Regis Corp (RGS) 2008 Q1 法說會逐字稿

Good morning, ladies and gentlemen. My name is Mary and I will be your conference facilitator for today. At this time I would like to welcome everyone to the Regis Corporation first quarter 2008 conference call. All lines have been placed on mute to prevent any background noise. If anyone has not received a copy of this morning's press release please call Regis Corporation at 952-806-1798 and a copy will be faxed to you immediately.

If you wish to access the replay for this call you may do so by dialing 1-800-405-2236 and enter the access code 11097199 followed by the pound sign. I would like to remind you that to the extent 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. Reconciliation to non-GAAP financial measures mentioned in the following presentation can be found on their website at www.regiscorp.com.

With us today are Paul Finkelstein, Chairman, President and Chief Executive Officer, and Randy Pearce, Senior Executive Vice President and Chief Financial Administrative Officer. After management has completed its review of the quarter, we will open the call for questions. (OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Paul Finkelstein for his comments. Paul, you may begin.

Thank you, Mary, and good morning, everyone. Thank you for joining us. We are pleased with our first quarter results. Our earnings and our consolidated same store sales came in right on plan at the midpoint of our guidance range. First quarter earnings were $0.46 a share and our consolidated same store sales increased 0.009%. North American first quarter service comps increased a very healthy 2.7% versus 0.5% last year. Our sales in the U.K. continued to be disappointing due to a difficult economic environment. Our consolidated service comps increased 2.3% for the quarter. Hair Club continues to perform extremely well. Product comps for the quarter were a negative 2.5% and I'll address product comps later on during my presentation. First quarter EBITDA was flat at almost $75 million.

We ended the quarter with 12,108 Company owned and franchise locations an increase of 81 locations during the quarter. Total locations, including businesses in which we hold an ownership interest, numbered 12,584. During the quarter, we completed nine transactions, acquiring 133 salons, including 42 franchise salons. Our franchisees built 57 locations and closed, relocated or sold 89 salons. Company owned salons as of September 30th numbered 8,315. Franchise locations were 3,793. We also have investments in salon companies which have 476 locations. This is a very important number as after the Provost transaction is completed, this number will exceed 2500 locations and will have an impact on sales and EBITDA, although EPS should not be significantly affected. If anything, EPS should grow.

Total debt at the end of the quarter was $719 million and our debt-to-cap ratio was 43.3%. As you can see from the strengthening of our service comps, our core business is starting to recover nicely. I would like to share with you an additional perspective on the whole issue of customer visitation patterns. I really don't like to make historical references because I'm more concerned about the present and the future. But I would like to share with you a perspective that history will provide. 40 years ago our core customer was a weekly salon customer. She literally came to the beauty salon 50 times a year. We allowed her two weeks off for vacation. At about that point in time, Vidal Sassoon was instrumental in changing our industry forever with blunt cutting and wash and wear hair that allowed customers to visit a salon every four to six weeks.

At that point in time we thought this would be a disaster for our industry but the industry was able to adapt and did enjoy significant growth for the next four decades. During the last five years, visitation patterns have lengthened, in part due to long hair and in part due to a more casual lifestyle. In many instances people who went every six weeks are now going every eight weeks. Although this creates a challenge for us it is nowhere near the magnitude of the challenge created 40 years ago. While this has been a difficult transition, it is not an impossible one and now it is basically anniversaried. With the aging population, coupled with the anniversarying factor, we seem to be on our way towards recovery. We are adapting by implementing price increases, new services such as hair extensions and hair color and super cuts.

All off these events attest to the resiliency of our business. We have never had a negative comp year in our 85 year history. As you know the big issue today is product sales. In our last conference we shared with you our plan to significantly transform Trade Secret into a true beauty boutique, rather than just a seller of professional hair care products. We know that other Trade Secret type companies within our industry have bath, body, cosmetic and skin categories, representing as much as 23% of their total sales. These categories represent only 2% of our sales. Please understand that we are not in any way, shape or form giving up on our hair care business. We will be thinning out our less popular lines, but from a practical point of view, the bath, body, face and cosmetic categories will represent incremental sales.

We are in the process of a significant Trade Secret redesign, as well as identifying which new vendors will partner with us in order to implement this transformation. We expect to show improvement in Trade Secret during the last half of our fiscal year. When I discussed our transformation strategy during our last conference call, our original plan was to test the strategy in five salons in the Minneapolis area. We have modified the strategy and now planning to test the strategy by using a new store design which will be rolled out in several locations which are already scheduled for remodeling. Our first test location will be at the Mall of America in Minneapolis and we will have seven to eight additional locations operating with a new assortment and design by the end of the fiscal year. Based on the results of this test group, we will develop a plan to retrofit our existing locations so that we can obtain incremental sales in all of our Trade Secret stores.

