Regis - Earnings Call - Q2 2021

Transcript

Speaker 0

Ladies and gentlemen, thank you for standing by. Welcome to the Regis Corporation Second Quarter Fiscal Year twenty twenty one Earnings Call. My name is Mary, and I will be your As a reminder, this call is being recorded for playback and will be available approximately twelve p. M.

Central Time today. I will now hand the conference over to Bismuth Shane, AVP Finance. Please go ahead.

Speaker 1

Good morning, everyone, and thank you for joining us. On the call with me today, we have Luisa Anteti, our chief executive officer Kristen Zephyr, our chief financial officer Gil May, Executive Vice President of Portfolio Brands and Amanda Ruffins, our General Counsel. Before turning the call over to Felipe, I would like to remind everyone that the language on forward looking statements included in our earnings release and eight ks 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 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.

Speaker 2

Thank you, Ben. Good morning, and thank you for joining us. Q two of fiscal year twenty one represents the first three months of my four month tenure every year. 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 I want to start to 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 lead franchisee, and our proprietary POS and salon master technology, OpenSalon Pro. Outside of government imposed restrictions and closures, the main factor impacting the hair salon business is the disruption of daily routine rather than people's desire to permanently change hair salon habits. Customers are socializing less and working from home more, both of which are typical demand drivers for our service. According to the December release of McKinsey's US consumer sentiment during the coronavirus crisis survey, the level of concern of Americans with visiting a hair salon is more than engaging in other activities such as dining in a restaurant, 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 rebound in a way that does not apply to other retail and service.

Simply put, you cannot get your haircuts online, and few people are willing to give or receive haircuts at home. Our stylists have been correctly leave yourself hair colors every day, and sales of at home hair color products have slowed down and salons reopen. We're confident that most hair salon services cannot be replaced or replicated. As our teams continue to roll out and offices reopen throughout the year, our service and market research among salon board worked for our customers wanting to get back to their overseas quickly. When we pay for Zoom, we believe visiting a hair salon will be top on people's priorities.

To be careful, in states such as Florida, where daily routines have been used to substance, our comp are better by anywhere between five and fifteen points. Lastly, we believe that Regions' focus on value brand will be an important strength during uncertain economic times and will provide a cost effective alternative to higher priced salons. In our first earnings call, I mentioned my goal to make Regions into 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 to a corporate organization that created three brand entities. One for our largest brand, Supercuts, one for our Walmart based brand, Smart Style, and a third group called Portfolio Brands, representing our smaller growth and innovation process.

Each of these three groups are well led by a dedicated brand president with their independent teams. Before the reorganization, we just have broken down into opco and francol with brand agnostic teams. In other words, one group was managing salons while the other was managing franchise relations. No specific executive or team was accountable for any of our individual brands. Moving forward, each brand president will have full accountability for their respective brands, brand strategy, performance metrics, and profitability.

We're also choosing the way 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 for our franchisees and shareholders over time. I also wanted to provide you with an update on our zero based purchase process, which has been underway for the past three 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 funding projects for companies such as Inwater, Bush, InBev, and Restaurant Brands International. The main component of our DVD process is a zero based organizational design.

In other words, we're designing our entire organizational structure from the ground up based on the roles and capabilities that we will need as a brand centric fully franchised business. Let me use our field based franchise consultant as an example. Historically, our franchise consultants have had a reactive approach to support franchisees without establishing fees or processes. This will result in a lot of inefficiencies and non value added activities. The zero phase organization process first sets the goals to be achieved by our franchise associates, adjust their job description accordingly, test the processes and routines that is performed by them along with the scope of the routine 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 next. Although we will not complete the BBB process until later in q four, we're taking action as we identify opportunities rather than waiting for the entire exercise to be complete. Moving on to our progress in refranchising our remaining corporate salon, a process that is now under the leadership of a former reference branch international executive who has also spent five years at JPMorgan 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 leading purchaser of our vendition salons will be sourced via a network of brokers and would engage in a forced salon transaction.

Although some of our new prospects are still coming from outside of the ecosystem, 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 territory or which provide them with entry points into territories from which they would like to consolidate and grow organically. So the individual transactions in our current pipeline involve portfolios with more than a 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 wanted to share some of our progress on our proprietary POS and salon management system, Open Salon Pro. We continue to move forward towards developing technologies that increasingly automates our salons and manages the customer journey from digital demand generation to corporate bookings to payment 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 salons.

