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Regis Corp.(NYSE:RGS)

F1Q08 (Qtr End 9/30/2007) Earnings Call

October 22, 2007 11:00 am ET

Executives

Paul Finkelstein - Chairman, President and CEO

Randy Pearce - Senior EVP and Chief Financial and Administrative Officer

Analysts

Jeff Stein - Keybanc Capital Markets

R.J. Hottovy - Next Generation Equity Research

Mike Hamilton - RBC Dain Rauscher

Jon Christensen - Kayne Anderson Rudnick Investment

Justin Hott-Bear - Stearns

Justin Boisseau - Gates Capital Management

Daniel Hofkin - William Blair

Operator

Good morning ladies and gentlemen. My name is Mary, and I will be your conference facilitator for today. At this time I would like welcome everyone to the Regis Corporation First Quarter 2008 Conference Call. All lines have been placed on mute to prevent any background noise.

If anyone has not received a copy of this morning's press release, please call Regis Corporation at 952-806-1798, and a copy will be faxed to you immediately. If you wish to access the replay for this call, you may do so by dialing 1-800-405-2236, and enter the access code of 11097199 followed by the pound sign.

I would like to remind you that to the extent the Company's statements or comments this morning represent forward-looking statements, I refer you to the risk factors and other cautionary factors in today's news release, as well as the Company's SEC filings. Reconciliation to non-GAAP financial measures mentioned in the following presentation can be found on their website at www.regiscorp.com.

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

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

Paul Finkelstein

Thank you Mary and good morning everyone. Thank you for joining us. We are all pleased with our first quarter results. Our earnings and our consolidated same-store sales came in right on plan at the midpoint of our guidance range. First quarter earnings were $0.46 a share, and our consolidated same-store sales increased nine-tenths of 1%.

North American first quarter service comps increased a very healthy 2.7% versus 0.5% or 1% last year. Our sales in the U.K. continues to be disappointing due to a difficult environment. Our consolidated service comps increased 2.3% for the quarter. Hair Club continues to perform extremely well.

Product comps for the quarter were a negative 2.5%, and I'll address product comps later on during my presentation.

First quarter EBITDA was flat at almost $75 million. We ended the quarter with 12,108 company-owned in franchise locations, an increase of 81 locations during the quarter. Total locations including businesses in which we hold an ownership interest, numbered 12,584. During the quarter, we completed nine transactions acquiring 133 salons, including 42 franchise salons. Our franchises built 57 locations and closed, relocated or sold 89 salons.

Company-owned salons as of September 30, numbered 8,315. Franchise locations were 3,793. We also have investments in salon companies which have 476 locations. This is a very important number, as after the Provost is completed, this number will exceed 2,500 locations, and will have an impact on sales and EBITDA, although EPS should not be significantly affected, if anything EPS should grow.

Total debt at the end of the quarter was $719 million and our debt to cap ratio was 43.3%. As you can see from the strengthening of our service comps, our core business is starting to recover nicely.

I’d like to share with you an additional perspective on the whole issue of customer visitation patterns. I really don’t like to make historically references, because I am more concerned about the present and the future.

But, I would like to share with you a perspective that history will provide. 40 years ago, our core customer was a weekly salon customer. She literally came to the beauty saloon 50 times a year. We allowed her two weeks off a vacation. At about that point in time the down customer was instrumental, in changing our industry forever, when blunt cutting ‘n wash that allowed customers to visit a salon every four to six weeks.

At that point in time we thought this would be a disaster for our industry, but the industry was able to adapt and did enjoy significant growth for the next more decades. During the last five years, visitation patterns have lengthened, in part due to long hair and in part due to a more casual lifestyle. In many instances people who went every six weeks are now going every eight weeks.

While all this creates a challenge for us, it is no way near the magnitude of the challenge created 40 years ago. While this has been a difficult transition, it is not at all impossible one and now it is basically anniversary. And with the aging population, coupled with the anniversarying factor we seem to be on our way towards recovery. We are adapting by implementing price increases, new services such as hair expansions and hair color and super cuts. All of these events test the resiliency of our business. We have never had a negative comp here in our 85 year history.

As you know, the big issue today is product sales. And in our last conference we shares with you our plan to significantly transform Trade Secret into a true beauty boutique, rather than just a seller, a professional hair care products. We know that other Trade Secrets type companies within our industry have bad body cosmetic and skin categories, representing as much as a 23% of their total sales. These categories represent only 2% of our sales.

Please understand that we are not in any way giving up on our hair care business. We will be thinning out all those popular lines, but from a practical point of view the bath, body, face in cosmetic categories will represent incremental sales. We are on a process of a significant Trade Secret redesign, as well as identifying, which new vendors will partner with us in order to implement this transformation. We expect to show improvement in Trade Secret during the last half of our fiscal year.

