Regis Corp (RGS) 2003 Q2 法說會逐字稿

Good morning. My name is Tom and I will be your conference facilitator for today. At this time, I’d like to welcome everyone to the Regis Corporation 2nd Quarter Fiscal Year 2003 earnings call. If anyone has not received a copy of this morning’s press release, please call Regis Corporation at 952-947-7798 and a copy will be faxed to you immediately. I would like to remind you that the company’s statements or comments this morning represent forward looking statements. I refer you to the risk factors and other cautionary factors in today’s news release as well as the company’s SEC filings.

With us today are Paul Finkelstein, President and Chief Executive Officer, and Randy Pearce, Chief Financial Officer and Executive Vice President. After management has completed its review of the quarter, we will open the calls for questions. I’d now like to turn the call over to Mr. Paul Finkelstein for his comments. Paul, you may begin.

Good morning and thank you for joining us. Our second quarter results remind me of the book, “A Tale of Two Cities.” On the one hand, we had incredible bottom line performance primarily driven by significant gross margin improvements as a result of extremely effective payroll control, coupled with a continued improvement in retail margins. A portion of the increase in profitability also relates to a positive book to physical inventory adjustment, which Randy will talk about during his presentation.

Our overall gross margins increased 180 basis points for 46.1%. Operating margins increased 103 basis points to 10.4%. EPS exceeded expectations, growing 33 % to 52 cents per share. Operating cash flow increased 26 % to $40 million and revenue growth increased 16 % to $415 million. System wide sales were $680 million, an increase of 28%.

On the other hand, domestic same store growth was an anemic 7/10ths of 1 % for the quarter and basically flat during December. When we contrast our performance to other retailers during December, we’re somewhat heartened as a combination of a very short selling season, coupled with a continuation of our recessionary environment resulted in lackluster sales. We continue to feel that fiscal 2003 results will meet our expectations with system wide sales increasing nearly 30 % to approximately $3 billion.

Revenue growth is projected to increase by 14% to 16%. We continue to forecast modest same store sales growth of 1 to 1.5% for the year, and budget EPS for increase approximately 16% to at least $1.89. Operating cash flow should increase at least 17 % to $152 million. We’re obviously very gratified with our second quarter earnings performance. On the sales front, we do feel that business will eventually bounce back and we know that our competitors are having the same kind of sales results as ours.

Let’s look at another scenario. In certain instances, people may have lengthened their visitation patterns. For example, from four to five weeks in terms of getting a haircut. If that is the case, and empirical evidence does not state that it is, but if it is, lengthening of visitation patterns will not go from four to five weeks and then the following year from five to six weeks because people will just be sick and tired of looking at themselves in the mirror. For long term, we are very confident that we will be able to achieve our low to mid-teen top and bottom line growth goals.

Acquisitions and capital expenditures for fiscal 2003 will be in the $160 million range. And we should increase our system wide salon count by approximately 1000 locations to 9500 stores at year end. We expect third quarter same store sales to increase approximately 1.5 % and EPS to increase at least 13 % to a range of 45 to 46 cents. We expect Europe expansion to increase by 110 salons. This assumes no additional significant economic downturn.

Our international business is operating at or slightly above as planned. The big story for the second quarter was the Vidal Sassoon acquisition. Vidal Sassoon puts us into a category which we have not treaded heretofore. That is the high end portion of the salon business with high quality real estate in major metropolitan cities in Europe, Canada and the United States.

We expect that this high end business will have at best modest growth, but we do expect significant growth in a new Vidal Sassoon studio concept. These growth opportunities are enormous. The Vidal Sassoon Studio’s hair cuts should be priced between $20 to $30 or 20 to 30 pounds depending on whether or not they're located in the U.S. or the U.K. They will be anywhere from a thousand to 1500 square feet and will be positioned at the high end of the affordable hair care business. The brand still remains incredibly strong, especially amongst the hair styling community.

