Regis (RGS) Q4 2018 Earnings Conference Call Transcript

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Regis (RGS 2.73%)
Q4 2018 Earnings Conference Call
Aug. 21, 2018 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Regis Corporation fiscal 2018 fourth-quarter and year-end earnings call. My name is Cecilia, and I will be your conference facilitator today. [Operator instructions] As a reminder, this call is being recorded for playback and will be available by approximately 12 p.m. Eastern Time today. I'll now turn the conference over to Paul Dunn, vice president of finance and investor relations. Please go ahead, sir.

Paul Dunn -- Vice President of Finance and Investor Relations

Thank you, Cecilia. Good morning, everyone, and thank you all for joining us. On the call with me today are Hugh Sawyer, our chief executive officer; Andrew Lacko, our chief financial officer; Eric Bakken, president of our franchise segment; and Amanda Rusin, our general counsel. Before turning the call over to Hugh, there are a few housekeeping items to address.

First, today's earnings release and conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of performance and by their nature are subject to inherent risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current earnings release and previous SEC filings, including our most recent 10-K for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call.

Second, this morning's conference call must be considered in conjunction with the earnings release we issued this morning and our previous SEC filings. In today's call, we will be discussing non-GAAP financial results that exclude the impact of certain business events. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons, which should not be considered superior to, as a substitute for, and should be read in conjunction with GAAP financial measures for the period. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in this morning's release, which is available on our website at www.regiscorp.com/investor.

With that, I will now turn the call over to Hugh.

Hugh Sawyer -- Chief Executive Officer

Thank you, Paul, and thanks for joining us today and for your interest in Regis. Although we are still in the early days of our multiyear strategy and recognize that we have much more work to do, we are pleased to report signs of progress in our 2018 financial performance and ongoing transformation efforts. The results we reported this morning mark the company's fifth consecutive quarter of year-over-year adjusted EBITDA improvement and the fourth out of five quarters of same-store sales growth. Additionally, we have continued to expand our franchise portfolio where we believe it will support our evolving strategy for the business and maximize shareholder value.

Franchise salon locations now make up 51% of our salon portfolio, versus 29% 16 months ago. Andrew Lacko, our CFO, will now take you through our results. Andrew?

Andrew Lacko -- Chief Financial Officer

Thanks, Hugh, and good morning, everyone. On this morning's call, I'd like to provide you with some additional color on both the quarter and full-year financial results, along with the balance sheet and liquidity update. Additionally, I will give you an overview of some accounting changes that will impact fiscal 2019 in the comparability of prior years. Turning to the results.

On a consolidated basis, fourth-quarter revenue totaled $295 million, a $26 million, or 8%, year-over-year decrease. The revenue decline was driven primarily by the closure of a net 701 salons and the conversion of 448 company-owned salons to franchise locations over the past 12 months. These reductions were partially offset by revenue growth in our franchise segment and a 70-basis-point improvement in company-owned same-store sales comps. I'd like to point out that our reported sales comps were negatively impacted by the shift of Easter traffic into the third quarter this year versus the fourth quarter last year.

We estimate this shift reduced the company-owned comps in the fourth quarter by approximately 90 basis points. So on an Easter-adjusted basis, same-store sales improved approximately 160 basis points year over year. Fourth-quarter adjusted EBITDA of $31.2 million increased $2 million, or 6%, year over year, driven primarily by our operational initiatives, which delivered approximately $6 million of benefit during the quarter. We also saw favorability from the closure of unprofitable salons, the sale of salons to franchisees, profitable growth in our franchise segment and positive company-owned same-store sales performance.

These benefits were partly offset by a year-over-year increase in the company's short-term incentive compensation expense based on improved year-over-year financial performance, stylists' minimum wage increases, strategic investments made in digital advertising during the quarter in support of our SmartStyle brand and various advertising costs in support of our Supercuts MLB sponsorship. Adjusted EBITDA as a percent of sales or adjusted EBITDA margin increased 140 basis points year over year to 10.6%. Full-year adjusted EBITDA of $94.1 million was $6.9 million, or 7.9%, favorable year over year, and full-year adjusted EBITDA margin increased to 90 basis points to 7.8%. Turning now to segment-specific performance, and starting with our company-owned salons.

