Regis Corporation (RGS) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Regis Corporation Second Quarter Fiscal 2020 Earnings Call. My name is Britney, and I will be your conference facilitator today. [Operator Instructions]. As a reminder, this call is being recorded for playback and will be available by approximately 12:00 p.m. central time today. I'll now turn the conference call over to Biz McShane, AVP Finance.

Thank you, Britney. Good morning, everyone, and thank you all for joining us. On the call with me today, we have Hugh Sawyer, our Chief Executive Officer; Kersten Zupfer, our Executive Vice President and Chief Financial Officer; Eric Bakken, President of Franchise segment; and Amanda Rusin, our General Counsel. Before turning the call over to Hugh, there are a few housekeeping items I'd like to address. First, yesterday's earnings release and today's conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of performance, and by their nature, are subject to inherent risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current earnings release and recent SEC filings, including in our most recent 10-Q and June 30, 2019 10-K, for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. Second, this morning's conference call must be considered in conjunction with the earnings release we issued yesterday and our previous SEC filings, including our most recent 10-K. On today's call, we will be discussing non-GAAP as adjusted financial results that exclude the impact of certain business events and other discrete items. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons but should not be considered superior to or the substitute for our GAAP financial measures and should be read in conjunction with GAAP financial measures for the period. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in yesterday's release, which is available on our website at www.regiscorp.com/investor-relations. With that, I will now turn the call over to Hugh.

Thank you, Biz, and good morning, everyone. Our guiding principle at Regis is to generate long-term value for our shareholders and key stakeholders. In that regard, I was honored to be asked to chair our company's Board of Directors, in addition to my continuing role as President and Chief Executive Officer. I believe that assuming the Chairman's role will help ensure continuity of leadership in our multiphase transformational strategy, during a period of ongoing change. The second quarter does represent an important milestone where we gained greater clarity into the end date of our portfolio transformation. Based on our year-to-date results and a robust pipeline of potential transactions, we now believe that our transition to a fully franchised business will be substantially complete by the end of this calendar year. This improved visibility into the cadence of our portfolio transition enabled us to begin meaningful reductions in our cost structure and to initiate other plans we have for the business, including reengineering our capital structure so that it will be appropriate for a fully franchised capital-light growth platform. We are pleased to report this quarter that we continue to make meaningful progress in our ongoing strategic transformation to a capital-light, high-growth franchise company. In August of 2019, we estimated that it would take us 18 to 24 months to complete our conversion to a fully franchised portfolio. However, due to the success we've had in the first half of fiscal year 2020, we expect that we will substantially complete this conversion at a somewhat earlier date than we originally anticipated. In the first half of fiscal 2020, we have converted 988 salons to franchise owners, with line of sight to the sale of approximately 900 additional salons. This means that net of closing roughly 350 to 500 underperforming salons, which typically occurs at lease expiration. We have approximately 50% of the remaining company-owned salon portfolio in the pipeline at various stages of transition. As of December 31, nearly 70% of our portfolio is now franchised. And you may recall that when I began my tenure as CEO in April of 2017, our salon portfolio was roughly 28% franchised and 72% company-owned. So by any measure, very significant progress in our portfolio transformation. As I mentioned, our transition to a fully franchised model has been occurring at a rapid pace. And