Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results.
BUSINESS DESCRIPTION
Regis Corporation (RGS) franchises, owns and operates beauty salons. As of June 30, 2021, the Company franchised, owned or held ownership interests in 5,917 locations worldwide. Our locations consisted of 5,839 system-wide North American and International salons, and in 78 locations where we maintain a non-controlling ownership interest. Each of the Company's salon concepts generally offer similar salon products and services. As of June 30, 2021, we had approximately 2,446 corporate employees worldwide. See discussion within Part I, Item 1.
In October 2017, the Company sold substantially all of its mall-based salon business in North America, representing 858 company-owned salons, and substantially all of its International segment, representing approximately 250 company-owned salons, to TBG. In the second quarter of fiscal year 2020, TBG transferred 207 of its North American salons to the Company. See Note 3 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K, as the results of operations for the mall-based business and International segment are accounted for as discontinued operations for all periods presented. The overall goal of the TBG transaction was to reduce the Company's exposure to the mall-based lease obligations. As of June 30, 2021, we have 43 TBG salons and remaining lease liability of $9 million.
As part of the Company's strategic transition to a fully-franchised model, the Company is selling salons to franchisees. The impact of these transactions are as follows:
Fiscal Years Increase (Decrease)
(Dollars in thousands)
The Company is also exiting its wholesale distribution business as part of its asset-light transformation. The Company will exit its distribution centers and cease selling products to franchisees in fiscal year 2022. Instead, franchisees will source product from third party distribution partners and the Company will receive a royalty payment based on franchisee purchases. Going forward, this change will significantly decrease both the Company's Franchise product revenue and general and administrative costs, including the Franchise distribution costs discussed in Note 1 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. In fiscal year 2021, the Company experienced the following one-time charges related to the plan to exit the distribution centers:
Financial Statement Caption Segment (in thousands)
Inventory reserve (Note 1) Cost of product Company-owned $ 12,068
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RESULTS OF OPERATIONS
The Company reports its operations in two operating segments: Franchise salons and Company-owned salons. In fiscal year 2019, the mall-based business and International segment were accounted for as discontinued operations.
COVID-19 Impact:
During fiscal year 2021 and the second half of fiscal year 2020, the global coronavirus pandemic (COVID-19) had an adverse impact on our operations. Nearly all salons were closed for some time during April 2020 with franchise salons gradually starting to open near the end of April. Company-owned salons began opening in June 2020 and our salons did not experience significant mandated closures during the remainder of the year, with the exception of California and Canada. California and Canada had significant mandated closures throughout fiscal year 2021, predominantly in the second half of the year. To offset the loss of revenue, in April 2020, a furlough program was implemented for a majority of the workforce across the corporate headquarters, field support, and distribution centers; and reductions in the pay for executives and other working employees. The furlough program was in effect for the majority of the fourth quarter of fiscal year 2020 and was gradually lifted in the first quarter of fiscal year 2021. Despite actions taken to resume business operations, COVID-19 and the volatile regional and global economic conditions stemming from the pandemic could potentially prolong and intensify the impact on our business.
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System-wide results
As an asset-light franchise platform, our results are impacted by our system-wide sales, which include sales by all points of distribution, whether owned by the Company or our franchisees. While we do not record sales by franchisees as revenue, and such sales are not included in our Consolidated Financial Statements, we believe that this operating measure is important in obtaining an understanding of our financial performance. We believe system-wide sales information aids in understanding how we derive royalty revenue and in evaluating performance.
System-wide same-store sales (1) by concept are detailed in the table below:
Fiscal Years
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(1)Fiscal year 2021 system-wide same-store sales are calculated as the total change in sales for system-wide franchise and company-owned locations that were open on a specific day of the week during the current period and the corresponding prior period. Fiscal years 2020 and 2019 system-wide same-store sales are calculated as the total change in sales for system-wide franchise and company-owned locations for more than one year that were open on a specific day of the week during the current period and the corresponding prior period. Adjusting the definition to include salons that were open under the current ownership for less than one year negatively impacted the 2021 comparables by approximately 1%. Year-to-date system-wide same-store sales are the sum of the system-wide same-store sales computed on a daily basis. Franchise salons that do not report daily sales are excluded from same-store sales. System-wide same-store sales are calculated in local currencies to remove foreign currency fluctuations from the calculation.
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Consolidated Results of Operations
The following table sets forth, for the periods indicated, certain information derived from our Consolidated Statement of Operations. The percentages are computed as a percent of total revenues, except as otherwise indicated.
Fiscal Years
(Dollars in millions) % of Total Revenues (1) Basis Point (Decrease) Increase
Goodwill impairment — 40.2 — — 6.0 — (600) N/A
Income from discontinued operations, net of taxes — 0.8 5.9 — 0.1 0.6 (10) (50)
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(1)Cost of service is computed as a percent of service revenues. Cost of product is computed as a percent of product revenues.
(2)Excludes depreciation and amortization expense.
(3)Total is a recalculation; line items calculated individually may not sum to total due to rounding.
(4)Computed as a percent of loss from continuing operations before income taxes. The income taxes basis point change is noted as not applicable (N/A) as the discussion below is related to the effective income tax rate.
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Fluctuations in major revenue categories, operating expenses and other income and expense were as follows:
Consolidated Revenues
Consolidated revenues primarily include product and equipment sales to franchisees, franchise royalties and fees, franchise rental income and revenues of company-owned salons. The following tables summarize revenues and same-store sales by concept, as well as the reasons for the percentage change.