After we have developed the right assortments, we will take certain elements of the bath, body, cosmetic and skin lines and install them in our Regis Salons as well. By the way, we will add these new assortments, once they prove to be successful, to the entire Trade Secret division prior to remodeling. Lastly, I would like to talk about the Provost transaction and share with you the history of the transaction and our thought process behind it. As you know, we recently issued a press release announcing that we are merging our European continental business into Provost. Our U.K. business is excluded from this transaction. Provost is a major salon brand in Europe, with a worldwide presence. Invis is a minority investor in Provost. Invis is a private equity house that has been very active in recent years. They took Weight Watchers private and then public.

They are a top notch, high quality firm. They called me about six months ago and asked whether they could purchase our business on the continent with the primary brands being Jean Louis David and Saint Algue. We told them that we do not want to exit Europe but that we would consider merging our business into theirs and retaining an equity position. Our continental business is doing extremely well with profits proceeding plan. The business is highly profitable. However, we all recognize today that bigger is better. Bigger does create account availing balance between us and our suppliers. Our suppliers continue to consolidate and become even more powerful. Bigger also allows us to be a stronger Company. When Franck Provost did call, we stated that there were four preconditions that had to be met for us to consider a merger.

First, our shareholders would have to be advantaged. Second, and most importantly, our franchisees would have to be advantaged. Third, we must retain an equity interest as we do not want to exit Europe. And fourth, Provost would have to make a commitment to keep the Jean Louis David brand very special and unique. Although our current performers has been more than satisfactory, it is very difficult for our American management to compete on a level playing field with the European management of Provost. Franchising in particular presents significant challenges. We do not have the same exit strategy for our European franchisees that we have in the United States. Provost has such an exit strategy with 200 of its salons being Company owned and 400 being franchised. We have almost 1600 franchise salons in Europe and only 40 are Company owned. The Regis business on the continent has been quite strong, with $60 million in revenues and EBITDA of $11 million.

However, the new combined business of Provo, including Regis, will have 2200 locations of which 240 will be Company owned, $900 million in systemwide sales and EBITDA of $39 million with huge opportunities for continued growth. Thus, merging Jean Louis David and Saint Algueto into Provost creates a very dominant Company in Europe. We retain a 30% equity interest in the new Company. We are very excited about this transaction and it should close sometime in early January. This also reflects a change in our thinking over the last several years. Historically, we had never had partnerships or strategic alliances, but as Regis gets bigger and the world becomes smaller, we feel that strategic alliances in certain areas are appropriate. Last year we created a joint venture Horst Rechelbacher, the founder of Aveda . This joint venture will be producing an organic line of products which will be introduced sometime this spring and will be a ground breaking line.

There are significant risks attached to this transaction but in no way, shape or form, should these risks be material to us financially. Horst and Regis each have a 50% interest in Intelligent Nutrients. We also announced this past spring that we purchased 30% of Goldman Sachs' 49% interest in a Japanese entity controlling 175 salons. This gives us a platform with which to grow with Wal-Mart in Japan if Wal-Mart so desires. We have a minority interest in Cool Cut 4 Kids, which is a 70 store chain headquartered in Dallas and a business that we feel is scalable. But a business which we wanted to initially operate with an entirely separate management team. We have a call on this business, hopefully this will be part of Regis within the next several years.

This past August we closed on a transaction with Empire Education Group in which we merged 51 of our cosmetology schools into Empire, which now has 87 schools and the management team with the potential to create within three to five years a $200 million business with very strong EBITDA margins. We retain a strong equity interest in Empire, approximating 50%. These alliances are quite strategic and in most instances we will be able to significantly expand our ownership percentage. I am more bullish about our Company than I have been in a long time, as our service business, which is in fact our core business, is improving and we know exactly what has to be done in the product arena. The issue is not the what, but the how. Once again, thank you for all of your patience. I'll now pass the baton on to Randy

Thanks, Paul. Good morning, everyone. We're very pleased today to report first quarter earnings of $0.46 a share. Perhaps what we are most encouraged by is the marked improvement in our service sales, which represent 70% of our overall business. Service comps increased 2.3% in the first quarter, up 100 basis points from the preceding fourth quarter. As we have said many times before, our earnings guidance correlates to our same store sales guidance. For example, guidance for our first fiscal quarter was for earnings to be in the range of $0.43 to $0.49 per share based on a forecasted same store sales range of flat to 2%. Our actual comps for the quarter came in near the midpoint at positive 90 basis points and therefore our earnings of $0.46 also met the midpoint of the range. A reported earnings of $0.46 would have been a penny stronger had it not been for a higher than expected effective income tax rate in the quarter.

The higher tax rate was simply a timing issue related to our first quarter adoption of the new FIN 48 accounting pronouncement, which I'll discuss further during my segments discussion. Other than that, our first quarter operating results were generally pretty straight forward. Please also note that effective August 1st we de-consolidated our title four school business due to our joint venture partnership with Empire Education Group. As we have discussed with you before, de-consolidation has no impact on our bottom line earnings. However, it does cause a reduction in our consolidated revenues and expenses. As a result, de-consolidation of our school business reduced our overall first quarter revenue increase from 6.6% to 4.4%. That was a reduction of 220 basis points in our revenue because of the de-consolidation.

