10-Q 1 a07-4002_110q.htm 10-Q

 

 

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 December 31, 2006

 

 

 

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 0-11230

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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

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 February 6, 2007:

Common Stock, $.05 par value

 

44,919,603

Class

 

Number of Shares

 

 




REGIS CORPORATION

INDEX

Part I.

Financial Information

 

 

 

 

 

 

 

 

Item 1.

Condensed Consolidated Financial Information:

 

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheet as of December 31, 2006 and June 30, 2006

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statement of Operations for the three months ended December 31, 2006 and 2005

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statement of Operations for the six months ended December 31, 2006 and 2005

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statement of Cash Flows for the six months ended December 31, 2006 and 2005

 

 

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Information

 

 

 

 

 

 

 

 

 

Review Report of Independent Registered Public Accounting Firm

 

 

 

 

 

 

 

 

Item 2.

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

 

 

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

 

 

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

 

 

 

 

Part II.

Other Information

 

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

 

 

 

 

 

 

 

Item 1A.

Risk Factors

 

 

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

 

 

 

 

 

 

 

Item 5.

Other Information

 

 

 

 

 

 

 

 

Item 6.

Exhibits and Reports on Form 8-K

 

 

 

 

 

 

 

 

Signatures

 

 

 

2




PART I - FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Information

REGIS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)
as of December 31, 2006 and June 30, 2006
(Dollars in thousands, except per share amounts)

 

 

December 31, 2006

 

June 30, 2006

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

156,130

 

$

135,397

 

Receivables, net

 

72,484

 

62,558

 

Inventories

 

207,407

 

193,999

 

Deferred income taxes

 

16,647

 

16,224

 

Other current assets

 

56,991

 

33,588

 

Total current assets

 

509,659

 

441,766

 

 

 

 

 

 

 

Property and equipment, net

 

490,343

 

483,764

 

Goodwill

 

797,482

 

778,228

 

Other intangibles, net

 

215,149

 

216,831

 

Other assets

 

78,992

 

61,475

 

 

 

 

 

 

 

Total assets

 

$

2,091,625

 

$

1,982,064

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Long-term debt, current portion

 

$

186,154

 

$

101,912

 

Accounts payable

 

81,481

 

70,807

 

Accrued expenses

 

238,580

 

230,236

 

Total current liabilities

 

506,215

 

402,955

 

 

 

 

 

 

 

Long-term debt

 

490,860

 

520,357

 

Other noncurrent liabilities

 

191,909

 

187,345

 

Total liabilities

 

1,188,984

 

1,110,657

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, authorized 250,000 shares at December 31, 2006 and June 30, 2006

 

 

 

 

 

Common stock, $.05 par value; issued and outstanding 44,832,926 and 45,303,459 common shares at December 31, 2006 and June 30, 2006, respectively

 

2,242

 

2,266

 

Additional paid-in capital

 

210,492

 

232,284

 

Accumulated other comprehensive income

 

64,788

 

58,066

 

Retained earnings

 

625,119

 

578,791

 

 

 

 

 

 

 

Total shareholders’ equity

 

902,641

 

871,407

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

2,091,625

 

$

1,982,064

 

 

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

3




REGIS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)
for the three months ended December 31, 2006 and 2005
(Dollars in thousands, except per share amounts)

 

 

2006

 

2005

 

Revenues:

 

 

 

 

 

Service

 

$

440,345

 

$

399,278

 

Product

 

196,752

 

188,108

 

Royalties and fees

 

19,893

 

19,237

 

 

 

656,990

 

606,623

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of service

 

249,613

 

226,938

 

Cost of product

 

100,164

 

95,859

 

Site operating expenses

 

54,967

 

50,112

 

General and administrative

 

81,411

 

71,175

 

Rent

 

93,163

 

85,046

 

Depreciation and amortization

 

30,412

 

27,259

 

Total operating expenses

 

609,730

 

556,389

 

 

 

 

 

 

 

Operating income

 

47,260

 

50,234

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

Interest

 

(10,671

)

(8,660

)

Other, net

 

1,582

 

570

 

 

 

 

 

 

 

Income before income taxes

 

38,171

 

42,144

 

 

 

 

 

 

 

Income taxes

 

(11,297

)

(14,834

)

 

 

 

 

 

 

Net income

 

$

26,874

 

$

27,310

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

Basic

 

$

0.60

 

$

0.61

 

Diluted

 

$

0.59

 

$

0.59

 

 

 

 

 

 

 

Weighted average common and common equivalent shares outstanding:

 

 

 

 

 

Basic

 

44,673

 

45,154

 

Diluted

 

45,596

 

46,411

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.04

 

$

0.04

 

 

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

4




REGIS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)
for the six months ended December 31, 2006 and 2005
(Dollars in thousands, except per share amounts)

 

 

2006

 

2005

 

Revenues:

 

 

 

 

 

Service

 

$

874,897

 

$

790,247

 

Product

 

381,677

 

361,860

 

Royalties and fees

 

39,659

 

38,745

 

 

 

1,296,233

 

1,190,852

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of service

 

495,138

 

448,797

 

Cost of product

 

194,393

 

184,395

 

Site operating expenses

 

110,773

 

99,828

 

General and administrative

 

159,364

 

145,242

 

Rent

 

185,335

 

167,881

 

Depreciation and amortization

 

59,954

 

53,155

 

Total operating expenses

 

1,204,957

 

1,099,298

 

 

 

 

 

 

 

Operating income

 

91,276

 

91,554

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

Interest

 

(20,509

)

(16,924

)

Other, net

 

2,393

 

1,369

 

 

 

 

 

 

 

Income before income taxes

 

73,160

 

