Regis Corp (RGS) 2005 Q3 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the fiscal year 2005 third quarter results conference call.

[OPERATOR INSTRUCTIONS]

As a reminder, this conference is being recorded today, Wednesday, April 27, 2005. I would now like to turn the conference over to Mr. Paul Finkelstein, Chairman and CEO. Please, go ahead, sir.

Good morning and thank you for joining us. Several weeks ago we pre-announced an $0.08 operational. shortfall to our third quarter earnings. We previously disclosed the major factors that negatively impacted third quarter earnings, such as product sales -- product cost which represented $0.03. G&A represented $0.03 and our international business operational shortfall represented $0.02.

I'll very briefly review the third quarter and then respond to several of the issues that some of our investors have brought up. I'll then talk about our current game plan and give some guidance as to fiscal 2006.

Third quarter revenues increased 16% to $557 million. Same-store sales increased 1.4 % contrasted to a 2.8% increase last year. As previously stated, third quarter comps were positively impacted by the timing of Easter. Excluding the $38.3 million non-cash goodwill impairment charge, third quarter net income decreased 13% to $0.47 a share, $0.08 below the mid-point of our previous earnings guidance. Parenthetically, it is highly unlikely that we will face another impairment charge for many years to come.

EBITDA increased 4% to $65 million. We ended the quarter with 10,807 units, which represented an increase of 921 units compared to last year and an increase of 289 units during the third quarter. During the quarter we acquired 273 locations. The most notable acquisitions included 129 TGF salons in Texas, 67 Head Start locations in Alabama and Florida. 52 Cost Cutter franchise locations in Pennsylvania and Illinois. And four beauty schools in Minnesota and Rhode Island.

The acquisitions should add over $60 million in annualized revenue and $0.07 of annual accretion. As of March 31, we had 6,818 Company-owned salons and 3,880 franchise salons. Our beauty careers school count was 19. Total debt at the end of the quarter was $542 million and our debt-to-cap ratio was 41%.

Some of our investors have made the following comments, which I would like to share with you. First -- Is the business getting too big for us to control? We categorically reject this premise. We have spent tens of millions of dollars on infrastructure during the last five to ten years and the systems and physical facilities are in place to handle 20,000 units, significantly more than the 11,000 that we presently have.

We continue to run the business small, having not changed our ratio of salons to supervisors in many years. Our IT is incredibly sophisticated, with us knowing daily what each of our 53,000 associates produced the day before. We're able to drill down for each employee exactly how many customers he or she had, the nature of their services and the amount of retail product that each individual sold. The controls are in place, it's a question of implementation.

Second -- Why didn't we appropriately budget G&A expenses relating to Sarbanes-Oxley and the label litigation costs?

With respect to Sarbanes, I'm confident that we are not alone in underbudgeting the first year costs of Sarbanes. With respect to the costs associated with label litigation, we knew that the legal fees would approximate $3 million, however we did not know when discovery would start as that process is determined by the judge. Most of the legal costs should be behind us within nine months.

Third -- Has management's attention been diverted due to our purchases of beauty schools and Hair Club? These businesses have entirely separate management teams and there has been virtually no diversion of senior management time. Parenthetically, I might add that Hair Club produced its highest profit ever in March.

Fourth -- Are we losing market share? Quite to the contrary, L'oreal has published data which shows that salon visits have been reduced by 2.7% over the last several years predominantly due to the long hair phenomenon. Likewise, statistics published at Cosmocross(ph) the world largest beauty convention, show a 1.5% decrease in hair salon shipments. Our company has, in fact, increased our share of the market.

Fifth -- Have there been any systemic changes that would affect our long-term growth expectations? We do not believe that our long-term growth expectations will change. However, without same-store sales increases of 2%, Regis will not be able to have double-digit EPS growth. Having said that, we are highly confident that over any five or ten-year period of time we will have double-digit top and bottom line growth. Most of the issues we currently face are fixable and we are addressing them very seriously.

Let's now talk about our current plans. First, we are implementing technical and training marketing initials -- initiatives that will be unfolded in June and July that will enable to us to take increased share of the long hair market. We will be the industry's long hair experts. Having said that, and soon as we become the long hair experts, I can assure you that short hair will be in, which is also good for us.

Second, as quickly as possible, we will fix the erosion of product gross margins and the payroll issues in the UK. The UK issues are being fixed and the product cost margins should improve within the next six to 12 months

Third, aggressively pursue price increases. As of this date, we have or plan to increase prices in at least 2800 of our Company-owned stores.

Fourth, be more selective in fiscal 2006 with respect to new builds and acquisitions. As you know, our basic model is to grow organically anywhere between 6 and 9% with acquisitions being the plug figure, to enable us to have low to mid-digit top and bottom line growth.

We know that this is un-- we know that is is unwise to make investment decisions when comps are -- are at historical highs or lows. But having said this, we will modestly scale back on new builds and acquisition plans in fiscal 2006. And will consider becoming more agressive in our stock buyback program.

With respect to our CapEx, acquisition and stock buyback budgeting, please be mindful of our desire to maintain our investment grade status, as well as our debt-to-cap ratio between the mid-30s and the low to mid-40s. Thus while we may become more agressive in buying back Regis stock, especially at this price, it's unrealistic to expect to us re-purchase stock above $100 million.