I'll now transition my comments and give you a bit more detail behind first quarter operating results for each of our business segments and a breakout of our segment performance as found in today's press release and I'll begin as always with our largest segment which is our North American salons. North American salon revenue, which represented 86% of our consolidated first quarter revenue, increased 7% during the quarter to $572 million. This revenue growth was due to a 6% quarter-over-quarter increase in the number of Company owned salons that we operated, as well as a 90 basis point increase in same store sales. In addition, our North American growth was favorably impacted by 100 points as a result of including one month of revenue related to our school group that was merged into Empire Education on August 1st of 2007. Last year this revenue was separately included in our Beauty School segment. This year, again, we've included the one month of results in North American salons.

Service revenue in our North American salons grew nearly 10% during the quarter to $407 million. This increase included a very nice 270 basis point increase in service same store sales and a 130 basis point benefit related to the inclusion of one month of school activity. Product revenue only grew 1% in the quarter to $155 million, largely due to a decline in product same store sales of 3.7%. Royalties and fees from our North American franchise salons increased 4% during the quarter, to $10 million. This increase was primarily due to a first quarter acquisition which added 42 franchise locations in the quarter. Absent this acquisition, new franchise units that were added to the system over the past 12 months are being slightly more than offset by franchise buybacks and franchise unit closures. Our combined gross margin rate for North American salons came in at 43.9% in the first quarter.

Although this rate was 50 basis points less than the same period last year, the 43.9% rate did meet our plan. Before I go into details of our first quarter service and product margins, I would like to point out one reclassification change that we made this past quarter. Due to recent refinements made to our inventory tracking systems, we're now able to better track and account for retail products that our salon stylists transfer from retail shelves to the back bar for use in servicing their customers. The cost of these products had historically been included as a component of our retail product gross margin. Whereas they are now more appropriately included in our service margin. These retail to shop transfers only amount to just over $1 million each quarter.

Although this classification has absolutely no impact on the combined North American salon gross margin rate, the result of this reclassification will serve to reduce service margins by approximately 30 basis points and will increase product margins by 70 basis points. Again, this is a reclassification only and has no bottom-line impact. Our first quarter service margin rate for North American salons came in at 42.3%. Although this rate was slightly better than plan, due to our stronger service comps, this rate was 50 basis points lower than the same period a year ago. The majority of this change was a result of the reclassification that I just discussed. In addition, our amalgamation of the Fiesta Salon acquisition, which has a slightly higher salon payroll cost, caused a slight increase -- I'm sorry, a slight decrease to our overall service margin rate. Our retail product margins for the quarter came in at 47.9%, which was 30 basis points lower than the same period a year ago.

As I just mentioned a moment ago, we had expected a 70 basis point improvement in product margins due to the reclassification of retail to shop items. Therefore, on an apples to apples basis, our product margins are 100 basis points below last year's first quarter rate and there were two primary reasons for this. First of all, we experienced negative payroll leverage in our Trade Secrets salons in the first quarter due to negative product comps of 8%. The second factor that reduced our product margin rate this quarter related to a sales mix whereby we sold a higher proportion of lower margin promotional items during the quarter, that's not to say we promoted more heavily during the quarter, because we did not. This is simply a mix play in our sales.

Next, I'll address our North American salon G&A expense, which came in essentially on plan in the first quarter at 5.8% of revenue, up 40 basis points over the same period last year. The majority of this increase was related to a planned increase in photo shoots and salon level collateral expenditures, such as posters, shelf talkers and other signage. Marketing expenditures in the prior year first quarter were a bit lower than normal, as we pointed out to you last year. Our North American salons experienced a slight 10 basis point increase in rent expense, which also came in essentially on plan in the first quarter at 14.5% of sales. We continue to experience some slight negative leverage in this fixed cost category, as salon rents are increasing at a slightly faster rate than our overall same store sales growth.

Sight operating expense, which includes costs directly incurred by our salon, such as advertising, insurance, utilities and janitorial costs, improved 40 basis points in the first quarter, coming in on plan at 8.6% of sales. Most of this improvement reflects a planned reduction in our Workers' Compensation cost. As we saw last year, we have seen significant improvements in this cost category due to improved salon safety programs and return to work programs. The net effect of all the items I just discussed caused operating income for our North American salons to come in at 12.1% of first quarter revenue. Next, let's review our first quarter performance of our international salon segment. This segment includes our Company owned salons located primarily in the United Kingdom as well as our franchise salons located on the continent of Europe.

Beginning this year in fiscal 2008, our international salon segment also includes our four Vidal Sassoon Academies in the United Kingdom, as we no longer report a separate school segment. Our overall international salon revenue represented 10% of our consolidated first quarter revenue and increased just over 13% over the same period a year ago, coming in at just over $63 million. Over one half of the overall revenue increase was due to a quarter-over-quarter improvement in the Euro and the British pound exchange rates over the U.S. dollar. Absent the currency impact, the balance of our fourth quarter revenue growth was due to the inclusion of the four Vidal Sassoon Academies and the addition of new and acquired beauty salons, partially offset by a 3.8% decrease in overall comps.

