Regis Corp (RGS) 2010 Q2 法說會逐字稿

Good morning, my name is Sarla and I will be your conference facilitator today. At this time I would like to welcome everyone to the Regis Corporation second quarter 2010 conference call. All lines have been placed on mute to prevent any background noise. If anyone has not received a copy of today's press release, please call Regis Corporation at 952-806-2154 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 800-406-7325 using access code 419-4363 followed by the pound sign. The replay will be available 60 minutes after the conclusion of today's call.

I would like to remind you that to the extent the Company's statements or comments this morning represent forward looking statements, I'll refer you to the risk factors and other cautionary factors in today's news release as well as the Company's SEC filings. Reconciliations 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 and 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 Mr. Paul Finkelstein for his comments. Paul, you may now begin.

Thank you, Sarla, and good morning, everyone. Thank you for joining us. I would like to apologize in advance in the event I start coughing. I'm getting rid of a cold. We're pleased to report second quarter operational earnings were ahead of plan at $0.28 a share versus $0.27 last year after adjusting for the impact of our recent equity and convert offering. The second quarter did include a non-operational benefit of $0.02 a share related to an adjustment in insurance reserve that Randy will talk about during his portion of the presentation.

As we mentioned in our first quarter conference call, the second quarter also saw a continuation of customer and business trends that we've seen during the last several quarters. The second half of December was stronger than the first half, even though we were significantly affected by the Saturday snowstorm that occurred just before Christmas. In this challenging economy our management team has been quite proactive in increasing average ticket, enhancing gross margin, reducing expenses and closing under-performing salons.

During the second quarter consolidated gross margins were much better than planned and improved 70 basis point compared to last year, primarily the result of the recently implemented leverage pay plans, as well as reducing retail product commissions. We continue to see improvement on the expense side in many other categories including travel and marketing costs and administrative head count. Our efforts to increase average ticket, through a combination of price increases and by selling add-on services and products, continue to produce strong results.

Second quarter average ticket was up almost 4%. Maintaining and strengthening our balance sheet by continuing to build cash and improving liquidity remains a top priority. Customer visits continue to be a major challenge. Compared to the prior year, North American average service ticket was up 3.7% in the quarter while customer visits were down 7.8%. Customer counts were down 6.7% in value and 11.5% in the higher-priced point Regis Division. As I'll discuss in a minute, we are starting to see some positive signs and we're expecting to see improvement in comps in the second half of the year.

Long term, our growth and earnings is primarily dependent upon increased sales. While we forecast continued expense control and gross margin enhancement, the major focus has to be on increasing our top line. There are two questions that obviously have to be asked and commented upon. First, are we losing market share? The short answer is no. We are not. Three weeks ago I was in L'Oreal's offices in Paris with the head of its worldwide professional division. L'Oreal is by far and away the leading company in the beauty industry and they constantly monitor salon visits by country. All of their data indicate that worldwide, salon visits continue to be a challenge. We believe the industry is nearing the tail end of a 5% to 10% worldwide contraction due to reduced visitations, which is primarily the result of a more frugal customer. The issues we are dealing with are impacting the entire salon industry, not just Regis.

The second question, which I've already referred to, is when will visitation patterns normalize? While we don't have a crystal ball and we can't predict whether or not that will be in the third quarter of our fiscal 2010, or the first quarter or second quarter fiscal 2011, it is inevitable that it will happen. And when it does, the industry should resume its 2% plus annual growth rate. In the event that we will negatively comp this year, it will only be the second year in our 88-year history where we will have had negative comps. There continues to be no evidence of consumers trading down in service or product, and our sweet spot value continues to become a larger part of our overall business.

There are some recent positive developments that I would like to share with you. First, our UK business started to show significant strengthening in the second quarter. Comps in the UK were down a modest 1.6% against a 10.7% decrease a year ago. The UK retail economy has been in the doldrums for over three years. We've had a dramatic change in our business and our results are ahead of plan in the UK. Likewise, in North America we're seeing more and more days with positive comps, which has not been the case for many months. In fact, comps over the last three weeks have been flat. Also, our Hair Club comps are improving significantly. They were flat for the quarter against a 1.5% decline a year ago. For the first time in two years, retail performed better than service. Supercuts in particular had positive 4.7% retail comps for the quarter. We have new initiatives in the retail arena, where we are adding impulse items at price points that are quite affordable. Lastly, the current fashion books such as the February issue of Elle, are showing more style than cut hair in their ads -- and the ads are the things to look at.-- that I've seen for quite some time.