As an example, we have fully integrated OST with our merchandising shipper so inventory can be automatically uploaded into the system upon delivery without the need for unproductive manual work from our salads. Through our merchandising, we have also released an algorithmic replenishment capability, which auto creates product orders for 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 roll off schedule of OSB into our salons. As of today, we have about a thousand salons with signed contracts for OSB, of which more than three fifty are live, with the rest of the migration soon following. Over the course of this calendar year, we will begin mandating the platform so all of our brands can leverage our new technological capabilities.

Back in December, we closely watched two companies, which provide software as a service to the beauty and wellness industry, raise substantial amount of capital. We believe both from salon pro is a formidable competitor to these services and are looking into the market opportunity of growing OSV 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, Kristen Zucker.

Speaker 1

Thank you, Felipe, and good morning. Yesterday afternoon, we reported on a consolidated basis second quarter revenues of $104,000,000 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 a result of the COVID-nineteen pandemic. California, certain areas in Canada, primarily Ontario, and a small amount of one off locations experienced government mandated 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 $27,000,000 during the quarter, mostly driven by the economic disruption caused by the pandemic, as it has been since the last quarter of our prior fiscal year. Second quarter consolidated adjusted EBITDA loss of $18,000,000 was $35,000,000 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 $18,000,000 and the planned elimination of the EBITDA that had been generated in the prior year period from the net seven sixty eight company owned salons that have been sold and converted to the franchise portfolio over the past twelve months. Traffic 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 $20,000,000 decreased $9,000,000 or 32% versus the same quarter last year.

The majority of the year over year decline was due to a $6,000,000 decline in corporate and advertising funds, which is entirely offset in site 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-nineteen. The decline in same store sales impacted royalties and cooperative advertising funds. As I mentioned earlier, government mandated temporary closures, most significantly in California and Canada, also contributed to the decline in royalties and fees. Offsetting these segment declines was the growth in our franchise base, which now represents 84% of our portfolio.

Product sales to franchisees decreased $3,000,000 year over year to $14,000,000 driven primarily by the decline in same store traffic. Second quarter franchise adjusted EBITDA of $11,000,000 declined approximately $2,000,000 year over year, driven by reduced royalties as a result of the COVID-nineteen 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 $38,000,000 a decrease of $91,000,000 or 71% versus the prior year. The impact of COVID nineteen along with the year over year decrease of 1,240 company owned salons over the past twelve months were drivers of the decline. The decrease in company owned salons can be bucketed into two primary categories.

First, the conversion of 769 company owned salons to our asset light franchise platform over the course of the past twelve months, of which a 145 were sold during the quarter. Second, the closure of approximately 477 company owned salons over the course of the last twelve months, most of which were underperforming salons at lease expiration and dilutive to our profitability. Second quarter company owned salons segment adjusted EBITDA decreased $15,000,000 year over year to a loss of $11,000,000 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 twelve months. As it relates to corporate overhead, second quarter adjusted EBITDA decreased $17,000,000 to $18,000,000 and is driven primarily by the $18,000,000 decline in net gains, excluding noncash goodwill derecognition in the prior year from the sale and conversion of company owned forum, partially offset by the net impact of management initiatives to eliminate noncore, nonessential g and a expense. We've been receiving a number of questions about the state of future g and a.

As Felipe mentioned, in q two, we initiated a DVD or a 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 DVD and DVL for a zero based organization process, and we expect to be able to provide some visibility to end state g and a during our '22. 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 funds 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 $150,000,000 This includes $99,000,000 of available revolver capacity and $51,000,000 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 twelve months. Yesterday, we filed a shelf registration and prospective supplement with the SEC under which we may offer and sell shares of our common stock through at the market offers. 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 the 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, OpenSwanPro. In the second quarter, we used $37,500,000 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 $20,000,000 to catch up on vendor payments and rent, pay fiscal year twenty twenty and executive bonuses, pay for insurance 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 we vendition 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 use to be less in the second half with cash use improving sequentially each quarter. We've venditioned 145 salons this quarter, which was consistent with Q1's pace. But this was intentional, and as we reviewed our venditioning strategies, moving from our retail approach to a wholesale approach. Since the beginning of the vendition process, salons were venditioned 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 an orderly fashion over their remaining lease term. 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 that salons cannot be appropriately bundled with other salons to form sellable portfolio. 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 closures to be towards the low end of the 600 to 800 range. On the balance sheet, I want to remind you that the lease liabilities on our balance sheet of $659,000,000 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 SmartVal and Supercuts one, which overstates the rent payments that we just have committed to. Excluding the option period, our total lease liability would be approximately $420,000,000, which is approximately $250,000,000 flat from the $6.70 shown on our balance sheet.

