UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2004
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of October 22, 2004:
REGIS CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
The accompanying notes are an integral part of the unaudited Condensed Consolidated Financial Statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)(Unaudited)
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REVIEW REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Directors of Regis Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of Regis Corporation as of September 30, 2004 and the related condensed consolidated statements of operations and of cash flows for the three month periods ended September 30, 2004 and 2003. These interim financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures 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 statements for them 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, 2004, 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 24, 2004, which contained an explanatory paragraph indicating the Company changed its method of accounting for equity-based compensation arrangements to begin expensing new awards as of July 1, 2003, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the accompanying consolidated balance sheet information as of June 30, 2004, 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, MinnesotaOctober 27, 2004
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MANAGEMENT’S OVERVIEW
Regis Corporation, based in Minneapolis, Minnesota, is an owner, operator and franchisor of hair and retail product salons and beauty career schools. Our worldwide operations include 10,251 system-wide North American and international salons and 11 beauty career schools at September 30, 2004. Each of our salon concepts has 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 operation includes 8,236 salons, including 2,303 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 2,015 salons, including 1,599 franchise salons, located throughout Europe, primarily in the United Kingdom, France, Italy and Spain. Our beauty career schools are managed in aggregate, regardless of geographical location, and include seven locations in the United States and four locations in the United Kingdom. During the first quarter of fiscal year 2005, we had an average of approximately 54,000 corporate employees worldwide.
Our growth strategy consists of two primary, but flexible, building blocks. Through a combination of organic and acquisition growth, we seek to achieve our long-term objective of 10-to-14 percent annual revenue growth. We anticipate that going forward, the mix of organic and acquisition growth to be roughly equal. However, depending on several factors, including the availability of appropriate real estate, availability of salons for sale and same-store sales trends, this mix will vary from year-to-year. We believe achieving revenue growth of 10-to-14 percent will allow us to increase annual earnings at a low-to-mid teen percent growth rate.
Organic revenue growth is achieved through the combination of new salon construction and same-store sales increases. Each fiscal year, we anticipate building several hundred corporate salons. We anticipate our franchisees will open several hundred salons as well. Although not a significant factor, older, unprofitable salons will be closed or relocated. Our long-term outlook is for annual consolidated low single-digit same-store sales increases. Based on current fashion and economic cycles, we project our annual fiscal year 2005 consolidated same-store sales increase to be at the low end of our long-term outlook range.
Historically, acquisitions have varied in size from as small as one salon to over one-thousand salons. The median acquisition size is approximately 10 salons. From fiscal year 1994 to fiscal year 2004, we completed nearly 300 acquisitions, adding over 7,400 salons. We anticipate adding several hundred corporate salons each year from acquisitions. Some of these acquisitions may include buying salons from our franchisees.
We execute our growth strategy by focusing on real estate. Our real estate strategy is dependent on adding salons in convenient locations with good visibility, strong customer traffic and appropriate trade demographics. Our various salon and product concepts are now operating in a wide range of retailing environments. We believe that the availability of real estate will augment our ability to achieve the aforementioned long-term growth objectives. We anticipate that we will add approximately 1,000 salons each year through a combination of organic, acquisition and franchise growth.
The conceptual strength of our business is in the fundamental similarity of our salon concepts that allow flexibility and multiple salon concept placement in shopping centers and neighborhoods, and broad customer mix. Each concept is targeted at the middle market customer, however each attracts a slightly 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 have begun acquiring and are exploring the possibility of building beauty career schools. The beauty career school business is highly profitable, and 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 industry, the beauty career school business is highly fragmented. As a result, we believe there is an opportunity to consolidate this industry. Expanding this business would allow us to add incremental revenue without cannibalizing our existing salon business. Primarily through acquisition, we believe beauty career schools could contribute over $100 million in annual revenue in five years.
Additionally, we desire to enter the Asian market within the next five years.
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For a discussion of our near-term expectations, please refer to the Investor Information section of our website at www.regiscorp.com.
