Regis Corp (RGS) 2013 Q2 法說會逐字稿

Good morning. My name is Ron, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Regis Corporation second-quarter 2013 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 4590684#. 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 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, as well as others, can be found on their website at www.regiscorp.com.

With us today are Dan Hanrahan, Chief Executive Officer; Eric Bakken, Executive Vice President; and Steve Spiegel, Chief Financial Officer. After management has completed its review of the quarter, we will open the call for questions.

(Operator Instructions)

I'd now like to turn the call over to Dan Hanrahan for his comments. Dan, you may begin.

Thank you, Ron. Good morning, and thanks for joining us, everyone. After I make my remarks with respect to our second quarter, I will turn the call over to Steve Spiegel, our new EVP & CFO, who will provide additional detail behind our second-quarter financial results. I'm pleased to report Steve added value from his first day on the job. Eric Bakken, our Executive Vice President, will conclude the prepared remarks by providing his operational update. Also with us today is Mark Fosland, our Senior Vice President of Finance.

As I said last quarter, and will continue to emphasize -- Regis remains a work in progress. While our financial results in the quarter were challenged, we are beginning to see some signs of traction, especially in our value businesses.

Before I talk more about the quarter, I have one comment. Today you will hear from the team that hurricane Sandy had a negative impact on our earnings in the quarter. However, as terrible event as it was for the people who had to endure it, there were some small bright spots. I'm very proud of our stylists who helped people who were dealing with the aftermath of the storm. Regis also donated money and products to the relief effort, and we provided our stylists with disaster-relief pay.

Now I will move on to my discussion on the quarter. For those of you who read the press release, you will find my comments on salon hours to be a bit repetitive. This topic was significant to our quarter, and it is significant to our overall strategy to fix the business. I want to ensure those who did not have an opportunity to read the release are on the same page. Second-quarter results reflect conscious decisions we've made to invest in our business to drive traffic.

We made the decision to increase salon hours, primarily in our SmartStyle salons located in Walmart and our Supercut salons. We knew this decision would impact gross margins, but we believed increasing hours would help stem continued declines in guest traffic. By adding hours, we are beginning to see improvements in guest traffic, especially in our Walmart and Supercuts businesses. Service traffic in Walmart was up over 4% for the quarter compared to the same period last year. And for the first time in 13 consecutive quarters, we posted same-store service sales in our Walmart salons. Overall, same-store sales trends improved 120 basis points compared to the first quarter of this fiscal year.

While this investment reduced gross margins, we are continuing to focus on scheduling optimization so that in the back half of this year our margins will be less impacted by increased hours. Scheduling optimization is in its early stages, and we are working diligently to strike the proper balance between staffing and guest traffic. Preliminary January findings indicate this gap may be narrowing in a number of our Supercut salons, giving me confidence we can and will continue to improve during the remainder of our fiscal year.

We are beginning to make progress across several test initiatives focused on staffing, pricing, marketing, stylist compensation and training. From a cost-management perspective, we continue to drive expense out of the business. General and administrative expenses, as adjusted, were reduced by over $6 million compared to the same quarter last year. Consistent revenue and profit growth will take time. However, we are beginning to move in the right direction.

Since Eric and Steve will walk you through the details of the quarter, I would like to focus on where the business is headed. Historically, our Company's focus was on same-store sales, payroll management, centralized corporate decision making, and management of financial performance. Today we view the business with a strategic focus on three key areas. First, throughout our system, we are focused on creating an ideal guest experience that drives loyalty and repeat business. Second, developing, retaining and attracting the best stylists is a top priority. Finally, optimizing our brand portfolio will improve the effectiveness of our marketing and merchandising efforts, as well as drive efficiencies.

We remain focused on our financial performance, but not to the detriment of creating the ideal guest experience. Instead, the foundation for improved financial performance will come from providing a guest experience that creates loyal guests, simplifying our business model, and implementing technological solutions that drive performance and efficiency. We are building a winning organization with a performance-based culture that fosters ownership, effectiveness, and efficiency. In shifting our focus, we are learning from our best people and our top-performing franchisees.

In my six months at Regis, I have spent considerable amounts of time in the field visiting our top-performing stores, consulting with our best people and franchisees. What we've learned is that managing a salon is more like managing an airplane than a retail store. An empty chair in a salon is lost revenue, just like an empty seat on an airplane. A store cannot recover lost time and capacity utilization as a key to profitability. Simply put, it's all about having the right stylist deliver the right experience at the right time. Accordingly, our focus is shifting to understanding and capitalizing upon the revenue potential of each salon, which entails transitioning from centralized corporate oversight to localized day-to-day salon management.

