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Regis (NYSE:RGS)
Q1 2021 Earnings Call
Nov 02, 2020, 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 first-quarter fiscal-year 2021 earnings call. My name is Anita, 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 12:00 p.m.

central time today. I'll now turn the conference over to Biz McShane, AVP finance. Please go ahead.

Biz McShane -- Assistant Vice President, Finance

Good morning, everyone. And thank you for joining us. On the call with me today, we have Felipe Athayde, our chief executive officer; Kersten Zupfer, the chief financial officer; Eric Bakken, president of our franchise segment; and Amanda Rusin, our General Counsel. Before I turn the call over to Felipe, I would like to remind everyone that the language on the forward-looking statements included in our earnings release and 8-K filings, all to apply to our comments made on the call today.

These documents can be found on our website, www.regiscorp.com\investor-relations along with any reconciliation of non-GAAP financial measures mentioned on today's call with their corresponding GAAP measures. With that, I will now turn the call over to Felipe.

Felipe Athayde -- Chief Executive Officer

Thank you, Biz. Good morning and thank you for joining us. My name is Felipe Athayde, and I'm the newly appointed president and CEO of Regis Corporation. I could not be more excited to be joining this amazing company.

And even though these are obviously uncertain times, I believe times like these always open new opportunities. But before I talk about some of the opportunities I see, let me start by sharing my background with you. I spent almost a decade at Restaurant Brands International, a portfolio company of 3G Capital, in parent company of the Burger King, Tim Hortons and Popeyes creams. I joined Burger King shortly after the 3G acquisition, and held positions in marketing, operations and development across all three RBI grades.

I served as president of Tim Hortons U.S., president of Burger King Latin America, and most recently as president of the Americas for Popeyes Louisiana Kitchen, where I led the launch of the Popeyes chicken sandwich and a successful revitalization of the brand resulting in some of the largest same-store sales increases in the history of quick service restaurants. I also lend the recovery of Popeyes following the COVID-19 pandemic. Many have asked why I'm excited to have made the transition to Regis. And the answer is simple.

Regis' brands are in the business of making people look and feel their best. Hair carries the weight of people's identities and because we cater to such an important human need, I believe core demand for hair salon services is and always will be inherently strong. Regis has already built the foundation that positions us well for growth even in the current environment. And the opportunities around us today are very real.

The way I see Regis today is exactly how I saw Burger king back in 2011. In terms of the magnitude of the value creation potential for our shareholders, and of the wealth creation that can be achieved by our franchisees when we focus on franchise profitability. Existing Regis franchisees who are good partners of our brands and have the right infrastructure, competencies and resources will have a tremendous opportunity to multiply their footprints, both by driving new unit growth in their territories as well as by acting as consolidators where applicable. New hospitality-focused franchisees from different franchises systems will be recruited into our many brands, helping us elevate the level of our customer experience.

We are well on our way to becoming a fully franchised business, and my main priority at this moment is to finish the refranchising process started by Hugh which I plan to do at an accelerated speed. We have seeing consistent high interest in the remaining salons left in the portfolio, and have been approached by a few potential private equity players who see the current environment as a great opportunity to build a portfolio of hair salons which can then serve as a platform for future consolidation and aggressive new unit growth. It is an avenue we're exploring to bring in new franchise owners. The hair salon industry in North America is incredibly fragmented, and it's mostly in the hands of independent players.

There's a tremendous opportunity for salon chains to earn market share through brand differentiation, differentiation through technology, through marketing or through advancement opportunities for our stylists. We are the largest hair salon network in the world. We own some of the most iconic brands in North America. We have a strong network of franchisees and a world-class in-house technology group that is not only developing innovative customer-facing technology, but also that will allow us to have a sophisticated business analytics platform based on transactional data from our salons via our OpenSalon Pro POS system.

