Thank you for joining the Regis Third Quarter 2021 Earnings Release Conference Call. All participants are in a listen only mode. After the prepared remarks by our Chief Executive Officer, Felipe Ittai and Chief Financial Officer, Kirsten Zephyr, we will have time for questions. Please use the chat feature or raise your hand feature to ask a question. Joining Felipe and Kirsten are Amanda Russin, our General Counsel and Jim Lane, our Portfolio Brand President.
I am your host, Biznik Shane, ABP Finance. As a reminder, this conference is being recorded. 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 8 ks filing 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.
Thank you, Biz. Good morning and thank you for joining us. Q3 of fiscal year 2021 has been an important quarter When it comes to progress on key initiatives that are critical to Regis' long term business model as a technology enabled, fully franchised asset light organization. And while the effects of COVID-nineteen are still ongoing and evident in our results, we remain confident about our business and our brands Getting back on track as we emerge from the pandemic. Before we jump into our key initiatives, I'll focus on recent sales trends And provide some color on consumer behavior.
Outside of government imposed restrictions and closures, which have been most prominent in California and Ontario, We continue to see a very linear correlation between traffic counts and the level of disruption to people's daily routines, Such routines being typical demand drivers for hair salon services. Despite the challenges of looking at comp figures as we start to lap the pandemic, We have seen an important quarter over quarter recovery in comp traffic to the magnitude of 10 points. Furthermore, in states where daily routines have been disrupted the least, Such as Texas or Florida, comparable sales figures are performing 5 to 15 points better than most restricted states such as California or Massachusetts. We also see a very linear correlation between urban density and traffic counts with denser areas such as downtown locations Performing significantly worse than suburban locations, which is also an important proxy for the impact of daily routine disruptions as customers work from home. During the month of April, we conducted extensive research to assess what the return to normal in hair care looks like and discovered some key learnings.
For those who have returned to salons, most are currently spending what they would have spent before the pandemic. Those spending more Our fixing do it yourself efforts, while those spending less are facing economic instability or have found cheaper options they're sticking with. For this latter group of customers, we believe Regis' focus on value brands will be an important strength as our salons provide a cost effective alternative To higher priced brands. The pandemic has also clearly brought a heightened awareness to health and safety in our business. As such, we believe our best in class focus on health and safety in our salons will draw both customers and stylists to our brands.
This is something I can personally attest to both as a customer of our brands and through my frequent salon visits around the country. We have also found out that as salon routines start to resume, customers are shopping around more than usual, with 50% of survey respondents open to new salons and 75% of respondents being at least somewhat open to switching salons. Our brands are ready to welcome this group of new customers With our safe salon commitment and highly trained stylists who will get them in and out of the salon quickly and with great value for money, which are top considerations for trying new salons. In addition to demand returning, we believe we're well positioned to capitalize on a change in salon supply. According to the Wall Street Journal, Federal Reserve Economists have reported that barbershops, nail salons And other providers of personal services appear to have been hit the hardest by the pandemic, accounting for more than 100,000 closures above and beyond Historically normal levels between March 2020 February 2021.
We believe Regis brands are well positioned to fulfill this gap and capture market share. Turning to our business, I'm excited to report on the progress we've made on 3 very important initiatives As we continue to transition to a fully franchised model, our proprietary POS and salon management system, OpenSalon Pro, Our refranchising efforts and our 0 based budgeting initiative. I will also cover some important changes to Regis' merchandising strategy moving forward That ties into our strategic shift to an efficient asset light model. Over the past months, we have been laying the foundation In building capabilities that will allow us to drive traffic into our salons. Open Salon Pro represents the core of these capabilities As it will feed Regis with critical business information through transactional level data.
We are in the process of building a robust business analytics platform and team around the data set that Open Salon Pro will provide, transforming us into a data driven organization. This data will enable us to drive traffic into our salons based on measured behaviors as well as to unlock the ability to implement relevant promotions, Loyalty Programs and Product Sales Initiatives. I am proud to share that as of this week, we have over 1700 salons with Signed contractual commitments to OSB, representing 35% of our franchise locations. Of these 1700 salons, about 1200 are currently live, Including the entire portfolio of our largest franchisee, the Align Group, currently running OSB in all of their 380 salons. As mentioned on previous earnings calls, we will begin mandating OpenSalon Pro over the course of this calendar year, so all of our brands can benefit Our California based team of product engineers continues to work hand in hand with our business leaders and franchisees To develop new solutions and capabilities to further automate our salons and manage the customer journey from digital demand generation To appointment booking, to payments at checkout.