The Vidal Sassoon academies are really the only place to go if you want to have graduate work in current hair styling techniques. Parenthetically I might add that Regis has been sending its artistic directors to the Vidal Sassoon School in Los Angeles for over 15 years. Amongst the hair styling community, the Vidal Sassoon academies have no peer. Thus, we are highly confident we will be able to stay up the Vidal Sassoon Studios with the very best talent available. We have a long term royalty agreement with Procter & Gamble which is quite affordable for us and gives us the opportunity to greatly expand visibility in Europe and North America.

Initially we will talk at Vidal Sassoon Studio expansion to surround the communities in which high priced, high image Vidal Sassoon salons presently exist, namely Boston, Los Angeles, San Francisco, Phoenix, Atlanta, Washington, Chicago, and several cities in the U.K. and Germany. This strategy has been successfully done before. In fact, the Jean Louis David international salon in the fashionable neighborhood in Paris continues to set revenue and profit records. This salon is as high end as you can get and yet it has created the umbrella image for over 1100 affordable Jean Louis David salons in Europe, United States and South America.

We're also very bullish about our relationship with Procter & Gamble. The Sassoon brand means too much to them not to re-launch it in a quality way in the United States and Europe. The brand has a huge presence in Asia and, once again, P & G is very bullish about the future prospects of Vidal Sassoon worldwide.

We plan to open three additional Jean Louis David salons in the New York metropolitan areas in the next two months. Expansion will accelerate after we have a suitable gestation period with these three salons. We intend to greatly expand the JLD salon and the New York tri-state area. Another significant acquisition for us during the quarter was the beauty warehouse salon in Kansas City which provides a significant opportunity to take the Trade Secret concept outside of the regional malls and put it into high traffic non-mall locations with great visibility. We intend to significantly expand this concept as well as under the Trade Secret management umbrella. Randy will now continue and then we can open it up for Q and A.

Thanks, Paul. Good morning, everyone. We're very pleased to report record performance both in terms of our second quarter revenues as well as earnings. Our revenues increased nearly 16 % during the quarter and our reported earnings grew 33 % to a record 52 cents a share, up from the 39 cents a share we reported in the same period a year ago. As Paul previously mentioned, our second quarter earnings were favorably impacted by a positive book to physical inventory variance which I will discuss further in a few moments.

Let me now give you a bit more detail behind our second quarter results starting first with the discussion of our revenues. Our consolidated revenues in the second quarter of fiscal 2003 essentially met our expectations, growing by 15.7 % to a record $414,759,000. Each of our operating divisions reported an overall sales increase for the quarter.

Franchise revenues grew to $26 million in the quarter, an increase of 43 %, due in large part to our recent acquisitions of the two French franchise companies. You will find a table in our press released to that breaks out second quarter revenues for each salon division. Service sales grew 15.4 % in the second quarter and our higher margin retail product sales increased 11.7 %. Our product sales mix represented just over 30 % of our total company owned sales in the second quarter, and that was comparable to the 31 % rate that we reported in the same period last year.

When you add in sales from our franchisee salons, our system wide sales in the second quarter grew to $679,903,000 and that was an increase of 27.7 %. We expect to report system wide sales of nearly $3 billion for our entire 2003 fiscal year. As you know, Regis is by far the leader in the salon industry. Yet, we only have a 2 % worldwide market share and 4 % domestic share which means we have plenty of opportunity for continued successful growth.

As we reported in our press release on January 8th, our consolidated same store sales in the second quarter came in at 1.1 %, which included growth and service sale comps of 60 basis points and growth in retail product comps of 2.2 %. Our overall comps of 1.1 % were lower than expected. However, we were able to meet our overall revenue expectations for the quarter due to the continued success of our new salon construction as well as our acquisition growth strategy.

Through the first six months of our current fiscal year, consolidated same store sales had increased overall by 1.3 %. The tough economy continues to impact our business, although, as you know, we certainly are not impacted to the same extent as a typical retailer due to the replenishment nature of our business. Our comps in the recent months close to 1 % and we expect same store sales for the balance of our current fiscal year to come in around 1 to 1.5 %.

I will now talk a bit about our second quarter gross margin rates, which reflect continued improvement. The expansion in our gross margin should not necessarily come as a surprise to anyone, as this has been a trend of ours in recent years and was also something we had anticipated for our second quarter of fiscal 2003. However, having said this, we expected margins to improve much more modestly than they actually did. During the second quarter this year our overall combined gross margin rate improved to 46.1 % compared to 44.3 % in the same period last year.