This will make us into a much smarter company and allow us to use data analytics to design traffic-driving initiatives, drive product attachment in our salons and create loyalty programs that will keep our customers coming back. My goal is to make Regis into a brand-led company that is in the business of supporting franchisees with a strong focus on their unit economics. In the franchisee world, unsurprisingly, the brands which have grown the fastest are those that have been the most profitable. I consider this to be my most important learning for my 10 years in the restaurant industry.

So Regis' obsession has to be and will be the profitability of our franchisees. Finally, I want to acknowledge that there is still work to do when it comes to our G&A as we transition to a fully franchised business model. I have engaged an outside consultant who I have known for many years and worked closely with in my restaurant days and who's already working with us on the implementation of a zero-based budgeting process at Regis, a process which I have been intimately familiar with in the past decade. Zero-based budgeting will create better visibility and control over our expenses, increase accountability over budgets and ensure expenses are aligned with our company's new business model and its respective priorities.

Regis will run as one fully franchised company and no longer as corporate opco and franchise. Thank you very much. I appreciate you being on the call. And I will now turn it over to our chief financial officer, Kersten Zupfer.

Kersten Zupfer -- Chief Financial Officer

Thanks, Felipe and good morning. Today, we reported, on a consolidated basis, first-quarter revenues of $111 million which represented a 55% decrease from the prior year. The decrease is the natural result of the transition to an asset-light franchise model, coupled with the negative continued impact of COVID-19. We estimate that we lost roughly $44 million of revenue in the first quarter due to the reduced traffic in-store closures associated with COVID-19.

As of today, approximately 95% of our solon systemwide are open, and management is evaluating the future of unopened corporate salons which may include keeping some salons permanently closed. We reported an operating loss of $31 million during the quarter. The economic disruption caused by the pandemic was the key driver of this loss as it has been in the last quarter of our prior fiscal year. First-quarter consolidated adjusted EBITDA loss of $19 million was $48 million unfavorable to the same period last year.

And was driven primarily by the decrease in the gain associated with the sale of company-owned salon of $27 million and the planned elimination of the EBITDA that had been generated in the prior period from the net 1,056 company-owned salons that has since been sold and converted to the franchise portfolio over the past 12 months. The COVID-19 pandemic also significantly contributed to the decline in the first-quarter adjusted EBITDA. Looking at the segment-specific performance and starting with our franchise segment, first-quarter franchise royalties and fees of $18 million decreased $10 million or 36% versus the same quarter last year. A substantial part of the year-over-year decline was due to a $6 million reduction in cooperative advertising funds which we would have typically charged to and collected from franchisees, but which the company temporarily reduced as part of the COVID-19 pandemic relief effort to help ease the financial burden, the pandemic placed on our franchisees.

This decline is offset in-site operating expense, and it has no impact on operating income. Royalties also declined approximately $7 million primarily due to COVID-19, certain state mandatory salon closures, state-mandated operating restrictions and pandemic-related customer behavior changes which we believe to be temporary. Offsetting these declines with the growth in our franchise fees which now represents 80% of our portfolio. Product sales to franchisees increased $1 million year over year to $14 million driven by the increase in the franchise fees.

As Felipe mentioned, we plan to use our technology capabilities to make better data-driven business decisions, leading to higher franchise profitability. We believe product attachment strategies can be created through better use of transactional data from our salon. First-quarter franchise adjusted EBITDA of $7 million declined approximately $5 million year over year driven primarily by reduced royalties as a result of the COVID-19 pandemic and the associated activities, as previously noted partially offset by a decline in G&A. Looking now at the company-owned salon segment.

First-quarter revenue was $47 million, a decrease of $127 million or 73% versus the prior year. The multifaceted reach and the impact of COVID-19 including increased governmental regulations, along with the year-over-year decrease of 1,243 company-owned salons over the past 12 months were the drivers of the decline. The decrease in the company-owned salons can be bucketed into three main categories: First, the successful conversion of 1,067 company-owned salons to our asset-light franchise platform over the course of the past 12 months, of which 137 were sold during the first quarter; second, the holder of approximately 400 company-owned salons over the course of the last 12 months, most of which were underperforming salons at lease expiration and not essential to our future strategy nor did we believe would be well suited within the current franchisee portfolio; and third, these net company-owned salon reductions were partially offset by 218 salons that were taken back from franchisees over the last year and six new company-owned organic salon openings during the last 12 months which we expect to transition to our franchise portfolio in the months ahead. First-quarter company-owned salon segment adjusted EBITDA decreased $22 million year-over-year to a loss of $11 million.