75,999

 

 

 

 

 

 

 

Income taxes

 

(23,193

)

(26,530

)

 

 

 

 

 

 

Net income

 

$

49,967

 

$

49,469

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

Basic

 

$

1.11

 

$

1.10

 

Diluted

 

$

1.09

 

$

1.07

 

 

 

 

 

 

 

Weighted average common and common equivalent shares outstanding:

 

 

 

 

 

Basic

 

44,858

 

45,059

 

Diluted

 

45,847

 

46,366

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.08

 

$

0.08

 

 

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

5




REGIS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
for the six months ended December 31, 2006 and 2005
(Dollars in thousands)

 

 

2006

 

2005

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

49,967

 

$

49,469

 

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

 

 

 

 

 

Depreciation

 

53,915

 

47,376

 

Amortization

 

6,039

 

5,779

 

Deferred income taxes

 

3,550

 

82

 

Excess tax benefits from stock-based compensation plans

 

(2,892

)

(2,419

)

Stock-based compensation

 

2,291

 

2,904

 

Other noncash items affecting earnings

 

1,497

 

277

 

 

 

 

 

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Receivables

 

(9,278

)

70

 

Inventories

 

(11,141

)

(16,022

)

Other current assets

 

(21,935

)

(3,549

)

Other assets

 

(3,729

)

(1,201

)

Accounts payable

 

14,947

 

11,921

 

Accrued expenses

 

9,975

 

24,584

 

Other noncurrent liabilities

 

8,075

 

7,243

 

Net cash provided by operating activities

 

101,281

 

126,514

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(46,281

)

(60,415

)

Proceeds from sale of assets

 

133

 

227

 

Purchase of salon, school and hair restoration center net assets, net of cash acquired

 

(25,343

)

(41,425

)

Proceeds from loans and investments

 

5,250

 

 

Disbursements for loans and investments

 

(20,063

)

 

Net investment hedge settlement

 

(8,897

)

 

Net cash used in investing activities

 

(95,201

)

(101,613

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Borrowings on revolving credit facilities

 

3,336,506

 

1,195,305

 

Payments on revolving credit facilities

 

(3,287,500

)

(1,178,705

)

Proceeds from issuance of long-term debt

 

25,000

 

 

Repayments of long-term debt

 

(28,889

)

(14,145

)

Excess tax benefits from stock-based compensation plans

 

2,892

 

2,419

 

Other, primarily (decrease) increase in negative book cash balances

 

(2,727

)

1,011

 

Repurchase of common stock

 

(37,481

)

 

Proceeds from issuance of common stock

 

8,970

 

7,108

 

Dividends paid

 

(3,643

)

(3,616

)

Net cash provided by financing activities

 

13,128

 

9,377

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

1,525

 

(854

)

 

 

 

 

 

 

Increase in cash and cash equivalents

 

20,733

 

33,424

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Beginning of period

 

135,397

 

102,718

 

End of period

 

$

156,130

 

$

136,142

 

 

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

6




REGIS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION

(Unaudited)

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

The unaudited interim Condensed Consolidated Financial Information of Regis Corporation (the Company) as of December 31, 2006 and for the three and six months ended December 31, 2006 and 2005, reflect, in the opinion of management, all adjustments necessary to fairly state the consolidated financial position of the Company as of December 31, 2006 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, 2006 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 Information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2006 and other documents filed or furnished with the Securities and Exchange Commission (SEC) during the current fiscal year.

With respect to the unaudited condensed financial information of the Company for the three and six month periods ended December 31, 2006 and 2005 included in this Form 10-Q, PricewaterhouseCoopers LLP reported that they have applied limited procedures in accordance with professional standards for a review of such information.  However, their separate report dated February 9, 2007 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. Inventories are stated at the lower of cost or market with cost determined on a weighted average basis. 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. 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. Additionally, the Company has outstanding stock options under its 1991 Stock Option Plan, although the Plan terminated in 2001.  Under these plans, three types of stock-based compensation awards are granted:  stock options, equity-based stock appreciation rights (SARS) and restricted stock.  These stock-based awards expire within ten years from the grant date.  The Company recognizes compensation expense for these awards on a straight-line basis over the five-year vesting period (includes retirement eligible recipients as there is no accelerated vesting terms for these recipients).

A summary of outstanding and exercisable options as of December 31, 2006, and changes during the three and six months ended December 31, 2006 is presented below:

7




 

Options

 

Shares
(in thousands)

 

Weighted-
Average Exercise
Price ($)

 

 

 

 

 

 

 

Outstanding at July 1, 2006

 

2,908

 

$

20.59

 

Granted

 

 

 

Exercised

 

(236

)

16.25

 

Cancelled

 

(9

)

38.02

 

Outstanding at September 30, 2006

 

2,663

 

$

20.89

 

Granted

 

 

 

Exercised

 

(302

)

16.62

 

Cancelled

 

(2

)

28.60

 

Outstanding at December 31, 2006

 

2,359

 

$

21.44

 

Exercisable at December 31, 2006

 

1,928

 

$

18.59

 

 

An additional 414,663 shares are expected to vest with a $34.11 weighted average exercise price and a weighted average remaining contractual life of 7.7 years. The total intrinsic value of options exercised during the six months ended December 31, 2006 and 2005, was $11.2 and $9.0 million, respectively.

As of December 31, 2006, 186,750 unvested restricted stock shares with a weighted average grant-date fair value of $36.96 were outstanding, of which 192,855 were outstanding at June 30, 2006.

As of December 31, 2006, 224,700 SARS with a weighted average grant-date fair value of $37.26 were outstanding, of which 231,250 were outstanding at June 30, 2006.