The service revenue component, which included a 5.3% decline in service comps, grew 14% overall in the quarter to $38.4 million. Once again, most of this increase was due to currency gains as well as to the inclusion of the Vidal Sassoon Academies. Product revenue also grew, increasing 14% during the quarter, primarily due to currency gains and, once again, the inclusion of the Vidal Sassoon Academies. The strong product comps in the U.K. that we have enjoyed in recent quarters have started to soften coming in at negative 30 basis points in the first quarter. Lastly, royalties and fees from our international franchisees grew just over 9% during the period. I'm going to switch gears now and discuss our gross margin rate. Our international salons' combined gross margin rate improved 110 basis points in the first quarter to exactly 46% of revenue. Our service margin rate improved 30 basis points in the quarter to 46.9%, despite the previously mentioned 5.3% decline in service same store sales.

The margin improvement was due to the inclusion of the Vidal Sassoon Academies in the U.K., partially offset by negative payroll leverage. We also experienced an improvement in our retail product margin rate, which came in essentially on plan at 43.7%, an improvement of 320 basis points over the same period last year. As we had expected, our international product margin rate is improving as we continue to migrate towards a similar product distribution model that we have here in the states. As we've discussed in the past, we are now shipping some product from our distribution center in Chattanooga, Tennessee to our U.K. operations in order to take advantage of our global purchasing power, which this certainly has helped our U.K. product margins. I'll now address the other expense line items for international segment and let me just say that every line item essentially met our plan for the first quarter. There really were no surprises.

Our site operating expense category came in at 5.1% of first quarter revenue. Although this rate met plan for the quarter, it was 90 basis points higher than the same period a year ago. This planned increase was primarily due to the current year inclusion of the Vidal Sassoon Academies. During the first quarter, Sassoon held its annual student recruitment event in Japan, which caused the site operating expense rate to increase as we expected. Our international G&A expense rate also met plan during the quarter, coming in at 18.7% of sales which was an increase of 50 basis points over the year-ago period. This planned increase was due the timing of advertising costs in our franchise business located on the continent of Europe. Next, our international rent expense met plan during the first quarter, coming in at exactly 20% of revenue, up 30 basis points over the same period last year.

Just like here in the states, rent renewal increases over the past year in the U.K. have outpaced our overall same store sales. Our depreciation and amortization expense for international salons came in at 3.9% of revenue, which was in line with our expectations but was 50 basis points higher than the prior year first quarter rate. This planned increase was due to increased depreciation following the completion of recent salon remodeling projects as well as certain salon asset disposals. In total, the net effect of all the factors we just discussed caused our operating income for our international salon segment to come in at $4.1 million or a rate of 6.5% of sales. Next we'll talk about Hair Club for Men and Women. Darryl Porter and his management team at Hair Club continue to run a very consistent business and one that is performing above plan.

Let me very briefly highlight just a couple of items. First quarter revenue from our hair restoration centers increased more than 10% to $32 million, which was $1 million above plan. Hair Club revenues represented nearly 5% of our consolidated first quarter revenue. Our first quarter operating margin rate for Hair Club came in at 21.7%, or 130 basis points stronger than the comparable period a year ago. In addition, first quarter EBITDA margin came in a very strong at nearly 30%. Once again, we remain very pleased with the performance of this segment of our business. Next I'll make a couple of brief comments regarding our beauty schools. As we previously announced and discussed with you, effective August 1st our title four funded beauty schools were merged with and are now managed by Frank Schoeneman and his Empire Education Group.

As a result, our first quarter consolidated results include only one month of the title four school results, which we grouped in our North American salon segment. We then de-consolidated our school business, effective August 1st, and it included the remaining two months of aftertax school performance under a new line item on the P&L called equity in affiliated companies. This line item will not only include the aftertax results of schools, but also our equity interest in other joint venture partnerships including Intelligent Nutrients. We no longer will report school performance under a separate business segment. I'm now going to make a quick comment regarding our first quarter G&A rate that appears in the corporate segment of our P&L. Although our G&A costs came in on plan at 5.2% of sales, this rate was 50 basis points higher than the same period a year ago. The primary reason for the planned increase related to consulting fees paid to Deloitte in connection with our expense control initiative.

With that, that concludes my comments concerning the individual business segments, but I would like to make a comment on our effective income tax rate. We still expect our tax rate for the full fiscal year to be in the range of 34%. However, our first quarter rate came in higher than planned at 35.8% due to implementation of a new accounting pronouncement. As required, we adopted FIN 48 on July 1st of 2007, which was the beginning of our fiscal year. And FIN 48 is titled Accounting for Uncertainty in Income Taxes. The higher than expected tax rate impacted our first quarter earnings by a little more than $0.01 a share. The impact of adopting FIN 48 will cause the tax rate for Regis, as well as most other companies, to fluctuate quarter-over-quarter, rather than being able to expense a constant annual rate. Again, we continue to expect our tax rate for the full fiscal year to be around 34%.