Obviously 2005 will at best be a flat year. However, we will have spent a half a billion dollars on buying and building businesses in 2005 and those expenditures should bear fruit in 2006 and beyond. With with respect to 2006, while we understand that fashion will eventually change, we'll be even more diligent in driving our same-store sales results.

Our outlook for 2006 is fairly consistent with our initial outlooks in the last several years, with organic EPS growth in the 7 to 9% range. This outlook assumes a modest same-store sales increase of 1%, which reflects our belief that longer hair will remain in fashion for at least the next year.

However, our renewed focus on price increases and long hair, as well as accretion from fiscal 2006 acquisitions could allow us to achieve EPS growth for 2006. While I realize that theoretically a price -- the price increases we are planning for the coming months implies an incremental one percentage point increase in same-store sales for next year it is too early to build that into our expectations. Before we can legitimately increase our expectations, we need to assess what impact the price increases will have on customer visitation patterns and our stylists.

However, if we do start to see improvement in our same-store sales results as a result of these price increases we will obviously increase our expectations. We understand that we must produce results. We are very results-oriented and you can rest assured that we will expend every effort to make sure that the confidence you have placed in us is not misplaced.

Randy Pearce will now continue. Thanks Paul and good morning, everyone.

Let me echo what Paul said a few moments ago, that we are clearly disappointed today to report quarterly results below our long-term growth expectations. While revenues increased 16% during the quarter, our net income, excluding the $38.3 million non-cash goodwill impairment charge, decreased 14% to $21.8 million or $0.47 per diluted share.

Inclusive of this charge, we are reporting a net loss today of $16.6 million or $0.37 per diluted share. Paul previously mentioned some of the key factors that impacted our third quarter performance. On April 13, we issued a press release that identified and quanitified the factors that led to the revised outlook for our third quarter earnings. Today we report third quarter results that met this revised guidance.

I'll first provide you with some additional details on our third quarter results and after doing so, I will discuss our updated guidance for the balance of our current 2005 fiscal year. I will then close with a few comments regarding our initial guidance for our upcoming 2006 fiscal year.

Let me now jump in and I'll give you more detail behind our third quarter results. Please note that in today's press release we have once again included a supplemental consolidating P&L that provides additional information on our salon, our hair restoration and our beauty school businesses. This will help you assess the operating performance of each these businesses. I will first begin by discussing revenues.

Third quarter consolidated revenues increased 16% to a record $557 million. As you know, our long-term growth expectations include both organic and acquisition growth with each representing roughly half of our total revenue growth. This quarter, organic growth, which includes a same-store sales increase of 1.4% represented 25% of our total revenue growth. While acquisitions made within the previous 12 months made up the remaining 75%.

Obviously these percentages will vary on a quarter by quarter basis due to the timing of new store openings and acquisitions. However, over a longer period of time, the mixture of organic and acquisition growth should be very consistent with our long-term expectations. You will you find a table in our press release today that breaks out our third quarter revenues for each salon concept.

Our service sales line item primarily includes revenues from services provided in our hair salons. However, this revenue category also includes service revenue from Hair Club as well as tuition and service revenue from our beauty schools. Our third quarter fiscal 2005 service sales grew nearly 16% to $369 million.

Likewise our line item called product sales which primarily represents retail products sold to customers in our hair salons, also includes sales of retail product to our franchisees, as well as product sales made by our Hair Club subsidiary.

Product sales which have higher gross margins than our service sales, grew nearly 17% in the third quarter to $169 million. In addition, our product sales mix for the quarter was 30.3% of consolidated revenue, slightly higher than the 30.1% rate that we reported in same period last year.

Third quarter franchise royalties and fees grew 8% to $19.9 million. This increase is related to our recent acquisition of Hair Club for Men and Women, as well as new franchise salon openings. Offset by our acquisitions of franchise salons as corporate units.

Our franchise business remains extremely healthy as evidenced by the 62 new franchise salons built during the quarter. We continue to believe that our franchisees will build approximately 300 new salons this fiscal year.

As we reported in our press release on April 7, consolidated same-store sales for our third quarter increased 1.4%, which fell within our third quarter forecast range of 0 to 2%.

While consolidated service comps of 2.1% were significantly higher than what we have experienced in recent periods, please keep that our third quarter same-store sales comparisons were positively impacted by the timing of Easter this year, which fell in the month of March. Compared to last year when Easter fall in the month of April.

Conversely, comps in the month of April will be negatively affected due to this calendar shift. Therefore you have to look at the two months together, which will reflect a continuation of the modest comps we have posted throughout this fiscal year.

We do believe that our service business continues to be impacted by the long hair fashion trend. Long-term we anticipate that our service same-store sales will return to the range of 2 to 4%.

Our retail product comps decreased 10 basis points in the third quarter as we were up against a very strong increase of 7% in the year-ago period. Long-term, we forecast retail product comps to also be in the 2 to 4% range. I will now switch gears and talk a bit about our third quarter gross margins.

