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Regis (NYSE:RGS)

Q3 2013 Earnings Call

May 07, 2013 11:00 am ET

Executives

Daniel J. Hanrahan - Chief Executive Officer, President and Director

Steven M. Spiegel - Chief Financial Officer and Executive Vice President

Analysts

William R. Armstrong - CL King & Associates, Inc., Research Division

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

Jeffrey S. Stein - Northcoast Research

Operator

Good morning. My name is Kev, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Regis Corporation Third Quarter 2013 Conference Call. [Operator Instructions] There is a webcast presentation for the call today. If you would like to view the live webcast, please log on to the third quarter 2013 results webcast link on the regiscorp.com in the Investor Relations section of the website.

If anyone has not received a copy of today's press release, please call Regis Corp. 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 the access code 4615164 followed by the # key. The replay will be available 60 minutes after the conclusion of today's call.

I would like to remind you that, today, the extent of the company's statements or comments this morning represent forward-looking statements. I refer to you 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; 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 would now like to turn the call over to Dan Hanrahan, for his comments. Dan, you may begin.

Daniel J. Hanrahan

Thank you, Kev. Good morning and thanks for joining us, everyone. After I make my remarks, with respect to our third quarter, I will turn the call over to Steve Spiegel, our Executive Vice President and Chief Financial Officer who will provide additional details behind our third quarter financial results. Also with us today are Eric Bakken, recently named Chief Administrative Officer; and Mark Fosland, our Senior Vice President of Finance.

As I said in the past, Regis remains a work in progress. Our primary focus has been to halt the downward spiral in service traffic, which is the engine of our business and accounts for over 75% of our revenue. We are starting to slow the revenue declines and are seeing sequential improvement in our Service business. Our third quarter consolidated same-store service sales declined 30 basis points, which improved to 120 basis points from the second quarter and 270 basis points from the first quarter.

We made the decision to strategically invest in salon hours, focusing mainly on our SmartStyle Salons located in Walmart and our Supercuts Salons. Both groups posted positive same-store service sales with SmartStyle up 2.6% and Supercuts up 1.3%. Although traffic improved, trends in the quarter were varied, and we benefited from an early Easter. We made the decision to invest in stylist hours knowing it would hurt margins, to begin to bring guests back to our brands. We did make progress with scheduling optimization, which helped us narrow the gap between staffing and guest traffic, and improve third quarter cost of service by 50 basis points when compared to second quarter.

We're energized here at Regis as we have been making strategic investments in our business that begin to build the foundation to enable us to turn around our business performance and position the company for long-term growth. On this call, I want to make sure that our shareholders understand the nature of these investments and how they help us to achieve our mission to create guests for life. There's nothing more important in a repeat business than creating loyal customers and consumers. Guests for life means delivering an outstanding guest experience in each of our salons so that our guests return.

I have now been with Regis for about 9 months and I have spent much of that time working in the field with outstanding Regis operators, top performing franchisees and talented leaders we have been fortunate to retain, over the years, from high performing businesses that Regis previously acquired. I refer to this group as our best-in-class. Most of my focus with our best-in-class was on what works. I have seen leading practices in action, and we're applying those learnings and taking necessary steps to lay the foundation that will transition Regis into a best-in-class operator.

So first, let's review what we've learned. The following 2 slides compare our best-in-class attributes to those of historical Regis. I'm not going to spend much time comparing to where Regis has been, instead my focus is on the changes we need to make in order for Regis to become a best-in-class operator. We have divided our learnings into 5 categories: Guests, organization, technology, stylist and marketing. Our best-in-class are obsessed with providing a great guest experience characterized by quality, convenience, affordability, a friendly salon staff an inviting salon appearance and atmosphere, and minimal wait times. Organizationally, our best-in-class epitomize ownership behaviors with a constant focus on stylist productivity and salon profits, few management layers and leadership and mentoring on the salon floor.

Attraction, development and retention of stylists are critical components of best-in-class success. Top performers invest in both technical and guest service training. They communicate openly and frequently with stylists and, of course, they have easy-to-understand pay plans and incent and reward performance. These attributes come together to create a family environment, characterized by loyal stylists and low turnover. Happy stylists make for delighted guests.

Best-in-class used technology in the salon to enhanced real-time decision-making and improve the overall guest experience. In fact, the majority of our franchisees have been using the SuperSalon point-of-sale system for some years. They focus marketing dollars and driving new traffic into their salons. Marketing campaigns are local, consumer facing has been designed to generate trial and reward loyalty.