Let me speak to our interest expense and our debt levels. As we had expected, our first quarter interest expense came in at $10.6 million, up from $9.8 million of expense we recorded in the same quarter last year. Our total debt on September 30th stood at $719 million, up $10 million over this past three months. Our debt to capitalization ratio at September 30th remained solidly investment grade at 43.3%. Assuming we repurchase 100 million of stock this fiscal year, we expect to end the year with total debt in the neighborhood of $780 million. As you also know, the cash flow characteristics of our Company are very strong and highly predictable, we're pleased to report that despite de-consolidation of our school business, our first quarter EBITDA grew slightly to nearly $75 million. I have one final item to address. Today's press release includes information regarding our earnings outlook for both the full 2008 fiscal year as well as our second quarter.

We reaffirm our previously issued guidance for fiscal 2008 earnings to be in the range of $2.01 to $2.27 a share. As we discussed with you last quarter, our initial annual comp guidance of 1% to 3% may have been a bit aggressive given the near-term challenge we face relating to retail product comps. Based on first quarter results, we now believe total comps for the full year should be in the range of 50 basis points to 250 basis points. Nevertheless, we still feel comfortable with our initial earnings target due to accretion from recent acquisitions as well as our expense control initiatives.

For our second fiscal quarter of 2008, we believe earnings should be in the range of $0.51 to $0.57 a share, based on a comp expectation of 50 basis points to 250 basis points. The adoption of FIN 48 is going to cause our quarterly effective tax rate to jump around this year, as we just discussed. We saw it happen in our first quarter and as a result our second quarter tax rate is expected to be about 36%, which again is higher than the estimated annual rate of 34%. This higher rate will impact second quarter earnings growth by about $0.02 a share, but this is simply a timing issue, as we will get most of this back with a lower tax rate in the second half of this current fiscal year. That's it. That completes my prepared remarks. Paul and I would be happy to answer any questions you have, so, Mary, can you step in and provide some instructions, we'd appreciate it?

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. (OPERATOR INSTRUCTIONS) Our first question comes from Jeff Stein with KeyBanc Capital Markets . Please go

Good morning, Paul. Just a couple of questions. First, with regard to visitation, you cited the fact that you're beginning to anniversary easier numbers and just kind of wondering in the quarter did you see a year-over-year increase in visitation in your domestic salons?

We were still slightly down. But --

On a comp basis.

On a comp basis. But the -- but 2.7% service comps are very, very strong. And we probably had a average ticket increase of slightly in excess of 3%. So we're marginally down in terms of foot traffic but that's a considerable improvement from being 3% or 4% down in customer count a couple years ago.

And the 3% increase that you saw in average ticket, is that primarily price or is it more related to mix, offering things such as hair extensions?

Oh, it's everything. It's hair color and super cuts. It's price. 82,000 of our salons have price increases. It's hair extensions, which now is a couple million dollar business, $3 million business, probably will be a $6 or $7 million business within the next year. It's just a whole bunch of little things, Jeff.

Okay. And can you talk a little bit about what you're trying to do over the near-term to improve your product sales? Because it seems like you've got some secular headwinds in this business with diversion, the fact that the mass channel is taking share of market and yet it seems that the initiatives, Paul, that you have underway are really very long-term initiatives, things like this -- the retrofit that you have planned and the test that you have planned for Trade Secret. It doesn't seem like this is a fiscal 2008 initiative. So is there anything that investors can look at over the next 12 months that will kind of hold out hope that we might see a pick-up on the product side?

Jeff, I really don't think these new initiatives are long-term at all. We'll be testing within the next 60 days new lines, new assortments. And we'll be putting those new SKUs in many of our Trade Secret stores long before they're remodeled. Also, believe it or not, our Trade Secret business is getting marginally better, not worse. So I think our investors are going to see -- I don't look at it totally negatively at all. The professional hair care category, for all the reasons you mentioned, has had its issues over the last year and we perhaps should have a little bit of self flagellation in that we haven't made these -- we haven't come up with our new plans early enough. But we've identified them now. We've identified vendors. And I think certainly the last quarter, I think you're going to see much improved results, Jeff, and that's not long-term. That's intermediate term.

Okay. I just want to make sure I understand, Paul. When you're talking about bringing in new vendors, are we talking about the beauty care products specifically or are you talking about other professional lines such as Intelligent Nutrients?

No, talking about beauty care products. Talking about face and skin.

Okay, so the beauty care products, they are going to start showing up in the Trade Secret salons in the back half of the year?

Correct.

Okay and just out of curiosity, I mean, it would seem to me that -- let's use Bath and Body Works as kind of a comparable because I would assume that that it's a mall-based competitor and they are very extensively involved in beauty care. How -- I guess how would you intend to compete against a Company like that when your store size would seem to be a limitation in terms of the assortments that you could offer to be competitive across, let's say, a broad spectrum of beauty products, whether it's skincare, shampoos, just the whole range of products that they offer?