Our third quarter overall combined gross margin rate came in at 44.4% of total service and product sales, which was exactly the same as the comparable period last year. Let's first talk about service margins.

Our third quarter service margin came in at 42.5%. That was down 40 basis points compared to the third quarter last year. This reduction in margin rate was due to increased salon payroll costs in our United Kingdom operations, as well as higher salon supply costs this past quarter. Looking ahead we expect fiscal year 2005 service margins to be approximately 43%. I'll now discuss our retail product margins.

Before this quarter began, we had forecasted that our product margins would improve over the same quarter last year, due to our recent acquisition of Hair Club, which has higher product margins than our salon business. Our third quarter product margins did improve, increasing 60 basis points to 48.4%. However, despite this improvement, we still fell short of our expectations. We noted in our press release on April 13 that several margin-related factors reduced third quarter earnings by about $0.03 per share.

Looking ahead, product margins for all of fiscal 2005 are expected to be in the 48% range of product revenue.

Let me now address the site operating expense category, which includes not only costs direct -- directly incurred by our salons, such as salon advertising, insurance, utilities and janitorial cost, but this line item also includes beauty school operating costs and hair restoration location costs. This expense category come in essentially on plan at 8.3% of third quarter sales.

A 40 basis point improvement compared to the third quarter last year. This rate improvement was largely due to a couple of factors. First, as you may recall, last year in our third quarter we incurred a higher level of salon advertising costs which caused our site operating expense rate to jump up a bit that quarter. This is simply a timing issue between the two comparable periods.

Another part of the current year rate improvement is due to our recent acquisition of Hair Club for Men and Women, which has lower site operating expenses as a percentage of their revenue. Looking at the balance of fiscal 2005 we continue to expect the site operating expense category to be in the low to mid 8% range of consolidated sales. I will now address our general and administrative costs.

All of the expenses within our G&A category relate to cost associated with our field supervision, our salon training and promotions, our two distribution centers and our corporate offices. This experience category for the third quarter fiscal 2005 came in above plan at 12.4% of consolidated revenue. This was a 140 basis point increase compared to the same quarter last year.

As we previously noted in our April 13 release, that several factors including higher expenses associated with Sarbanes-Oxley compliance, legal fees associated with pending litigation, health insurance costs and the timing of a new AS400 computer lease, impacted this category. We expect the full 2005 fiscal year rate to be in upper 11% range of consolidated revenue. I will now discuss rent.

Our consolidated rent expense in the third quarter came in essentially on plan at 14.1% of total revenue. The rate of 14.1% for this fixed-cost category was 20 basis points higher than last year, primarily due to a reduced level of same-store sales when you compare the two periods. We continue to expect our rent expense rate for all of fiscal 2005 to be about 14%.

I will now switch to our depreciation and amortization expense. During the third quarter this year D&A was 4.5% compared to 3.9% during the year-ago period. A large part of this 60 basis point increase is related to amortization of intangible assets that we acquired in the Hair Club transaction. Also, the timing of salon closures in the quarter, as well as a reduced level of comps caused this fixed-cost category to spike up a bit in the third quarter this year.

Looking ahead, we expect that our D&A rate for our entire fiscal year of 2005 should be in the low 4% range of consolidated revenue. Exclusive of the goodwill charge, our third quarter operating income declined by $3.9 million to $39.7 million or 7.1% of sales. This was down 200 basis points from the same period a year ago. Despite a challenging quarter and year for that matter, we believe that our operating income for fiscal 2005 will be north of 8% of sales.

Let me now drop down to interest expense which came in at $7 million or 1.3% of total third quarter sales, which was up $2.2 million over the same period last year. This increase in interest expense relates to increased debt levels, the result of our acquisition activity this fiscal year that included the $210 million purchase of Hair Club, as well as additional expenditures we've made for the purchase of salons and beauty schools.

Taking into account the Hair Club acquisition, our total debt at March 31 came in generally where we expected it to be, standing at at $542 million. This was up $241 million over the balance that we had at June 30.

Our debt-to-capitalization ratio continues to remain solidly investment grade, standing at 42.1% as of the end of March. We continue to feel that our internal cash flow and our available debt capacity should be sufficient to cover our salon expansion costs, as well as our scheduled debt retirements and dividend payments.

During fiscal year 2005 we continue to expect to spend at least $90 million of our cash flow to acquire salons and will spend an additional $50 million or so to acquire beauty schools. We also plan to spend up to $115 million for capital expenditures, including the construction of 550 to 600 new corporate salons. Based on these budgeted assumptions and the recent Hair Club acquisition, our debt levels will go up this fiscal year. However, our debt-to-capitalization ratio should end the year in the low 40% range, still solidly investment grade.

Next item I'll address is our effective income tax rate. Our third quarter tax rate on the surface looks very high. However, this is due to the impact of our goodwill impairment charge which is non-deductible for income tax purposes. Excluding this charge, our underlying consolidated effective tax rate improved 150 basis points in the quarter to 34.2%. We anticipate that our underlying effective rate for all of fiscal 2005 should be just under 35%. Next I will address our earnings.