Maintaining financial flexibility is a key element in continuing our successful growth. With strong operating cash flow and an investment grade credit rating, we are confident that we will be able to financially support our long-term growth objectives.
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Results of Operations
The following table sets forth, for the periods indicated, certain information derived from our Condensed Consolidated Statements of Operations, expressed as a percent of revenues. The percentages are computed as a percent of total revenues, except as noted.
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CRITICAL ACCOUNTING POLICIES
The Condensed Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the Condensed Consolidated Financial Statements, we are required to make various judgments, estimates and assumptions that could have a significant impact on the results reported in the Condensed Consolidated Financial Statements. We base these estimates on historical experience and other assumptions believed to be reasonable under the circumstances. Changes in these estimates could have a material effect on our Condensed Consolidated Financial Statements.
Our significant accounting policies can be found in Note 1 to the Consolidated Financial Statements contained in Part II, Item 8 of the June 30, 2004 Annual Report on Form 10-K. 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, 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 our June 30, 2004 Annual Report on Form 10-K. No changes have been made to these policies since June 30, 2004.
RESULTS OF OPERATIONS
Revenues
Consolidated revenues include revenues of company-owned salons, beauty career school revenues, franchise royalties, franchise fees and product and equipment sales to franchisees. During the first quarter of fiscal year 2005, consolidated revenues increased 9.9 percent to $506.2 million as compared to the corresponding period of the prior fiscal year. The following chart details our consolidated revenues by concept:
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 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 revenue attributable to its organic growth (new salon construction and same-store sales growth) versus growth from acquisitions.
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The 9.9 percent increase in consolidated revenues during the first quarter of fiscal year 2005 was driven by the following:
We acquired 379 company-owned salons during the twelve months ended September 30, 2004, including 169 franchise buybacks. The organic growth stemmed from the construction of 479 company-owned salons during the twelve months ended September 30, 2004, as well as consolidated same-store sales increases. During the first quarter of fiscal year 2005, the foreign currency impact was driven by the weakening of the United States dollar against the British pound, Euro and Canadian dollar as compared to the prior period’s exchange rates. The impact of foreign currency was calculated by multiplying current year revenues in local currencies by the change in the foreign currency exchange rate between the current fiscal year and the prior fiscal year.
North American Salon Revenues. Total North American salon revenues were as follows:
The percentage increase during the first quarter of fiscal year 2005 was due to the following factors:
We acquired 351 company-owned North American salons during the twelve months ended September 30, 2004, including 169 franchise buybacks. The organic growth stemmed from the construction of 451 company-owned salons in North America during the twelve months ended September 30, 2004, as well as North American same-store sales increases. Revenues were negatively impacted during the first quarter of fiscal year 2005 by the hurricanes in the southeast United States, which caused nearly 650 of our company-owned salons to be closed for at least one day, as well as reduced customer visits to salons. The foreign currency impact during the first quarter of fiscal years 2005 was driven by the weakening of the United States dollar against the Canadian dollar as compared to the prior period’s exchange rate.
International Salon Revenues. Total international salon revenues were as follows:
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We acquired 28 company-owned international salons, primarily located in France and the United Kingdom, during the twelve months ended September 30, 2004. The organic growth stemmed from the construction of 28 company-owned salons in the United Kingdom during the twelve months ended September 30, 2004, as well as international same-store sales increases. International same-store product sales increased 14.7 and 32.3 percent during the first quarter of fiscal year 2005 and 2004, respectively, benefiting from our continuing improvement in assessing the merchandising demands of our international customers. The foreign currency impact during the first quarter of fiscal year 2005 was driven by the weakening of the United States dollar against the British pound and the Euro as compared to the prior period’s exchange rates.
School Revenues. Total revenues earned by beauty career schools were as follows:
a. We did not own or operate any beauty career schools until December of 2002.
We acquired six Blaine Beauty Career Schools during the fourth quarter of fiscal year 2004. The organic growth stemmed from increased tuition earned by the existing beauty career schools during the three months ended September 30, 2004 due to increased attendance. The foreign currency impact during the first quarter of fiscal year 2005 was driven by the weakening of the United States dollar against the British pound as compared to the prior period’s exchange rate.