During the quarter, we made great progress towards finalizing our overall strategic blueprint. While I'm not quite ready to provide you with the specifics of that strategy, let me provide you with an update on where we are today and where we're headed. As mentioned earlier, we are becoming a guest-focused organization. We continue to learn and understand what guests expect from us, and we are modifying and enhancing our salon and stylist field training programs to incorporate those learnings. We are changing the culture at Regis. The guest experience is our number-one focus. Loyalty is earned one guest at a time.

On the marketing front, we are strengthening our guest traffic-generation capabilities. Heather Passe, our Chief Marketing Officer, and her team have just implemented a new guest relationship management data base. And in February, we will have a new e-mail platform to help us drive guest traffic by delivering personalized marketing to our guests. Additionally, Heather and her team are re-purposing our marketing efforts and investments to drive incremental traffic, and to become more guest facing by shifting our emphasis from marketing within the four walls of our salons, to marketing to guests outside of the salon.

To improve the guest experience, pricing must also be aligned with our guests' expectations. Our new pricing team is hard at work understanding the role of price and promotion. We have several price tests underway, and are developing a better understanding of price elasticity that will help use price and promotion levers to improve guest experience and drive profit.

Last earnings call, we mentioned the need to invest in technology to enhance the guest and stylist experience. Doug Reynolds, our Chief Information Officer, and his team continue to move forward with the implementation of SuperSalon, our new point-of-sale system throughout North America. We begin the initial rollout this February, with all of our salons up and running by the end of this fiscal year.

We have spent a good deal of time discussing the importance of the guest experience, and all the changes underway to enhance the delivery of that experience. Perhaps the most essential element of that experience starts with the connection between our stylists and our guests. Accordingly, stylists must view Regis as a great place to work. To that end, we have several test initiatives underway, including incentives to reward our more productive performers, and training programs to ensure they are successful.

As part of this process, it is critical we optimize our scheduling and staffing. As discussed last quarter, Regis historically reduced stylist hours to offset the impact from declining same-store sales. This resulted in a self-fulfilling spiral. Reduced guests results in declining hours. Declining hours lead to further declining guest counts.

We are at the very beginning of working our way out of that spiral. However, we have work to do to optimize the balance between staffing and guest traffic. We rolled out our scheduling optimization tool at the beginning of November, and are working hard to get that balance correct. I'm confident Eric and his team will make progress in the third quarter.

Our overall business model is too complex. We must simplify and focus. Our financial performance will improve when we remove complexity, and focus on drivers of profitability.

To summarize, we are committed to creating an ideal guest experience that drives loyalty and repeat business; developing, retaining, and attracting the best stylists; and optimizing our brand portfolio. We are focused on simplifying the business, and are on our way towards building a winning organization with a performance-based culture that fosters ownership, effectiveness, and efficiency. This approach is the foundation for improved and sustainable financial performance.

Changing the strategic direction of any established business requires investment, execution, and time. I remain extremely confident about being able to improve Regis's performance, and the entire Organization shares my sense of urgency. I feel even more confident about where we need to go strategically. We continue to do a lot of testing. We continue to learn, and we continue to improve our execution.

I'll now hand the call over to Steve.

Thank you, Dan, and good morning. Today I will begin by discussing our consolidated financial and operating performance, followed by a review of the major items impacting each of our business segments. Before I get started, I want to get everyone familiar with new terminology we will be using moving forward. As mentioned in our press release today, we'll be referring to non-operational items as discrete items, and we will be referring to operational earnings as adjusted earnings.

For the second quarter, Regis reported a diluted net loss per share of $0.22. This loss included net discrete after-tax expense of $14 million, or $0.25 per share, primarily related to the impairment of our investment in Empire Education, partly offset by earnings from our discontinued Hair Club operations. Excluding discrete items, our second-quarter diluted net earnings per share as adjusted were $0.03, down from $0.27 last year in the second quarter. Diluted net earnings per share as adjusted for the current quarter were negatively impacted by approximately $0.02 relating to the effects of Hurricane Sandy on our business.

Last year's diluted net earnings per share as adjusted of $0.27 included $0.10 related to two items. First, we sold our equity investment in Provalliance, and we are no longer recognizing equity in earnings from this investment, which amounted to $0.05 per share in the prior year. Second, last year's effective tax rate benefited significantly from employment credits that were no longer available to the Company in the current year, and the release of tax reserves related to resolution of a state audit. The impact of these tax items was $0.05 per share in the prior year. Tax legislation enacted earlier this month reinstated employment credits, and we expect to record a benefit from this legislation during the balance of this fiscal year.

With second-quarter same-store sales declines of 1.9%, and, all other things being equal, one would expect diluted earnings per share as adjusted to approximate $0.13 per share. Actual earnings per share as adjusted of $0.03 are $0.10 per share lower than this expectation. Increases in salon labor costs, the impact of Hurricane Sandy, and reduced equity in earnings from Empire Education were partly offset by lower general and administrative spending associated with cost-savings initiatives and explain the gap from this expectation. I will discuss these items in more detail shortly.