Over the past 3 months, we have continued to create new report builders So franchisees can customize the way their organization see data, roll out enhancements to Open Salon Go, a mobile app platform that puts real time salon information at the fingertips of our franchisees and made performance enhancements to our cloud infrastructure. 1 of the most rewarding parts of my recent salon visits has been my interaction with and franchisees when it comes to OSP functionalities. They have been very complementary of the ease of use and robustness of feature set, while providing real time feedback to enhance the platform. In many instances, I have called our CTO directly from the salons To make suggestions or request modifications, the responsiveness of our product engineering team in Fremont has been unparalleled It remains a critical component to building out this differentiated platform. During our Q2 earnings call, I mentioned we were strategic partnerships as we've looked into the market opportunity of growing OSB beyond the Regis family of brands.
To date, we've had a number of exciting conversations with potential partners, further reinforcing our confidence in the robustness of our platform As a competitive software as a service solution for the beauty and wellness industries. Moving on to our efforts of refranchising corporate salons Our franchise partners, since the end of Q2, we have transitioned another 235 salons into new franchise ownership, 109 of which occurred during the month of April, which represents the most transitions in a single month since March 2020. Having moved away from our past practice of transacting a small number of salons, our new typical buyer for corporate salons is either one of our large, Well capitalized existing franchisees looking for growth opportunities or sophisticated multiunit retail franchisees from other industries Who see current market conditions as an attractive opportunity to enter the hair salon business. We are really proud of the progress we have made on conditions Where we allocated every single salon to either a deal or a strategic closure. By the end of this fiscal year, we expect to have 250 300 company owned salons remaining, all of which are either due to a contractual arrangement in which the salon cannot be sold Or we just proactively taking the stance it would not benefit a franchisee to take these salons on as part of their portfolios.
The majority of the remaining portfolio will be closed as leases run off over the course of their terms. However, we believe this number can still be lower as we continue to work closely with landlords around the country on solutions for early exits. Turning to our 0 based budgeting process, which is now nearing its final stages. As a reminder, the core of this process for Regis was a 0 based organizational design, A process that designs our entire organizational structure from the ground up based on the roles and capabilities that we will need as a fully franchised business. We've already completed the exercise of documenting the right work for each function, defining the right size of each team based on resources and priorities And the right structure to succeed as an organization.
We're now finalizing the G and A budget, which is an outcome of this entire process, And we'll align our overall G and A to the current reality of our business, while ensuring we have the right capabilities for growth and success. In parallel to the 0 based organization process, our team is conducting 0 based budgeting for all non people G and A expenses, Whereby each department lead has to justify every dollar in their budget submission, while the CVV team ensures consistency, Sets policies and defines clear priorities as to where we will spend our G and A. As both work streams are finalized over the next few weeks, We will lock our fiscal year 2022 G and A budget and kick off the ZBB tracking and monitoring process, which will set up the business routines and processes to manage actual versus budget throughout the year. Lastly, and very much in conjunction with the ZBB process and transition to a fully franchised model, We have made an important change to Regis' retail product strategy given the role of retail sales as a major potential driver of top line revenue growth, unit economics And importantly, stylist compensation. Although Regis' legacy systems and supply chain infrastructure were well suited For distributing to a network of company owned salons, the cost of carrying such infrastructure when taking into account franchise unit economics Was inadequate to both cover our costs and adequately service our franchisees.
Therefore, consistent with our asset light model, We have made the decision to transition away from our wholesale distribution. Moving forward, our franchisees will source retail products from approved Industry leading partners. This new strategy will allow Regis to unload a considerable amount of G and A and lease liability And free up a substantial amount of working capital, while focusing on our core competencies of owning brands and driving franchise performance, Along with providing our salons with best in class sales support and stylist education through our distribution partners. VGS' franchise product sales division will wind down throughout this calendar year as our franchisees gradually shift into sourcing retail products from the new distributors. We are in the process of finalizing agreements with the new partners and will make an official announcement in the coming weeks once the process is complete.
To wrap up, we are proud of the progress we have made against our key initiatives that will put us in the best position to optimize our brands and support our franchisees. While there's still much work to be done, we're putting in the hard work, not cutting corners and taking the necessary steps To lay the foundation for the future of Regis. This is not an overnight job, but with the commitment of our great team and franchise partners, We believe we're positioning Regis for sustained growth. Thank you very much for joining us. We appreciate your interest in Regis.
