Regis Corporation F3Q08 (Qtr End 03/31/08) Earnings Call Transcript

Apr.28.08 | About: Regis Corporation (RGS)

Regis Corporation (NYSE:RGS)

F3Q08 (Qtr End 03/31/08) Earnings Call

April 23, 2008 11:00 am ET


Paul Finkelstein - Chairman, President, and CEO

Randy Pearce - Senior EVP and Chief Financial and Administrative Officer


Daniel Hofkin - William Blair

Lee Mathewson - KJ Harrison and Partners

Michael Lee - Royal Capital


Ladies and gentlemen, thank you for standing by. Good morning, my name is Pattie, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Regis Corporation Third 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 with the access code of 11110899 '#'. I would like to remind everyone that to the extent of the company's statements or comments in this morning's forward-looking statements, I refer to you the risk factor 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

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 this review of the quarter, we will open the call for questions. (Operator Instructions).

And I would now like to turn the call over to Paul Finkelstein for his comments. Please go ahead, Paul.

Paul Finkelstein

Thank you, Pattie, and good morning everyone. Thank you for joining us. We're pleased to report our third quarter results. Operational earnings per share were $0.51 compared to $0.50 last year. Last year we reported $0.12, primarily after taking a [$0.48] impairment charge for our beauty schools. Third quarter EBITDA decreased $3.5 million in the quarter to $74 million, compared to $78 million last year. However, last year's EBITDA included $5.9 million from European schools that are now deconsolidated and not included in our third quarter EBITDA.

Including salons in which we maintain an ownership interest, we ended the quarter with 13,449 worldwide locations; an increase of 814 locations in the quarter. Out of the 13,449 locations, 9283 are company-owned, and 4166 are franchise.

Total debt at the end of the quarter was $799 million, and our debt-to-cap ratio was 45.8%. Consolidated same-store sales increased 1.4% at the mid-point of our guidance range. Third quarter service comps increased 3.3%, the highest in eight years. Product comps decreased 3.3%.

I would like to now focus on certain miscellaneous items prior to delving in on the main topic of my presentation, mainly the conversion of Trade Secret into PureBeauty. The Jean Louis David sale to Provo closed in late January; the initial results have been excellent. The Provo Group has several attractive acquisition targets on their radar screen, and we're very optimistic that long-term our initial growth projections will prove out to be conservative.

A brief update on Empire Schools. We have a 55% interest in the Empire School business. There are significant integration costs. However, this should be a very good business for us. The management team is excellent, the education business is countercyclical. It performs extremely well during recessions.

Let's go onto Intelligent Nutrients. Goods should be on the shelves sometime during early summer. The product formulations are completed. This is an industry first. It's the first line of USDA certified organic haircare products made from food grade ingredients. Because of its performance and safety, IN will set a new standard for the beauty industry. Performance is excellent, and the line is safe for everyone. There is a huge opportunity for a major public relations coup because nobody has anything quite like it in the market place. We had a few packaging issues that held us back, but most of these issues have been resolved. Our strong businesses for the quarter were Hair Club, Supercuts, Promenade and MasterCuts.

Lastly, I would like to address our European operations which now consist mainly of our salon operations in the U.K. After many years of service, Raymond Duke, our Managing Director in the U.K. is retiring. Raymond has been one of our top operators for many years. Jackie Lang, currently Raymond's top lieutenant will be taking over Raymond's responsibilities. Jackie and her team will face significant challenges. The retail environment in the U.K. has been soft for a couple of years. Obviously with negative 4% comps in the quarter and year-to-date, our profits are down significantly. Retail environment in the U.K. will improve, and when it does, our profits should return to historic levels.

Let's drill down on our major business. As you know, we have two basic segments, 70% of our business is service. Service sales reflect the health of our business. We've had the best quarterly service comp performance even prior to the early March Easter season, than we had in eight years. The major reason is pricing. We raised prices in 5,600 salons, compared to 2,500 salons per year over the last three years.

Service comps are up 3.3% for the quarter. January and February service comps are up 2.9%. Price increases have added very little consumer resistance. Some investors have asked rhetorically whether our price increases negatively increased our decreased comp customer count. The short answer is no. During the quarter all of our salons experienced similar visitation patterns. The visitation pattern of salons with price increases, mirror the visitation patterns of those without price increases. As I pointed out during our last conference call, this is a very affordable luxury, and even with increased prices women are spending less on their hair than they have in years due to reduced visitation patterns.