The Company’s primary employee stock-based compensation grant occurs during the fourth quarter. The total unrecognized compensation cost related to unvested stock-based compensation arrangements was $11.7 million at December 31, 2006 and the related weighted average period over which it is expected to be recognized is approximately 3.3 years.

Recent Accounting Pronouncements:

On July 13, 2006, FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109 (FIN 48), was issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new FASB standard provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 (i.e., the beginning of the Company’s fiscal year 2008), and the provisions are to be applied to all tax positions upon initial adoption of this standard. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 must be reported as an adjustment to the opening balance of retained earnings for that fiscal year. The Company is currently evaluating the impact of FIN 48 on its Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measures (SFAS No. 157). SFAS No. 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 (i.e., the beginning of the Company’s fiscal year 2009). The Company is currently evaluating the impact of SFAS No. 157 on its Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS No. 158). SFAS No. 158 amends SFAS No. 87, Employers’ Accounting for Pensions (SFAS No. 87), SFAS No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Plans and for Termination Benefits (SFAS No. 88), SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions (SFAS No. 106) and SFAS No. 132(R), Employers’ Disclosures about Pensions and Other

8




Postretirement Benefits (SFAS No. 132(R)).  SFAS No. 158 requires balance sheet recognition of the funded status for all pension and postretirement benefit plans as of the end of the Company’s current fiscal year (i.e., in the Company’s fiscal year 2007 Annual Report on Form 10-K). The impact of initial adjustment will be recorded as an adjustment of the ending balance of other comprehensive income. Subsequent changes in funded status must also be recognized as a component of other comprehensive income to the extent they have not yet been recognized as a component of net periodic benefit cost pursuant to SFAS No. 87, SFAS No. 88 or SFAS No. 106. The Company has unfunded deferred compensation contracts covering key executives based on their accomplishments within the Company which will be subject to the provisions of SFAS No. 158.  The Company intends to fund its future obligations under these contracts through company-owned life insurance policies on the participants.  The Company is currently evaluating the impact of SFAS No. 158 on its Consolidated Financial Statements.

2.             SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME:

Additional Paid-In Capital

The decrease in additional paid-in capital during the six months ended December 31, 2006 was due to the following:

(Dollars in thousands)

 

 

 

Balance, June 30, 2006

 

$

232,284

 

Exercise of stock options

 

8,943

 

Franchise stock incentive program

 

233

 

Tax benefit realized upon exercise of stock options

 

4,171

 

Stock-based compensation

 

2,291

 

Stock repurchase

 

(37,430

)

Balance, December 31, 2006

 

$

210,492

 

 

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 income for the three and six months ended December 31, 2006 and 2005 were as follows:

 

For the Periods Ended December 31,

 

Components of Comprehensive Income

 

Three Months

 

Six Months

 

(Dollars in thousands)

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

26,874

 

$

27,310

 

$

49,967

 

$

49,469

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

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

 

359

 

1

 

(687

)

2

 

Change in cumulative foreign currency translation, net of taxes

 

3,141

 

(3,389

)

7,409

 

(880

)

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

 

$

30,374

 

$

23,922

 

$

56,689

 

$

48,591

 

 

3.                                      NET INCOME PER SHARE:

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

9




 

 

For the Periods Ended December 31,

 

 

 

Three Months

 

Six Months

 

(Shares in thousands)

 

2006

 

2005

 

2006

 

2005

 

Weighted average shares for basic earnings per share

 

44,673

 

45,154

 

44,858

 

45,059

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Dilutive effect of stock-based compensation

 

872

 

1,125

 

938

 

1,175

 

Contingent shares issuable under contingent stock agreements (see Note 5)

 

51

 

132

 

51

 

132

 

Weighted average shares for diluted earnings per share

 

45,596

 

46,411

 

45,847

 

46,366

 

 

Stock options, SARs and restricted stock representing 621,891 and 435,950 shares were excluded from the shares used in the computation of diluted earnings per share for the six months ended December 31, 2006 and 2005, respectively, as they were anti-dilutive.

Restricted stock awards of 186,750 and 141,650 shares for the six months ended December 31, 2006 and 2005, respectively, were excluded from the computation of basic weighted average shares outstanding as such shares were not yet vested at these dates.

4.             GOODWILL AND OTHER INTANGIBLES:

The tables below contain detail related to our recorded goodwill and other intangibles as of December 31, 2006 and June 30, 2006.

 

Salons

 

Beauty

 

Hair Restoration

 

 

 

(Dollars in thousands)

 

North America

 

International

 

Schools

 

Centers

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2006

 

$

520,314

 

$

41,224

 

$

81,886

 

$

134,804

 

$

778,228

 

Goodwill acquired

 

16,020

 

1,381

 

1,777

 

(1,305

)

17,873

 

Translation rate adjustments

 

(1,448

)

2,614

 

215

 

 

1,381

 

Balance at December 31, 2006

 

$

534,886

 

$

45,219

 

$

83,878

 

$

133,499

 

$

797,482

 

 

Goodwill acquired includes adjustments to prior year acquisitions, including the finalization of the purchase price allocation to identifiable intangible assets of the hair restoration centers, which resulted in the decrease to the recorded goodwill for that segment during the six months ended December 31, 2006.