Fiscal Years
(Dollars in thousands)
Franchise salons:
Franchise same-store sales (decrease) increase (1) (24.5) % (4.4) % 0.3 %
Company-owned salons:
Company-owned salon same-store sales decrease (2) (33.4) % (4.4) % (0.4) %
Percent change from prior year (38.0) % (37.4) % (13.5) %
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(1)Franchise same-store sales in fiscal year 2021 are calculated as the total change in sales for franchise locations that were open on a specific day of the week during the current period and the corresponding prior period. Fiscal years 2020 and 2019 franchise same-store sales are calculated as the total change in sales for franchise locations for more than one year that were open on a specific day of the week during the current period and the corresponding prior period. Adjusting the definition to include salons that were open under the current ownership for less than one year negatively impacted the 2021 comparables by approximately 1%. Year-to-date franchise same-store sales are the sum of the franchise same-store sales computed on a daily basis. Franchise salons that do not report daily sales are excluded from same-store sales. Franchise same-store sales are calculated in local currencies to remove foreign currency fluctuations from the calculation.
(2)Company-owned same-store sales are calculated as the total change in sales for company-owned locations that were open on a specific day of the week during the current period and the corresponding prior period. Fiscal year company-owned same-store sales are the sum of company-owned same-store sales computed on a daily basis. Locations relocated within a one-mile radius are included in same-store sales as they are considered to have been open in the prior period. Company-owned same-store sales are calculated in local currencies to remove foreign currency fluctuations from the calculation.
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Fiscal Year Ended June 30, 2021 Compared with Fiscal Year Ended June 30, 2020
Consolidated Revenues
Consolidated revenues are primarily comprised of service and product revenues, franchise royalties and fees, advertising fees and rental income.
Consolidated revenue decreased $254.6 million, or 38.0%, during fiscal year 2021. Service revenue and product revenue decreased $223.4 million and $46.0 million, respectively. The decline in service and product revenue is primarily due to the Company's sale of salons to franchisees. During fiscal year 2021, 747 salons were sold to franchisees, net of buy backs and 1,038 and 36 system-wide salons were closed and constructed, respectively (2021 Net Salon Count Changes). The impact to consolidated revenue due to the sale of salons to franchisees and closure of salons was $223.3 million. System-wide sales also declined, primarily due to fewer guest visits and government-mandated closures related to the COVID-19 pandemic, which also contributed to the decline in service, product and royalties and fees revenue. In fiscal year 2020, the Company refunded $14.9 million of previously collected cooperative advertising fees, which reduced royalties and fees in the prior period.
Service Revenues
The decrease of $223.4 million, or 67.4%, in service revenues during fiscal year 2021 was primarily due to 2021 Net Salon Count Changes. The impact to service revenue due to the sale of salons to franchisees and closure of salons was $179.5 million. The remaining decrease in service revenue relates primarily to fewer guest visits as a result of the COVID-19 pandemic.
Product Revenues
The decrease of $46.0 million, or 33.5%, in product revenues during fiscal year 2021 was primarily due to 2021 Net Salon Count Changes. The impact to product revenue due to the sale of salons to franchisees and closure of salons was $43.8 million. Additionally, franchise same-store product sales declined 25.3% contributing to the decline.
Royalties and Fees
Royalties and fees increased $14.7 million, or 20.0%, during fiscal year 2021. This increase was primarily due to an increase in cooperative advertising funds charged to franchisees of $8.7 million. In fiscal year 2020, the Company refunded $14.9 million of previously collected cooperative advertising fund fees, which reduced royalties and fees in the prior period. Cooperative advertising funds were temporarily reduced as part of our COVID-19 pandemic relief effort and also declined due to lower same-store sales. The declines in cooperative advertising are offset in site expense and have no impact on operating income. Royalties and fees were also impacted by the decreases in franchise same-store sales of 24.5%, partially offset by an increase in franchise salons. Total franchised locations open at June 30, 2021 were 5,563 as compared to 5,209 at June 30, 2020.
Franchise Rental Income
The increase of $0.2 million, or 0.1%, in franchise rental income during fiscal year 2021 is due to the increase in franchise salons.
Cost of Service
The 610 basis point increase in cost of service as a percent of service revenues during fiscal year 2021 was primarily due to inefficient and non-productive stylist hours as a result of reduced guest visits and higher minimum wages.
Cost of Product
The 2,500 basis point increase in cost of product as a percent of product revenue during fiscal year 2021 was primarily due to an $12.1 million reserve for excess and obsolete inventory related to the change in the Company's merchandising strategy. The shift from retail sales to franchise product sales also contributed to the basis point increase. Excluding the excess and obsolescence reserve, margins on retail product sales were 40.7% and 47.6% for fiscal years 2021 and 2020, respectively. Margins on franchise product sales were 18.1% and 23.6% for fiscal years 2021 and 2020, respectively. The decrease in product margin is primarily due to lower prices in connection with the closing of company-owned salons and the Company exiting the wholesale distribution product business.
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Site Operating Expenses
The decrease of $20.1 million, or 28.1%, in site operating expenses during fiscal year 2021 was primarily due to a net reduction in company-owned salon counts and decreases in marketing spend, partially offset by a $8.7 million increase in cooperative advertising expense, as noted above in Royalties and Fees.
General and Administrative
The decrease of $25.5 million, or 19.5%, in general and administrative during fiscal year 2021 was primarily due to lower administrative and field management salaries due to reductions in headcount as we aligned our cost structure with our transition to an asset-light franchise model. A benefit from the forfeiture of equity awards related to the departure of the Company's former CEO contributed $2.4 million to the decrease in fiscal year 2021. Additionally, $1.3 million of the decline is due to the Company not holding its annual franchise convention in fiscal year 2021 due to the COVID-19 pandemic.
Rent
The decrease of $35.5 million, or 46.4%, in rent expense during fiscal year 2021 was primarily due to the net reduction in the number of company-owned salons associated with the Company's transformation to a fully-franchised portfolio.