Last quarter, I explained the negative impact of the business that result from reducing stylist hours to manage short-term profitability. To counter the negative impact, we made the decision to invest in salon hours, mainly in our 2 biggest assets, SmartStyle and Supercuts. As illustrated by past SmartStyle experience, the business historically cut hours and raised prices in response to declining traffic.

In the affordable space, an outstanding guest experience starts with quality convenience and value. Long wait times and rising prices incented our guests to visit our competition. By investing in stylist hours, we have seen our SmartStyle traffic trends begin to improve. However, we haven't been able to optimize these hours or drive enough volume to cover them to make them profitable yet. In just under half of our Supercuts operations, we are starting to see evidence, where we've not only stopped the declining trends, but we recently have been able to increase revenue at a higher rate and hours we've added. However, this represents only a fraction of our total salons and is an example of the work we have to do in all of our salons to make optimization a core competency.

Strategically investing in stylist hours alone will not fix our business. We need to apply the remaining attributes that our best-in-class follow. As we considered why some salons were effective and others were not, we realized that it really came down to people. Even without tools like point-of-sale and guest relationship management, our top performers were able to improve their results in the wake of increased stylist hours.

So let's focus on organization next. One of our challenges in addressing the discrepancy and performance was getting through 2 layers of corporate management. By spending time in the field, we realized the impediments these layers were to effective change. Last week, we announced changes to our field organization. This structure allows us to execute better with fewer layers of management and our leaders working shoulder to shoulder with stylists, cutting hair and mentoring.

In that past, we were not organized around geography and this restricted our ability to be local. Our prior focus of organizing around brands and segments made it difficult for operators to spend as much time in the salon as necessary to be effective. Going forward, field leadership and decision-making will be more localized and field leaders will be geographically aligned with their salons in order to promote, in the salon, leadership and mentoring. Aligning geographically and reducing travel, makes this a very efficient structure. The field leader's incentives have been redesigned to align in their interests with those of shareholders by rewarding ownership behaviors focused on profitable revenue growth. All aspects of this change represent a collaborative effort among many top Regis field employees and members of our salon support team, formerly referred to as the home office. In fact I'm pleased to report that the majority of our new regional vice president have been sourced from our best-in-class operators. What excites me most is that our best field people, not only helped to develop the structure, but are also leading it.

On this slide is an example of what one of our outstanding operators was able to accomplish. And we recently promoted him to regional vice president. This person doesn't have SuperSalon or guests relationship management tools, but he does have excellent operating skills and motivates his team to drive results. While he was able to add hours and grow his business profitably, imagine what could've been if other levers were utilized.

By placing top performers into leadership positions, we not only plan to improve our business performance across the Board, but we are providing a clear path for our people who desire to ascend within our organization. While we believe our new field organization will go a long way in earning the hearts and minds of our stylists, we need to continue to invest in stylist training programs that educate both technically and experientially. First our leaders will be active on the salon floor, where they can lead by example and supplement training furnished by the company. We recently leveraged our own franchisee training materials to help all levels of field employees navigate the running of the salon. Our Moments of Truth guest experience program, continues to gain traction and we are becoming a much more 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 these learnings.

Moving on to our progress with technology. The company will complete its roll out of the SuperSalon point-of-sale system and salon work stations in well over 90% of North American salons. This will significantly improve communications with our salons; facilitate delivery of training to stylists; provide improved real-time salon analytics on guest retention, stylist productivity and salon performance; and enhance our guest relationship management capabilities.

Guest relationship management is a strategically important marketing initiative under development. Early reads of our customer data indicate we can do a much better job of guest retention. With the roll out of SuperSalon, our capabilities in this area are improving. And today, over 50% of our transactions are associated with a unique guest. Having this information allows us to gain insight into guest behavior, communicate with guests and incent return visits. In addition, we can monitor retention and survey our guests to see how we can improve.

Other best-in-class areas we are working on, whose progress and associated impacts are longer term in nature, include traffic generating marketing, a guest loyalty program and planogram standardization and inventory rationalization. Historically, Regis focused most of its efforts on upselling services and products to existing guests, rather than generating trial among new guests. We're developing plans to repurpose our marketing efforts and investments to become more localized and guest facing, by shifting an emphasis from marketing within the 4 walls of our salons to marketing to guests outside of the salon. In our recent past, about 50% of our marketing spend was directed towards generating traffic. In the last half of fiscal 2013, about 75% of our spend will be consumer facing. Next year, we expect that number to approach 85% to 90%.