And I will now turn it over to our Chief Financial Officer, Kirsten Zuppert.
Thanks, Felipe, and good morning. Yesterday afternoon, we reported on a consolidated basis 3rd quarter revenues of $100,000,000 which represented a 35% decrease from the prior year. This decrease is consistent with our transition to an asset light franchise model and also reflects lower traffic levels, which are primarily the result of the COVID-nineteen pandemic. California and Ontario experienced government mandated closures for most of January and into February, which also contributed to the decline in revenue. These locations accounted for approximately 15% of our fleet.
In Q3, we reported a decline in system wide comps of 21%. While system wide comps were down 21% in the quarter, We are pleased that system wide comps improved approximately 11% from down 32% in Q2 to down 21% in Q3. We reported an operating loss of $19,000,000 during the quarter, which includes a $5,000,000 non cash inventory reserve charge associated with the change in our merchandising strategy that Felipe just described. 3rd quarter consolidated adjusted EBITDA loss was $20,000,000 which is $26,000,000 lower versus Q3 of 2020 and was driven primarily by the decrease in the gain associated with the sale of company owned salons of $14,000,000 and the planned elimination of the EBITDA that had been generated in the prior year period from the net 5 19 company owned salons that have been sold and converted to the franchise portfolio over the past 12 months. In Q2, 2021, our adjusted EBITDA loss was $18,000,000 However, when normalizing EBITDA For the loss from additions in both periods and one time non cash inventory reserve charge in the Q3 of fiscal 2021, Adjusted EBITDA for Q3 was a loss of $10,000,000 versus a loss of $14,000,000 in Q2, representing an improvement of 4,000,000 from Q2 to Q3 due to improved comps and lower G and A.
It's worth noting that Q3 adjusted EBITDA Included $13,000,000 of losses related to our company owned salon portfolio that will be dramatically reduced as we continue our transition to fully Franchise business model, which as Felipe mentioned, we are making strong progress towards. Looking at the segment specific performance and starting with our franchise segment, 3rd quarter franchise royalties and fees of $24,000,000 increased $15,000,000 171% versus the same quarter last year. The majority of the year over year increase was due to the refunding of $15,000,000 of cooperative advertising funds in the prior year, which was entirely offset in site expense and had no impact on operating income. Franchise same store sales were down 19.3%, primarily related to decreased traffic due to the pandemic. While franchise same store sales were down 19.3%, this represents an improvement from down 31% in Q2.
As I mentioned earlier, Government mandated temporary closures, most significantly in California and Ontario, also contributed $1,500,000 to the decline in royalties and fees. Offsetting these segment declines was the growth in our franchise base, which now represents 87% of our portfolio. Product sales to franchisees decreased $2,000,000 year over year to $13,000,000 driven primarily by the decline in traffic. 3rd quarter franchise EBITDA of $12,000,000 was flat year over year, driven by increased salon count, offset by reduced royalties. Turning now to the company owned salon segment, 3rd quarter revenue was $32,000,000 a decrease of $66,000,000 or 67% versus the prior year.
The impact of COVID-nineteen along with the year over year decrease of 989 company owned salons Over the past 12 months were drivers of the decline. The decrease in company owned salons can be bucketed into 2 primary categories. First, the conversion of a net 5 19 company owned salons to our asset light franchise platform over the course of the past 12 months, of which 126 were sold during the Q3. 2nd, the closure of approximately 4 74 company owned salons over the 3rd quarter company owned salon segment adjusted EBITDA decreased $12,000,000 year over year to a loss of 13,000,000 Consistent with the total company consolidated results, the unfavorable year over year variance was driven primarily by the elimination of the adjusted EBITDA that have 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, 3rd quarter adjusted EBITDA loss of $19,000,000 decreased $15,000,000 from A $4,000,000 loss in the prior year.
This decrease is driven primarily by the $14,000,000 decline in net gains, Excluding non cash goodwill derecognition in the prior year from the sale and conversion of company owned salons, partially offset by the net impact management initiatives to eliminate non core, non essential G and A expense. As Felipe mentioned, we are wrapping up the ZBB work and are pleased with the insight we've gained through the process. We have identified significant cost savings, but we have also identified areas where we need to invest in new operational functions as a world class franchisor. The work is being finalized and we expect to Provide more visibility to our future G and A run rate at our Q4 earnings call in August. Turning now to the cash flow and balance sheet.