Today we are reporting a third quarter net loss of $16.6 million or $0.37 a share. As we've already discussed this loss was entirely due to the non-cash charge related to goodwill. Let me just parenthetically say that despite this charge, we remain upbeat on our European business and the prospect for future growth and profitability. We certainly are not giving up, nor are we pulling out. Our European cash flow remains very strong and our earnings on the continent are actually up this year over last year.

However, the fact of the matter is, we have not grown the European business as rapidly as we had hoped to, or as fast as we needed to in order to avoid this write-down of goodwill. Exclusive of the goodwill charge, our third quarter earnings were $21.8 million or $0.47 a share, that was off $0.07 from the restated $0.54 a share that we reported in the third quarter last year.

Let me now provide you some information regarding our salon comps. At the end of our third quarter, the end of March, we had a total of 10,807 corporate and franchise locations. These locations included 10,698 beauty salons, 90 hair restoration centers and 19 beauty schools. In total a net increase of 921 locations compared to the year-ago period.

In today's press release, you will find a table that breaks out our salon counts for each salon division. I would like to touch on one additional point before I move on and discuss our earnings outlook. Since our April 13 press release a few of you have raised questions regarding our controls and whether we are now at a size that inhibits our ability to effectively manage our business.

Paul has given you his thoughts, let me also just reassure you that our controls today are better than ever. That being said, we will have expenses move from one quarter to the next unexpectedly, but that certainly should not imply that our controls are not sound. In fact, we believe we are clearly structured today to support twice the number of salons that we current have. All right. I will now update you on our revised outlook for our fourth quarter and entire 2005 fiscal year.

Our January -- on January 4, we provided revenue and earnings guidance for our third and fourth quarters. In light of our third quarter results, we did suspend this guidance on April 13 when we announced that third quarter results would fall short of expectations.

In today's press release we provided revised fourth quarter earnings and revenue guidance. We continue to anticipate fourth quarter revenue to be about $595 to $600 million. This assumes a same-store sales increase of 0 to 1.5%. However, based on recent trends, we now anticipate that fourth quarter earnings will be in the range of $0.62 to $0.67 a share.

Combined with our reported results through our third quarter, we continue to project fiscal 2005 revenue to grow approximately 14% to $2.2 billion. And earnings, excluding the non-cash goodwill impairment charge, are now anticipated to be in a range of $2.22 to $2.27 a share, basically flat with last year.

I 'm now going to switch gears entirely and provide you a few thoughts pertaining to our financial expectations for next fiscal year. Our fiscal 2006.

Paul provided you some comments regarding our salon growth and our related capital expenditure expectations. I'll focus my comments primarily on a few key line items on the P&L, as well as our fiscal 2006 cash flow and expected debt levels. Please refer to today's press release or to our website for a complete fiscal 2006 guidance summary.

Before I begin, we like to always remind investors that our long-term goals are for annual revenue growth of 10 to 14% and annual earnings growth of low to mid-teens. With these growth targets in mind, our forecast for fiscal 2006 does not include revenue or earnings accretion from future acquisitions. While accretive acquisitions are an integral component of our overall growth strategy, their timing is always difficult to predict. We learned our lesson last year when we included accretion from future acquisitions in our projections.

Naturally, the timing of several handshake deals ended up being later in the year than what we had initially anticipated. So to reiterate, our earnings guidance today does not include accretion from future acquisitions.

As we have done historically, we will provide updated guidance as the year unfolds, and as acquisitions are completed throughout the year. We project revenue, excluding future acquisitions, so increase 10 to 11% in fiscal 2006 to a range of $2.42 billion to $2.44 billion. As we all know, changes in hair fashion occurs glacially, and as a result we do not anticipate a significant change in the near-term comp environment.

Our fiscal 2006 revenue and earnings projection assumes a modest same-store sales increase of 1%. For reasons Paul mentioned earlier, this assumption excludes the potential benefit of recent price crease -- increase initiatives. Recall that an annual same-store sales increase of one full percentage point above our expectations, can increase our earnings by approximately $0.12 per share.

I now will discuss our expectations for various expense line items. I'll start first with our consolidated gross margin, which are we are budgeting to improve in fiscal 2006. We anticipate our consolidated gross margin to improve nearly 100 basis points to be in the mid-45% range. Much of this improvement is expected to be on the product margin side.

Product margins are expected to improve to the mid-49% range, due in large part to the full-year impact of the higher gross margins associated with Hair Clubs' retail product sales. Our service margins are expected to also improve by about 50 basis points next year to the mid-43% range. This is due in large part to the full-year impact of Hair Club and beauty schools, which are higher service margin concepts.

Several our other expense line items, such as site operating costs, G&A and rent expense, are each expected to be relatively similar as a percent of consolidated revenue to what we anticipate for our current 2005 fiscal year. We do however anticipate a modest increase in depreciation and amortization expense next year, in 2006. This is due to the full-year impact of the amortization of intangibles associated with our Hair Club acquisition in December of 2004.

We anticipate fiscal 2006 depreciation and amortization to be in the low 4% range of consolidated revenue. Perhaps 10 to20 basis points higher than our anticipated figure for fiscal 2005. In total, our operating income rate is expected to be in the mid to upper 8% range of consolidated revenue. With an anticipated debt level on June 30th of 2005, we will be roughly $260 million higher than the year-ago period debt level.