We're also in the planning stage of a guest loyalty program that will be introduced in 2014. While most of our time has been focused on service, we've recently begun to address planogram standardization and product rationalization in an effort to simplify and manage the ongoing inventory investment. Doing so, will make it easier for guests to shop and stylists to sell retail products, improve our salon appearance, reduce inventory management time and enable distribution efficiency. I'm sure we'll have more to say on this topic next quarter as our plans begin to take shape.

As I've said earlier, our mission is to create guests for life. Everything we are working on is about creating loyal guests and loyal motivated stylists. Our vision is to be the salon of choice, the employer of choice and the partner of choice. As we accomplish this, we'll become the investment of choice. Today, our business is too complex. To improve our execution and financial performance, we need to simplify it. We are committed to creating an ideal guest experience that drives loyal and repeat business, 1 guest at a time. We are focused on earning the hearts and minds of our stylist, so we can retain and attract the best. We must enhance our guest traffic capabilities. 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. I'm confident in our ability to improve Regis's performance and our entire organization shares my sense of urgency. We have the right strategy. I'm encouraged that we have seen pockets of improvement taking place without having pulled all the necessary levers yet. Changing the strategic direction of any established business requires investment, execution and, most certainly, time. 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. Steve?

Steven M. Spiegel

Thank you, Danny, and good morning. Today, I'll 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 begin, I want to remind everyone of terminology we began using last quarter. We now refer to non-operational items as discrete items, and to operational earnings as adjusted earnings. For the third quarter, we just reported diluted net income per share of $0.04. This included net discrete after-tax income of $1.7 million, or $0.03 per share, primarily related to earnings from our discontinued Hair Club operations and work opportunity tax credits partly offset by accelerated depreciation and senior management restructuring costs. Excluding discrete items, third quarter diluted net earnings per share as adjusted were $0.01, compared to $0.29 in the same period last year.

Last year's diluted net earnings per share as adjusted of $0.29 included after tax earnings of $0.03 per share, mainly due to earnings from our equity investment in Provalliance, which was sold in the first quarter of this fiscal year, and last year's effective tax rate benefiting from the release of tax reserves related to resolving income tax audits.

Diluted net earnings per share, as adjusted for the current quarter, were negatively impacted by approximately $0.05 per share, attributed to 2 fewer sales days in the third quarter of this year when compared to last year, which are not reflected on our same-store sales trends. Considering this, coupled with third quarter same-store sales declines of 1.4%, and all other things being equal to the prior year, one would expect diluted earnings per share as adjusted to approximate $0.18 per share. Actual diluted earnings per share as adjusted of $0.01 per share are $0.17 per share lower than this expectation.

Increased salon labor costs, higher connectivity costs for new point-of-sale and salon workstations, increased salon repairs and maintenance expenses, and the impact of clearance sales on product costs comprised the majority of the decline. 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 third quarter of the current and prior years.

Moving on to third quarter operating results, my comments this morning will focus on as adjusted results. Starting with revenues, revenues for the quarter declined $31 million or 5.8% compared to the prior year quarter. Service revenues during the quarter were $392.1 million, a decrease of $20.8 million or 5% from the prior year quarter, mainly driven by declines in North American Salons. North American service revenues for the quarter were $370.7 million, a decrease of $19.5 million or 5% compared to the same period last year. Compared to the prior year quarter, North American same-store service sales declined 0.4%, comprised of a 1 point cent (sic) [percent] decrease in guest counts, and a 1.3% increase in average ticket price, reflecting continued management of promotional spending in a more efficient manner. Two fewer sales base and the net decrease in store counts drove the remaining 4.6% decrease in North American service sales compared to the prior year quarter.

North American company-owned store counts decreased by 203 locations during the trailing 12 months ended March 31, 2013. During the quarter, we built 38 company-owned salons, and closed or relocated 96 other company-owned locations. Product revenues for the quarter were $103.2 million, a decrease of $9.9 million or 8.8%, compared to the same period last year. Product same store sales declined 5.2%. While our focus has mainly been on service, we are beginning to address his part of our business. As Dan mentioned earlier, the company is considering simplifying and standardizing it's planograms and rationalizing its Retail Product line. We anticipate that this streamlined approach will lead to an improved guest experience and, in turn, improve retail sales.