as a result, we have been thoughtful and intentional in our plans to begin more aggressive expense reductions. In January, we announced actions that will reduce G&A by approximately $19 million on an annualized basis. As we consider the magnitude of these planned G&A reductions, we decided to schedule our actions at the beginning of the third quarter, as we recognized by scheduling the execution of these G&A reductions in January would dilute our second quarter results, given the increased pace of our venditions. However, we wanted to ensure that our actions to reduce expense did not create an unacceptable level of risk to the stability of our company-owned salons and corporate operations. We expect to consider further G&A reductions as we draw closer to the end date of our transition and gain additional visibility into our path to sustainable growth. Further, we believe it is the right time to redesign our capital structure so that our debt facility is better suited for a company that is now 70% franchised. We recently engaged Guggenheim Securities to help us design the optimal capital structure for what is now a franchise business. Guggenheim has an outstanding track record of success in working with large franchisors and assuming continued favorable market conditions, we anticipate that this process will be successful and that we will complete our replacement financing no later than the fourth quarter. Once we have completed our financing, we anticipate that we will continue to make investments to prepare the company for the growth phase of our multi-phase transformation. This could include additional investments in the following franchisor capabilities: frictionless customer-facing technology; the company's new internally-developed back office salon management system, which is now in beta; disruptive marketing and advertising; print driven merchandise, including investments we have made in a new private label brand, we've named Blossom, and the relaunch of our historically successful DESIGNLINE brand. Ongoing investments in stylists' recruiting and education and then stylists and franchise partner education will also be considered. We may also utilize our cash in the next 18 months to complete any remaining elements of our multiyear restructuring, including closing nonperforming company-owned salons, when it's justified by the economics, although our operational bias is typically to manage these salons to lease expiration; paying down some debt, we determined that it's wise to do so; supporting our ongoing G&A reductions through severance programs and if needed, capital investments in salon refurbishments and remodels as we consolidated our various brands into what we have called the Fab 5. And as you all know, we have utilized cash to repurchase our shares in circumstances where we believe that would be in the best interest of our shareholders. We decided to push the pause button on share repurchases during the second quarter in order to reduce our debt levels and continue investments in other growth initiatives. Upon completion of our refinancing, management and the board will continue to assess our capital allocation strategies on a periodic basis as we have done historically. Despite the inherent variability and near-term risks associated with our transformational strategy, we remain convinced that a fully franchised business has the potential to generate a higher return on its capital and will prove to be in the best long-term interest of our shareholders and franchise constituents. We do have a significant amount of work ahead of us in order to substantially complete the portfolio transformational phase of our strategy by calendar year-end. However, we are determined to bring this phase to a conclusion so that we can continue to shift our time and energy in our talent toward the organic growth phase of our strategy. Although conditions could change, we have growing confidence in our plan and our ability to successfully execute our multiphase transformation. Our restructuring and portfolio transformational phases are each moving rapidly toward their end dates. And we intend for Regis to be well positioned for its growth phase, a period we expect to generate sustainable revenue and earnings in the years ahead. With that, I'll ask Kersten Zupfer, our Chief Financial Officer, to take us through the numbers. Kersten?