Franchise Rent Expense
The increase of $0.2 million, or 0.1%, in franchise rent expense is due to the increase in franchise salons.
Depreciation and Amortization
The decrease of $14.2 million, or 38.5%, in depreciation and amortization during fiscal year 2021 was primarily due to the net reduction in company-owned salon counts. Additionally, salon asset impairment of $3.9 million was recorded to depreciation expense in fiscal year 2020. Salon asset impairment in fiscal year 2021 was recorded to long-lived asset impairment.
Long-Lived Asset Impairment
In fiscal year 2021, the Company recorded a long-lived asset impairment charge of $13.0 million, which included a right of use asset impairment of $9.5 million and a salon asset impairment of $3.5 million. In fiscal year 2020, the Company recorded a long-lived asset impairment charge of $22.6 million, which included a right of use asset impairment of $17.4 million.
TBG Mall Restructuring
In fiscal year 2020, the Company recorded $2.3 million of TBG restructuring charges, which related to professional fees and the Company assisting TBG with operating expenses to mitigate the risk of default associated with TBG's lease obligations. See Note 3 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K.
Goodwill Impairment
In fiscal year 2020, the Company recorded $40.2 million of goodwill impairment related to the Company-owned reporting unit. The Company's forecasted cash flows for company-owned salons decreased significantly due to the impact of the COVID-19 pandemic. As a result, the carrying value of the Company-owned reporting unit exceeded its fair value resulting in a full impairment of goodwill.
Interest Expense
The increase of $6.3 million in interest expense for fiscal year 2021 was primarily due to greater levels of debt at higher interest rates.
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Loss from Sale of Salon Assets to Franchisees, net
In fiscal year 2021, the loss from sale of salon assets to franchisees was $16.7 million. In fiscal year 2020, the loss from sale of salon assets to franchisees was $27.3 million, including non-cash goodwill derecognition of $77.0 million. There was no goodwill derecognition in fiscal year 2021 due to the company-owned goodwill impairment reported in fiscal year 2020.
Interest Income and Other, net
The increase of $12.5 million in interest income and other, net during fiscal year 2021 was primarily due to the gain associated with the leases for the Company's distribution centers (see Note 8 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K), partially offset by the sale of the Company's headquarters recorded in fiscal year 2020.
Income Taxes
During fiscal year 2021, the Company recognized a tax benefit of $5.4 million, with a corresponding effective tax rate of 4.6%, compared to recognizing a tax benefit of $4.6 million, with a corresponding effective tax rate of 2.6% during fiscal year 2020.
See Note 10 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K.
Income from Discontinued Operations
Income from discontinued operations was $0.8 million during fiscal year 2020 due to actuarial reserve adjustments.
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Results of Operations by Segment
Based on our internal management structure, we report two segments: Franchise salons and Company-owned salons. See Note 15 to the Consolidated Financial Statements in in Part II, Item 8, of this Form 10-K. Significant results of operations are discussed below with respect to each of these segments.
Franchise Salons
Fiscal Years
(Dollars in millions) Increase (Decrease)
Revenue
Franchise same-store sales (3) (24.5) % (4.4) % 0.3 %
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(1)Includes $1.6 million of royalties related to TBG during fiscal year 2019.
(2)Total is a recalculation; line items calculated individually may not sum to total due to rounding.
(3)Franchise same-store sales in fiscal year 2021 are calculated as the total change in sales for franchise locations that were open on a specific day of the week during the current period and the corresponding prior period. Fiscal years 2020 and 2019 franchise same-store sales are calculated as the total change in sales for franchise locations for more than one year that were open on a specific day of the week during the current period and the corresponding prior period. Adjusting the definition to include salons that were open under the current ownership for less than one year negatively impacted the 2021 comparables by approximately 1%. Year-to-date franchise same-store sales are the sum of the franchise same-store sales computed on a daily basis. Franchise salons that do not report daily sales are excluded from same-store sales. F same-store sales are calculated in local currencies to remove foreign currency fluctuations from the calculation. TBG same-store sales are excluded from fiscal year 2019 to be consistent with fiscal years 2020 and 2021.
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Fiscal Year Ended June 30, 2021 Compared with Fiscal Year Ended June 30, 2020
Franchise Salon Revenues
Franchise salon revenues increased $19.1 million during fiscal year 2021. The increase in franchise salon revenue was primarily due to increased cooperative fund contributions due to the refunding of $14.9 million of previously collected contributions to the cooperative advertising funds. Product revenue increased primarily due to the increase in franchise salons. During fiscal year 2021, Franchisees purchased (net of Company buybacks) 747 salons from the Company and constructed (net of relocations) and closed 32 and 425 franchise-owned salons, respectively.
Franchise Salon Operating Income
During fiscal year 2021, Franchise salon operations generated operating income of $40.7 million, an increase of $7.8 million compared to the prior comparable period. The increase was primarily due to the increase in royalties per salon due to the net 747 salons purchased from the Company.
Cash Generated from Salons Sold to Franchisees
During fiscal years 2021 and 2020, the Company generated $8.4 million and $91.6 million of cash, respectively, from the sale of company-owned salons to franchisees. The decrease is due to lower proceeds per salon sold due to diminished salon performance due to COVID-19 pandemic as well as the mix of salons sold.
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Company-owned Salons
Fiscal Years
(Dollars in millions) Increase (Decrease)
Fiscal Year Ended June 30, 2021 Compared with Fiscal Year Ended June 30, 2020
Company-owned Salon Revenues
Company-owned salon revenues decreased $273.7 million in fiscal year 2021, primarily due to the closure of a net 613 salons and the sale of 747 company-owned salons (net of buybacks) to franchisees during the year and a decline in sales as a result of lower traffic.
