Description
Filed with the SEC from Sep 27 to Oct 03:
Regis (RGS)
Starboard Value increased its holdings to 3,316,023 shares (5.7%) after it bought 200,000 from Sept. 18 through Sept. 20 at prices of $18.93 to $19.18 apiece.
BUSINESS OVERVIEW
Industry Overview:
Management estimates that annual revenues of the hair care industry are approximately $50 to $60 billion in the United States and approximately $160 billion worldwide. The Company estimates that it holds approximately two percent of the worldwide market. The hair salon and hair restoration markets are each highly fragmented, with the vast majority of locations independently owned and operated. However, the influence of salon chains on these markets, both franchise and company-owned, has increased substantially. Management believes that salon chains will continue to have a significant influence on these markets and will continue to increase their presence. As the Company is the principal consolidator of these chains in the hair care industry, it prevails as an established exit strategy for independent salon owners and operators, which affords the Company numerous opportunities for continued selective acquisitions.
Salon Business Strategy:
The Company's long-term goal is to provide high quality, affordable hair care services and products to a wide range of mass market consumers, which enables the Company to expand in a controlled manner. The key elements of the Company's strategy to achieve these goals are taking advantage of (1) salon growth opportunities, (2) economies of scale and (3) centralized control over salon operations in order to ensure (i) consistent, quality services and (ii) a superior selection of high quality, professional products. Each of these elements is discussed below.
Salon Growth Opportunities. The Company's salon expansion strategy focuses on organic (new salon construction and same-store sales growth of existing salons) and salon acquisition growth.
Organic Growth. The Company executes its organic growth strategy through a combination of new construction of company-owned and franchise salons, as well as same-store sales. The square footage requirements related to opening new salons allow the Company great flexibility in securing real estate for new salons as the Company has small or flexible square footage requirements for its salons. The Company's long-term outlook for organic expansion remains strong. The Company has at least one salon in all major cities in the U.S. and has penetrated every viable U.S. market with at least one concept. However, because the Company has a variety of concepts, it can place several of its salons within any given market.
A key component to successful North American organic growth relates to site selection, as discussed in the following paragraphs.
Salon Site Selection. The Company's salons are located in high-traffic locations such as regional shopping malls, strip centers, lifestyle centers, Walmart Supercenters, high-street locations and department stores. The Company is an attractive tenant to landlords due to its financial strength, successful salon operations and international recognition. In evaluating specific locations for both company-owned and franchise salons, the Company seeks conveniently located, visible sites which allow guests adequate parking and quick and easy location access. Various other factors are considered in evaluating sites, including area demographics, availability and cost of space, the strength of the major retailers within the area, location and strength of competitors, proximity of other company-owned and franchise salons, traffic volume, signage and other leasehold factors in a given center or area.
Pricing is a factor in same-store sales growth. The Company actively monitors the prices charged by its competitors in each market and makes every effort to maintain prices which remain competitive with prices of other salons offering similar services. Price increases are considered on a market-by-market basis and are established based on local market conditions.
Salon Acquisition Growth. In addition to organic growth, another key component of the Company's growth strategy is the acquisition of salons. With an estimated two percent worldwide market share, management believes the opportunity to continue to make selective acquisitions exists.
Over the past 18 years, the Company has acquired 8,052 salons, expanding both in North America and internationally. When contemplating an acquisition, the Company evaluates the existing salon or salon group with respect to the same characteristics as discussed above in conjunction with site selection for constructed salons (conveniently located, visible, strong retailers within the area, etc.). The Company generally acquires mature strip center locations, which are systematically integrated within the salon concept that it most clearly emulates.
In addition to adding new salon locations each year, the Company has an ongoing program of remodeling its existing salons, ranging from redecoration to substantial reconstruction. This program is implemented as management determines that a particular location will benefit from remodeling, or as required by lease renewals. A total of 235 and 271 salons had major remodels in fiscal years 2012 and 2011, respectively.
Recent Salon Additions. During fiscal year 2012, the Company constructed 319 new salons (209 company-owned and 110 franchise). Additionally, the Company acquired 13 company-owned salons, including 11 franchise salon buybacks, and purchased a 60.0 percent ownership interest in a franchise network consisting of 31 locations.
During fiscal year 2011, the Company constructed 213 new salons (146 company-owned and 67 franchise). Additionally, the Company acquired 105 company-owned salons, including 78 franchise salon buybacks.
Salon Closures. The Company evaluates its salon performance on a regular basis. Upon evaluation, the Company may close a salon for operational performance or real estate issues. In either case, the closures generally occur at the end of a lease term and typically do not require significant lease buyouts.
During fiscal year 2012, 384 salons were closed, including 333 company-owned salons and 51 franchise salons (excluding 11 franchise buybacks).
During fiscal year 2011, 305 salons were closed, including 245 company-owned salons and 60 franchise salons (excluding 78 franchise buybacks).
Economies of Scale. Management believes that due to its size and number of locations, the Company has certain advantages which are not available to single location salons or small chains. Economies of scale are realized through the centralized support system offered by the home office. Additionally, due to its size, the Company has numerous financing and capital expenditure alternatives, as well as the benefits of buying retail products, supplies and salon fixtures directly from manufacturers. Furthermore, the Company can offer employee benefit programs, training and career path opportunities that are often superior to its smaller competitors.
Centralized Control Over Salon Operations. During fiscal year 2012 the Company implemented a new field structure to support our long-term strategy. The Company manages its expansive salon base through a combination of district leaders, regional directors, vice presidents and chief operating officers. Each district leader is responsible for the management of approximately 12 to 15 salons. Regional directors oversee the performance of six to nine district leaders or approximately 80 to 130 salons. Vice presidents manage approximately 700 to 1,000 salons while chief operating officers are responsible for the oversight of an entire consumer concept. During fiscal year 2012 the Company also created Field Human Resources and Corporate Operations departments to support salon operations. The operational hierarchy is key to the Company's ability to expand successfully.
The Company also has an extensive training program, including the production of training DVDs for use in the salons, to ensure its stylists are knowledgeable in the latest haircutting and fashion trends and provide consistent quality hair care services. Finally, the Company tracks salon activity for all of its company-owned salons through the utilization of daily sales detail delivered from the salons' point of sale system. This information is used to reconcile cash on a daily basis.
Salon Concepts:
The Company's salon concepts focus is on providing high quality hair care services and professional products, primarily to the middle consumer market. The Company's North American salon operations consist of 9,340 salons (including 2,016 franchise salons), operating under several concepts, each offering attractive and affordable hair care products and services in the United States, Canada and Puerto Rico. The Company's international salon operations consist of 398 hair care salons located in Europe, primarily in the United Kingdom. The number of new salons expected to be opened within the upcoming fiscal year is discussed within Management's Discussion and Analysis of Financial Condition and Results of Operations. In addition to these openings, the Company typically acquires salons each year. The number of acquired salons, and the concept under which the acquisitions will fall, vary based on the acquisition opportunities which develop throughout the year.
Regis Salons. Regis Salons are primarily mall based, full service salons providing complete hair care and beauty services aimed at moderate to upscale, fashion conscious consumers. In recent years, the Company has expanded its Regis Salons into strip centers. As of June 30, 2012, of the 953 total Regis Salons, 156 Regis Salons were located in strip centers. The guest mix at Regis Salons is approximately 79 percent women, and both appointments and walk-in guests are common. These salons offer a full range of custom styling, cutting, hair coloring and waving services, as well as professional hair care products. Service revenues represent approximately 82 percent of the concept's total revenues. The average ticket was approximately $43 and $42 for fiscal years 2012 and 2011, respectively. Regis Salons compete in their existing markets primarily by emphasizing the high quality of the services provided. Included within the Regis Salon concept are various other trade names, including Carlton Hair, Sassoon, Hair by Stewarts, Hair Excitement, and Renee Beauty.
The average initial capital investment required for a new Regis Salon is approximately $190,000 to $240,000, excluding average opening inventory costs of approximately $22,000. Average annual salon revenues in a Regis Salon which has been open five years or more are approximately $400,000.
MasterCuts. MasterCuts is a full service, mall based salon group which focuses on the walk-in consumer (no appointment necessary) that demands moderately priced hair care services. MasterCuts salons emphasize quality hair care services, affordable prices and time saving services for the entire family. These salons offer a full range of custom styling, cutting, hair coloring and waving services as well as professional hair care products. The guest mix at MasterCuts is approximately 58 percent women. Service revenues compose approximately 80 percent of the concept's total revenues. The average ticket was approximately $22 for fiscal years 2012 and 2011.
The average initial capital investment required for a new MasterCuts salon is approximately $150,000 to $200,000, excluding average opening inventory costs of approximately $14,300. Average annual salon revenues in a MasterCuts salon which has been open five years or more are approximately $280,000.
SmartStyle. The SmartStyle salons share many operating characteristics of the Company's other salon concepts; however, they are located exclusively in Walmart Supercenters. SmartStyle has a walk-in guest base, pricing is promotional and services are focused on the family. These salons offer a full range of custom styling, cutting, hair coloring and waving services, as well as professional hair care products. The guest mix at SmartStyle Salons is approximately 75 percent women. Professional retail product sales contribute considerably to overall revenues at approximately 34 percent. Additionally, the Company has 122 franchise salons located in Walmart Supercenters. The average ticket was approximately $21 for fiscal years 2012 and 2011.