Last year has been a year of transformation for Regis. Today we have a leaner Company that is focused primarily on value, and that is a good strategy for us in the long term. We believe there are significant opportunities in our franchise business and we are being more aggressive with respect to growing this business. A little bit of self-flagellation is in order as we have not made some of the progress that some of our franchise competitors have made in recent years. We're changing that. In markets where we are extremely strong, like Boston, we feel there are significant opportunities to expand. We're going to aggressively sign leases and give those opportunities to existing and new franchisees. And we're more than prepared to step in and have Company-owned Supercuts stores in the Boston market in the event that we cannot add a franchise operation.

As I have mentioned many times before, ours is one of the few companies in retailing that does not have a ceiling. We certainly have all of the liquidity and resources to resume our expansion strategy once comps normalize. At that point in time, we should be building 400 salons a year and buying 400 salons a year with our franchisees growing as well.

We certainly will not resume this level of expansion until comps normalize. However, we will be opportunistic in markets where we are strong because the business model works extremely well for both Company-owned and franchise locations in these strong markets. Individual investors have asked why we don't make more acquisitions at this point in time and the answer is quite simple. If a 50-salon chain is experiencing 3% negative comps, their profits are probably going to be down 15% or 20%. Thus we'll wait a year until comps normalize and buy it cheaper. We have the ability to wait it out as there are no other purchases and there's no reason to pay a 15% premium in the event that profits go down 15%. Likewise, we feel strongly that many of our landlords have not adjusted to the new retail environment. And until rents are reduced significantly in the places in which we want to be located, we'll be curtailing on new builds. More additional salons will close in the UK during the second quarter and there are plans to close 13 more in the current quarter. We should be finished with our negotiations to close or get significant rent relief in the UK by the end of March. We expect to realize approximately $2.4 million in annual cash savings once the project is completed. We also rebranded 41 Hair Express salons to Supercuts or Regis and have seen significant improvement in sales and profits.

I'd like to now talk about our investments in Empire Education Group and Provalliance. Both companies are doing extremely well. Empire Education sales and EBITDA in fiscal 2009 were $150 million and $16 million respectively, and are on track to grow to $170 million in sales and $20 million in EBITDA during this fiscal year. Likewise Provalliance, which include Jean Louis David and Franck Provost salon operations, expects to meet its 2009 EBITDA projections, and is forecasting positive comps of approximately 2% in 2010 with significant growth in EBITDA.

As we stated in our press release, we now believe EBITDA may come in towards the higher end of our previously stated range of $200 million to $240 million. And at this level, we should produce excess cash flow of at least least $90 million, which will be used to pay down debt and build cash reserves. I know that we have been talking about the visitation problem for three or four years and the story does become old, not only for investors, but for me as well. It is, however, inevitable that visits will normalize. People have to get their hair cut and colored on a regular basis. The sole issue is when visits will normalize, and we see enough positive signs that make us quite confident that by this time next year our results will be much better.

We believe our strategy is appropriate so we will continue to focus on value. We can't force customers to come in more often, however, we can make sure that the customer experience is as good as it possibly can be so that when they return, they return to us. We continue to be very bullish about our future. It is inevitable that this industry, which is an enormous industry -- $150 billion to $170 billion worldwide -- will stabilize. We're extremely well-positioned strategically to grow our Company when visits do normalize. Our balance sheet is extremely strong, the business model is still very attractive, buying and building salons have extremely rates of return. We're ten times larger than our nearest competitor and yet only have a 2% worldwide share. Our stock price is quite important to us, and with our stock trading at 12 times Street estimated this fiscal year EPS, versus an historical multiple of 17 times, and with free cash flow per share of $1.70, we think that our future is bright indeed. And our shareholders should be able to benefit in the long term.

Randy will now continue.

Thanks, Paul, and good morning, everyone. Overall I believe we've had a relatively straightforward quarter. Today we're reporting second quarter fiscal 2010 earnings of $0.30 a share which includes about $0.02 of non-operational benefit associated with an adjustment to our prior year worker compensation and insurance claim reserves. Therefore, on an operational basis, we're reporting second quarter earnings of $0.28 a share, up slightly from our operational results of $0.27 that we reported last year on our second quarter, after you adjust for the impact of our recent equity and convert issuance.

For many years, we've talked about the direct correlation of our earnings with our same-store sales performance. With our actual comps declining 3.7% during the second quarter, we would have expected our operational earnings to be about $0.20 a share, which included an incremental $2.5 million or $0.025 per share of planned cost savings that we discussed with you in recent quarters. Therefore, our operational results of $0.28 a share are about $0.08 higher than what our comps would indicate. The $0.08 of upside came from strong expense control, including gross margin enhancement.

