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Regis 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-15
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

 

 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended September 30, 2008

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                 to                 

 

Commission file number 1-12725

 

Regis Corporation

(Exact name of registrant as specified in its charter)

 

Minnesota

 

41-0749934

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

7201 Metro Boulevard, Edina, Minnesota

 

55439

(Address of principal executive offices)

 

(Zip Code)

 

(952) 947-7777
(Registrant’s telephone number, including area code)

 

N/A
(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

 

 

(Do not check if a smaller

 

 

 

reporting company)

 

 

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Act).Yes  o   No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of November 3, 2008:

 

Common Stock, $.05 par value

 

43,199,513

Class

 

Number of Shares

 

 

 



Table of Contents

 

REGIS CORPORATION

 

INDEX

 

Part I.

 

Financial Information UNAUDITED

 

 

 

 

 

 

 

 

 

 

 

Item 1.

 

Condensed Consolidated Financial Statements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheet as of September 30, 2008 and June 30, 2008

 

3

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statement of Operations for the three months ended September 30, 2008 and 2007

 

4

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statement of Cash Flows for the three months ended September 30, 2008 and 2007

 

5

 

 

 

 

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

6

 

 

 

 

 

 

 

 

 

 

 

Review Report of Independent Registered Public Accounting Firm

 

21

 

 

 

 

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

22

 

 

 

 

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

40

 

 

 

 

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

41

 

 

 

 

 

 

 

Part II.

 

Other Information

 

 

 

 

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

41

 

 

 

 

 

 

 

 

 

Item 1A.

 

Risk Factors

 

41

 

 

 

 

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

43

 

 

 

 

 

 

 

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

43

 

 

 

 

 

 

 

 

 

Item 6.

 

Exhibits

 

43

 

 

 

 

 

 

 

 

 

Signatures

 

44

 

2



Table of Contents

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

REGIS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)

as of September 30, 2008 and June 30, 2008
(In thousands, except share data)

 

 

 

September 30,
2008

 

June 30,
2008

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

125,266

 

$

127,627

 

Receivables, net

 

37,837

 

37,824

 

Inventories

 

241,742

 

212,468

 

Deferred income taxes

 

15,349

 

15,954

 

Other current assets

 

47,419

 

51,278

 

Total current assets

 

467,613

 

445,151

 

 

 

 

 

 

 

Property and equipment, net

 

482,498

 

481,851

 

Goodwill

 

888,700

 

870,993

 

Other intangibles, net

 

142,122

 

144,291

 

Investment in and loans to affiliates

 

245,323

 

247,102

 

Other assets

 

46,805

 

46,483

 

 

 

 

 

 

 

Total assets

 

$

2,273,061

 

$

2,235,871

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Long-term debt, current portion

 

$

272,442

 

$

230,224

 

Accounts payable

 

89,682

 

69,693

 

Accrued expenses

 

189,824

 

207,605

 

Total current liabilities

 

551,948

 

507,522

 

 

 

 

 

 

 

Long-term debt and capital lease obligations

 

534,754

 

534,523

 

Other noncurrent liabilities

 

212,488

 

217,640

 

Total liabilities

 

1,299,190

 

1,259,685

 

Commitments and contingencies (Note 7)

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.05 par value; issued and outstanding 43,198,763 and 43,070,927 common shares at September 30, 2008 and June 30, 2008, respectively

 

2,160

 

2,153

 

Additional paid-in capital

 

148,142

 

143,265

 

Accumulated other comprehensive income

 

82,010

 

101,973

 

Retained earnings

 

741,559

 

728,795

 

 

 

 

 

 

 

Total shareholders’ equity

 

973,871

 

976,186

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

2,273,061

 

$

2,235,871

 

 

The accompanying notes are an integral part of the unaudited Condensed Consolidated Financial Statements.

 

3



Table of Contents

 

REGIS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)

for the three months ended September 30, 2008 and 2007
(In thousands, except per share data)

 

 

 

2008

 

2007

 

Revenues:

 

 

 

 

 

Service

 

$

478,117

 

$

459,718

 

Product

 

191,353

 

186,782

 

Royalties and fees

 

10,799

 

21,025

 

 

 

680,269

 

667,525

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of service

 

274,910

 

263,060

 

Cost of product

 

99,942

 

94,077

 

Site operating expenses

 

53,821

 

53,685

 

General and administrative

 

83,293

 

86,352

 

Rent

 

104,875

 

97,763

 

Lease termination costs

 

1,173

 

 

Depreciation and amortization

 

30,960

 

31,582

 

Total operating expenses

 

648,974

 

626,519

 

 

 

 

 

 

 

Operating income

 

31,295

 

41,006

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

Interest expense

 

(10,278

)

(10,578

)

Interest income and other, net

 

1,760

 

2,155

 

 

 

 

 

 

 

Income before income taxes and equity in income (loss) of affiliated companies

 

22,777

 

32,583

 

 

 

 

 

 

 

Income taxes

 

(8,783

)

(11,650

)

Equity in income (loss) of affiliated companies, net of income taxes

 

492

 

(334

)

 

 

 

 

 

 

Net income

 

$

14,486

 

$

20,599

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

Basic

 

$

0.34

 

$

0.47

 

Diluted

 

$

0.34

 

$

0.46

 

 

 

 

 

 

 

Weighted average common and common equivalent shares outstanding:

 

 

 

 

 

Basic

 

42,787

 

43,906

 

Diluted

 

43,107

 

44,579

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.04

 

$

0.04

 

 

The accompanying notes are an integral part of the unaudited Condensed Consolidated Financial Statements.

 

4



Table of Contents

 

REGIS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)

for the three months ended September 30, 2008 and 2007
(In thousands)

 

 

 

2008

 

2007

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

14,486

 

$

20,599

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

28,428

 

28,522

 

Amortization

 

2,532

 

3,060

 

Equity in (income) loss of affiliated companies

 

(492

)

334

 

Deferred income taxes

 

586

 

1,640

 

Excess tax benefits from stock-based compensation plans

 

(280

)

(1

)

Stock-based compensation

 

2,004

 

1,591

 

Other noncash items affecting earnings

 

(529

)

(35

)

Changes in operating assets and liabilities:

 

 

 

 

 

Receivables

 

(677

)

(1,981

)

Inventories

 

(29,319

)

(16,654

)

Other current assets

 

1,024

 

(12,607

)

Other assets

 

(126

)

(2,707

)

Accounts payable

 

24,096

 

(1,601

)

Accrued expenses

 

(14,388

)

1,125

 

Other noncurrent liabilities

 

458

 

3,289

 

Net cash provided by operating activities

 

27,803

 

24,574

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(23,975

)

(22,389

)

Proceeds from sale of assets

 

10

 

10

 

Asset acquisitions, net of cash acquired and certain obligations assumed

 

(30,987

)

(35,475

)

Disbursements for loans and investments

 

(5,971

)

(14,500

)

Transfer of cash related to contribution of schools

 

 

(7,254

)

Net cash used in investing activities

 

(60,923

)

(79,608

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Borrowings on revolving credit facilities

 

2,295,300

 

2,337,600

 

Payments on revolving credit facilities

 

(2,248,200

)

(2,368,000

)

Proceeds from issuance of long-term debt

 

 

50,000

 

Repayments of long-term debt and capital lease obligations

 

(9,367

)

(13,424

)

Excess tax benefits from stock-based compensation plans

 

280

 

1

 

Proceeds from issuance of common stock

 

2,291

 

698

 

Dividends paid

 

(1,725

)

(1,767

)

Other

 

(3,507

)

5,090

 

Net cash provided by financing activities

 

35,072

 

10,198

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

(4,313

)

5,280

 

 

 

 

 

 

 

Decrease in cash and cash equivalents

 

(2,361

)

(39,556

)

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Beginning of period

 

127,627

 

184,785

 

End of period

 

$

125,266

 

$

145,229

 

 

The accompanying notes are an integral part of the unaudited Condensed Consolidated Financial Statements.