The average initial capital investment required for a new SmartStyle salon is approximately $35,000 to $45,000, excluding average opening inventory costs of approximately $13,100. Average annual salon revenues in a SmartStyle salon which has been open five years or more are approximately $230,000.
Strip Center Salons. The Company's Strip Center Salons are comprised of company-owned and franchise salons operating in strip centers across North America under the following concepts:
Supercuts. The Supercuts concept provides consistent, high quality hair care services and professional products to its guests at convenient times and locations and at a reasonable price. This concept appeals to men, women and children, although male guests account for approximately 66 percent of the guest mix. Service revenues represent approximately 89 percent of total company-owned Supercuts revenues. The average ticket was approximately $17 for fiscal years 2012 and 2011.
The average initial capital investment required for a new Supercuts salon is approximately $80,000 to $130,000, excluding average opening inventory costs of approximately $8,800. Average annual salon revenues in a company-owned Supercuts salon which has been open five years or more are approximately $270,000.
The Supercuts franchise salons provide consistent, high quality hair care services and professional products to guests at convenient times and locations and at a reasonable price. These Supercuts franchise salons appeal to men, women and children, although male guests account for approximately 71 percent of the guest mix. Service revenues represent approximately 92 percent of the Supercuts franchise total revenues. Average annual revenues in a Supercuts franchise salon which has been open five years or more are approximately $340,000.
Cost Cutters (franchise salons). The Cost Cutters concept is a full service salon concept providing value priced hair care services for men, women and children. These full service salons also sell a complete line of professional hair care products. The guest mix at Cost Cutters is split relatively evenly between men and women. Average annual salon revenues in a franchised Cost Cutters salon which has been open five years or more are approximately $280,000.
In addition to the franchise salons, the Company operates company-owned Cost Cutters salons, as discussed below under Promenade Salons.
Promenade Salons. Promenade Salons are made up of successful regional company-owned salon groups acquired over the past several years operating under the primary concepts of Hair Masters, Cool Cuts for Kids, Style America, First Choice Haircutters, Famous Hair, Cost Cutters, BoRics, Magicuts, Holiday Hair, Head Start, Fiesta Salons and TGF, as well as other concept names. Most concepts offer a full range of custom hairstyling, cutting, coloring and waving, as well as hair care products. Hair Masters offers moderately-priced services to a predominately female demographic, while the other concepts primarily cater to time-pressed, value-oriented families. The guest mix is split relatively evenly between men and women at most concepts. Service revenues represent approximately 89 percent of total company-owned Promenade revenues. The average ticket was approximately $19 and $20 for fiscal years 2012 and 2011, respectively.
The average initial capital investment required for a new Promenade Salon is approximately $75,000 to $125,000, excluding average opening inventory costs of approximately $9,300. Average annual salon revenues in a Promenade Salon which has been open five years or more are approximately $245,000.
Other Franchise Concepts. This group of franchise salons includes primarily First Choice Haircutters, Magicuts, Beauty Supply Outlets, and Pro-Cuts. These concepts function primarily in the high volume, value priced hair care market segment, with key selling features of value, convenience, quality and friendliness, as well as a complete line of professional hair care products. In addition to these franchise salons, the Company operates company-owned First Choice Haircutters and Magicuts salons, as previously discussed above under "Strip Center Salons".
During fiscal year 2012, the Company acquired a 60.0 percent ownership interest in Roosters MGC International LLC, a franchise concept that combines modern grooming techniques with classic barbershop elements. This ownership interest along with the Company's other men's franchise concepts will allow the Company to expand its focus on the male demographic.
International Salons. The Company's International salons are comprised of company-owned salons operating in the United Kingdom primarily under the Supercuts, Regis and Sassoon concepts. These salons offer similar levels of service as the North American salons previously mentioned. However, the initial capital investment required is typically between ÂŁ110,000 and ÂŁ130,000 for a Regis salon, and between ÂŁ60,000 and ÂŁ80,000 for a Supercuts salon. Average annual salon revenues for a salon which has been open five years or more are approximately ÂŁ210,000 in a Regis salon and ÂŁ165,000 in a Supercuts salon. Sassoon is one of the world's most recognized names in hair fashion and appeals to women and men looking for a prestigious full service hair salon. Salons are usually located on prominent high-street locations and offer a full range of custom hairstyling, cutting, coloring and waving, as well as professional hair care products. The initial capital investment required is approximately ÂŁ500,000. Average annual salon revenues for a salon which has been open five years or more is approximately ÂŁ770,000.
Salon Franchising Program:
General. The Company has various franchising programs supporting its 2,016 franchise salons as of June 30, 2012, consisting mainly of Supercuts, Cost Cutters, First Choice Haircutters, Magicuts, Pro-Cuts, and Roosters. These salons have been included in the discussions regarding salon counts and concepts on the preceding pages.
The Company provides its franchisees with a comprehensive system of business training, stylist education, site approval and lease negotiation, professional marketing, promotion and advertising programs, and other forms of support designed to help the franchisee build a successful business.
Standards of Operations. The Company does not control the day to day operations of its franchisees, including hiring and firing, establishing prices to charge for products and services, business hours, personnel management and capital expenditure decisions. However, the franchise agreements afford certain rights to the Company, such as the right to approve location, suppliers and the sale of a franchise. Additionally, franchisees are required to conform to the Company's established operational policies and procedures relating to quality of service, training, design and decor of stores, and trademark usage. The Company's field personnel make periodic visits to franchise stores to ensure that the stores are operating in conformity with the standards for each franchising program. All of the rights afforded to the Company with regard to the franchise operations allow the Company to protect its brands, but do not allow the Company to control the franchise operations or make decisions that have a significant impact on the success of the franchise salons.
To further ensure conformity, the Company may enter into the lease for the store site directly with the landlord, and subsequently sublease the site to the franchisee. The franchise agreement and sublease provide the Company with the right to terminate the sublease and gain possession of the store if the franchisee fails to comply with the Company's operational policies and procedures. See Note 10 to the Consolidated Financial Statements for further information about the Company's commitments and contingencies, including leases.
Franchise Terms. Pursuant to their franchise agreement with the Company, each franchisee pays an initial fee for each store and ongoing royalties to the Company. In addition, for most franchise concepts, the Company collects advertising funds from franchisees and administers the funds on behalf of the concept. Franchisees are responsible for the costs of leasehold improvements, furniture, fixtures, equipment, supplies, inventory, payroll costs and certain other items, including initial working capital.
CEO BACKGROUND
Mr. Daniel G. Beltzman, age 37, Director, Director Since 2012
Mr. Beltzman was elected a director of Regis in August 2012. Mr. Beltzman currently serves as a Managing Member of Birch Run Capital, LLC, a financial investment advisory firm, a position he has held since he co-founded Birch Run in May 2006. Prior to managing investments, Mr. Beltzman worked at both Deutsche Bank Securities, Inc. and Bank of America Securities, LLC focusing on equity research and mergers and acquisitions. Thereafter he founded an entrepreneurial venture that provided services to help European builders more efficiently manage their supply chains. Mr. Beltzman also worked with a boutique investment firm that specializes in joint venture equity and mezzanine debt for real estate ventures. Mr. Beltzman has spent the last ten years managing assets and during that time he has critically studied the businesses of public companies and has developed expertise in capital allocation.
During the course of Birch Run's investment analysis of Regis, it engaged in several discussions with management and certain directors regarding Regis' strategic direction and the opportunities to enhance shareholder value. Thereafter, members of the Board engaged in discussions with Mr. Beltzman about his potential nomination for election to the Board. The Board subsequently nominated Mr. Beltzman as a director because of the Board's belief that Mr. Beltzman's financial experience and expertise will contribute valuable insights to the Board. In addition, Mr. Beltzman, as an affiliate of Birch Run Capital, which owned approximately 10.4% of the Company's common stock on August 28, 2012, brings an additional perspective as a shareholder of the Company. The Board also considered Birch Run's strong support of the Company's strategy to enhance value for the Company's shareholders by focusing on the Company's core operations.
Mr. Joel Conner, age 61, Director, Director Since 2010
Mr. Conner was elected a director of Regis in 2010, and was appointed Chairman of the Board effective May 1, 2012. Mr. Conner currently serves as the Chairman and Chief Executive Officer of Bellisio Foods, a privately-held frozen entree company with exports to 12 countries worldwide. Mr. Conner has been with Bellisio Foods since it was founded in 1990, and prior to becoming CEO was instrumental in leading the company's international development and many of its strategic partnerships. Prior to joining Bellisio Foods, Mr. Conner was the co-founder and director of Cornell Associates, which provided financial management and consulting services to the hotel and restaurant industry worldwide. Prior to Cornell, Mr. Conner served as the Chief Marketing Officer for ServiceMaster Industries.
Mr. Conner is a former director of Republic Banks and has been involved in dozens of successful start-up and turnaround companies, both public and private. He has served on the board of directors or advisory board of numerous organizations in real estate, restaurant management, professional sports, and manufacturing. Mr. Conner recently served for two years as the Chairman of the Board of Directors of Students in Free Enterprise (SIFE), where he has served as a board member for 17 years, and as a director of the Page Foundation. Mr. Conner is also a past chairman of Children's HeartLink. Mr. Conner's various business leadership experiences allow him to make meaningful contributions to the many strategic and operational issues considered by our Board.