Thanks, Hugh, and good morning. As you mentioned, we are pleased to share significant progress in our transition to a fully franchised model. Yesterday, we reported on a consolidated basis, second quarter revenues of $208.8 million, which represented a decrease of $65.9 million or 24% versus the prior year. The year-over-year revenue decline was driven primarily by the conversion of a net 1,447 company-owned salons to the company's franchise portfolio over the past 12 months and the closure of 172 salons, of which the majority were cash-flow negative and not essential to our future plans. When targeting salons for closure, our bias is to exit the location at lease expiration, unless the economics justify a course of action to buy out of the lease early. The headwinds in the quarter were partially offset by a $5.8 million increase in franchise revenues and $33.6 million of rent revenue recorded in connection with the new lease accounting guidance adopted in the first quarter of fiscal 2020. Second quarter consolidated adjusted EBITDA of $17 million was $3.6 million or 17.5% unfavorable to the same period last year and was driven primarily by the elimination of the EBITDA that had been generated in the prior period from the net 1,447 company-owned salons that had been sold and converted to the franchise portfolio over the past 12 months. Second quarter adjusted EBITDA was also impacted by lower comps, minimum wage increases and strategic investments in technology. We believe our comps may have been impacted by fewer retail days between the Thanksgiving and Christmas holidays. The decline in adjusted EBITDA was partially offset by a $5.6 million increase in the gain associated with the sale of company-owned salons. Excluding discrete items and the income from discontinued operations the company reported decreased second quarter 2020 adjusted net income of $4.6 million or $0.13 earnings per diluted share as compared to adjusted net income of $8 million or $0.18 earnings per diluted share for the same period last year. The year-over-year decrease in adjusted net income was driven primarily by the elimination of adjusted net income that had been generated in the prior year from salons that were sold and converted to the company's asset-light franchise portfolio over the past 12 months. On a year-to-date basis, consolidated adjusted EBITDA of $46.8 million was $1.1 million or 2.3% favorable versus the same period last year. The year-over-year favorability was driven primarily by a $24.7 million increase in the gain, excluding noncash goodwill derecognition related to the year-to-date sale and conversion of 988 company-owned salons to the franchise portfolio. Excluding the impact of the gains second quarter year-to-date adjusted EBITDA totaled $5.6 million, which was $23.7 million unfavorable year-over-year and like the second quarter results, this unfavorable variance is also driven largely by the elimination of EBITDA related to the sold and transferred salons over the past 12 months. As you noted, we disclosed at the close of fiscal year 2019 that our transition to a capital-light franchise model would initially have a dilutive impact on the company's adjusted EBITDA. So this decline in our reported adjusted EBITDA was not unexpected. Nevertheless, please note that as we continue our transition, we are certainly paying attention to cash from operations. As you know, we do not provide guidance. However, assuming no unexpected changes in market conditions and after adjusting for unusual and transition-related items. Our objective is for our run rate trajectory to be cash flow positive in the fourth quarter as we accelerate into the end state of our transition. Looking at the segment-specific performance and starting with our franchise segment second quarter franchise royalties and fees of $29.3 million increased $6.7 million or 29.8% versus the same quarter last year, driven primarily by increased franchise salon counts. Product sales to franchisees decreased to $1 million year-over-year, to $16.9 million, driven primarily by a $6.5 million decrease in products sold to TBG, partially offset by increased franchise salon counts. Franchise same-store sales was unfavorable 1.4%, and we believe may have been negatively impacted by the reduced retail days between Thanksgiving and Christmas. As a reminder, franchise same-store sales are calculated in a manner that is consistent with how we calculate our same-store sales in our company-owned salon portfolio and represents the total change in sales for salons that have been a franchise location for more than 12 months. As we are in this transition phase, salons are leading company-owned comps but not entering franchise comps for 12 months, which adds temporary noise to same-store sales comparisons. Further, as we've previously discussed, our comps represent salon transactions and are not necessarily a precise representation of customer traffic in the traditional retail sense. Second quarter franchise adjusted EBITDA of $13.1 million grew approximately $4.6 million year-over-year, driven by growth in the franchise salon portfolio and better leverage of our cost structure, partially offset by lower margins on franchise product sales. We believe that the franchise portfolio may have been temporarily challenged by the operational complexity of onboarding new owners and transitioning salons to a more -- to our more experienced owners, among other factors. With the revenue recognition and the lease accounting guidance we have adopted over the last 2 years as well as sales of merchandise to TBG at cost, our EBITDA margin percentage is not comparable year-over-year. After adjusting for the noncontributory revenue associated with ad fund revenue, franchisee rent revenue and TBG product sales EBITDA margin was approximately 37.5%, which is approximately 4.2% favorable year-over-year and is in line with where we would expect it to be. Year-to-date, franchise adjusted EBITDA of $24.9 million grew approximately $6.6 million or 36% year-over-year. Now looking at the company-owned salon segment, second quarter revenue decreased $105.3 million or 45% versus the prior year to $128.9 million. This year-over-year decline is driven and consistent with the decrease of approximately 1,598 company-owned salons over the past 12 months, which can be bucketed into 2 main categories. First, the conversion of 1,498 company-owned salons to our asset-light franchise platform over the course of the past 12 months. These net company-owned salon reductions were partially offset by 51 salons that were brought -- bought back