 

5



Table of Contents

 

REGIS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.             BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

 

The unaudited interim Condensed Consolidated Financial Statements of Regis Corporation (the Company) as of September 30, 2008 and for the three months ended September 30 2008 and 2007, reflect, in the opinion of management, all adjustments necessary to fairly state the consolidated financial position of the Company as of September 30, 2008 and the consolidated results of its operations and its cash flows for the interim periods. Adjustments consist only of normal recurring items, except for any discussed in the notes below. The results of operations and cash flows for any interim period are not necessarily indicative of results of operations and cash flows for the full year.

 

The Consolidated Balance Sheet data for June 30, 2008 was derived from audited Consolidated Financial Statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (GAAP). The unaudited interim Condensed Consolidated Financial Statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2008 and other documents filed or furnished with the Securities and Exchange Commission (SEC) during the current fiscal year.

 

The unaudited condensed financial statements of the Company as of September 30, 2008 and for the three month periods ended September 30, 2008 and 2007 included in this Form 10-Q, have been reviewed by PricewaterhouseCoopers LLP, an independent registered public accounting firm. Their separate report dated November 10, 2008 appearing herein, states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited financial information because that report is not a “report” or a “part” of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.

 

Inventories:

 

Inventories consist principally of hair care products held either for use in services or for sale. Cost of product used in salon services is determined by applying estimated gross profit margins to service revenues, which are based on historical factors including product pricing trends and estimated shrinkage. In addition, the estimated gross profit margin is adjusted based on the results of physical inventory counts performed at least semi-annually and the monthly monitoring of factors that could impact the Company’s usage rate estimates. These factors include mix of service sales, discounting, and special promotions. Cost of product sold to salon customers is determined based on the weighted average cost of product to the Company, adjusted for an estimated shrinkage factor. Product and service inventories are adjusted based on the results of physical inventory counts performed at least semi-annually.

 

Stock-Based Employee Compensation:

 

Stock-based awards are granted under the terms of the 2004 Long Term Incentive Plan (2004 Plan) and the 2000 Stock Option Plan (2000 Plan). Additionally, the Company has outstanding stock options under its 1991 Stock Option Plan (1991 Plan), although the Plan terminated in 2001. Under these plans, four types of stock-based compensation awards are granted: stock options, equity-based stock appreciation rights (SARs), restricted stock awards (RSAs) and restricted stock units (RSUs). The stock-based awards, other than the RSUs, expire within ten years from the grant date. The RSUs cliff vest after five years, and payment of the RSUs is deferred until January 31 of the year following vesting.  Unvested awards are subject to forfeiture in the event of termination of employment.  The Company utilizes an option-pricing model to estimate the fair value of options and SARs at their grant date. Stock options and SARs are granted at not less than fair market value on the date of grant.  The Company’s primary employee stock-based compensation grant occurs during the fourth fiscal quarter.  The Company generally recognizes compensation expense for its stock-based compensation awards on a straight-line basis over a five-year vesting period. Awards granted do not contain acceleration of vesting terms for retirement eligible recipients.

 

Total compensation cost for stock-based payment arrangements totaled $2.0 and $1.6 million ($1.2 and $1.0 million

 

6



Table of Contents

 

after tax) for the three months ended September 30, 2008 and 2007, respectively.

 

Stock options outstanding, weighted average exercise price and weighted average fair values as of September 30, 2008 were as follows:

 

Options

 

Shares

 

Weighted-
Average Exercise
Price

 

 

 

(In thousands)

 

 

 

Outstanding at June 30, 2008

 

1,713

 

$

24.55

 

Granted

 

2

 

26.79

 

Exercised

 

(133

)

17.17

 

Forfeited or expired

 

(6

)

36.24

 

Outstanding at September 30, 2008

 

1,576

 

$

25.14

 

Exercisable at September 30, 2008

 

1,207

 

$

22.44

 

 

Outstanding options of 1,575,646 at September 30, 2008 had an intrinsic value of $8.6 million and a weighted average remaining contractual term of 4.3 years.  Exercisable options of 1,207,346 at September 30, 2008 had an intrinsic value of $8.6 million and a weighted average remaining contractual term of 3.0 years.  An additional 348,468 options are expected to vest with a $34.08 per share weighted average grant price and a weighted average remaining contractual life of 8.4 years.

 

All options granted relate to stock option plans that have been approved by the shareholders of the Company.

 

Stock options were granted under the 2004 Plan in fiscal year 2008. No stock options had been granted under the 2004 Plan prior to fiscal year 2008.

 

Grants of RSAs, RSUs and SARs outstanding under the 2004 Plan, as well as other relevant terms of the awards, were as follows:

 

 

 

Nonvested

 

SARs Outstanding

 

 

 

Restricted
Stock
Outstanding
Shares/Units

 

Weighted
Average
Grant Date
Fair Value

 

Shares

 

Weighted
Average
Exercise
Price

 

 

 

(in thousands)

 

 

 

(in thousands)

 

 

 

Balance, June 30, 2008

 

523

 

$

36.76

 

527

 

$

35.70

 

Granted

 

 

 

 

 

Vested/Exercised

 

(—

)

 

(—

)

 

Forfeited or expired

 

(8

)

34.31

 

(14

)

38.27

 

Balance, September 30, 2008

 

515

 

$

36.80

 

513

 

$

35.69

 

 

Outstanding and unvested RSAs of 299,743 at September 30, 2008 had an intrinsic value of $8.2 million and a weighted average remaining contractual term of 2.0 years.  An additional 286,679 awards are expected to vest with a total intrinsic value of $7.9 million.

 

Outstanding and unvested RSUs of 215,000 at September 30, 2008 had an intrinsic value of $5.9 million and a weighted average remaining contractual term of 3.5 years.  All unvested RSUs are expected to vest.

 

Outstanding SARs of 513,150 at September 30, 2008 had a total intrinsic value of zero and a weighted average remaining contractual term of 7.6 years.  Exercisable SARs of 176,980 at September 30, 2008 had a total intrinsic value of zero and a weighted average remaining contractual term of 6.7 years.  An additional 324,883 rights are expected to vest with a $34.04 per share weighted average grant price, a weighted average remaining contractual life of 8.1 years and a total intrinsic value of zero.

 

During the three months ended September 30, 2008 and 2007 total cash received from the exercise of share-based instruments was $2.3 and $0.7 million, respectively.

 

As of September 30, 2008, the total unrecognized compensation cost related to all unvested stock-based compensation arrangements was $21.5 million.  The related weighted average period over which such cost is expected to be recognized was approximately 3.2 years as of September 30, 2008.

 

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Table of Contents

 

The total intrinsic value of all stock-based compensation (the amount by which the stock exceeded the exercise or grant date price) that was exercised during the quarters ended September 30, 2008 and 2007 was $1.6 and $0.3 million, respectively.