Mr. James P. Fogarty , age 44, Director, Director Since 2011
Mr. Fogarty was elected a director of Regis in October 2011. Mr. Fogarty is Chief Executive Officer and a Director of Orchard Brands, a multi-title catalog and internet retailer, a position he has held since November 2011. Prior to that, Mr. Fogarty was a private investor from November 2010 to November 2011. From April 2009 until November 2010, Mr. Fogarty was President, Chief Executive Officer and Director of Charming Shoppes, Inc., a multi-brand, specialty apparel retailer. Prior to that, Mr. Fogarty was a Managing Director of Alvarez & Marsal ("A&M"), an independent global professional services firm, from August 1994 until April 2009. He was also a member of A&M's Executive Committee for North America Restructuring. During his tenure at A&M, Mr. Fogarty most recently served as President and Chief Operating Officer of Lehman Brothers Holdings (subsequent to its Chapter 11 bankruptcy filing) from September 2008 until April 2009. From September 2005 through February 2008, Mr. Fogarty was President and Chief Executive Officer of American Italian Pasta Company, the largest producer of dry pasta in North America. He served as the Chief Financial Officer of Levi Strauss & Co., a brand-name apparel marketer, from 2003 until 2005. From December 2001 through September 2003, he served as Senior Vice President and Chief Financial Officer and for a period as a Director of The Warnaco Group, a global apparel maker, which emerged from bankruptcy in early 2003 after completing a successful turnaround during his tenure.
Mr. Fogarty's operational and turnaround experience allows him to make significant contributions to the Board, particularly during this time of transition at the Company. He has significant executive officer and director experience at a variety of public and private companies, including companies in the specialty retail industry, which provides meaningful industry expertise to the Board. Mr. Fogarty was initially identified as a candidate for director by Starboard Value, a shareholder of the Company.
Mr. Daniel J. Hanrahan , age 55, President and Chief Executive Officer, Director, Director Since 2012
Mr. Hanrahan is the President and Chief Executive Officer of the Company, and a member of the Company's Board of Directors, which positions he has held since August 6, 2012. Prior to joining the Company, he served as President of Celebrity Cruises at Royal Caribbean Cruises Ltd., a global cruise vacation company, since February 2005, and as its President and Chief Executive Officer since September 2007. Mr. Hanrahan served as President and Chief Executive Officer of Azamara Cruises at Royal Caribbean from February 2005 to July 2009. From 1999 until February 2005, Mr. Hanrahan served in a variety of positions with the Royal Caribbean International brand, including Senior Vice President, Sales and Marketing. Mr. Hanrahan has served on the board of directors of Cedar Fair, L.P., an amusement-resort operator, since 2012, and is a member of its Audit Committee.
The Board chose to nominate Mr. Hanrahan as a director in connection with his appointment as President and Chief Executive Officer since he will, in such capacity, have a deep understanding of the Company's operations, strategy, results of operations and financial condition, as well as issues affecting the Company's industry, and will need to share responsibility with the Board for guiding the direction of the Company. Mr. Hanrahan's prior operational background and his extensive experience across a wide spectrum of consumer-facing brands enable him to provide important insights to the Board related to the Company's strategy to improve the salon experience.
Mr. Michael J. Merriman , age 56, Director, Director Since 2011
Mr. Merriman was elected a director of Regis in October 2011. Mr. Merriman has been an operating advisor with Resilience Capital Partners, LLC, a private equity firm, since July 1, 2008. From November 2006 until its sale in November 2007, Mr. Merriman served as Chief Executive Officer of The Lamson & Sessions Co., a publicly held manufacturer of thermoplastic conduit, fittings and electrical switch and outlet boxes. Prior to joining Lamson & Sessions, Mr. Merriman served as the Senior Vice President and Chief Financial Officer of American Greetings Corporation, a publicly held creator and manufacturer of innovative social expression products, from September 2005 until November 2006. He served as the President and Chief Executive Officer of Royal Appliance Mfg. Co., a publicly held manufacturer and marketer of Dirt Devil vacuum cleaners, from 1995 until April 2004, was its Chief Financial Officer from 1992 to 1995, and served on the board of directors from 1993 to 2004. Mr. Merriman has served as a director of American Greetings Corporation since 2006, Nordson Corporation, a publicly held manufacturer of equipment used for precision dispensing, testing and inspection, surface preparation and curing, since 2008, and OMNOVA Solutions Inc., a publicly held innovator of emulsion polymers, specialty chemicals, and decorative and functional surfaces, since 2008. Mr. Merriman also served as a director of RC2 Corporation, a publicly held manufacturer of pre-school toys and infant products, from 2004 until its sale in April 2011.
The Board chose to nominate Mr. Merriman as a director because of his financial acumen, his significant public accounting experience, his experience as a chief executive officer of other publicly traded companies, his service on boards of directors of other publicly traded companies and his retail experience. Mr. Merriman has significant finance, financial reporting and accounting expertise and was formerly a certified public accountant with Arthur Andersen & Co., which will provide the Board with valuable expertise and qualifies him as an audit committee financial expert. In addition, the Board believes that his wide range of management experience at various public companies will allow him to provide valuable insight into the Company's operations as well as its interactions with investors and financial analysts.
Mr. Jeffrey C. Smith , age 40, Director, Director Since 2011
Mr. Smith was elected a director of Regis in October 2011. Mr. Smith has served as Managing Member, Chief Executive Officer and Chief Investment Officer of Starboard Value LP since its inception in February 2011. Prior to founding Starboard Value, Mr. Smith was a Partner Managing Director of Ramius LLC, a subsidiary of Cowen Group, Inc., and the Chief Investment Officer of Ramius Value and Opportunity Master Fund Ltd. Mr. Smith was also a member of Cowen's Operating Committee and Cowen's Investment Committee. Prior to joining Ramius LLC in January 1998, he served as Vice President of Strategic Development for The Fresh Juice Company, Inc. Previously, Mr. Smith served as a member of the Board of Directors of Surmodics, Inc., a leading provider of drug delivery and surface modification technologies to the healthcare industry, from January 2011 to August 2012, and as a member of the Board of Directors of Zoran Corporation, a leading provider of digital solutions in the digital entertainment and digital imaging market, from March 2011 until its merger with CSR plc in August 2011. Mr. Smith was the Chairman of the Board of Phoenix Technologies Ltd., a provider of core systems software products, services and embedded technologies, from November 2009 until the sale of the company to Marlin Equity Partners in November 2010. He also served as a director of Actel Corporation, a provider of power management solutions, from March 2009 until its sale to Microsemi Corporation in October 2010. Mr. Smith has also served as a member of the Board of Directors of S1 Corporation, Kensey Nash Corp., The Fresh Juice Company, Inc., and Jotter Technologies, Inc., an internet infomediary company. Mr. Smith served as a member of the Management Committee for Register.com, which provides internet domain name registration services. He began his career in the Mergers and Acquisitions department at Société Générale. Mr. Smith is a General Securities Registered Representative.
Mr. Smith's experience with various investment firms has given him significant experience evaluating companies from a financial, operational and strategic perspective, with a focus on identifying opportunities for value creation. These perspectives are particularly important to the Board during this current time of transition as the Company has implemented various initiatives to focus on the Company's core business and evaluate additional opportunities to create value for the Company's shareholders. As a representative of Starboard Value, which beneficially owned approximately 5.4% of the Company's common stock on August 28, 2012, he also brings the perspective of a shareholder of the Company. His prior experience in various management roles also enables Mr. Smith to provide the Board with valuable financial and executive insights. Mr. Smith was initially identified as a candidate for director by Starboard Value, a shareholder of the Company.
Mr. Stephen E. Watson , age 67, Director, Director Since 2008
Mr. Watson was elected a director of Regis in 2008. Mr. Watson brings to the Board nearly 40 years of executive and director experience in the retail industry. From 1973 through 1996, Mr. Watson held various executive officer positions with Dayton Hudson Corporation, including Chairman and Chief Executive Officer of Dayton Hudson Department Stores Co. and President of Dayton Hudson Corporation. From 1972 to 1996, Mr. Watson held various executive officer positions, including President and Chief Executive Officer of the Department Store Division. From 1997 until his retirement in 2002, Mr. Watson was President and Chief Executive Officer of Gander Mountain Company, a privately held retailer for outdoor sports and recreation activities. In addition to serving as a director of Regis, Mr. Watson is currently also a director of Kohl's Corporation, a specialty, family-focused, value-oriented department store, where he serves as Lead Director and Chairman of the Audit Committee, and of Chico's FAS, Inc., a women's specialty retailer of private branded, sophisticated clothing and accessories where he serves on the Audit and the Compensation and Benefits Committees. From 1997 through December 2005, Mr. Watson was a director of ShopKo Stores, Inc., an operator of general merchandise stores. From 2004 through May 2007, Mr. Watson was a director of Smart & Final, Inc., an operator of grocery stores. He also served on the boards of Norwest Bank from 1990 to 1996, Target Corporation from 1991 to 1996, Retek Inc. from November 1999 to 2004, and Eddie Bauer Holdings, Inc. from 2005 to 2009.