Likewise government statistics are very misleading. As you know, inflation statistics don't include energy or food. Inflation is prevalent. Our competitors have raised prices. European prices of hair services are more than double our domestic prices, and there are cost pressures not only for Regis but for the industry as well. Thus service seems to be on the mend, and eventually the reduced salon visits will anniversary, and our customer count will become stable, and then we'll be right back in our long range historical range of service comps increasing 3% to 5% a year. During the quarter average ticket increased 7.6%, two-thirds of this increase was due to pricing. Service customer visits were down 3.7%.

Let's now move onto product. Product sales comprised 30% of our total revenue, and 30% of our product sales are in a Trade Secret division, which by the way now has more than 1.2 million customers enrolled in our loyalty program. We have a significant opportunity in our additional salons to increase our product business. In our last conference call, we talked about combo tickets, namely the retail product purchased by our service customer.

We know that our 62,000 stylists have a huge opportunity to do a much better job in converting a service customer into a retail product purchaser. We have undertaken many initiatives to increase combo tickets including enhanced training programs, contests, and the like. The opportunities for increased sales are enormous. Our combo ticket percentage companywide is 7% today. Many of our salons have combo ticket results in excess of 25%, and many of our individual stylists have combo tickets well in excess of 50%. Thus the issue is not opportunity, it's execution.

Let's move onto PureBeauty. Mall of America opened on March 13, exceeding expectations. After our first month same-store sales are up 66%. Cosmetics, skincare and bath & body comprised 47% of our sales, with Prestige haircare and Professional haircare adding another 35%. Approximately 50% of our sales were in product categories, which historically have had minimal sales in our Trade Secret division.

Vendors and industry watchers are very impressed. We had a wonderful full page story in Women's Wear Daily which created enormous vendor interest. We can and will be very selective with respect to our vendors. Our boxes are only 1,500 square feet plus or minus 400 square feet. These are very efficient boxes with low break-even points, which by the way has been our corporate strategy for many, many years. We like low break-even points. Thus we can be selective because of our size and rest assured we will be selective.

Let's talk about the store itself. It's beautiful. It's boutiqueous without be intimidating, it's very inviting, very European. In fact, we think it's the very best environment for the consumer to shop in the entire beauty world. PureBeauty is very special and unique. The combination of Prestige products coupled with exceptional services is extraordinary. We have an exceptional mix of vendors and including industry firsts in an exclusive mall setting. Some of our special product lines include [J&R Adale] and YSO Cosmetics, Thermalogica, skin products and skin services, Skincare from Murad, Bliss, and [Amathy Pericone] and Joy, Acai, and Oh, John haircare. Bath and Beauty assortments include Times, Pangia, and h2o.

The European Boutique setting is truly spectacular, yet many of the SKUs are quite affordable. The staff is exceptional, with both cosmetologist and aestheticians in place. We highlight an exclusive European hair and skin technology called Beauty Metrics, which is able to prescribe skin and haircare regimen better than anything else in the marketplace. This should be a major transformation and homerun for us. We have the locations. Both mall owners and manufacturers are very excited about PureBeauty.

Let's put this in perspective. Alta has 250 units, [Saforo] 185 in the U.S., and we have 720 that are either PureBeauty or Trade Secret candidates that can be converted into PureBeauty. The plan is to initially convert 70 units by the end of the summer. We'll have two types of Trade Secret to PureBeauty conversions in this first phase. The first are relocations or full remodelings of existing locations. The second type are remodels of existing locations with a more modest CapEx; importantly whether the conversion is a relocation or a full or partial remodel, it will have the look and feel of our flagship Mall of America PureBeauty boutique. Assuming the initial 70-store conversion is successful, we plan to convert an additional 150 locations.

Most of the second tranche conversion will have modest capital investments. However, once again we will not put the PureBeauty sign over a door that does not have the look and feel of our flagship Mall of America PureBeauty boutique. The maximum incremental investment for the 220 locations breaks down as follows. CapEx including IT of $10 million, inventories of $13 million. On the expense side, the 220 store conversion will require one-time expenses of approximately $9.5 million and continuing annual expenses of $4.5 million. If all goes according to plan, our payback should be less than two years.