To take it one step further, only 16% of the 420,000,000 or $70,000,000 is the least exposure on the company owned block. For our discussion last quarter, you'll note a reduction in the lease liability. Approximately $73,000,000 is directly related to revisit strategies

Speaker 2

as we move to

Speaker 1

a closed franchise model of no longer being the primary tenant on real estate leases where allowed by franchise agreement. 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 trends. 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, post pandemic traffic levels, and the fact that some salads are struggling to return to work as their children are home from school. However, there are inherent components 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 adjusts the fluctuating sales such as royalties, advertising funds, and certain brand structures, primarily our 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. We just have also adjusted collections across 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 with up to date, easy to find, PPP 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 go to quickly and easily retrieve information regarding both US and Canadian small business service efforts, in addition to all of the internally built 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 far and open quickly and safely upon the listing of any closure mandate.

Moving on to trends in the business. Throughout the first half of our second quarter, 97% of the bonds across our portfolio were opened 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 given reduced travel and decreased family and social gatherings as reflected in our reported comp.

The business was also impacted by mandated salon closures, primarily in California and Canada, which is not reflected in reported comp as a flaw of results. As of December 31, approximately 85% of the system was open. This has now improved to 89% at the January. While traffic is still well below pre pandemic levels, January average volumes for open stores are rebounding back to similar levels to those we have seen in the late summer months. While we recognize that some of the historical seasonality has been altered post 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 as restrictions lift. I would like to thank you for your continued support and interest in Regions, and I will now turn the call back to the operator.

Speaker 0

Thank you, Felipe and Kirsten. The question and answer session will begin at this time. We can take our first question now from Laura Champine of Alun Capital. Please go ahead.

Speaker 3

Thanks for taking my question. It's on the trajectory of selling off the remaining company owned locations. I heard, Kirsten, 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?

Speaker 4

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

Speaker 5

Hey, Laura, Felipe here. Look, the main concern that we had in this process, you know, throughout the past quarter was a change in direction when it comes to the refranchising process, right? So we went, to Kirsten's point, from having an average transaction of four salon portfolios to steering towards 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 Kristen'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 we wanna make sure that we have the right franchisees growing, and we're also bringing you know, new blood into the system. I mean, think people who have, you know, operated other franchise brands outside of hair salons or, you know, broader retail as well. Right? So it's less about, you know, the ability to finance and more about us wanting to bring in a slightly different type of incoming franchisee as the vendition process moves through.

Speaker 2

Understood. Thank you. Thank you, Laura.

Speaker 0

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

Speaker 6

Thank you. Hello, everyone. We have two follow-up questions if we could. Kristen, 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 the franchisee responsibility where you may have venditioned the salon and you might still be the master tenant on that lease.

Speaker 1

Can you just help bring us up to speed on

Speaker 6

where you are in rolling off some of those master and minor roles more towards a franchise direct to landlord responsibility? And then secondly, Felipe, maybe this one's for

Speaker 4

you is it was a little bit hard to

Speaker 6

hear some of your comments on merchandising, product development, and the rollout of Open Salon Pro. So if we 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 Open Salon Pro, you could just remind us where you are in the rollout of that, how many salons are in test or are actively using it? Maybe some of the initial feedback would be great. Thank you.

Speaker 4

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, you know, more flexibility in terms of communication and being able to negotiate leases and having that relationship with their landlord. So like I said, it's happening as leases come up for renewal.

Speaker 5

Hey, Steph. Felipe here. So a little bit on the progress of OSV. So our focus this past quarter was to launch some functionalities that would automate some of the manual, non value added activities in the salons. 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 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 and and places an ideal order that then the franchisee has the ability to edit as they please. So we wanted to make sure that before we pushed Open Salon 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 OSB in the next few weeks and months, of which 350, just north of 350 are live. You know, remember, there's there's a few important buckets when it comes to OSB. One is, you know, to my point, you know, franchise profitability and the, you know, 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, we'll be able to better drive traffic and check.

And to your point about DesignLine and Blossom, it's gonna 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 tech 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, you know, top five of the past five brands to to have some sort of loyalty program in the future that will will be powered by by Open Salon 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 system wide mandate.

Speaker 6

That's great. One follow-up on OpenSwamp Pro. And maybe, Kristen, this is best for you. But the investment on the front end was quite high. With Felipe's comments of a thousand salons potentially on the system here in the very near term, where are you in that pathway towards covering that cost on an annual basis?

So 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 open salon?

Speaker 4

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

Speaker 6

Excellent. Thank you very much.

Speaker 5

Thank you, Steph.

Speaker 0

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

Speaker 5

Thank you, Mary. And I apologize, everyone. I heard from a few of you there have been a few technological issues on the audio side. We're gonna post, obviously, 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, q three progress. Thank you, and have a great day.

Speaker 0

This concludes today's call. Thank you for your participation. You may now disconnect.