The table below presents other intangible assets as of December 31, 2006 and June 30, 2006:

 

December 31, 2006

 

June 30, 2006

 

 

 

 

 

Accumulated

 

 

 

 

 

Accumulated

 

 

 

(Dollars in thousands)

 

Cost

 

Amortization

 

Net

 

Cost

 

Amortization

 

Net

 

Amortized intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Brand assets and trade names

 

$

111,148

 

$

(8,566

)

$

102,582

 

$

110,087

 

$

(7,019

)

$

103,068

 

Customer list

 

48,743

 

(9,970

)

38,773

 

48,743

 

(7,598

)

41,145

 

Franchise agreements

 

26,404

 

(6,675

)

19,729

 

24,907

 

(5,967

)

18,940

 

Product license agreements

 

16,524

 

(2,598

)

13,926

 

15,784

 

(2,221

)

13,563

 

School-related licenses

 

25,428

 

(929

)

24,499

 

24,818

 

(613

)

24,205

 

Non-compete agreements

 

663

 

(605

)

58

 

674

 

(603

)

71

 

Other

 

19,758

 

(4,176

)

15,582

 

19,325

 

(3,486

)

15,839

 

 

 

$

248,668

 

$

(33,519

)

$

215,149

 

$

244,338

 

$

(27,507

)

$

216,831

 

 

10




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 four to 40 years). The Company follows the straight-line method of amortization, which approximates the economic benefit amortized to earnings in that reporting period. The weighted average amortization periods, in total and by major intangible asset class, are as follows:

 

Weighted Average

 

 

 

Amortization Period

 

(Dollars in thousands)

 

(in years)

 

Amortized intangible assets:

 

 

 

Brand assets and trade names

 

39

 

Customer list

 

10

 

Franchise agreements

 

21

 

Product license agreements

 

30

 

School-related licenses

 

40

 

Non-compete agreements

 

6

 

Other

 

19

 

Total

 

29

 

 

Total amortization expense related to amortizable intangible assets was approximately $2.9 and $2.8 million during the three months ended December 31, 2006 and 2005, respectively, and $5.8 and $5.5 million during the six months ended December 31, 2006 and 2005, respectively.   As of December 31, 2006, future estimated amortization expense related to amortizable intangible assets is estimated to be:

(Dollars in thousands)

 

 

 

Fiscal Year

 

 

 

2007

 

$

5,699

 

2008

 

11,387

 

2009

 

11,127

 

2010

 

10,932

 

2011

 

10,818

 

 

5.             ACQUISITIONS, LOANS AND INVESTMENTS:

Acquisitions

During the six months ended December 31, 2006 and 2005, the Company made numerous 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.

11




The components of the aggregate purchase prices of the acquisitions made during the six months ended December 31, 2006 and 2005 and the allocation of the purchase prices were as follows:

 

Allocation of Purchase Prices

 

 

 

For the Six Months Ended
December 31,

 

(Dollars in thousands)

 

2006

 

2005

 

Components of aggregate purchase prices:

 

 

 

 

 

Cash

 

$

25,343

 

$

41,425

 

Liabilities assumed

 

844

 

34

 

 

 

$

26,187

 

$

41,459

 

Allocation of the purchase price:

 

 

 

 

 

Current assets

 

$

1,964

 

$

3,453

 

Property and equipment

 

3,774

 

4,779

 

Deferred income tax asset

 

1,043

 

 

Other noncurrent assets

 

9

 

1

 

Goodwill

 

17,873

 

31,902

 

Identifiable intangible assets

 

2,044

 

6,509

 

Accounts payable and accrued expenses

 

(84

)

(4,952

)

Deferred income tax liability

 

(436

)

(233

)

 

 

$

26,187

 

$

41,459

 

 

In a limited number of acquisitions, the Company guarantees that the stock issued in conjunction with the acquisition will reach a certain market price. If the stock should not reach this price during an agreed upon time frame (typically three years from the date of acquisition), the Company is obligated to issue additional consideration to the sellers. Once the agreed upon stock price is met or exceeded for a period of five consecutive days, the contingency is met and the Company is no longer liable. At December 31, 2006, one contingency of this type exists, which expires in March of 2008. Based on the December 31, 2006 market price, the Company would be required to provide an additional 51,277 shares with an aggregate market value on that date of $2.0 million related to this acquisition contingency if the agreed upon time frame was assumed to have expired December 31, 2006. These contingently issuable shares have been included in the calculation of diluted earnings per share.

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 under current accounting guidance, 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 (driven by word of mouth referrals), service quality and price point competitiveness. These attributes represent the “going concern” value of the salon. While the value of the acquired customer base is the primary driver of any potential acquisition’s cash flows (which determines the purchase price), it is neither known nor identifiable at the time of the acquisition. The cash flow history of a salon primarily results from repeat walk-in customers driven by the existing personal relationship between the customer and the stylist(s). Under SFAS No. 141, Business Combinations, a walk-in customer base does not meet the criteria for recognition apart from goodwill.

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, beauty schools 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 and certain beauty school 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, such as Hair Club, is not deductible for tax purposes due to the acquisition structure of the transaction.

During the six months ended December 31, 2006 and 2005, the Company purchased salon operations 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,

12




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.

Loans and Investments

During the three months ended September 30, 2006, the Company invested $5.3 million in the preferred stock of a privately held entity. This investment was recorded within other assets in the Condensed Consolidated Balance Sheet and as an investing activity within the Condensed Consolidated Statement of Cash Flows.  During the three months ended December 31, 2006, the preferred stock was redeemed for the original investment amount of $5.3 million.  The Company received $93 thousand of preferred dividends from this investment in the six months ended December 31, 2006.

The Company holds a 19.9 percent interest in the voting common stock of another privately held entity. The Company is accounting for this investment under the equity method. During the six months ended December 31, 2006, the Company recorded a loss of $0.5 million related to this equity investment. As of December 31 and June 30, 2006, the Company has $10.0 and $6.0 million, respectively, in long-term notes receivable outstanding under a credit agreement with the entity that is the majority corporate investor in this investment. The long-term notes receivable are included within other assets in the Condensed Consolidated Balance Sheet and as investing activities within the Condensed Consolidated Statement of Cash Flows. Refer to Note 3 to the Consolidated Financial Statements contained in Part II, Item 8 of the June 30, 2006 Annual Report on Form 10-K for additional details.

