Regis Corporation

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. At this time, all participants are in a listen-only mode. Following management's presentation, we will conduct a question and answer session. If you would like to ask a question during this time, please press star one on your push button phone. If you wish to withdraw your question, please press star two. As a reminder, this call is being recorded for playback and will be available approximately 12 p.m. Central Time today. I will now hand the conference over to Faison McShane, AVP Finance. Please go ahead.

Good morning, everyone, and thank you for joining us. On the call today, we have Felipe Atayi, our Chief Executive Officer, Kirsten Zuffer, our Chief Financial Officer, Bill Lane, Executive Vice President of Portfolio Brands, and Amanda Ruffin, 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 AP filing also apply to our comments made on the call today. These documents can be found on our website, www.regiscorp.com backslash Investor Relations, along with any reconciliations 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.

Thank you, Beda. Good morning and thank you for joining us. Q2 of fiscal year 21 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 brand. So I want to start this 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 re-franchising, and our proprietary POS and salon management technology, Open Salon Growth. Outside of government-imposed restrictions and closures, the main factor impacting the hair salon business is the disruption of daily releases, 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 services. According to the December release of McKinsey's U.S. Consumer Sentiment During the Coronavirus Crashes survey, the level of concern of Americans when visiting a hair salon is lower than engaging in other activities such as dining in a restaurant, visiting a shopping mall, being at a hotel or using a ride-sharing service. At the heart of our confidence around the solid compact is the fact that our category has the potential to rebound in a way that does not apply to other retail and services. Simply put, you cannot get your haircuts 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 since salons reopened. 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 surveys and market research among salon boards point to our customers wanting to get back to their old teams quickly. When our teams resume, we believe visiting a hair salon will be top on people's priority list. For example, in states such as Florida, where daily routines have been leased disruptions, our comps are better by anywhere between 5 and 15 points. Lastly, we believe that Regions' 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 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 through a corporate prioritization that created three brand-centered teams, one for our largest brand, SuperCup, one for our Walmart-based brand, SmartStyle, and a third group called Portfolio Brands, representing our smaller growth and innovation concept. Each of these three groups are now led by a dedicated brand president with their independent team. Before the reorganization, Regus was broken down into OPPO and FRANCO 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, including brand strategy, performance metrics, and profitability. We're also changing the way in which we engage with our franchise partners from a passive, reactive stance to actually leading, nurturing, and growing our individual brand. 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 dual-based purchasing 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 company projects for companies such as Enhorser, Bush, and Bass, and Restaurant Brand International. The main component of our DDB 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 rank-centric, fully franchised business. Let me use our field-based franchise consultants as an example. Historically, our franchise consultants have had a reactive approach to supporting franchisees without establishing fees or properties. This will 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 consultants adjust their job description accordingly, set the processes and routines to be 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 connections. Although we will not complete the B2B process until later in Q4, We're taking action as we identify opportunities rather than waiting for the entire exercise to be complete. Moving on to our progress in re-franchising our remaining corporate salons, a process that is now under the leadership of a former Western Grand International executive who has also spent five years at G.P. Morgan as an investment banker. We have made an important change in approach when it comes to the full file of the buyers of our corporate salons. Up until now, the median purchaser of our condition salons would be sourced via a network of brokers and would engage in a core salon transaction. Although some of our new prospects are still coming from outside the region system, 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 each provide them with entry points into territories from which they would like to consolidate and grow organically. Finally, 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 roll-ups. 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 for developing technologies that increasingly automate our salons and manages the customer journey from digital demand generation to appointment booking 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 salons. As an example, we have fully integrated OSP with our merchandising shippers, so inventory can be automatically uploaded into the system upon delivery without the need for unproductive manual work from our salaries. Still on 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-up schedule of OSBs into our salons. As of today, we have about 1,000 salons with signed contracts for OSBs, of which more than 350 are live, with the rest of the migration soon following. Over the course of this calendar year, we will begin mandating the process so all of our grants can leverage our new technological capabilities. Back in December, we closely watched two companies, which provides software as a service to the beauty and wellness industry, raised substantial amounts of capital. We believe Open Siloam Pro is a formidable competitor to these services and are looking into the market opportunities of growing OSB beyond the region's 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 Zeltz.