We continue to maintain our positive overall liquidity position. As of March 31st, we had liquidity of $133,000,000 This includes $99,000,000 of available revolver capacity and $35,000,000 of cash. To the best of our knowledge and based on our current liquidity position and forecast, we believe we have adequate liquidity to run our business and support our growth initiatives. In the Q3, we used $14,500,000 of cash operating the business. This is a decrease of $22,000,000 from a second quarter cash use of $37,000,000 Consistent with the Last few quarters, I'm going to dive into the details regarding cash use as there are a few one time cash benefits and uses in Q3.
In Q3, improving comps drove cash collections and cash flows benefited $4,500,000 Due to fewer inventory purchases related to SKU rationalization and our transition to our merchandising strategy. This benefit is expected to continue into the 4th fiscal quarter, but is not expected to significantly impact next During Q3, we used approximately $3,000,000 to pay rent due from fiscal year 2020. While not a 100% cut up, future cash flows similar to Q3 will be much less burdened by prior period expenses. Removing the inventory benefit and the catch up of rent payments, our pro form a cash use in Q3 was $16,000,000 We expect Q4 cash used to increase slightly from Q3 pro form a levels due to expected one time cash uses in the 4th quarter. As Felipe mentioned, we continue to make progress toward our goal of a fully franchised asset light organization.
We have worked hard over the last few months and now have a strategy in place for every remaining company owned salon, whether that be allocated to a deal or a strategic closure to help the overall remaining portfolio. At June 30, we expect to have approximately 250 to 300 company owned salons remaining, of which the majority will be closed in an orderly fashion over the remaining lease terms, which on average is 22 months prior to On the balance sheet, I wanted to remind you that the lease liabilities of 659,000,000 represents liabilities for both our corporate and franchise locations. Approximately 84% is serviced by and personally guaranteed by our franchisees. Additionally, the liability on our balance sheet includes the lease payments for the current term of the leases plus one option period for SmartStyle and Supercut Salons, which overstates the rent payments that Regis has committed to. Excluding the option period, our total lease liability would $414,000,000 which is approximately $245,000,000 less than the $659,000,000 shown on our balance sheet.
To take it one step further, only 15% of the $414,000,000 or $61,000,000 is the lease exposure on the company owned salons. Before wrapping up, I thought I'd spend a few minutes on the business and industry. According to a McKinsey and Company COVID-nineteen U. S. Consumer Pulse Survey, Vaccinated people expect their routines will return to normal by the end of this year.
More than half of the respondents said they plan to treat themselves in 2021 And Beauty and Personal Care was only behind dining out, travel and apparel categories. According to the same McKinsey study, consumers with under a $100,000 in household income have changed their buying behavior to trade down to less expensive brands. As the same trade down may occur with personal services, we believe our Regis Family of Brands is well positioned to welcome these new customers to our value salons. Our salon traffic improved in March and continued to improve in April. Parts of the country like Texas, Florida, Oklahoma and Nebraska, which represent approximately 30% of our salons That have had less restrictions during the pandemic are performing 5 to 15 basis points better than the rest of the country.
Combination of our own traffic trends, consumer research and external positive indicators fuel our confidence that Regis will be a major player in the salon industry comeback in 2021 2022. In closing, we remain optimistic. Our progress on key initiatives accompanied with encouraging trends has us feeling very confident as we wrap up fiscal year 2021 and move into fiscal year 2022. This concludes my prepared remarks. I would like to thank you for your continued support and interest in Regis.
And we'll now turn the call back to Biz for questions.
Thank you, Kirsten. Our first question is from Laura Champine from Loop Capital. Please go ahead, Laura.
Thanks for taking my question. It is really on the transitions to a franchise model. As you decide which stores just are not suitable to be franchised, Kind of where are you setting the hurdle rates for the stores that you or the salons that you intend to vendition as opposed to the ones that will just close?
Hi, Laura. It's Kirsten. I'll take that question. As it relates to the salons that We don't expect to vendition. Some of those contractually, we cannot vendition.
And then others, There's a couple of different components that we look at when looking at those salons, One of which is location, other is the economics of that particular salon, and then also the brand also plays in. So Each salon that we look at is unique, but there isn't a specific like threshold in terms of economics that just Pushes it over to one side or the other. It's a combination of many factors in determining whether
or not we should vendition those locations.
Laura, Felipe here. So just to give you more clarity on that, to Kirsten's point, it's not that we have a hurdle rate for an individual salon, but Rather, we try to build healthy viable portfolios to the incoming franchisees, right. So a good example to give you, We had a 60 salon transaction in one of our geographies, which we end up making into a 160 salon Transaction, right. So we added 100 salons to a portfolio of 60, which we made into 160. If you look at this delta of 100 salons that were added, 40 of them probably would have been not viable on a stand alone basis, right?