In October 2006, the Company invested $9.9 million to form a new limited liability company called Intelligent Nutrients, LLC. The Company holds a 50 percent interest in the newly formed LLC. 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 in calendar year 2007.  These products will be offered at the Company’s corporate and franchise salons, as well as other independently owned salons. The Company is accounting for this investment under the equity method.  During the six months ended December 31, 2006, the Company recorded a loss of $0.5 million related to this equity investment.

6.             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. Estimated recorded reserve amounts are not significant; however, 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.

7.             SEGMENT INFORMATION:

The Company operates or franchises 9,493 North American salons (located in the United States, Canada and Puerto Rico), 2,077 international salons, 55 beauty schools and 88 hair restoration centers.  The Company operates its North American salon operations through five primary concepts: Regis Salons, MasterCuts, Trade Secret, SmartStyle and Strip Center salons.  Each of 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 generally display similar economic characteristics. The salons share interdependencies and a common support base.  The Company’s international salon operations, which are primarily in Europe, are located in malls, leading department stores, mass merchants and high-street locations.  The Company’s beauty schools are located in the United States and the United Kingdom. The Company’s hair restoration centers are located in the United States and Canada.

13




Based on the way the Company manages its business, it has reported its North American salons, international salons, beauty schools and hair restoration centers as four separate reportable operating segments.

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

 

Total Assets

 

 

 

As of

 

(Dollars in thousands)

 

December 31, 2006

 

June 30, 2006

 

North American salons

 

$

1,131,666

 

$

1,030,720

 

International salons

 

197,922

 

184,296

 

Beauty schools

 

185,323

 

177,295

 

Hair restoration centers

 

254,651

 

259,739

 

Unallocated corporate

 

322,063

 

330,014

 

Consolidated

 

$

2,091,625

 

$

1,982,064

 

 

 

 

For the Three Months Ended December 31, 2006

 

 

 

Salons

 

Beauty

 

Hair
Restoration

 

Unallocated

 

 

 

(Dollars in thousands)

 

North America

 

International

 

Schools

 

Centers

 

Corporate

 

Consolidated

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service

 

$

372,161

 

$

35,234

 

$

20,142

 

$

12,808

 

$

 

$

440,345

 

Product

 

163,256

 

15,919

 

1,834

 

15,743

 

 

196,752

 

Royalties and fees

 

9,496

 

9,216

 

 

1,181

 

 

19,893

 

 

 

544,913

 

60,369

 

21,976

 

29,732

 

 

656,990

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of service

 

215,863

 

18,618

 

8,184

 

6,948

 

 

249,613

 

Cost of product

 

84,591

 

9,883

 

1,126

 

4,564

 

 

100,164

 

Site operating expenses

 

46,739

 

2,721

 

4,216

 

1,291

 

 

54,967

 

General and administrative

 

30,345

 

11,556

 

2,796

 

6,542

 

30,172

 

81,411

 

Rent

 

77,690

 

11,111

 

2,241

 

1,608

 

513

 

93,163

 

Depreciation and amortization

 

20,631

 

2,193

 

829

 

2,390

 

4,369

 

30,412

 

Total operating expenses

 

475,859

 

56,082

 

19,392

 

23,343

 

35,054

 

609,730

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

69,054

 

4,287

 

2,584

 

6,389

 

(35,054

)

47,260

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest

 

 

 

 

 

(10,671

)

(10,671

)

Other, net

 

 

 

 

 

1,582

 

1,582

 

Income before income taxes

 

$

69,054

 

$

4,287

 

$

2,584

 

$

6,389

 

$

(44,143

)

$

38,171

 

 

14




 

 

 

For the Three Months Ended December 31, 2005

 

 

 

Salons

 

Beauty

 

Hair
Restoration

 

Unallocated

 

 

 

(Dollars in thousands)

 

North America

 

International

 

Schools

 

Centers

 

Corporate

 

Consolidated

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service

 

$

342,343

 

$

31,590

 

$

13,955

 

$

11,390

 

$

 

$

399,278

 

Product

 

159,413

 

13,332

 

1,052

 

14,311

 

 

188,108

 

Royalties and fees

 

9,827

 

8,164

 

 

1,246

 

 

19,237

 

 

 

511,583

 

53,086

 

15,007

 

26,947

 

 

606,623

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of service

 

198,748

 

16,687

 

4,931

 

6,572

 

 

226,938

 

Cost of product

 

82,455

 

8,250

 

781

 

4,373

 

 

95,859

 

Site operating expenses

 

44,603

 

2,591

 

1,835

 

1,083

 

 

50,112

 

General and administrative

 

24,504

 

10,125

 

1,767

 

5,638

 

29,141

 

71,175

 

Rent

 

71,772

 

9,835

 

1,544

 

1,463

 

432

 

85,046

 

Depreciation and amortization

 

19,002

 

1,980

 

652

 

2,286

 

3,339

 

27,259

 

Total operating expenses

 

441,084

 

49,468

 

11,510

 

21,415

 

32,912

 

556,389

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

70,499

 

3,618

 

3,497

 

5,532

 

(32,912

)

50,234

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest

 

 

 

 

 

(8,660

)

(8,660

)

Other, net

 

 

 

 

 

570

 

570

 

Income before income taxes

 

$

70,499

 

$

3,618

 

$

3,497

 

$

5,532

 