We have included in today's press release, as well as on our corporate website, a reconciliation that bridges reported results to earnings as adjusted for the impact of discrete items for the second quarter of the current and prior years.

Moving on to second-quarter operating results, my comments this morning will focus on as-adjusted results. Revenues for the quarter declined $20 million or 3.8% compared to the prior-year quarter. Salon revenues during the quarter were $496.5 million, a decrease of $20.4 million or 3.9% from the prior-year quarter, mainly driven by declines in North American salons. North American service revenues for the quarter were $364.5 million, a decrease of $15.2 million or 4% compared to the same period last year. Compared to the prior-year quarter, North American same-store service sales declined 1.5%, comprised of a 2.2% decrease in guest counts and a 0.7% increase in average ticket price.

While we are not increasing prices, we are managing our promotional spending in a more efficient manner. We estimate that lost business from Hurricane Sandy negatively impacted same-store service sales by approximately 30 basis points. Net changes in store counts drove the remaining 2.5% decrease compared to the prior-year quarter. Store counts decreased by 226 locations during the trailing-12 months ended December 31, 2012. During the quarter, we built 59 Company-owned salons, closed or relocated 124 others, and franchisees built 36 salons, offset by the closure or relocation of 23 franchise locations.

Product revenues for the quarter were $108.2 million, a decrease of $4.7 million or 4.1% versus the same period last year. Product same-store sales declined 3.6%. Royalties and fees for the quarter of $9.6 million increased $400,000 or 4.7% versus the prior-year quarter. Our franchisees posted positive same-store sales during the quarter, and added 32 net locations over the last 12 months. We continue to see a great deal of new franchisees joining the system.

Now, a look at gross margin. Gross margin as a percent of service and product revenues for the second quarter decreased 250 basis points to 41.7% compared to the prior-year quarter. Service margin as a percent of service revenues for the quarter was 39.7%, a decline of 300 basis points compared to the prior-year quarter, primarily related to increased salon labor costs in North American salons.

As Dan noted, we made the decision to invest in stylist hours in order to stop the downward spiral in same-store sales. During the current quarter, hours increased by approximately 3.5%, mainly in SmartStyle and Supercuts salons. We saw improvement in sales at these salons, with SmartStyle and Supercuts posting positive comps of 80 basis points and 50 basis points, respectively. We expect that as we optimize staffing levels, focus our marketing investment towards driving guest traffic, and enhance our guest experience, increased staffing will lead to increased profitability.

Clearly, we are in the early stages of scheduling optimization, having rolled out our scheduling optimization program at the beginning of November. This tool will be helpful in balancing the need for additional staff hours, with our goal of driving profitable sales. Our entire team is committed to scheduling optimization that enables better management of our workforce by having the right staff at the right locations at the right times.

Hurricane Sandy also impacted labor rates, as we made the decision to pay stylists disaster pay while salons were closed. In the second quarter, we paid over $500,000 to our stylists.

Product margin as a percent of product revenues for the quarter was 49.1%, a decline of 40 basis points compared to the prior-year quarter, in part driven by product donations for Hurricane Sandy relief efforts. We also had an increase in inventory write-offs, primarily the result of store closures during the quarter.

Site operating expenses for the quarter decreased $500,000 or 0.9% compared to the same quarter last year. This decrease was mainly driven by the fact that we were lapping $1.3 million of marketing expenses associated with a holiday promotion in the prior year that was not repeated this year, partly offset by increased communications and favorable insurance adjustments in the prior year.

General and administrative expenses for the quarter decreased $6.1 million or 9.9% compared to the same quarter last year, representing an 80-basis-point decline as a percent of revenues. This improvement was driven by cost-savings initiatives the Company put in place to simplify and become efficient in supporting salon operations. These initiatives reduced compensation expense, professional fees, and other costs. While we expect our general and administrative run rate to continue in the second half, we continue to focus on areas of the business that can drive further cost efficiencies.

Before moving on to a discussion about our liquidity, I want to address one housekeeping item. We previously disclosed to you that our Hair Club business would be sold before the conclusion of our second quarter. The transaction is still under review by the US Federal Trade Commission, and we will continue to update you as more information becomes available.

Focusing for a few moments on liquidity, our December 31, 2012 balance sheet is strong. We have over $220 million of working capital, including cash of $218 million. And our business generated almost $60 million of operating cash flow for the six months ended December 31, 2012. Assuming the Hair Club sale is approved, we further expect to receive approximately $156 million of proceeds, net of transaction costs.

In addition, total debt was $269 million, and we had no outstanding borrowings under our $400 million revolving credit facility. Based on current conditions, we believe our liquidity is sufficient to enable the Company to invest in all of the areas earlier noted to service our debt, to consider share repurchases as appropriate, and to manage the upcoming maturation of our convertible debt in July of 2014.