Mr. Watson's experience as the leading senior executive officer of several complex and specialty retail businesses, his experience as a director of other retail-oriented public companies, and his broad-based knowledge in the areas of retail operations, corporate finance, accounting, marketing and merchandise procurement, bring significant value to our Board. He also contributes a wealth of knowledge and experience of serving on the boards of several public retail companies where he has also served as an audit and governance committee chair.
Mr. David P. Williams , age 51, Director, Director Since 2011
Mr. Williams was elected a director of Regis in October 2011. Mr. Williams currently serves as the Executive Vice President and Chief Financial Officer of Chemed Corporation, a provider, through its subsidiaries, of hospice care, and repair and maintenance services. Mr. Williams has served as Chemed's Chief Financial Officer since February 2004. From 1998 until 2004, Mr. Williams was the Senior Vice President and Chief Financial Officer of the Roto-Rooter Group, a leading provider of commercial and residential plumbing and drain cleaning services. Prior to that, Mr. Williams was the Chief Financial Officer of Chemed's Omnia Group subsidiary, a manufacturer of disposable healthcare products, and prior to that was Senior Vice President and Chief Financial Officer of Omnicare's Veratex Group, a national distributor of disposable medical, dental and pharmaceutical products. Prior to joining Chemed, Mr. Williams was with Price Waterhouse in their Comprehensive Professional Services Group.
Mr. Williams' depth of experience in various senior executive roles of public and private companies and his significant accounting and financial expertise enable him to provide meaningful contributions to the oversight of financial and accounting matters at the Company, and qualifies him as an audit committee financial expert. Mr. Williams was initially identified as a candidate for director by Starboard Value, a shareholder of the Company.
MANAGEMENT DISCUSSION FROM LATEST 10K
MANAGEMENT'S OVERVIEW
Regis Corporation (RGS) owns or franchises beauty salons and hair restoration centers. As of June 30, 2012, we owned, franchised or held ownership interests in approximately 12,600 worldwide locations. Our locations consisted of 9,738 system wide North American and international salons, 98 hair restoration centers, and 2,811 locations in which we maintain a non-controlling ownership interest less than 100 percent. Our salon concepts offer generally similar products and services and serve mass market consumers. Our salon operations are organized to be managed based on geographical location. Our North American salon operations include 9,340 salons, including 2,016 franchise salons, operating in the United States, Canada and Puerto Rico primarily under the trade names of Regis Salons, MasterCuts, SmartStyle, Supercuts and Cost Cutters. Our international salon operations include 398 salons located in Europe, primarily in the United Kingdom. Hair Club for Men and Women includes 98 North American locations, including 29 franchise locations. During fiscal year 2012, we had approximately 52,000 corporate employees worldwide.
Salon Business
The strength of our salon business is in the fundamental similarity and broad appeal of our salon concepts. Each concept generally targets the middle market guest, however, each attracts a different demographic.
We execute our salon growth strategy by focusing on real estate. Our salon real estate strategy is to add new units in convenient locations with good visibility and guest traffic, as well as appropriate trade demographics. Our various salon and product concepts operate in a wide range of retailing environments, including regional shopping malls, strip centers and Walmart Supercenters. We believe that the availability of real estate will augment our ability to achieve the aforementioned long-term growth objectives.
Organic salon revenue is achieved through the combination of new salon construction and salon same-store sales results. Older, unprofitable salons will be closed or relocated. Although we have generally been experiencing negative same-store sales we believe our strategy of focusing on the in-salon guest experience will improve same-store sales.
Historically, our salon acquisitions have varied in size from as small as one salon to over one thousand salons. The median acquisition size is approximately ten salons. From fiscal year 1994 to fiscal year 2012, we acquired 8,052 salons, net of franchise buybacks.
Hair Restoration Business
In December 2004, we acquired Hair Club for Men and Women. Hair Club for Men and Women is a provider of hair loss solutions with an estimated five percent share of the $4 billion domestic market. This industry is comprised of numerous locations domestically and is highly fragmented. In an effort to provide confidentiality for guests, the hair restoration centers operate primarily in professional or medical office buildings. Further, the hair restoration business is more marketing intensive. As a result, organic growth at hair restoration centers is dependant on successfully generating new leads and converting them into hair restoration guests.
During the fiscal year ended June 30, 2012, the Company began reviewing alternatives for non-core assets. On July 13, 2012, the Company entered into a definitive agreement to sell its Hair Club for Men and Women business (Hair Club), a provider of hair restoration services. The transaction is expected to close during the first half of fiscal year 2013.
CRITICAL ACCOUNTING POLICIES
The Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the Consolidated Financial Statements, we are required to make various judgments, estimates and assumptions that could have a significant impact on the results reported in the Consolidated Financial Statements. We base these estimates on historical experience and other assumptions believed to be reasonable under the circumstances. Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made, and (2) other materially different estimates could have been reasonably made or material changes in the estimates are reasonably likely to occur from period to period. Changes in these estimates could have a material effect on our Consolidated Financial Statements.
Our significant accounting policies can be found in Note 1 to the Consolidated Financial Statements contained in Part II, Item 8 of this Form 10-K. We believe the following accounting policies are most critical to aid in fully understanding and evaluating our reported financial condition and results of operations.
Investment In and Loans to Affiliates
The Company has equity investments in securities of certain privately held entities. The Company accounts for these investments under the equity method of accounting. The Company also has loan receivables from certain of these entities. Investments accounted for under the equity method are recorded at the amount of the Company's investment and adjusted each period for the Company's share of the investee's income or loss. Investments are reviewed for changes in circumstance or the occurrence of events that suggest the Company's investment may not be recoverable. During fiscal year 2012, we recorded an impairment of $19.4 million related to our investment in EEG. In addition, during fiscal year 2012 we recorded a net $17.2 million other than temporary net impairment charge associated with the Share Purchase Agreement to sell the Company's 46.7 percent equity interest in Provalliance to the Provost Family for a purchase price of €80 million. During fiscal year 2011, we recorded an impairment of $9.2 million related to our investment in MY Style.
Note Receivables, Net
The note receivable balances within the Company's Consolidated Balance Sheet primarily include note receivables related to the Company's investments in EEG and MY Style, a note receivable with the purchaser of Trade Secret and note receivables with our franchisees. The balances are presented net of a valuation reserve for estimated losses. The Company monitors the financial condition of its counterparties with an outstanding note receivable and records provisions for estimated losses on receivables when it believes the counterparties are unable to make their required payments. The valuation reserve is the Company's best estimate of the amount of probable credit losses related to existing notes receivable.
During the third quarter of fiscal year 2011, the Company did not receive a scheduled interest payment related to the outstanding note receivable with the purchaser of Trade Secret, the fair value of the collateral decreased to a level below the carrying value of the outstanding note receivable, and the purchaser of Trade Secret provided the Company with a new five year business plan that was well below their original projections. Due to these factors that occurred during the third quarter of fiscal year 2011, the Company evaluated the note receivable for impairment based on a probability weighted expected future cash flow analysis. During the third quarter of fiscal year 2011, the Company recorded a $9.0 million valuation reserve for the excess of the carrying value of the note receivable over the present value of expected future cash flows.
During the fourth quarter of fiscal year 2011, the Company did not receive a scheduled interest payment related to the outstanding note receivable with the purchaser of Trade Secret and the fair value of the collateral continued to decrease and was at a level significantly below the carrying value of the outstanding note receivable. In addition, the Company received updated financial projections that were below the projections received during the third quarter of fiscal year 2011. Due to these negative financial events in the fourth quarter of fiscal year 2011, the Company performed an extensive evaluation on the Company's option to realize the collateral under the note receivable and recorded an additional $22.2 million valuation reserve that fully reserved the carrying value of the note receivable as of June 30, 2011. The carrying value of the note receivable continues to be fully reserved at June 30, 2012.
Goodwill
Goodwill is tested for impairment annually or at the time of a triggering event. In evaluating whether goodwill is impaired, the Company compares the carrying value of each reporting unit, including goodwill, to the estimated fair value of the reporting unit. The carrying value of each reporting unit is based on the assets and liabilities associated with the operations of the reporting unit, including allocation of shared or corporate balances among reporting units. Allocations are generally based on the number of salons in each reporting unit as a percent of total company-owned salons.
The Company calculates the estimated fair value of the reporting units based on discounted future cash flows that utilize estimates in annual revenue, gross margins, fixed expense rates, allocated corporate overhead, and long-term growth rates for determining terminal value. The Company's estimated future cash flows also take into consideration acquisition integration and maturation. Where available and as appropriate, comparative market multiples are used in conjunction with the results of the discounted cash flows. The Company considers its various concepts to be reporting units when testing for goodwill impairment because that is where the goodwill resides. The Company periodically engages third-party valuation consultants to assist in evaluation of the Company's estimated fair value calculations.
In the situations where a reporting unit's carrying value exceeds its estimated fair value, the amount of the impairment loss must be measured. The measurement of impairment is calculated by determining the implied fair value of a reporting unit's goodwill. In calculating the implied fair value of goodwill, the fair value of the reporting unit is allocated to all other assets and liabilities of that unit based on the relative fair values under the assumption of a taxable transaction. The excess of the fair value of the reporting unit over the amount assigned to its assets and liabilities is the implied fair value of goodwill. The goodwill impairment is measured as the excess of the carrying value of goodwill over its implied fair value.