Royalties and fees for the quarter of $9.6 million, decreased $0.2 million or 2.1% versus the prior year quarter. Our franchisees posted positive same-store sales during the quarter and added 45 net locations over the last 12 months. We continue to see a great deal of new franchisees joining the system.

Shifting our focus to cost of sales. Cost of service and product as a percent of associated revenues for the third quarter increased to 180 basis points to 58.1% compared to the prior year quarter. Cost of service as a percent of service revenues for the quarter was 59.8%, an increase of 180 basis points compared to the prior quarter, primarily related to increased salon labor cost in North American salons and increased holiday pay due to an early Easter. We continue to invest in stylist hours in order to stabilize same-store service sales.

During the current quarter, hours increased by approximately 2.6% compared to the prior year quarter, mainly in SmartStyle and Supercuts Salons. These salons reported positive same-store sales of 2.6% and a 1.3% respectively, which improved sequentially from the previous quarter. Improvement on our optimization initiative contributed to a 50 basis point reduction in cost of service as a percent of service revenues compared to the previous quarter.

Cost of product, as a percent of product revenues for the quarter, was 51.6%, an increase of 130 basis points compared to the prior year quarter. Mainly driven by increased clearance sales. We made the decision to mark down salon inventories in advance of plans to standardize and simplify retail planograms and rationalize products next fiscal year. While this activity increased cost of product as a percent of product revenues, marking down inventories generates higher cash returns than the past practice of repackaging and returning these products to our distribution centers, for restocking, disposal or return to vendors.

Site operating expenses for the quarter increased $3 million or 5.8% compared to the same quarter last year. This increase was primarily driven by increased connectivity cost to support the company's new point-of-sale system and salon workstations, advertising costs and higher salon repairs and maintenance expense.

General and administrative expenses for the quarter increased $1.3 million or 2.3% compared to the same quarter last year, representing a 90 basis point increase as a percent of revenues. The current quarter has begun to lap significant cost reductions made in the prior quarter, when the company restructured its senior management and corporate organizations. While general and administrative expenses during the third quarter were consistent with the first half of our fiscal year, we continue to focus on ways to simplify to drive further cost efficiencies.

Moving on to a discussion of our liquidity -- I'm sorry, before moving on to a discussion on our liquidity, I would like to provide a brief update on the Hair Club transaction. On April 9, 2013, we announced that we completed the sale of Hair Club, and received $162.8 million, which was the purchase price of $163.5 million, adjusted for a preliminary working capital closing provision. After closing adjustments, transaction fees and removal of current and long-term assets and liabilities held for sale, the company anticipates recognizing an after-tax gain during the fourth quarter.

Focusing for a few moments on liquidity, our March 31, 2013 balance sheet is strong. Before considering the impact of the recent Hair Club sale, we have over $250 million of working capital, including cash of $180 million, and our business generated over $80 million of operating cash flow for the 9 months ended March 31, 2013. In addition, total debt was $269 million, and we have 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 turn around our business, to service our debt and to manage the upcoming maturation of our convertible debt in July of 2014.

This concludes the financial portion of this call. We would now like to answer any questions you may have. Kev, can you please provide the instructions for the Q&A portion of this call?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Bill Armstrong from CL King & Associates.

William R. Armstrong - CL King & Associates, Inc., Research Division

I guess the first question is on your field reorganization and in Slide 9, I just want to understand what I'm looking at. Your old organization was divided between corporate and field, and it looks like there's nothing in corporate now, is that how to read this? And so you're going from 4 layers to 3, but I'm not sure if there's a change in headcount, if you could flesh that out for us?

Daniel J. Hanrahan

Sure, Bill, this is Dan, I'd be happy to. What we had in the past is we had a lot more focus at corporate. We had COOs that managed different portions of our business, and we had VPs that spent a fair amount of their time in Minneapolis in our offices. And what we've done is we've focused our effort down into the field. So all of our field people will live in their territory; they'll be in them every single day and if we would need them for any reason in corporate, they'll have to come here, but the effort there was really to focus it down onto the field. What you're not seeing on the chart is we will have a Chief Operating Officer that those RVPs will report to. The old COOs of the business also did. So what we did here is we've flattened the organization out quite a bit. And at the bottom of the organization, at the district level, we've reduced the scope that the district leaders have, so they'll have anywhere from 5 to 8 salons. They'll be productive, that means they'll be cutting hair. So they'll be in the salon shoulder to shoulder with people every day. They also won't have far to travel, which they did in the past, because we weren't organized geographically. So the whole effort here was on getting good operators spending more time in the salon. We're still in a process, we've made the changes at the top of the organization, and we are into now adjusting the regional directors and district leaders and senior district leaders.

