UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended March 31, 2003
OR
For the transition period from ________________________ to _____________________
________________
Commission file number 011230
Regis Corporation
(952)947-7777
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 the number of shares outstanding of each of the issuer’s classes of common stock as of May 1, 2003:
TABLE OF CONTENTS
REGIS CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
The accompanying notes are an integral part of the unaudited Consolidated Financial Statements.
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REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Directors of Regis Corporation:
We have reviewed the accompanying consolidated balance sheet of Regis Corporation as of March 31, 2003 and the related consolidated statements of operations for the three and nine month periods ended March 31, 2003 and 2002 and of cash flows for the nine months ended March 31, 2003 and 2002. These financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. 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 auditing standards generally accepted in the United States of America, 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 consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We previously audited in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet as of June 30, 2002, and the related consolidated statements of operations, of changes in shareholders’ equity and of cash flows for the year then ended (not presented herein), and in our report dated August 27, 2002, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the accompanying consolidated balance sheet information as of June 30, 2002, is fairly stated, in all material respects in relation to the consolidated balance sheet from which it has been derived.
PRICEWATERHOUSECOOPERS LLP
Minneapolis, MinnesotaApril 22, 2003
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Summary
Regis Corporation (the Company), based in Minneapolis, Minnesota, is the world’s largest owner, operator, franchisor and acquirer of hair and retail product salons. The Company’s worldwide operations include 9,353 salons at March 31, 2003 operating in two reportable operating segments: domestic and international. Each of the Company’s concepts generally have similar products and services, concentrates on the mass-market consumer marketplace and generally display similar economic characteristics. The Company is organized to manage its operations based on geographical location. The Company’s domestic segment includes 7,220 salons, including 2,214 franchised salons, operating in North America primarily under the trade names of Regis Salons, MasterCuts, Trade Secret, SmartStyle, Supercuts and Cost Cutters. The Company’s international operations include 2,133 salons, including 1,734 franchised salons, located throughout Europe, primarily in the United Kingdom, France, Italy and Spain. The Company has approximately 45,000 employees worldwide.
Third quarter fiscal 2003 revenues grew to a record $422.3 million, including franchise revenues of $25.4 million, a 16.8 percent increase over the third quarter of the prior fiscal year. Revenues for the first nine months of fiscal 2003 grew to a record $1.2 billion, including franchise revenues of $77.4 million, a 15.6 percent increase over the first nine months of the prior fiscal year.
Operating income in third quarter of fiscal 2003 increased to $38.6 million, a 17.5 percent increase over the corresponding period of the prior fiscal year. Operating income in the first nine months of fiscal 2003 increased to $118.2 million, a 23.6 percent increase over the corresponding period of the prior fiscal year.
Net income in the third quarter of fiscal 2003 increased to a record $20.9 million, or $0.46 per diluted share, a net income and earnings per share increase of 8.1 and 4.5 percent, respectively, from the third quarter of the prior fiscal year. During the first nine months of fiscal 2003, net income increased 24.2 percent to $64.2 million and earnings per diluted share increased 20.3 percent to $1.42 as compared to the corresponding period of the prior fiscal year. During the third quarter of the prior fiscal year, the Company recognized a nonrecurring income tax benefit (see Note 6 to the Consolidated Financial Statements) of $1.8 million, thereby increasing earnings per diluted share by $0.04 for the three and nine months ended March 31, 2002.
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Results of Operations
The following table sets forth for the periods indicated certain information derived from the Company’s Consolidated Statement of Operations expressed as a percent of revenues. The percentages are computed as a percent of total Company revenues, except as noted.
(1) Computed as a percent of company-owned revenues.(2) Computed as a percent of company-owned service revenues.(3) Computed as a percent of company-owned product revenues.(4) Computed as a percent of franchise revenues.(5) See Note 6 to the Consolidated Financial Statements regarding the nonrecurring income tax benefit.
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CRITICAL ACCOUNTING POLICIES
The preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases these estimates on historical experience and other assumptions believed to be reasonable under the circumstances. However, actual results could differ from these estimates.
Management believes the Company’s critical accounting policies and areas that require more significant judgments and estimates used in the preparation of its Consolidated Financial Statements to be:
Depreciation and amortization are recognized using the straight-line method over the long-lived assets’ estimated useful lives. The Company estimates useful lives based on historical data and industry trends. The Company periodically reassesses the estimated useful lives of its long-lived and intangible assets. Changes to estimated useful lives would impact the amount of depreciation and amortization expense recorded in earnings and potentially the need to record an impairment charge.