As I'll now address, both the service and the product portions of our business contributed to the increase in our overall gross margin rate. Our fiscal second quarter service margin improved to 43.6 %, up 70 basis points over the same period a year ago. The factors driving this improvement are very similar to what we reported and what we discussed with you last quarter. About 20 basis points of this improvement was due to a mixed play. In other words, our fastest growing salon concepts are the ones with the highest service margins.

The balance of the rate improvement was largely due to lower payroll costs, primarily in our Regis salon division, a trend that began in the third fiscal quarter of last year. Looking ahead, we continue to expect our service margin for all of our 2003 fiscal year to be slightly better than the 43.4 % rate we posted in fiscal 2002. That or by, perhaps, 20 basis points or so.

Let me now switch to our retail product margin. During the second quarter, our product margin rate improved to approximately 48.8 %, excluding the positive impact from our second quarter true up of the precision of our interim estimates of our product usage, which I'll discuss in a moment. So, when you include the positive results from our recent fiscal inventory, our second quarter reported retail product margin was 52 %. Our retail product business continues to involve having increased 74 % in just the past four years.

This fiscal year alone we expect to sell nearly $460 million of retail product which represents about 10 % of the professional retail product market. In recent years, our merchandising strategy has taken a much more traditional retail focus. With the introduction of retail plan-a-grams in all of our salons and the implementation of a new JDA merchandising system, our retail product margins continue to improve.

In addition, we continue to manage our promotional buying and our opening orders of new product lines better than ever before. This past June we completed the roll out of the auto replenishment function of the JDA system to all of our 513 Trade Secret salons, where over one half of our total corporate product sales are generated. The auto replenishment function provides us greater information on which product lines are selling and how to more efficiently manage our salon inventory levels.

In addition, the JDA merchandising system provides greater detail and accuracy as to our retail sales data, which helps us manage our inventory levels for all of our product lines. It helps us minimize shrink and markdowns and helps us control unauthorized discounting in our salons, all of which has contributed to growth in our retail product margins. Results from our most recent inventory count contributed to the expansion of our second quarter product gross margins.

As we've described in our previous SEC filings, on an interim basis, we estimate the cost of the retail product we sell to our customers, as well as the cost of the product that we use in our salon services. Our estimates take into consideration a variety of factors including shrink and discounting. On a semi-annual basis, we true up the precision of our interim estimates through a physical inventory count.

The results of our physical inventory counts are then used to validate our cost of product assumptions and any variances are booked through our service and our retail product gross margins. Our estimated gross margins are then adjusted to reflect these results in future fiscal quarters. We expect product margins for our fiscal third quarter to improve to approximately 48 %. In addition, we expect the product margins for all of our fiscal 2003 year should improve 140 basis points or so to about 49 %.

So, let me now address the other expense line items impacting our second quarter operating results and I will start first with rent expense. Consolidated rent expense in the second quarter fiscal 2003 came in at 14.6 % of company owned revenue, and that was up 40 basis points over the same period a year ago. We had budgeted that our rent rate would increase in the quarter due to several factors. The first related to our acquisition of Jean Louis David in April 2002. As we discussed with you in the past, the JLD chain has very few company owned stores. However, the salons they do have are located in New York City and have higher base minimum rents.

The second factor relates to a slight increase in common area maintenance costs primarily in our regional mall salons. We include common area maintenance costs in our rent expense category and as we discussed with you in the past, landlords are experiencing higher insurance costs, higher utilities and higher maintenance costs which they are in turn passing on to their tenants. Smaller mall tenants such as Regis, are frequently forced to absorb a higher share of these costs. A third and final factor that impacted our second quarter rent percentage was lower than expected same store sales growth. We expect our rent expense for all of fiscal 2003 to come in around 14.7 % of sales.