While I've discussed our transformation strategy during our last conference call, our original plan was to test the strategy in five salon Minneapolis area. We have modified the strategy and are now planning to test the strategy by using a new store design, which will be rolled out in several locations which are already scheduled for remodeling.

Our first test location will be at the mall of American Minneapolis and we will have seven to eight additional locations operating with the new assortment and design by the end of the fiscal year. Based on the results of this test group we will develop a plan to retrofit our existing locations so that we can obtain incremental sales in all of our Trade Secret stores. After we have developed a right assortment, we will take certain elements of the bath, body cosmetic and skin lines and install them in our Regis lines as well. Part of the way we will add this new assortments, once they proved to be successful to the entire Trade Secret division prior to remodeling.

Lastly, I would like to talk about the Provost transaction and share with you the history of the transaction and our thought process behind it. As you know we recently issued a press release announcing that we are merging our European continental business into Provost. Our U.K. business is excluded from this transaction. Provost was the largest known long brand in Europe, with the worldwide presence. [Invus] is a minority investor in Provost. [Invus] is a private equity house that has been very active in recent years and it’s a Weight Watchers private, an equity house that has been very active in recent years.

They took Weight Watchers private and then public. They are a top notch high quality firm. They called me about six months ago and asked whether they could purchase our business on the continent where the primary brands being Jean-Louis David and St. Algue. We told them that we do not want to exit Europe, but that we would consider merging our business into theirs and retaining an equity position.

Our continental business is doing extremely well, with profits proceeding plan, the business is highly profitable. However, we all recognize today that bigger is better, bigger does create account an account prevailing balance between us and our suppliers. Our suppliers continue to consolidate and become even more powerful.

Bigger also allows us to be a stronger company. When Franck Provost did call, we stated that they were four preconditions that had to be met for us to consider our merger. First, our shareholders would have to be advantaged; second, and the most importantly, our franchisees would have to be advantaged; third, we must retain an equity interest as we do not want to exit Europe, and fourth, Provost would have to make a commitment to keep the Jean-Louis David brand very special and unique.

Although our current performance has been more than satisfactory, it is very difficult for our American management to compete on a level playing field with the European management of Provost.

Franchising in particular prevents significant challenges. We do not have the same exit strategy for our European franchisees that we have in the United States. Provost has such an exit strategy with 200 of its salons being company-owned and 400 being franchised.

We have almost 1,600 franchise salons in Europe and only 40 are company-owned. The Regis business on the continent has been quite strong, with $60 million in revenues and EBITDA of $11 million. However, the new combined business of Provost including Regis will have 2,200 locations of which 240 will be company owned, $900 million in system-wide sales, and EBITDA of $39 million with huge opportunities for continued growth. Thus merging Jean-Louis David and St. Algue into Provost creates a very dominant company in Europe.

We retain a 30% equity interest in the new company. We are very excited about this transaction and it should close sometime in early January. This also reflects a change in authenting over the last several years. Historically, we have never had partnerships for strategic alliances. But as Regis bigger and the world become smaller, we feel that strategic alliances and certain areas are appropriate.

Last year, we created a joint venture with Horst Rechelbacher, the founder of Aveda. This joint venture will be producing an organic line of products which will be introduced sometime this spring. It will be groundbreaking line. There are all significant risks attached to this transaction. But in no way should it perform, should these risks be material to us financially.

Horst and Regis, each have 50% interest in Intelligent Nutrients. We also announced this past spring, that we purchased 30% of Goldman Sachs' 49% interest in a Japanese entity controlling 175 salons. This gives us a platform with which to grow with Wal-Mart in Japan, if Wal-Mart so desires.

We have a minority interest in Cool Cuts 4 Kids, which the 70 stores chain, headquartered in Dallas, and a business that we feel is scalable, but a business which we wanted to initially operate, with an entirely separate management team.

We have a call on this business. Hopefully, this will be part of Regis within the next several years. This past August, we closed in a transaction with Empire Education Group, in which we merged 51 of all cosmetology schools in the Empire, which now has 87 schools and the management team with the potential to create within three to five years, a $200 million business with very strong EBITDA margins. We retained a strong equity interest in Empire approximating 50%.

These alliances are quite strategic and in most instances, we will be able to significantly expand our ownership percentage. I am more bullish about our company than I have been in a long time, as our service business, which is in fact our core business is improving, and we know exactly what has to be done in the product arena. The issue is not the what, but the how.

Once again, thank you for all of your patience. I will now pass the baton onto Randy Pearce.