The Company reviews long-lived and intangible assets, including goodwill, for impairment annually, or at any time events or circumstances indicate that the carrying value of such assets may not be fully recoverable. For long-lived assets and amortizable intangible assets, an impairment is evaluated based on the sum of undiscounted estimated future cash flows expected to result from use of the assets compared to its carrying value. For goodwill, if an impairment were to be recognized, the carrying value of the impaired asset would be reduced to its implied fair value based on discounted estimated future cash flows. The Company generally considers its concepts to be reporting units when it tests for goodwill impairment because that is where the Company believes goodwill naturally resides. Goodwill is evaluated for impairment based on the fair value of the brand concept to which the goodwill relates. During the quarter ended March 31, 2003, goodwill was tested for impairment in this manner and the estimated fair value of each reporting unit exceeded its carrying amount, indicating no impairment of goodwill.
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The Company makes numerous acquisitions that are recorded using the purchase method of accounting. Accordingly, the purchase prices are allocated to assets acquired, including intangible assets, and liabilities assumed based on their estimated fair values at the dates of acquisition. Fair value is estimated based on the amount for which the asset or liability could be bought or sold in a current transaction between willing parties. The majority of the purchase price 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 and the limited value and customer preference associated with the acquired hair salon brand. 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 our expansion strategies.
In the normal course of business, the Company must make continuing estimates of potential future loss accruals related to legal, tax, self-insurance accruals and uncollectible accounts. These accruals require the use of management’s judgment on the outcome of various issues. Management’s estimates for these items are based on the best available evidence, but due to changes in facts and circumstances, the ultimate outcomes of these accruals could be different than management estimates.
On an interim basis, product costs are determined by applying an estimated gross profit margin to product and service revenues. The estimated gross profit margins are based primarily on historical factors. Management also incorporates into the margin its best estimate of the current product mix impact. The Company performs physical inventories at least semi-annually and adjusts product costs to actual as determined under a weighted average, lower of cost or market basis and updates its gross profit margins accordingly.
RESULTS OF OPERATIONS
Revenues
Revenues for the third quarter of fiscal 2003 grew to a record $422.3 million, an increase of $60.7 million, or 16.8 percent, over the same period in the prior fiscal year. Approximately 52 percent of this increase was attributable to domestic salon acquisitions and 28 percent to domestic new salon construction, with the remaining increase primarily due to revenue growth from International operations. Domestic salons, associated with operations in the United States and Canada (domestic salons), accounted for $43.5 million of the increase in total revenues. Franchise revenues increased $5.8 million, primarily related to Jean Louis David (JLD), the European franchise company acquired during the fourth quarter of the prior fiscal year. Revenue from company-owned International operations increased $11.4 million primarily due to the recently acquired Vidal Sassoon salons and training academies and approximately $2.2 million related to favorable fluctuations in the exchange rates.
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Revenues for the first nine months of fiscal 2003 grew to a record $1.2 billion, an increase of $166.5 million, or 15.6 percent, over the corresponding period in the prior fiscal year. Approximately 47 percent of this increase was attributable to domestic salon acquisitions and 29 percent to domestic new salon construction, with the remaining increase primarily due to revenue growth from International operations related to acquisitions and favorable fluctuations in the exchange rate between periods. Domestic salons accounted for $121.4 million of the increase in total revenues, while franchise revenues increased $23.9 million, primarily due to International operations. Revenue from company-owned International operations increased $21.2 million primarily due to the recently acquired Vidal Sassoon salons and training academies and approximately $6.7 million related to favorable fluctuations in the exchange rates.
Revenues by brand concept for the three and nine months ended March 31, 2003 and 2002 were as follows:
Included in the table above, primarily as part of Strip Center Salons and International, are franchise revenues of $25.4 and $19.6 million for the three months ended March 31, 2003 and 2002, respectively, and $77.4 and $53.4 million for the nine months ended March 31, 2003 and 2002, respectively.
During the third quarter of fiscal 2003, consolidated same-store sales from all company-owned salons open more than 12 months decreased 0.7 percent, compared to an increase of 4.1 percent in the third quarter of the prior fiscal year. The decrease in third quarter same-store sales was primarily the result of the shift in Easter from March in the prior fiscal year to April in fiscal 2003. Additionally, the tough economic environment and consumers’ preoccupation with the war had an unfavorable impact on fiscal 2003 same-store sales for the third quarter and year-to-date. Consolidated same-store sales increased 0.6 percent during the nine months ending March 31, 2003, compared to an increase of 3.4 percent in the corresponding period of the prior fiscal year. Same-store sales increases achieved during the first nine months of fiscal 2003 were driven primarily by a shift in the mix of service sales toward salon services such as hair color and waxing services, as well as increased product sales.