Our service and retail product margins came in about $0.03 per share better than planned during the second quarter. In addition, our site operating and G&A expenses were about $0.03 favorable to plan on an overall basis. Earnings from our equity investments exceeded plan by about $0.01 a share, primarily due to the performance of our European salons managed by by Franck Provost. Finally, our effective income tax rate came in favorable to plan by about $0.01, and I'll address each of these items with you in more detail a bit later on. As always, we've included in today's press release as well as on our Corporate website, a concise reconciliation that bridges our reported earnings to our operational earnings for both the current year and the prior year second quarter's. Also, feel free to contact Mark Fosland or Alex Forliti here at the Regis Corporate office should you have any questions regarding our financial models.

I'll now transition my comments by giving you a bit more detail behind our second quarter operating results for each of our business segments. A break-out of our segment performance is once again found in today's press release. My comments this morning are going to focus on our operational performance, and I'll begin with our largest segment, which is our North American salons.

Please remember that our former Trade Secret results have been removed from the prior year individual revenue and expense line items on the North American segment P&L, as required by the discontinued operations accounting treatment. As we've discussed in past quarters, Regis has agreed to provide certain transitional support services to Premier Salons, the company that now owns Trade Secret. These services included the sale of certain retail products to Premier at Regis' cost for a limited period of time. These product sales to Premier effectively ended this past September 30, the end of our first fiscal quarter. As a result, beginning in the second quarter, you will no longer see the revenue and the related offsetting cost on the face of our P&L.

Our total North American salon revenue, which represented 87% of our consolidated second quarter revenue, declined 2% during quarter to $500 million. This revenue decrease was the result of a decline in total same-store sales of 400 basis points, partially offset by revenue from Company-owned salons that were built or acquired over the past year. Service revenue declined 240 basis points during the quarter, to $390 million. This reduction was due to a decline in service comps during the quarter of 4.1%, partially offset by revenue from new and acquired salons over the past 12 months. Our same-store service sales continued to benefit during the second quarter by an increase in average ticket of 3.7%, in large part due to price increases that we implemented during our third fiscal quarter of our prior 2009 fiscal year. However, more than offsetting the increase in average ticket was a 7.8% decline in same-store customer business during the quarter as many consumers continued to lengthen their salon visitation patterns due to the economy.

Our retail product revenue fell 1.8% in the quarter to $101 million due to a decline in product comps of 3.7%. Second quarter royalties and fees from our North American franchise salons were $9 million, flat to the same period a year ago. New franchise units that were added to the system over the past 12 months were slightly more than the total number of franchise buybacks, franchise unit closures and relocations during the same period of time. In addition, our franchise salons continued to experience the same general weakness in consumer visitation patterns and same-store sales trends as our Company-owned concepts.

And let me make one anecdotal comment regarding our North American salon revenue. As Paul mentioned, our value-priced salon concepts are performing much better during this recession than our higher priced salons. To illustrate, service comps in our value concepts were off just 2% in the December quarter compared to a much larger decline of 9.3% in our higher priced Regis salon division. Although our Regis salons remain quite profitable, the level of profitability has understandably declined in recent years due to general economic conditions. Rest assured that our operating people continue to focus on a variety of initiatives to increase sales and improve profitability.

I'm going to now speak to our gross margins, and I'm very pleased to report that our combined gross margin rate from North American salons came in better than planned at 43.8%. This rate was 50 basis points better than the rate that we reported last year in the second quarter. And as I'll discuss in a moment, the growth in overall margin was the result of both service as well as product margin rate improvements. Our second quarter service margin rate came in better than planned at 42.4%, and was 40 basis points better than the rate we reported in the same quarter last year. The primary reason for this improvement was reduced salon labor costs. As each of you know, salary and commissions paid to our salon stylists represent our single largest expense category, and our operational control over salon payrolls continues to be excellent. During the second quarter, we continued to realize benefit from new leverage pay plans that we implemented this past year in many of our salons. Partially offsetting this improvement was a slight increase in salon health insurance costs that we had planned for.

Looking forward to the balance of our current fiscal year, we expect that our service gross margin rate should be at or slightly better than the rate we reported in our second quarter. Our retail product margin rate for the second quarter improved to 49.5%, which was 100 basis points above the same period a year ago. There were several factors contributing to the improvement in rate, many of which we continue -- we expect should be continued to be realized in the future. One major item contributing to the rate improvement was our continued focus to work with product vendors to improve our gross margin on those products we choose to promote. We discussed this initiative with you in the past. As we've also discussed, our product margins are benefiting from our recent initiative to pay new stylists an 8% commission rate on their product sales rather than the historical rate of 10%. As we look forward to the balance of the current fiscal year we expect product margins for our North American salons should approximate 50%.