Randy Pearce

Thanks Paul and good morning everyone. We are very pleased today to report first quarter earnings of $0.46 a share. Perhaps over most encouraged buy is the marked improvement in our service sales which represents 70% of our overall business. Service comps increased 2.3% in the first quarter, up 100 basis points from the preceding fourth quarter.

As we said many times before, our earnings guidance correlates to our same-store sales guidance. For example, guidance for our first fiscal quarter was for earnings to be in the range of $0.43 to $0.49 per share based on a forecasted same store sales range of flat to 2%. Our actual comps for the quarter came in near the midpoint at positive 90 basis points, and therefore our earnings of $0.46 also met the mid point of the range.

Our reported earnings of $0.46 would have been a penny stronger, had it not been for a higher than expected effective income tax rate in the quarter. The higher tax rate was simply a timing issue related to our first quarter adoption of the new FIN48 accounting pronouncement, which I will discuss further during my segment's discussions.

Other than that, our first quarter operating results were generally pretty straightforward. Please also note, that effective August 1, we deconsolidated our Title IV school business due to our joint venture partnership with Empire Education Group.

As we've discussed with you before, deconsolidation has no impact on our bottom line earnings. However, it does cause a reduction in our consolidated revenues and expenses. As a result, deconsolidation of our school business reduced our overall first quarter revenue increase from 6.6% to 4.4%. That was a reduction of 220 basis points in our revenue because of the deconsolidation.

I'll now transition my comments and give you a bit more detail behind first quarter operating results for each of our business segments and a breakout of our segment performance as found in today's press release. And I'll begin as always with our largest segment which is our North America salons.

North American salon revenue, which represented 86% of our consolidated first quarter revenue, increased 7% during the quarter to $572 million. This revenue growth was due to a 6% quarter-over-quarter increase in the number of company owned salons that we operated, as well as a 90 basis points increase in same-store sales. In addition, our North American growth was favorably impacted by 100 points, as a result of including one month of revenue related to our school group that was merged into Empire Education on August 1 of 2007. Last year this revenue was separately included in our beauty schools segment. This year again, we’ve included the one month of results in North American salons.

Service revenue in our North American salons grew nearly 10% during the quarter to $407 million. This increase included a very nice 270 basis points increased in service same-store sales and a 130 basis points benefit related to the inclusion of one month of school activity.

Product revenue only grew 1% in the quarter to a $155 million largely due to a decline in product same-store sales of 3.7%. Royalties and fees from our North American franchise salons increased 4% during the quarter, to $10 million. This increase was primarily due to our first quarter acquisition, which added 42 franchise locations in the quarter. Absent these acquisitions, new franchise units that were added to the system over the past 12 months are being slightly more than offset by franchise buybacks and franchise unit closures.

Our combined gross margin rate for North American salons came in at 43.9% in the first quarter. Although this rate was 50 basis points less than the same period last year, the 43.9% rate did meet our plan. Before I go into details of our first quarter service and product margins, I would like to point out one reclassification change that we made this past quarter. Due to recent refinements made to our inventory tracking systems, we are now able to better track and account for retail products that our salon stylish transfer from retail shelves to the back bar for use and servicing their customers. The cost of these products had historically been included as a component of our retail product gross margin, whereas they are now more appropriately included in our service margin.

These retail-to-shop transfers, only amount to just over a $1 million each quarter, although this classification has absolutely no impact on a combined North American salon gross margin rate. The result of this reclassification will serve to reduce service margins by approximately 30 basis points and will increase product margins by 70 basis points, again this is a reclassification only, it has no bottom line impact.

Our first quarter service margin rate for North American salons came in at 42.3%. Although, this rate was slightly better than plan, due to our stronger service comps, this rate was 50 basis points lower than the same period a year ago. The majority of this change was a result of the reclassification that I just discussed. In addition, our amalgamation of the Fiesta Salon acquisition, which has a slightly higher salon payroll cost, caused a slight decrease to our overall service margin rate.

Our retail product margins for the quarter came in at 47.9%, which was 30 basis points lower than the same period a year ago. As I just mentioned, a moment ago, we had expected a 70 basis point improvement in product margins, due to the reclassification of retail to shop items. Therefore, on an apples-to-apples basis, our product margins are 100 basis points below last years first quarter rate. And there were two primary reasons for this. First of all, we experienced negative payroll leverage in our Trade Secret salons in the first quarter, due to negative products comps of 8%.

The second factor that reduced our product margin rate this quarter, related to a sales mix, whereby we sold a higher proportion, of lower margin promotional items during the quarter. That's not to say, we have promoted more heavily during the quarter, because we did not. This is simply a mix play in our sales.

