Regis Corporation — Fiscal 2018 First-Quarter 10-Q Summary
Business Context and Reporting Period
Regis Corporation owns, operates and franchises beauty salons. This Form 10-Q covers the three months ended September 30, 2017, compared with the three months ended September 30, 2016. At September 30, 2017, the company reported 8,855 system-wide salons and approximately 40,000 corporate employees worldwide.
During October 2017, Regis sold substantially all of its North American mall-based salon business, consisting of 858 salons, and substantially all of its International segment, consisting of approximately 250 salons, to The Beautiful Group. These businesses were classified as discontinued operations in the September 30 financial statements and will operate primarily as franchise locations.
Financial Performance and Position
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Revenue | $309.9 million | $318.8 million | Down 2.8% |
| Operating income | $16.7 million | $10.3 million | Up $6.4 million |
| Operating margin | 5.4% | 3.2% | Up 220 basis points |
| Income from continuing operations | $10.8 million | $5.7 million | Up $5.1 million |
| Net income (loss) | $(23.0) million | $3.3 million | Declined $26.3 million |
| Basic and diluted EPS | $(0.49) | $0.07 | Declined $0.56 |
| Cash provided by operating activities | $10.9 million | $12.3 million | Down $1.4 million |
Service revenue was $235.6 million, product revenue was $60.9 million and royalties and fees were $13.4 million. Company-owned salon revenue decreased to $288.8 million from $299.4 million, while franchise salon revenue increased to $21.1 million from $19.4 million. Same-store sales increased 0.4%, reflecting a 3.5% increase in average ticket price partly offset by a 3.1% decline in guest visits.
Income from continuing operations benefited from lower operating expenses, including reduced rent and cost of service, a $7.986 million gain on life insurance and improved stylist productivity. Reported income tax expense was $4.8 million, with a 30.9% effective tax rate; approximately $3.7 million of the quarter’s tax expense was non-cash and related to the deferred tax valuation allowance.
At September 30, 2017, cash and cash equivalents were $176.3 million and total assets were $1.017 billion. Long-term debt was $120.8 million, consisting primarily of 5.5% senior term notes. The company had no revolver borrowings and $198.5 million of unused availability under its $200 million revolving credit facility, subject to $1.5 million of outstanding letters of credit. Debt to capitalization was 20.1%, compared with 19.5% at June 30, 2017.
Investing activities used $6.1 million, including $7.1 million of capital expenditures, partly offset by $1.5 million of proceeds from salon asset sales. Financing activities used $1.5 million for taxes on shares withheld. Cash increased by $3.9 million during the quarter.
Material Changes Versus the Prior Comparable Period
- Revenue decreased $8.9 million, primarily due to salon closures, sales of company-owned salons to franchisees and hurricane-related disruptions.
- Operating margin improved to 5.4% from 3.2%, despite lower revenue.
- Operating income increased 62%, to $16.7 million, supported by lower rent, cost savings, improved productivity and a life insurance gain.
- Discontinued operations produced a $33.8 million loss versus a $2.5 million loss in the prior-year quarter. The current-period loss included a $30.5 million loss on assets held for sale, $1.7 million of operating losses and $1.6 million of transaction-related professional fees.
- Hurricanes Harvey, Irma and Maria caused 3,418 salon days to be lost; management estimated a $2.4 million revenue reduction and a $0.7 million expense increase.
- The company reorganized field leadership by brand and geography. The resulting expense reclassification shifted approximately $5.5 million into general and administrative expense from cost of service and site operating expense, without affecting operating income or cash flow.
- Regis changed its reportable segments to Company-owned salons and Franchise salons, replacing its former four-segment structure.
Outlook, Commentary, Risks and Unusual Items
The filing does not provide quantitative earnings or revenue guidance. Management is implementing a strategic transformation focused on improving company-owned salon performance and accelerating franchise growth. The company began franchising SmartStyle in the United States and plans to continue selling selected company-owned salons to franchisees.
The Beautiful Group became Regis’s largest franchisee following the October 2017 transaction. Regis expects future revenue to include royalties, product sales and transition-service fees, but stated that near-term revenue may be minimal and future benefits are uncertain. Regis remains liable under certain salon leases if The Beautiful Group fails to perform.
Key risks include execution of the new strategy under recently appointed leadership, dependence on franchisee performance, minimum-wage and healthcare cost increases, declining guest traffic, competition and changing product-distribution channels, Walmart traffic trends, cybersecurity and information-technology risks, tax exposures, litigation and compliance with debt covenants. The company is also party to various lawsuits and purported class-wide consumer and wage-and-hour claims whose outcomes cannot presently be determined.
Regis expects the new lease accounting standard to materially increase reported assets and liabilities when adopted in fiscal 2020. The company expects to adopt the new revenue-recognition standard in fiscal 2019 using the modified retrospective method and currently believes the principal impact will involve the timing of gift-card breakage recognition, without a material overall financial statement effect.
Important Facts for Investors to Verify
- Confirm the final accounting, consideration, lease obligations and ongoing royalty economics for the October 2017 sale to The Beautiful Group.
- Assess whether the $30.5 million held-for-sale loss fully captures remaining exposure from the divested businesses.
- Monitor same-store guest visits, average ticket growth and the effect of continued salon closures and refranchising on revenue and margins.
- Evaluate the ability of The Beautiful Group and other franchisees to improve salon performance and support expected royalty growth.
- Review liquidity and refinancing plans for the $123.0 million senior notes due in 2019 and the revolving facility expiring in June 2018.
- Assess the recurring versus nonrecurring nature of the life insurance gain, hurricane effects, transaction costs and other unusual items.
- Review pending litigation, IRS Appeals matters, lease contingencies and the company’s deferred tax valuation allowance.