As a result, we anticipate interest expense to increase in fiscal 2006 to about $33 million for the full year. We also anticipate that our effective income tax rate next year will be in the low 35% range.

The last item I have relating to the P&L deals with our earnings forecast for fiscal 2006. Based on a modest 1% same-store sales assumption, we are budgeting earnings from organic growth to increase 7 to 9% next year to $2.42 per diluted share. This EPS computation is based on a weighted average, fully diluted share count of 46.5 million shares.

Keep in mind that we believe that we need same-store sales growth of about 2% in order to generate positive leverage over our expenses, and therefore to achieve double-digit earnings increases. And I'd like to make one side comment regarding our earnings guidance as well. Beginning next year in fiscal 2006, the FASB requires all companies to begin expensing their long-term incentive grants, such as stock options and restricted stock. As you recall, last fiscal year, in our fiscal 2004, Regis prospectively elected to adopt the practice of expensing all future long-term incentive grants. The recent FASB mandate now requires us to expense all historic grants as well.

As a result, our fiscal 2006 earnings guidance includes, or in other words, has been reduced by $0.035 per share related to the required expensing of historic stock option grants.

To wrap up our earnings discussion , let me say that actual earnings in fiscal 2006 could end up being well in excess of our $2.42 guidance, given the potential upside that our recent price increase initiatives could have on our modest same-store sales assumption, coupled with accretion from future acquisitions. As we have stated in the past our long-term growth objective is to achieve a low to mid-teen earnings growth rate.

We're almost done here. Let me now touch on our 2006 budget assumptions regarding cash flow and debt levels. We expect our EBITDA to increase next fiscal year to a range of $310 million to $320 million and our after tax cash flow to grow to at least $215 million.

Most of our cash will continue to be reinvested back into the business by buying and building salons. Therefore, we are forecasting our debt levels over the course of fiscal 2006 to be in the range of $600 million to $610 million. We do expect continued improvement in our leverage, with debt-to-capitalization ratio to be in the very low 40% range by the end of fiscal 2006.

Once again for a more detailed summary of our guidance, please visit our corporate website. Well, that's it. 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.

Certainly. Thank you.

[OPERATOR INSTRUCTIONS] Our first question comes from Jeff Stein with KeyBanc Capital Markets. Please go ahead with your question.

Okay. I've got several questions, Paul and Randy.

First of all, I just want to make sure that I understand what you are including in your organic growth assumptions. Because it seems to me like you're looking for Hair Club, unless the projections have changed, to add about $0.06 a share and you indicated that acquisitions that you completed during the third quarter would add about $0.07 a share. So, if you -- if we just rough it out and use, let's say 222 as a base, and you add those two components, we're looking for about 235, so that almost suggests that the rest of the business is expected to be about flat and I just want to make sure I understand. Is that a correct way to look at it?

Jeff, I 'll take a shot at it.

I think you are more right than wrong. Again, there's going to be some unusual items. For example we talked about the $0.035 that's reflected in our '06 assumption relating to expensing options. We also are benefiting in our current fiscal year by $0.02 or $0.03 associated with foreign currency translation gains that we haven't budgeted next year. We also realize however, that this current fiscal year includes some expenses that we don't expect to repeat next year.

We've kind of taken a look at things, Jeff and we have said a couple of times that we expect that we need comps of about 2% in order to get some -- some leverage and we -- back of the envelope here, we have looked at that and we believe that next year with 11% revenue growth, and call it about an 8%, 7 to 9%, call it 8% earnings growth, that we are having some negative leverage and it's because of a modest comp assumption of 1%. If we were to get 2% comps, another $0.12 a share, I think you will find that we'll start seeing that our earnings growth would keep pace with our revenue growth as well.

Okay.

You talked a little bit about the impact that your acquisitions that you made this year will have on your gross margins and I'm curious, what kind of salon gross margin for both products and for the service component are you assuming year-over-year in FY '06, could you just isolate that?

Jeff, I don't have that right in front of me. I'll be happy to get back to you. Right now the guidance has always been on a consolidated basis. I think you will find that the 50 -- I think we added about a 50 basis point improvement in service margin and 130 basis point in product margin. Much of that expectation deals with schools and Hair Club.

Over time, we have seen that our service margin rate should continue to improve maybe 10 basis points, maybe 20 basis points a year, because of a mix play, where our higher margin concepts like MasterCuts, Supercuts and Wal-Mart are growing faster.

Product margins, we generally are not on a year-over-year basis don't really expect much change in product margin rate. Because we buy it pretty darn well today. However, we have seen that some of the factors we pointed to with some booked physical adjustments in the UK, we do expect some improvement in product margin rate.

Jeff, I don't have any precise numbers I -- I'm really reluctant to even start venturing some guesses. But I think you would see that we are looking for modest growth in both service and product margins on the -- related to the salon side of the business.

Okay. And final question, Randy, what are you -- what stage are you in now in terms of getting more comfortable that you are getting accurate inventory counts in the stores when you are taking physical inventory? Where are you in that process, and can you describe to us, if there is any change in the process to ensure you will get accurate counts?