But let's put this in perspective. Trade Secret accounts for 9% of our revenues and 5% of our system wide sales. We feel that Trade Secret is also different from our Salon concepts, and that it acts as a more traditional retailer. Traditional retailers need to be transformed from time to time. We'll obviously keep you apprised in future conference calls about how we're tracking. But the one thing I would urge all of us to be is patient. This will take time. But our 720 locations are huge assets.

Let's now move onto guidance. The budget process has been incredibly challenging for us this year, because of the transformation of Trade Secret into PureBeauty. We have thus taken a baseline approach in giving estimates of fiscal 2009. And this approach assumes no Trade Secret conversion into PureBeauty. The ATF costs associated with the conversion can range anywhere between $0.10 and $0.20 a share. We'll identify the impact of the conversion in future conference calls, but without conversion costs our guidance for fiscal 2009 is in the range of $2.03 to $2.29 per share.

We have the balance sheet, the strategy, and most importantly the management team to do the Trade Secret transformation right. We'll take whatever time is necessary to make sure that it is successful. I would like to thank all of you for your continued support. Randy Pearce will now take over.

Randy Pearce

Thanks, Paul. Good morning, everyone. The results we're reporting today include additional income tax expense of $3 million or $0.07 a share, associated with our repatriation of $30 million of international cash following the third quarter closure of our joint venture transaction with Frank Provo. Therefore, absent this one-time tax charge, we are reporting third quarter earnings today of $22 million or $0.51 per diluted share, which met the midpoint of our previous guidance.

As you're aware, our quarterly earnings guidance directly correlates to our same-store sales guidance. We forecasted our third quarter same-store sales to be within a range of positive 50 basis points to 2.5%, and earnings would therefore be in a range of $0.48 to $0.54 per share. Actual same-store sales growth essentially came in at the mid-point of the range at positive 1.4%, and as a result our operational earnings for the quarter of $0.51 also met the midpoint of the range.

As a reminder, last year we discussed with you the fact that our third quarter reported results of $0.12 per share included a goodwill impairment charge associated with our school business, as well as $0.05 per share of non-operational benefits associated with a reduction to workers' compensation reserves and increased jobs tax credits. Therefore, excluding those items our third quarter operational results a year ago came in at $0.50 per share.

Let me now transition my comments by giving you some detail behind our third quarter operating results by business segment. I think you'll see that operationally we had a pretty straight forward quarter. A breakout of our segment performance is found in today's press release. Following that, I will discuss our fourth quarter guidance as well as our fiscal 2009 outlook. As usual, I will begin with our largest segment which is our North American salons.

North American salon revenue, which represented 87% of our consolidated third quarter revenue, increased 9% during the quarter to $589 million. This revenue growth was due primarily to corresponding quarter-over-quarter increase in the number of company-owned salons that we operated. Service revenue in our North American salons grew 11% during the quarter to $422 million. This increase included a 380 basis point increase in service same-store sales. Product revenue grew nearly 5% in the quarter to $157 million, but was tempered due to a decline in product comps of negative 4%.

Royalties and fees from our North American franchise salons grew 6% during the quarter to $9.9 million. This increase was primarily due to an acquisition of 42 Canadian franchise salons that took place in our first quarter of this fiscal year, as well as 51 BeautyFirst franchise locations that we acquired in February. 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, franchise unit closures, and relocations.

Our combined gross margin rate for North American salons came in on plan at 43.2% in the third quarter, which represented 70 basis points of reduction over the same period a year ago. Our third quarter service margin rate came in slightly better than planned at 41.8%, yet represented a 30 basis points decline over the same quarter last year.

We had expected a service margin decline due to the same two factors we discussed with you last quarter. The first item related to an accounting reclassification associated with retail to shop product transfers. The second factor related to slightly higher payroll costs in certain salons that we recently acquired. However, partially offsetting these margin declines were favorable leverage we enjoyed from strong service comps of 3.8% in our North American salons during the quarter.

Our retail product margin rate for the third quarter came in at 46.8%, down 180 basis points from the rate we reported in the same period a year ago. Although we had budgeted for a decline in product margins, the actual reduction was a little more than we had expected, and there were a few major reasons for the overall decline. The first item related to the impact of several current year acquisitions. As we mentioned, we recently acquired 42 Canadian franchise salons that we sell product to, at a lower average margin. We also recently completed the PureBeauty/BeautyFirst acquisition which has slightly lower product margins.