Next, I will address our North American salon G&A expense, which came in essentially on plan in the first quarter of 5.8% of revenue, up 40 basis points over the same period last year. The majority of this increase was related to a planned increase in photo shoots and salon level collateral expenditure such as posters, shelf talkers and other signage. Marketing expenditures in the prior year first quarter were a bit lower than normal, as we pointed out to you last year.

Our North American salon, experienced a slight 10 basis point increase in rent expense, which also came in essentially on plan, in the first quarter at 14.5% of sales. We continue to experience some slight negative leverage in this fixed cost category as salon rents are increasing at a slightly faster rate than our overall same-store sales growth. Site operating expense, which includes cost directly incurred by our salon such, as advertising, insurance, utilities and janitorial cost, improved 40 basis points in the first quarter, coming in on plan at 8.6% of sales. Most of this improvement reflects a planned reduction in our workers compensation cost. As we saw last year, we have seen significant improvements in this cost category due to improved salon safety programs and return-to-work programs.

The net effect of all the items I just discussed caused operating income for our North American salons to come in at 12.1% of first quarter revenue.

Next, let's review our first quarter performance of our international salon segment. This segment includes our company-owned salons located primarily in the United Kingdom as well as our franchised salons located on the continent of Europe.

Beginning this year in fiscal 2008, our international salon segment also includes our four Vidal Sassoon Academies in the United Kingdom, as we no longer report a separate school segment.

Our overall international salon revenue represented 10% of our consolidated first quarter revenue and increased just over 13% over the same period a year ago, coming in at just over $63 million.

Over one half of the overall revenue increase was due to a quarter-over-quarter improvement in the Euro and the British Pound exchange rates over the U.S. Dollar.

Absence of currency impact, the balance of our fourth quarter revenue growth was due to the inclusion of the four Vidal Sassoon Academies and the addition of new and acquired beauty salons partially offset by a 3.8% decrease in over all comps.

The service revenue component which included a 5.3% decline in service comps grew 14% overall in the quarter to $38.4 million. Once again, most of this increase was due to currency gains, as well as to the inclusion of the Vidal Sassoon Academies.

Product revenue also grew, increasing 14% during the quarter, primarily due to currency gains and once again, the inclusion of the Vidal Sassoon Academies. The strong product comps in the U.K. that we have enjoyed in recent quarters, have started to soften, coming in at negative 30 basis points in the first quarter.

Lastly, royalties and fees from our international franchisees grew just over 9% during the period.

I’m going to switch gears now, and discuss our gross margin rate. Our international salons combined gross margin rate improved 110 basis points in the first quarter to exactly 46% of revenue. Our service margin rate improved 30 basis points in the quarter to 46.9%, despite the previously mentioned 5.3% decline in service same-store sales. The margin improvement was due to the inclusion of the Vidal Sassoon Academies in the U.K., partially offset by negative payroll leverage.

We also experienced an improvement in our retail product margin rate, which came in essentially on plan at 43.7%, an improvement of 320 basis points over the same period last year.

As we had expected, our international product margin rate is improving as we continue to migrate towards a similar product distribution model that we have here in the States. As we’ve discussed in the past, we are now shipping some product from our distribution center in Chattanooga, Tennessee, to our U.K. operations, in order to take advantage of our global purchasing power, which that certainly has helped our U.K. product margins.

I'll now address the other expense line items for our international segment, and let me just say that every line item essentially met our plan for the first quarter, there were really were no surprises.

Our site operating expense category came in at 5.1% of first quarter revenue. Although this rate met plan for the quarter, it was 90 basis points higher than the same period a year ago. This planned increase was primarily due to the current year inclusion of the Vidal Sassoon Academies.

During the first quarter, Sassoon held its annual student recruitment event in Japan, which caused the slight operating expense rate to increase as we expected.

Our international G&A expense rate also met plan during the quarter, coming in at 18.7% of sales which was an increase of 50 basis points over the year ago period. This planned increase was due to the timing of advertising cost in our franchise business located on the continent of Europe.

Next, our international rent expense met plan during the first quarter, coming in at exactly 20% of revenue, up 30 basis points over the same period last year. Just like here in the States, rent renewal increases over the past year in the U.K. have outpaced our overall same-store sales.

Our depreciation and amortization expense for international salons came in at 3.9% of revenue which was in line with our expectations, but was 50 basis points higher than the prior year first quarter rate. This planned increase was due increased depreciation, following the completion of recent salon remodeling projects, as well as certain salon asset disposals.

In total, the net effect of all the factors we just discussed caused our operating income for international salons segment to come in at $4.1 million or a rate of 6.5% of sales.

Next, we'll talk about Hair Club for men and women. Darryll Porter and his management team at Hair Club continue to run a very consistent business, and one that is performing above plan.