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Consolidated Revenues. North American salon and international salon revenues are primarily comprised of company-owned service and product revenues, as well as franchise revenues from franchise fees and royalties, and product and equipment sales to franchisees. School revenues are primarily comprised of tuition; fluctuations in school revenues are discussed above. Fluctuations in the three salon revenue categories were as follows:
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Cost of Revenue
Total company-owned salon gross margin. Our cost of salon revenues includes salon based labor costs, the cost of product to provide services for company-owned salons and the cost of products sold to salon customers. The resulting gross margin for the first quarter of fiscal years 2005 and 2004 was as follows:
Company-owned salon service margin. Service margin for the first quarter of fiscal year 2005 and 2004 was as follows:
The basis point decrease in salon service margins during the first quarter of fiscal year 2005 was primarily related to our decision to compensate employees while salons were closed in the southeast United States due to the hurricanes.
Company-owned salon product margin. Product margin for the first quarter of fiscal year 2005 and 2004 was as follows:
The first quarter fiscal year 2005 basis point improvement in product margins was primarily related to a lower cost of goods stemming from our ability to negotiate favorable terms with our suppliers due to our size and volume of purchases.
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Rent
Rent expense, which includes base and percentage rent, common area maintenance and real estate taxes related to salons was as follows:
The increase in this fixed-cost expense as a percent of company-owned salon revenues during the first quarter of fiscal year 2005 was primarily due to lower same-store sales growth in the first quarter of fiscal year 2005 as compared to the corresponding period of the prior fiscal year.
General and Administrative
General and administrative (G&A) includes expenses related to salon operations (field supervision, salon training and promotions and product distribution) and home office administration costs (such as salaries and professional fees), including indirect franchise and schools costs. During the first quarter of fiscal year 2005 and 2004, G&A costs were as follows:
The basis point improvement in G&A costs as a percent of total revenues during the first quarter of fiscal year 2005 was primarily due to a $1.3 million expense during the first quarter of the prior fiscal year related to the write-off of loans associated with split dollar life insurance arrangements and $0.6 million of expense related to the write-off of the cash surrender value of the related policies. The loans were written off due to final regulations issued by the IRS on the taxation of such split dollar arrangements.
School Direct Costs
School direct costs include all direct costs related to the beauty career schools, such as the cost of product and equipment used in the beauty career schools and direct costs incurred to support school activities (e.g., salaries). During the first quarter of fiscal year 2005 and 2004, school direct costs were as follows:
The basis point increase in school direct costs during the first quarter of fiscal year 2005 was primarily due to increased school direct costs related to the integration of the Blaine beauty career schools, which were acquired during the fourth quarter of fiscal year 2004.
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Income Taxes
Our reported effective tax rate was as follows:
Changes in our overall effective tax rate are largely the result of a larger percentage of our income being generated in lower rate international tax jurisdictions. The associated effective tax rate on our international businesses, which are in lower tax jurisdictions, resulted in the improvement in the effective tax rate for the first quarter of fiscal year 2005.
Effects of Inflation
We compensate some of our salon employees with percentage commissions based on sales they generate, thereby enabling salon payroll expense as a percent of company-owned salon revenues to remain relatively constant. Accordingly, this provides us certain protection against inflationary increases as payroll expense and related benefits (our major expense components) are variable costs of sales. In addition, we may increase pricing in our salons to offset any significant increases in wages. Therefore, we do not believe inflation has had a significant impact on the results of operations.
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Constant Currency Presentation
The presentation below demonstrates the effect of foreign currency exchange rate fluctuations from year to year. In the first quarter of fiscal year 2005, foreign currency translation had a positive impact on consolidated revenues and net income before income taxes due to the strengthening of the Canadian dollar, British pound and Euro. To present this information, current period results for entities reporting in currencies other than United States dollars are converted into United States dollars at the average exchange rates in effect during the corresponding period of the prior fiscal year, rather than the actual average exchange rates in effect during the current fiscal year. Therefore, the foreign currency impact is equal to current year results in local currencies multiplied by the change in the average foreign currency exchange rate between the current fiscal period and the corresponding period of the prior fiscal year. Using this method, foreign currency exchange rate fluctuations had a positive impact on consolidated net income of $0.5 million during the first quarter of fiscal year 2005.