Jeff, I think we have to go back to the topics I talked about in our conference call. All these sales will be incremental sales, so it doesn't take that much to really have a significant impact on Trade Secret comps and we'll be thinning out hair care lines. Bath and Body basically is a private label concept. We'll be selling branded merchandise, so I think we're comparing apples and orangutan. We have the locations. The locations are excellent. Over 600 and we're 30-yard line in most of the major malls in the country. So I think our locations and our foot traffic will create a huge opportunity for us to push the needle slightly to the right. That's all we need.

Okay. Thanks.

You're welcome.

Thank you. Next question comes from R.J. Hottovy with the Next Generation Equity Research. Please go ahead.

Good morning, everyone. Paul, quick question for you, just in terms of the diversion data. I don't know if it was referred to at the first part of the call, but the Beauty Industry Fund website doesn't seem to have anything past June of '07. I just wanted to get a sense of where things were tracking in the third quarter there, I guess your first quarter, in terms of that diversion number if we're seeing any improvement on that front.

Whatever is on the website is the most current number. We continue to have Loreal affect us negatively. And yet companies like Joico and Mitchell are doing extremely well fighting diversion. I think it's pretty much same old, same old in terms of I don't think there's anything that's really new in the diversion front other than it gets marginally worse.

Okay. I guess my next question, I guess, just has to do with you talked a lot about the different JVs and taking a different stance over the last couple years it terms of being more open to these strategic alliances. Is there anything else out there that you might be looking at or anything else -- it's probably too early to talk about but what other types of things you may be looking at on that front?

I think we've -- I think most of that, which we even feel we should joint venture with or have extra strategic alliances have already been implemented. We're not working on anything new right now. Okay, I guess that's it. Good luck in the next quarter here.

Thank you.

Our next question comes from Mike Hamilton with RBC Dain Rauscher. Please go ahead.

Good morning, everyone.

Hi, Mike.

Given what's gone on in establishing these JVs expense with IN, can you take a stab at what we're running in one-time cost here and in the big picture, where it's showing up in line items?

Yes, let me take a stab at that. In terms of where it's showing up on line items, on the face of the P&L, I referred to the new line item it's called equity in income or loss of affiliated companies and we had $334,000 loss. Now, that's on an aftertax basis. So that's showing up -- that includes IN, which was the major contributor for the loss this quarter, as well as offsetting, slightly offsetting it with some profit coming out of the Empire school business for the quarter. In terms of overall financial impact, IN continues to sell product to other third party retail outlets, as well as to Regis, and we in turn are selling product to our consumers. In terms of sales, we ended up -- we're probably selling $0.25 million to $0.5 million of product in our salons each quarter, Mike, and once again, we ended up with a net aftertax loss of around $200,000, $300,000 for the quarter. I don't see it -- once again, we've talked about the implementation of the roll-out of the professional line, which I think Paul had indicated will come later in the fiscal year. So I don't see until that launch takes place that there will be much change in terms of revenue or operating impact.

Fair enough. Is there anything worth noting in terms of one-time expense related to either schools or the continental European changes that is showing up there in the quarter?

No. No.

Thanks, that's it for me. All right, Mike.

Thank you. Next question comes from Jon Christensen with Kayne Anderson Rudnick Investment.

You mentioned 3% increase of price and mix. Could you tell us what same store sales growth you need to offset inflation and gain positive operating margin?

2%.

All right. And if I look at your operating margin at above 9% in 2004, 7% last year, 6% currently, we understand that same store sales pressure is a big part of that, but could you give us the other contributors to that decline in order of magnitude?

It's mostly comps. But the -- our franchise business has actually shrunk and that has a much higher margin. 40% some odd margin contrasted to our Company-owned business. And our Company-owned stores have grown faster than our franchise division, in part because we bought so many franchisees back.

Are there other reasons for the shrink in the franchise business besides your purchase? Has the business been less franchisee?

Our franchisees do very well. We've cut back on our growth, Company-owned growth. I think our franchisees have as well, because during the last, three, four, five years we've had reduced visitations and ramp-ups have taken longer and we have more resources, more financial resources than they. But if you take a look at the total franchise stores, coupled with the buybacks, we've had about a 4.5% increase in total units from that franchise division, compounded over the last four years.

And when I look at total system-wide salons in your press release, I see the number for salons constructed going from 420 in June of '07 to 85 in September. I see a similar decline in acquired. What do I read from that?

Help me with it. When you say 422 salons acquired that's for the full fiscal year and you're comparing it to the 85 that we built in the first quarter of this year, I believe.

Okay. That goes a long way to --

Right. Because overall, we continue to expect that our new store construction as well as the acquisitions should be comparable in the current fiscal year with that of last year.

Thank you.

You're welcome.

Next question comes from Justin Hott with Bear, Stearns. Please go ahead.