Let me very briefly highlight just a couple of items. First quarter revenue from our hair restoration centers increased more than 10% to $32 million, which was a $1 million above plan. Hair Club revenues represented nearly 5% of our consolidated first quarter revenue.

Our first quarter operating margin rate for Hair Club came in at 21.7% or 130 basis points stronger than the comparable period a year ago. In addition, first quarter EBITDA margin came in a very strong at nearly 30%. Once again, we remain very pleased with the performance of this segment of our business.

Next, I will make a couple of brief comments regarding our beauty schools. As we previously announced and discussed with you, effective August 1st our Title IV Funded beauty schools, were merged with and are now managed by Frank Schoeneman at his Empire Education Group. As a result, our first quarter consolidated results includes only one month, of the Title IV school results, which we grouped in our North American salon segment. We have then deconsolidated our business, effective August 1st and then included the remaining two months of after tax school performance, under a new line item on the P&L called equity and affiliated companies. This line item will not only include the after tax results of schools, but also our equity interest in other joint venture partnerships, including Intelligent Nutrients. We no longer will report school performance, under a separate business segment.

I am now going to make a quick comment regarding our first quarter G&A rate that appears in the corporate segment of our P&L. Although our G&A cost came in on plan, at 5.2% of sales, this rate was 50 basis points higher than the same period a year ago. The primary reason for the planned increased related to consulting fees paid to Deloitte, in connection with our expense control initiative.

With that, that concludes my comments concerning the individual business segments. But I would like to make a comment, on our effective income tax rate. We still expect our tax rate for the full fiscal year to be in the range of 34%. However, our first quarter rate came in higher than plan at 35.8%, due to implementation of a new accounting pronouncement. As required, we adopted FIN 48 on July 1st of 2007, which was the beginning of our fiscal year. And FIN 48 is titled accounting for uncertainty in income taxes.

The higher than expected tax rate impacted our first quarter earnings by a little more than penny a share. The impact of adopting FIN 48 will cause the tax rate for Regis, as well as most other companies, to fluctuate quarter-over-quarter, rather than being able to expense a constant annual rate. Again, we continue to expect our tax rate for the full fiscal year to be around 34%.

Let me speak to our interest expense in our debt levels. As we had expected, our first quarter interest expense came in at $10.6 million, up from $9.8 million of expense we recorded in the same quarter last year. Our total debt on September 30th stood at $719 million, up $10 million over this past three months. Our debt to capitalization ratio with September 30th remained solidly investment grade at 43.3%. Assuming we repurchase a 100 million of stock this fiscal year, we expect to end the year with total debt in the neighborhood of $780 million.

As you also know, the cash flow characteristics of our company are very strong and highly predictable, we are pleased to report that despite deconsolidation of our school business, our first quarter EBITDA grew slightly to a nearly $75 million.

I have one final item to addressed, today's press release include information regarding our earnings outlook, for both the full 2008 fiscal year, as well as our second quarter. We reaffirm our previously issued guidance for fiscal 2008 earnings to be in the range of $2.01 to $2.27 a share. As we have discussed with you last quarter, our initial annual comp guidance of 1% to 3% may have been a bit aggressive given the near term challenge we have faced relating to retail product comps.

Based on first quarter results, we now believe total comps for the full year should be in the range of 50 basis points to 250 basis points. Nevertheless, we still feel comfortable with our initial earnings target, due to accretion from recent acquisitions, as well as our expense control initiatives. For our second fiscal quarter of 2008, we believe earning should be in the range of $0.51 to $0.57 a shares, based on a comp expectation of 50 basis points to 250 basis points.

The adoption of FIN 48 is going to cause our quarterly effective tax rate to jump around this year, as we just discussed. We saw it happened in our first quarter and as a result our second quarter tax rate is expected to be above 36%, which again is higher than the estimated annual rate of 34%. This higher rate will impact second quarter earnings growth by about $0.02 a share, but this is simply a timing issue, as we will get most of this back with the lower tax rate in the second half of this current fiscal year.

That's it, that completes my prepared remarks. Paul and I'd be happy to answer any question you have. So Marry, can you step in and provide some instructions we'd appreciate it.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Jeff Stein with Keybanc Capital Markets. Please go ahead.

Jeff Stein - Keybanc Capital Markets

Good morning Paul. Just a couple of questions; first with regard to visitation you stated the fact that you are beginning to anniversary with your numbers and just kind of wondering, in the quarter did you see a year-over-year increase in visitation, in your domestic salon?

Paul Finkelstein

We were still slightly down but--

Randy Pearce

On a comp basis.

Paul Finkelstein

On a comp basis, but 2.7% service comps is very, very strong.

Jeff Stein - Keybanc Capital Markets

Sure.

