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Regis (NYSE:RGS)
Q2 2021 Earnings Call
Feb 04, 2021, 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 second-quarter fiscal year 2021 earnings call. My name is Mary, and I will be your conference facilitator today. [Operator instructions] As a reminder, this call is being recorded for playback and will be available approximately 12:00 PM Central Time today.

I will now hand the conference over to Biz McShane, AVP of finance. Please go ahead.

Biz McShane -- Assistant Vice President, Consolidations, Technical Accounting, and Reporting

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, our chief financial officer; Jim Lain, executive vice president of portfolio brands; and Amanda Rusin, our general counsel. Before I turn the call over to Felipe, I would like to remind everyone that the language on forward-looking statements included in our earnings release and 8-K filings also apply to our comments made on the call today. These documents can be found on our website, www.regiscorp.com/investorrelations, along with any reconciliations of non-GAAP financial measures mentioned on today's call with the 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. Q2 of fiscal year 2021 represents the first three months of my four-month tenure at Regis. And while the effects of the pandemic are evident in our results, we remain very confident about the strength of our business and our brands.

So allow me to first focus on why we're confident about the recovery of our business, after which, I would like to cover four important topics: our recent corporate reorganization, our zero-based budgeting process, the progress of our corporate salon refranchising, and our proprietary POS and salon management technology OpenSalon Pro. Outside of government-imposed restrictions and closures, the main factors impacting the hair salon business is the disruption of daily routine rather than people's desire to permanently change their salon habits. Customers are socializing less and working from home more, both of which are typical demand drivers for our services. According to the December release of McKinsey's U.S.

Consumer Sentiment during the coronavirus crisis survey, the level of concern of Americans when visiting a hair salon is more than engaging in other activities such as dining in restaurants, visiting a shopping mall, staying at a hotel or using a ride sharing service. At the heart of our confidence around the solid comeback is the fact that our category has the potential to be down in a way that is not applied to other retail service. This in part, you cannot get your haircut online and few people are willing to give or receive haircuts at home. Our stylists have been correcting do-it-yourself hair colors every day and sales of at-home hair color products have slowed down as salons reopened.

We're confident that most hair salon services cannot be replaced or replicated. And [Inaudible] continue to roll out and offices reopen throughout the year, our surveys and market research among salon goers are for customers wanting to get back to their old routines quickly. When we can resume, we believe visiting a hair salon will be top on people's priorities. As an example, in states such as Florida, where daily routines have been eased and open often, our comps are better by anywhere between five and 15 points.

Lastly, we believe that Regis's focus on value brands will be an important strength during uncertain economic times and will provide a cost-effective alternative to higher priced salons. In my first earnings call, I mentioned my hope to make Regis a brand-led company that is in the business of supporting franchisees with a strong focus on their unit economics. As of early December, we went through a corporate reorganization that created three main entities. One for our largest brand, Supercuts; one for our Walmart-based brand, SmartStyle; and a third group of portfolio brands representing our slower growth and innovation closet.

Each of these three groups are well led by a dedicated brand president with their independent teams. Before the reorganization, Regis was broken down into opco and [Inaudible] with brand-agnostic fees. In other words, one group was managing salons, while the other group was managing franchise relations. No specific executive working was accountable for any of our individual brands.

Moving forward, each brand president will have full accountability for their respective brands, including brand strategies, performance metrics and profitability. We're also changing the ways in which we engage with our franchise partners from a passive/reactive stance to actually leading, nurturing and growing our individual brands. We believe this fundamental change will create enormous value to our franchisees and shareholders over time. I also wanted to provide you with an update on our zero-based budgeting process which has been under way for the past few months.

As I mentioned during the November call, we're working with an external consultant who I have personally worked with for many years and who led multiple zero-based budgeting projects for companies such as Anheuser-Busch InBev and restaurant brands internationally. The main component of our ZBB process is a zero-based organizational design. In other words, we're designing our entire organizational structure from the ground up based on the bolts and capability that we will need as a brand-centric, fully franchised business. Let me use our zero-based franchise consultants as an example.