Hi, just another question on diversion. You mentioned before, Paul, that it was sort of business as usual on diversion. Can you update sort of the strategy you have for when companies divert too much, if any of them are seeing any decreased shelf space so far?

Yes, they are. We moved matrix from a prime spot to a less prime spot and we have -- Justin, we have -- we published on our website those lines that are getting more footage and those lines that are getting less footage.

You also made a decision about hair color as well. Because -- largely because of diversion, where we switch from Loreal color to Wella.

We felt in Regis the Regis division would be better off having one brand. We had split Regis between Matrix and Wella and we obviously picked the brand that we felt was more committed to reduce diversion. It doesn't mean that Matrix hair color won't grow with us in other divisions, but we reward our friends.

What has the response been from some of the suppliers so far as you decrease or give them less prime spots? How are they -- how are they responding?

Some of them are not euphoric.

Are they changing their behavior yet?

No. They say they are but the numbers will dictate.

And can you give us maybe just a little bit more on the Intelligent Nutrients rollout on the brand, some of the discoveries and learnings you've had. How you are working with Mr Rechelbacher so far. Maybe you could tell us -- .

He's an amazing man. And we have ground-breaking products. We're right there in terms of all the [fixidus]. They're done. And we're in the final stages, hopefully, of coming up with a shampoo and conditioner. And his objective is to have 100% of it food grade organic and we believe that 90% somewhat of the SKUs will be 100% food grade organic and nobody has that in the world. There may be some SKUs where we'll be organic but not totally food grade organic. But he's going to -- we're going to have something very special, very unique.

Paul, just one more question. Just for people out there, the phantom salon concept, things like Ulta, the large 10,000 square foot store plate, something people are paying close attention to right now. Can you talk about how you think -- we're not talking thousands of stores, but can you talk about how you think that could affect your business over the next -- over the long-term, next five years?

It's not only Ulta. It's Victoria's Secret. It's become a more competitive category. Shampoo is not -- it's like Starbucks in coffee. Coffee was nothing years ago. And really the shampoo business was a commodity business 15 years ago. And now it's become a hot category. So there's more competition. Ulta has a big box, 10,000 feet is -- that's $3.5 million, $4 million. That's an awful lot, Justin. We like our lower risk footprint. We think it's a lot easier for us to continue to grow and have a model that works long-term. But I'm not here to throw stones at Ulta. They've done a good job. We'll do fine. Anybody who sells shampoo competes with us, whether it's Ulta or whether its Banana Republic.

I'm thinking more about the large floor plate with a couple of salon chairs in there as well, too.

Yes, but I'm not terribly concerned about that.

Can you just flush out a little bit more of why? Outside of that you have 12,000 stores and -- .

Once again, we just -- if we continue to add 500 to 1,000 stores a year and the locations are good, we'll get our fair share, especially now when we're morphing into beauty. This is not something which we're trying to invent. We're not inventing the wheel here. Some of our competitors have done it and done it extremely well. And we'll do it even better. We know what has to be done. It's a question of cherry picking the lines. Jeff Stein's comments are right on the mark. We have a smaller footprint so we just going to have to be a lot smarter, but we will be.

Paul, one more question I guess on long hair. Can you talk a little bit --

I hate long hair, Justin.

It's in your press release, I understand.

Yes, I know.

You put it out there. I'm going to ask. And just with the comment, I'm seeing some of the things you're saying now on the trend. But some of the things I see worry me about them just being a part of change in season and people wanting a change in hair style. Can you point to something in your data that would give us more comfort that this trend is ending?

Yes, 2.7%.

More than that. More than what we saw today.

In our business, the numbers mean everything. And if you have 2.7% North American service comps contrasted to 0.5% the year before, then more people are coming in more often to get their haircut. It's as simple as that. The numbers tell everything in our business. When you have 12,000 stores, you only have -- the only thing you can look at is the numbers.

Any signs in October that this is sustainable, it's not just a one quarter so far, that's it's really going to go.

Our service comps continue to be just fine.

All right. Thank you very much.

Thanks, Justin.

Thank you. (OPERATOR INSTRUCTIONS) One moment, please. Our next question comes from Justin Boisseau with Gates Capital Management. Please go ahead.

Hi, thanks. Did you repurchase any stock in the quarter and what are your plans to repurchase the rest of the year? Is it going to be sort of equally distributed through the quarters or do you have a particular time period when you think you'll do most of it?

We did not repurchase any stock in the quarter because we were precluded from trading in the stock because of the Provost joint venture that we were setting on here. So absent that, we still are planning on repurchasing $100 million worth of stock and I would just assume that it would come ratably throughout the remaining three quarters. Having said that, if we find that the opportunity presents itself for us to get a little more active, based on stock price, we may do it sooner. If we find acquisition opportunities that come our way above the $75 million that we budgeted for the year, we may do less of it. But at this point we're still looking to repurchase $100 million over the next three quarters.

Your outlook for 780 of debt at the year-end, it looked like an update on the numbers I had. I thought I had something closer to 660. Has something changed there?