Let me now address our site operating expense, which includes costs directly incurred by our salons, such as advertising, insurance, utilities, and janitorial costs. Our site operating expense in the second quarter came in better than planned at 8.5% of sales, which was 10 basis points higher than the rate we reported in the same period a year ago. As I mentioned earlier, second quarter site operating expense benefited from an unplanned reduction of $1.9 million or $0.02 a share due to prior year accruals for our workers compensation and insurance claim reserves being adjusted. This reduction was made following a periodic review by our independent insurance actuaries. As we've discussed with you over the past several years, our actuaries have allowed us to record significant reductions to our workers comp insurance reserves due to the effectiveness of our aggressive salon safety and return to work programs. Also remember that last year in our second quarter we also recorded a reduction to our insurance reserves, resulting in a $6.7 million pretax benefit.

Cleansing, both this year and our prior results of the workers comp benefits, our site operating expense rate improved 90 basis points in the second quarter. We had planned for all of this improvement. As we discussed with you during past conference calls, certain expense items which had previously been categorized within our rent expense have now been appropriately reclassified into our site operating expense. These items primarily related to utilities and rubbish removal costs for which Regis pays its landlords as part of our lease agreements. You may recall that last year in our second quarter, we made a reclassification that included amounts for both the first and second quarters, and therefore the prior-year rate was about 85 basis points higher than normal. In addition to the impact of this reclassification, site operating expense benefited in the second quarter from certain cost saving initiatives in areas such as freight expense and salon repairs. These cost savings essentially mitigated any negative leverage from declining sales and inflation.

Next we'll talk about our North American G&A expense, which came in at exactly 6% of revenue during the second quarter. This rate came in on plan and was 10 basis points above the rate we experienced in the same period last year. We would have expected to see some negative sales leverage in this expense category during the second quarter. However, continued focus on expense control, and reduced year-over-year marketing costs allowed us to keep North American G&A relatively flat as a percentage of sales compared to the same period last year. And let me make one final comment on North American G&A. Many of you monitor the sequential run rates of this category, and you'll notice that North American G&A was up about $2 million in the second quarter compared to the preceding first quarter. Our first quarter G&A is generally a little lower than the remainder of the year due to the timing of certain marketing and advertising programs. Rent expense, which is primarily a fixed expense, came in at 14.6% of total second quarter sales, which was 100 basis points above the rate we reported last year in the comparable quarter.

As I just discussed, the six-month reclassification of certain expenses from rent into site operating expense favorably reduced last year's second quarter rent rate by about 90 basis points. In addition, the negative leverage in this fixed cost category caused from reduced sales volume is being largely offset by a reduction in our percentage rent payments, also the result of reduced sales levels. Depreciation and amortization came in essentially on plan at 3.6% of sales, equal to the rate we reported last year in our second quarter. Our reduced level of capital and acquisition expenditures during the past 12 months is serving to slightly reduce our D&A expense, which in turn is helping to offset the negative leverage from reduced same-store sales. The net effect of all the items I just discussed, caused our operational operating income to come in at 11.8% of sales, that's up 30 basis points from the rate of 11.5% we reported last year in our second quarter.

Next let's discuss the second quarter performance of our international salon segment, which includes our Company-owned salons located primarily in the United Kingdom. We're very pleased that our comps came in better than planned during the quarter and significantly better than last year, declining 1.6% versus a decline of 10.7% last year. We remain focused on improving our overall profitability. For example, second quarter results were favorably impacted by strong payroll management, aggressive expense control and through the closure or obtaining lease concessions for unprofitable salons. These efforts continue to pay dividends, as we have improved our UK operational profitability, with second quarter operating margin coming in at 4.7% of sales, up from an operating loss of 2.3% of sales in the second quarter last year.

Today, I once again plan to provide some brief commentary behind the quarterly change in revenue and also give you some high level comments on any expense categories that may have surprised us during the quarter.

Once again, those of you who build segment models may want to give Mark or Alex a call here at Regis and they can help you further. Total revenue from our international segment represented 7% of our consolidated second quarter revenue and came in at $40 million in the quarter, a reduction of $1 million from the same period a year ago. The slight drop in sales quarter-over-quarter was due to the decline in same-store sales of 1.6%, as well as a reduction in revenue following the closure of 48 underperforming salons in the UK over the past year as part of our UK store closure initiative. Partially offsetting these declines was a favorable foreign currency impact. Improved service and product margins contributed to an increase in the combined overall gross margin rate of 310 basis points versus last year. Service margin improved 200 basis points over last year, and was due to a few factors, including improved operational payroll control, as well as the benefit from closing underperforming stores. Let me now address retail product margins in a little more detail.