This concludes the financial portion of the call. I will now hand the call over to Eric.

Thanks, Steve, and good morning, everyone. Today I will give you an update on the operational progress we made in the second quarter. As Dan mentioned, the necessary reengineering of our business is beginning. I'll give you an update on our financial results and our progress to improve the guest experience.

Let's start off by reviewing our same-store service sales in a little more detail. In our North American salons, our same-store service sales declined 1.5% in the second quarter. This was a 150-basis-point improvement versus our first-quarter results. Hurricane Sandy hurt our comps by about 30 basis points.

Service visitation trends were flat for the first quarter, but did improve by 60 basis points compared to our fiscal-2012 results. In the quarter, we were less promotional than in the previous several quarters, and as a result, average ticket increased 70 basis points compared to the prior-year second quarter. Getting the pricing right, both on the everyday pricing menu as well as from a promotional perspective, is critical. As Dan mentioned, we now have a new pricing team dedicated to this area. This is a big opportunity for us. Overall, we are seeing improvement, and we are encouraged with the improvement, but we still have significant work to do.

The majority of our improvement is in our value business, especially SmartStyle and Supercuts. Our business in the malls continues to be challenging. We're making progress in our 2,400-plus SmartStyle salons located in Walmart. As Dan just mentioned, for the first time in 13 quarters, SmartStyle posted positive service same-store sales. Additionally, service guest visits were up over 4% compared to the second quarter last year.

We have some exciting promotional activity in SmartStyle. For the first time ever, we ran a Walmart register tape coupon. SmartStyle was the first business ever to have a coupon printed on Walmart register tapes. This is a good example of getting the marketing out of the four walls of the salon and directly to the consumer to drive traffic.

As I discussed with you last quarter, we have a significant staffing opportunity with this business, and we have made a focused effort to increase our staffing. Extended wait times and under-staffed salons certainly detract from the guest experience. In all of our salons, we are continuing to work on the balance of hours and staffing. As you can see by our labor costs in the quarter, we do not yet have the proper balance. We're extremely focused on this area, and we're in the process of making the necessary adjustments.

We just rolled out our scheduling optimization tool to the field at the beginning of November. Emphasis continues in this area, and we are learning and adjusting as we move forward. I believe the investments we're making in our stylists are necessary, and will provide long-term benefit. I'm excited that traffic trends and our value concepts have continued to improve over the last six months, and I'm optimistic that improved guest trends will continue.

The challenge for us is to increase our staffing and traffic in a more profitable way. We are focused on improving our approach to scheduling and staffing, and on driving traffic. We're not all the way there yet, but it is a top priority of the entire Organization. We need to improve the guest experience to ensure our guests return to us more frequently. This is a big opportunity for us.

As I discussed with you last quarter, we rolled out a program which is called The Moments of Truth. The Moments of Truth program focuses on the critical points in the service, which include the welcome, consultation, and checkout. This quarter was all about implementing and executing this program at the salon and stylist level. The Moments of Truth review forms were introduced during the October salon manager meetings, and were subsequently rolled out in all of our salons.

Organizationally, we now have the foundation built which will allow us to focus on the behaviors that lead to an improved guest experience. We're building on the foundation, and starting next week, we'll be implementing a series of biweekly trainings on the various components of The Moments of Truth. I'm confident that we're building a culture that is focused on creating a great guest experience.

As we've discussed with you, our stylists really appreciate and want more technical and guest training. In several markets, we conducted special training events which were linked to our ongoing test initiatives. In all cases where we have done these types of events, we have seen an immediate positive impact with our stylists and our performance. It's clear to me that when we invest in our stylists, it creates confidence, energy, and excitement, which translates into increased sales.

Our objective is to create a process to enhance our training programs in a cost-effective manner. In the last half of the quarter, we started a test that involved technical and guest training. We are moving away from video training to a more hands-on localized approach with multiple trainers in our markets. Training and educating our stylists are critical to improving the guest experience, and winning the hearts and minds of our stylists.

As Dan mentioned, we're testing and we're learning. I'm really excited about the progress we've made in reengineering our Business. Change is underway in many areas. Financial results in the quarter were challenging, but I'm confident that the changes we're implementing will drive improved results and shareholder value in the future.

All right. So, that does it for my operational update. We would now like to answer any questions you may have. So, operator, if you could please step in and provide the instructions for the Q and A portion of the call, we would appreciate it. Thanks a lot.

(Operator Instructions)

Your first question comes from the line of Lorraine Hutchinson from Banc of America. Please go ahead.