First Quarter, Fiscal Year 2005
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LIQUIDITY AND CAPITAL RESOURCES
Overview
We continue to maintain a strong balance sheet to support system growth and financial flexibility. Our debt to capitalization ratio, calculated as total debt as a percentage of total debt and shareholders’ equity at fiscal quarter end, was as follows:
Our principal on-going cash requirements are to finance construction of new stores, remodel certain existing stores, acquire salons and beauty career schools, and purchase inventory. Customers pay for salon services and merchandise in cash at the time of sale, which reduces our working capital requirements.
Total assets at September 30, 2004 and June 30, 2004 were as follows:
Total shareholders’ equity at September 30, 2004 and June 30, 2004 was as follows:
During the first quarter of fiscal year 2005, equity increased as a result of net income, increased accumulated other comprehensive income due to foreign currency translation adjustments as the result of the strengthening of foreign currencies that underlie our investments in those markets, and additional paid-in capital primarily recorded in connection with the exercise of stock options.
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Cash Flows
Operating Activities
Net cash provided by operating activities in the first quarter of fiscal year 2005 and 2004 was $35.4 and $52.6 million, respectively. The cash flows from operating activities were a result of the following:
During the first quarter of fiscal year 2005, inventories increased during the first quarter of fiscal year 2005 primarily due to the receipt of holiday promotions, beginning in August. Additionally, accounts payable and accrued expenses decreased primarily due to the timing of payments made related to the inventory.
Investing Activities
Net cash used in investing activities of $33.5 and $41.1 million in the first quarter of fiscal year 2005 and 2004, respectively, was the result of the following:
We constructed 121 company-owned salons and acquired 65 company-owned salons (58 of which were franchise buybacks) during the first quarter of fiscal year 2005. Acquisitions were primarily funded by a combination of operating cash flows and debt. The company-owned constructed and acquired salons consisted of the following number of salons in each concept:
Additionally, we completed 41 major remodeling projects during the first quarter of fiscal year 2005.
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Financing Activities
Net cash provided by financing activities was $6.4 million during the first quarter of fiscal year 2005 and net cash used in financing activities was $5.6 million during the first quarter of fiscal year 2004, resulting from the following:
The proceeds from the issuance of common stock were related to the exercise of stock options. In the third quarter of fiscal year 2004, the quarterly dividend was increased from its historical rate of $0.03 per share to $0.04 per share.
Acquisitions
The acquisitions during the first quarter of fiscal year 2005 consisted of 58 franchise buybacks and seven other acquired salons. These acquisitions individually and in the aggregate are not material to our operations. Therefore, pro forma information is not included in the Notes to the Consolidated Financial Statements. The acquisitions were funded primarily from operating cash flow and debt. Since 1994, we have acquired over 7,400 salons.
Contractual Obligations and Commercial Commitments
There have been no significant changes in our commercial commitments such as commitments under lines of credit or standby letters of credit since June 30, 2004. We are 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 our salon development program, we continue to negotiate and enter into leases and commitments for the acquisition of equipment and leasehold improvements related to future salon locations, and continue to enter into transactions to acquire established hair care salons and businesses.
Prior to December 31, 2002, we became guarantor on a limited number of equipment lease agreements between our franchisees and leasing companies. If the franchisee should fail to make payments in accordance with the lease, we will be held liable under such agreements and retain the right to possess the related salon operations. We believe the fair value of the salon operations exceeds the maximum potential amount of future lease payments for which we could be held liable. The existing guaranteed lease obligations, which have an aggregate undiscounted value of $2.6 million at September 30, 2004, terminate at various dates between June 2006 and April 2009. We have not experienced, and do not expect, any material loss to result from these arrangements.