Consistent with the total company consolidated results, the unfavorable year-over-year variance was driven primarily by the elimination of the adjusted EBITDA that had been generated in the prior-year period from the company-owned salons that were sold and converted into the franchise platform over the past 12 months. As it relates to corporate overhead, first-quarter adjusted EBITDA decreased $21 million to a loss of $15 million and is driven primarily by the $27 million decline in net gains excluding noncash goodwill derecognition in the prior year from the sale and conversion of company-owned salon partially offset by the net impact of management initiatives to eliminate non-core, non-essential G&A expense. There is still work to be done in taking out non-core, non-essential G&A expense. And as Felipe mentioned, we have recently initiated a zero-based budgeting and organization process which will ensure expenses are aligned with our new franchise business model.

Turning now to the cash flow and balance sheet. As you heard from Felipe, our top priority is to finish the refranchising process at an accelerated pace. In addition, cash proceeds during the first quarter were $3.7 million or approximately $27,000 per salon. We continue to maintain our strong overall liquidity position.

As of September 30, we have liquidity of $184 million. This includes $99 million of availability under our revolver and $85 million of cash. In the first quarter, we used $29 million of cash, operating the business. As you may recall, at the end of the third quarter and during fourth quarter, we utilized cash management strategies, such as modifying payment terms on vendor payables and renegotiating rent payments which actions have now impacted cash used in the first quarter and will also impact second-quarter cash use as some of these actions delayed payments into the second quarter.

Additionally, we used $2.5 million in the first quarter to buy out of underperforming salons early at a discount that will improve future cash flows. We expect additional cash to be utilized in the second quarter as bonus payments that are typically paid in first quarter will be paid in the second quarter in addition to certain CEO-transition and onboarding expenses. We believe our largest uses of cash will occur in the first half of this year with cash utilization improving in the back half of the fiscal year. We've had a number of investors ask about the lease liability on our balance sheet.

So I thought it would be worth mentioning that these lease liabilities on our balance sheet represent liabilities for both our corporate and franchise locations, of which approximately 80% of our liability is service and personally guaranteed by our franchisees. Additionally, the liability on our balance sheet includes the lease payments for the current term of the leases, plus one option period for all leases we expect to renew at our discretion which overstates the rent payments that Regis has committed to. Excluding the option period, the lease liability would be approximately $460 million which is $300 million, less than the $760 million on our balance sheet. So to take that one step further, only 20% of the $460 million or $92 million is release exposure on the company-owned salon.

Before wrapping up, I thought I would spend a few minutes on what we are seeing with the business and related traffic trends. As a reminder, government-mandated closures started impacting the business in March, and we fully started reopening with a few locations in late April, with more opening in May and June. Even with these reopenings, most states impose onerous operating limitations including reduced salon capacity. We sign an initial reopening surge lasting about a week post reopen and the normalized traffic patterns reported this quarter.

We saw our lowest traffic levels in August which was further impacted by significantly reduced back-to-school traffic. The business was also impacted by states and provinces that were mandated to reclose again. The West Coast, specifically California, where we have over 500 locations was largely impacted by reclosures mandated in mid-July, lasting through most of August. The island of Oahu also reclosed in September and El Paso, Texas recently announced another two reclosure.

We have seen some improvement in traffic across the brands in September and October. The best performance has come out of the middle of the country where there has been relatively less disruption post reopening. We are seeing better performance in the South and Southeast as well, likely as these areas have been less restrictive. The Northeast states in Canada primarily Ontario as well as the West Coast, post reclosure disruption continue to struggle with building traffic back up.

I would like to thank you for your continued support and interest in Regis, and I will now turn the call back to the operator for questions.