 

Recent Accounting Pronouncements:

 

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 157, Fair Value Measurements (SFAS No. 157). SFAS No. 157 establishes a single definition of fair value and a framework for measuring fair value, sets out a fair value hierarchy to be used to classify the source of information used in fair value measurements, and requires new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy. This statement applies under other accounting pronouncements that require or permit fair value measurements, but does not change existing guidance as to whether or not an instrument is carried at fair value. In February 2008, the FASB issued FASB Staff Position (FSP) No. 157-1 and No. 157-2, which, respectively, removed leasing transactions from the scope of SFAS No. 157 and deferred for one year the effective date for SFAS No. 157 as it applies to certain nonfinancial assets and liabilities. On July 1, 2008, the Company adopted, on a prospective basis, SFAS No. 157 and became subject to the new disclosure requirements (excluding FSP 157-2) with respect to the Company’s fair value measurements of (a) nonfinancial assets and liabilities that are recognized or disclosed at fair value in our financial statements on a recurring basis (at least annually) and (b) all financial assets and liabilities.  The Company’s adoption did not impact its consolidated financial position or results of operations as all fair value measurements were in accordance with SFAS No. 157 upon adoption.  The additional disclosures required by SFAS No. 157 are included in Note 3.  The Company is evaluating the impact FSP No. 157-2 will have on its nonfinancial assets and liabilities that are measured at fair value, but are recognized or disclosed at fair value on a nonrecurring basis.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Companies are not allowed to adopt SFAS No. 159 on a retrospective basis unless they choose early adoption. The Company did not adopt the provisions of SFAS No. 159.

 

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (SFAS No. 141(R)). SFAS No. 141(R) replaces SFAS No. 141, Business Combinations. SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interests in the acquiree and the goodwill acquired. Some of the key changes under SFAS No. 141(R) will change the accounting treatment for certain specific acquisition related items including: (1) accounting for acquired in process research and development as an indefinite-lived intangible asset until approved or discontinued rather than as an immediate expense; (2) expensing acquisition costs rather than adding them to the cost of an acquisition; (3) expensing restructuring costs in connection with an acquisition rather than adding them to the cost of an acquisition; (4) including the fair value of contingent consideration at the date of an acquisition in the cost of an acquisition; and (5) recording at the date of an acquisition the fair value of contingent liabilities that are more than likely than not to occur. SFAS No. 141(R) also includes a substantial number of new disclosure requirements. SFAS No. 141(R) will be effective for the Company’s fiscal year 2010 and must be applied prospectively to all new acquisitions closing on or after July 1, 2009. Early adoption is prohibited. SFAS No. 141(R) is expected to have a material impact on how the Company will identify, negotiate and value future acquisitions and may materially impact the Company’s Consolidated Financial Statements.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS No. 161). SFAS No. 161 requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedge items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008 (i.e. the Company’s third quarter of fiscal year 2009). The Company intends to comply with the disclosure requirements upon adoption.

 

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Table of Contents

 

2.             SHAREHOLDERS’ EQUITY:

 

Net Income Per Share:

 

The Company’s basic earnings per share is calculated as net income divided by weighted average common shares outstanding, excluding unvested outstanding RSAs and RSUs. The Company’s dilutive earnings per share is calculated as net income divided by weighted average common shares and common share equivalents outstanding, which includes shares issuable under the Company’s stock option plan and long-term incentive plan and dilutive securities. Stock-based awards with exercise prices greater than the average market value of the Company’s common stock are excluded from the computation of diluted earnings per share.

 

The following table sets forth a reconciliation of shares used in the computation of basic and diluted earnings per share:

 

 

 

For the Three Months
Ended September 30,

 

 

 

2008

 

2007

 

 

 

(Shares in thousands)

 

Weighted average shares for basic earnings per share

 

42,787

 

43,906

 

Effect of dilutive securities:

 

 

 

 

 

Dilutive effect of stock-based compensation

 

320

 

591

 

Contingent shares issuable under contingent stock agreements

 

 

82

 

Weighted average shares for diluted earnings per share

 

43,107

 

44,579

 

 

The following table sets forth the awards which are excluded from the various earnings per share calculations:

 

 

 

For the Three Months
Ended September 30,

 

 

 

2008

 

2007

 

 

 

(Shares in thousands)

 

Basic earnings per share:

 

 

 

 

 

RSAs (1)

 

300

 

247

 

RSUs (1)

 

215

 

215

 

 

 

515

 

462

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

Stock options (2)

 

798

 

475

 

SARs (2)

 

518

 

394

 

RSAs (2)

 

148

 

140

 

RSUs (2)

 

 

215

 

 

 

1,464

 

1,224

 

 


(1)            Shares were not vested

(2)            Shares were anti-dilutive

 

Additional Paid-In Capital:

 

The change in additional paid-in capital during the three months ended September 30, 2008 was due to the following:

 

 

 

(Dollars in
thousands)

 

Balance, June 30, 2008

 

$

143,265

 

Exercise of stock options

 

2,285

 

Tax benefit realized upon exercise of stock options

 

590

 

Stock-based compensation

 

2,004

 

Taxes related to restricted stock

 

(2

)

Balance, September 30, 2008

 

$

148,142

 

 

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Comprehensive Income:

 

Components of comprehensive income for the Company include net income, changes in fair market value of financial instruments designated as hedges of interest rate or foreign currency exposure and foreign currency translation charged or credited to the cumulative translation account within shareholders’ equity. Comprehensive (loss) income for the three months ended September 30, 2008 and 2007 was as follows:

 

 

 

For the Three Months Ended
September 30,

 

 

 

2008

 

2007

 

 

 

(Dollars in thousands)

 

Net income

 

$

14,486

 

$

20,599

 

Other comprehensive income (loss):

 

 

 

 

 

Changes in fair market value of financial instruments designated as cash flow hedges of interest rate exposure, net of taxes

 

52

 

(1,741

)

Change in cumulative foreign currency translation

 

(20,015

)

12,195

 

 

 

 

 

 

 

Total comprehensive (loss) income

 

$

(5,477

)

$

31,053

 

 

3.             FAIR VALUE MEASUREMENTS:

 

As discussed in Note 1 to the Consolidated Financial Statements, the Company adopted SFAS No. 157, subject to the deferral provisions of FSP No. 157-2, on July 1, 2008. This standard defines fair value, establishes a framework for measuring fair value and expands disclosure requirements about fair value measurements. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy prescribed by SFAS No. 157 contains three levels as follows:

 

Level 1 — Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.

 

Level 2 — Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:

 

·                  Quoted prices for similar assets or liabilities in active markets;

 

·                  Quoted prices for identical or similar assets in non-active markets;

 

·                  Inputs other than quoted prices that are observable for the asset or liability; and

 

·                  Inputs that are derived principally from or corroborated by other observable market data.

 

Level 3 — Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment.  These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

 

Assets and Liabilities that are Measured at Fair Value on a Recurring Basis

 

The fair value hierarchy requires the use of observable market data when available.  In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability. The following table sets forth by level within the fair value hierarchy, our financial assets and liabilities that were accounted for at fair value on a recurring basis at September 30, 2008, according to the valuation techniques the Company used to determine their fair values.

 

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Table of Contents

 

 

 

Fair Value at

 

Fair Value Measurements
Using Inputs Considered as

 

 

 

September 30, 2008

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

(Dollars in thousands)

 

LIABILITIES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term liabilities

 

 

 

 

 

 

 

 

 

Derivative instruments

 

$

1,810

 

 

 

$

1,810

 

 

 

Equity put option

 

22,683

 

 

 

 

 

$

22,683

 

 

 The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

 

Derivative instruments. The Company’s derivative instrument liabilities consist of cash flow hedges represented by interest rate swaps and forward foreign currency contracts.  The instruments are classified as Level 2 as the fair value is obtained using observable inputs available for similar assets and liabilities in active markets at the measurement date, as provided by sources independent from the Company

 

Equity put option. The Company’s merger of the European franchise salon operations with the operations of the Franck Provost Salon Group on January 31, 2008 contained an equity put option and an equity call option. See further discussion within Note 5 of the Condensed Consolidated Financial Statements.  At September 30, 2008, the equity put option was valued using a binomial lattice models that incorporated assumptions including the business enterprise value at that date, and future estimates of volatility and EBITDA multiples based on available market data.  At June 30, 2008 the fair value of the equity put option was $24.8 million. The $2.0 million decrease in the fair value of the equity put option since June 30, 2008 relates to foreign currency translation and has been recorded in accumulated other comprehensive income in the September 30, 2008 balance sheet. The Company determined the equity call option to have no value at September 30, 2008.