from franchisees over the last year and 21 new company-owned organic salon openings during the last 12 months, which we expect to transition to our portfolio in the month's end. Second quarter company-owned salon segment adjusted EBITDA decreased $17 million year-over-year to $4.2 million. Consistent with the total company consolidated results, the 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. The quarter was also impacted year-over-year by increases in stylist minimum wage and styles commissions and a decline in same-store sales in our company-owned salon. As you might expect, we are carefully monitoring our company-owned salons as we continue through our transition. Our objective is to maintain focus and stability in those salons until they are venditioned. On a year-to-date basis, company-owned salon consolidated adjusted EBITDA of $15.7 million was $33.2 million unfavorable versus the same period last year. The unfavorable year-over-year variance is driven by the elimination of the adjusted EBITDA related to the sold and transferred salons over the past 12 months, partially offset by management initiatives to rightsize the source structure in the field. Of course, it's important to note that our company-owned salon performance will continue to become less critical to the future trajectory of our business as we accelerate our conversion to franchise. Turning now to corporate overhead. Second quarter adjusted EBITDA of $0.3 million increased $8.8 million and is driven primarily by the $15 million of net gains excluding noncash goodwill derecognition from the sale and conversion of company owned salons, the net impact of management initiatives to eliminate noncore, nonessential G&A expense and lower year-over-year incentive and equity compensation. In January, based on the improved visibility into the speed of our transition, we began meaningful reductions in our expenses. By eliminating approximately 290 positions, including 15 contractors across the U.S. and Canada, which is expected to result in approximately $19 million of annualized G&A savings as the company accelerates into its multiyear transformation. We expect the removal of these G&A costs will also positively impact the company's cash from operations in the back half of fiscal 2020 and in future periods. Lastly, I wanted to point out that vendition cash proceeds during the second quarter were approximately $71,000 per salon compared to approximately $69,000 per salon in the first quarter of our fiscal 2020, which is consistent quarter-over-quarter. However, as we vendition more Signature Style salons this fiscal year, we may have lower net proceeds per salon due to the cost of converting some of these salons as part of our brand consolidation efforts, along with more SmartStyle venditions. Looking now at the balance sheet. At the end of the quarter, we made a decision to pay $30 million towards our outstanding debt, which decreased our cash balance to $49.8 million as of December 31, 2019. We paid down the debt to remain in compliance with the net leverage covenants that are part of our existing credit facility. Given our successful vendition process, we have known for some time that our existing credit facility would not be appropriate for our end state franchise business and that we would need to reengineer our credit facility to meet the opportunities inherent in our new business model. We believe we now have the visibility and facts that we need to move forward with our refinancing efforts. After careful consideration, we retained Guggenheim because they have a strong track record of establishing capital structures for growth-oriented franchise companies. We expect a successful outcome in our refinancing efforts and to complete the process, no later than the fourth quarter of this fiscal year. Turning now to cash flow. I thought it might be helpful to provide a high-level reconciliation of how we see adjusted EBITDA flow-through to cash from operations and our free cash flow. When looking at the cash flow statement, the single largest use of cash is approximately $17 million use of working capital. As we noted in the prior quarter, this net use of cash is significantly impacted by cash outlays associated with the wind down of company-owned salons as we convert to a fully franchised platform, including transaction-related payments and severance payments related to restructuring our field teams to better align with our future state. As you noted, we also invested in our new Blossom brand of our private label merchandise, which was received in December and will be in the salons in the spring. We have also invested in the repackaging and reformulation of our historically successful DESIGNLINE private label brands. In addition to change in working capital, when reconciling the adjusted EBITDA to operating capital, you will need to take into account the fact that the $41.2 million net gain from the conversion of our company-owned salons to the franchise platform are included in our net income and adjusted EBITDA but not included in cash from operations as the proceeds are reported as inflows in the investing section of the cash flow statement. I also wanted to provide a brief update on TBG. At the end of December, TBG transferred back to Regis 207 of its North American mall-based salons, a roughly 10% of the company's portfolio. When TBG approached Regis about their financial situation in late 2019, we just determined that acquiring the salons, where we just had continuing obligations under real estate leases, would provide greater control over the outcome and maximum optionality for these locations. This was always a previously considered strategy for these salons. The remaining lease liability associated with the TBG salons is approximately $30 million and Regis will operate the salons until lease end date or until a new franchise owner is identified. Essentially, we are now managing these salons in the normal course and will treat the former TBG salons as we would any other location in our company-owned salons portfolio. We continue to believe the overall transaction, which was always intended to mitigate the company's lease obligation on these salons, was a financial and strategic success. As a reminder, when we executed the original transaction with TBG back in October of 2017, the lease liability for the mall-based portfolio was approximately $140 million, and as noted, is less than $30 million today. With that, I'd like to thank you for your continued and -- support and interest in Regis. And we'll now turn the call back to Britney for questions.