Another item impacting our third quarter product margin rate, related to a proportionally higher mix of promotional sales that we experienced during the quarter, which were at lower margin. In addition, we continued to experience negative payroll leverage in our Trade Secret salons due to negative product comps of 6.5% during the quarter.

Site operating expenses, which includes costs directly incurred by our salons such as advertising, insurance, utilities, and janitorial costs came in at exactly 8% of sales, identical to the rate we reported last year in our third quarter. However, I would recall that a year ago our site operating expense rate was favorably impacted due to a reduction in previous year's workers comp claim reserves. Despite that benefit, our current year workers comp expense is comparable to that of our prior year third quarter due to continued reductions in salon injury claims, the result of our successful salon safety programs.

Next we'll talk about our North American, general and administrative expense. Although our third quarter G&A rate of 5.9% came in slightly better than planned, it was 40 basis points higher than the comparable prior year rate. This quarter-over-quarter increase was in large part due to the back office functions we recently acquired with the PureBeauty/BeautyFirst transaction.

I will now address rent. During the third quarter, our rent expense rate improved to 14.5% of sales, which was down 20 basis points over the same quarter last year. The slight improvement in this category was largely due to several recent salon acquisitions which have slightly lower occupancy costs as a percentage of sales. Our depreciation and amortization expense came in slightly better than planned, improving 20 basis points during the quarter to 3.6% of sales. This slight improvement was due to our planned reduction in the number of new salons constructed this current fiscal year. The net effect of all of the items I just discussed caused our third quarter operating income for our North American salons to come in at 12.1% of revenue.

Next let's review the third quarter performance of our International salon segment. Analyzing the quarter-over-quarter comparisons for this business is very difficult this quarter. This segment includes our company-owned salons located primarily in the United Kingdom. Also recall that beginning this fiscal year, this segment also includes our Vidal Sassoon academies in the U.K. As, unlike last year, we no longer report schools as a separate segment.

Our International salon segment historically had also included results from our franchise business on the continent of Europe. However, following our joint venture transaction with Frank Provo, the European business was deconsolidated at the end of January. As a result, our fiscal 2008 third quarter results includes only one month of continental Europe activity this year, versus three months last year.

Again, the quarter-over-quarter comparisons are tough. However, I will provide you a bit more color behind the quarterly change in revenue, and also give you some high level comments on any expense categories which may have surprised us during the quarter. Those of you who build segment models may want to give [Mark Bosland] or [Alex Verledy] a call here at Regis if you haven't already done so and they'll certainly help you with your models.

Our International salon revenue which comprised 8% of our consolidated third quarter revenue, declined by $5 million from the same period a year ago coming in at $56 million. This decline was due to the deconsolidation of our continental Europe salon business, which had the effect of reducing our third quarter revenue by about $10 million, as well as a 4.2% decrease in overall comps. Partially offsetting these two revenue reductions was a quarter-over-quarter improvement in the Euro and the British pound exchange rates over the U.S. dollar. It also included the inclusion of the Vidal Sassoon academies and the addition of new and acquired beauty salons.

When reviewing the International third quarter operating results on an apples-to-apples basis, we were clearly disappointed with our U.K. salon performance this past quarter, which posted unplanned negative comps of 4.2%, and as a result operating income for the quarter was marginally profitable. Weak comps had a negative impact on service margin as well as various fixed cost categories such as ramp and depreciation. As Paul has already mentioned, we are focusing our efforts on improving the performance and profitability of our U.K. Salon business.

Let's now talk about Hair Club for Men and Women. This business remains incredibly consistent. During the third quarter virtually every revenue and expense category came in on plan or slightly better than planned, and I will highlight just a couple of items. Third quarter revenue from our hair restoration centers grew 10% to $35 million and represented 5% of our consolidated revenue. Hair Club's revenue growth benefited from a third quarter comp of 3.4%, as well as the acquisition of six franchise centers over the past year. Operating margin came in on plan for the quarter at a very strong 20.3% of sales, and Hair Club's EBITDA margin was nearly 28%. Darryl Porter and his team continue to do a very nice job in managing this business segment, and we remain very pleased with his performance.

Next let me make a couple of brief comments, which are more reminder type in nature regarding our Beauty Schools. As you know, we merged our Title IV funded beauty school business with Empire Education Group on August 1, which was during our first fiscal quarter this year. As you'll also recall, the merger means that the school business was deconsolidated from the Regis financial statements and we no longer report school performance under a separate business segment.