 

Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis

 

As indicated in Note 1 to the Consolidated Financial Statements, the aspects of SFAS No. 157 for which the effective date was deferred for one year (i.e., the Company’s first quarter fiscal year 2010) under FSP No. 157-2 relate to nonfinancial assets and liabilities that are measured at fair value, but are recognized or disclosed at fair value on a nonrecurring basis. This deferral applies to such items as nonfinancial assets and liabilities initially measured at fair value in a business combination (but not measured at fair value in subsequent periods) or nonfinancial long-lived asset groups measured at fair value for an impairment assessment.

 

4.             GOODWILL AND OTHER INTANGIBLES:

 

The table below contains details related to the Company’s recorded goodwill as of September 30, 2008 and June 30, 2008:

 

 

 

Salons

 

Hair Restoration

 

 

 

 

 

North America

 

International

 

Centers

 

Consolidated

 

 

 

(Dollars in thousands)

 

Balance at June 30, 2008

 

$

668,799

 

$

48,461

 

$

153,733

 

$

870,993

 

Goodwill acquired

 

24,064

 

(1,255

)

537

 

23,346

 

Translation rate adjustments

 

(1,510

)

(4,129

)

 

(5,639

)

Balance at September 30, 2008

 

$

691,353

 

$

43,077

 

$

154,270

 

$

888,700

 

 

Goodwill acquired includes adjustments to prior year acquisitions, primarily representing the finalization of purchase price allocations. For the three months ended September 30, 2008 the $1.3 million reduction to international goodwill related to the settlement of the escrow account on an acquisition that closed in September 2007.

 

Goodwill is tested for impairment annually or at the time of a triggering event in accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. Fair values are estimated based on the Company’s best estimate of the expected present value of future cash flows and compared with the corresponding carrying value of the reporting unit, including goodwill. Where available and as appropriate comparative market multiples are used to

 

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corroborate the results of the present value method. The Company considers its various concepts to be reporting units when it tests for goodwill impairment because that is where the Company believes goodwill resides. The Company’s policy is to perform its annual goodwill impairment test during its third quarter of each fiscal year ending June 30.

 

We have experienced a decline in same-store sales which has negatively impacted our operating results during the three months ended September 30, 2008. The most significant decline in our same-store sales was within our Trade Secret concept, which is in the early stages of a strategy to improve the concept’s operating results by converting product assortment.  In addition, subsequent to September 30, 2008, the fair value of our stock has declined such that it began trading below book value per share.  Adverse changes in expected operating results, continuation of our stock trading below book value per share, and unfavorable changes in other economic factors will require us to reassess goodwill impairment prior to the third quarter of the fiscal year.

 

The table below presents other intangible assets as of September 30, 2008 and June 30, 2008:

 

 

 

September 30, 2008

 

June 30, 2008

 

 

 

 

 

Accumulated

 

 

 

 

 

Accumulated

 

 

 

 

 

Cost

 

Amortization (1)

 

Net

 

Cost

 

Amortization (1)

 

Net

 

 

 

(Dollars in thousands)

 

Amortized intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Brand assets and trade names

 

$

81,242

 

$

(8,568

)

$

72,674

 

$

81,407

 

$

(8,072

)

$

73,335

 

Customer lists

 

52,045

 

(19,189

)

32,856

 

51,316

 

(17,444

)

33,872

 

Franchise agreements

 

27,165

 

(6,623

)

20,542

 

27,115

 

(6,363

)

20,752

 

Lease intangibles

 

14,951

 

(3,189

)

11,762

 

14,771

 

(2,887

)

11,884

 

Non-compete agreements

 

772

 

(637

)

135

 

785

 

(631

)

154

 

Other

 

7,394

 

(3,241

)

4,153

 

7,974

 

(3,680

)

4,294

 

 

 

$

183,569

 

$

(41,447

)

$

142,122

 

$

183,368

 

$

(39,077

)

$

144,291

 

 


(1)  Balance sheet accounts are converted at the applicable exchange rates effective as of the reported balance sheet  dates, while income statement accounts are converted at the average exchange rates for the year-to-date periods presented.

 

All intangible assets have been assigned an estimated finite useful life and are amortized over the number of years that approximate their respective useful lives (ranging from one to 40 years). The cost of intangible assets is amortized to earnings  in proportion to the amount of economic benefits obtained by the Company in that reporting period. The weighted average amortization periods, in total and by major intangible asset class, are as follows:

 

 

 

Weighted Average

 

 

 

Amortization Period

 

 

 

(In years)

 

 

 

September
30, 2008

 

June
30, 2008

 

Amortized intangible assets:

 

 

 

 

 

Brand assets and trade names

 

39

 

39

 

Customer lists

 

10

 

10

 

Franchise agreements

 

22

 

21

 

Lease intangibles

 

20

 

20

 

Non-compete agreements

 

5

 

5

 

Other

 

18

 

17

 

Total

 

26

 

26

 

 

Total amortization expense related to amortizable intangible assets was approximately $2.5 and $2.9 million during the three months ended September 30, 2008 and 2007, respectively. As of September 30, 2008, future estimated amortization expense related to amortizable intangible assets is estimated to be:

 

Fiscal Year

 

(Dollars in
thousands)

 

2009 (Remainder: nine-month period)

 

$

7,849

 

2010

 

10,150

 

2011

 

9,915

 

2012

 

9,677

 

2013

 

9,419

 

 

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5.             ACQUISITIONS, INVESTMENT IN AND LOANS TO AFFILIATES:

 

Acquisitions

 

During the three months ended September 30, 2008 and 2007, the Company made numerous salon and hair restoration center acquisitions and the purchase prices have been allocated to assets acquired and liabilities assumed based on their estimated fair values at the dates of acquisition. Operations of the acquired companies have been included in the operations of the Company since the date of the respective acquisition.

 

The components of the aggregate purchase prices of the acquisitions made during the three months ended September 30, 2008 and 2007 and the allocation of the purchase prices were as follows:

 

 

 

For the Three Months Ended
September 30,

 

Allocation of Purchase Prices

 

2008

 

2007

 

 

 

(Dollars in thousands)

 

Components of aggregate purchase prices:

 

 

 

 

 

Cash

 

$

30,987

 

$

35,475

 

Deferred purchase price

 

75

 

281

 

 

 

$

31,062

 

$

35,756

 

Allocation of the purchase price:

 

 

 

 

 

Current assets

 

$

1,490

 

$

1,589

 

Property and equipment

 

3,890

 

4,547

 

Goodwill

 

25,320

 

26,688

 

Identifiable intangible assets

 

770

 

4,324

 

Other long-term assets

 

 

1,621

 

Accounts payable and accrued expenses

 

(288

)

(2,970

)

Other noncurrent liabilities

 

(120

)

(43

)

 

 

$

31,062

 

$

35,756

 

 

The majority of the purchase price in salon acquisitions is accounted for as residual goodwill rather than identifiable intangible assets. This stems from the value associated with the walk-in customer base of the acquired salons, which is not recorded as an identifiable intangible asset, as well as the limited value and customer preference associated with the acquired hair salon brand. Key factors considered by consumers of hair salon services include personal relationships with individual stylists, service quality and price point competitiveness. These attributes represent the “going concern” value of the salon.