Historically, our franchise consultants have had a reactive approach to support facilities without establishing fees or processes. This would result in a lot of inefficiencies and non-value-added activities. The zero-based organization process first sets the goals to be achieved by our franchise facilities, adjust their job description, accordingly, test the processes and [Inaudible], along with the scope of the team and their cadence. The resulting organization has the right people in the right places doing the right work and being held accountable for the right mix.

Although we will not complete the ZBB process until later in Q4, we're taking action as we identify opportunities rather than waiting for the entire exercise to be completed. Moving on to our progress in refranchising our remaining corporate salons, a process that is now under the leadership of a former restaurant brands international executive who have also spent five years at JP Morgan as an investment banker. We have made an important change in approach when it comes to the profile of the buyers of our corporate salons. Up until now, the median purchaser of our transition salons will be served via a network of brokers and would engage in a salon transaction.

Although some of our new prospects are still coming from outside of these systems, we're working closely with many of our larger, well-capitalized franchisees to match them with salon portfolios that are either contiguous to their current territories or which provide them with entry points into territories in which they would like to consolidate and grow organically. Some of the individual transactions in our current pipeline involve portfolios with more than 100 salons representing prospective buyers who see current market conditions as a very attractive opportunity to grow their business, especially in light of an acceleration in vaccine rollouts. Finally, I want to share some of our progress on our proprietary POS and salon management system, OpenSalon Pro. We continue to look forward toward developing technologies that increasingly automate salons and manages the customer journey from digital demand generation, to corporate bookings, to payments at checkout.

Our goal in the past quarter was to release a variety of advanced features that we believe will strongly contribute to the four-wall profitability of our salon. As an example, we have fully integrated OSPs with our merchandising shipments so inventories can be automatically uploaded into the system upon delivery without the need for unproductive manual work from our salons. Through our merchandising, we have also released [Inaudible] which auto creates product loaders to our salons, both removing manual work and creating orders that are better aligned with the sales of that particular location. With these capabilities now in place, we will move forward with a more aggressive rollout schedule of OSP into our salons.

As of today, we have about 1,000 salons with signed contracts for OSP, of which more than [Inaudible] live, with the rest of the migration team followers. Over the course of this calendar year, we will begin migrating the process so all our brands can leverage our new technological capabilities. Back in December, we closely watched two companies which provide Software-as-a-Service solutions for the beauty and wellness industry, bring substantial amounts of [Inaudible]. We believe OpenSalon Pro is a formidable competitor to these services and are working into the market opportunities of growing OSP beyond the Regis family of brands.

For this initiative, we're exploring strategic partnerships to help support this process should we choose to move in that direction. 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

Thank you, Felipe, and good morning. Yesterday afternoon, we reported, on a consolidated basis, second-quarter revenues of 104 million which represented a 50% decrease from the prior year. This decrease is the natural result of the transition to an asset-light franchise model, coupled with lower traffic levels, primarily as the result of the COVID-19 pandemic. California, certain areas in Canada, primarily Ontario and a small amount of one-off locations, experienced government mandating closures for most of December and into January.

California restrictions have since relaxed, and currently all California salons are available to be open for business. We have approximately 400 salons in Canada currently closed, and we are expecting an update regarding the reopening of these salons on Monday, February 8. We reported an operating loss of 27 million during the quarter, mostly driven by the economic disruptions caused by the pandemic as it has been since the last quarter of our prior fiscal year. Second-quarter consolidated adjusted EBITDA loss of $18 million was $35 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 salons of $18 million and the planned elimination of the EBITDA that had been generated in the prior-year period from the net 768 company-owned salons that have been sold and converted to the franchise portfolio over the past 12 months.