Let me now address the direct salon expense category which includes costs directly incurred by the salon such as salon advertising, workers' compensation, insurance, utilities and janitorial costs. The direct salon expense category in the second quarter came in at 18 -- sorry, at 8.8 % of company owned revenue, which was virtually identical to the rate we reported in the same period last year. Our second quarter rate came in lower than what we initially planned, primarily due to a reduced level of salon advertising expenditures in the quarter.

Looking ahead to the balance of our current 2003 fiscal year, we continue to expect the direct salon expense category to come in 20 basis points higher than the 9 % rate we reported for all of last year. This increase primarily relates to increased workers' compensation costs which we discussed with you in past quarters.

I'll now address the line item titled ‘franchise direct costs.’ And as we've discussed with you in the past few conference calls, you'll no longer find an expense line item called ‘other’ in our expense category. Rather, we've now labeled this ‘franchise direct costs.’ This new line item includes the cost of the product that we sell to our franchisees, as well as all direct costs we incur at our home office and in other countries to support a franchising activities.

Our second quarter franchise direct costs represented exactly 59 % of franchise revenues, compared to 49 % in the second quarter last year. The acquisitions we've made during fiscal 2002 of the two French franchise companies have caused this expense category to increase as a percentage of franchise revenues over the prior year. As all direct costs incurred by our French franchise companies to support franchising activities are now included.

In addition, continued growth in the sale of retail product to our franchisees in the United States has also contributed to the quarter over quarter increase in this percentage. Looking forward, we're budgeting that our franchise direct costs should come in around 53 % for our third quarter and about 54 % for all of fiscal 2003.

I'll now address our corporate overhead and our corporate overhead expense which is labeled on the P&L as ‘corporate and franchise support costs.’ As we discussed with you the past few quarters, this line item is what we used to call ‘SG&A.’ All direct costs we incur to support our franchise activities have been removed from this line item and have been reclassified in the expense line we just talked about called ‘franchise direct costs.’

Therefore, all of the expenses remaining within this corporate and franchise support category relate to the costs associated with our field supervision, our salon training and promotions, our corporate office and our two distribution centers. This expense category for the second quarter of our 2003 fiscal year represented 9.5 % of total revenues, down slightly from the 9.7 % we reported in the same period a year ago. We had expected that our second quarter rate would be lower than last year, as our prior year results included higher costs associated with closing our Minneapolis distribution center.

In addition, our second quarter rate of 9.5 % would have been a bit lower yet, had our same store sales met plan. Looking ahead, we continue to expect our corporate and franchise support costs for the entire 2003 fiscal year to come in around 9.5 %, a 10 basis point improvement from the year ago.

I'll now switch to our two depreciation and amortization expense category and quite frankly there's not a lot to talk about here, as both categories came in essentially on plan for the quarter. And as a percentage of sales, second quarter rates were virtually identical to the same period a year ago. During the second quarter of our current year, the salon portion of this expense was 3.3 % of company owned sales, comparable to the 3.4 % rate we reported in the second quarter last year. In addition, the corporate portion of our D & A represented 80 basis points of second quarter sales identical to the same period last year.

The combined effect of all of our revenue and expense items I've discussed have caused our four-wall salon contribution rate, before any corporate overhead allocation, to improve to 19.3 % of second quarter company owned sales. This rate reflects the health and the profitability of our company salon operations and frankly in this retail environment, we continue to be quite pleased with our salon operating performance. After factoring in corporate overhead our overall operating income increased in the second quarter to over $43 million, or 10.4 % of sales, compared to a rate of 9.1 % that we reported in the second quarter last year.

Let me now speak to our interest expense and our debt levels. Interest expense came in on plan at $5.4 million, or 1.3 % of total second quarter sales. Our total debt at December 31st also came in generally where we expected it to be, standing at $315 million, which was up $16 million from our previous June 30th fiscal year-end. The increase in debt was primarily due to our acquisition activities during the first half of our current fiscal year. Our debt to capitalization ratio continues to remain solidly investment grade standing at 38.5 % as of the end of the December, and that was an improvement of 170 basis points from our June 30th rate of 40.2 %. We continue to feel that our internal cash flow and our available debt capacity will be sufficient to cover our salon expansion costs as well as our scheduled debt retirements and dividend payments.