 

Residual goodwill further represents the Company’s opportunity to strategically combine the acquired business with the Company’s existing structure to serve a greater number of customers through its expansion strategies. In the acquisitions of international salons and hair restoration centers, the residual goodwill primarily represents the growth prospects that are not captured as part of acquired tangible or identified intangible assets. Generally, the goodwill recognized in the North American salon transactions is expected to be fully deductible for tax purposes and the goodwill recognized in the international salon transactions is non-deductible for tax purposes. Goodwill generated in certain acquisitions is not deductible for tax purposes due to the acquisition structure of the transaction.

 

During the three months ended September 30, 2008 and 2007, certain of the Company’s salon acquisitions were from its franchisees. The Company evaluated the effective settlement of the preexisting franchise contracts and associated rights afforded by those contracts in accordance with Emerging Issues Task Force (EITF) No. 04-1, Accounting for Preexisting Relationships Between the Parties to a Business Combination. The Company determined that the effective settlement of the preexisting franchise contracts at the date of the acquisition did not result in a gain or loss, as the agreements were neither favorable nor unfavorable when compared to similar current market transactions, and no settlement provisions exist in the preexisting contracts. Therefore, no settlement gain or loss was recognized with respect to the Company’s franchise buybacks.

 

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Investment in and loans to affiliates

 

The table below presents the carrying amount of investments in and loans to affiliates as of September 30, 2008 and June 30, 2008:

 

 

 

September 30, 2008

 

June 30, 2008

 

 

 

(Dollars in thousands)

 

Provalliance

 

$

110,104

 

$

119,353

 

Empire Education Group, Inc.

 

109,181

 

109,307

 

Intelligent Nutrients, LLC

 

7,776

 

5,657

 

MY Style

 

13,233

 

7,756

 

Hair Club for Men, Ltd.

 

5,029

 

5,029

 

 

 

$

245,323

 

$

247,102

 

 

Provalliance

 

On January 31, 2008, the Company merged its continental European franchise salon operations with the operations of the Franck Provost Salon Group in exchange for a 30.0 percent equity interest in the newly formed Provalliance entity (Provalliance). 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 2,400 company-owned and franchise salons as of September 30, 2008.

 

The merger agreement contains a right (Equity Put) to require the Company to purchase additional ownership interest in Provalliance between specified dates in 2010 to 2018.  The acquisition price is determined based on the earnings before interest, taxes, depreciation and amortization of Provalliance for a trailing twelve month period which is intended to approximate fair value.  The estimated fair value of the Equity Put has been included as a component of the Company’s investment in Provalliance. A corresponding liability for the same amount as the Equity Put has been recorded in other noncurrent liabilities. Any changes in the fair value of the Equity Put in future periods, will be recorded in the Company’s consolidated statement of operations. The merger agreement also contains an option (Equity Call) whereby the Company can acquire additional ownership interest in Provalliance between specific dates in 2018 to 2020 at an acquisition price determined consistent with the Equity Put.

 

The Company’s investment in Provalliance is accounted for under the equity method of accounting. During the three month period ended September 30, 2008, the Company recorded $1.0 million of equity in income related to its investment in Provalliance. The exposure to loss related to the Company’s involvement with Provalliance is the carrying value of the investment and future changes in fair value of the Equity Put.

 

Empire Education Group, Inc.

 

On August 1, 2007, the Company contributed its 51 wholly-owned accredited cosmetology schools to Empire Education Group, Inc. (EEG) in exchange for a 49.0 percent equity interest in EEG. In January 2008, the Company’s effective ownership interest increased to 55.1 percent related to the buyout of EEG’s minority interest shareholder. This transaction leverages EEG’s management expertise, while enabling the Company to maintain a vested interest in the beauty school industry. Once the integration of the Regis schools is complete, the Company expects to share in significant synergies and operating improvements. EEG operates 87 accredited cosmetology schools.

 

As of September 30, 2008 the Company has loaned $36.4 million to EEG. During the three months ended September 30, 2008 and 2007 the Company recorded $0.4 and $0.1 million of interest income, respectively, related to the loan.

 

The Company accounts for the investment in EEG under the equity method of accounting as Empire Beauty School retains majority voting interest and has full responsibility for managing EEG. During the three months ended September 30, 2008 and 2007, the Company recorded ($0.1) and less than $0.1 million, respectively, of equity (loss)/earnings related to its investment in EEG. The exposure to loss related to the Company’s involvement with EEG is the carrying value of the investment and the outstanding loans.

 

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Table of Contents

 

Intelligent Nutrients LLC

 

The Company holds a 49.0 percent interest in Intelligent Nutrients, LLC. The Company’s ownership percentage decreased from 50.0 percent to 49.0 percent during the Company’s 2008 fiscal year due to the issuance of additional shares by Intelligent Nutrients, LLC to the other investor.

 

Intelligent Nutrients, LLC currently carries a wide variety of organic, harmonically grown™ products, including dietary supplements, coffees, teas and aromatics. Additionally, a full line of professional hair care and personal care products is in development and is expected to be available by the end of calendar year 2008. These products will be offered at the Company’s corporate and franchise salons, and eventually in other independently owned salons. The Company’s investment in Intelligent Nutrients, LLC is accounted for under the equity method of accounting. During the three months ended September 30, 2008 and 2007 the Company recorded losses of $0.5 and $0.3 million, respectively. The Company completed $3.0 million of loans to Intelligent Nutrients, LLC in August 2008 of which $3.0 million was outstanding as of September 30, 2008. During the three months ended September 30, 2008, the Company recorded less than $0.1 million of interest income related to the loans. The exposure to loss related to the Company’s involvement with Intelligent Nutrients, LLC is the carrying value of the investment and the outstanding loans.

 

MY Style

 

In April 2007, the Company purchased exchangeable notes issued by Yamano Holding Corporation (Exchangeable Note) and a loan obligation of a Yamano Holdings subsidiary, MY Style, formally known as Beauty Plaza Co. Ltd., (My Style Note) for an aggregate amount of 1.3 billion JPY ($11.3 million USD). In September 2008, the Company advanced an additional 300 million JPY ($2.9 million USD) to Yamano Holding Corporation and extended the maturity date of the existing Exchangeable Note to September 2011.  In connection with the 300 million JPY advance the exchangeable portion of the Exchangeable Note increased from approximately 14.8 percent to 27.1 percent of the outstanding shares of MY Style. The exchangeable portion of the Exchangeable Note is recorded as an equity method investment as it is probable that the Company will exercise its right to exchange a portion of the note into equity of My Style.

 

As of September 30, 2008 the amount outstanding under the Exchangeable Note and My Style Note were $6.7 and $2.5 million, respectively.  As of September 30, 2008, $1.5 and $7.6 million are recorded in the condensed consolidated balance sheet as current assets and investment in affiliates and loans representing the outstanding principal of the notes. The notes are due in installments through May of  2012. The Company recorded less than $0.1 million in interest income related to the Exchangeable Note and My Style Note during the quarters ended September 30, 2008 and 2007, respectively. The exposure to loss related to the Company’s involvement with MY Style is the carrying value of the investment and the outstanding notes.

 

Yamano Holding Corporation and the Company have an agreement with respect to their joint pursuit of opportunities relating to retail hair salons in Asia.

 

Hair Club for Men, Ltd.

 

The Company acquired a 50.0 percent interest in Hair Club for Men, Ltd. through its acquisition of Hair Club in fiscal year 2005. The Company accounts for its investment in Hair Club for Men, Ltd. under the equity method of accounting. Hair Club for Men, Ltd. operates Hair Club centers in Illinois and Wisconsin. During the three months ended September 30, 2008 and 2007 the Company recorded income of $0.3 and $0.5 million, respectively. The exposure to loss related to the Company’s involvement with Hair Club for Men, Ltd. is the carrying value of the investment.

 

Cool Cuts 4 Kids, Inc.