Company-owned Salon Operating Loss
During fiscal year 2021, company-owned salon operating loss decreased $26.1 million to a loss of $70.0 million. The decrease in the loss was primarily due to the goodwill impairment of $40.2 million recorded in the third quarter of fiscal year 2020, partially offset by an $12.1 million inventory reserve charge recorded in fiscal year 2021.
Corporate
Fiscal Year Ended June 30, 2021 Compared with Fiscal Year Ended June 30, 2020
Corporate Operating Loss (1)
Corporate operating loss of $74.8 million decreased $7.3 million during fiscal year 2021, primarily driven by lower general and administrative salaries due to lower headcount and the cancellation of the traditional in-person franchise convention in fiscal year 2021.
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(1) The Corporate operating loss consists primarily of unallocated general and administrative expenses, including expenses associated with salon support, depreciation and amortization related to our corporate headquarters and unallocated insurance, benefit and compensation programs, including stock-based compensation.
Recent Accounting Pronouncements
Recent accounting pronouncements are discussed in Note 1 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K.
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LIQUIDITY AND CAPITAL RESOURCES
Sources of Liquidity
Funds generated by operating activities, available cash and cash equivalents, proceeds from sale of salons sold to franchisees, and our borrowing agreements are our most significant sources of liquidity. Additionally, on February 3, 2021, the Company filed a $150 million shelf registration and $50 million prospectus supplement with the Securities and Exchange Commission under which it may offer and sell, from time to time, up to $50 million worth of its of its Class A common stock in “at-the-market offerings.” Net proceeds from sales of shares under the “at-the-market” program, if any, may be used to, among other things, fund working capital requirements, repay debt and support of our brands and franhisees. The timing and amount of sales of shares, if any, will depend on a variety of factors, including prevailing market conditions, the trading price of shares, and other factors as determined by the Company. To date we have not issued any shares under the agreement.
As of June 30, 2021, cash and cash equivalents were $19.2 million, with $16.8, $2.0 and $0.4 million within the United States, Canada and Europe, respectively.
The Company has a credit agreement which as of June 30, 2021 provided for a $294.4 million five-year unsecured revolving credit facility that expires in March 2023, of which $88.8 million was available as of June 30, 2021. The credit facility includes a minimum liquidity covenant of not less than $75.0 million. See additional discussion under Financing Arrangements and Note 8 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K.
Uses of Cash
The Company closely manages its liquidity and capital resources. The Company's liquidity requirements depend on key variables, including the performance of the business, the level of investment needed to support its business strategies, capital expenditures, credit facilities and borrowing arrangements and working capital management. Capital expenditures are a component of the Company's cash flow and capital management strategy, which can be adjusted in response to economic and other changes in the Company's business environment. The Company has a disciplined approach to capital allocation, which focuses on investing in key priorities to support the Company's response to the COVID-19 pandemic, as well as its strategic plan as discussed within Part I, Item 1. 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.
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Cash Flows
Cash Flows Used In Operating Activities
During fiscal year 2021, cash used in operating activities was $99.9 million. Cash used in operations increased year-over-year by $13.5 million due to lower revenues, margins and same-store sales, CEO transition expense of $0.7 million, CEO sign-on bonus of $2.5 million and an increase in lease termination payments of $8.3 million. The increase in cash use was partially offset by lower salaries due to lower headcount and a decline in general and administrative expense.
During fiscal year 2020, cash used in operating activities was $86.4 million. Cash from operations declined due to lower revenues and margins and the refunding of the cooperative advertising funds to franchisees as a direct result of the COVID-19 pandemic, as well as lower same-store sales, partially offset by the elimination of certain general and administrative costs.
During fiscal year 2019, cash used in operating activities was $17.5 million, primarily as a result of a decline in Company-owned operating margin, strategic investment in new retail product lines and planned strategic general and administrative investments to enhance the Company's franchisor capabilities and support the increase in volume and cadence of transactions and conversions into the Franchise portfolio, partially offset by the elimination of certain general and administrative costs.
Cash Flows from Investing Activities
During fiscal year 2021, cash used in investing activities of $2.1 million was primarily related to capital investments, partially offset by cash proceeds from the sale of salon assets of $8.4 million.
During fiscal year 2020, cash provided by investing activities of $61.0 million was primarily from cash proceeds from sale of salon assets of $91.6 million and the sale of the Company's headquarters of $9.0 million, partially offset by capital expenditures of $37.5 million.
During fiscal year 2019, cash provided by investing activities of $87.8 million was primarily from cash proceeds from sale of salon assets of $94.8 million and proceeds from company-owned life insurance policies of $24.6 million, partially offset by capital expenditures of $31.6 million.
Cash Flows from Financing Activities
During fiscal year 2021, cash provided by financing activities of $7.8 million was primarily due to a net $9.4 million draw on the Company's line of credit.
During fiscal year 2020, cash provided by financing activities of $56.2 million was primarily due to the net $87.5 million draw on the Company's line of credit and for the repurchase of common stock of $28.2 million
During fiscal year 2019, cash used in financing activities of $126.7 million was primarily for repurchase of common stock of $152.7 million and employee taxes paid for shares withheld of $2.5 million, partially offset by proceeds from the sale and leaseback of the Company's distribution centers of $28.8 million.
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Financing Arrangements
Financing activities are discussed in Note 8 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. Derivative activities are discussed in Part II, Item 7A, "Quantitative and Qualitative Disclosures about Market Risk."