$

(41,002

)

$

42,144

 

 

15




 

 

 

For the Six Months Ended December 31, 2006

 

 

 

Salons

 

Beauty

 

Hair
Restoration

 

Unallocated

 

 

 

(Dollars in thousands)

 

North America

 

International

 

Schools

 

Centers

 

Corporate

 

Consolidated

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service

 

$

743,360

 

$

68,924

 

$

37,106

 

$

25,507

 

$

 

$

874,897

 

Product

 

317,164

 

29,360

 

4,235

 

30,918

 

 

381,677

 

Royalties and fees

 

19,295

 

17,960

 

 

2,404

 

 

39,659

 

 

 

1,079,819

 

116,244

 

41,341

 

58,829

 

 

1,296,233

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of service

 

428,235

 

36,596

 

16,220

 

14,087

 

 

495,138

 

Cost of product

 

164,295

 

17,875

 

2,928

 

9,295

 

 

194,393

 

Site operating expenses

 

94,844

 

5,075

 

8,546

 

2,308

 

 

110,773

 

General and administrative

 

59,390

 

21,726

 

5,163

 

12,819

 

60,266

 

159,364

 

Rent

 

154,585

 

22,106

 

4,477

 

3,272

 

895

 

185,335

 

Depreciation and amortization

 

40,770

 

4,065

 

1,641

 

4,724

 

8,754

 

59,954

 

Total operating expenses

 

942,119

 

107,443

 

38,975

 

46,505

 

69,915

 

1,204,957

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

137,700

 

8,801

 

2,366

 

12,324

 

(69,915

)

91,276

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest

 

 

 

 

 

(20,509

)

(20,509

)

Other, net

 

 

 

 

 

2,393

 

2,393

 

Income before income taxes

 

$

137,700

 

$

8,801

 

$

2,366

 

$

12,324

 

$

(88,031

)

$

73,160

 

 

16




 

 

 

For the Six Months Ended December 31, 2005

 

 

 

Salons

 

Beauty

 

Hair
Restoration

 

Unallocated

 

 

 

(Dollars in thousands)

 

North America

 

International

 

Schools

 

Centers

 

Corporate

 

Consolidated

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service

 

$

679,536

 

$

62,963

 

$

25,757

 

$

21,991

 

$

 

$

790,247

 

Product

 

305,926

 

25,033

 

2,472

 

28,429

 

 

361,860

 

Royalties and fees

 

19,664

 

16,571

 

 

2,510

 

 

38,745

 

 

 

1,005,126

 

104,567

 

28,229

 

52,930

 

 

1,190,852

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of service

 

392,664

 

33,701

 

9,768

 

12,664

 

 

448,797

 

Cost of product

 

158,346

 

15,450

 

1,901

 

8,698

 

 

184,395

 

Site operating expenses

 

89,612

 

4,417

 

3,660

 

2,139

 

 

99,828

 

General and administrative

 

52,881

 

20,666

 

3,692

 

11,162

 

56,841

 

145,242

 

Rent

 

141,658

 

19,673

 

2,943

 

2,914

 

693

 

167,881

 

Depreciation and amortization

 

37,207

 

3,799

 

1,143

 

4,531

 

6,475

 

53,155

 

Total operating expenses

 

872,368

 

97,706

 

23,107

 

42,108

 

64,009

 

1,099,298

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

132,758

 

6,861

 

5,122

 

10,822

 

(64,009

)

91,554

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest

 

 

 

 

 

(16,924

)

(16,924

)

Other, net

 

 

 

 

 

1,369

 

1,369

 

Income before income taxes

 

$

132,758

 

$

6,861

 

$

5,122

 

$

10,822

 

$

(79,564

)

$

75,999

 

 

8.             DERIVATIVE FINANCIAL INSTRUMENTS:

During September 2006, the Company’s cross-currency swap (which had a notional amount of $21.3 million and hedged a portion of the Company’s net investment in its foreign operations) was settled, resulting in a cash outlay of $8.9 million.  This cash outlay was recorded within investing activities within the Condensed Consolidated Statement of Cash Flows.  Approximately $0.1 million of tax-effected gain related to this derivative was charged to the cumulative translation adjustment account during the six months ended December 31, 2006.  The cumulative tax-effected net loss recorded in accumulated other comprehensive income related to the cross-currency swap was $7.9 million at December 31, 2006. This amount will remain deferred within OCI indefinitely, as the event which would trigger its release from OCI and recognition in earnings is the sale or liquidation of the Company’s international operations that the cross-currency swap hedged (and the Company has no intent to sell or liquidate this portion of its business operations).

9.             INCOME TAXES:

The reported effective tax rate was 29.6 percent and 35.2 percent for the three months ended December 31, 2006 and 2005, respectively, and 31.7 percent and 34.9 percent for the six months ended December 31, 2006 and 2005, respectively. 

In December 2006, President Bush signed the Tax Relief and Health Care Act of 2006 into law. This Act retroactively reinstated the Work Opportunity and Welfare-to-Work Tax Credits for a two year period beginning January 1, 2006. In accordance with generally accepted accounting principles, the financial impact of the tax credits earned during the entire calendar year is required to be reflected in the Company’s tax rate for the quarter in which

17




the Act was signed into law, which is the Company’s quarter ended December 31, 2006.  The reinstatement of these credits provided a tax benefit of $2.2 million for the three months ended December 31, 2006.

For the six months ended December 31, 2006, the effective tax rate was impacted by the Work Opportunity and Welfare-to-Work Tax Credits and a favorable ruling the Company received from the IRS. This favorable ruling increased net income by approximately $0.8 million. For the six months ended December 31, 2005, the reported effective tax rate included benefit from the Work Opportunity credits.