Our proportionate share of our after tax school performance is now included on the P&L under the line item called equity and affiliated companies. This line item not only includes the after tax results of schools, but also our equity interests in other joint venture partnerships with Intelligent Nutrients and with Frank Provo. I would now like to make a quick comment regarding our third quarter G&A rate that appears in the Corporate segment of our P&L.

Our G&A cost for the quarter came in at $32 million or 4.7% of sales, which, as we expected was down nearly $1 million or 30 basis points from the same period a year ago. Prior year third quarter expense was a bit higher than normal due to a benefit accrual adjustment we had recorded. In addition, the current year reduction pertains to a reduced level of professional fees that we paid to Deloitte Consulting in connection with our current expense reduction initiative project, which incidentally continues to go very well. Deloitte has completed their portion of the project, so we no longer are incurring significant consulting fee expense.

Now that concludes my comments concerning our individual business segments, but let me now speak to our interest expense and our debt levels. Our third quarter interest expense came in on plan at $11.3 million, and our total debt on March 31, stood at $799 million, up $90 million from our previous June 30, fiscal year end. Our investment grade debt-to-capitalization ratio stood at 45.8% at the end of March.

As we previously mentioned, during the third quarter we repatriated $30 million of International cash following the closure of our joint venture transaction with Frank Provo this past January. Given the strength of the Euro and our diminishing need for cash in Europe, we believe the timing was right to repatriate a large portion of our Euro cash balance. The cash repatriation was used during the third quarter to pay down debt. We expect our debt levels to decline during the fourth quarter, and we should end the fiscal year with total debt in the neighborhood of $760 million.

Our reported effective tax rate came in at nearly 44% during the third quarter. However, absent the tax impact of repatriating the cash overseas, our underlying effective rate came in on plan.

Let me now transition to our earnings guidance for the balance of our current 2008 fiscal year. As noted in today's press release, we continued to reiterate our full fiscal 2008 guidance. We are making no changes. For the full year, we continue to believe revenue should grow to about $2.7 billion and operational earnings will be in the range of $2.03 to $2.10 per share, with a mid-point of $2.07. Today's press release also includes our guidance for the fourth quarter of our current fiscal year. We forecast revenues to be in the range of $710 million to $720 million, which includes a same-store sales growth assumption of 50 basis points to 2.5%.

Based on this comp sales range, our fourth quarter earnings this year should therefore be in the range of $0.55 to $0.62 a share. Remember that last year we reported fourth quarter results of $0.62 a share, which included $0.09 of benefit from a reduction in previous year's worker comp reserves. Absent that benefit, our operational earnings in the fourth quarter last year were $0.53 a share. So operationally we are expecting earnings in the fourth quarter this year to be up slightly from the same period a year ago.

As we've done each year at this time, we're also including in today's earnings release a detailed forecast pertaining to our upcoming 2009 fiscal year. We're very pleased to present an underlying operating budget for fiscal 2009 that reflects an increased earnings target of $2.03 to $2.29 a share, based on same-store sales assumption of 50 basis points to 2.5%. The midpoint of this earnings range of $2.16 represents an increase of $0.09 a share from the midpoint of our underlying fiscal 2008 guidance.

Consistent with prior years our budgeted operating results for next year exclude accretion from future acquisition due to the inability to predict the quantity, timing, and magnitude of such future unknown deals. And I just have a few additional items to point out regarding our forecast. As Paul mentioned, development of our 2009 budget did present a unique and significant challenge due to our upcoming efforts to transform Trade Secret to PureBeauty. This transformation effort is expected to be far reaching, impacting store design, product assortment, information systems, gross margin, store employee compensation, as well as marketing. There is also potential to close certain Trade Secret salons.

Our prototype PureBeauty store recently opened at Mall of America on March 13, approximately 70 Trade Secret salons have been identified to serve as a test group, and will be converted to the PureBeauty format sometime before or during the summer. Once those conversions take place, results from this test group of salons will then be evaluated for about 120 days, which will likely take us into our second fiscal quarter of 2009. These results will be used as the basis to formulate a definitive business plan and rollout strategy for the next 150 store tranche.