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System-wide sales, inclusive of non-consolidated sales generated from franchisee salons, increased to $697.7 million during the third quarter of fiscal 2003 and $2.1 billion during the nine months ended March 31, 2003, representing increases of 28.3 and 30.4 percent, respectively, over the same periods last year. The increases in system-wide sales during fiscal 2003 were primarily the result of salons added to the system through acquisitions, as well as net salon openings. Consolidated system-wide same-store sales decreased 0.4 percent in the third quarter and increased 0.9 percent in the first nine months of fiscal 2003, compared to increases of 4.0 and 3.7 percent in the corresponding periods of the prior year. A total of 34.2 and 30.5 million customers were served system-wide in the third quarter of fiscal 2003 and 2002, respectively. During the first nine months of fiscal 2003 and 2002, a total of 103.2 and 91.7 million customers were served system-wide, respectively. The increase in total customers was primarily the result of additional salons added to the system.
Service Revenues. Service revenues in the third quarter of fiscal 2003 grew to $281.8 million, an increase of $42.9 million, or 18.0 percent, over the same period in the prior fiscal year. During the first nine months of fiscal 2003, service revenues increased $108.4 million, or 15.3 percent, to $815.5 million. The increase in service revenues for the quarter and year-to-date was primarily a result of acquisitions and new salon construction.
Product Revenues. Product revenues in the third quarter of fiscal 2003 grew to $115.2 million, an increase of $12.1 million, or 11.7 percent, over the same period in the prior fiscal year. During the first nine months of fiscal 2003, product revenues grew to $343.4 million, an increase of $34.2 million, or 11.0 percent, over the corresponding period of the prior fiscal year. These increases demonstrate the Company’s continuous commitment to merchandising professional salon products. Product sales decreased as a percent of company-owned revenues in the three and nine months ended March 31, 2003 as compared to the corresponding periods of the prior fiscal year. These decreases were primarily due to the large number of strip center salons which were acquired over the past year. Strip center salons have a lower product sales mix than the corporate average.
Franchise Revenues. Franchise revenues, including royalties and initial franchise fees from franchisees, and product and equipment sales made by the Company to franchisees, increased to $25.4 and $77.4 million in the quarter and nine months ended March 31, 2003, respectively, compared to $19.6 and $53.4 million for the corresponding periods of the prior fiscal year. Of the total year-to-date increase of $24.0 million, 59.7 percent is related to royalties, 30.6 percent due to increased sales of product to franchisee salons and 9.7 percent to initial franchise fees. The increase in franchise revenues for the quarter was primarily due to the European franchise company Jean Louis David (JLD), which was acquired in the fourth quarter of the prior fiscal year. The increase for the nine months ended March 31, 2003 was also primarily due to JLD, as well as growth in franchise revenues from Groupe Gerard Glemain (GGG) since its acquisition in the first quarter of the prior fiscal year.
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Cost of Revenue
The aggregate cost of service and product revenues for company-owned salons in the third quarter of fiscal 2003 was $216.7 million compared to $191.1 million in the same period in the prior fiscal year. For the first nine months of fiscal 2003 and 2002, the aggregate cost of service and product revenues was $630.3 and $566.3 million, respectively. Compared to the corresponding periods of the prior fiscal year, the resulting combined gross margin percentage improved 130 basis points in both the third quarter and nine months ended March 31, 2003, to 45.4 and 45.6 percent of company-owned revenues, respectively.
Service margins improved 40 basis points in the third quarter and 60 basis points in the first nine months of fiscal 2003 to 43.5 and 43.7 percent of company-owned service revenues, respectively. These improvements were primarily due to salon initiatives that resulted in lower payroll and payroll related costs as compared to the corresponding periods of the prior fiscal year.
Product margins improved 340 basis points to 50.0 percent of company-owned product revenues in the third quarter of fiscal 2003. During the first nine months of fiscal 2003, product margins improved 310 basis points to 50.2 percent of company-owned product revenues. The prior year third quarter product margin was lower than normal resulting primarily from a discount promotion in connection with the repackaged MasterCuts private label product line. Additionally, the quarter and year-to-date improvements were primarily the result of favorable physical inventory counts finalized in the second quarter of fiscal 2003 and improving margins in the Company’s product sales. The estimated gross profit margin used to determine product costs on an interim basis was revised for the current quarter and future periods based on the results of the physical inventories and the continued trend of overall product margin improvement. The product margin improvement is being primarily driven by improved purchasing power.