Thank you. Good morning, everyone. Was just hoping maybe you could provide a little more clarity on how you expect the cost of service to trend in the coming quarters as you optimize some of the scheduling systems. Should we expect it to still be higher but perhaps not as high, not as much of an increase as we saw in the second quarter, or do you think it will actually become a benefit over the next three to four quarters?

I think for the rest of this year we would project that it's going to improve relative to where it was this quarter and I wouldn't expect it to be a benefit in the back half of this year.

Lorraine, this is Dan. I may add just a little bit to that as well is that over time not only have we cut hours back that would try to protect EBITDA, but what we've done is we've effectively trained the consumer, or what we call a guest, that when the salon is open and how many stylists we have in the salon. What we need to do is we need to retrain the consumer. And the only way we're going to be able to do that is by investing in the hours and the consumer is going to need to learn over time that when they kind of come in, they can actually get a service from us and they don't have to wait a long time. Or they walk up and they look in the door and they see there's only one stylist on duty and they walk away as a result of that. So I think this is going to be a methodical fix. It's not something that we're going to be able to fix right away. But I do want to assure you we're 100% focused on how we get the right balance between hours and driving revenue with it.

Thank you, and then I know the Hair Club deal has not closed yet, but can you just talk through some of your priorities for the incoming cash flow once that does close?

Sure. I'll take that. In the past we told you that we would maximize shareholder value as we explore all the alternate uses for cash and we continue to reiterate that message hasn't changed. While improving and investing in the business is really our number 1, number 2 and number 3 priority we also need to address a few other issues before use of cash becomes clear.

First, we're awaiting the outcome of the Hair Club transaction, which we're anticipating net proceeds of approximately $156 million. And second, we've just begun to turn our focus toward capital structure. And while we draw significant liquidity from our balance sheet, you know, our operating cash flow and credit facility, we certainly have opportunities to optimize that capital structure. So my sense is that when these activities take shape, we're going to be in a better position to answer that question and tell you specifically where we would turn our cash.

Thank you.

Lorraine, I can tell you that Steve and I are headed -- we've got bank meetings coming up with a series of bankers to help us think about the best way to optimize our balance sheet, but with the primary focus being get the business fixed and figure out how we increase shareholder value.

Great. Thanks.

Thank you.

Your next question comes from Jeff Stein from Northcoast Research. Please go ahead.

Hey, Dan, couple questions for you. First of all, would like you to perhaps address the issues where you do have challenges in the business away from the value salons. Namely the UK, Empire and the mall-based groups, namely MasterCuts and Regis. What are the -- what solutions do you have that are going to get those businesses stablized and turned around?

Thanks, Jeff. You know, let me take them in order. The mall-based is -- also has opportunities around optimization and hours. So hours weren't only cut out of the value-based salons. What we have been able to get is we've been able to get more traction on the value-based salons than we've been able to get on the mall based. Our mall-based salons are appointments and so I think it's going to take us longer to train the consumer that we are putting people back in the salons than it is in the value based where it's more walk-up and it's convenience based. So I think that the approach is fairly similar. You know, the things you heard Eric talk about in terms of training and development of our people and making it a great place for stylists to work is similar but I think that's going to be a longer, longer turnaround. We do, quite honestly, have challenges with malls -- with just mall traffic in general. So we have to deal with that, but the real challenge we have is retraining that consumer.

On Empire, you know, in the time I've been here I haven't spent a lot of time in Empire, but I do believe that there is opportunity for a stronger relationship between Regis and Empire than we have today. There are people that go into their schools not knowing where they're going to be employed when they come out. We have over 7,200 of our wholly-owned salons. We should be a great place for the students that go into the schools to come out and have a job. So I'm working with Empire on how we strengthen our relationship there and how we figure out how we can create more job opportunities for people coming out of Empire than we're doing today. It's an obvious one, but it's something that we haven't done in the past.

And then in the UK -- our challenges are similar in the UK that they are here in the US market. What we've been doing with the UK is we've been sharing all the tools we've been developing. Quite honestly, our focus has been on the North American business so as we develop the tools we're getting them over to the UK. So the development of the optimization tool that's now over to the UK. And I think it's important to remember that we didn't get the optimization tool finalized and out into the salons until early in November. So the UK was behind that. So they should benefit from that. The guest experience training that we're doing, we really got that up and running and late in the first quarter. So the UK didn't get that until into our second quarter. So they're just a little bit behind us on all that, but the challenges are very similar. So we're focused on the UK, but it has come a little bit behind what we're doing with the North American business, Jeff.

Thank you.

Thank you.

Your next question comes from Bill Armstrong from CL King & Associates. Please go ahead.

Good morning. I was wondering if you could give us an update on your POS rollout.