 

The Company holds an interest of less than 20 percent in the preferred stock of a privately held entity, Cool Cuts 4 Kids, Inc. This investment is accounted for under the cost method. During fiscal year 2006, the Company determined that its investment was impaired and recognized an impairment loss for the full carrying value of the investment. The Company’s securities purchase agreement contains a call provision, giving the Company the right of first refusal should the privately held entity receive a bona fide offer from another company, as well as the right to purchase all of the assets of the privately held entity during the period from April 1, 2008 to January 31, 2009 for a multiple of cash flow.

 

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6.            LEASE TERMINATION COSTS:

 

In July 2008, the Company approved a plan to close up to 160 underperforming company-owned salons in fiscal year 2009.  Approximately 100 locations are regional mall based concepts, another 40 locations are strip center concepts and 20 locations are in the United Kingdom.  The timing of the closures is dependent on successfully completing lease termination agreements and is therefore subject to change.  The Company expects to offer employment to associates affected by such closings at nearby Regis-owned salons.  The decision is a result of a comprehensive evaluation of the Company’s salon portfolio, further continuing the Company’s initiatives to enhance profitability.

 

The Company anticipated the pre-tax charge for the store closings would total approximately $20 to $25 million.  This included approximately $4.5 million, of incremental non-cash asset write-downs which were recognized in the fourth quarter of fiscal year 2008.  The incremental non-cash asset write-down in the fourth quarter of fiscal year 2008 was $3.4 million for the North America reportable segment and $1.1 million for the International reportable segment.  The balance of approximately $15 to $20 million was related to the original estimate of lease termination costs that were expected to be recognized primarily in fiscal year 2009.

 

As of September 30, 2008, 21 stores ceased using the right to use the leased property or negotiated a lease termination agreement with the lessor in which the Company will cease using the right to the leased property subsequent to September 30, 2008.  The 21 stores were within the North America reportable segment, no stores within the International segment have ceased using the right to use the leased property. Lease termination costs are presented as a separate line item in the Consolidated Statement of Operations.  As lease settlements are negotiated the Company has found that the lessors are willing to negotiate rent reductions which has allowed the Company to keep operating certain stores.  As a result, the Company expects that the number of stores to be closed will be less than the 160 stores originally communicated and reducing the estimated lease termination costs of  $15 to $20 million to approximately $6 million.

 

Lease termination costs represent either the lease settlement or the net present value of remaining contractual lease payments related to closed stores, after reduction by estimated sublease rentals.  The transactions reflected in the accrual for lease termination costs are as follows:

 

 

 

For the Three Months
Ended
September 30, 2008

 

 

 

(Dollars in thousands)

 

Balance at July 1, 2008

 

$

 

Provision for lease termination costs:

 

 

 

Provisions associated with store closings

 

1,173

 

Change in assumptions about lease terminations and sublease income

 

 

Cash payments

 

(695

)

Balance at September 30, 2008

 

$

478

 

 

7.             LITIGATION:

 

The Company is a defendant in various lawsuits and claims arising out of the normal course of business. Like certain other large retail employers, the Company has been faced with allegations of purported class-wide wage and hour violations. Litigation is inherently unpredictable and the outcome of these matters cannot presently be determined. Although company counsel believes that the Company has valid defenses in these matters, it could in the future incur judgments or enter into settlements of claims that could have a material adverse effect on its results of operations in any particular period.

 

8.             DERIVATIVE FINANCIAL INSTRUMENTS:

 

The primary market risk exposure of the Company relates to changes in interest rates in connection with its debt, some of which bears interest at variable rates based on LIBOR plus an applicable borrowing margin. Additionally, the Company is exposed to foreign currency translation risk related to its net investments in its foreign subsidiaries and, to a lesser extent, foreign currency denominated transactions. The Company has established policies and procedures that govern the management of these exposures through the use of derivative financial instrument contracts. By policy, the Company does not enter into such contracts for the purpose of speculation.

 

9.             INCOME TAXES:

 

The reported effective income tax rate was 38.6 percent and 35.8 percent for the three months ended September 30, 2008 and 2007, respectively. The provision for income taxes differs from the amount of income tax determined by applying the applicable United States (U.S.) statutory rate to earnings before income taxes, as a result of the following:

 

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For the Three Months
Ended September 30,

 

Tax Rate Reconciliation

 

2008

 

2007

 

U.S. statutory tax rate

 

35.0

%

35.0

%

Adjustments resulting from:

 

 

 

 

 

State income taxes, net of federal income tax benefit

 

5.9

 

3.8

 

Foreign income taxes at other than U.S. rates

 

(1.4

)

(3.3

)

Work Opportunity Tax Credits and Jobs Tax Credits, net

 

(2.4

)

(1.8

)

Other, net

 

1.5

 

2.1

 

Effective income tax rate

 

38.6

%

35.8

%

 

The effective income tax rate for the three months ended September 30, 2008 was negatively impacted by the shift in income from low to high tax jurisdictions as a result of the merger of European franchise salon operations with the Franck Provost Salon Group in January 2008. In addition, new state taxes in Texas, Michigan, and other states have increased the effective tax rate for the three months ended September 30, 2008. The increase in the effective tax rate for the three months ended September 30, 2008 was partially offset by Work Opportunity and Welfare-to-Work tax credits.

 

The effective income tax rate during the three months ended September 30, 2007 of 35.8 percent was adversely affected by the adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109 (FIN 48).

 

The Company accrues for the effects of open uncertain tax positions and the related potential penalties and interest.  There were no material adjustments to our recorded liability for unrecognized tax benefits during the three months ended September 30, 2008.  It is reasonably possible that the amount of the unrecognized tax benefit with respect to certain of our unrecognized tax positions will increase or decrease during the next 12 months; however, we do not expect the change to have a significant effect on our consolidated results of operations or financial position.

 

The Company files tax returns and pays tax primarily in the United States, Canada, the United Kingdom, and the Netherlands as well as states, cities, and provinces within these jurisdictions. In the United States, fiscal years 2005 and after remain open for federal tax audit. For state tax audits, the statute of limitations generally spans three to four years, resulting in a number of states remaining open for tax audits dating back to fiscal year 2004. However, the company is under audit in a number of states in which the statute of limitations has been extended to fiscal years 2000 and forward. Internationally (including Canada), the statute of limitations for tax audits varies by jurisdiction, but generally ranges from three to five years.

 

10.          SEGMENT INFORMATION:

 

As of September 30, 2008, the company owned, franchised, or held ownership interests in over 13,600 worldwide locations. The Company’s locations consisted of 10,299 North American salons (located in the United States, Canada and Puerto Rico), 468 international salons, 94 hair restoration centers and approximately 2,700 locations in which the Company maintains an ownership interest. The Company operates its North American salon operations through six primary concepts: Regis Salons, MasterCuts, Trade Secret, SmartStyle, Supercuts and Promenade salons. The concepts offer similar products and services, concentrate on the mass market consumer marketplace and have consistent distribution channels. All of the company-owned and franchise salons within the North American salon concepts are located in high traffic, retail shopping locations that attract mass market consumers, and the individual salons display similar economic characteristics. The salons share interdependencies and a common support base.

 

The Company operates its international salon operations, primarily in the United Kingdom, through four primary concepts: Regis, Supercuts, Trade Secret, and Sassoon salons. Consistent with the North American concepts, the international concepts offer similar products and services, concentrate on the mass market consumer marketplace and have consistent distribution channels. All of the international salon concepts are company-owned and are located in malls, leading department stores, and high-street locations  Individual salons display similar long-term economic characteristics. The salons share interdependencies and a common support base.

 

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The Company’s company-owned and franchise hair restoration centers are located in the United States and Canada. The Company’s hair restoration centers offer three hair restoration solutions; hair systems, hair transplants and hair therapy, which are targeted at the mass market consumer. Hair restoration centers are located primarily in office and professional buildings within larger metropolitan areas.