Questions & Answers:


Operator

[Operator instructions] We'll take our first question from Laura Champine from Loop Capital. Please go ahead.

Laura Champine -- Loop Capital -- Analyst

Thank you and thanks for the color on the lease exposure. I'd love to hear since there's a new CEO in the virtual room, what the view is on keeping those leases on Regis' balance sheet as opposed to trying to move them off the balance sheet? And a related question, are there ongoing rent negotiations, just given the declining revenues out of these locations? Are there lease discussions with landlords to try to get some relief for your franchisees and for the company itself?

Kersten Zupfer -- Chief Financial Officer

Good morning, Laura. This is Kersten. I'll take that, and then I'll kick it over to Eric for the second half related to the lease negotiations. So yes, we've continuously looked at our strategy as it relates to Regis Corporation being on the leases.

And we've looked at it for a number of years. And recently, we are looking at making the decision to move off of the leases which gives our franchisees more flexibility to be on the leases and control their relationship with the landlord. So that's the direction that we're heading as it relates to we just setting the strategy of historically being on those leases. Eric, a couple of thoughts on the lease renegotiations?

Eric Bakken -- President, Franchise Segment

Sure. Thanks, Kersten. Hi, Laura. Yeah, we are actively, as we've discussed in the past, working on the leases and trying to secure better terms obviously, on the financial side.

And so we're working on our opco locations as well as our franchised locations. As we mentioned previously, we retained JLL, Jones Lang LaSalle, to help us, but we're also utilizing our internal team and our network of franchisees, many of whom have significant experience in this area. So we're reasonably pleased with our results so far. We'll continue to work at it as -- when you look at California and other places that have shut down, for a second time that creates additional opportunities to not only get deferrals of rent to get future abatement.

So we'll continue to push hard to secure the best deals that we can.

Laura Champine -- Loop Capital -- Analyst

Got it. Thank you.

Operator

[Operator instructions] And we'll take our next question from Steph Wissink from Jefferies. Please go ahead.

Steph Wissink -- Jefferies -- Analyst

Thank you. Good morning, everyone. Felipe, I want to start with you with just a couple of initial impression questions. It struck me that you mentioned a number of times in your remarks, just to focus on franchise profitability.

Maybe talk a little bit about as you've arrived on the scene, what you're noticing about the business model? Where you see the opportunities to really enhance that profitability strategy? And then if you could, just help us think through next steps in the process, as you think about technology, products, services. How do you really help your franchisees to succeed as they're kind of coming out of this period of pressure?

Felipe Athayde -- Chief Executive Officer

Hey. Steph, thank you for the question. Look, I think one of the main sources of increased franchise profitability is going to come from technology, right? So there's a few ways to look at it. But from one side, technology will allow us to make better data-driven business decisions.

Will allow us to design initiatives that will drive traffic toward our salons. It will increase the ability for us to attach products to our transactions in our salons and would also create loyalty programs that would keep our customers coming back. Also, technology can work from a demand generation perspective. So we've increased the channels through which we provide bookings for our customers.

So for example, Google Maps, Google Search. Today, you can go on one of these platforms and go straight to booking an appointment at one of our salons, and that removes some of the friction from the booking process, making it much easier for the customer, right? As you know, we're developing a sophisticated salon management solution, it is OpenSalon Pro. And the idea is to assist our franchisees and improving the operation of their salons, right? Ultimately, we want our franchisees to only have to worry about running great salons and providing great service to our customers, and we'll leave the system do the rest. The system can provide insights into the behavior of our customers, they can do predictive analytics.

So there's a lot that we can do to help our franchisees manage their businesses better. I mean, as I mentioned in my remarks, that the franchise systems that have grown the fastest are those with increased franchise profitability. So this is going to be our obsession moving forward. I think there's a great opportunity here for both our existing and new franchisees to build platforms of salons from which to consolidate and grow from there to new unit growth.

And there's a lot of opportunities for us to build density in some of our markets. Our brands do better in the markets where they have more density. So great opportunity for us to build platforms and make our salons most successful and the most profitable in the business. Thanks again, Steph, for your question.