William R. Armstrong - CL King & Associates, Inc., Research Division

Got it. Okay. And turning to use of proceeds from your recent asset sales, your balance sheet is now at a net cash position for the first time in I don't know how long. Could you talk about maybe capital allocation and how you're looking at that, your newly strengthened balance sheet?

Steven M. Spiegel

Most definitely, I'll take that. At this point, we haven't come to any final decision. But we continue to emphasize that deployment of excess cash will definitely be in the best interest of our shareholders. Improving and investing in the turnaround of our business remains our top priority, and as Dan discussed earlier, we're starting to make foundational investments that position the company for longer term growth. We're also still having discussions with our lending banks regarding optimizing our capital structure and capitalizing on favorable credit market conditions. Be assured, all of these activities are focused on maximizing shareholder value, and as we gain more clarity from these events, we'll be happy to report where we'll deploy the cash at that time.

William R. Armstrong - CL King & Associates, Inc., Research Division

Are there any restrictions or impediments to your redeeming or refinancing the converts before they mature, before they get converted into potentially dilutive shares?

Steven M. Spiegel

Well, technically, our bank agreements have a covenant that restrict our ability to make restricted payments in the amount in excess of $100 million. So if you were to take a look at the market value of the converts, call it in excess of $200 million, we would be restricted from making a payment, a cash payment, in that amount.

William R. Armstrong - CL King & Associates, Inc., Research Division

Okay. And then lastly, on Empire Education Group, could you just maybe update us on. I can see that enrollments are down, what's the outlook there? And is this an asset that you're looking to liquidate as well?

Daniel J. Hanrahan

We have been keeping a close eye on Empire. We follow-up with the team there constantly and as you mentioned, we are concerned about the unfavorable enrollment trends. I do feel like the team there has a good plan to get that in shape. And I think that they'll make good progress. It's a good team there. Contractually, we can't sell this investment to a third-party until the summer of 2014, which would actually be during our 2015 fiscal year.

Operator

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

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Let's just see the sequential improvement in the sales trend. I guess, just to make sure the math is right, if you were to back out, that 70 basis points was strictly for the service sales in North America, correct? The impact of the Easter shift?

Daniel J. Hanrahan

Yes.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Okay, so overall, what would be the -- I mean it would be something less than that, presumably because...

Steven M. Spiegel

Yes, 90% of our business is U.S. based. So I would say the bulk of it is North America.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Okay, so it's going to be close to that. All right. And then in terms of maybe sort of a timeframe that you're thinking of to get to the sort of optimized level of payroll in the 2 biggest divisions that you've really been pressing, what's your current thinking on that?

Daniel J. Hanrahan

I anticipated, Daniel, that somebody would ask this question along those lines. We've been at this for about 9 months now and the approach that Regis has been taking has been a long one. We've been going down the path that we're in of cutting hours back and raising prices for quite a while. So I'm not comfortable at this point drawing a line in the sand and saying I think we're going to be fixed in a certain amount of time. There's a lot of things that we've got underway. We've got to get the stylist hours right and we're making progress with our optimization tool. Getting SuperSalon in place is going to be crucial to our success. We've just now are in the midst of the field reorganization. We've got to figure the retail piece out. So it's going to take time, and I'm not at the point where I'm comfortable drawing a line in the sand, Daniel, and giving you a number. But I can tell you I feel good about the fact that we've got a strategy in place now that we're feeling really good about. The organization has embraced it and the field reorganization that we're doing now, I think, will also have a big impact on us. But I think we're heading in the right direction, but it is going still to take some time.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Yes. Directionally, I mean, it seems to be starting to work. I guess 1 maybe just overall big picture question, in your 9 months so far, maybe just 1 or 2 things that you've found to be positive or negative, relative to your initial expectations, just on a summary level.