Probably these would have led to the closure of those 40. But the aggregate portfolio of 160 is very viable. It's a healthy one. It provides the incoming franchisee with a very position from where to consolidate with the opportunity of acquiring franchisees in those geographies in the surrounding areas And also a good position from where to grow greenfield. So we have this very holistic portfolio centric view And that's how we've approached them.
So to Kirsten's point, a lot of those 250 to 300 salons that we expect Remain in OpCo and then run off the leases from there. Either we could not contractually transfer or we believe that as part of portfolios, they probably wouldn't have been viable to the health Of our franchisees. So we want to make sure that our franchisees are going to be into a very viable position moving forward economically, so they can prosper and grow.
Got it. And this just may be mechanics on a business that I think you're discontinuing anyway, but it looks like for your company owned Stores, the product sales were actually loss creating, so the gross margin looks negative if I go through your Q today. What drove that? And how could we any kind of pointers you can give us to model the wind down of your In house managed product line would be
helpful. Laura, it's Kirsten. The largest driver of that That is the inventory reserve that we recorded in the
quarter to $2,500,000 So that's the largest driver of that cost of sale Non cash one time charge that we took in the quarter. Got it. Thank you.
Thank you, Laura.
Okay. Our next question is from Steph Wissink Jefferies, please go ahead.
Hi, it's Grace Mike on for Steph. Can you hear me okay?
Yes, we can. Thank you. Great.
So I have a couple of questions, the first being on the monthly cadence that you saw In the quarter, so within that down 20% number, was there an acceleration into March or Any color you can give there.
Hi, Grace, it's Kirsten. Yes, as it relates to kind of the month To month progression in comps, we kind of thought it's in the similar range for the entire quarter. Maybe a little bit of recovery in January, February and into March, but nothing significant.
Okay, great. Thanks. And then pivoting to the rollout of the Open Salon Pro, which Appears to be ahead of plan. Can you remind us how that value flows through the P and L? Is it in royalties and fees?
Is there a pass through for Hardware sales.
Yes. So again, this is Kirsten. Two components to this. There's the hardware component. So franchisees are purchasing the When they migrate to Open Salon Pro, that's coming through the royalties and fees line.
And then the other component of it is the monthly subscription. So that also is that for each location, they pay
a monthly subscription that also runs through the royalties and diffuse line and the P and L.
Okay, got it. Thank you. That's helpful.
And then on G
and A, can you just give us
a framework for what level of G and A you need support the business and how you think about the dollars per salon in the future periods?
Yes. As we mentioned in the call, we're Still wrapping up the ZBB process
and going through it. I don't know how familiar you are with how that process works, We're going through what we kind of call negotiations in terms of the G and A spend for next year and future years. So at this Point, I'm asking people to hold tight until we can share that information in our Q4 earnings call.
Okay, that makes sense. Thanks. And then lastly,
Just a quick comment, right. So the balance here is, look, to adjust the G and A to the current realities of the business, While still keeping our capabilities to grow from here and have a sustainable level of support to our franchisees, right? So that's the balance that we're going to strike. To Kirsten's point, please hold on until Q4. We're not going to be able to share with you with more details, but The process is very much on track and it's been very meticulous so far.
Okay. Thank you for that color. And then just lastly, if you could share some more about the external distribution partnership for product And how the economic benefit goes to Regis? And then do you get a referral fee or sales loyalty for the business You direct to the distributor.
Yes. Hey, Grace. Felipe here. So look, since we're still in negotiations with the partners, I mean, we prefer not to disclose Too much right now about the model and the economics, but more to come later. As we Finalize those deals, we're going to come up with a press release kind of announcing a little bit more of how this is going to play out.
But We're still in the process. But the important thing here is we are changing the model away from being wholesale ourselves such that we can focus on our core business, which is managing brands and managing a franchise system, right. We're going to leave products in the hands of partners that can help our franchisees with much stronger sales support, stylist education. We're going to focus a lot on our private label brands as well, which are more profitable to our franchisees, right. So we're going to focus On the core of what we do as a franchise company and then have merchandise in the hands of the experts here.
But as soon as we Finalize those deals, we will offer you more color.
Great. Thank you so much.
That concludes our question and answer. We thank you for joining us this morning. A reminder that this webcast recording will be available on our website later today. Thank you and have a great day.