Yes. I'm feeling better as time goes on, on this, Jeff. It's been an area of focus for us for several months now. And, we saw the results at this past count that I think, a lot of factors indicate to me that we are getting our arms around it.

We are doing things more -- like in our trade secret division utilizing an outside count service, we're using more electronic equipment to help scan product. We started testing that in Regis salon division last count we did and we are looking at expanding that to other salons in the upcoming count. We are getting our arms around it.

Kyle Didier, our VP of Finance has been working very closely with our operating people, as well as our product purchasing people and we are coming up with new initiatives that will, that should help us get more complete and accurate counts. On a scale of one to ten, if maybe we were at a four or five, I think we are probably at a six or seven now.

I don't ever expect that we'll be perfect on it, but I think within the next six to nine months we're going to make a lot more headway on it.

Okay. Thank you.

Our next question comes from Mark Chekanow with Sidoti. Please go ahead with your question.

Hi. Could you talk about some of the cost controls [used] on the payroll side in Europe that hurt you in the third quarter, and how quick can you be to adjust? On the last conference call you said that that has already been addressed. Could you give us a little bit more detail as to what is actually happening in Europe and what you are doing from a payroll perspective?

Yes. We have all the software and all the systems in place, Mark. It's a question of being diligent. And we believe that the payroll problems in the UK are largely fixed as we speak. It's just a question of being more diligent.

Okay.

I know you guys said that if the price increase sticks and with -- in acquisitions you could significantly exceed your guidance. Could you give us a ballpark range, what acquisitions could add next year?

Historically acquisitions have added anywhere between $0.01 and $0.15. We probably will reduce somewhat our acquisitions, and because stock buybacks look very inviting for us right now.

So if we had to guess, in the $0.05 or $0.10 range rather than $0.10 or $0.15 range. Once again that, coupled with increased comps, creates an environment where we would not be pleased, unless we did have double-digit growth. EPS growth that is.

Okay. Thank you .

You're welcome.

Our next question comes from Adam Weiss with Chilton Investment Company. Please, go ahead with your question.

I have a couple of questions. Talk about needing 2% comps for leverage before you just reported comps in the U.S. were up 1.4 and your margins were down 200 basis points. Trying to understand how much of that margin contraction is temporary.

Adam, I will take a stab at it. Again, we were, as we talked about I think on April 13, the margins were impacted by several factors that we had not forecasted, nor do we necessarily expect are going to continue. Things, such as -- specifically when we talk about margins, we are talking about payroll costs in the UK being higher.

I'm talking about the U.S..

I'm sorry.

I'm talking about the U.S..

Well, the $750,000 inventory charge affected margins. And we don't think that that is systemic or will continue in the future.

I look at U.S. margins, just U.S.

That is U.S. That is solely U.S.

$750,000 on --

Well, that is just one item, Adam.

What were some of the other ones that are temporary?

We ended up -- had a obsolescence reserve, it was about $750,000 that we pointed to. We talked about cash discounts. After the holiday season we had expected that inventory levels would come down a bit giving us the ability to recognize cash discounts associated with early payment. Inventory levels did not come down to that extent.

Private label, we had some system modifications that more accurately computes the weighted average costs, those are things that are behind us.

What does that all amount to if you add that back? Because the North America operating margin was 11.6%, down 200 basis points.

So on a 1.4% comp, you add back some of those issues you just mentioned, what would a normalized margin have been? You did have a positive comp in the quarter and sequentially and year-over-year margins were down dramatically, and that $750,000 inventory write-down on a $470 million in revenue is not that -- not that much.

Adam we have given out -- we have given you a tremendous amount of information. We are not going to drill down to that level. I think let's take your next question.

I'm just wondering, what can you do to grow comps, Paul in this environment? I mean I know it's a tough macro and it's long hair trend and everything, but what can you do proactively to try and grow your comps?

Well, we spend about $80 or 90 million a year marketing our business. The largest segment in terms of consumer advertising is reflected in Supercuts. So, we spend about $25 million advertising the Supercuts brand. All the other [marketing ]expenses really are at the salon level and the -- you just -- it is unrealistic for us to expect that we are going to have a $200 million consumer ad budget, which probably would fall flat anyway.

So what we have to do is make sure we do become the long hair experts and at the same time the demographics work very much in our favor. Older people, and this population is aging, older people need to cut their hair and need color their hair and they need to do it more often. So it's a question of just be somewhat patient. 2001 was just a few years ago and we had a flat year and essentially we have a flat year now.

We did not become dumb overnight, it does not make any sense to have any major change in strategy, it's a question of making sure we are more selective in terms of location and we're more diligent in blocking and tackling. And there's nothing else we really can do, Adam.

Okay. Thank you.

Our next question comes from Mitch Kaiser with Piper Jaffray. Please go ahead with your question.

Hi guys. I was wondering, I know you are reluctant to put out a comp and -- for next year and factor in price increases, because you don't really know what the visits are going to do, but could you maybe just shed a little bit of light on what you've seen in the past when you've raised prices and what impact that might have had on visit trends?