Financing
Financing activities are discussed above and derivative activities are discussed in Item 3, “Quantitative and Qualitative Disclosures about Market Risk.” There were no other significant financing activities during the first quarter of fiscal year 2005.
We believe that cash generated from operations and amounts available under our existing debt facilities will be sufficient to fund its anticipated capital expenditures, acquisitions and required debt repayments for the foreseeable future.
Dividends
We paid dividends of $0.04 per share during the first quarter of fiscal year 2005. On October 28, 2004, our Board of Directors declared a $0.04 per share quarterly dividend payable November 26, 2004 to shareholders of record on November 12, 2004.
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Share Repurchase Program
Our Board of Directors has approved a stock repurchase program under which up to $100.0 million could be expended for the repurchase of Regis Corporation common stock. The timing and amounts of any repurchases will depend on many factors, including the market price of the common stock and overall market conditions. The repurchases to date have been made primarily to eliminate the dilutive effect of shares issued in conjunction with acquisitions and stock option exercises. As of September 30, 2004, a total of 1.8 million shares have been repurchased for $53.4 million. No shares were repurchased during the first quarter of fiscal year 2005. All repurchased shares are immediately retired. This repurchase program has no stated expiration date.
Risk Factors
Impact of Acquisition and Real Estate Availablity
The key driver of our revenue and earnings growth is the number of salons we acquire or construct. While we believe that substantial future acquisition and organic growth opportunities exist, any material decrease in the number of such opportunities would have an impact on our revenue and earnings growth.
Impact of the Economic Environment
Changes to the United States, Canadian, United Kingdom and other European economies have an impact on our business. Visitation patterns to our salons can be adversely impacted by changes in unemployment rates and discretionary income levels.
Impact of Key Relationships
We maintain key relationships with certain companies. Termination of these relationships could have an adverse impact on our ability to grow or future operating results.
Impact of Fashion
Changes in consumer tastes and fashion trends can have an impact on our financial performance.
Impact of Changes in Regulatory and Statutory Laws
With more than 10,000 locations and 54,000 employees world-wide, our financial results can be adversely impacted by regulatory or statutory changes in laws.
Impact of Competition
Competition on a market by market basis remains strong. Therefore, our ability to raise prices in certain markets can be adversely impacted by this competition.
Impact of Changes in Manufacturers’ Choice of Distribution Channels
The retail products that we sell are licensed to be carried exclusively by professional salons. Should the various product manufacturers decide to utilize other distribution channels, such as large discount retailers, it could negatively impact the revenue earned from product sales.
Impact of Changes to Interest Rates and Foreign Currency Exchange Rates
Changes in interest rates will have an impact on our expected results from operations. Currently, we manage the risk related to fluctuations in interest rates through the use of floating rate debt instruments and other financial instruments. See discussion in Item 3., “Quantitative and Qualitative Disclosures about Market Risk,” for additional information.
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Changes in foreign currency exchange rates will have an impact on our reported results from operations. The majority of the revenue and costs associated with the performance of our foreign operations are denominated in local currencies such as the Canadian dollar, Euro and British pound. Therefore, we do not have significant foreign currency transaction risk; however, the translation at different exchange rates from period to period may impact the amount of reported income from our international operations. For the quarter ended September 30, 2004, operations denominated in currencies other than the United States dollar represented approximately 23 percent of consolidated net income before income taxes, and changes in foreign currency exchange rates benefited net income before income taxes by approximately $0.7 million. This impact was calculated by multiplying current year net income before income taxes in local currencies by the change in the average foreign currency exchange rate between the first quarter of the current fiscal year and the corresponding period of the prior fiscal year. Refer the constant currency discussion in “Management’s Discussion and Analysis” for further detail.
Impact of Seasonality
Our business is not subject to substantial seasonal variations in demand. However, the timing of Easter may cause a quarterly variation in the third and fourth quarters. Historically, our revenue and net earnings have generally been realized evenly throughout the fiscal year. The service and retail product revenues associated with our corporate salons, as well as our franchise revenues, are of a replenishment nature. We estimate that customer visitation patterns are generally consistent throughout the year.