Sure. I'd be happy to. The POS rollout is going extremely well. We have a great relationship with the SuperSalon people. We are doing all the work necessary to create the attachment to our back end. That is going very well. Quite honestly, that was one of the things I was quite worried about was would we be able to easily attach to the back end. And while I wouldn't call it an easy attachment, it's on schedule and everything is going just as we'd planned. We have a series of events that need to take place with the SuperSalon rollout. All of those are on schedule and we begin the actual implementation in early February of the first set of salons. We have a very detailed plan that will put a number of stores in place. We'll take a week off. We'll see what happens with those. We anticipate that will go extremely well based on some preliminary testing that we've done. Then we will ramp up over time so that we will have SuperSalons in all of our North American salons by the end of our fiscal year. And we still see that very much on schedule.

Okay. That's great. And then just a housekeeping -- can you give us your salon count at the end of December, the owned salons in North America and the UK and the number of franchise salons?

Sure. Yes. Bill, what we're going to do is we're going to post all the -- in the press release the salon counts. We're going to post those on our website here in just a minute, moment or two after the call is over. But in terms of salon counts at the end of the second quarter we had -- company owned we had 7,672 and then from a franchise perspective we had 2,068 and out of the company-owned piece there was 381 that were international. We'll have all those schedules up here in a moment.

Okay, great thanks.

Thanks, Bill.

Your next question comes from [Jacob Vitter] from Robert W. Baird. Please go ahead.

Thanks. I'm in for Erika Maschmeyer. Last quarter you talked about targeting hours flattish by the end of the fiscal. Today it sounds like you are more committed to the investment of increasing hours throughout the year. Is that correct and just the thought process behind that?

Yes. We're -- Jacob, we're committed to getting the hours right. You know, it varies by segment in our, you know, value businesses where we're seeing more traffic and more growth. That's going to call for, you know, more hours. And likewise in our businesses that Dan just discussed where traffic is down there's an opportunity to pare that back a little bit. But our objective is really to get the right mix between hours called for and scheduled and staffing. And we're making good progress in doing in and I think you'll see, as Steve mentioned earlier, improvement as we move through the back half of our year.

Okay, great. And then could you just elaborate on what the staffing optimization tool is and maybe how it helped Supercuts in January?

Yes. It's really looking at what happened last year at a similar time and looking at what the most current trend is in traffic and sales and it comes out with a formulation to let us know what we should be scheduling going forward. And we really -- part of it is science and part of it is art. So we have to manage it. Sometimes there are changes in staffing at a salon. You know, if you have a real high producer who leaves, the schedule that comes out might not take that into account, so we really have to apply some art there as well. But in general it's looking at traffic, what we experienced in prior periods and coming up with a proposed schedule that we use to balance with a little bit of art in the field.

Okay. Thank you. Lastly on SmartStyle. I know you ran a back to school coupon last quarter and now the Walmart promotion this quarter. Is there any way to break out the benefits between that, those promotions, and the increased hours? And then maybe just going forward as these promotions, is that going to be part of your ongoing strategy of that concept?

Yes. Good question. You know, that's part of the reason why we've brought on a pricing team. We -- and we're doing especially in our Walmart salons. We're very focused on pricing analysis that looks at every single Walmart salon and the impact that promotions have on it, the impact of the everyday low price has on revenue.

We're early in that and so we're not sophisticated enough today to give you a good answer to that question and say that we know that the revenue that was driven by the coupon event was X and the revenue that was driven by the hours is Y. We're going to get there. I mean we've got some very smart pricing people that we've brought onto the team and we've engaged an outside firm that is, I think, a real strong partner for us. So we're working through that because that's exactly where we want to be able to get so that we understand what kind of revenue is driven by the decisions that we're making and that will just make us a smarter company. I think you heard Steve talk about investment in technology that will help us improve. That's not a big investment, but we think it will pay strong dividends for us over time.

All right. Thanks.

Thank you.

Your next question comes from Daniel Hofkin from William Blair & Company. Please go ahead.

Good morning, guys. Nice to see the sequential improvement in the off-mall traffic. Just had, I guess, a question in terms of how you're thinking about what the ramp or what the sources of the increased profitability in the future are likely to be. Is it going to come more from just, you know, gradual retraining of the consumer and word of mouth and the like in the off-mall concepts or do you feel like you've, you know, overshot in terms of staffing and that there's opportunities to kind of optimize the staffing based on customer traffic patterns? Which of those is going to be more important in terms of your long range profit ramp? That's my first question.

Okay. I think that, you know, it's hard to parse out which is going to be more important. One of the things that we know we need to do is drive traffic into our salons. So we are working to -- with our marketing department and our operating folks we're working very hard to figure out which are the marketing triggers that we can pull that will drive traffic. Then on top of that we've got to figure out what is the right balance between the amount of hours that we put into the salon and the revenue that it generates.