Steph Wissink -- Jefferies -- Analyst

Yes. Kersten, can I throw a couple more just out there in terms of things that we're getting asked about. One of the things I think that you've addressed a bit is on the lease liability. And I appreciate that additional color as well.

But could you talk a little bit about the cost structure? And then second to that, as you project out and look at the recovery curve of some of the salons, I know you don't want to get into a lot of clustering, but you did share some regional specificities. Could you maybe talk about some of your top-performing salons? And maybe looking at classes or groups of salons where you see outliers, any insights that that's giving you in terms of how the recovery curve may look? Some of the strategic initiatives you put in place around marketing and just reassuring your customers around clean and safe environment, how those things are striking the customer. Could you just talk a little bit about maybe some of the upper class performers? Give us a sense of how the recovery might look.

Kersten Zupfer -- Chief Financial Officer

Eric, do you want to start with that on the performers then.

Eric Bakken -- President, Franchise Segment

Sure, sure. So, Steph, it's Eric. So if you look at some of our markets that opened early on, Oklahoma would be just an example of that. That business started out a little bit better than the rest of the portfolio after the other salons opened, but it's continued to improve.

And that gives us confidence, number one, with sort of middle of the country and reviews there. But also as the storage remained open longer, they are improving. We try to look at the business kind of week-over-week in these times as opposed to what we went on for last year. It takes out some of the noise that exists in back-to-school, etc.

And we were pleased with that. So that there are other markets [Inaudible] We're getting pretty significant business there. Business has done well, started out a little better, but I would say now it's a lot better than the balance. And then you go to other markets where it's been more challenging.

And Kersten alluded to California, Ontario would be another example. And those markets due to [Inaudible] The residents have been more problematic, but we have we have work to do there, for sure, and we'll continue to push at it, but we're pleased with some of our markets, in particular ones that have been open awhile.

Kersten Zupfer -- Chief Financial Officer

And then Steph, you were asking about cost structure. Can you expand on that just a bit to make sure I understand your question. I can't answer it appropriately.

Steph Wissink -- Jefferies -- Analyst

Yeah. I think you mentioned that you anticipated your cash flow -- operating cash flow to continue to improve. And clearly, with the refranchising or the -- even additioning, your capex will continue to come down. But just wanted to understand the interior of the P&L.

How we should think about cost the structure to support a fully franchised business or the migration from 80% to close to 100%?

Kersten Zupfer -- Chief Financial Officer

Yeah. So of course, I don't want to get into too many specifics, but as both Felipe and I mentioned, we've engaged a consulting firm that we started working with already to do a zero-based budgeting and zero-based Org or project to really build that up from the scratch, right, bottoms-up in terms of that cost structure. So I don't want to get too far into the details as we're really just kicking that off. But that's where we're headed in terms of cost structure.

And then as it relates to cash, I did mention that we do expect our second quarter cash to -- and our first-quarter cash to be higher uses of cash in the fiscal year. And that we anticipate in the second half of the year, that cash utilization to come down. There's a lot of timing of cash payments that, as we were furloughed and the government-mandated shutdown that moved from our third and fourth quarters into the first and second quarter.

Steph Wissink -- Jefferies -- Analyst

Thank you.

Operator

It appears there are no further questions at this time. Ms. McShane, I'd like to turn the call back to you for any additional or closing remarks.

Felipe Athayde -- Chief Executive Officer

Anita, thank you so much. This is Felipe. I just wanted to thank everyone for participating on the call, and I look forward to updating you on our progress next quarter. Thank you so much.

Operator

[Operator signoff]

Duration: 29 minutes

Call participants:

Biz McShane -- Assistant Vice President, Finance

Felipe Athayde -- Chief Executive Officer

Kersten Zupfer -- Chief Financial Officer

Laura Champine -- Loop Capital -- Analyst

Eric Bakken -- President, Franchise Segment

Steph Wissink -- Jefferies -- Analyst

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