Impact of Changes in Securities Laws and Regulations
The Sarbanes-Oxley Act of 2002 that became law in July 2002 requires changes in some of our corporate governance and securities disclosure or compliance practices. We are presently preparing for our required compliance with the Sarbanes-Oxley Act of 2002, and management’s assertions concerning financial reporting controls. While we believe that we can ultimately comply with the new legislated requirements associated with being a registrant with the Securities and Exchange Commission, this process is costly and presents both challenge and risk.
The Sarbanes-Oxley Act of 2002 also requires the SEC to promulgate new rules on a variety of subjects, in addition to rule proposals already made, and the New York Stock Exchange has approved revisions to its requirements for listed companies. We expect these developments to increase our compliance costs. These developments could possibly make it more difficult and more expensive to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These developments could make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers. We are presently evaluating and monitoring regulatory developments and cannot estimate the timing or magnitude of additional costs which may be incurred as a result.
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SAFE HARBOR PROVISIONS UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
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,” “forecast,” “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, 2004 and incorporated by reference into Form S-3 Registration Statement filed with the Securities and Exchange Commission on June 4, 2004. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. However, your attention is directed to any further disclosures made in our subsequent annual and periodic reports filed or furnished with the SEC on Forms 10-Q and 8-K and Proxy Statements on Schedule 14A.
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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. Additionally, the Company is exposed to foreign currency translation risk related to its net investments in its foreign subsidiaries. The Company has established policies and procedures that govern the management of these exposures. By policy, the Company does not enter into such contracts for the purpose of speculation. The following details the Company’s policies and use of financial instruments.
Interest Rate Risk:
The Company has established an interest rate management policy that attempts to minimize its overall cost of debt, while taking into consideration the earnings implications associated with the volatility of short-term interest rates. As part of this policy, the Company has elected to maintain a combination of floating and fixed rate debt. As of September 30, 2004 and June 30, 2004, the Company had the following outstanding debt balances, considering the effect of interest rate swaps and including $4.1 and $3.5 million related to the fair value swaps at September 30 and June 30, 2004, respectively:
In addition, the Company has entered into the following financial instruments:
Interest Rate Swap Contracts:
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.
(Pay fixed rates, receive variable rates)
The Company had interest rate swap contracts that pay fixed rates of interest and receive variable rates of interest (based on the three-month LIBOR rate) on notional amounts of indebtedness of $11.8 million at September 30, 2004, June 30, 2004 and September 30, 2003. These swaps are being accounted for as cash flow swaps.
The cumulative tax-effected net loss recorded in other comprehensive income, set forth under the caption shareholders’ equity in the Condensed Consolidated Balance Sheet, related to the cash flow swap was $0.4 and $0.5 million at September 30, 2004 and 2003, respectively. The following table depicts the hedging activity recorded in the accumulated other comprehensive income account related to the cash flow swap for the three months ended September 30, 2004 and 2003.
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(Pay variable rates, receive fixed rates)
The Company has interest rate swap contracts that pay variable rates of interest (based on the three-month and six-month LIBOR rates plus a credit spread) and receive fixed rates of interest on an aggregate $71.0 and $81.0 million notional amount at September 30, 2004 and June 30, 2004, respectively, with maturation dates between July 2005 and March 2009. These swaps were designated as hedges of a portion of the Company’s senior term notes and are being accounted for as fair value swaps.
The Company’s fair value swaps are recorded at fair value within other assets in the Condensed Consolidated Balance Sheet, with a corresponding cumulative adjustment to the underlying senior term note within long-term debt of $3.1 and $2.4 million at September 30, 2004 and June 30, 2004, respectively. Additionally, $1.0 and $1.1 million of deferred gain remained in long-term debt at September 30, 2004 and June 30, 2004, respectively, related to the early termination of a fair value swap contracts. No hedge ineffectiveness occurred during the first quarter of fiscal year 2005 or 2004. As a result, the fair value swaps did not have a net impact on earnings.