10.          SUBSEQUENT EVENT:

On January 3, 2007, the Company terminated its $14.5 million Canadian forward contracts hedging the cash flows between US and Canadian dollars.  The termination resulted in a deferred gain of $0.4 million which is recorded in other comprehensive income in the Consolidated Balance Sheet and will be recorded into income through May 31, 2009 as the forecasted foreign currency transactions are recognized in earnings.

18




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 December 31, 2006 and the related condensed consolidated statements of operations for the three and six month periods ended December 31, 2006 and 2005 and of cash flows for the six month periods ended December 31, 2006 and 2005.  This interim financial information is 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 to financial data 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 information for it to be in conformity with accounting principles generally accepted in the United States of America.

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, 2006, and the related consolidated statements of operations, of changes in shareholders’ equity and comprehensive income and of cash flows for the year then ended, management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2006 and the effectiveness of the Company’s internal control over financial reporting as of June 30, 2006; and in our report dated September 8, 2006, which contained an explanatory paragraph indicating the Company changed its method of accounting for share-based payments as of July 1, 2005, we expressed unqualified opinions thereon.  The consolidated financial statements and management’s assessment of the effectiveness of internal control over financial reporting referred to above are not presented herein.  In our opinion, the accompanying consolidated balance sheet information as of June 30, 2006, 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

February 9, 2007

 

19




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 information 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 5 sections:

·                  Management’s Overview

·                  Critical Accounting Policies

·                  Overview of Results

·                  Results of Operations

·                  Liquidity and Capital Resources

MANAGEMENT’S OVERVIEW

Regis Corporation (RGS) owns or franchises beauty salons, hair restoration centers and educational establishments. As of December 31, 2006, our worldwide operations included 11,570 system wide North American and international salons, 88 hair restoration centers and 55 beauty schools. Each of our salon concepts offer generally similar products and services and serves mass market consumers. Our salon operations are organized to be managed based on geographical location. Our North American salon operations include 9,493 salons, including 2,185 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 2,077 salons, including 1,601 franchise salons, located throughout Europe, primarily in the United Kingdom, France, Italy and Spain. Our beauty schools are managed in aggregate, regardless of geographical location, and include 51 locations in the United States and four locations in the United Kingdom. Our hair restoration centers are located in the United States and Canada. During the six months ended December 31, 2006, we had approximately 60,000 corporate employees worldwide.

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 eight to 12 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, student enrollment, hair 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 eight to 12 percent, including same-store sales increases in excess of two percent, will allow us to increase annual earnings at a low-double-digit growth rate. Impacted by long hair fashions, during the past two fiscal years we have not been able to realize the same-store sales growth required to leverage some of our fixed cost categories, therefore resulting in less than double digit annual earnings growth. We anticipate expanding our presence in both North America and Europe. Additionally, we desire to enter the Asian market within the next year.

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.

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. In addition, 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 2007, although we have tempered our outlook for constructed salons to between 325 to 375 units, we still expect to add between 500 and 700 net locations through a combination of organic, acquisition and

20




franchise growth. Our long-term outlook anticipates that we will add between 800 to 1,000 net locations each year through a combination of organic, acquisition and franchise growth.

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 several hundred 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 fashion and economic cycles (i.e., longer hairstyles and lengthening of customer visitation patterns), we project our annual fiscal year 2007 consolidated same-store sales increase to be in a range of flat to one 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 December 31, 2006, we acquired 7,393 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

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 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 will be evaluated closely for additional growth opportunities.

Beauty School Business

The beauty school business often participates in governmental programs designed to encourage education. We believe there is an opportunity to place graduates in our various salon concepts which may provide us with another competitive advantage. Similar to the salon and hair restoration industries, the beauty school industry is highly fragmented. As a result, we believe there is an opportunity to consolidate this industry through acquisition. Capitalizing on these opportunities would allow us to add incremental revenue without cannibalizing our existing salon or hair restoration center businesses. The beauty school business has not met our expectations during the current fiscal year. We are currently addressing the post acquisition integration difficulties which we have encountered in order to return the acquired schools to internally anticipated profit levels. During fiscal year 2007, we expect to moderate our acquisitions activity.

The success of a beauty school location is not dependent on good visibility or strong customer traffic; however, access to parking and/or public transportation is important. The success of existing and newly constructed schools is dependent on effective marketing and recruiting to attract new enrollees.

CRITICAL ACCOUNTING POLICIES

The Condensed Consolidated Financial Information is prepared in conformity with accounting principles generally accepted in the United States of America.  In preparing the Condensed Consolidated Financial Information, 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 Information.  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 Information.

21




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, 2006 Annual Report on Form 10-K, as well as Note 1 to the Condensed Consolidated Financial Information 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, 2006 Annual Report on Form 10-K.  There were no significant changes in or application of our critical accounting policies during the three months ended December 31, 2006.

OVERVIEW OF RESULTS FOR THE THREE MONTHS ENDED DECEMBER 31, 2006

·                  Revenues increased 8.3 percent to $657 million and consolidated same-store sales increased 0.5 percent during the three months ended December 31, 2006. Same-store service sales continue to be modest due to the current customer visitation patterns stemming from a fashion trend towards longer hairstyles.

·                  The decrease in operating income as a percentage of consolidated revenues during the three months ended December 31, 2006 was primarily due to a lower quarter same-store sales increase of 0.5 percent compared to the comparable prior quarter increase of 1.2 percent in our salon business that resulted in less leverage of our fixed costs. In addition, G&A increased due to the timing of advertising and professional fees.