 

Based on the way the Company manages its business, it has reported its North American salons, International salons and hair restoration centers as three separate reportable segments.

 

Financial information for the Company’s reporting segments is shown in the following tables:

 

Total Assets by Segment

 

September 30,  2008

 

June 30, 2008

 

 

 

(Dollars in thousands)

 

North American salons

 

$

1,220,365

 

$

1,249,827

 

International salons

 

110,127

 

120,443

 

Hair restoration centers

 

285,892

 

284,898

 

Unallocated corporate

 

656,677

 

580,703

 

Consolidated

 

$

2,273,061

 

$

2,235,871

 

 

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For the Three Months Ended September 30, 2008

 

 

 

Salons

 

Hair
Restoration

 

Unallocated

 

 

 

 

 

North America

 

International

 

Centers

 

Corporate

 

Consolidated

 

 

 

(Dollars in thousands)

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Service

 

$

426,631

 

$

35,399

 

$

16,087

 

$

 

$

478,117

 

Product

 

159,883

 

13,049

 

18,421

 

 

191,353

 

Royalties and fees

 

10,160

 

 

639

 

 

10,799

 

 

 

596,674

 

48,448

 

35,147

 

 

680,269

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Cost of service

 

247,488

 

18,750

 

8,672

 

 

274,910

 

Cost of product

 

87,238

 

7,025

 

5,679

 

 

99,942

 

Site operating expenses

 

49,758

 

2,645

 

1,418

 

 

53,821

 

General and administrative

 

37,099

 

4,167

 

8,704

 

33,323

 

83,293

 

Rent

 

89,969

 

12,347

 

2,052

 

507

 

104,875

 

Lease termination costs

 

1,173

 

 

 

 

1,173

 

Depreciation and amortization

 

21,883

 

1,816

 

2,704

 

4,557

 

30,960

 

Total operating expenses

 

534,608

 

46,750

 

29,229

 

38,387

 

648,974

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

62,066

 

1,698

 

5,918

 

(38,387

)

31,295

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

(10,278

)

(10,278

)

Interest income and other, net

 

 

 

 

1,760

 

1,760

 

Income (loss) before income taxes and equity in income of affiliated companies

 

$

62,066

 

$

1,698

 

$

5,918

 

$

(46,905

)

$

22,777

 

 

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For the Three Months Ended September 30, 2007(1)

 

 

 

Salons

 

Hair
Restoration

 

Unallocated

 

 

 

 

 

North America

 

International

 

Centers

 

Corporate

 

Consolidated

 

 

 

(Dollars in thousands)

 

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Service

 

$

407,139

 

$

38,429

 

$

14,150

 

$

 

$

459,718

 

Product

 

154,833

 

15,293

 

16,656

 

 

186,782

 

Royalties and fees

 

10,149

 

9,559

 

1,317

 

 

21,025

 

 

 

572,121

 

63,281

 

32,123

 

 

667,525

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Cost of service

 

234,888

 

20,421

 

7,751

 

 

263,060

 

Cost of product

 

80,633

 

8,611

 

4,833

 

 

94,077

 

Site operating expenses

 

49,208

 

3,207

 

1,270

 

 

53,685

 

General and administrative

 

32,994

 

11,814

 

7,159

 

34,385

 

86,352

 

Rent

 

82,996

 

12,629

 

1,657

 

481

 

97,763

 

Depreciation and amortization

 

21,895

 

2,459

 

2,497

 

4,731

 

31,582

 

Total operating expenses

 

502,614

 

59,141

 

25,167

 

39,597

 

626,519

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

69,507

 

4,140

 

6,956

 

(39,597

)

41,006

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

(10,578

)

(10,578

)

Interest income and other, net

 

 

 

 

2,155

 

2,155

 

Income (loss) before income taxes and equity in loss of affiliated companies

 

$

69,507

 

$

4,140

 

$

6,956

 

$

(48,020

)

$

32,583

 

 


(1)   On August 1, 2007, the Company contributed its accredited cosmetology schools to Empire Education Group, Inc. The results of operations for the month ended July 31, 2007 for the accredited cosmetology schools are reported in the North American salons segment. The Company retained ownership of its one North America and four United Kingdom Vidal Sassoon schools. Results of operations for the Vidal Sassoon schools are included in the respective North American and International salon segments.

 

11.          SUBSEQUENT EVENTS:

 

On October 3, 2008, the Company completed an $85 million term loan that matures in July 2012.  The monthly interest payments are based on a one-month LIBOR rate plus a 1.75% spread.  The term loan includes customary financial covenants including a leverage ratio, fixed charge coverage ratio and minimum net equity test.  The Company used the proceeds from the term loan to pay down the Company’s revolving credit facility.  In connection with the term loan, the Company completed two $20.0 million floating to fixed swaps that are effective November 3, 2008 and mature in July 2011.

 

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REVIEW REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Shareholders and Directors of Regis Corporation:

 

We have reviewed the accompanying condensed consolidated balance sheet of Regis Corporation as of September 30, 2008 and the related condensed consolidated statements of operations and of cash flows for each of the three month periods ended September 30, 2008 and 2007.  These interim financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 3 to the Condensed Consolidated Financial Statements, Regis Corporation changed the manner it which it measures fair value for certain assets and liabilities effective July 1, 2008.  As discussed in Note 9 to the Condensed Consolidated Financial Statements, Regis Corporation changed the manner in which it accounts for unrecognized income tax benefits effective July 1, 2007.

 

We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of June 30, 2008, and the related consolidated statements of operations, of changes in shareholders’ equity and comprehensive income and of cash flows for the year then ended (not presented herein), and in our report dated August 29, 2008, we expressed an unqualified opinions on those financial statements. In our opinion, the accompanying consolidated balance sheet information as of June 30, 2008, is fairly stated, in all material respects in relation to the consolidated balance sheet from which it has been derived.

 

/s/ PricewaterhouseCoopers LLP

 

 

PRICEWATERHOUSECOOPERS LLP

 

Minneapolis, Minnesota
November 10, 2008

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results.  Our MD&A is presented in five sections:

 

·                  Management’s Overview

 

·                  Critical Accounting Policies

 

·                  Overview of Results

 

·                  Results of Operations

 

·                  Liquidity and Capital Resources

 

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 September 30, 2008, we owned, franchised or held ownership interests in over 13,600 worldwide locations. Our locations consisted of 10,767 system wide North American and International salons, 94 hair restoration centers and approximately 2,700 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 10,299 salons, including 2,095 franchise salons, operating in the United States, Canada and Puerto Rico primarily under the trade names of Regis Salons, MasterCuts, Trade Secret, SmartStyle, Supercuts and Cost Cutters. Our International salon operations include 468 company-owned salons, located in the United Kingdom. Our hair restoration centers, operating under the trade name Hair Club for Men and Women, include 94 North American locations, including 33 franchise locations. As of September 30, 2008, we had approximately 65,000 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 September 30, 2008, 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 as Empire Beauty School retains majority voting interest and has full responsibility for managing EEG. This transaction leverages EEG’s management expertise, while enabling us to maintain a vested interest in the beauty school industry. The combined Empire Education Group, Inc. includes 87 accredited cosmetology schools with annual revenues of approximately $130 million. Results of operations of the accredited beauty schools for the month ended July 31, 2007 are reported in the North American salons segment. The Company retained ownership of its one North American and four United Kingdom Vidal Sassoon schools. Results of operations for the Vidal Sassoon schools are included in the respective North American and International salon segments.

 

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. This transaction is expected to create significant growth opportunities for Europe’s salon brands. The Provost Salon Group management structure has a proven platform to build and acquire company-owned stores as well as a strong franchise operating group that is positioned for expansion. Provalliance operates over 2,400 company-owned and franchise salons.