The Company's financing arrangements consists of the following:
(Fiscal year) (Interest rate %) (Dollars in thousands)
As of June 30, 2021 and 2020, the Company had $186.9 and $177.5 million, respectively, of outstanding borrowings under its revolving credit facility. The five-year revolving credit facility expires in March 2023 and includes a minimum liquidity covenant of not less than $75.0 million, provides the Company's lenders security in substantially all of the Company's assets, adds additional guarantors, and grants a first priority lien and security interest to the lenders in substantially all of the Company's and the guarantors' existing and future property. Total liquidity per the agreement was $128.9 million as of June 30, 2021.See Note 8 to the Consolidated Financial Statements. The revolving credit facility includes a $30.0 million sub-facility for the issuance of letters of credit and a $30.0 million sublimit for swingline loans. The Company may request an increase in revolving credit commitments under the facility of up to $115.0 million under certain circumstances. The applicable margin for loans bearing interest at LIBOR ranges from 3.75%-4.25%, the applicable margin for loans bearing interest at the base rate ranges from 2.75%-3.25%, and the facility fee ranges from 0.5%-0.75%, each depending on average utilization of the revolving line of credit.
In fiscal year 2021, the Company determined it would no longer lease the distribution centers for the majority of the assets' useful lives, which resulted in the transactions being considered sale and leaseback transactions. As a result, the Company derecognized the financing lease liability and the carrying value of the related assets. See Note 8 to the Consolidated Financial Statements.
Our debt to capitalization ratio, calculated as the principal amount of debt as a percentage of the principal amount of debt and shareholders' equity at fiscal year-end, was as follows:
As of June 30, Debt toCapitalization
The increase in the debt to capitalization ratio as of June 30, 2021 compared to June 30, 2020 was primarily due to the loss incurred in fiscal year 2021 and the increase in debt.
The increase in the debt to capitalization ratio as of June 30, 2020 compared to June 30, 2019 was primarily due to the increase in the Company's borrowings.
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Contractual Obligations and Commercial Commitments
On-Balance Sheet Obligations
Our debt obligations are primarily composed of our revolving credit facility at June 30, 2021.
Non-current deferred benefits of $10.0 million includes $5.0 million related to a Non-qualified Deferred Salary Plan and a salary deferral program of $2.5 million related to established contractual payment obligations under retirement and severance agreements for a small number of employees. See Note 4 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K
Operating leases primarily represent long-term obligations for the rental of salons, including leases for company-owned locations, as well as salon franchisee lease obligations, which are reimbursed to the Company by franchisees. Regarding franchisee subleases, we generally retain the right to the related salon assets, net of any outstanding obligations, in the event of a default by a franchise owner. The loss of revenue related to the COVID-19 pandemic has increased the risk of default by franchisees, which may be material.
The Company has unfunded deferred compensation contracts covering certain management and executive personnel. Because we cannot predict the timing or amount of future payments related to these contracts, such amounts were not included in the table above. See Note 11 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K.
As of June 30, 2021, we have liabilities for uncertain tax positions. We are not able to reasonably estimate the amount by which the liabilities will increase or decrease over time; however, at this time, we do not expect a significant payment related to these obligations within the next fiscal year. See Note 10 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K.
Off-Balance Sheet Arrangements
Interest payments on long-term debt are calculated based on the revolving credit facility's rates. The applicable margin for loans bearing interest at LIBOR ranges from 3.75%-4.25%, the applicable margin for loans bearing interest at the base rate ranges from 2.75%-3.25% and the facility fee ranges from 0.5%-0.75%, each depending on average utilization of the revolving line of credit.
We are a party to a variety of contractual agreements that we may be obligated to indemnify the other party for certain matters, which indemnities may be secured by operation of law or otherwise, in the ordinary course of business. These contracts primarily relate to our commercial contracts, operating leases and other real estate contracts, financial agreements, agreements to provide services and agreements to indemnify officers, directors and employees in the performance of their work. While our aggregate indemnification obligation could result in a material liability, we are not aware of any current matter that we expect will result in a material liability.
We do not have other unconditional purchase obligations or significant other commercial commitments such as standby repurchase obligations or other commercial commitments.
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet financial arrangements or other contractually narrow or limited purposes at June 30, 2021. As such, we are not materially exposed to any financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships.
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Dividends
In December 2013, the Board elected to discontinue declaring regular quarterly dividends.
Share Repurchase Program
In May 2000, the Board approved a stock repurchase program with no stated expiration date. Since that time and through June 30, 2021, the Board has authorized $650.0 million to be expended for the repurchase of the Company's stock under this program. All repurchased shares become authorized but unissued shares of the Company. The timing and amounts of any repurchases depends on many factors, including the market price of the common stock and overall market conditions. During fiscal year 2021, the Company did not repurchase any shares. As of June 30, 2021, 30.0 million shares have been cumulatively repurchased for $595.4 million, and $54.6 million remained outstanding under the approved stock repurchase program.
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CRITICAL ACCOUNTING POLICIES
The Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the Consolidated Financial Statements, we are required to make various judgments, estimates and assumptions that could have a significant impact on the results reported in the Consolidated Financial Statements. We base these estimates on historical experience and other assumptions believed to be reasonable under the circumstances. Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made, and (2) other materially different estimates could have been reasonably made or material changes in the estimates are reasonably likely to occur from period to period. Changes in these estimates could have a material effect on our Consolidated Financial Statements.
Our significant accounting policies can be found in Note 1 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. We believe the following accounting policies are most critical to aid in fully understanding and evaluating our reported financial condition and results of operations.
Goodwill
As of June 30, 2021 and 2020, the Franchise reporting unit had $229.6 and $227.5 million of goodwill, respectively, and the Company-owned segment had no goodwill at either period. See Note 5 to the Consolidated Financial Statements. The Company assesses goodwill impairment on an annual basis during the Company's fourth fiscal quarter, and between annual assessments if an event occurs, or circumstances change, that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Goodwill impairment assessments are performed at the reporting unit level, which is the same as the Company's operating segments. The goodwill assessment involves a one-step comparison of the reporting unit's fair value to its carrying value, including goodwill (Step 1). If the reporting unit's fair value exceeds its carrying value, no further procedures are required. However, if the reporting unit's fair value is less than the carrying value, an impairment charge is recorded for the difference between the fair value and carrying value of the reporting unit.