·                  During the quarter, we acquired 15 salons (including nine franchise salon buybacks).  We built 85 corporate salons and closed or relocated 39 salons, for a net increase of 61 salons.  Our franchisees constructed 62 salons and closed, sold back to us or relocated 43 salons, for a net increase of 19 franchise salons during the quarter.  As of December 31, 2006, we had 7,784 company-owned salons, 3,786 franchise salons, 55 beauty schools and 88 hair restoration centers (47 company-owned and 41 franchise locations).

·                  Total debt at the end of the quarter was $677 million and our debt-to-capitalization ratio, calculated as total debt as a percentage of total debt and shareholders’ equity at fiscal quarter end, decreased 120 basis points to 42.9 percent as compared to June 30, 2006.

·                  A tax benefit related to the Work Opportunity and Welfare-to-Work Tax Credit of $2.2 million was recognized during the three months ended December 31, 2006 that lowered the effective tax rate by an incremental 6 percentage points or 600 basis points.

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.

22




 

 

For the Periods Ended December 31,

 

 

 

Three Months

 

Six Months

 

Results of Operations as a Percent of Revenues

 

2006

 

2005

 

2006

 

2005

 

Service revenues

 

67.0

%

65.8

%

67.5

%

66.3

%

Product revenues

 

30.0

 

31.0

 

29.4

 

30.4

 

Royalties and fees

 

3.0

 

3.2

 

3.1

 

3.3

 

 

 

100.0

 

100.0

 

100.0

 

100.0

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of service (1)

 

56.7

 

56.8

 

56.6

 

56.8

 

Cost of product (2)

 

50.9

 

51.0

 

50.9

 

51.0

 

Site operating expenses

 

8.4

 

8.3

 

8.5

 

8.4

 

General and administrative

 

12.4

 

11.7

 

12.3

 

12.2

 

Rent

 

14.2

 

14.0

 

14.3

 

14.1

 

Depreciation and amortization

 

4.6

 

4.5

 

4.6

 

4.5

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

7.2

 

8.3

 

7.0

 

7.7

 

Income before income taxes

 

5.8

 

6.9

 

5.6

 

6.4

 

Net income

 

4.1

 

4.5

 

3.9

 

4.2

 

 


(1)   Computed as a percent of service revenues and excludes depreciation expense.

(2)   Computed as a percent of product revenues and excludes depreciation expense.

Consolidated Revenues

Consolidated revenues primarily include revenues of company-owned salons, product and equipment sales to franchisees, beauty schools revenues, hair restoration center revenues, and franchise royalties and fees. As compared to the respective prior fiscal year, consolidated revenues increased 8.3 percent to $657.0 million during the three months ended December 31, 2006 and 8.8 percent to $1,296.2 million during the six months ended December 31, 2006. The following table details our consolidated revenues by concept. All service revenues, product revenues (which include product and equipment sales to franchisees), and franchise royalties and fees are included within their respective concept within the table.

 

 

For the Periods Ended December 31,

 

 

 

Three Months

 

Six Months

 

(Dollars in thousands)

 

2006

 

2005

 

2006

 

2005

 

North American salons:

 

 

 

 

 

 

 

 

 

Regis

 

$

125,461

 

$

121,665

 

$

247,736

 

$

240,795

 

MasterCuts

 

44,093

 

44,441

 

88,142

 

87,945

 

Trade Secret(1)

 

72,442

 

73,711

 

137,904

 

138,202

 

SmartStyle

 

112,513

 

102,150

 

223,802

 

200,014

 

Strip Center(1)

 

190,404

 

169,616

 

382,235

 

338,170

 

Total North American Salons

 

544,913

 

511,583

 

1,079,819

 

1,005,126

 

 

 

 

 

 

 

 

 

 

 

International salons(1)

 

60,369

 

53,086

 

116,244

 

104,567

 

Beauty schools

 

21,976

 

15,007

 

41,341

 

28,229

 

Hair restoration centers(1)

 

29,732

 

26,947

 

58,829

 

52,930

 

Consolidated revenues

 

$

656,990

 

$

606,623

 

$

1,296,233

 

$

1,190,852

 

Percent change from prior year

 

8.3

%

12.9

%

8.8

%

14.1

%

Salon same-store sales increase(2)

 

0.5

%

1.2

%

0.2

%

1.0

%

 


(1)             Includes aggregate franchise royalties and fees of $19.9 and $19.2 million for the three months ended December 31, 2006 and 2005, respectively, and $39.7 and $38.7 million for the six months ended December 31, 2006 and 2005, respectively.  North American salon franchise royalties and fees represented 47.7 and 51.1 percent of total franchise revenues in the three months ended December 31, 2006 and 2005, respectively, and 48.7 and 50.8 percent of total franchise revenues in the six months ended December 31, 2006 and 2005, respectively.

(2)             Salon same-store sales increases or decreases are calculated on a daily basis as the total change in sales for company-owned salons which were open on a specific day of the week during the current period and the corresponding prior period.  Quarterly and year-to-date salon same-store sales increases are the sum of the same-store sales increases computed on a daily basis.  Relocated salons are included in same-store sales as they are considered to have been open in the prior period.  International same-store sales are calculated in local currencies so that foreign currency fluctuations do not impact the calculation.  Management believes that same-store sales, a component of organic growth, are useful in order to help determine the increase in salon revenues attributable to its organic growth (new salon construction and same-store sales growth) versus growth from acquisitions.

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The percent changes in consolidated revenues during the three and six months ended December 31, 2006 and 2005, respectively, were driven by the following:

 

 

Percentage Increase (Decrease) in Revenues

 

 

 

For the Periods Ended December 31,

 

 

 

Three Months

 

Six Months

 

 

 

2006