Direct Salon
This expense category includes direct costs associated with salon operations such as salon advertising, insurance, workers’ compensation, utilities and janitorial costs. For the third quarter of fiscal 2003, direct salon expense of $35.7 million increased ten basis points to 9.0 percent of company-owned revenues as compared to the third quarter of the prior fiscal year. For the first nine months of fiscal 2003, direct salon expense of $105.5 million increased ten basis points to 9.1 percent of company-owned revenues as compared to the corresponding period of the prior year. The increases as a percent of company-owned revenues were primarily related to higher workers’ compensation insurance costs due to an increase in claim activity.
Rent
Rent expense during the third quarter and first nine months of fiscal 2003 was $59.3 and $170.0 million, respectively, compared to $48.4 and $143.8 million in the same periods of the prior fiscal year. Rent expense increased 70 and 50 basis points as a percentage of company-owned revenues for the third quarter and first nine months of fiscal 2003, respectively, primarily due to higher minimum rents related to acquired JLD salons in Manhattan as well as continuing increases in common area costs. Common area costs increase as landlords in regional malls experience higher insurance, utility and maintenance costs and pass such increases on to their tenants. Further, lower same-store sales increases, as compared to the prior year, caused rent expense to increase as a percent of sales.
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Depreciation - Salon Level
Depreciation expense at the salon level remained relatively consistent as a percent of company-owned revenues at 3.5 percent during the quarter and 3.4 percent during the nine months ended March 31, 2003, compared to 3.6 and 3.5 percent, respectively, in the corresponding periods of the prior fiscal year. The ten basis point improvements were primarily related to higher than normal salon asset write-offs during the third quarter of the prior fiscal year stemming from the timing of salon closures and relocations.
Direct Salon Contribution
For reasons previously discussed, direct salon contribution, representing company-owned salon revenues less associated operating expenses, increased $11.6 million to $71.3 million in the third quarter of fiscal 2003 and increased $34.4 million to $213.5 in the first nine months of fiscal 2003. As a percent of sales, direct salon contribution improved 50 and 80 basis points to 18.0 and 18.4 percent of company-owned revenues during the quarter and nine months ended March 31, 2003, respectively.
Franchise Direct Costs, Including Product and Equipment
Franchise direct costs include all direct costs related to franchise salons, such as the cost of products and equipment sold to franchisees and direct costs incurred to support franchising activities. Franchise direct costs increased to $14.4 million, or 56.8 percent of franchise revenues, during the quarter ended March 31, 2003. For the first nine months of fiscal 2003, franchise direct costs increased to $43.6 million, or 56.4 percent of franchise revenues. The increases were primarily related to the costs associated with the back-office integration of the acquired GGG and JLD businesses.
Corporate and Franchise Support Costs
Expenses in this category include field supervision (payroll, related taxes and travel), salon training, warehousing and corporate office administration costs (such as salaries, occupancy costs and professional fees). Corporate and franchise support costs (CFSC) were $40.8 million in the third quarter of fiscal 2003, compared to $34.2 million in the same period of the prior fiscal year. CFSC were $120.0 million in the first nine months of fiscal 2003, compared to $104.1 million during the corresponding period of the prior fiscal year due to further staffing needs as a result of adding 999 new company-owned salons since March of the prior fiscal year. As a percent of total revenues, CFSC increased 20 basis points for the quarter and remained constant for the nine months ended March 31, 2003. The 20 basis point increase stems from the decrease in same-store sales during the third quarter of fiscal 2003, causing the fixed cost components of CFSC to increase as a percent of total revenues.
Depreciation and Amortization - Corporate
Corporate depreciation and amortization remained consistent at 0.7 percent of total revenues in the third quarter and first nine months of fiscal 2003 and 2002.
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Operating Income
Operating income in the third quarter of fiscal 2003 improved $5.8 million to $38.6 million, and remained consistent at 9.1 percent of total revenues, compared to the third quarter of the prior fiscal year. For the nine months ended March 31, 2003, operating income improved $22.6 million to $118.2 million over the same period of the prior fiscal year, representing a 70 basis points improvement as a percent of total revenues. The improvement in operating income during fiscal 2003 is related to improvements in the product and service margins and other operational improvements previously discussed.