Rapid declines and related pressure on labor optimization also contributed to the decline in the second-quarter adjusted EBITDA. Looking at the segment-specific performance and starting with our franchise segment, second-quarter franchise royalties and fees of $20 million decreased $9 million or 32% versus the same quarter last year. The majority of the year-over-year decline was due to a $6 million decline in corporate advertising time, which is entirely offset in sight operating expense and has no impact on operating income. Franchise same store sales were unfavorable 31.1%, primarily related to decreased traffic associated with COVID-19.

The decline in same store sales impacted royalties and corporate advertising spend. As I mentioned earlier, government-mandated temporary closures, more significantly in California and Canada, also contributed to the decline in royalty revenue. Offsetting these segment declines with the growth in our franchises, which now represents 84% of our portfolio. Product sales to franchisees decreased $3 million year over year to $14 million, driven primarily by the decline in same-store traffic.

Second-quarter franchise adjusted EBITDA of $11 million declined approximately $2 million year over year, driven by reduced royalties as a result of the COVID-19 pandemic and the associated activity as previously noted, partially offset by a decline in bad debt expense in the quarter. Looking now at the company-owned salon segment, second-quarter revenue was 38 million, a decrease of 91 million or 71% versus the prior year. The impact of COVID-19, along with the year-over-year decrease of 1,240 company-owned salons over the past 12 months were drivers of the decline. The decrease in company-owned salons can be bucketed into two primary categories: first, the conversion of 759 company-owned salons to our asset-light franchise platform over the course of the past 12 months, of which 145 were sold during the quarter.

Second, the closure of approximately 477 company-owned salons over the course of the last 12 months, most of which were underperforming salons on lease expiration and dilutive to our profitability. Second-quarter company-owned salon segment adjusted EBITDA decreased 15 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, second-quarter adjusted EBITDA decreased $17 million to $18 million and is driven primarily by the $18 million decline in net gains, excluding noncash royalty recognition in the prior year from the sale and conversion of company-owned salons, partially offset by the net impact of management initiatives to eliminate non-core, nonessential G&A expense.

We've been receiving a number of questions about the state of future G&A. As Felipe mentioned, in Q2 we initiated a ZBB or zero-based budgeting process. This is a very detailed bottoms-up approach that will take some time to complete. We are on track with both the ZBB and ZBO or zero-based organization process, and we expect to be able to provide strong visibility to interstate G&A during our first quarter of fiscal year 2022.

However, let me clarify, as we have identified savings, we have taken immediate action. For example, in November we initiated a competitive proposal process from multiple audit firms, including PWC as the incumbent. The proposal process was centered around our future state as a fully franchised organization. This process resulted in savings that we took action on immediately and engaged Grant Thornton in early December.

Turning now to the cash flow and balance sheet, we continue to maintain our positive overall liquidity position. As of December 31, we have liquidity of $150 million. This includes $99 million of available revolver capacity and $51 million of cash. To the best of our knowledge and based on our current liquidity position and forecast, we believe we have adequate liquidity for at least the next 12 months.

Yesterday, we filed a shelf registration and prospectus supplement with the SEC, under which we may offer and sell shares of our common stock throughout the market offer. Please note, we have not done so at this time. Net proceeds from sales of shares under the aftermarket program, if any, may be used among other things to fund working capital requirements, repay debt and support our growth strategies and technology capabilities. Such strategies may include positioning the company for potential expansion through targeted industry acquisitions and alternatives to fund additional capital investment requirements related to potential partnership opportunities to facilitate continued growth of our proprietary technology, OpenSalon Pro.

In the second quarter, we used $37.5 million of cash operating the business. As I mentioned in our last call, we anticipated a higher usage of cash in the second quarter due to cash management strategies used earlier in the calendar year. This quarter, we used $20 million to catch up on vendor payments and rent, pay fiscal year 2020 and executive bonuses, pay franchise premiums for the year and to terminate certain unprofitable leases. As it relates to projected cash used in the second half of the fiscal year, we continue to use cash as recondition forms, assuming traffic levels do not improve significantly.