Paul Finkelstein

And we probably got an average ticket increase of slightly in excess of 3%. So, we are marginally down in terms of foot traffic, but that’s a considerable improvement from being 3% or 4% down in customer count a couple years ago.

Jeff Stein - Keybanc Capital Markets

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

Paul Finkelstein

It's everything. It’s a hair color and Supercuts, its price, maybe 2000 of our salons have price increases. It's hair extensions which now is a couple million dollar business, $3 million business, probably it will be $6 or $7 million business within the next year. It's just a whole bunch of little things, Jeff?

Jeff Stein - Keybanc Capital Markets

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

Paul Finkelstein

Jeff, I really don’t think these new initiatives are all long-term at all. We'll be testing within the next 60 days, new lines -- new assortments. And we'll be putting those new skills and many of our Trade Secret stores long before they are remodeled. We also -- believe it or not, our Trade Secret business is getting marginally better, not worse. So, I think our investors are going to see -- I don't look at it total negatively at all. They have the professional pack or category for all the reasons you mentioned, as those additions over the last year. And we perhaps should have a little bit of self-flagellation and that we haven't come up with our new plans early enough.

But we will identify now, we have identified vendors, and I think, certainly the last quarter, I think you are going to see much improved results, Jeff. And that's not long-term, that's intermediate term.

Jeff Stein - Keybanc Capital Markets

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

Paul Finkelstein

No, I am talking about beauty care products. I'm talking about --

Jeff Stein - Keybanc Capital Markets

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

Paul Finkelstein

Correct.

Jeff Stein - Keybanc Capital Markets

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

Paul Finkelstein

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

Jeff Stein - Keybanc Capital Markets

Okay. Thanks.

Paul Finkelstein

Welcome.

Operator

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

R.J. Hottovy - Next Generation Equity Research

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

Paul Finkelstein

You have the most -- whatever is on the website is the most current number. And we continue to have L'Oreal affect us negatively, and yet companies like Joy Co. and Mitchell are doing extremely well fighting diversion. So, I think it's pretty much same all same all in terms of -- I don’t think there's anything that’s really new in our diversion front, other than it gets marginally worse.

R.J. Hottovy - Next Generation Equity Research

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

Paul Finkelstein

I think most of that which we even feel we should joint venture with or have a strategic alliances have already been implemented. We are not working on anything new right now.

R.J. Hottovy - Next Generation Equity Research

Okay. I guess that's it. Good luck in the next quarter.

Paul Finkelstein

Thank you.

Operator

Thank you. Your question comes from Mike Hamilton with RBC Dain Rauscher. Please go ahead.

Mike Hamilton - RBC Dain Rauscher

Good morning everyone.

Paul Finkelstein

Hi Mike.

Mike Hamilton - RBC Dain Rauscher

I was wondering given what's going on in establishing the JV's expense with IN, can you take a stab at what we were running in one time cost here in and in the big picture where it’s showing up in line items?

Randy Pearce

Yeah, let me take a stab at that. In terms of where it’s showing up on line items, on the page of the P&L, I referred to the new line item it’s called equity and income or loss of affiliated companies. And we had $334,000 loss, now that's an -- on an after tax basis. So that's showing up, that includes IN, which was the major contributed for the loss this quarter, as well as offsetting, a slightly offsetting it was some profit coming out of the Empire School business for the quarter. In terms of overall financial impact, IN continues to sell product to other third party retail outlets, as well as to Regis and we in turn are selling products to our consumer.

So in terms of sales, we ended up -- we are probably selling $0.25 million to $0.50 million of product in our salons each quarter. Mike and, once again, we ended up with a net after tax loss around $200,000, $300,000 for the quarter. I don't see it, once again, we've talked about the implementation of the rollout of the professional line, which I think Paul had indicated will come later in the fiscal year. So I don't see until that launch takes place, but there will be much change in terms of revenue or operating impact.

Mike Hamilton - RBC Dain Rauscher

Yeah, fair enough. Is there any thing worth noting in terms of one time expense related to either schools or the continental European changes that have shown up during the quarter?

Randy Pearce

No.

Mike Hamilton - RBC Dain Rauscher

Thanks. That's it from me.

Randy Pearce

Alright, Mike.

Operator

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

Jon Christensen - Kayne Anderson Rudnick Investment

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

Randy Pearce

2%.

Jon Christensen - Kayne Anderson Rudnick Investment

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

Paul Finkelstein

It's modestly comps, but our franchise business have actually shrunk and has a much higher margin, 40 somewhat percent margin contrast to a company owned business. And our company owned stores have grown faster than our franchise division, in part, because we bought so many franchisees back.