Daniel J. Hanrahan

Sure, I guess the most positive thing and the thing I'm most excited about is the quality of people we have in the field. I've spent most of the 9 months out in the field working with our best operators. And I purposely chased good performance. So our financial folks sent me in the right direction and I worked with a lot of good people and I spent a lot of time working with our franchisees. And I think the thing that I'm most pleasantly surprised about is the quality of the people. And when you look at what we've just done to the field reorganization at the top, the majority of those regional vice presidents that we showed on Slide 9 are our people. So there's a lot of good talent out there and we just need to figure out how to tap into it better than we have.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Okay, anything you'd call out on the other side of the ledger?

Steven M. Spiegel

We still got a lot of work to do. Anybody that comes into my role wants to fix things instantly. And that's just -- and we're not going to be able to fix it instantly. But no, I think when I came in, the board did a good job of -- when they brought me in, helping me have my eyes wide open. And so nothing really sticks out dramatically. I guess, if there's one thing that was a little bit of a surprise is the amount that we had cut hours out of the field system in the past. And that's a part of the business that is going to take time to fix, more than anything else, I think, is getting that right. But with this new organization that we put in place and a reenergized field team, I think, we'll definitely get there. It's just a question of doing it in a way that has the least impact on profitability, that's the biggest challenge, I think, we have going forward.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

So when you say -- just to clarify that, when you say, that will take still some time to kind of zero in on the right level, is it because of that just not wanting to have an overly adverse near-term profit impact? Or is it because it takes time, from a customer awareness standpoint, to build the perception back up that the salons are staffed and you can get seen in a relatively short period of time?

Daniel J. Hanrahan

Yes, that -- you asked the right question, and I think the you gave -- you clarified a good answer there as well, Daniel, because it is more of the latter, a think we need to get the guests to see that we're staffed, and that we have people coming -- good people coming back for services. And at the same time, we want to be careful that we don't overdo it. It's not good for us to have 2 or 3 stylists in the salon not having anything to do. So we need to strike the right balance and we're working hard on that, and that's what the optimization tool does for us. And elevating these folks from the field into these RVP roles that are really good operators, will help us execute against that.

Operator

The next question comes from Lorraine Hutchinson from Bank of America Merrill Lynch.

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

What would you need to see from the MasterCuts and Supercuts businesses to call this a success? And I guess, roll the increased stylists hours out to some of the other brands as well?

Daniel J. Hanrahan

Good question, Lorraine, what we want to see is sustained service revenue growth and we want to see it -- we want to be able to do it in a profitable way. And as we're able to do that, then we believe that we can roll it out more completely. We've rolled it out, bits and pieces. But our major focus has been on the SmartStyle Salons in Walmart and on Supercuts. They're our 2 biggest businesses, each of them has a single operating model. So it's the fastest and the easiest to get executed. And as we see the success there, then we won't hesitate to roll it out. The other thing that's going to help us a lot is having the right structure in place. And having quality people running our regions and executing at the salon level.

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

But as we wait for the optimization to catch up to the extra hours, I guess, we should start thinking about 2014 as another year where service margins go down, is that fair?

Daniel J. Hanrahan

We're not ready to call 2014 yet. So it's a little early for that. We've got a lot of learning under our belt and still a long ways to go. But we're not ready to make a call on 2014 at this point.

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

Okay. And then I just wanted to ask about the product comps, where you're clearing a lot of product to bring in a new format. How long will that take? And when should we expect to see the comps stabilize with the new product and, hopefully, higher-margin products coming through?

Steven M. Spiegel

Well, we've rolled out our standardized planogram in approximately 20 salons. And we're watching the activity now. Our hope would be to try to get that implemented throughout much of the fourth quarter, so what we could begin the fiscal year with a revised planogram. But it takes too little time after you revise your planogram, especially coming off of a period of time where you're clearing inventory, in order to be able to see the improvement on comp. So I would say some time towards the middle of the first quarter into next year.

Operator

The next question comes from Jill Caruthers from Johnson Rice.

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

A bit more clarification on service traffic trends. I know there was some one-time shifts, given the Sandy hit last quarter, Easter benefited this quarter, so when I try to adjust those numbers, it does appear that on a sequential basis, traffic trends actually worsened a bit in the quarter, I guess, could you just talk through some of those events and numbers.

Steven M. Spiegel

We're not seeing that in our numbers. Perhaps maybe we should circle back with you after the call and we can review your numbers and sort of reconcile why we're seeing it differently.