We still have some rent related to earlier in the calendar year that we expect to pay in the second half of the fiscal year. We expect our cash used to be less in the second half with cash use improving sequentially each quarter. We registered 145 salons this quarter, which was consistent with Q1. This was intentional as we reviewed our positioning strategy moving from a retail approach to a wholesale approach.

Since the beginning of the transition process, salons were commissioned to approximately 350 franchisees with a median of four salons per franchisee. Under the wholesale approach, we will market larger bundles for new and existing franchisees. We are pleased with the current pipeline, and our goal remains to be fully franchised by the end of the fiscal year, with any remaining company-owned salons being closed in orderly fashion over their remaining lease terms. As we work through the remaining company-owned portfolio, we will close certain leases on or before their lease end date if it makes economic sense to do so.

And only if we believe such salons cannot be appropriately bundled with other salons to form sellable portfolios. In our prior fourth-quarter earnings release, we communicated that we would close 600 to 800 company-owned salons. Fiscal year to date, we have closed 316 company-owned salons and expect remaining company-owned orders to be toward the low end of the 600 to 800 range. On the balance sheet, I want to remind you that the lease liability on our balance sheet of $669 million represent liabilities for both our corporate and franchise locations.

Approximately 84% is serviced by 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 SmartStyle and Supercut salons, which overstates the rent payments that Regis has committed to. Excluding the option period, our total lease liability would be approximately $420 million, which is approximately $250 million less than the [Inaudible] on our balance sheet. To take it one step further, only 16% of the 420 million, or $70 million is the lease exposure on the company-owned salons.

For our discussion last quarter, you'll note a reduction in the lease liability. Approximately $73 million is directly related to Regis's strategy as we move to a fully franchised model, of no longer being the primary tenants on real estate leases where allowed by franchise agreements. Before wrapping up, I thought I would spend a few minutes on the business, specifically the health of our franchisees and what we are seeing with business and related traffic terms. The ongoing health of our franchisees is top of mind.

We are taking every possible step to help mitigate expenses where possible. First and most important is the ability to reopen and operate at full capacity. While the restrictions on mandated closures are lifting, the business is still impacted by capacity restrictions, both pandemic traffic levels and the fact that some stylists are struggling to return to work as their children are now from school. However, there are inherent performance to the business model, as well as measures Regis and the franchisees have taken to mitigate the impact.

The franchise business model includes many variable cost components that adjust for fluctuating sales such as royalties, advertising funds and certain rent structures, primarily on the SmartStyle brand. While we do not control the labor models used by our franchisees, most of the brands have labor expenses that are largely controllable with business modifications to adapt to reduced hours of operation and reduced traffic. Regis has also adopted questions about many brands to assist our franchisees during this time. We've temporarily reduced advertising fund rates in certain brands with higher marketing requirements as a percentage of revenue.

We've also deferred royalty payment collections to assist our franchisees in timing of cash spend. Additionally, we have actively supported our franchisees in navigating the new Paycheck Protection Program by building out a communication process that's up-to-date, easy to find, QTC, overviews and detailed procedures. This process includes real-time email updates directly to our franchisees, as well as an online franchise resource center where our franchisees can both quickly and easily retrieve information regarding both U.S. and Canadian small business efforts, in addition to all of the internally focused COVID safety protocols and support.

It's also important to note that we are providing our franchisees strong support in terms of marketing and internally developed recommended COVID protocols to make it easier for our franchisees to get funds quickly and safely beyond the listing of any closure mandates. Moving on to trends in the business. Throughout the first half of our second quarter, 97% of the salons in the contract portfolio were open in some capacity. While hours of operation was still reduced, the average traffic volume in the first half of the quarter was holding steady.