Interest
Interest expense in the third quarter of fiscal 2003 increased $0.7 million to $5.2 million. During the nine months ended March 31, 2003, interest expense increased $1.7 million to $15.7 million. The dollar increase in interest expense between periods stems from a higher average outstanding debt balance during fiscal 2003 related to the timing of acquisitions. Compared to the corresponding periods of the prior year, interest expense remained consistent as a percent of total revenues at 1.2 and 1.3 percent for the three and nine months ended March 31, 2003, respectively.
Income Taxes
The Company’s effective income tax rate for the third quarter of fiscal 2003 was 37.8 percent, compared to 32.6 percent in the third quarter of the prior fiscal year. During the nine months ended March 31, 2003 and 2002, the Company’s effective tax rate was 37.9 and 37.1 percent, respectively. During the third quarter of the prior fiscal year, the Company recognized a one-time income tax benefit of approximately $1.8 million resulting from the implementation of certain tax planning strategies. The nonrecurring benefit decreased the Company’s underlying effective tax rate by 6.1 and 2.1 percent for the quarter and nine months ended March 31, 2002, respectively. The improvement in the fiscal 2003 effective rate, exclusive of the nonrecurring income tax benefit in the prior fiscal year, was primarily due to a larger percentage of the Company’s earnings being earned in lower international tax jurisdictions, as well as tax savings resulting from certain tax strategies adopted late in the prior fiscal year. Additionally, the year-to-date rate was favorably impacted by the successful resolution of certain tax matters related to previous periods, which were discussed during the first quarter.
Net Income
Net income in the third quarter of fiscal 2003 grew to a record $20.9 million, or $0.46 per diluted share, compared to $19.3 million, or $0.44 per diluted share, in the same period in the prior fiscal year. During the nine months ended March 31, 2003, net income increased to a record $64.2 million, or $1.42 per diluted share, representing a net income and earning per share increase of $12.5 million and $0.24, respectively, over the corresponding period of the prior fiscal year.
The the prior fiscal year nonrecurring income tax benefit increased net income and diluted earnings per share by $1.8 million and $0.04, respectively, for the three and nine months ended March 31, 2002.
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Effects of Inflation
The Company compensates many of its salon employees with percentage commissions based on the sales they generate, thereby enabling salon payroll expense as a percent of revenues to remain relatively constant. Accordingly, this provides the Company certain protection against inflationary increases as payroll expense and related benefits (the Company’s major expense components) are, with respect to these divisions, variable costs of sales. The Company does not believe inflation, due to its low rate, has had a significant impact on the results of operations associated with its hourly paid hairstylists.
Recent Accounting Pronouncements
Recent accounting pronouncements are discussed in Note 2 to the Consolidated Financial Statements.
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LIQUIDITY AND CAPITAL RESOURCES
Customers pay for salon services and merchandise in cash at the time of sale, which reduces the Company’s working capital requirements. Net cash provided by operating activities for the first nine months of fiscal 2003 grew to $111.6 million compared to $106.0 million during the same period in the prior fiscal year. The increase between the two periods was primarily due to improved operating performance and higher accrued expenses related to the timing of estimated income tax payments. These increases were partially offset by an increase in inventory levels in order to support the Company’s increasing base of new, acquired and franchise salons.
Capital Expenditures and Acquisitions
During the first nine months of fiscal 2003, the Company had worldwide capital expenditures of $69.5 million (excluding $5.0 million related to non-cash asset purchases under capital leases), of which $19.9 million related to acquisitions. The Company constructed 299 new corporate salons in the first nine months of fiscal 2003, including 123 new SmartStyle salons, 62 new Strip Center Salons, 42 new Regis Salons, 33 new MasterCuts salons, 29 new Trade Secret salons and 10 new International salons, and completed 142 major remodeling projects. All capital expenditures during the first nine months of fiscal 2003 were funded by the Company’s operations and borrowings under its revolving credit facility.
The Company anticipates its worldwide salon development program, excluding salon closures, for fiscal 2003 will include approximately 440 new company-owned salons, 250 to 300 new franchised salons, 200 major remodeling and conversion projects and 400 to 500 acquired salons. It is expected that expenditures for these development activities will be approximately $155.0 to $160.0 million, of which $69.0 million (excluding $6.0 million allocated to non-cash asset purchases under capital leases) is allocated to new salon construction, maintenance, remodeling and conversions.