[Operator Instructions]. And our first question will come from Stephanie Wissink with Jefferies.

This is Sebastian Barbero for Stephanie Wissink. Just had a couple of questions and a couple of follow-ups, if I may. The first one, the comp sales performance of the system and franchise level, any further explanation for the December quarter step down and how has the business performed post-holiday? And the second one, on the product sales to the core franchisees were up nicely year-over-year. Can you talk about the initiative, including the rebranding and updating of your private label brands? And what percentage of product sales are now private label? And do you believe there's a room to advance on that percentage?

Why don't I take the first part of the -- both questions, and I'll toss it to Eric for follow-up on franchise. We still have a high degree of confidence in the ability of our franchise partners to grow their service and product sales at the salon level. We do believe strongly that they were impacted by the retail days that occurred between the holidays, the compressed retail days between the holidays of Thanksgiving and Christmas. So we don't have a high degree of concern about our partners' ability or franchise partners' ability to grow their businesses with [Technical Difficulty] hypothesis from the beginning has been that when you turn these salons over to local owners who are entrepreneurial and they put their own capital to work, they tend to be highly focused on growth and performance. But it's also important to remember that the vendition process is a distraction for all of us. It's a distraction for the corporation. And it's a distraction for new franchisees and our legacy franchisees who take control of salons that we're venditioning. But that's transitional in nature. And we're coming to the end state of that, and I still feel very confident that our franchise partners will grow their businesses and all the historical data that we have confirms that. As to the new private label brands, Blossom and DESIGNLINE, DESIGNLINE has been an important part of our company for years, and it's been extremely successful with great margins. We repackaged DESIGNLINE and reformulated DESIGNLINE to support future growth initiatives and that's relaunching prior to the summer. And Blossom is a brand-new product line that's been reformulated with an emphasis on sustainability. And so we feel very optimistic about both of those launches. We don't yet know what percentage of merchandise sales it will represent in the future years. But we're very well aware of the success other retailers have had with private label, including Target and Walmart, and we're watching their results. So we got behind this initiative and supported it, and we're optimistic that it will become an important part of our merchandise offering for our franchisees and for the end consumer. And Eric, you can build on -- please do build on all of that.

Sure. Thanks, Hugh. So this is Eric Bakken. As it relates to the comps, if you peel back the layers a little bit, for the quarter Supercuts, on the Service side, was still positive, up 0.1%. And we were negatively impacted in December for the reasons that both Hugh and Kersten mentioned. If you look at year-to-date, Supercuts on the Service side was up 0.9% and then overall franchise Service was up 0.3% in the year-to-date numbers. So we saw some negative impact in December, and in December, our service comp in franchise was off 2.5%. So that really hurt our numbers, it's an important month, but we're confident that we'll see the numbers bounce back as we go forward. As it relates to retail, just 1 item that I would mention on the franchise side. So when we transfer stores to franchisees on the corporate side, we utilize auto-replenishment. So that is all centralized here in Minneapolis. When we converted the stores to franchise, they did not have that model in place. So we've developed that now internally, and we're able to provide a very similar replenishment model for our franchisees, it's called auto guided ordering. And the only difference is that the franchisees can decide if they want to modify what we suggest that they order. So we now have north of 500 locations on auto guided ordering, and that number will grow. We're making some technology enhancements to it to make it work more effectively and efficiently. And we expect, as I said, that number to grow as we go forward.

Got it. And one more, if I may. Could you please reiterate the bridge to a $12,500 in G&A per salon and how do marketing costs get accounted for in the future? And this does include tech investment?

So the marketing is not included in our G&A line, that marketing, advertising expenses are included in the site operating line. As we move to a fully franchised entity platform those marketing and advertising costs will be borne by the ad fund. The 12.5% as it relates to the G&A per store, some of the guidance that we have provided in the past, that does include technology spend in the G&A of the 12.5%.