And I would tell you that in a fair number of our salons we did it. I mean we put the right amount of hours in and we saw an improvement in revenue that contributed to our profitability. But we had enough that we didn't do that and I think that's where it's going to take us some time with the consumer to retrain them to understand that the salons are now being staffed to the point where you can come in and get the service you want in a reasonable amount of time remembering that in our business we're a value-based business.

Consumers are looking for convenience. They're looking for quality and they want to get in and out and then -- but having said that there are also salons that we've seen where, to your point, Daniel, that we have over invested in hours. We just put too many in and what we need to do is we need to back that off a little bit and build the consumer up, build the consumers confidence in their ability to get a service from us based on what kind of traffic we're seeing in that salon. That's why I should repeat what I said earlier. This is going to be a methodical approach to fixing this and so it's a little bit hard for me to parse them out because they're all so important to fixing this business.

I appreciate that color. I guess next question would be, as you think about the mall-based concepts and hearing what you said earlier about some traffic challenges and a lot of that is kind of out of your control I think it would be fair to say. How are you thinking about those concepts in general? Is there possibility that you would envision the Company being more weighted toward the Walmart and strip mall concepts going forward?

Well, I think that will happen naturally. You know, as we invest in new salons as we're growing our franchise business, you know, we have terrific support from our franchise partners. Our franchise sales team is doing a great job selling franchises. So we'll grow naturally in the businesses in the value-based strip center type businesses that you just described. And our franchisees will grow there as well. But we need to figure out regardless of what's happening with traffic in malls, it's still our responsibility to figure out how we drive traffic into those salons in those malls. I want to be careful that I don't blame the declining traffic in malls as the reason for our decline in business in the mall-based salons. It's still our responsibility to get those salons healthy.

I mean I suppose there theoretically could be opportunities to relocate in some cases, but maybe you don't see that as a big opportunity.

We've done some of that. We've done very, very little bit of that where we've moved salons out of the malls into the strip centers. But it's such a small sample size it's pretty hard for me to say that I could give you any meaningful color on that as I just don't think that -- you know, my correlation analysis on that is a little weak at this point.

Finally just last quick house -- how long would you say, if you had to guess at this point, we are from a point where you feel a little more comfortable, you have your arms more around the various parameters and the impact of your initiatives such that you're able to provide some just general financial guidance type framework?

You know, that's going to still take us some time. I'm not sure that, you know--one thing we want to make sure we aren't doing is chasing quarters. We believe that this is a long term fix. We believe strongly that this is a business that can generate a lot of cash. You know, we look at what our franchisees do and our franchisees generate a lot of cash. You can go and look at the FTD and see the kind of revenues the franchisee gets and that's where we want to be. We want to work towards those kind of revenues. It's going to take us a little bit of time on that. We've got so much stuff underway right now and I'm not comfortable at this time saying that there's a certain date where I'll be able to give the exact information on that. What we want to be is very transparent on what we're doing. We want to be as clear as we can on our results, but we're reluctant to provide any guidance at this point.

Okay. Thanks very much.

Thank you.

Your next question comes from Jill Caruthers from Johnson Rice. Please go ahead.

Good morning. A little bit more on to your strategy of increasing salon hours. Could you talk about -- is it more of the customer having to wait and kind of what's that average wait time? Or is it the view of perception of kind of an empty salon as they walk by?

You know, I think it's both, Jill. One of our Board members gave me a great analogy at a Board meeting where he said when he was a -- he managed a restaurant as a young man and he closed the restaurant early one night because nobody was in it. And then his boss gave him a very hard time the next day because he said how many people walked by and now think that our restaurant closes an hour earlier than it closed? And so we're up against that and then we're up against the fact that when people that do come in and sit there so long -- in the past have had to sit there so long so they just haven't come back, so it's both.

You know, one thing we have learned. We've done a fair amount of marketing research and we have learned that the consumer that comes to our salons, our value-based salons, to get a service is very focused on convenience. You know, consumers are so time strapped these days that they're very focused on convenience. So we need to provide a high quality, very convenient experience at the right price. And so it's really hard for me to say which is the bigger driver of the turnaround because I think that they all contribute a great deal to the opportunity for us to get this business going in the right direction.

Okay. And then looking at the Supercuts division. If I'm clear you started to increase the hours there back in the first quarter. So second quarter kind of second time around and when you look at the results first quarter, second quarter you see a deterioration on the comp side on both service and total comps at Supercuts. Could you talk about that trend whether something odd went off or are you starting to see less productiveness from the increased hours?

There's a few things going on there. You know, we've got the tool in place. When we first started with Supercuts we didn't have the tool in place. So now we've got the tool in place and, you know, clearly we did some good things with that tool. We also made some mistakes with that tool. The other thing that we, you know, our Supercuts were disproportionately hit by Sandy. So, we talked about what percentage it was of our total business, but we are heavily -- we lean heavily towards Supercuts where Sandy impacted us, so we had that. We experienced that as well. So I actually feel fairly good about what I've seen from the salon optimization -- or the hours optimization from Supercuts.