As we've previously discussed with you, our expectations going into our our current 2010 fiscal year, was for international product margins to improve to the mid-to high 40% range due to a number of recent initiatives. Product margins have indeed improved. In our preceding first quarter we saw our product margin rate grow to exactly 49%, and we're pleased to say that we posted the identical rate of 49% here in the second quarter. Looking ahead to the second half of our fiscal year, we expect that our international product margin rate should remain near the current level of 49%. I'm now going to discuss Hair Club for Men and Women.

Our Hair Club business performance remains strong, but as we've discussed last quarter, the economy is having a slight impact, with second quarter comps up slightly. Let me highlight a couple of items. Revenue from our hair restoration centers came in at $35 million in the quarter, up 2% over the same period a year ago, and represented 6% of our consolidated second quarter sales. Second quarter operating margin rate for Hair Club came in at 14.7% which, as we expected, was down from the rate of 18.3% we recorded last year in the second quarter. The largest reason for the decline in operating margin rate was an increase in advertising during the second quarter. Hair Club's second quarter EBITDA margin came in at just over 23%.

I'm now going to switch gears and make a couple of comments regarding our corporate G&A expense. The major component within our corporate G&A continues to be salaries and related benefits for the more than 700 employees working here in Minneapolis and the 500 associates that work in our two distribution centers. Centralized back office support functions provide leverage on our operating model. As I've said before, our Company-owned salon counts have continued to increase over the past five to six years at a much greater rate than our corporate home office head office. Despite this leverage, we continue to be very aggressive with expense control during these challenging times of slow sales growth.

Our second quarter corporate G&A expense came in a bit better than planned at just under under $31 million, and was comparable to the amount we reported in the same period a year ago. Barring the impact of any timing issues, we generally expect our corporate G&A to be in the range of $31 million to $33 million each quarter. We continue to aggressively manage our G&A expenses and we continue to be pleased with our results. Let me make one reminder type comment to you regarding our corporate G&A.

This expense category in the second quarter included $1.1 million of home office and distribution center costs related to providing transitional back office support to our former Trade Secret salons. As we've discussed with you in the past, Premier Salons, who once again owns Trade Secret, is fully reimbursing Regis for all costs that we're incurring on their behalf. However, accounting convention requires that this expense reimbursement be included in our P&L under Other Income rather than being netted against our G&A expense.

Now that concludes my comments regarding business segments. And I'd like to move on now to our investments, which are reported on the P&L line item called Equity and Income of Affiliated Companies. This line item includes the after-tax results of our investment in businesses such as Empire Education Group and Provalliance. Let me quickly say that we are pleased to report that our share of the second quarter earnings in these equity investments grew to $2.7 million on an after-tax basis. Both businesses are posting results that are ahead of plan, and are up from last year.

Let me now make a couple of comments regarding our effective income tax rate, which came in about 300 basis points better than we expected in the second quarter, at 36.3%. There were two primary reasons. The first related to a higher than anticipated amount of workers opportunity tax credits. And the second item related to a true-up or our Canadian income tax provision following the filing of that tax return. Looking ahead, we anticipate that our underlying tax rate for the second half of our 2010 fiscal year should be in the range of 39% to 40%.

Our balance sheet continues to be in great shape. Today we have no borrowings under our $300 million revolving credit facility. We have no liquidity issues, we continue to be in good standing with all of our financial debt covenants and we have plenty of covenant cushion. At December 31, total cash has increased to $114 million and total debt declined slightly to $470 million over the preceding quarter. Anecdotally, let me also say that our total debt of $470 million includes our recently issued convertible notes, which have generally been trading above the strike price. Assuming these notes were all converted today to equity, our debt is actually less than $325 million.

And I have one last item. As we look forward to the remainder of the current fiscal year, our outlook really hasn't changed all that much. We still expect same-store sales in the second half of our fiscal year to be better than the first half. As we are now halfway through our current fiscal year, we expect that comps for the entire year may likely be closer to the low end of our previously stated range of negative 3% to positive 1%. However, let me reiterate a comment Paul made. Due to strong expense control and gross margin enhancement, our EBITDA in fiscal 2010 may come in at the high end of our previously stated range of $200 million to $240 million. As a result ,we're budgeting to generate excess cash this year of $90 million or more.

So that's it. That completes my prepared remarks. And Paul and I are now happy to answer any questions you have. So Sarla, if you could step in and provide instructions, we'd appreciate it.