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 the result of the COVID-19 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 8th. We reported an operating loss of $27 million 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 million, was $35 million unfavorable to the same period last year. It 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. 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 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 cooperative advertising funds, which is entirely offset in site operating expense. It 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 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 with the growth in our franchisees, 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 consumer 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 activities 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 769 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 at lease expiration and diluted 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 gain, excluding non-cash goodwill derecognition 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, non-essential GMA expenses. We've been receiving a number of questions about the state of Future G&A. As Felipe mentioned, in Q2, we initiated a ZDD, or a zero-based budgeting process. This is a very detailed, bottom-buffer approach that will take some time to complete. We are on track with both the ZDD and ZBL, or zero-based organization process, and we expect to be able to provide some visibility to interstate G&A during our first quarter of fiscal year 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 of 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 31st, 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 prospective supplement with the SEC to 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 at-the-market 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, OpenSwan 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 rents, pay fiscal year 2020 and executive bonuses, pay for insurance premiums for the year, and to terminate certain unprofitable leases. As it relates to projected cash use in the second half of the fiscal year, we continue to use cash as re-venditions go on, 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 venditioned 145 salons each quarter, which was consistent with Q1's pace. But this was intentional, and as we reviewed our venditioning strategy, moving from a resale approach to a wholesale approach. Since the beginning of the vendition process, salons were banditioned 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 years. As we work through the remaining company-owned portfolios, 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 owners 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 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 SmartValue and SuperCut Go On, which overstates the grant 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 $670 million balance sheet. To take it one step further, only 16% of the $420 million, or $70 million, is the lease exporter on the company-owned salon. For our discussion last quarter, you'll note a reduction in the lease liability. Approximately $73 million is directly related to Regis' strategy as we move to a fully franchised model of no longer being the primary tenant 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 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 sales 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 adjust with 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 reduce hours of operations and reduce traffic. Regus has 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 revenues. 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 CPP 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 franchisee can go to quickly and easily retrieve information regarding both U.S. and Canadian small business release 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 mandates. Moving on to trends in the business. Throughout the first half of our second quarter, 97% of the plans across our portfolio were open in some capacity. While hours of operation were 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 comps. The business was also impacted by mandated salon reclosures, primarily in California and Canada, which is not reflected in reported comps as the salons were closed. As of December 31st, 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 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 REGIS and I will now turn the call back to the operator.

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

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? For how many of the conversions have you identified a buyer?

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.

And hey, 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 re-franchising process, right? So we went to Kirsten's point from having, you know, an average transaction of, you know, four salon portfolios to steering towards our largest franchisees, you know, already in the system who want to grow and allow them the ability to, you know, 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 Kirsten's point about, you know, 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 want to make sure that we have the right franchisees going, 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. 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 vendition process moves through.

Understood. Thank you. Thank you, Laura.

We can now take our next question from Stephanie. We think of Jeffries. Please go ahead.

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 franchisee responsibility where you may have venditioned a 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 towards a franchise direct to landlord responsibilities? And then secondly, Felipe, maybe this one's for you. It was a little bit hard to 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 pros, 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. Thanks, Seth.

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.

Hey, it's Felipe here. So a little bit on the progress of OSV. So our focus, you know, this past quarter was to launch some functionalities that would automate, you know, 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. 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. Basically, there's an AI system that looks into the sales of that specific salon and places an ideal order that then the franchisee has the ability to 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 non-productive 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 alive. Remember, there's a few important buckets when it comes to OSB. One is, to my point, franchise profitability and just automation of activities that can be automated by the system instead of manual work. Our ability to leverage transactional level data. So, you know, 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, you know, DesignLine and Blossom, you know, it's going to allow us to gather much more intelligence around, you know, not only our third-party brands, but our, you know, private label brands as well, right? So we can optimize, you know, 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, you know, based on local tastes and all of that. And lastly, you know, the ability for us to have, you know, consumer tech capabilities that will drive, you know, traffic and loyalty, right? So we've had, you know, 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, the top five brands to have some sort of loyalty program in the future that will be powered by Open Salon Pro, right? So now that these capabilities are in place and live, and especially on the cost-saving side, you know, we're going to push Open Salon Pro much more aggressively. And, you know, from now through the end of the year, you know, it will become a brand standard for all of our brands, and we will announce a system-wide mandate.

That's great. One follow-up on Open Salon Pro. Maybe, Kristen, this is just for you, but the investment on the front end was quite high. With Felipe's comments of 1,000 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? 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 salons?

Yeah, good question. Unfortunately, we haven't disclosed the actual amount of what we've invested in in Open Salon Pro, but as we roll out Open Salon 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 Open Salon Pro has been incurred. So, you know, going forward, the majority of that revenue stream, the monthly revenue stream associated with Open Salon Pro, drops down to EBITDA. Excellent. Thank you very much.

Thank you, Steph.

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

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.