You know, I want to be very clear that I'm not declaring victory by any stretch of the imagination there but we've learned quite a bit in the Supercuts. Because what we did in the first quarter of this year is we said look, we got to stop cutting hours, so we added hours. But we didn't do it -- it was all art at that part. There wasn't any science. Now we're bringing science into it. We're in early learning stages at this point.

Thank you.

Thank you.

Your next question comes from Alex Yaggy from Cortina Asset Management. Please go ahead.

Good morning, everyone. I have two quick questions and first is on sales trends and the second is on real estate. So first, on the sales trends. If I recall correctly, generally speaking, your sales across the chains, say Supercuts, would generally be in line. There wasn't a huge divergence from best performing to worst performing stores. And I'm wondering if in the areas where you're getting it right as you said on the scheduling, you're seeing a market difference in your top quartile of stores and if so what that is in terms of sales gains?

Well, we aren't going to break out the detail to that level. I can tell you that there's a lot of analysis going on in terms of how we viewed the optimization and we have salons that are in different buckets. And what we're trying to do now, Alex, is go back and make sure we fully understand what drove the business in those buckets. So we see buckets -- we have a bucket where the salons are doing really, really well. If you're a guy that's doing the hours optimization, you're taking full credit. If you're our marketing person, you're taking full credit. If you're an operator, you're taking full credit.

So we need to understand a little better exactly what's driving it and then the buckets kind of go down to that bottom bucket where we've seen that we've added hours and we've had sales not respond. So we need to understand. I think it's important to note that we've only been at the hours optimization since the beginning of November in any scientific way. So we've got two months worth of data that we're looking at. People are on it. So I can't give you any greater detail than that at this time, Alex.

Okay, thank you and then on the real estate side you have a lot of stores and over the years you've made a lot of acquisitions. Do you all have the tools and information yet to look at your real estate portfolio and know the bottom 20% you can relocate? And prove, like the restaurants and other retailers have, to measure where stores should be and really understand how good or how improved your real estate portfolio could be over the next two to three years?

Hi, Alex, it's Eric. We are getting much better in that area. We're working with an outside provider really the best in the business and we're able to assess the quality of our real estate and really look at in terms of its productivity and performance versus the assessment of the quality of the real estate. That continues to get better as we add additional attributes and variables that we're aware of. So we're much further along on that than we were even, say, six months ago. So to answer your question yes, we can identify those locations. To the extent that they're not profitable or there's a better opportunity in close proximity, we're moving out of those locations today.

I know you're not giving guidance at all but just generally speaking should we expect any additions to the salon count? I assume you do add here and there, but is it going to be markedly different from what it's been over the last 12 months?

No. You shouldn't expect markedly different change in what we've been doing.

Okay. Thank you for the answers.

You bet.

Next we have a follow-up question from Jeff Stein from Northcoast Research. Please go ahead.

Yes, Dan, just one quick follow-up question. In assessing the opportunity at Supercuts, what is the difference between the average unit sale of a franchisee versus a company operated location?

Today it's $40,000 to $50,000.

$40,000 to $50,000.

Yes.

All right. That's pretty significant.

Yes, it is.

In terms of flow through, let's say you're able to narrow that GAAP by 50%, how much -- what percent of that could you flow through the bottom line? Is it pretty much a pure flow through from the standpoint that you would take -- apply the labor percentage and the rest drops to the bottom line, or is there some variable cost that we should consider?

No. There shouldn't be increased variable costs. The margins should stay roughly where they are. If we get our hour optimization better, it would improve the hour -- the margins. If our hour optimization got worse, it would hurt it. But you should assume that we shouldn't have to add significant costs to it to get that unless we made a decision that we were going to add an awful lot of marketing money to get it. Then obviously that would have an impact.

Right. But it sounds at this point like you're operating under the assumption that, at least in the Supercuts division, it's more of a payroll-hour issue than a marketing issue.

I would say there's opportunities on both sides. If you think about what's happened over time where we've trained the consumer not to come to get a haircut because we've cut hours. We're going to need to find a way to bring them back. So to say that we don't need marketing to do that, I wouldn't go that far, Jeff, because I do think we need marketing to bring people back. So we're developing what we call guest relationship management, which is the same thing as customer relationship management. We're developing tools around that. The SuperSalon POS will give us a lot better information that we can use in our GRM tools but we also need to drive people in. We can't just work off of people that have been there and bring them back. We want to make sure we do that obviously, but we also want to drive people into the salons with marketing.

Got it. Thank you.

You bet.

As we're out of time we will now finish the call. I'll turn the conference back to Dan.

Thanks, Ron. I appreciate everybody tuning in this morning and thank you for the thoughtful questions. We'll be back to you in another quarter

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