(Operator Instructions). Our first question comes from Lorraine Hutchinson from Banc of America/Merrill Lynch. Please go ahead.

Hi, good morning, this is Rick Patell in for Lorraine. Could you just provide some color around your January comp improvement? Can you point to any difference between the service and product comps? And secondly, did you do anything differently in the business in the new year that you didn't do during the second quarter to get people in the door?

The -- we're quite pleased with respect to our product business. Our product business continues to be stronger than our service business. And that's the main reason for the pickup in business. The -- any changes with respect to customer visits and the like in this industry, Rick, become -- are really glacial. It isn't as though haircuts are on sale and 1400 people come barging in a particular salon door. It just doesn't work that way. But we're very pleased with what is happening in the retail environment in terms of the [regional product] environment.

And did the January comp improvement occur across the chain or did you see pockets of improvement in certain regions, in certain areas?

No. It is getting better all over.

Great, thank you very much.

You are welcome.

Thank you. Our next question comes from Paul Lejuez of Credit Suisse. Please go ahead with your question.

Thanks. It is Tracy Kogan filling in for Paul. Just a quick follow-up on January. What is the traffic versus the ticket there? And then secondly, for the December quarter, just looking at the performance of your value concepts it was better than the overall results. But just wondering about the SmartStyle results and if you could give more color on the comp there, and if there are any things you are doing at that concept maybe to drive traffic. Thank you.

Well, our locations in SmartStyle -- in Wal-Mart are by far the best locations in the entire system. I mean, we're right in front of the store so we have plenty of Wal-Mart traffic. The -- in part, the Wal-Mart comps throughout the years have been very, very strong. And so we're just meeting up -- we're just meeting very, very strong comps from -- from several years ago. The Wal-Mart business is extremely strong. It is quite profitable. And we'll continue to grow with Wal-Mart. And so if you have a two or three month period of time where -- where business is somewhat flat, it -- it doesn't create any major concern for us or our partner in Wal-Mart --

And to address the first part of your question, I think in Paul's earlier comments he indicated that in the last several weeks comps have been essentially flat. What we're seeing average ticket continues to be up 3, 3.5% and so what it's really saying is that customer declines have improved. As we've said in the first -- in the second quarter, customer counts were off close to 7.5%, 8.5%, which means in the last they weeks they are down maybe 3.5%.

Great, thank you.

You are welcome.

Thank you. Our next question comes from Bill Armstrong from CL King & Associates. Please go ahead with your question.

Good morning. Paul, you mentioned lower commissions and we -- we've been seeing that, I guess for a few quarters now, helping margins. What's the rate of employee turnover among your stylists? So I know that the commissions -- the lower commissions are only for new stylists. So I guess I'm trying to get a sense for how long of a tail do we have where we'll continue to see benefits from that?

Oh, quite a long time. We have turnover of about 40% a year. The industry has turn of about 60%. And our turn is overstated because if somebody goes from one branch -- from one store to another, that is a turn. And if somebody does go from one store to another, obviously we don't affect that person's commission rate. But there should be a betterment over the next two or three years. Because once again we're turning our workforce about 35%, 40% a year.

Right. And can you just remind me, is that lower commission just on product sales or is it on service also?

Well, commissions on product went from 10% to 8%. The -- the question with respect to service is a far more difficult one to explain because we have a myriad of commission arrangements. But basically what we're trying to do is get leveraged payrolls in terms of increased -- increased sales will generate a higher margin for us because the hair stylist will still make more dollars but a lower percentage commission on the incremental business. I do not know if I'm explaining it appropriately, but at least --

Yes, yes, I remember this now.

Okay.

And then one other question for Randy. I think, I missed in the corporate G&A you had some Trade Secret transition cost. How much was that?

I think it was $1.8 million is what I said, Bill.

$1.8 million. Okay great. All right, thanks.

You are welcome. And bill, I just want to clarify the offsetting reimbursement is in Other Income. So overall, there is no overall cost to Regis.

Understood. Thanks.

You're welcome, Bill.

Thank you. Our next question comes from Erika Maschmeyer from Robert Baird. Please go ahead with your question.

Thanks. Good morning. Anecdotally, is there anything that you think could be behind the differential in trends you are seeing in January from December? I mean, is it mostly comparisons?