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

Okay. And if you could talk about -- the big focus now is building the guests for life, if you could talk about -- the bulk of your salon traffic is not appointment-based, so if you could talk about kind of that shift, given you're still can see greater declines at Regis and MasterCuts, which are, I guess, more of the appointment-based versus the more value-oriented salons, kind of that way to transition that customer into more of a repeat?

Daniel J. Hanrahan

Well, there's a number of things that we're doing. Our franchisees are not appointment-based either. And they do excellent job of getting their guest to come back again and again. In the walk-in business, we need to provide a good guest experience regardless of stylist. So that when somebody comes back, they don't care which stylists they go to, they get a great experience every time. So that's around -- there's a lot to do there around the actual guest training. Experience, there's also technical training that we need to do going forward to make sure that the technical experience is as strong. And also the cutting back of hours was not just in the SmartStyle and the Supercuts business. It was across the Board. So when you see declines in MasterCuts and Regis, part of that is a result of us cutting back on hours, historically. We've stopped cutting back the hours there. We haven't made the investment in the hours like we have in Walmart and in Supercuts. But as we get that done, we think that we have the ability to grow those businesses well. And I could tell you that in both Regis and MasterCuts, we didn't get into any of the details today, but we do have salons and we have districts that are performing well, that have been able through the guest training and a stronger focus on the guest experience, start to turn this. Not anywhere near declaring victory yet, but we have seen that we've been able to make progress in those businesses as well.

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

Could you talk about if you did a -- ran any price testing this quarter, I know, in the second quarter, you ran a Walmart receipt tape [ph] that was somewhat productive. If you could talk about if you did anything in the third quarter on pricing?

Daniel J. Hanrahan

Yes, we've done a fair amount of analysis, especially on our Walmart business, where we've actually looked that the last $300 million transactions at Walmart. And trying to build out a price elasticity model. We're very, very early stages on that. We've done some testing, but very, very early and we're not ready to say that we're anywhere near a decision on price elasticity, but it is something that we're working on to get a better handle. We do think that is going to take some time before we can figure that piece out of it. We did see, as mentioned in the last quarter, that we got some results from a test on the Walmart tape. Didn't drive profitability, drove some traffic. So we know that we can drive traffic with price, we just need to be able to do it in a profitable way. That's way we're digging deeper into price elasticity and what that looks like. But again, I want to stress that that's very, very early stages, that work, and we won't have anything that we want to hang our hat on for quite some time.

Operator

The next question comes from David Kim [ph] from [indiscernible] Capital.

Unknown Analyst

So as expected, I guess, margins over the last few quarters clearly been pressured by stylists costs and IT investments. And while the latter might be temporary, it seems like the former, the increased stylist costs might not be. So I guess should we sort of expect to see, structurally, lower margins to drive positive comps going forward? And I guess where do you kind of see all that shaking out? And I guess on a related note, so with the Walmart and Supercuts concept, where it seems like you've been investing pretty heavily in the salons hours, has the revenue growth there, so far, offset the increased investment in hours? Are you seeing sort of margin improvement there on a four-wall basis?

Steven M. Spiegel

All right. So let me start with your first question, just about our cost of service. We've just begun to strike a balance between the investment in our stylist hours and guest traffic. While our objective is to make optimization a core competency, we're only 6 months into this initiative. And I think as an organization, we still have a lot to learn. Also, continued improvement in the cost of service is also highly dependent on our ability to leverage stylist hours against sales comps. So as sales comps improve, we get more productivity out of them and vice versa. We're not going to return as a company to the past practice of cutting hours to manage short-term profitability to the detriment of providing that ideal guest expense that Dan referred to. So with these things noted, I would continue to expect, in the short-term, some margin pressure. But we are beginning to anniversary initial investments in stylists hours of Supercuts in the fourth quarter of last year. And at SmartStyle towards the end of the first quarter of next fiscal year, which should counter those headwinds. As it relates to, are we closing the gap in hours versus traffic? We're seeing signals that the gap is closing. But we haven't cracked the code yet. In Supercuts, in the select stores that we showed you at Supercuts, we've been able to narrow that gap quite sizably and in SmartStyle, I'd like to say the same. Some months we're seeing where we're in the black and other months in the red. And I think as we get better at optimization and as we continue to be able to leverage improving guest traffic, we'll be able to invest in those stylists hours and get the return we're hoping to achieve.