However, in the back half of the quarter, the business faced a couple of challenges. First, we experienced weak holiday traffic due to reduced travel and decreased family and social gatherings as reflected in our reported comps. The business was also impacted by mandated salon closures, primarily in California and Canada, which is not reflected in reported comps as the salons were closed. As of December 31, approximately 85% of the system was open.

This has now improved to 89% at the end of January. While traffic is still well below pre-pandemic levels, January average volumes for open stores are revolving back to similar levels, those we had seen in the late summer months. While we recognize that some of the historical seasonality has been halted for the pandemic, this is a positive indication of second-quarter trends. Additionally, as I mentioned earlier, most of the mandated closures in California have been lifted and we remain optimistic that volumes will continue to improve our restructuring plans.

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.

Questions & Answers:


Operator

[Operator instructions] We can take our first question now from Laura Champine of Loop Capital. Please go ahead.

Laura Champine -- Loop Capital -- Analyst

Thanks for taking my question. It's on the trajectory of selling off the remaining company-owned locations. I heard, Kersten, you say that the plan is still to have that done on the prior schedule. Is that reliant mostly on financing for those franchisees? How many of the conversions, for how many of the conversions have you identified a buyer?

Kersten Zupfer -- Chief Financial Officer

Thanks for the question, Laura. As it relates to the pipeline, we have about 50% of the remaining locations in some various stage of the pipeline at this point.

Felipe Athayde -- Chief Executive Officer

Laura, Felipe here. Look, the main concern that we had in this process throughout the past quarter was a change in direction when it comes to the refranchising process, right? So we went, to Kersten's point, from having an average transaction of four salon portfolios, to steering toward our largest franchisees already in the system who want to grow and allow them the ability to acquire new portfolios from which they can consolidate faster and then get to a more robust future organic growth. So some of the deals on the pipeline, to Kersten's point about we have transactions on the pipeline for about 50% of the opco portfolio, some of these deals are north of 100 salons in terms of their size. So I want to make sure that we have the right franchisees growing, and we're also bringing in new blood into the system.

I mean think people who have operated other franchise brands outside of hair salons or broader retail as well, right? So it's less about the ability to finance and more about us wanting to bring in a slightly different type of incoming franchisee as the rendition process moves through.

Laura Champine -- Loop Capital -- Analyst

Understood. Thank you.

Felipe Athayde -- Chief Executive Officer

Thank you. laura

Operator

We can now take our next question from Stephanie Wissink of Jefferies. Please go ahead.

Stephanie Wissink -- Jefferies -- Analyst

Hello, everyone. We have two follow-up questions, if we could. Kersten, the first one is for you. Just on the lease liabilities, if we could come back to that, thank you for all of the detail.

Help us think through the franchisee responsibility where you may have transitioned the salon and you might still be the master tenant on that lease. Can you just help bring us up to speed on where you are in rolling off some of those master and minor roles more toward a franchise direct to landlord responsibility? And then secondly, Felipe, maybe this one is for you, it was a little bit hard to hear some of your comments on merchandising, product development and the rollout of OpenSalon Pro. If you could just go back to those key areas of franchise support services, talk a bit about DESIGNLINE and Blossom, some of the uptake and interest there, some of the things that you have planned for merchandising, and maybe more systemizing the merchandising and some of the inventory flow to your salon partners? And then lastly, on OpenSalon Pro, if you could just remind us where you are in the rollout of that. How many salons are in test or actively using it? Maybe some of the initial feedback would be great.

Thank you.

Kersten Zupfer -- Chief Financial Officer

Thanks, Steph. Thanks for the question. So as it relates to our change in strategy on the lease liability, the way that we're executing that is as leases come up for renewal and as franchise agreements allow for, we are making that conversion from us, Regis Corporation, being on the lease to the lease being in the name of the franchisee. Which allows them more flexibility in terms of communication and being able to negotiate leases and having that relationship with their landlord.

Like I said, it's happening as leases come up for renewal.