Jon Christensen - Kayne Anderson Rudnick Investment

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

Paul Finkelstein

No, our franchisee are very well. We've cutback on higher growth, company owned growth. I think our franchisee have as well, because they are in a last three or four, five years. We have reduced visitations and ramp ups have taken longer. And we have more resources, more financial resources than they. But if you take a look at the total franchise stores, coupled with the buybacks, we've had about a 4.5% increase in total units from that franchise division compounds that over the last four years.

Jon Christensen - Kayne Anderson Rudnick Investment

And when I looked at total systemized salons in your press release, I see the numbers for salons constructed going from 420 in June of '07 to 85 September, I see a similar decline in acquired? What do I read from that?

Randy Pearce

Help me with it, when you say 422 salons acquired that's for the full fiscal year. And you are comparing it to the 85 that we built in the first quarter this year I believe?

Jon Christensen - Kayne Anderson Rudnick Investment

Okay. That is, that goes a long way to…

Paul Finkelstein

Yeah.

Randy Pearce

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

Jon Christensen - Kayne Anderson Rudnick Investment

Thank you

Randy Pearce

You are welcome

Operator

Thank you. Your next question comes from Justin Hott with Bear Stearns. Please go ahead.

Justin Hott-Bear Stearns

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

Paul Finkelstein

Yeah, they are, we have moved Matrix from a prime spot to less prime spot, and we just have -- we've published on our website, those lines that are getting are more footage, and those are lines are getting less footage.

Justin Hott - Bear Stearns

You also made a decision about hair color as well, lot larger because of diversion, where we switch from L'Oreal color to --?

Paul Finkelstein

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

Justin Hott - Bear Stearns

What has the response been from some of the supplier so far, as you decrease or give them les prime spots? How are they responding?

Paul Finkelstein

Some of them are not euphoric.

Justin Hott - Bear Stearns

Are they changing their behavior yet?

Paul Finkelstein

No. They are say they are, but the numbers all dictate.

Justin Hott - Bear Stearns

And, can you give us maybe just a little bit more on the Intelligent Nutrients roll out on the brands, some of the discoveries and learning you've had? How you are working with Mr. Rechelbacher so far? Hope you could tell us?

Paul Finkelstein

Yeah. He is an amazing man, and we have groundbreaking products. We are like him in terms of all the fix that they had done. And we are in the final stages hopefully of coming up with a shampoo and conditioner. And his objective is to have 100% of it food-grade organic, and we believe that 90 somewhat percent of the SKU's will be 100% food-grade organic, and nobody has that in the world. There may be some SKU's where we'll be organic, but not totally food-grade organic. We are going to have something very special, very unique.

Justin Hott - Bear Stearns

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

Paul Finkelstein

It's not only Ulta, its Victoria's Secret, I mean it's become a more competitive category; shampoo is not -- its like Starbucks and Coffee. Coffee was nothing years ago and really, the shampoo business was a commodity business 15 years ago, and now it's become a hot category, so there is more competition.

Ulta has a big box, 10,000 feet, that's we're going to have $4 million. That's an awful lot, Justin. We like power lower risk footprint, we think it’s a lot easier for us to continue to grow, and have a model that works long-term, but I’m not here to throw stones at Ulta, yes, they have done a good job. Well, good, fine. Anybody who sell shampoo competes with us, whether it's Ulta or whether it's Banana Republic.

Justin Hott - Bear Stearns

But I’m thinking more about the large floor play where there is couple of salons chairs in there as well too.

Paul Finkelstein

Yeah, but I’m not terribly concerned about that.

Justin Hott - Bear Stearns

Can you just flush out a little bit more of why, outside that you have 12,000 stores.

Paul Finkelstein

Well, once again, if we continue to add 500 to 1000 stores a year, and the locations are good, we'll get off that share, especially now, when we are morphing into beauty. And this is not something which we are trying to invent, we are not inventing the wheel here. Some of our competitors have done it, and done it extremely well. And we'll do it even better. We know what has to be done, it’s a question of cherry-picking the line, and just finds comments or right on the mark, we have a smaller footprint. So, we are just going to have to grow a lot smarter, but we will be.

Justin Hott - Bear Stearns

Paul, one more question I guess on long hair, when, you know -- can you talk a little bit --

Paul Finkelstein

I hate long hair, Justin.

Justin Hott - Bear Stearns

It's in your press release, I understand.

Paul Finkelstein

Yeah, I know.

Justin Hott - Bear Stearns

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

Paul Finkelstein

Yeah, 2.7%.

Justin Hott - Bear Stearns

More than that, more than what we saw to that.

Paul Finkelstein

Well, it's only then and in our business, the numbers mean everything. And if you had 2.7% North American service comps, contrasted to 0.5% or 1% the year before, then more people are coming in more often to get their hair cut. It's simple as that. The numbers tell everything in our business, when you have 12,000 stores, the only thing you can look at is the numbers.