Unknown Analyst

Okay. And then just a quick one on the Hair Restoration sales, so after transaction fees and taxes on the gains, what do you expect the net proceeds will be?

Daniel J. Hanrahan

Well, it's still subject to a reconciliation of working capital with the buyer. So we don't have a defined estimate at this point in time. We're going to be resolving that during the fourth quarter. But it will be a gain.

Operator

The next question comes from Jeff Stein from Northcoast Research.

Jeffrey S. Stein - Northcoast Research

Question for Dan and then a couple for Steve. So if you look at -- I understand that you want to focus on your biggest and best assets, but you still have roughly 3,000 salons invested in your Regis division and your Promenade division. So how long do you think it will take before you really get around to making those a priority, or I should say, maybe the same priority as the value salons? And could these continue to be an anchor on your recovery for several years as a result of just the scope of what you're up against in trying to turn around so many different salon groups?

Daniel J. Hanrahan

Good question, Jeff. When we showed that example of the regional vice president that we had recently promoted, where we had invested hours in his salon, it was one of the markets that we had taken to invest hours in that he didn't have any Supercuts. Had a couple of SmartStyles, but the majority of the salons were out of the Promenade group. So we saw traction, good traction. And the thing that's important to stress that all the things that we're doing go across all of our different models. So the SuperSalon investment which is the POS, across all models; the guest relationship management tool that we're building out goes across all models; this restructure that we did; and I'm convinced that the most important part of this turnaround is people, goes across all models. So while we focus today, quite a bit, on Supercuts and SmartStyles, because that's where we invested the bulk of our hours, all these other things that we're doing and -- including our Moments of Truth guest program, go across the entire portfolio. So we've got a very strong focus on everything. We have prioritized for hours, SmartStyle and Supercuts, but that doesn't mean that we have invested hours where it makes sense in the Promenade as well as in Regis.

Jeffrey S. Stein - Northcoast Research

And Steve, just a couple of housekeeping questions on the P&L. Depreciation and amortization, it kind of bumped up into Q3. Was there any accelerated asset write-downs in the quarter that would account for that? Or is that kind of the run rate we should look for on a go forward basis? And then similar questions with regard to site operating expenses?

Steven M. Spiegel

There was probably about roughly $800,000 pretax of accelerated depreciation relating to our planned consolidation of office space here in Minneapolis, we're leaving a lease. And so some of the fixed assets there are depreciating on an accelerated basis. So I think if you take a look at the back of our release, we provide the information that sits in depreciation expense that's discrete and that will tell you what to take out.

Jeffrey S. Stein - Northcoast Research

Got it. And how about the site operating expenses?

Steven M. Spiegel

Site operating expenses, was largely driven by salon connectivity. And with the roll out of SuperSalon, which is largely occurring not only in the third quarter, but in the fourth quarter, and the support that's going to be required going into next year as we're live on all of our salons, I anticipate we're probably going to be running higher on salon connectivity cost than we have historically.

Jeffrey S. Stein - Northcoast Research

So the third quarter run rate would be more representative of what we should expect on a go forward basis?

Steven M. Spiegel

Hard to say, we're also, at the same time, we're looking at that. We're looking at ways to mitigate it. So I'd hope it would be lower than that. But at this point, I'm not sure we've determined just how much lower.

Jeffrey S. Stein - Northcoast Research

Got it, and final question would be on the equity and affiliates line, little lumpy there, it jumped almost fivefolds from where you were in the second quarter, is that $1 million run rate, is that a run rate or is there a reason why it jumped so much from Q2 to Q3?

Steven M. Spiegel

Let me get back to you on that one. We'll circle back with you after the call.

Operator

There appear to be no further questions. I will now turn the conference back to Dan.

Daniel J. Hanrahan

Thank you, Kev. Thanks everybody for tuning in today. We appreciate all the questions and look forward to communicating with you -- many of you, between now and the next call. And if there are any further questions, you can contact Mark Fosland for answers. Thanks very much for your time today.

Operator

Ladies and gentlemen, if you wish to access the replay for this presentation you may do so by visiting regiscorp.com in the Investor Relations section of the website, or by dialing 1 (800) 406-7325 with an ID of 4615164 followed by the #. This concludes our conference for today, thank you for participating and have a nice day. All parties may now disconnect.

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