We ended the year at 709, just three months ago. So I don't know where the 660 was.

Okay, that may have been my fault. One more thing on traffic, I just want to make sure I was clear. You all talked about the improvement in the service comp but traffic was down, right, for the period, year-over-year?

On a comp basis, slightly down.

Okay, thanks.

Thank you. Next question comes from Daniel Hofkin with William Blair. Please go ahead.

Good morning, guys. Just a quick question on first on the comp trend and the improving trend that you're seeing in service. Is that exclusively, would you say, in customer traffic or has there been some increased ability to move product or cost or mix up or is it primarily traffic so far?

It's price, it's new services, it's combination of a whole bunch of things.

I'm just looking in terms of the sequential acceleration. It's all of that? It's not just that the traffic is getting closer to flat?

It's all of that.

Okay. And then with regard to just the guidance in the back half and the -- or in the last three quarters and the comp sales, is the slight change in the comp guidance strictly on the retail product side? Because if anything -- ?

Totally.

Would I be correct in inferring that the service business, if anything, is a little bit ahead of what you would have expected three months ago?

You are correct.

Okay. Thank you.

Thank you. Next question is a follow-up from Jeff Stein. Please go ahead.

Randy, just a follow-up question on G&A. You indicated in your presentation that there were some consulting fees in the first quarter numbers and I'm just kind of wondering, have you kind of identified a chunk of expenses that you could perhaps quantify that we could maybe look forward to on an annualized basis upon seeing a reduction at some point this year and when did the consulting fees begin to disappear.

That's a good question, Jeff. Deloitte -- we're asking Deloitte to really scale back and hand the reins to us at the end of this calendar year. So I think you're going to see a precipitous drop in the consulting fees beginning January 1. We've got a lot of very good, and I mean very good momentum going here at Regis on a number of fronts in terms of cost savings. What we're finding is that certain things have been implemented, certain cost saving ideas will be implemented this year and so we're not going to enjoy the full benefit of the annual run rate. Certain things as well, Jeff, we've seen a cost saving initiatives that over the next several years they're going to be phased in and the savings will continue to accelerate. In terms of this current fiscal year, we've got $4 million to $8 million of gross savings that we're estimating and I hope it may be larger than that. But I'm not going to create that expectation. $4 million to $8 million of savings. We will be paying Deloitte about $3 million of that. But again, the Deloitte costs go away and savings will continue to accelerate in the future. We're also -- when you look at G&A, one could assume that all of the savings will flow through G&A. The cost certainly does to Deloitte. But as a matter of fact, much of the savings will appear in other line items of the P&L, maybe it's in the form of interest expense when we reduce inventory carrying costs. It might be in the site operating expense line item and even the depreciation expense line item.

Got it. And could you care to just take a shot at the kind of the annualized run rate that you hope to achieve by the end of this year?

Over 10 million.

Over 10 million. Okay. Thank you.

Our final question is a follow-up from John Christiansen. Please go ahead.

What is your average store age and how does your same store sales vary by store age?

Should have had that question. Had to laugh, we should have -- stop laughing. We're just fine. I don't know we'll come back to you with that number. It's a very difficult number to compute because of so many acquisitions, so we have to go back to see when those acquired stores were built and when they were remodeled. But obviously comps with respect to stores that are fully mature aren't as strong as stores that are two or three years old. But we'll get back to you.

We do see -- I mean, it's intuitive that 350 to 400 stores that we built from scratch, on average it takes five years for a store to reach maturity. Some are faster. Some are a little bit longer. But on average, five years and we do see in terms of total revenue that after the first year it's about 60% of the way there of mature revenue and then it adds about 10 points a year for each year thereafter. So Paul is right. We do see that as we open up new stores you get a bigger boost of comps in the earlier years as they're in the maturation cycle.

And once a store is open five years and you could consider it mature, do you still get increased customer visits per store?

Yes, but at a modest basis. Again, I don't want to say the last couple, three years is indicative, because it's not. But we used to see for example our largest and most mature salon concept is our flagship concept of Regis Hair Stylists. And we would see that the Regis Salon division was still comping positive but modest, largely because of increased traffic, not necessarily price increases.

Fully mature stores.

Fully mature stores.

If I look at customer visits per store as sort of a capacity utilization measure, has there been a consistent trend? What is the range and where are you today?

Well, you've talked, Paul, in the past about capacity is really tough in this business because of -- .

Yes, because Monday mornings you can shoot a canon through them. I don't think it's a significant issue for us. It's not a matrix that we utilize.

Thank you very much.

Thank you.

Thank you. There are no further questions. We'll turn it back to you, Paul. Please go ahead.

Thank you, Mary, and thank you all. Have a good day.

Thank you. Ladies and gentlemen, that will conclude today's teleconference. If you wish to access the replay for this call you may do so by dialing 1-800-405-2236 and enter the access code of 11097199 followed by the pound. This concludes the call. Thank you all for participating and have a nice day. All parties may now disconnect.