As previously disclosed, the Company concluded that it was reasonably likely that goodwill for the Regis and Hair Restoration Centers reporting units might become impaired in future periods.
As a result of the Company's annual impairment testing of goodwill during the fourth quarter of fiscal year 2012, a $67.7 million impairment charge was recorded within continuing operations for the excess of the carrying value of goodwill over the implied fair value of the goodwill for the Regis salon concept. The Regis salon concept reported same-store sales of negative 4.0 percent for the ten months ended April 30, 2012, which was unfavorable compared to the Company's budgeted same-store sales. Visitation patterns did not rebound as quickly as the Company originally projected. Accordingly, the Company reduced the budgeted financial projections for future years. After the impairment charge the Regis salon concept reporting unit had $35.1 million of goodwill. The impairment was only partially deductible for tax purposes resulting in a tax benefit of $12.5 million.
During the three months ended December 31, 2011 the Company updated the projections for the Hair Restoration Centers reporting unit used in the fiscal 2011 annual impairment test to reflect the impact of recent industry developments, including a slow down in revenue growth and increasing supply costs. The Company determined there was a triggering event as it was more likely than not that the fair value of the Hair Restoration Centers was below carrying value and performed an interim impairment test of goodwill during the three months ended December 31, 2011.
As a result of the Company's interim impairment test of goodwill related to the Hair Restoration Centers reporting unit during the second quarter of fiscal year 2012, a $78.4 million impairment charge was recorded within continuing operations for the excess of the carrying value of goodwill over the implied fair value of the goodwill for the Hair Restorations Centers reporting unit. After the impairment charge the Hair Restoration Centers reporting unit had $74.4 million of goodwill. The impairment was only partially deductible for tax purposes resulting in a tax benefit of $5.9 million. See further discussion on the effective tax rate for the twelve months ended June 30, 2012 within Note 12 to the Consolidated Financial Statements.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
MANAGEMENT’S OVERVIEW
Regis Corporation (RGS, we, our, or us) owns, franchises or holds ownership interests in beauty salons, hair restoration centers and educational institutions. As of March 31, 2012, we owned, franchised or held ownership interests in approximately 12,700 worldwide locations. Our locations consisted of 9,782 system wide North American and international salons, 98 hair restoration centers and approximately 2,780 locations in which we maintain an ownership interest. Our salon concepts offer generally similar products and services and serve mass market consumers. Our salon operations are organized to be managed based on geographical location. Our North American salon operations include 9,380 salons, including 2,015 franchise salons, operating in the United States, Canada and Puerto Rico primarily under the trade names of Regis, MasterCuts, SmartStyle, Supercuts and Cost Cutters. Our international salon operations include 402 company-owned salons, located in the United Kingdom. Our hair restoration centers, operating under the trade name Hair Club for Men and Women, include 98 North American locations, including 29 franchise locations. As of March 31, 2012, we had approximately 52,000 corporate employees worldwide.
On August 1, 2007, we contributed our 51 accredited cosmetology schools to Empire Education Group, Inc., creating the largest beauty school operator in North America. As of March 31, 2012, we own a 55.1 percent equity interest in Empire Education Group, Inc. (EEG). Our investment in EEG is accounted for under the equity method. The combined Empire Education Group, Inc. includes 105 accredited cosmetology schools with annual revenues of approximately $193 million.
On January 31, 2008, we merged our continental European franchise salon operations with the Franck Provost Salon Group in exchange for a 30.0 percent equity interest in the newly formed entity, Provalliance. The merger agreement contains a right, equity put, to require us to purchase an additional ownership interest in Provalliance between specified dates in 2010 to 2018. In March 2011 the Company acquired approximately 17 percent additional equity interest in Provalliance for $57.3 million (approximately € 40.4 million). As of March 31, 2012, we own 46.7 percent of the equity interest in Provalliance. Our investment in Provalliance is accounted for under the equity method. The merger with the operations of the Franck Provost Salon Group, which are also located in continental Europe, created Europe’s largest salon operator with approximately 2,500 company-owned and franchise salons as of March 31, 2012.
On April 9, 2012, the Company entered into a Share Purchase Agreement (Agreement) to sell the Company’s 46.7 percent equity interest in Provalliance to the Provost family for a purchase price of €80 million. The transaction is expected to close no later than September 30, 2012 and is subject to the Provost family securing financing for the purchase price. The purchase price was negotiated independently of the equity put and the equity put and equity call will automatically terminate upon closing. If the closing does not occur by September 30, 2012, the Provost family will not be entitled to exercise their equity put rights until September 30, 2014.
The Company recorded a $37.0 million other than temporary impairment charge for the three months ended March 31, 2012 related to the difference between the €80 million (approximately $106.7 million) purchase price and €107.8 million (approximately $143.8 million) carrying value of its investment in Provalliance. In addition, the fair value of the equity put decreased by $20.2 million to $0.7 million as of March 31, 2012. The remaining equity put liability as of March 31, 2012 is associated with the probability of the Agreement not closing and the equity put remaining effective. The $37.0 million other than temporary impairment charge, partially offset by the $20.2 million reduction in the fair value of the equity put, resulted in a net impairment charge of $16.8 million that is recorded within the equity in (loss) income of affiliated companies during the three and nine months ended March 31, 2012. Regis will not receive a tax benefit on the net impairment charge.
In connection with the Agreement, the Company is considering alternatives which may require reclassification of certain material cumulative foreign currency translation balances from the consolidated balance sheet to results of operations. As of March 31, 2012, the balance of cumulative foreign currency translation within accumulated other comprehensive income on the Condensed Consolidated Balance Sheet was $62.6 million.
Our fiscal year 2012 growth strategy has been focused on increasing customer visits by improving the salon experience. We are executing our strategy through four focus areas of putting customers and stylists first, leveraging the power of our salon brands, technology and connectivity, and delivering improved financial performance. Initiatives of these four focus areas include:
• Putting customers and stylists first through improving both the experience for the person in the chair and behind the chair. The Company is working on attracting, developing and retaining the best stylists through orientation programs, training and development and rewards and recognition.
• Leveraging the power of our salon brands through focusing on the best brands within the best markets, enhanced focus and alignment and aggressive strategies including discounting. We are focused on our consumer segmentation strategy and currently working to categorize our salons into one of four distinct consumer segments: Value, Value Full Service, Enhanced Full Service, and Mass Premium. We will achieve scale by simplifying and consolidating our operating models around these four consumer segments. By simplifying our operating models we can convert existing brands within a consumer segment and leverage our marketing spend. Brand consolidation will focus on a “best brands in the best markets” approach.
• Using technology and connectivity, including internet in the salons, to enhance effectiveness of field management and improve customer satisfaction and retention.
• Delivering improved financial performance through undertaking cost savings initiatives in the range of $35.0 to $40.0 million, including a home office workforce reduction, renegotiated interest rates, and reduced travel costs. Net of investments in our various business initiatives and cost increases in other expense categories, our net cost savings will be approximately $25.0 million in fiscal year 2012.
Maintaining financial flexibility is a key element in continuing our successful growth. With strong operating cash flow and balance sheet, we are confident that we will be able to financially support our long-term growth objectives.
We are in compliance with all covenants and other requirements of our financing arrangements as of March 31, 2012.
Salon Business
The strength of our salon business is in the fundamental similarity and broad appeal of our salon concepts that allow flexibility and multiple salon concept placements in shopping centers and neighborhoods. Each concept generally targets the middle market customer, however, each attracts a different demographic. We believe there are growth opportunities in all of our salon concepts. When commercial opportunities arise, we anticipate testing and developing new salon concepts to complement our existing concepts.
We execute our salon growth strategy by focusing on real estate. Our salon real estate strategy is to add new units in convenient locations with good visibility and customer traffic, as well as appropriate trade demographics. Our various salon and product concepts operate in a wide range of retailing environments, including regional shopping malls, strip centers and Walmart Supercenters. We believe that the availability of real estate will augment our ability to achieve the aforementioned long-term growth objectives. In fiscal year 2012, our outlook for constructed salons is approximately 285 units. In fiscal year 2012, capital expenditures and acquisitions are expected to be approximately $95 and up to $5 million, respectively.
Organic salon revenue is achieved through the combination of new salon construction and salon same-store sales results. Once customer visitations stabilize, we expect we will continue with our historical trend of building several hundred company-owned salons. We anticipate our franchisees will open approximately 100 to 120 salons in fiscal year 2012. Older, unprofitable salons will be closed or relocated. Our long-term outlook for our salon business is annual consolidated low single digit same-store sales increases. We project our annual fiscal year 2012 consolidated same-store sales to be in a range of negative 2.5 percent to negative 3.5 percent.
Historically, our salon acquisitions have varied in size from as small as one salon to over one thousand salons. The median acquisition size is approximately ten salons. From fiscal year 1994 to the third fiscal quarter of 2012, we acquired 8,051 salons, net of franchise buybacks. Once customer visitations normalize, we anticipate adding several hundred company-owned salons each year from acquisitions. Some of these acquisitions may include buying salons from our franchisees.