Contractual Obligations and Commercial Commitments
There have been no significant changes in the Company’s commercial commitments such as commitments under lines of credit or standby letters of credit since June 30, 2002. The Company is in compliance with all covenants and other requirements of its credit agreements and indentures. Additionally, the credit agreements do not include rating triggers or subjective clauses that would accelerate maturity dates.
As a part of its salon development program, the Company continues to negotiate and enter into leases and commitments for the acquisition of equipment and leasehold improvements related to future salon locations, and continues to enter into transactions to acquire established hair care salons and businesses.
In certain franchise area development agreements, a buyback program is included allowing the franchisee to require the Company to purchase all of their salon assets within a specified market for 90 percent of their original cost within two years from the date of the franchisee opening their first salon. As of March 31, 2003, 19 existing franchised salons were covered by such agreements and the related maximum potential amount of undiscounted future payments was estimated to be approximately $1.3 million. However, the Company has not and does not expect to incur material expenditures under the buyback program as most franchisees choose to continue operating the salons themselves. Further, in the case of a franchisee initiating the buyback program, the Company often facilitates the purchase of the salons directly by another franchisee rather than purchasing them itself.
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Off-Balance-Sheet Arrangements
The Company’s off-balance-sheet arrangements consist primarily of operating leases for the rental of salon premises, including leases for company-owned salons as well as franchisee accommodation leases, which are funded by franchisees. Regarding the franchisee accommodation leases, the Company generally retains the right to the related salon assets net of any outstanding obligations in the event of a default by a franchise owner. There have been no material changes in these off-balance-sheet arrangements since June 30, 2002, the Company’s fiscal year end. Management has not experienced and does not expect any material loss to result from these arrangements.
The Company is guarantor on a limited number of lease agreements between its franchisees and leasing companies. If the franchisee should fail to make payments in accordance with the lease, the Company will be held liable under such agreements and retains the right to possess the related salon operations. The Company believes the fair value of the salon operations exceeds the maximum potential amount of future lease payments for which it could be held liable. The existing guaranteed lease obligations, which have an aggregate undiscounted value of $6.6 million at March 31, 2003, terminate at various dates between December 2003 and March 2009. Management has not experienced and does not expect any material loss to result from these arrangements.
Additionally, a residual value guarantee exists related to a five-year operating lease agreement for the Company’s distribution center and various equipment in Salt Lake City, Utah for a maximum of $10.2 million. The lease agreement terminates during fiscal 2005. Under the agreement, the Company is obligated to pay the deficiency between the residual value guarantee and the fair market value at the termination of the agreement. The Company expects the fair market value of the distribution center and related equipment, subject to the purchase or remarket options, to substantially reduce or eliminate the Company’s potential $10.2 million liability under the residual value guarantee.
Financing
During the second quarter of fiscal 2003, the Company extended its revolving credit facility through November 2006. In the third quarter of fiscal 2003, the Company renewed one of its private placement debt facilities, thereby extending its terms through October 1, 2005 and increasing its related borrowing capacity from $125.0 to $246.0 million. No other significant changes were made to either of the facilities’ terms. There were no other significant financing activities during the first nine months of fiscal 2003. Derivative instruments are discussed in Note 3 to the Consolidated Financial Statements.
Management believes that cash generated from operations and amounts available under its existing debt facilities will be sufficient to fund its anticipated capital expenditures, acquisitions and required debt repayments for the foreseeable future.
The Company operates in international markets and translates the financial statements of its international subsidiaries to U.S. dollars for financial reporting purposes, and accordingly is subject to fluctuations in currency exchange rates.
Dividends
During the first nine months of fiscal 2003, the Company paid dividends totaling $3.9 million, or $0.09 per share. On May 7, 2003, the Board of Directors of the Company declared a $0.03 per share quarterly dividend payable on June 4, 2003 to shareholders of record on May 21, 2003.
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Outlook
Regis Corporation is the world’s largest owner, operator, franchisor and acquirer of hair and retail product salons in the $135 billion hair care industry. The 9,353 company-owned and franchised salons, which generated $2.1 billion of system-wide sales in the first nine months of fiscal year 2003, are located in the United States, Canada, France, Italy, the United Kingdom, Spain, Belgium, Switzerland, Poland and Puerto Rico.
Over the last ten years, the Company has been able to average double-digit revenue and earnings growth through its strategy of building, acquiring and franchising salons in high traffic locations throughout North America (United States and Canada) and Europe. Eight times larger than its nearest competitor, the Company maintains just a two percent worldwide market share, signaling substantial opportunities for long-term future growth.