The challenge that presents itself at this early date is how to estimate the financial impact this transformational process will have on our fiscal 2009 results, given that concept testing and the resulting finalization of a business plan will not and cannot occur until midway through the upcoming 2009 fiscal year. As a result, we developed a consolidated baseline operating budget for fiscal 2009, which includes Trade Secret divisional results using a business-as-usual approach. In other words, this budget excludes all future costs associated with transformation to PureBeauty. Throughout fiscal 2009 we plan to track and report all incremental revenue and cost related to the Trade Secret transformation product. These items will then be removed from our consolidated reported results in order to measure our underlying performance on an apples-to-apples basis, against the fiscal 2009 baseline budget.

There is two additional budget related topics worth noting. First, a key driver of our annual budget continues to be our same-store sales growth assumption. We once again estimate that same-store sales must increase at least 2% annually in order for us to leverage inflationary cost increases in our expense structure. Our fiscal 2009 budget includes an overall comp assumption range of 50 basis points to 2.5%. Although this range represents a budgeted year-over-year improvement in comps, a rate below 2% will nevertheless create negative leverage. However, offsetting any negative leverage our budgeted savings in fiscal 2009 from our successful cost reduction initiative as well as reduced professional fees paid to Deloitte Consulting. We certainly believe there could be upside in fiscal 2009 to our stated earnings range coming from acquisitions, and perhaps from further cost reduction initiatives as well as any improvement in retail product sales.

Let me now touch on our 2009 budget assumptions regarding cash flow and debt levels. Assuming the midpoint of our earnings guidance range, we expect our EBITDA next year to be around $308 million and our after tax cash flow to be approximately $217 million. Most of our cash will continue to be reinvested back into the business by buying and building salons, as our combined acquisition and CapEx budget is $170 million for next year. We remain solidly investment grade. We are forecasting our debt levels over the course of fiscal 2009 to be in the neighborhood of $725 million. This leverage would yield a debt-to-EBITDA ratio close to two times and a debt to capitalization ratio near 40% by the end of fiscal 2009. For a more detailed summary of our guidance, please visit our corporate website and refer to today's press release as well.

That concludes my prepared remarks. Paul and I are now happy to answer any questions you may have, so Pattie, if you can step in and provide some instructions, we would appreciate that.

Question-and-Answer Session


Thank you, sir. (Operator Instructions). The first question comes from the line of Daniel Hofkin from William Blair. Please go ahead.

Daniel Hofkin - William Blair

Good morning, guys. Just wanted to talk a little bit about average ticket particularly on the service side, stripping out the impact of the price increase, what do you think is driving the improvement? Is it more or let's say the mix component. What specifically is driving that? And then is there any way to sort of looking at the trend where you have taken the price increases at some of the more value segment or value salons in your business, is there any way to sort of determine whether there was any difference in the trend of customer traffic between those locations and your -- let's say Regis concept where you were not taking the price increase so much?

Paul Finkelstein

We've taken price increases across all divisions. And two-thirds of our increase in average ticket is due to price. The balance mostly is due to service mix. You take SuperCuts, five years ago we didn't have hair color in SuperCuts. Now SuperCuts hair color represents 5% or 6% of SuperCuts sales, and that continues to increase. That will be 10%. Hair color will represent 10% within the next two or three years. So it's mostly price, but it is also mix as well. And no, there is no real difference in terms of impact by concept.

Daniel Hofkin - William Blair

Okay. No difference, not just in the rate of the decline but also in the trend?

Paul Finkelstein

No, no significant difference.

Daniel Hofkin - William Blair

Okay. Is that any different than what you might have expected going in or were you thinking --?

Paul Finkelstein

No, we've been actually surprised even with service comps being flat over the last four or five years, solely due to fashion. It's impacted every single segment of our business from Vidal Sassoon to SuperCuts. So, no, we're not surprised at all.

Daniel Hofkin - William Blair

Okay. Thank you.

Paul Finkelstein

Thank you.


Thank you. And our next question comes from the line of [Lee Mathewson] from [KJ Harrison and Partners]. Please go ahead.

Lee Mathewson - KJ Harrison and Partners

Hi, guys.

Paul Finkelstein

Good morning.

Lee Mathewson - KJ Harrison and Partners

Just a couple of quick questions. First of all, the Ratner Company's deal for Hair Cuttery, I was a little bit confused by that. It seemed to be picking up, maybe 15% of their store base. Is that maybe prelude to something, a larger deal down the road? Is it the first time you guys have run stores there I guess technically under a banner that you don't fully control? I was just wondering if you can comment on that.