Hair Restoration Business
In December 2004, we acquired Hair Club for Men and Women. Hair Club for Men and Women is a provider of hair loss solutions with an estimated five percent share of the $4 billion domestic market. This industry is comprised of numerous locations domestically and is highly fragmented.
The success of our hair restoration business is not dependent on the same real estate criteria used for salon expansion. In an effort to provide confidentiality for our customers, our hair restoration centers operate primarily in professional or medical office buildings. Further, the hair restoration business is more marketing intensive. As a result, organic growth at our hair restoration centers will be dependent on successfully generating new leads and converting them into hair restoration customers.
During the three months ended December 31, 2011 the Company began reviewing alternatives for non-core assets, including the exploration of a potential sale of the hair restoration business.
CRITICAL ACCOUNTING POLICIES
The Condensed Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the Condensed Consolidated Financial Statements, we are required to make various judgments, estimates and assumptions that could have a significant impact on the results reported in the Condensed Consolidated Financial Statements. We base these estimates on historical experience and other assumptions believed to be reasonable under the circumstances. Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made, and (2) other materially different estimates could have been reasonably made or material changes in the estimates are reasonably likely to occur from period to period. Changes in these estimates could have a material effect on our Condensed Consolidated Financial Statements.
Our significant accounting policies can be found in Note 1 to the Consolidated Financial Statements contained in Part II, Item 8 of the June 30, 2011 Annual Report on Form 10-K, as well as Note 1 to the Condensed Consolidated Financial Statements contained within this Quarterly Report on Form 10-Q. We believe the accounting policies related to the valuation of goodwill, the valuation and estimated useful lives of long-lived assets, investment in and loans to affiliates, purchase price allocations, revenue recognition, self-insurance accruals, stock-based compensation expense, legal contingencies and estimates used in relation to tax liabilities and deferred taxes are most critical to aid in fully understanding and evaluating our reported financial condition and results of operations. Discussion of each of these policies is contained under “Critical Accounting Policies” in Part II, Item 7 of our June 30, 2011 Annual Report on Form 10-K. There were no significant changes in or application of our critical accounting policies during the three and nine months ended March 31, 2012.
Goodwill:
Goodwill is tested for impairment annually or at the time of a triggering event. In evaluating whether goodwill is impaired, the Company compares the carrying value of each reporting unit, including goodwill, to the estimated fair value of the reporting unit. The carrying value of each reporting unit is based on the assets and liabilities associated with the operations of the reporting unit, including allocation of shared or corporate balances among reporting units. Allocations are generally based on the number of salons in each reporting unit as a percent of total company-owned salons.
The Company calculates the estimated fair value of the reporting units based on discounted future cash flows that utilize estimates in annual revenue, gross margins, fixed expense rates, allocated corporate overhead, and long-term growth for determining terminal value. The Company’s estimated future cash flows also take into consideration acquisition integration and maturation. Where available and as appropriate, comparative market multiples are used to corroborate the results of the discounted cash flow. The Company considers its various concepts to be reporting units when testing for goodwill impairment because that is where the Company believes the goodwill resides. The Company periodically engages third-party valuation consultants to assist in evaluation of the Company’s estimated fair value calculations.
In the situations where a reporting unit’s carrying value exceeds its estimated fair value, the amount of the impairment loss must be measured. The measurement of impairment is calculated by determining the implied fair value of a reporting unit’s goodwill. In calculating the implied fair value of goodwill, the fair value of the reporting unit is allocated to all other assets and liabilities of that unit based on the relative fair values under the assumption of a taxable transaction. The excess of the fair value of the reporting unit over the amount assigned to its assets and liabilities is the implied fair value of goodwill. The goodwill impairment is measured as the excess of the carrying value of goodwill over its implied fair value.
As previously disclosed, the Company concluded that it was reasonably likely that goodwill for the Hair Restoration Centers reporting unit might become impaired in future periods. During the three months ended December 31, 2011 the Company updated the projections used in the fiscal 2011 annual impairment test to reflect the impact of recent industry developments, including a slow down in revenue growth and increasing supply costs. The Company determined there was a triggering event as it was more likely than not that the fair value of the Hair Restoration Centers was below carrying value and performed an interim impairment test of goodwill during the three months ended December 31, 2011. There were no triggering events relative to the Company’s other reporting units.
As a result of the Company’s interim impairment test of goodwill related to the Hair Restoration Centers reporting unit during the second quarter of fiscal year 2012, a $78.4 million impairment charge was recorded within continuing operations for the excess of the carrying value of goodwill over the implied fair value of the goodwill for the Hair Restorations Centers reporting unit. After the impairment charge the Hair Restoration Centers reporting unit had $74.4 million of goodwill. The impairment was only partially deductible for tax purposes resulting in a tax benefit of $5.9 million. See further discussion on the effective tax rate for the three and nine months ended March 31, 2012 within Note 10 to the Condensed Consolidated Financial Statements.
The Company recorded a $74.1 million impairment charge for the Promenade salon concept as a result of the Company’s impairment testing of goodwill during the third quarter of fiscal year 2011. As of June 30, 2011, the estimated fair value of the Regis salon concept reporting unit exceeded the carrying value by approximately 18.0 percent. The respective fair values of the Company’s remaining reporting units exceeded fair value by greater than 20.0 percent at June 30, 2011. While the Company has determined the estimated fair values of Promenade, Hair Restoration Centers and Regis to be appropriate based on the historical level of revenue growth, operating income and cash flows, it is reasonably likely that Regis, Hair Restoration Centers, and Promenade may experience additional impairment in future periods. The term “reasonably likely” refers to an occurrence that is more than remote but less than probable in the judgment of the Company. Because some of the inherent assumptions and estimates used in determining the fair value of the reportable segment are outside the control of management, changes in these underlying assumptions can adversely impact fair value. Potential impairment of a portion or all of the carrying value of the Regis and Promenade salon concepts and Hair Restoration Centers goodwill is dependent on many factors and cannot be predicted with certainty.
CONF CALL
Paul Finkelstein
Thank you Sarah and good morning everyone. Thank you for joining us. I would like to apologize in advance in the event I start coughing. I’m getting rid of a cold.
We are pleased to report second quarter operational earnings were ahead of plan at $0.28 per share versus $0.27 last year, after adjusting for the impact of our recent equity and convert offering. The second quarter did include a non-operational benefit of $0.02 a share related to an adjustment in insurance reserves that Randy will talk about during his portion of the presentation.
As we mentioned on our first quarter conference call, the second quarter also saw continuation of customer and business trends that we've seen during the last several quarters. Second half of December was stronger than the first half, even though we were significantly affected by the Saturday snowstorm that occurred just before Christmas.
In this challenging economy, our management team has been quite proactive in increasing average ticket, enhancing gross margin, reducing expenses and closing underperforming salons.
During the second quarter, consolidated gross margins were much better than plan and improved 70 basis points compared to last year primarily the result of a recently implemented leverage pay plan as well as reducing retail product commissions.
We continue to see improvements on the expense side in many other categories including travel and marketing costs and administrative head count. Our efforts to increase average ticket through a combination of price increases and by selling add-on services and products continued to produce strong results.
Second quarter average ticket was up almost 4%, maintaining and strengthening our balance sheet by continuing to build cash and improving liquidity remains a top priority. Customer visits continues to be a major challenge.
Compared to the prior year in North American average service ticket was up 3.7% in the quarter while customer visits were down 7.8%. Customer counts were down 6.7% in value and 11.5% in the higher price point of Regis division.
As I'll discuss in a minute, we are starting to see some positive signs and we are expecting to see improvement in comps in the second half of the year. Long-term, our growth in earnings is primarily dependent upon increase sales.
While we forecast continued expense control on gross margin enhancement, the major focus has to be on increasing our top line. There are two questions that obviously have to be asked and commented upon.
First, are we losing market share? The short answer is, no we are not. Three weeks ago I was in Loreal’s offices in Paris with the head of its worldwide professional division. Loreal is by far and away the leading company in the beauty industry and they constantly monitor salon visits by country.
All of that data indicate that worldwide salon visits continue to be a challenge. We believe industry is nearing the tail end for the 5% to 10% worldwide contraction due to reduced visitations, which is primarily the result of a more frugal customer. Issues we are dealing with are impacting the entire salon industry, not just Regis.
The second question, which I’ve already referred to, is when will visitation patterns normalize. We don’t have the crystal ball and we can’t predict whether or not that will be in the third quarter of our fiscal 2010 or the first or second quarter fiscal 2011. It’s inevitable that will happen and when it does the industry should resume it’s 2% plus annual growth rate.
In the event that we will negatively comp this year, it will only be the second year in our 88-year history where we will have had negative comp. There continues to be no evidence of consumers trading down on service or product and our sweet spot value continues to become a larger part of our overall business. There is some reason positive developments that I’d like to share with you.
First our U.K. business started to show significant strengthening in the second quarter. Comps in the U.K. were down a modest 1.6% against the 10.7% decrease a year ago. The U.K. retail economy has been in the doldrums for over three years. We’ve had a dramatic change in our business and our results are ahead of plan in the U.K.
Likewise in North America, we're seeing more and more days with positive comps, which was not in the case for many months. In fact, comps over the last three weeks have been flat. Also our Hair Club comps are improving significantly, they were flat for the quarter against the 1.5% decline a year ago.