In applying the goodwill impairment assessment, the Company may assess qualitative factors to determine whether it is more likely than not that the fair value of the reporting units is less than its carrying value (Step 0). Qualitative factors may include, but are not limited to, economic, market and industry conditions, cost factors, and overall financial performance of the reporting unit. If after assessing these qualitative factors, the Company determines it is "more-likely-than-not" that the carrying value is less than the fair value, then performing Step 1 of the goodwill impairment assessment is unnecessary.
The carrying value of the reporting unit is based on the assets and liabilities associated with the operations of the reporting unit, including allocation of shared or corporate balances among reporting units. Allocations are generally based on the number of salons in each reporting unit as a percent of total salons or expenses of the reporting unit as a percentage of total company expenses.
The Company calculates estimated fair values of the reporting units based on discounted cash flows utilizing estimates in annual revenue, fixed expense rates, allocated corporate overhead, franchise salon counts, and long-term growth rates for determining terminal value. Where available and as appropriate, comparative market multiples are used in conjunction with the results of the discounted cash flows. The Company engages third-party valuation consultants to assist in evaluating the Company's estimated fair value calculations. See Note 1 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K
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Long-Lived Assets, Excluding Goodwill
A lessee's Right of Use (ROU) asset is subject to the same asset impairment guidance in ASC 360, Property, Plant, and Equipment, applied to other elements of property, plant, and equipment. The Company has identified its asset groups at the individual salon level as this represents the lowest level that identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. Poor salon performance in fiscal years 2020 and 2021, primarily due to the COVID-19 pandemic, resulted in ASC 360-10-35-21 triggering events. As a result, management assessed underperforming salon asset groups, which included the related ROU assets, for impairment in accordance with ASC 360.
The first step in the impairment test under ASC 360 is to determine whether the long-lived assets are recoverable, which is determined by comparing the net carrying value of the salon asset group to the undiscounted net cash flows to be generated from the use and eventual disposition of that asset group. Estimating cash flows for purposes of the recoverability test is subjective and requires significant judgment. Estimated future cash flows used for the purposes of the recoverability test were based upon historical cash flows for the salons, adjusted for expected changes in future market conditions related to the COVID-19 pandemic, and other factors. The period of time used to determine the estimates of the future cash flows for the recoverability test was based on the remaining useful life of the primary asset of the group, which was the ROU asset in all cases.
Step two of the long-lived asset impairment test requires the fair value of the asset group be estimated when determining the amount of any impairment loss. For the salon asset groups that failed the recoverability test, an impairment loss was measured as the amount by which the carrying amount of the asset group exceeds its fair value. The Company applied the fair value guidance within ASC 820-10 to determine the fair value of the asset group from the perspective of a market-participant considering, among other things, appropriate discount rates, multiple valuation techniques, the most advantageous market, and assumptions about the highest and best use of the asset group. To determine the fair value of the salon asset groups, the Company utilized market-participant assumptions rather than the Company's own assumptions about how it intends to use the asset group. The significant judgments and assumptions utilized to determine the fair value of the salon asset groups include; the market rent of comparable properties, the asset group's projected sales for properties with no recently negotiated leases, and a discount rate.
The fair value of the salon long-lived asset group is estimated using market participant methods based on the best information available. The significant judgments and assumptions utilized to determine the fair value of the salon asset groups include: the market rent of comparable properties, the asset group's projected sales, and a discount rate. In fiscal year 2020, the Company engaged a third-party valuation specialist to assist with the research related to inputs used in their determination of the fair value of the ROU asset, which included providing information related to significant inputs and assumptions utilized in the measurement of the impairment loss.
For fiscal year 2021, the Company recognized a long-lived impairment charge of $13.0 million, which included $9.5 million related to ROU assets on the Consolidated Statement of Operations. The impairment loss for each salon asset group that was recognized was allocated among the long-lived assets of the group on a pro-rata basis using their relative carrying amounts. Additionally, the impairment losses did not reduce the carrying amount of an individual asset below its fair value, including for the ROU assets included in the salon asset groups. Assessing the long-lived assets for impairment requires management to make assumptions and to apply judgment that can be affected by economic conditions and other factors that can be difficult to predict. The Company does not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions it uses to calculate impairment losses for its long-lived assets, including its ROU assets. However, the ultimate severity and longevity of the COVID-19 pandemic is unknown, therefore, if actual results are inconsistent with the estimates and assumptions used in the calculations, the Company may be exposed to future impairment losses that could be material.
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Income Taxes
Deferred income tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the Consolidated Financial Statements or income tax returns. Deferred income tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities using currently enacted tax rates in effect for the years in which the differences are expected to reverse.
We recognize deferred tax assets to the extent that we believe these assets are more likely than not to be realized. The Company evaluates all evidence, including recent financial performance, the existence of cumulative year losses and our forecast of future taxable income, to assess the need for a valuation allowance against our deferred tax assets. While the determination of whether or not to record a valuation allowance is not fully governed by a specific objective test, accounting guidance places significant weight on recent financial performance.
The Company has a valuation allowance on its deferred tax assets amounting to $192.5 and $122.4 million at June 30, 2021 and 2020, respectively. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make necessary adjustments to the deferred tax asset valuation, which would reduce the provision for income taxes.
Significant components of the valuation allowance which occurred during fiscal year 2021 are as follows:
•The Company recognized a tax loss on its investment in Luxembourg and established a corresponding valuation allowance of $34.4 million.