We now expect our fiscal 2003 EBITDA to increase to over $227 million and our after tax cash flow should grow to over $152 million. We expect to spend nearly $75 million on salon corporate capital expenditures for fiscal 2003. And as we've said in the past, acquisitions are always a bit harder to predict due to timing when opportunities will present themselves to us. However, this year we are now budgeting to spend another 85 to $90 million on acquisitions.

Based on these assumptions, we expect our overall level of debt at the end of our current fiscal 2003 to be approximately $315 million, which would be an increase of about $15, $16 million over the previous fiscal year-end. However, we're expecting that our debt to capitalization ratio will continue to improve at as the fiscal year progresses due to the continued growth in our earnings and the favorable impact that that has on the equity portion of our balance sheet.

I have just a few more items. Our second quarter consolidated effective income tax rate came in on plan at 38.3 %, and that was lower than the basic underlying effective rate of 39.2 % that we reported last year in fiscal 2002. Our current fiscal results will include full year performance from the two French franchise businesses that we acquired last year. As a result, our current year consolidated tax rate should improve over last years due to the benefit of international tax rates. We continue to budget our consolidated effective tax rate for the remaining two quarters of fiscal 2003 to be in the neighborhood of our second quarter rate of 38.3 %.

Let's now move on to net income. The second quarter earnings that we're reporting today increased to a record $23,573,000, or 52 cents per share, up from the 39 cents per share we reported in the second quarter last year. We are forecasting third quarter earnings per share to increase by 13 % to 15 % to a range of 45 to 46 cents per share. Revenue is expected to increase between $430 to $432 million with consolidated same store sales growing in a range of 1 to 1.5 %.

For the entire 2003 fiscal year, our reported revenues are expected to grow to a range of $1.66 billion to $1.69 billion, while earnings are expected to increase 16 to 17 percent to a range of $1.89 to $1.91 per diluted share. We are currently in the process of developing our grassroots budget for our upcoming fiscal 2004, and we will provide you with more detail regarding our fiscal 2004 expectations during our upcoming third quarter conference call.

Let me now provide you some information regarding our salon counts. At the end of our second quarter, the end of December, we had a total of 9,313 salons and that was a net increase of 629 units over the number of salons we had at the end of our previous June 30th fiscal year. And in today's press release you will find a table that breaks out our salon counts for each of our divisions.

For our entire 2003 fiscal year, we are planning to build about 435 new company owned salons from scratch and we plan to open around 300 new Supercuts, Cost Cutter, and international franchise units. And in addition our salon base continues to grow through our salon real estate acquisition strategy. With that, Paul and I would now like to answer any questions you may have. So, Operator, if you can step in and provide some instructions, we'd appreciate that.

Thank you, gentlemen. Ladies and gentlemen, the question and answer session will begin at this time. If you are using a speakerphone, please pick up the handset before pressing any numbers. If you have a question, please press ‘star 1’ on your push button telephone. If you wish to withdraw your question, please press ‘star 2.’ The questions will be taken in the order that they are received. Please stand by for your first question, sir. Gentlemen, your first question comes from Mark Chekanow from Sidoti. Please state your question.

Good morning, gentlemen.

Hi, Mark.

Could you talk about the maintain ability of these gross margins and if you have any plans to move away from the semiannual inventory count onto a further automated system in and then I'll follow-up with a question about the Sassoon studios.

Sure. I'll handle the first part of the question, Mark. As I mentioned, I think this morning in the conference call, we are expecting the gross margins will continue with historic pattern of gradual improvement. We're budgeting that the gross margin rate for the final two quarters, I'm talking specifically our product margins, should improve to around 48 %. A lot of the factors that have driven margin expansion in the past, we expect should continue in the future as well.

We do take semiannual physical inventory counts which helps us validate the interim estimated usage percentages. As our business continues to involve in the near term, we're likely going to take maybe an extra count or two during the course of the year. So, in terms of solely relying on an automated function to help us with that, only time will tell. Right now as I mention we’ve completed the roll out of the JDA merchandising system to our Trade Secret division where over half of our corporate product sales are generated. That seems to be going very well and as time goes on, we'll look at expanding that to other operating divisions. But in the near term, no, we will not use a completely automated function. Paul or Mark you want to ask Paul the question as it relates to Sassoon?

