential outcomes and timing. If we prevail in tax matters for which provisions have been established or are required to settle matters in excess of established provisions, our effective tax rate for a particular period could be significantly affected. Additionally, deferred income taxes are recognized for the future tax consequences attributable to differences between our financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are estimated to be recovered or settled. We believe that it is more-likely-than-not that our results of operations in the future will generate sufficient taxable income to realize our deferred tax assets, net of the valuation allowance currently recorded. We have recorded a valuation allowance to account for uncertainties regarding the recoverability of certain deferred tax assets, primarily foreign loss carryforwards. In the future, if we determine that certain deferred tax assets will not be realizable, the related adjustments could significantly affect our effective tax rate at that time. An estimated tax benefit related to an uncertain tax position is recorded in our consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax position will withstand challenge, if any, from applicable taxing authorities.
Assessment of Long-Lived Assets and Intangible Assets for Impairment
Long-lived assets, such as property and equipment, including store equipment, and purchased intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. The recoverability of long-lived assets and intangible assets subject to amortization is assessed by comparing the net carrying amount of each asset to its total estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds the sum of its undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset.Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in a business combination.Goodwill and intangible assets with indefinite lives are not amortized; rather, they are reviewed for impairment at least annually, and whenever events or changes in circumstances indicate it is more-likely-than-not that the value of the asset may be impaired. For the purpose of reviewing goodwill for impairment, we aggregate components of our operating segments with similar economic characteristics into a reporting unit. When assessing goodwill and intangible assets with indefinite lives for potential impairment, we compare the carrying amount of the asset to its fair value. In addition, we consider whether the value of an asset has been impaired by evaluating if various factors (including current operating results, anticipated future results and cash flows, and relevant market and economic conditions) indicate a possible impairment. Based on our assessments and after considering potential triggering events, we recognized impairment losses of$4.4 million in the fiscal year endedSeptember 30, 2017 , in connection with our long-lived assets and intangible assets. No material impairment losses were recognized in fiscal years 2019 or 2018.
Share-Based Payments
The amount of share-based compensation expense related to stock option awards is
determined based on the fair value of each stock option award on the date of
grant. The fair value of each stock option is estimated using the Black-Scholes
option pricing model. The amount of expense recognized in connection with stock
option awards is significantly affected by our estimates.
The amount of share-based compensation expense related to performance-based
restricted stock awards is determined based on the fair value of each award on
the date of grant, which is based on the closing market price of our common
stock on the date of grant. In addition, we record periodic expense (which is
estimated quarterly) in connection with performance-based awards based on our
estimate of the number of awards actually expected to vest. This requires that
we estimate our future performance over the performance period (generally three
years) associated with each award. Actual performance could differ from these
estimates and could significantly affect the amount and timing of recognition of
our share-based compensation expense related to performance-based awards.
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If actual results are not consistent with our estimate or assumptions, we may be
exposed to changes in share-based compensation expense that could be material. A
10% change in our share-based compensation expense for the year ended September
30, 2019 , would affect net earnings by approximately $0.7 million .
Recent Accounting Pronouncements
See Note 3 of the Notes to Consolidated Financial Statements in Item 8 - "Financial Statements and Supplementary Data" contained in this Annual Report for information about recent accounting pronouncements.
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