Paul Finkelstein

Well, Dennis Ratner sold his European -- his U.K. business to us a year or so ago. He has two daughters in the business. He has family in the business. He has no desire to sell the remaining part of his business to us. So no, this is not the first step by Hair Cutterry. We're not operating those Hair Cuttery salons under the Hair Cuttery banner. We have six months to change the signage, and we'll be changing the signage to Hair Masters, and we have today 500, 600 Hair Masters stores nationwide.

Lee Mathewson - KJ Harrison and Partners

I see, okay. And were they geographically in areas that they -- I know they have done a couple of franchise agreements and such, but they didn't have critical mass and you guys did, is that the idea?

Paul Finkelstein

Yes. They wanted to get out of the Carolinas and Georgia.

Lee Mathewson - KJ Harrison and Partners

I see Carolina and Georgia. And then with the U.K. business, I mean, again, it's weak over there. I think when we talked last; you mentioned there was a large amount of traffic, a large amount of store base was exposed to department store traffic which is down. Is there anything you can do to rectify that or ultimately you are going to cycle those leases out of the department stores or what's the --?

Paul Finkelstein

We'll have far, far less department store presence in the years ahead.

Lee Mathewson - KJ Harrison and Partners

I see. Okay. And then just on Provo and Empire; are you guys willing to give any sort of rough guidance in terms of the EBITDA generation at those two units?

Paul Finkelstein

It's too early.

Lee Mathewson - KJ Harrison and Partners

Too early? Okay.

Paul Finkelstein

Absolutely too early. Provo in a sense doubled its size. Empire doubled its size. There are transition costs. We'll monitor it and give you a better feel for it probably second or third quarter, fiscal '09. It's just too early.

Lee Mathewson - KJ Harrison and Partners

Great. That's no problem. Thanks, guys.


Thank you. (Operator Instructions). Next question is from the line of [Michael Lee] from [Royal Capital]. Please go ahead.

Michael Lee - Royal Capital

Hi, guys. Just Randy wondering if you could walk us through the rationale for paying down debt at this point, given where your stock is trading?

Randy Pearce

Yes. We've -- again, there is probably no right or wrong answer. We've talked about the fact that we wanted to become more aggressive this year in buying back stock, and we did. We bought back $50 million through the first half of the year. We did discuss that with acquisition opportunities this year running ahead of plan, we're going to be spending $75 million to $100 million more than budgeted on acquisitions, and that's where we get more bang for the buck, that we were going to curtail our stock repurchase program at that time, and as a result we found that our overall debt levels because of the acquisitions despite curtailing the share repurchase was still at a level above where we wanted it to be, so that's the reason, primary reason that management and the Board decided to use that cash and pay down debt.

We are going to be continuing to look at the best utilization of our cash going forward. We continue to see that acquisition opportunities -- we've never had a pipeline and nor do we today, acquisition opportunities come our way, and to Paul and he will quickly assess whether it is something we're interested in or not. And if we find that over the course of the upcoming months and year that acquisition opportunity aren’t as plentiful, we could consider share repurchase at that point in time.

Michael Lee - Royal Capital

It just seems like you're writing less than three times EBITDA leverage, your stock is trading at 12% free cash flow yield, your debt I think based on my calculation cost you about 8%, so from a returns perspective, the equity would make more sense than your debt.

Randy Pearce

Yeah. Overall borrowing rate on the debt is just around 6%. But having said that, again, we've been -- a lot of our debt is private placement debt where we have to be concerned about debt-to-capitalization ratio. The banks love the credit and so does the private placement lenders. But as you know, this quarter, despite paying down $30 million of debt from the international cash repatriation, our debt-to-capitalization was about 46% and the private placement guys and gals insist that it can be no higher than 50%. We like the ability to have flexibility and dry powder on the balance sheet, should acquisitions like a Hair Club come along again in the future. Again, I won't say that there's a right or a wrong answer but I'm giving you just our thought process as to why we did it.

Michael Lee - Royal Capital

Okay, thank you.


(Operator Instructions). And I am showing that we have no further questions at this time. Please continue, Paul.

Paul Finkelstein

Thanks for joining us. Have a good day everybody.


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