And to emphasize Eric's point, which is an important one, the auto guided ordering is enabling merchandise growth through technology. It essentially is a lift and shift of the historical capability we had in OpCo that we did not yet have fully integrated and franchised. Where they can make informed judgments, our franchise partners can they conform judgments by utilizing that technology. So it's an important initiative. And as Eric noted, we have about 500 of the franchise salons enabled but we're going to continue to migrate that throughout the platform.

Our next question comes from Laura Champine with Loop Capital.

It strikes us that you paid down debt in the quarter, although the goal with Guggenheim is to raise debt, were there EBITDA covenants that were at risk of being violated? Is that why you paid down debt in the quarter?

It wasn't -- well, our intent with Guggenheim, Laura, is -- our intent with Guggenheim is not to raise that, but it's a debt replacement facility. We'll scale that facility that we put in place for the franchise business. The prior facility, I suspect, would -- if you do the comparative analysis would be larger than what we will need going forward. We look at some of the covenants that were in the existing historical facility. And we knew that some of the net leverage ratios would not -- could not be supported by the future franchise business. But we -- Laura, we've known this for months, maybe a year. We just wanted to time our entry into the debt markets at the right moment. And as you well know, the debt markets are robust today, and there's a lot of money out there to put to work. And so we feel good that we've selected the right moment in time when we have the visibility we need to make informed judgment. We could have proceeded down this path earlier, but we didn't have all the visibility or facts when needed. So the simple way to think about it is we had a an old facility that was designed for a different time and a different company, and it just simply is not structured correctly for the future state of the business. So it's bound to make that transition, too.

Understood. With the shortened calendar, can you look back to the last time we had that same calendar and tell us how much that impacted comps then? Because it's just tough to parse out what's going on with disruption versus the calendar in December?

I'll take the first -- go ahead, Kersten. The answer is yes. We did actually go back and price back through the history and then -- that's a good question, Laura, because we -- it doesn't happen very often, but it's always academically interesting until it happens to you [Technical Difficulty].

Dearest to us that, that haircut that haircut or color that occurred before the Thanksgiving holiday, and we picked up in early January, at some point in January.

Got it. And then lastly, if it's -- if you had more of a haircut, but you still would've comped negatively, how do you get comfort that your investments in tech are working? So the relationship with Google, it's been long enough, I would think, for it to have an impact. You've had the group in Silicon Valley for a while. So how do you get comfort that those tech investments are the right thing to do with the comps getting worse, not better?

Laura, as you may remember when we started down the path of technology investments, the board was quite focused on generating the appropriate return on those investments and to help govern the process, we went out and recruited a world-class Director Virginia Gambale, who, if you've had a chance to look at her bio, she is extraordinarily gifted in the technology space. And so we convened the tech committee of the board on a quarterly basis to make certain that we are utilizing our shareholders' money in a good way, and we continue to feel good about the technology investments we're making. When you think about it, break it into 3 buckets. Bucket one is demand gen, which is open salon, which essentially gives us access to users of Facebook Messenger, Alexa and Google through all the Google search functions, but particularly important, Laura, is the investments that we've made in our back office salon support capability. That program is in beta. And as you think about that back office support capability, think about it as a fee-generating capability that will begin to migrate this year and -- calendar year. And as to the third components of technology, we've just publicly disclosed on prior calls that we know we need to make an ERP conversion at some point in the process, and we're looking at various options in that regard as well. We need to bring reaches into the modern age on our back office technology functionality, and we're beginning to think about that as well. And we've talked about that in our prior calls, and we intend to do it. So 3 basic functions, back office technology,for our salons, back office technology for corporate and demand gen capability with open salon.

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

Well, thanks, everyone, for your attendance today. We appreciate your continued support and interest in Regis, and look forward to speaking with you again next quarter. Thank you, everyone. Good day.

Thank you. Ladies and gentlemen, this concludes our conference call for today. If you wish to access the replay for this presentation, you may do so by visiting regiscorp.com, in the Investor Relations section of the website or by dialing 1-888-2031112, access code 8274513. Thank you for all for participating, and have a nice day. All parties may now disconnect.