Significant components of the valuation allowance which occurred during fiscal year 2020 are as follows:
•In connection with the Coronavirus Aid, Relief and Economic Security Act (CARES Act), Net Operating Losses (NOLs) resulting from accounting periods which straddled December 31, 2017 are now considered definite-lived NOLs. Therefore, the Company established a valuation allowance against the U.S. NOLs generated during its fiscal year 2018 and recorded a net tax expense of $14.7 million.
•The Company determined that it no longer had sufficient U.S. indefinite-lived taxable temporary differences to support realization of its U.S. indefinite-lived NOLs and its existing U.S. deferred tax assets that upon reversal are expected to generate indefinite-lived NOLs. As a result, the Company recorded an additional $17.0 million valuation allowance on its U.S. federal indefinite-lived deferred tax assets.
•The Company recognized a capital loss and established a corresponding valuation allowance of $14.9 million on investment outside basis previously impaired for financial accounting purposes.
The Company reserves for unrecognized tax benefits, interest and penalties related to anticipated tax audit positions in the U.S. and other tax jurisdictions based on an estimate of whether additional taxes will be due. If payment of these amounts ultimately proves to be unnecessary, the reversal of these liabilities would result in tax benefits being recognized in the period in which it is determined that the liabilities are no longer necessary. If the estimate of unrecognized tax benefits, interest and penalties proves to be less than the ultimate assessment, additional expenses would result.
Inherent in the measurement of deferred balances are certain judgments and interpretations of tax laws and published guidance with respect to the Company's operations. Income tax expense is primarily the current tax payable for the period and the change during the period in certain deferred tax assets and liabilities.
See Note 10 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The primary market risk exposure of the Company relates to changes in interest rates in connection with its debt, specifically the revolving credit facility, which bears interest at variable rates based on LIBOR plus an applicable borrowing margin. Additionally, the Company is exposed to foreign currency translation risk related changes in the Canadian dollar and to a lesser extent the British pound. The Company has established policies and procedures that govern the management of these exposures through the use of derivative financial instrument contracts. By policy, the Company does not enter into such contracts for the purpose of speculation. The following details the Company's policies and use of financial instruments.
Interest Rate Risk:
The Company has established an interest rate management policy that attempts to minimize its overall cost of debt, while taking into consideration earnings implications associated with volatility in short-term interest rates. In the past, the Company has used interest rate swaps to further mitigate the risk associated with changing interest rates and to maintain its desired balances of fixed and floating rate debt. In addition, access to variable rate debt is available through the Company's revolving credit facility. The Company reviews its policy and interest rate risk management quarterly and adjusts in accordance with market conditions and the Company's short- and long-term borrowing needs. As of June 30, 2021, the Company had outstanding variable rate debt of $186.9 million and the Company did not have any outstanding interest rate swaps.
Foreign Currency Exchange Risk:
Over 92% of the Company's operations are transacted in United States dollars. However, because a portion of the Company's operations consists of activities outside of the United States, the Company has transactions in other currencies, primarily the Canadian dollar, and to a lesser extent, the British pound. In preparing the Consolidated Financial Statements, the Company is required to translate the financial statements of its foreign subsidiaries from the currency in which they keep their accounting records, generally the local currency, into United States dollars. Different exchange rates from period to period impact the amounts of reported income and the amount of foreign currency translation recorded in accumulated other comprehensive income (AOCI). As part of its risk management strategy, the Company frequently evaluates its foreign currency exchange risk by monitoring market data and external factors that may influence exchange rate fluctuations. As a result, the Company may engage in transactions involving various derivative instruments to hedge assets, liabilities and purchases denominated in foreign currencies. As of June 30, 2021, the Company did not have any derivative instruments to manage its foreign currency risk.
During fiscal years 2021, 2020 and 2019, the foreign currency gain (loss) included in loss from continuing operations was $0.3, $(0.1) and $0.1 million, respectively.
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Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements:
Reports of Independent Registered Public Accounting Firms 50
Notes to Consolidated Financial Statements 59
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Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Regis Corporation
Opinion on the financial statements
We have audited the accompanying consolidated balance sheet of Regis Corporation (a Minnesota Corporation) and subsidiaries (the "Company") as of June 30, 2021, the related consolidated statements of operations, comprehensive loss, shareholders' equity, and cash flows for the year then ended, and the related notes (collectively referred to as the "financial statements"). In our opinion, thefinancial statements present fairly, in all material respects, the financial position of the Companyas of June 30, 2021, and the results of itsoperations and itscash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the Company’s internal control over financial reporting as of June 30, 2021 based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"), and our report dated August 26, 2021 expressed an unqualified opinion.
Basis for opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
Critical audit matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing aseparate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Right of Use Asset Impairment Assessment for the Company-Owned Salon Asset Groups
As described in Notes 1 and 15 to the consolidated financial statements, the Company operates in two reportable segments, Company-owned salons and Franchise salons. Note 6 describes the Company’s Right of Use Assets ("ROU asset"), a portion of which relates to Company-owned salons. Management determined that triggering events had occurred related to Company-owned salons and was required to perform quantitative impairment assessments during fiscal year 2021. The Company first assessed its Company-owned salon asset groups at the individual salon level, which included the ROU assets, to determine if the carrying value was recoverable. Recoverability is determined by comparing the net carrying value of the salon asset group to the undiscounted net cash flows to be generated from the use and eventual disposition of that asset group. For the Company-owned salon asset groups that failed the recoverability test, an impairment loss was measured as the amount by which the ROU asset within the asset group exceeded its fair value, which was determined using a discounted cash flow methodology. As described by management, the results of this assessment indicated that the estimated fair value of certain Company-owned salon asset groups did not exceed the carrying value and an impairment expense was recorded to the ROU asset balance.