Well, three weeks does not necessarily make a real difference, and I would be far more comfortable when we have three or four months of flat comps or positive comps. It -- it's really difficult to make a decision, to make any kind statement concerning what happened in the last three weeks. Obviously, we're gratified. It's about time. Eventually, visitation patterns normalize. We don't expect them to go back to the old rate. Let me give you an example. In -- in Portugal, two years ago the average woman went eight times a year to a salon. Last year the average female in Portugal went 5.4 times a year. I mean that is a tremendous decline. Now in fairness, customers, -- clients, female clients in Portugal and Spain do go more often to get their hair blown dry, for instance. And so it is sort of an unfair comparison. But eventually it does normalize. And we think we are close to a normalization.

You think your trends are closely tied to unemployment?

No. I think they are tied to the fact that the consumer has become more frugal. If you look at the spa business, the spa business nationwide is off 25%. And people are just spending less money on those kinds of [casual] luxuries. Now, especially if you are unemployed and if you have a job interview, you want to look good. And so some guy having a job interview is not going to wear a pony tail. I mean, that would be absurd.

No. That makes a lot of sense. And then I guess, could you give us more detail on your thinking behind expanding your franchise business? How much do you think of your kind of 2011 expansion could be franchise versus Company-owned acquisitions?

Well, as I mentioned in my transcript, we're going to be far more aggressive in markets where we have a tremendous share and tremendous strength -- Northern New Jersey, Boston, Los Angeles. There are plenty of markets where we're extremely strong and we're going to sign a bunch of leases, and it -- and it is really appealing to new franchisees because the brand is already established, so the returns are really quite strong. Now having said that, financing today continues to be a problem for our smaller businesses. Not a problem for people like -- for companies like ours, but that's the issue. So, I mean, we're going to -- we've always been very, very good partners with our franchisees. We'll continue to be good partners with our franchisees. But it is in everyone's best interests, especially our franchisees, if we are able to -- to aggressively build those brands. Let's not forget we have ad funds and ad funds are dependent upon volume. So the more volume we do, the more money we have to spend to really merchandise these brands:

Thank you. That's helpful. And then in terms of what you are doing to increase your add-on sales and adding impulse items, was that something that was new for Q2? And can you talk a little bit more about that?

Well, as I mentioned, the -- we're experimenting with an awful lot of impulse items. The main drivers of our sales betterment in product are a small line called "It's a Ten" and that's really driving sales tremendously. We've also added Purology in a lot of our stores and added appliances in salons where we haven't had appliances before. And -- and those are the big generators of volume.

All right. Thanks so much.

You are welcome.

Thank you. Our next question comes from Jill Caruthers from Johnson Rice. Please go ahead with your question.

Good morning. I know that you mentioned that you are going to be anniversarying a chunk of your price increases in the third quarter. I was wondering if you could talk about your outlook for I guess the second half of this fiscal year, trying to lap those price increases.

Let's assume that we will -- that we will raise prices in about 5,000 of our Company-owned store. And -- and I'll give you a better fix on this next quarter, because the -- because most of the price increases will have been implemented.

Paul, we would expect maybe 2% to 3% --

It will be the same order of magnitude as this year. Price should add about 2.5% to our comps.

Okay. And then just given your overall expense cuts. I know you had kind of given a plan out there to cut $10 million incremental expenses. How is that tracking? I mean you are doing really well. Do you feel like you are going to cut more than that this year?

Well, I'd rather be more conservative than bullish. But I will say that we are -- we still have our sights on at least $10 million. Through the first half of the year we've achieved close to $6 million. And so I think if you did the math you'd probably see that we're going to be ahead of plan. Once again, we just continue to be very aggressive on looking for opportunities to shave costs without dramatically cutting into the bone or impacting the business. And we've been successful at that.

All right, thanks.

You are welcome.

Thank you. Our next questions comes from Mimi Noel from Sidoti & Company. Please go ahead with your question.

Hi, Paul, hi Randy.

Hi, Mimi.

Hi, Mimi.

Would you first just remind me --

I hope that you are asking Randy a question?

I'm sorry?

I hope you are asking Randy a question.

I am. I will not leave him out. But I'm not leaving you out either. Would you remind me of some of the advantages to the franchise model?

Sure. Are you -- ?

Advantages for the franchisee or for us?

For Regis. For you.

You make, in effect, an instant return on capital because the franchisee fronts the capital. But we can -- there are 40, 000 strip centers in the United States. We could never build them all out from a Company-owned perspective. And so we want and we need franchisees to help to build out the strip centers. Now having said that, we don't -- the franchise model doesn't work well in malls. And with a limited universe such as Wal-Mart, we'd just as soon have a Company-owned store rather than a franchise store. But the franchise model, I mean we are generating about 40%, 45% pretax on our royalty income. And that's fully loaded with everything.

Okay.

The model works extremely well for us.