Fourth-quarter revenue totaled $263 million, a $36 million or 12.1% decline versus the prior year. The year-over-year decline is driven primarily by a decrease of approximately 1,150 salons over the past 12 months, which can be bucketed into three main categories: First, the closure of 597 nonperforming SmartStyle salons during the third quarter that we had previously disclosed; second, the sale of 448 company-owned salons to franchisees throughout the year; and lastly, the closure of roughly 100 unprofitable company-owned salons over the course of the year. Partially offsetting the impact of these salon closures was a 70 basis point improvement in same-store sales, favorable foreign currency impacts and the opening of two new locations over the past 12 months. Fourth-quarter company-owned adjusted EBITDA totaled $38.2 million, which was essentially flat year over year.

And fourth-quarter company-owned adjusted EBITDA margin increased 170 basis points to 14.5%. The key drivers of the year-over-year performance include the closure of unprofitable salons, management's operational initiatives, and the positive same-store sales performance. These were offset by increases in stylists' minimum wages, lapping a favorable self-insurance reserve adjustment recorded last year, strategic investments made during the quarter related to our SmartStyle brand and various advertising costs in support of our Supercuts MLB sponsorship. On a full-year basis, company-owned adjusted EBITDA of $126.7 million was approximately $800,000, or 60 basis points, favorable year over year.

And adjusted EBITDA margin increased 90 basis points to 11.5%. In the franchise segment, total revenue of $31.5 million increased $10.2 million, or 47.6%, year over year. Royalties and fees of $15.5 million increased $2.3 million, or 17.3%, versus the same period last year. Royalties increased 13.1%, driven primarily by positive same-store revenue growth and increased franchise salon counts.

Initial franchise fees increased $700,000, or 40.5%, as the company opened or converted a net 165 franchise locations in the quarter, as compared to 113 in the prior-year quarter. Product sales to franchisees were $16 million, an increase of $7.9 million, or 97.1%. Of this, $6.2 million related to sales to The Beautiful Group. I'd like to remind you that product sales to The Beautiful Group, which are in line with the transaction agreements, are currently at lower margin rates than our normal franchise business.

Fourth-quarter franchise-adjusted EBITDA of $11.9 million improved $2.4 million, or 25.3%, year over year, driven primarily by the revenue increase, partly offset by cost of goods sold on product sales to franchisees and higher warehouse expenses related to increased product sales volumes. The franchise EBITDA margin rate of 37.9% was negatively impacted by roughly 820 basis points due to the lower margins on product sales to The Beautiful Group. Removing the dilutive impact of these sales, adjusted EBITDA margin rates in the franchise segment improved approximately 150 basis points year over year. On a full-year basis, franchise-adjusted EBITDA of $41.8 million was approximately $6.9 million, or 19.9%, favorable year over year.

Consistent with the first -- with the fourth-quarter results, the full-year franchise EBITDA margin rate was negatively impacted by low-margin rates on product sales to The Beautiful Group. We estimate that the full-year franchise adjusted EBITDA margin rate of 38% was diluted by approximately 740 basis points by these low-margin sales. Removing this impact, we estimate that the full-year adjusted EBITDA margin rate in the franchise segment was 45.4%, an increase of 130 basis points year over year. Turning now to corporate overhead.

Fourth-quarter corporate-related expenses increased $600,000, or 3%, year over year. The year-over-year unfavorability was driven primarily by an increase in the company's short-term incentive compensation expense, increased equity compensation expense due to the reversals last year caused by the voluntary departure of a senior executive, increased benefits costs due to monetization of company-owned life insurance policies and increased recruiting fees as we filled the remaining vacancies on our executive management team. These items were partially offset by gains on sales of company-owned salons to franchisees and payroll and benefit decreases, driven by work to remove stranded G&A. Turning to total G&A.

During the quarter, although it may not be readily apparent looking at the reported numbers off the face of the P&L, we continued to make meaningful progress on our commitment to remove noncontributory, nonstrategic costs. Specifically, a few items in particular make it difficult to compare year-over-year adjusted G&A expenses. First, as a reminder, our adjusted G&A excludes a small number of discrete items as reconciled on the non-GAAP tables in the press release we issued this morning. Second is the realignment of our field leadership team.

In last year's numbers, the expenses associated with these leaders were in cost of service inside operating expense. This year, our field leaders' costs are in G&A. While there is no impact to our P&L in total, this change increased G&A year over year by $8.6 million in the quarter and $32.3 million for the full year. And third, is our third -- is our year-over-year short-term incentive compensation expense.