Right. Regarding the Vidal Sassoon studios, can you talk about the economics and what impact it would have on margins as they compare to your other salon concepts?

Sure. I'd like to take a pass on it, other than talk to you conceptually, because we're right now working with Vidal Sassoon senior management to come up with a program. But we won't accept any program where margins aren't at the high end of our range. You're talking salon contributions well in excess of 20 %. But the actual program itself, the services that will be offered and the exact price points are a work in progress and we're not going to be opening any this fiscal year. We should be able to open some during the summer or fall.

Okay. Thank you very much.

You're welcome.

Gentlemen, your next question comes from Ellen Schlossberg from William Blair. Please state your question.

Hi. Thanks and congratulations on a great quarter. Couple questions. Can you give us an update on the ’Me & Max’ and also how the integration of the European companies are going? And then also, do you see any changes significant to the advertising budget in the last couple quarters of the year?

Let's look at the ad budget first. Most of the money we spent on advertising relates to ad funds with our franchise concepts, and they are contractually governed, really. So there's going to be no change, Ellen, it as it relates to that. The ‘Me & Max, about 50 operations now, we're adding about 20 or 30 this fiscal, and probably we'll add a like amount next year, and they're doing just fine. Most importantly they're not cannibalizing the Regis or MasterCuts businesses in the malls in which they are placed.

And the third item relates to the integration of our French businesses and that integration is right on plan and we're doing just fine with respect to that. We are in the process of closing the Jean Louis David office on Rue Royale and merging those operations into our G. G. G. office near the -- well, another part of town which is less expensive from a rent perspective.

Okay, great. And then also, just wanted to get your thoughts, historically we've seen service sales or product sales outpacing service sales which has had a favorable mix shift on blended margins and for the last couple quarters it's flip-flopped. What are your expectations for going forward on that measure?

We think service sales right now have a greater opportunity than product sales because it's just a huge amount of competition out there. We're trying to get our arms around it. But as it relates to the third and fourth quarters, we think that those quarters will mirror the second quarter.

When you say huge amount of competition, are you seeing additional channels of competition? Are you seeing more of the professional product leaking into the channels they're not supposed to be in?

Well, both, Ellen. The category has been so successful that there's been a bunch of new entrants into the business and we're working on that now. We still have a huge advantage, because we have in the system 70 or 80,000 hair stylists that can prescribe what product of good for the consumer. So long term, we have a huge competitive advantage over other retail outlets selling similar kinds of goods. But the success of the whole category has created a situation where more entrants have come in, and we're just going to have to be sharper and better and we are long term just as bullish as we've ever been.

Okay. Thanks.

Gentlemen, your next question comes from Peter Norton with Norton Capital Management. Please state your question, sir.

Yes, good morning. Congratulations also on another great quarter. You're initiating coloring at a number of strip stores and centers in the near future. I'm wondering what effect that might have on the projections you've provided us?

Well, any changes we have in this business are glacial. In other words, MasterCuts today has a hair coloring percentage of 7 or 8 % of our service sales. That took five years. We have now added hair coloring for instance as an offering in our Supercuts salons, but it's going to take the full year to get the training completed.

So, if you're looking at what it could add to Supercuts alone? Next year maybe 1.5 % in terms of comps in that order of magnitude. The following year, another point. It will take a while for Supercuts to end up at a 5 or 6 % level but that should take place in three to four years.

Margins, I assume, would also be positively impacted by that kind of offering?

Well, lots of debate that we've had internally for about 30 years. You know, haircut has no supply cost. Therefore, the margin is greater. On the other hand, hair color has a lot more sales per minute associated with it. So, the accountants arm wrestle and at the end of the day I think its margin impact is neutral, in my opinion.

Great. Thanks.

Gentlemen, your next question comes from Greg Eisen from Safeco. Please state your question.

Thanks. Good morning, Paul, good morning, Randy.

Hi, Greg.

On the Vidal Sassoon acquisition, and I guess I'm trying my lack of knowledge of the marketplace since I'm going to go to Supercuts for a haircut --

Good for you.