Felipe Athayde -- Chief Executive Officer

Felipe here. So a little bit on the progress of OSP. So our focus this past quarter was to launch some functionalities that automate some of the manual non-value-added activities in the salons, right? So to give you an example, the ability to automatically upload merchandise that is ordered by a salon into the salon management system, right? So this is a process that would have taken many hours per month that is now fully automated. Still on merchandising, we have now a capability of algorithmic replenishment.

So basically, there's an AI system that looks into the sales of that specific salon in places in ideal order that then the franchisee has the ability to edit as they please. So we wanted to make sure that before we pushed OpenSalon Pro more broadly that we would have those capabilities that would drastically over time improve franchise profitability just by eliminating nonproductive labor hours. So at this point, we have about 1,000 contracts, 1,000 salons committed to installing OSP in the next few weeks and months, of which 350, just north of 350, are live. Remember, there's a few important buckets when it comes to OSP.

One is, to my point, franchise profitability and the just automation of activities that can be automated by the system instead of manual work. Our ability to leverage transactional level data. So if you can look at the granularity of single transactions, you will better understand consumer behavior and hence, will be able to better drive traffic and check. And to your point about Design Line and Blossom, it's going to allow us to gather much more intelligence around not only our third-party brands, but our private label brands as well, right? So we can optimize the merchandising portfolio, not only from a brand-specific perspective, but also from an individual salon perspective.

It can vary based on demographics, it can vary based on local tastes and all of that. And lastly, the ability for us to have consumer test capabilities that will drive traffic and loyalty, right? So we've had, for example, our cost cutters brand has recently launched its loyalty platform. It's still very early days, but we're very optimistic about the potential for incrementality here. And we want all of our Top 5, the Fab 5 brands to have some sort of loyalty program in the future that will be powered by OpenSalon Pro, right? So now that these capabilities are in place and live, and especially on the cost saving side, we're going to push OpenSalon Pro much more aggressively.

And from now through the end of the year, it will become a brand standard for all of our brands and we will announce a systemwide mandate.

Stephanie Wissink -- Jefferies -- Analyst

That's great. One follow-up on OpenSalon Pro. And maybe, Kersten, this is best for you, but the investment on the front end was quite high. With fully based comments of 1,000 salons potentially on the system here in the very near term, where are you in that pathway toward covering that cost on an annual basis? What's the stair step look like as you look out over the next several quarters in terms of getting to a cost cover on an annual investment basis around OpenSalon?

Kersten Zupfer -- Chief Financial Officer

Yeah, good question. Unfortunately, we haven't disclosed the actual amount of what we've invested in, in OpenSalon Pro. But as we roll out OpenSalon Pro to our locations here within Regis Corporation, and then as we look even outside of Regis Corporation to continue to roll that out, the majority of that investment in OpenSalon Pro has been incurred. So going forward, the majority of that revenue stream, the monthly net revenue stream associated with OpenSalon Pro drops down to EBITDA.

Stephanie Wissink -- Jefferies -- Analyst

Excellent. Thank you very much.

Felipe Athayde -- Chief Executive Officer

Thank you, Steph.

Operator

This concludes the Q&A portion of the call. I will now turn conference back to Felipe.

Felipe Athayde -- Chief Executive Officer

Thank you, Mary. And I apologize everyone. I heard from a few of you that there have been a few technological issues on the audio side. We're going to post, obviously, the webcast to our website very soon.

Thank you so much for your continued interest in Regis, and I look forward to updating all of you on our Q3 progress. Thank you and have a great day.

Operator

[Operator signoff]

Duration: 35 minutes

Call participants:

Biz McShane -- Assistant Vice President, Consolidations, Technical Accounting, and Reporting

Felipe Athayde -- Chief Executive Officer

Kersten Zupfer -- Chief Financial Officer

Laura Champine -- Loop Capital -- Analyst

Stephanie Wissink -- Jefferies -- Analyst

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