Last year, due to underperformance, the company recorded a minimum amount of bonus expense in the fourth quarter and virtually no expense for the full year. This year, based on the company's performance, we recorded a higher bonus expense. As a result, the net year-over-year impact of our short-term incentive program was a $2.3 million increase in expense in the fourth quarter and approximately $10 million for the full year. Taking these into account and normalizing last year's fourth-quarter total adjusted G&A of $37 million by approximately $10.9 million results in fourth-quarter 2017 G&A in the range of $47.9 million.

Comparing that to this year's fourth-quarter adjusted G&A of $44.2 million means we have reduced total G&A by $3.7 million, or 7.7%, during the fourth quarter and approximately $11.5 million, or 6.1%, for the full year versus what should have otherwise been expected. Turning now to the balance sheet. During the quarter, we continued to maintain our strong overall liquidity position, while providing optimal balance sheet flexibility for the company's continued strategic transformation work. During the quarter, we surrendered our portfolio of company-owned life insurance policies.

We believe this action will allow us to better deploy the capital to higher-returning projects related to our strategic transformation. I'd like to call out that at quarter-end, our receivable balance included approximately $25 million related to the cash surrender value of these policies, which we have since collected in the first quarter. The company also repurchased 883,000 shares or roughly 1.9% of its shares outstanding for a total of $15.1 million during the fourth quarter. At quarter-end, we had approximately $35 million of remaining share-repurchase capacity under our previously approved stock-repurchase program.

In addition to this, in August, the board recently authorized an additional $200 million of share-repurchase capacity. Year-end balance sheet cash totaled $110 million and we had $90 million of outstanding borrowings under our existing credit facility. The $61 million year-over-year decrease in balance sheet cash is driven primarily by the $34 million used to fund the retirement of our 5.5% senior term notes and $25 million used to repurchase shares during the quarter. Before I open the call up for questions, I'd like to remind you of a couple items that impact the year-over-year comparability of the results we reported this morning.

First, due to the sale and subsequent franchising of substantially all of our mall-based salons in U.K. business back in October last year, these operations are shown as discontinued operations in the P&L. The financial statements provided in our press release and 10-K for both current and prior periods have been recast to reflect the discontinued operations. However, prior-year press releases and disclosures would not reflect this change and are not comparable to our current operations.

The second item involves the field reorganization change I described earlier, which creates an $8.6 million decrease in cost of goods sold and site expense with a corresponding $8.6 million increase in G&A when compared to the fourth quarter of last year. I call these to your attention because the prior-year results provided in our press release and 10-K do not reflect this reclassification. However, to help you with your financial modeling, we have provided a pro forma P&L on our website with recast financial statements to better assist you with your comparisons. Lastly, I'd like to give you a quick update on an accounting change that went into effect July 1 of this year -- actually July 1, 2019.

The new guidance for revenue recognition will impact the way we recognize franchise fees and gift card revenue and will change the way we account for the various ad funds that support our operations. The accounting change has no impact on the company's cash position. The changes to gift card and ad fund accounting are not expected to have a material impact to our operating income, but the new standard will cause changes to the coming treatment of franchisees. For fiscal 2018 and prior, we recognized franchise fee revenue at the time a franchisee opened a new salon.

Under the new guidance, initial fees from the franchisees will be recognized over the life of the related franchise agreement, which is roughly 10 years. In fiscal years 2018, 2017 and 2016, we recognized $8.5 million, $4.3 million and $4.5 million, respectively, of revenue related to initial fees from franchises. These will now be deferred and recognized over 10 years. We currently expect to apply the full retrospective method upon adoption of this new standard.

As a result, all future financial statements we issue will be comparable to the prior results in those releases, but they will not be comparable to the financial results issued today and prior. To better assist you with your modeling, we intend to provide a pro forma P&L with recast of historical financial statements on our website when we release our first-quarter results in late October or early November. With that, I'd like to thank you for your support as we continue to make progress on our transformation efforts. And I'd like to now turn the call back over to Cecilia for questions. Go ahead, Cecilia.

Questions and Answers:

Operator

Thank you. [Operator instructions] And at this time, I'd like to turn the call back over to Hugh Sawyer for any additional or closing remarks.

Hugh Sawyer -- Chief Executive Officer

Thank you, operator, and thanks to everyone who joined us today. It's certainly been a team effort here at Regis. Thanks to all our colleagues around the company here at salon support and in our field organization for your great effort. We look forward to talking to you again soon.

Thank you.

Operator

[Operator signoff]

Duration: 19 minutes

Call Participants:

Paul Dunn -- Vice President of Finance and Investor Relations

Hugh Sawyer -- Chief Executive Officer

Andrew Lacko -- Chief Financial Officer

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