At the first time in two years retail performed better than service, Supercuts in particular had positive 4.7% of retail comps for the quarter. We have new initiatives in the retial arena where we're adding impulse items at price points that are quite affordable.
Lastly, the current fashion books such the February issue with ELLE are showing more style than cut hair in their ads and the ads are the things to look at, that I've seen for quite sometime.
Last year has been the year of transformation for Regis. Today, we have leaner company that is focused primarily on value and that's a good strategy for us in the long-term. We believe there are significant opportunities in our franchise business and we're being more aggressive with respect to growing this business.
A little bit of self-flagellation as in order as we have not made some of the progress that some of our franchise competitors have made in recent years. We're changing that. In markets where we're extremely strong like Boston, we feel there are significant opportunities to expand.
We're going to aggressively sign leases and give those opportunities to existing and new franchisees and we're more than prepared to step-in and have company on Supercut stores in the Boston market in the event that we cannot add a franchise operation.
As I have mentioned many times before, ours is one of the few companies in retailing that does have a ceiling. We certainly have all the liquidity and resources to resume our expansion strategy once comps normalize. At that point in time, we should be building 400 salons a year and buying 400 salons a year with our franchises rolling us well.
We certainly will not resume this level of expansion until comps normalize. However, we will be opportunistic in markets where we're strong because the business model works extremely well, for both company-owned and franchised locations in these strong markets.
Individual investors have asked why we don’t make more acquisitions at this point in time and the answer is quite simple. If a 50-salon chain is experiencing 3% negative comps, their profits are probably going to be down 15% to 20%.
That’s what we are waiting on, until accounts normalize and buy it cheaper. We have the ability to wait that out as there are no other purchases and there is no reason to pay a 15% premium in the event that profits go down 15%.
Likewise, we feel strongly that many of our landlords have not adjusted to the new retail environment and until rents are reduced significantly in the places in which we want to be located, would be propelling our new bills.
Four additional salons were closed in the U.K. during the second quarter and there are plans to close 13 more in the current quarter. We should be finished with our negotiations to close or get significant rent relief in the U.K. by the end of March.
We expect to realize approximately $2.4 million in annual cash saving once the project is completed. We also rebranded 41 Hair Express salons to Supercuts or Regis and have seen significant improvement in sales and profits.
I’d like to now talk about our investments in Empire Education Group and Provalliance. Both companies are doing extremely well. Empire Education sales and EBIDA in fiscal 2009 were a $150 million and $16 million respectively and they were on track to go to 170 million in sales and 20 million in EBIDA during this fiscal year.
Likewise Provalliance, which includes Jean Louis David and Franck Provost Salon operations expects to meet its 2009 EBIDA projections and is forecasting positive comps of approximately 2% in 2010 with significant growth in EBIDA.
As we stated in our press release, we now believe EBIDA may come in towards the higher end of our previously stated range of $200 million to $240 million and at this level we should produce excess cash flow of at least $90 million which will be used to pay down debt and build cash reserves.
I know that we have been talking about the visitation problem for three or four years and the story does become old not only for investors but for me as well. It is however inevitable that visits will normalize. People have to get their haircut and colored on a regular basis.
This sole issue is when visits will normalize and we see enough positive signs that makes us quite confident that by this time next year our results will be much better. We believe our strategy is appropriate, so we’ll continue to focus on value. We can’t force customers to come in more often, however we can make sure that the customer experience is as good as it possibly can be, so that when they return they return to us.
We continue to be very bullish about our future. It’s inevitable that this industry, which is an enormous industry, $150 billion to $170 billion worldwide, will stabilize. We’re extremely well positioned strategically to grow our company when visits do normalize. Our balance sheet is extremely strong. The business model is still very attractive. Buying and building salons have extremely high rates of return. We are 10 times larger than our nearest competitor and yet only have a 2% worldwide share.
Our stock price is quite important to us and with our stocks trading at 12 times street estimated this fiscal year EPS versus an historical multiple of 17 times and with free cash flow per share of a $1.70 we think that our future is bright indeed and our shareholders should be able to benefit in the long term.
Randy will now continue.
Randy Pearce
Thanks Paul, and good morning everyone. Overall, I believe we’ve had a relatively straightforward quarter. Today we are reporting second quarter fiscal 2010 earnings of $0.30 a share, which includes about $0.02 of non-operational benefit associated with an adjustment to our prior year worker compensation and insurance claim reserves.
Therefore on an operational basis, we are reporting second quarter earnings of $0.28 a share, up slightly from our operational results of $0.27 that we reported last year on our second quarter after you adjust for the impact of our recent equity and convert issuance.
For many years, we’ve talked about the direct correlation of our earnings with our same store sales performance. With our actual comps declining 3.7% during the second quarter, we would have expected our operational earning could be about $0.20 a share, which included an incremental $2.5 million or two and half cents per share of planned cost savings that we discussed with you in recent quarters.
Therefore, our operational results of $0.28 a share are about $0.08 higher than what our comps would indicate. The $0.08 of upside came from strong expense control including gross margin enhancement. Our service and retail product margins came in about $0.03 per share better than planned during the second quarter.
In addition, our site operating and G&A expenses were about $0.03 favorable to plan on an overall basis. Earnings from our equity investments exceeded plan by about a penny a share primarily due to the performance of our European Salons managed by Franck Provost.
Finally, our effective income tax rate came in favorable to plan by about a penny and I will address each of these items with you in more detail a bit later on.
As always, we've included in today's press release, as well as on our corporate website a concise reconciliation that bridges our reported earning to our operational earnings for both the current year and the prior year second quarters. Also feel free to contact Mark Fosland or Alex Forliti here at the Regis corporate office should you have any questions regarding the financial models.
I will now transition my comments by giving you a bit more detail behind our second quarter operating results for each of our business segments. A breakout of our segment performance is once again filed in today's press release. My comments this morning is going to focus on our operational performance.
And I'll begin with our largest segment, which is our North American salons. Please remember that our former Trade Secret results have been removed from the prior year individual revenue and expense line items on the North America segment P&L as required by the discontinued operations accounting treatment.
As we've discussed in past quarters, Regis has agreed to provide certain transitional support services to Premier Salons, the company that now owns Trade Secret. These services included the sale of certain retail products to Premier at Regis's cost for a limited period of time.
These product sales to Premier effectively ended this past September 30th, the end of our first fiscal quarter. As a result, beginning in the second quarter you will no longer see the revenue and the related offsetting cost on the face of our P&L.
Our total North American salon revenue, which represented 87% of our consolidated second quarter revenue, declined 2% during the quarter to $500 million. This revenue decrease was the result of a decline in total same-store sales of 400 basis points, partially offset by revenue from company owned salons that were built or acquired over the past year.
Service revenue declined 240 basis points during the quarter to $390 million. This reduction was a due to a decline in service comps during the quarter of 4.1%, partially offset by revenue from new and acquired salons over the past 12 months.
Our same-store service sales continued to benefit during the second quarter by an increase in average ticket of 3.7% in large part due to price increases that we implemented during our third fiscal quarter of our prior 2009 fiscal year.
However more than offsetting the increase in average ticket was a 7.8% decline in same-store customer business during the quarter as many consumers continued to lengthen their salon visitation patterns due to the economy. Our retail product revenue fell 1.8% in the quarter to $101 million due to a decline in product comps of 3.7%.
Second quarter royalties and fees from our North American Franchise Salons were $9 million flat to the same period a year ago. New franchise units that were added to the system over the past 12 months were slightly more than the total number of franchise buybacks, franchise unit closures and relocations during the same period of time.
In addition, our Franchise Salons continued to experience the same general weakness in consumer visitation patterns and same-store sales trends as our company-owned concepts. And let me make one anecdotal comment regarding our North American salon revenue.
As Paul mentioned, our value priced salon concepts are performing much better during this recession than our higher priced Salons to illustrate service comps and our value concepts were off just 2% in the December quarter compared to a much larger decline of 9.3% in our higher priced Regis Salon division.
Although our Regis Salons remain quite profitable, the level of profitability is understandably declined in recent years due to general economic conditions. Rest assured that our operating people continue to focus on a variety of initiatives to increase sales and improve profitability.
I'm going to now speak to our gross margins and I am very pleased to report that our combined gross margin rate from North American Salons came in better than planned at 43.8%, this rate was 50 basis points better than the rate we reported last year in the second quarter and as I will discuss in a moment, the growth in overall margin was the result of both service as well as product margin rate improvement.
Our second quarter service margin rate came in better than planned at 42.4% and was 40 basis points better than the rate we reported in the same quarter last year. The primary reason for this improvement was reduced salon labor costs.
As each of you know, salary and commissions paid to our salon stylists represent our single largest expense category and our operational control over salon payrolls continues to be excellent.
During the second quarter, we continued to realize benefit from new leverage pay plans that we implemented this past year in many of our salons. Partially offsetting this improvement was a slight increase in salon health insurance costs that we had planned for.
Looking forward to the balance of our current fiscal year, we expect that our service gross margin rat should be at or slightly better than the rate we reported in our second quarter.
Our retail product margin rate for the second quarter improved to 49.5%, which was 100 basis points above the same period a year ago. There were several factors contributing to the improvement in rate, many of which we expect should be continued to be realized in the future.