Foreign Currency Exchange Risk:
The majority of the Company’s revenue, expense and capital purchasing activities are transacted in United States dollars. However, because a portion of the Company’s operations consists of activities outside of the United States, the Company has transactions in other currencies, primarily the Canadian dollar, British pound and Euro. In preparing the Condensed Consolidated Financial Statements, the Company is required to translate the financial statements of its foreign subsidiaries from the currency in which they keep their accounting records, generally the local currency, into United States dollars. Different exchange rates from period to period impact the amounts of reported income and the amount of foreign currency translation recorded in accumulated other comprehensive income. As part of its risk management strategy, the Company frequently evaluates its foreign currency exchange risk by monitoring market data and external factors that may influence exchange rate fluctuations. As a result, the Company may engage in transactions involving various derivative instruments to hedge assets, liabilities and purchases denominated in foreign currencies. As of September 30, 2004, the Company has entered into the following financial instrument:
Hedge of the Net Investment in Foreign Subsidiaries:
The Company has a cross-currency swap with a notional amount of $21.3 million to hedge a portion of its net investments in its foreign operations. The purpose of this hedge is to protect against adverse movements in exchange rates. The cross-currency swap hedged approximately seven percent of the Company’s net investments in foreign operations at September 30, 2004 and June 30, 2004.
The Company’s cross-currency swap is recorded at fair value within other noncurrent liabilities in the Condensed Consolidated Balance Sheet. At September 30, 2004 and June 30, 2004, the Company’s net investment in this derivative financial instrument was in a $9.3 and $8.7 million loss position, respectively, based on its estimated fair value. The corresponding tax-effected offset is charged to the cumulative translation adjustment account, which is a component of accumulated other comprehensive income set forth under the caption shareholders’ equity in the Condensed Consolidated Balance Sheet. For the quarters ended September 30, 2004 and 2003, $0.5 and $0.7 million of tax-effected loss related to this derivative was charged to the cumulative translation adjustment account, respectively.
For additional information, including a tabular presentation of the Company’s debt obligations and derivative financial instruments, refer to Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in the Company’s June 30, 2004 Annual Report on Form 10-K. Other than the information included above, there have been no material changes to this information during the three months ended September 30, 2004.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures:The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including the chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management’s control objectives.
With the participation of management, the Company’s chief executive officer and chief financial officer evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures at the conclusion of the period ended September 30, 2004. Based upon this evaluation, the chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level in ensuring that material information required to be disclosed is included in the reports that it files with the Securities and Exchange Commission.
Changes in Internal Controls:
There were no 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 1. Legal Proceedings
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. The Company is currently a defendant in a collective action lawsuit in which the plaintiffs allege violations under the Fair Labor Standards Act (“FLSA”). The Company denies these allegations and will actively defend its position. 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.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
(e) Share Repurchase Program
The Company’s Board of Directors approved a stock repurchase program under which up to $100.0 million can be expended for the repurchase of the Company’s common stock. The timing and amounts of any repurchases will depend on many factors, including the market price of the common stock and overall market conditions. All repurchased shares are immediately retired. This repurchase program has no stated expiration date.
There were no repurchases of the Company’s common stock during the quarter ended September 30, 2004. The approximate dollar value of shares that may yet be purchased under the Company’s stock repurchase program is approximately $46,590,000.
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(b) Reports on Form 8-K:
The following reports on Form 8-K were filed during the three months ended September 30, 2004:
Form 8-K dated July 8, 2004 related to the announcement of the Company’s consolidated revenues and consolidated same-store sales for the month, quarter and fiscal year ended June 30, 2004.
Form 8-K dated August 24, 2004 related to the announcement of the Company’s financial results for its fiscal fourth quarter and fiscal year ended June 30, 2004.
Form 8-K dated September 22, 2004 related to the announcement that the Company had lowered its first quarter earnings per share expectations as compared to previously reported expectations.
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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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