It's a mixed bag. Overall, Mitch, you generally get a boost in comps initially, but long-term, you can also get a reduction in customer count oh, six to 12 months afterwards, so that's the tricky part of it.

I personally believe that the country is ripe for price increases in a lot of areas, and I think that a good hunk of these will stick, but time will tell.

Okay. Is there anything you can do to kind of manage that then, on the back end to maybe shy away from that?

If it's not working, you give $2.00 off coupons. But generally speaking we are pretty conservative and we are risk-averse and we're pretty darn confident that most of them will stick.

Okay. I noticed over the weekend, here in the Twin Cities area that it seems that Great Clips was pretty aggressive with their $9.99 haircuts. I don't know if you guys have any comments on that, or if you've seen anything different from their pricing structure that is causing them to do that, or if that's just market-specific?

It's market-specific and it is very typical of what Great Clips does from time to time in different markets.

Okay.

They haven't changed their strategy one bit.

Okay. Sounds good. And then just lastly, in 2004 your G&A as a percent of sales was 11.2 and now you are projecting 12.

Is that all due to the deleverage on the comps or is some of that due to the G&A expense associated with the school acquisitions or the Hair Club?

Well, it's not really Hair Club. It is dealing with schools, but I think Mitch, if you look back , certainly deleveraging of comps affects the rate. I think back in '04 we had 2.6% comps, today it's 90 basis points.

Right. Okay. All right. Thank you.

You're welcome.

our next question comes from Kevin Foll with Next Generation Equity. Please, go ahead with your question.

Hi, guys. Could you provide a little more detail on the $100 million of acquisition spend that you are targeting for '06, maybe between salon, schools and potentially share buyback?

Well, the $100 million has nothing to do with -- acquisition spending has nothing to do with share buyback, that would be all incremental. The -- Probably at least half of the $100 million will be school and Hair Club-related and the balance will be salons.

So you're talking about $50 million in salons and $50 million in schools and Hair Club.

Okay. And then --

Don't hold us to that because we can be $20 million off either way. The $100 million total should be just fine.

And you don't typically get as much accretion per dollar of acquisition spend on the school -- of beauty -- in the Hair Club as you do on the salons, is that correct?

Well, the Hair Club will be terrific. On an EBITDA basis. On an EPS basis, less so, obviously.

Right. Okay. Thank you.

You're welcome.

Our next question comes from John Anderson with William Blair. Please go ahead with your question.

Hi guys. The question I had for you, is it looks like with your '06 outlook, you're expecting operating margins in the mid-8% range. The business has historically operated more of a kind of mid-9%. Should be thinking about the business longer term, in more the 8.5% range versus where it has been historically?

I don't believe so, John. I think the -- again, a lot of this is going to be reflected on 1% comp assumption.

Longer term, we have seen comps generally to be in that 2 to 4% range and we are able to achieve a lot of leverage when we start getting comps north of 2%. We have had many quarters, a good number of quarters that -- where our operating margin rate was 10%.

Clearly, the mix of franchising to Company-owned business impacts the gross margin rate -- I'm sorry the operating margin rate, but no, I would not say that the business is trending -- that long-term we are expecting a mid-8% operating margin rate. It should be better than that, once comps start to -- are restored to a more normalized level.

But over time, I totally agree with what Randy has said, but over time you really have to look at the mix of Company-owned versus franchise stores. The -- it wasn't too long ago we had 4100 franchise stores and now we have just short of 3900 and our Company-owned stores are 6800. If that percent -- if those numbers -- if those trends continue, then we can have significant double-digit EPS growth, but operating margins will shrink somewhat, based on the percentage of franchise business.

Okay. Thank you

And in the quarter it looks like on a consolidated basis, your product margins actually increased sequentially and service margins were slightly down. I would have expected kind of the reverse given the adjustments to the usage percentage that you made going forward. So, can you explain that?

Yes, a lot of it, John, is due to Hair Club.

Hair Club has much higher product margins. We think ours are pretty good, Hair Club's are much better, and so for that reason we had budgeted that margins were going to be up sequentially and over the same period a year ago, and they were up. But some of the other factors that we've pointed to kept them below what we even had expected them to be.

Okay. And then last, in terms of the price increases that were recently implemented, can you -- do you have any insight as of yet, as to the impact on customer visits and the impact at the salon level?

Too early to tell. Thus far, there's been -- there are no negatives, but it's too early to tell.

Okay. Thanks.

You're welcome.

[OPERATOR INSTRUCTIONS]

Our next question comes from Peter [Eisel] with Synder Capital. Please go ahead go ahead with your question.

Yes. Could you just talk about the -- which concepts you have instituted the price increases and across how many stores?

Across the board, Peter.

Across the board, all concepts?

Yes, but not every single salon. We price by market so not every salon in every division has had a price increase, that just doesn't occur.

Okay, great. Thanks.

You're welcome.

Our next question comes from Mike Hamilton with ARBC/Dain (ph). Please go ahead.

Good morning. Wondering if you could go to macro level, given that we have had a couple of years now of the long hair trends.

If we are running a 1% comp environment, is your feeling that you are able to be taking market share?