One major item contributing to the rate improvement was our continued focus to work with product vendors to improve our gross margin on those products we choose to promote. We discussed this initiative with you in the past.
As we have also discussed our product margins are benefiting from our recent initiative to pay new stylists an 8% commission rate on their product sales rather than the historical rate of 10%. As we look forward to the balance of the current fiscal year, we expect product margins for our North American salons should approximate 50%.
Let me now address our site operating expense, which includes costs directly incurred by our salons such as advertising, insurance, utilities and janitorial costs. Our site operating expense in the second quarter came in better than planned at 8.5% of sales, which was 10 basis points higher than the rate we reported in the same period a year ago.
As I mentioned earlier, second quarter site operating expense benefited from an unplanned reduction of $1.9 million or $0.02 a share due to prior year accruals for our workers' compensation and insurance claim reserves being adjusted. This reduction was made following a periodic review by our independent insurance actuaries.
As we've discussed with you over the past several years, our actuaries have allowed us to record significant reductions to our workers' comp and insurance reserves due to the effectiveness of our aggressive salon safety and return to work programs. Also remember that last year in our second quarter, we also recorded a reduction to our insurance reserves resulting in a $6.7 million pre-tax benefit.
Cleansing both this year and our prior results of the workers' comp benefits, our site operating expense rate improved 90 basis points in the second quarter. We had planned for all of this improvement as we discussed with you during past conference calls, certain expense items, which had previously been categorized within our rent expense have now been appropriately reclassified into our site operating expense.
These items primarily related to utilities and rubbish removal costs for which Regis pays its landlords as part of our lease agreements. You may recall that last year, in our second quarter we made a reclassification that included amounts for both the first and second quarters and therefore the prior year rate was about 85 basis points higher than normal.
In addition to the impact of this reclassification, site operating expense benefited in the second quarter from certain cost saving initiatives in areas such as freight expense and salon repairs. These cost savings essentially mitigated any negative leverage from declining sales and inflation.
Next we will talk about our North American G&A expense, which came in at exactly 6% of revenue during the second quarter. This rate came in on plan and was 10 basis points above the rate we experienced in the same period last year.
We would have expected to see some negative sales leverage in this expense category during the second quarter, however continued focus on expense control and reduced year-over-year marketing cost allowed us to keep North American G&A relatively flat as a percentage of sales compared to the same period last year.
And let me make on final comment on North American G&A, many of you monitor the sequential run rates of this category and you’ll notice that North American G&A was up about $2 million on the second quarter compared to the preceding first quarter.
Our first quarter G&A is generally a little lower than the remainder of the year due to the timing of certain marketing and advertising programs. Rent expense which is primarily a fixed expense came in at 14.6% of total second quarter sales, which was 100 basis points above the rate we’ve reported last year on the comparable quarter.
As I just discussed, the six-month reclassification of certain expenses from rent into site operating expense favorably reduced last year’s second quarter rep rate by about 90 basis points.
In addition, the negative leverage in this fixed cost category caused from reduced sales volume is being largely offset by reduction in our percentage rent payments, also the result of reduced sales levels.
Depreciation and amortization came in essentially on plan at 3.6% of sales, equal to the rate we reported last year in our second quarter. Our reduced level of capital and acquisition expenditures during the past 12 months is servicing to slightly reduce our D&A expense, which in turn is helping to offset the negative leverage from reduced same-store sales.
The net effect of all the items I just discussed caused our operational operating income to come in at 11.8% of sales that’s up 30 basis points from the rate of 11.5% we reported last year in our second quarter.
Next let’s discuss the second quarter performance of our international salons segment which includes our company owned salons located primarily in the United Kingdom. We were very pleased that our comps came in better than planned during the quarter and significantly better than last year, declining 1.6% versus a decline of 10.7% last year.
We remain focused on improving our overall profitability. For example, second quarter results were favorably impacted by strong payroll management, aggressive expense control and through the closure or obtaining lease concessions for unprofitable salons.
These efforts continued to pay dividends as we have improved our U.K. operational profitability with the second quarter operating margin coming in at 4.7% of sales up from an operating loss of 2.3% of sales in the second quarter last year.
Today, I once again plan to provide some brief commentary behind the quarterly change in revenue and also give you some high-level comments on any expense categories that may have surprised us during the quarter. Once again those of you who built segment models may want to give Mark or Alex a call here at Regis and they can help you further.
Total revenue from our international segment represented 7% of our consolidated second quarter revenue and came in at $40 million in the quarter, a reduction of $1 million from the same period a year ago.
This slight drop in sales quarter-over-quarter was due to a decline in same-store sales of 1.6% as well as a reduction in revenue following the closure of 48 underperforming salons in the U.K. over the past year as part of our U.K. store closure initiative. Partially offsetting these declines with a favorable foreign currency impact.
Improved service and product margins contributed to an increase in the combined overall gross margin rate of 310 basis points versus last year. Service margin improved 200 basis points over last year, and was due to a few factors including improved operational payroll control as well as the benefit from under performing stores.
Let me now address retail product margins in a little more detail. As we previously discussed with you, are expectations going into our current 2010 fiscal year was for international product margins to improve to the mid-to-high 40% range due to a number of recent initiatives. Product margins have indeed improved.
In our preceding first quarter, we saw our product margin rate grow to exactly 49% and we’re pleased to say that we post the identical rate of 49% here in the second quarter.
Looking ahead to the second half of our fiscal year, we expect that our international product margin rates should remain near the current level of 49%.
I’m now going to discuss Hair Club for men and women. Our Hair Club business performance remained strong, but as we had discussed last quarter, the economy is having a slight impact with second quarter comps up slightly.
Let me highlight a couple of items. Revenue from our hair restoration centers came in at $35 million in the quarter, up 2% over the same period a year ago and represented 6% of our consolidated second quarter sales.
Second quarter operating margin rate for Hair Club came in at 14.7%, which as we expected was down from the rate of 18.3% we reported last year in the second quarter. The largest reason for the decline in operating margin rate was an increase in advertising during the second quarter. Hair Club second quarter EBIDA margin came in at just over 23%.
I’m now going to switch gears and make a couple of comments regarding our corporate G&A expense. The major component within our corporate G&A continues to be salaries and related benefits for more than 700 employees working here in Minneapolis and the 500 associates that work in our two distribution centers.
Centralized back office support functions provide leverage on our operating model. As I have said before, our company owned salon counts have continue to increase over the past five to six years at a much greater rate than our corporate home office head count. Despite this leverage we continue to be very aggressive with expense control during these challenging times of slow sales growth.
Our second quarter corporate G&A expense came in a bit better than planned at just under $31 million and was comparable to the amount we reported in the same period a year ago. Borrowing the impact of any timing issues we generally expect our corporate G&A to be in the range of $31 million to $33 million each quarter.
We continue to aggressively manage our G&A expenses and we continue to be pleased with our results. Let me make one remainder type comment to you regarding our corporate G&A. This expense category in the second quarter included $1.1 million of home office and distribution center cost related to providing transitional back office support to our former trade secret salons.
As we have discussed with you in the past Premier Salons who once again owns trade secret is wholly reimbursing Regis for all cost and that we are incurring on their behalf. However accounting convention requires that this expense reimbursement be included in our P&L under other income rather than being netted against our G&A expense.
Now that concludes my comments regarding business segments and I’d like to move on now to our investments, which are reported on the P&L line item called equity and income of affiliated companies.
This line item includes the after tax results of our investment in businesses such as Empire Education Group and Provalliance. Let me quickly say that we are pleased to report that our share of the second quarter earnings in these equity investments grew to $2.7 million on an after tax basis. Both businesses are posting results that are ahead of plan and are up from last year.
Let me now make a couple of comments regarding our effective income tax rate which came in about 300 basis points better than we expected in the second quarter at 36.3%. There were two primary reasons, the first related to a higher than anticipated amount of workers opportunity tax credits.
The second item related to a true up of our Canadian income tax provision following the filing of that tax return. Looking ahead we anticipate that our underlying tax rate for the second half of our 2010 fiscal year should be in the range of 39 to 40%.
Our balance sheet continues to be in great shape. Today we have no borrowings under our $300 million revolving credit facility, we have no liquidity issues, we continue to be in good standing with all of our financial debt covenants, and we have plenty of covenant cushion. At December 31st, total cash has increased to $114 million and total debt declined slightly to $470 million over the preceding quarter.
Anecdotally let me also say that our total debt of $470 million includes our recently issued convertible notes which have generally been trading above the strike price, assuming these notes were all converted today to equity, our debt is actually less than $325 million.
I have one last item, as we look forward to the remainder of the current fiscal year, our outlook really hasn’t changed all that much. We still expect same store sales in the second half of our fiscal year to be better than the first half.
As we are now half way through our current fiscal year, we expect that comps for the entire year may likely be closer to the low end of our previously stated range of negative 3% to positive 1%. However, let me reiterate a comment Paul made.
Due to strong expense control and gross margins enhancement, our EBITDA in fiscal 2010 may come in at the high end of our previously stated range of $200 million to $240 million. As a result, we’re budgeting to generate excess cash this year of $90 million or more.
So that’s it. That completes my prepared remarks. And Paul and I are now happy to answer any questions you have. So Sarah if you could step in and provide instructions, we would appreciate it.
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