 

On February 20, 2008, the Company acquired the capital stock of Cameron Capital I, Inc. (CCI), a wholly-owned subsidiary of Cameron Capital Investments, Inc. CCI owns and operates PureBeauty and BeautyFirst salons. CCI is now accounted for as a wholly-owned subsidiary of the Company. Prior to the acquisition, the Company held a 19.9 percent interest in the voting common stock of CCI which was accounted for under the equity method of accounting. Since the acquisition of CCI, the Company transformed 15 Trade Secret locations to PureBeauty locations and constructed two PureBeauty locations. Future transformations will depend on the success of initial transformations.

 

Our growth strategy consists of two primary, but flexible, components. Through a combination of organic and acquisition growth, we seek to achieve our long-term objective of six to ten percent annual revenue growth. We anticipate that going forward, the mix of organic and acquisition growth will be roughly equal. However, depending on several factors, including the ability of our salon development program to keep pace with the availability of real estate for new construction, hair

 

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restoration lead generation, the availability of attractive acquisition candidates and same-store sales trends, this mix will vary from year to year. We believe achieving revenue growth of four to six percent, including same-store sales increases of 0.5 to 2.5 percent, will allow us to increase annual earnings at a mid to high single-digit growth rate. We anticipate expanding our presence in North America.

 

Maintaining financial flexibility is a key element in continuing our successful growth. In the current credit crisis economic environment, the Company maintains its position to access financing as the Company continues to have a predictable business model, strong operating cash flow and balance sheet.

 

We are in compliance with all covenants and other requirements of our financing arrangements as of September 30, 2008. However, the continued global economic downturn and credit crisis have negatively impacted our operating results in the quarter ended September 30, 2008. Accordingly we are taking immediate steps to reduce debt and interest expense by repatriating cash from foreign locations to the United States, reducing capital expenditure and acquisition budgets, reducing inventory levels, and reducing overhead. We believe these steps should help us continue to be in compliance with our financial debt covenants provided same store sale results do not decline below the results we experienced during the period ended September 30, 2008.

 

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 anticipate expanding 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 Wal-Mart Supercenters. We believe that the availability of real estate will augment our ability to achieve the aforementioned long-term growth objectives. In fiscal 2009, our outlook for constructed salons is between 175 and 200 units, and we expect to add between 350 and 370 net locations through a combination of organic, acquisition and franchise growth. Capital expenditures in fiscal year 2009, excluding acquisition expenditures which are currently budgeted for $55.0 million, are projected to be approximately $75.0 million.

 

Organic salon revenue growth is achieved through the combination of new salon construction and salon same-store sales increases. Each fiscal year, we anticipate building several hundred company-owned salons. We anticipate our franchisees will open approximately 100 to 125 salons as well. Older, unprofitable salons will be closed or relocated. Our long-term outlook for our salon business is for annual consolidated low single digit same-store sales increases. Based on current economic cycles (i.e., lengthening of customer visitation patterns), we project our annual fiscal year 2009 consolidated same-store sales to be in the range of negative 1.0 to positive 1.0 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 September 30, 2008, we acquired 7,952 salons, net of franchise buybacks. 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. As a result, we believe there is an opportunity to consolidate this industry through acquisition. Expanding the hair loss business organically and through acquisition would allow us to add incremental revenue which is neither dependent upon, nor dilutive to, our existing salon business.

 

Our organic growth plans for hair restoration include the construction of a modest number of new locations in untapped markets domestically and internationally. However, 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, 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

 

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Table of Contents

 

and converting them into hair restoration customers. Our growth expectations for our hair restoration business are not dependent on referral business from, or cross marketing with, our hair salon business, but these concepts are continually evaluated closely for additional growth opportunities.

 

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, 2008 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, purchase price allocations, revenue recognition, the cost of product used and sold, 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, 2008 Annual Report on Form 10-K. Other than the valuation of goodwill, there were no significant changes in or application of our critical accounting policies during the three months ended September 30, 2008.

 

Goodwill:

 

As disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2008, we perform our impairment analysis of goodwill during the third quarter of each fiscal year in accordance with Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets (SFAS No. 142).  Fair values are estimated based on our best estimate of the expected present value of future cash flows and compared with the corresponding carrying value of the reporting unit, including goodwill.  Where available and as appropriate comparative market multiples are used to corroborate the results of the present value method.  We consider our various concepts to be reporting units when we test for goodwill impairment because that is where we believe goodwill resides.

 

We have experienced a decline in same-store sales which has negatively impacted our operating results during the three months ended September 30, 2008. The most significant decline in our same-store sales was within our Trade Secret concept, which is in the early stages of a strategy to improve the concept’s operating results by converting product assortment.  In addition, subsequent to September 30, 2008, the fair value of our stock has declined such that it began trading below book value per share.  Adverse changes in expected operating results, continuation of our stock trading below book value per share, and unfavorable changes in other economic factors will require us to reassess goodwill impairment prior to the third quarter of the fiscal year.

 

As of September 30, 2008, we do not believe a triggering event under SFAS No. 142 requiring an assessment of goodwill impairment has occurred.  Although the most significant decline in our same-store sales was within our Trade Secret concept, we are in the process of revising our transformation strategy.

 

OVERVIEW OF RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008

 

·                  Revenues increased 1.9 percent to $680.3 million, primarily related to built and acquired locations and consolidated same-store sales decreased 1.6 percent during the three months ended September 30, 2008.

 

·                  During the three months ended September 30, 2008, we acquired 108 corporate locations, including 82 franchise location buybacks (two of which were hair restoration centers). We built 52 corporate locations and closed, converted or relocated 68 locations. Our franchisees constructed 29 locations and closed, sold back to us, converted or relocated 97 locations during the three months ended September 30, 2008. As of September 30, 2008, we had

 

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8,672 company-owned locations, 2,095 franchise locations and 94 hair restoration centers (61 company-owned and 33 franchise locations).

 

·                  Lease termination costs of $1.2 million were incurred as a result of 21 stores that ceased using the right to use the leased property or negotiated a lease termination agreement in connection with the Company’s planned closure of up to 160 underperforming company-owned salons.

 

·                  Trade Secret transformation costs of $2.7 million related to the conversion of existing Trade Secret locations to PureBeauty locations during the three months ended September 30, 2008.

 

·                  Product margins have decreased 180 basis points compared to the three months ended September 30, 2007 due to the fiscal year 2008 acquisitions of PureBeauty and Beauty Supply Outlet, negative payroll leverage at our Trade Secret salons, and increased sales of promotional products.

 

RESULTS OF OPERATIONS

 

Consolidated Results of Operations

 

The following table sets forth, for the periods indicated, certain information derived from our Condensed Consolidated Statement of Operations, expressed as a percent of revenues. The percentages are computed as a percent of total consolidated revenues, except as noted.

 

 

 

For the Three Months Ended
September 30,

 

Results of Operations as a Percent of Revenues

 

2008

 

2007

 

Service revenues

 

70.3

%

68.9

%

Product revenues

 

28.1

 

28.0

 

Franchise royalties and fees

 

1.6

 

3.1

 

Operating expenses:

 

 

 

 

 

Cost of service (1)

 

57.5

 

57.2

 

Cost of product (2)

 

52.2

 

50.4

 

Site operating expenses

 

7.9

 

8.0

 

General and administrative

 

12.2

 

12.9

 

Rent

 

15.4

 

14.6

 

Lease termination costs

 

0.2

 

 

Depreciation and amortization

 

4.6

 

4.7

 

 

 

 

 

 

 

Operating income

 

4.6

 

6.1

 

Income before income taxes

 

3.3

 

4.9

 

Income taxes

 

1.3