Impact of Inflation
The impact of inflation on results of operations has not been significant. The Company does not expect inflation to have a significant impact on its abilities to achieve its long-term growth targets.
Impact of Seasonality
The Company’s business is not subject to substantial seasonal variations in demand. However, the timing of certain holidays may cause quarterly variations. Historically, the Company’s revenue and net earnings have generally been realized evenly throughout the fiscal year. The service and retail product revenue associated with its corporate salons, as well as the Company’s franchise revenue, is of a replenishment nature. The Company estimates that customer visitation patterns are generally consistent throughout the year.
Impact of the Economic Environment
Changes to the United States, Canadian, United Kingdom and other European economies may have an impact on the Company’s business. However, the replenishment nature of the Company’s business, as well as the fact that its various concepts span across all levels of consumer objectives regarding price and style, mitigates the impact that changes in economic conditions may have on the Company’s business.
Impact of changes to Interest Rates and Foreign Currency Exchange Rates
Changes in interest rates may have an impact on the Company’s expected results from operations. Currently, the Company manages the risk related to fluctuations in interest rates through the use of floating rate debt instruments and other financial instruments. See Note 3 to the Consolidated Financial Statements for additional information.
Changes in foreign currency exchange rates may have an impact on the Company’s expected results from operations. The majority of the revenue and costs associated with the performance of its foreign operations are denominated in local currencies such as the Canadian dollar, Euro and British Pound. For the three and nine months ended March 31, 2003, operations denominated in currencies other than the U.S. dollar equaled 8.3 and 12.3 percent of consolidated net income, respectively.
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Near-term Expectations
For fiscal year 2003, the Company expects revenue and earnings growth of approximately 15.0 and 18.0 percent, respectively. The Company plans to achieve this revenue growth through the combination of salon acquisitions (7.0 to 8.0 percent), new salon construction (4.0 to 5.0 percent), same-store sales increases (0.5 to 1.5 percent) and franchise revenue growth (1.0 to 2.0 percent). Earnings for fiscal year 2003 are also expected to benefit from the continued improvement in both service and product margins.
Long-term Expectations
The Company’s growth strategy will continue to focus on building and acquiring company-owned and operated salons in convenient locations with good visibility, strong customer traffic and appropriate trade demographics. In addition, it will continue to focus on the middle to moderately upscale market with its broad-based salon concepts.
The Company believes that the availability of real estate and quality stylists will not constrain its ability to achieve its long-term growth objectives of low-to-mid teens revenue and earnings growth.
Franchising will also be a key component of the Company’s future growth. Through the combination of company-owned and franchise salon growth, the Company expects to be able to strengthen its presence in existing markets as well as successfully enter new markets.
The variety of salon services offered continues to grow as the various concepts expand their services from primarily hair cutting and styling to include hair coloring, as well as additional services such as waxing. Based on years of industry experience, the Company has the knowledge and resources to provide many additional benefits beyond traditional hair care to its customers.
In addition to growth in salon services, the Company has been successful in growing the retail product business. During the first nine months of fiscal year 2003, retail product sales increased 11 percent to $343 million. Through the offering of the largest assortment of professional hair care products in the industry and superior merchandising, the Company believes it can continue to successfully grow its retail product business. Today, the Company estimates that it serves approximately 10 percent of the U.S. professional retail product market.
Maintaining financial flexibility is also a key element in continuing the Company’s successful growth. With strong operating cash flow and an investment grade rating, the Company is confident that it will be able to financially support its future growth.