Justin Hott - Bear Stearns

Any signs in October that’s sustainable, that's not just one quarter so far that its never going to go?

Paul Finkelstein

Our service comps continue to be just fine.

Justin Hott - Bear Stearns

Alright, thank you very much.

Paul Finkelstein

Thanks Justin.

Operator

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

Justin Boisseau - Gates Capital Management

Hi, thanks. Did you repurchase any stock in the quarter, and what are your plans to repurchase? The rest of the years are going to be sort of evenly distributed through the quarters or do you have particular time period where you can get the most of it?

Randy Pearce

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

Justin Boisseau - Gates Capital Management

And then your for 780 of debt at the year end. It looked like an update on the numbers I have, I thought I have something closer to 660, has something changed there?

Randy Pearce

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

Justin Boisseau - Gates Capital Management

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

Paul Finkelton

On a comp basis slightly down.

Justin Boisseau - Gates Capital Management

Alright, okay thanks

Operator

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

Daniel Hofkin-William Blair

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

Paul Finkelton

Its price of new services, it’s a combination of whole bunch of things.

Daniel Hofkin-William Blair

I am just looking in terms of the sequential acceleration. Is it -- it's all of that, it's not just the traffic is getting closer to flat?

Paul Finkelstein

It’s all of that.

Daniel Hofkin-William Blair

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

Paul Finkelstein

Not fully.

Daniel Hofkin-William Blair

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

Randy Pearce

You are correct.

Daniel Hofkin-William Blair

Okay. Thank you.

Operator

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

Jeff Stein - Keybanc Capital Markets

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

Randy Pearce

We – yeah, it’s a good question Jeff. Deloitte, we are asking Deloitte to really scale back and hand the reins to us at the end of this calendar year. So I think you are going to see a precipitous drop in the consulting fees beginning January 1. We've got a lot of very good and I mean a very good momentum going on here at Regis on a number of fronts in terms of cost savings, And what we are finding is that certain things have been implemented, certain cost saving ideas will be implemented this year and so we are not going to enjoy the full benefit of the annual run rate. Certain things, as well Jeff, we've seen on cost saving initiatives that over the next several years, they are going to be phased in and the savings will continue to accelerate.

In terms of this current fiscal year, we’ve got $4 million to $8 million of gross savings, that we are estimating and I hope it maybe a larger than that, but I’m not going to create that expectation. $4 million to $8 million of savings, we will be paying Deloitte about $3 million of that. So but again, the Deloitte cost go away and savings will continue to accelerate in the future. We are also, when you look at G&A one could assume that all of this savings will flow through G&A, the cost certainly does to Deloitte, but as a matter of fact much of the savings will appear in other line items of the P&L, maybe its in the form of interest expense when we reduce inventory carrying cost, it might be in the site operating expense line item and even the depreciation expense line item.

Jeff Stein - Keybanc Capital Markets

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

Randy Pearce

Over $10 million.

Jeff Stein - Keybanc Capital Markets

Over $10 million, okay thank you.

Randy Pearce

You're welcome.

Operator

Thanks. Your final question is follow-up from Jon Christensen. Please go ahead.

Jon Christensen - Kayne Anderson Rudnick Investment

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

Paul Finkelstein

You should have had that question out of the last. We should have stopped --- we are just fine. I don't know. We'll come back to you with that number. Now it’s a very difficult number to compute, because of so many acquisitions. We have to go back to see when those acquired stores were build and when they were remodeled. But obviously, comps with respect to store that are fully matured aren’t strong as stores that are two or three years old, but we'll get back to you.

Randy Pearce

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

Jon Christensen - Kayne Anderson Rudnick Investment

And once the store is open five years and you get considered mature, do you still get increased customer visit per store?

Randy Pearce

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

Jon Christensen - Kayne Anderson Rudnick Investment

And if I look at--

Paul Finkelstein

Fully matured stores.

Randy Pearce

Fully matured stores.

Jon Christensen - Kayne Anderson Rudnick Investment

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

Randy Pearce

Would you talk, Paul if asked about capacity is really tough in this business because of--

Paul Finkelstein

Yeah, because Monday mornings, you consider can be intuitive. I don't think it's a significant issue for us, it's not a metrics that we utilize.

Jon Christensen - Kayne Anderson Rudnick Investment

Thank you very much.

Paul Finkelstein

Thank you.

Operator

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

Paul Finkelstein

Well, thank you Marian, and thank you all. Have a good day.

Operator

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

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Source: Regis F1Q08 (Qtr End 9/30/2007) Earnings Call Transcript
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