-- is there potential risk of cannibalization in cross competition between Vidal Sassoon and Jean Louis David when they're in the same metropolitan markets?

The market there is so low with each concept that any cannibalization would be immaterial. Now, it realistically relates to New York City because we're going to be expanding David. Will we expand Sassoon in New York City? Probably not, at least not the first year or two, but there are plenty of other areas where Sassoon has a presence like Chicago and L.A. and San Francisco. We'll be plenty busy expanding it in those areas. But Sassoon and David also have a different kind of image. David is a little bit trendier. Sassoon is a bit more elegant. I think they're appealing to different kinds of clientele.

Okay. So, you don't see that as an immediate challenge?

I don't see it as an issue.

Okay, thanks.

You're welcome.

Gentlemen, your final question comes from Jeff Stein from McDonald Investors. Please state your question.

Question is for Randy. Randy could you talk about inventory levels? If you look at them on a year-over-year basis, they were up roughly 30 % and I'm wondering why were they up so much? Are you at all concerned about potential markdown risk in the back half of the year and where do you see inventories at the end of the year?

Good question, Jeff because quite frankly inventories are high. We ended the quarter at $145 million of inventory. As we've seen in the past, inventories will always be expected to grow in our business because our store base that we support also grows.

Having said that, we saw inventories grow faster than our store base growth here this past quarter. Some of that, Jeff, was largely due to the fact that our sales weren't at the expected level, so we had more inventory remaining than we thought we would have. The other one, sometimes it's timing of when we buy -- we continue to buy better than ever before. Sometimes that means we have to bring in more product, which we’ll carry and sell at a later date. But net, net, net, the $145 million was larger than what we had anticipated.

Jeff, my expectations as we look through the second half of the year, we should not see much growth from inventory levels going forward. A lot of times when you hear the fact that inventories maybe are -- if somebody reaches a conclusion they're on the high side you would expect some people in a typical retail environment would logically have concern then you have some up in the future you'd have markdowns, you'd have a lot of discounting going on, you would maybe have some write-offs of obsolete inventory.

As you and others know, that is not the nature of our inventory. We have -- we sell shampoo and conditioner which has a very, very long shelf life. It has really no fashion obsolescence. There is very little risk of obsolescence, so you will not expect to see any incremental discounts or write downs of inventory from us in the future. With JDA, we will continue to manage our inventory levels better. There is opportunity to do so.

Final question, Randy, can you talk a little bit about just generally control over operating costs? It seems to me that with a 1 to 1.5 % comp expectation built into the back half of the year, that if we do see some upside to that, this could allow for still some upside from an earnings per share standpoint in the back half. But, I'm also wondering what areas of the business have you been taking cost out in order to be able to see a 13 to 15 % type of earnings increase with such a meager improvement in comps?

Yeah. Well, as we’ve talked about, it's primarily a lot of that growth, Jeff, is coming through excellent payroll control. We talked about this on several quarters. You're only going to have those types of improvements probably once, like when we closed the San Francisco Supercuts office and you have the annual savings. It only happens once. We started realizing more improvement - significant improvement - in our payroll controls in about the third quarter last year. We have effectively anniversaried that. So, I'm not expecting in the future as comps if they continue at that 1 to 1.5 % level, we will not see that same type of leverage in the future. We are not really taking significant cost cutting measures here. Over 50 % of every dollar we bring in, over half goes back out in terms of payroll and related benefits.

All of our operating people, they live and die by managing payroll costs and they do a very good job of that. So that is something that is part of our culture and will continue in the future. We are able to see leverage that, as we continue to expand in sales, we don't have to add proportionately to our corporate infrastructure, so we'll continue to see leverage there. But I think your overall conclusion is right. At this point, we feel comfortable with the earnings estimates that are out there in Qs 03 and 04 despite factoring in a range of 1 to 1.5 % of comps. If we do start seeing a pickup in the overall business in the economy and the impact of our business, there should be upside to those numbers.

Okay. Thanks a lot.

You're welcome.

Gentlemen, I show no further questions. Ladies and gentlemen, that concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.