Okay. And then the only other question I had was for Randy. You said that you had planned on increases in certain areas of site operating costs, and I think that you did list them but I missed them. Would you repeat them?

Hang on, Mimi.

Oh, thanks a lot, Mimi.

Mimi, can I do this? Can I call you? Because I will have to dig it out of the transcript here.

That's no problem. Have a glass of water, Paul.

Thanks, Mimi.

Thank you. Our next question comes from Jeff Stein from Soleil Securities. Please go ahead with your question.

Good afternoon, guys. First, question for Randy. So your run rate on expense cuts looks like it is slightly above above $10 million. you do have some inflation embedded in your expense structure. So I'm wondering ,what kind of comp increase just generally would you need on a go-forward basis to hold your operating income margin flat?

We think in this current environment, given the level of expense cuts that we have and the where inflation is currently running, Jeff, it would be about 0% comps should give us leverage. That would be our tipping point today.

Got it, okay. And can you talk a little bit about the real estate environment? I mean you guys have 8,000 Company-owned locations. So when leases come up, what kind of rent relief are you seeing, and can you talk about the number of leases that will expire over the next 12 months?

Well, all -- all the strip center stores have five-year leases. We have about 1500 stores a year coming up for renewal. And we are getting some significant rent relief. But as we mentioned in previous calls, it is offset in large part by increases in [tam] and taxes. And there are some places, like New York city for instance, where I personally think the landlords are delusional. They just do not get it. And we're going to be reducing our foot print in New York unless the landlords do get it. And I think in the long run they will. I just think they just are not facing reality, Jeff. But we don't need New York City to build our business.

Got it. And aside from trying to grow the franchise business, if we look at Company-owned unit growth and net your openings against the closings, should we modeling flattish type unit growth on a go-forward basis?

Yes. Flat is good right now. As soon as comps become positive, it won't be flat, Jeff.

Right.

Because we generally close a couple of hundred. And we should be opening 300 or 400. And that is without the [Zs]. And let's not forget by the way, we have 8,000 Company-owned stores, but we are on thousands of franchisee leases. And we control the lease. And that's, we think, a huge asset.

Got it. And free cash flow? If you guys generate $90 million or better of free cash this year, what are you going to use if for? Will it be debt repayment? Or is there another priority?

No. We have -- Jeff, our strategy right now is just to continue to maintain liquidity and build cash until we start utilizing it to grow the business through new stores and acquired stores. We have about $10 million of scheduled maturities over the next six months -- of debt maturities. And we have maybe maybe $75 million coming due next fiscal year. So we're not in any hurry to pay down debt, largely because most of our remaining debt has make hold provisions and we just don't think it is prudent to incur those costs. And so I think what you are going to see is that debt levels remain pretty consistent over the next six months and cash will continue to increase.

Okay, thank you.

You are welcome.

Thank you. Our next question comes from from Ross Haberman from Haberman Funds. Please go ahead with your questions.

Hi, gentlemen, how are you.

Hi, Ross. Good.

Just two quick questions. On the two equity investments, the Empire and the Provaliance, I think you talked about roughly $20 million in cash flow you expected for Empire in 2010. What was the cash flow number for the other operation you expect?

Well, they have a calendar year.

Okay.

And calendar year --

Or what did they do last year -- if you have that?

Yes. Brent, EBITDA in Euros for Provalliance, $20 million what? --

For calendar 2009, it's $23 million.

$23 million. And they are projecting somewhere in the upper -- call it $27 million, $28 million.

Is that in Euros or dollars?

Euros. Euros.

And -- and just refresh my memory, what percentage do you own of each of those?

55% for Empire and 30% for Provalliance.

And the -- and the plans for that are, over the next couple of years, what?

Well, we don't control the boards in either case.

Okay.

And so please understand that it's -- it's -- it's their plans, not our plans. At some point in the future, we would hope to monetize, certainly Empire. And -- and hopefully either buy Provalliance or monetize our investment. But that's not a two-year deal, that's probably closer to a four- or five-year deal.

And just one question for Randy. Any of that cash flow besides the GAAP income in your $[200] million to $240 million of cash flow estimate?

Ross, what was the question about the -- you are talking EBITDA now?

Correct, yes.

Is there anything other than the GAAP estimate?

Yes. In -- in your cash flow of those two operations.

No.

No, no.

Equity is not --

If that's what you are referring -- Yes, $240 million is GAAP.

Okay, all right. Thank you, guys. Best of luck.

You are welcome. Thanks.

If there are no further questions, I would like to turn the conference back to Paul.

Thanks for joining us, everyone. Have a good day.

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