Well, we are taking market share. It's clear that we are taking market share, but still not enough to generate double-digit growth, that's the issue. We had a flat year in 2001 and essentially have a flat year now. We need 2% comps to have double-digit growth We are taking market share; that's not even an issue.

What the dynamics there then, because obviously we have anniversaried a couple of years of long hair and I realize it can still play against us in trends, but in overall population that is certainly growing more than 1% and I would assume some of the demographic factors that you laid into, what is your feeling on what is happening to lay out that kind of growth versus demographics?

Yes. The -- it doesn't quite work that way.

If I grew my hair this year, grew it out and went to a barbershop, oh eight times this year contrasted to ten times last year, and I anniversary myself, it's highly unlikely I'm going to go from -- from ten to eight to six or else I will just stay in my house. So I anniversaried myself.

The real issue is will other people also go in future years from ten to eight? It's the new people it's not the old people. And you really can't tell. I mean there are no studies. There is nothing other than looking at people in restaurants and in sporting arenas to see what is happening.

So your feeling is trends are still going against you for some period of time?

I think they are moderating in time and the aging population helps. It's so hard to be precise. It's impossible to be precise.

Fair enough. Thanks. It's -- intuitively, with population growth well ahead of comping [in here it] at some point you have to seen an acceleration?

This Company has been around 83 years and never had a comp decrease. I mean, this is the quintessential replenishment business. Doesn't mean we won't have a flat year every once in a while. But, I know where you're coming from.

Yes, no. Thanks for your thoughts, I understand what you are saying there.

Okay. That is fair.

Our next question comes from -- is a follow-up question from Jeff Stein with KeyBanc Capital Markets. Please go ahead.

Okay. Paul, I'm kind of curious, you indicated in your comments that you were planning to trim back -- trim back salon construction, and yet 550 to 600 new salons sounds like a lot to me.

I guess my question is, where were you planning to be, and what do you see as kind of the net addition of locations from an organic standpoint in FY '06?

Well, as I mentioned before Jeff, it is really inappropriate to make investment decisions based upon systemically high comps, the comps that beyond being able to be sustained and likewise comps that are very, very mediocre. But especially given our stock price, it's somewhat compelling for us to -- originally we were talking about between 650 and 700 new salon -- new builds. And we'll probably end up in the 550 to 575 range. So, we have taken a bunch of the CapEx away from us in fiscal 2006.

But as a -- but if you take a look at having 6800 stores, adding oh, 6 or 7% new square footage per year, given the opportunities we have, we don't think that's being terribly aggressive, we think it's appropriate and we certainly have a balance sheet to support it.

Has cannibalization been an issue in any -- in any of your salon concepts?

Zero. The only time we cannibalize in the strip center environment -- let's pick on Las Vegas. We own Las Vegas and sure, we'll add a lot of Supercuts units in Las Vegas and it will negatively impact comps in Las Vegas for a year, but we keep everybody else out. And that's just -- that's just smart strategic real estate management.

You don't have the same cannibalization effect at all in the mall environment and obviously not in the Wal-Mart environment, but if we cannibalize ourselves, it's done on purpose. But generally speaking, if we open up a HairMasters near a Supercuts, there is really no cannibalization whatsoever. If we open up a Supercuts within a mile of a Supercuts there is cannibalization.

Back to the price increases for a moment, at the beginning of April you raised prices on about 1500 salons and I think you indicated the price increase was like $0.50 to $0.60.

Can you tell us what the magnitude of the price increases are in the incremental 2800?

It depends on the division. In the Regis division there'd be $1.00 or $2.00 per service. In the strip center environment, there'd be $0.50 to $1.00. It just depends on the price points.

And where would it average -- does it average out to 1%?

I will tell you in a year.

On paper, yes. But whether -- whether it sticks.

We don't know. We just don't know, Jeff.

Okay. Just understanding what the intent is, not in terms of what's it's going to be. And maybe, can you give us some update in terms of how have the prices been sticking in the first round of increases you initiated earlier in the month?

Just fine, no issues at all, but it's too early to tell. We'll see what our customer count looks like in six months. That is the issue , Jeff.

Okay. Thanks.

You're welcome.

Our next question is also a follow-up question from Mark Chekanow with Sidoti. Please go ahead.

Actually, you just answered my question about 15 seconds ago. Sorry.

And our final question is from Kevin Foll with Next Generation Equity. Please, go ahead.

Just a quick follow-up on the share count for the quarter. It came in a little lighter than my expectation. Did you guys back buy a little bit of shares already or -- ?

Yes, we bought back, I think 260-some thousand shares this past quarter. And also remember that our common stock equivalents will come down with a reduced share price as well.

Right. Right. Okay. Thanks.

You're welcome.

At this time there are no further questions. I would like to turn the conference back over to management for any closing comments.

Thank you for joining us and we appreciate your support and we'll deliver for you. Have a good day.

Ladies and gentlemen this concludes the fiscal 2005 third quarter results conference call. If you would like to listen to a replay of today's conference, please dial 800-405-2236 with the access code 11029122. Again, if you would like to listen to a replay of today's conference, please dial 800-405-2236 with the access code 11029122. You may now disconnect and thank you for using AT&T teleconferencing.