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SAFE HARBOR PROVISIONS UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF1995
This quarterly report on Form 10-Q, as well as information included in, or incorporated by reference from, future filings by the Company with the Securities and Exchange Commission and information contained in written material, press releases and oral statements issued by or on behalf of the Company contains or may contain “forward-looking statements” within the meaning of the federal securities laws, including statements concerning anticipated future events and expectations that are not historical facts. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward–looking statements in this document reflect management’s best judgment at the time they are made, but all such statements are subject to numerous risks and uncertainties, which could cause actual results to differ materially from those expressed in or implied by the statements herein. Such forward-looking statements are often identified herein by use of words including, but not limited to, “may,” “believe,” “project,” “expect,” “estimate,” “anticipate,” and “plan.” In addition, the following factors could affect the Company’s actual results and cause such results to differ materially from those expressed in forward-looking statements. These factors include competition within the personal hair care industry, which remains strong, both domestically and internationally, and price sensitivity; changes in economic condition; changes in consumer tastes and fashion trends; labor and benefit costs; legal claims; risk inherent to international development (including currency fluctuations); the continued ability of the Company and its franchisees to obtain suitable locations and financing for new salon development; governmental initiatives such as minimum wage rates, taxes and possible franchise legislation; the ability of the Company to successfully identify and acquire salons that support its growth objectives; or other factors not listed above. The ability of the Company to meet its expected revenue growth is dependent on salon acquisitions, new salon construction and same-store sales increases, all of which are affected by many of the aforementioned risks. Additional information concerning potential factors that could affect future financial results is set forth in the Company’s Annual Report on Form 10-K for the year ended June 30, 2002 and included in Form S-3 Registration Statement filed with the Securities and Exchange Commission on January 31, 2003.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
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 floating rates based on LIBOR plus an applicable borrowing margin. To a lesser extent, the Company is also exposed to foreign currency translation risk related to its net investments in its foreign subsidiaries.
As of March 31, 2003, the Company had $58.7 million of floating and $249.5 of fixed rate debt outstanding. The Company manages its interest rate risk by balancing the amount of fixed and floating rate debt. On occasion the Company uses interest rate swaps to further mitigate the risk associated with changing interest rates and to maintain its desired balances of fixed and floating rate debt. Generally, the terms of the interest rate swap agreements contain quarterly settlement dates based on the notional amounts of the swap contracts. As of March 31, 2003, the Company has entered into interest rate swap agreements covering $55.0 million of its floating rate obligations and $88.5 million of its fixed rate obligations, as discussed in Note 3 of the Registrant’s March 31, 2003 quarterly report on Form 10-Q.
The Company has also entered into interest rate swap agreements with a notional amount of $11.8 million to hedge its variable rate operating lease obligations and a cross currency swap with a notional amount of $21.3 million to hedge its foreign currency exposure in certain of its net investments.
The table below presents information about the Company’s debt obligations, variable lease obligations and derivative financial instruments that are sensitive to changes in interest rates. For fixed rate debt obligations, the table presents principal amounts and related weighted-average interest rates by fiscal year of maturity. For variable rate obligations, the table presents principal amounts and the weighted-average interest rates as of March 31, 2003. For variable lease obligations, the table presents the maximum potential obligation under the residual value guarantee. For the Company’s derivative financial instruments, the table presents notional amounts and weighted-average interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contract.
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Expected maturity date as of June 30,
The table below provides information about the Company’s net investments in foreign operations and derivative financial instruments by functional currency and presents such information in U.S. dollar equivalents. The table summarizes the Company’s exposure to foreign currency translation risk related to its net investments in its foreign subsidiaries along with its derivative financial instruments used to hedge against such exposure.
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The cross currency swap derivative financial instrument expires in fiscal 2007 and at March 31, 2003, the Company’s net investment in this derivative financial instrument was in a $5.1 million loss position, based on its estimated fair value.
At March 31, 2003, the Company’s cash is concentrated at a limited number of financial institutions. This exposes the Company to credit risk due to the concentrations of cash at these institutions. However, the Company believes that the credit risk is mitigated due to the financial strength of the financial institutions.
Item 4. Controls and Procedures
With the participation of management, the Company’s chief executive officer and chief financial officer evaluated the Company’s disclosure controls and procedures within 90 days of the filing date of this quarterly report (the “Evaluation Date”). Based upon this evaluation, the chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that material information required to be disclosed is included in the reports that it files with the Securities and Exchange Commission.
There were no significant changes in the Company’s internal controls or, to the knowledge of management of the Company, in other factors that could significantly affect internal controls subsequent to the date of the Company’s most recent evaluation of its disclosure controls and procedures utilized to compile information included in this filing.
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Part II – Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(b) Reports on Form 8-K:
The following report on Form 8-K was filed during the three months ended March 31, 2003:
Form 8-K dated April 7, 2003 related to the announcement of the Company’s consolidated revenues and consolidated same-store sales for the month and third quarter ended March 31, 2003.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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CERTIFICATIONS
CERTIFICATION PURSUANT TO RULE 15D-14 OF THE SECURITIES EXCHANGE ACT OF 1934,AS AMENDED AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Paul D. Finkelstein, President and Chief Executive Officer of Regis Corporation, certify that:
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I, Randy L. Pearce, Executive Vice President, Chief Financial and Administrative Officer of Regis Corporation, certify that:
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