We identified the evaluation of the impairment of ROU asset balances at the Company-owned salon asset group level as a critical audit matter. Subjective auditor judgment was required to evaluate, for each Company-owned salon asset group: (i) the assumptions used by management to calculate the undiscounted future cash flow, (ii) management's method to determine the fair value and, (iii) significant judgments and assumptions related to the fair value determination, including the discount rate, the market rent of comparable properties based on recently negotiated leases, as applicable, the projected sales for fiscal years 2022 through 2023 and market capitalization rate for properties with no recently negotiated leases.
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Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. We performed the following procedures:
a.evaluated the design and tested the operating effectiveness of relevant controls relating to management’s impairment assessment of the ROU asset balances related to Company-owned salons, including controls over the valuation of the Company-owned salon asset groups
b.tested the Company-owned salon impairment analyses as follows:
i.evaluated the completeness of the population of Company-owned salon locations determined to be impaired,
ii.evaluated and tested management's models and processes for developing the undiscounted and discounted cash flows,
iii.selected a sample of Company-owned salons to test the appropriateness of management's methodology and significant assumptions noted above, and the accuracy of the computations and data used for both the undiscounted and discounted cash flow analyses
c.assessed the reasonableness of management’s ability to forecast future sales by comparing past projections to actual financial statement results
d.performed sensitivity analyses of the significant assumptions to evaluate the impact on the fair value of each of the Company-owned salons resulting from changes in the underlying assumptions.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2021.
Minneapolis, Minnesota
August 26, 2021
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Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Regis Corporation
Opinion on internal control over financial reporting
We have audited the internal control over financial reporting of Regis Corporation (a Minnesota corporation) and subsidiaries (the "Company") as of June 30, 2021, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2021, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the consolidated financial statements of the Company as of and for the year ended June 30, 2021, and our report dated August 26, 2021 expressed an unqualified opinion on those financial statements.
Basis for opinion
The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting ("Management's Report"). Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and limitations of internal control over financial reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ GRANT THORNTON LLP
Minneapolis, Minnesota
August 26, 2021
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Regis Corporation
Opinion on the Financial Statements
We have audited the consolidatedbalance sheet of Regis Corporation and its subsidiaries (the "Company") as of June 30, 2020, and the related consolidated statements of operations, of comprehensive loss, of shareholders' equity and of cash flows for each of the two years in the period ended June 30, 2020, including the related notes (collectively referred to as the "consolidatedfinancial statements").In our opinion, theconsolidatedfinancial statements present fairly, in all material respects, the financial position ofthe Company as of June 30, 2020, and the results of its operations and itscash flows for each of the two years in the period ended June 30, 2020 in conformity with accounting principles generally accepted in the United States of America.
Change in Accounting Principle
As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for leases as of July 1, 2019.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits of these consolidatedfinancial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidatedfinancial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidatedfinancial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
August 31, 2020
We served as the Company's auditor from at least 1990to 2020. We have not been able to determine the specific year we began serving as auditor of the Company.
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REGIS CORPORATION
CONSOLIDATED BALANCE SHEET
(Dollars in thousands, except per share data)
ASSETS
Current assets:
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term financing liabilities (Note 8) — 27,981
Commitments and contingencies (Note 9)
Shareholders' equity:
Accumulated other comprehensive income 9,543 7,449
______________________________________________________________________________
The accompanying notes are an integral part of the Consolidated Financial Statements.
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REGIS CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars and shares in thousands, except per share data)
Fiscal Years
Revenues:
Operating expenses:
TBG mall location restructuring (Note 3) — 2,333 21,816
Goodwill impairment (Note 1) — 40,164 —
Other (expense) income:
Income from discontinued operations, net of income taxes (Note 3) — 832 5,896
Net loss per share:
Basic and diluted:
Loss from continuing operations $ (3.15) $ (4.79) $ (0.48)
Income from discontinued operations — 0.02 0.14
Net loss per share, basic and diluted (1) $ (3.15) $ (4.77) $ (0.34)
Weighted average common and common equivalent shares outstanding:
_____________________________________________________________________________
(1)Total is a recalculation; line items calculated individually may not sum to total due to rounding.
The accompanying notes are an integral part of the Consolidated Financial Statements.
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REGIS CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS
(Dollars in thousands)
Fiscal Years
Other comprehensive income (loss), net of tax:
Net current period foreign currency translation adjustments 1,888 (1,462) 185
Recognition of deferred compensation 206 (431) (499)
_______________________________________________________________________________
The accompanying notes are an integral part of the Consolidated Financial Statements.
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REGIS CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Dollars in thousands, except share data)
Shares Amount
Foreign currency translation — — — 185 — 185
Stock-based compensation — — 9,003 — — 9,003
Recognition of deferred compensation (Note 11) — — — (499) — (499)
Minority interest (Note 1) — — — — 51 51
Foreign currency translation — — — (1,462) — (1,462)
Stock-based compensation — — 3,275 — — 3,275
Recognition of deferred compensation (Note 11) — — — (431) — (431)
Minority interest (Note 1) — — — — (84) (84)
Foreign currency translation (Note 1) — — — 1,888 — 1,888
Stock-based compensation — — 3,254 — — 3,254
Recognition of deferred compensation (Note 11) — — — 206 — 206
Minority interest (Note 1) — — — — (520) (520)
_______________________________________________________________________________
The accompanying notes are an integral part of the Consolidated Financial Statements.
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REGIS CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in thousands)
Fiscal Years
Cash flows from operating activities:
Adjustments to reconcile net loss to net cash used in operating activities:
Non-cash adjustments related to discontinued operations — (1,098) 306
Inventory reserve 12,068 — —
Gain from disposal of distribution center assets (14,997) — —
Gain from sale of company headquarters, net — (2,513) —
Loss (gain) from sale of salon assets to franchisees, net 16,696 27,306 (2,918)
Non-cash TBG mall location restructuring charge (Note 3) — — 21,008
Goodwill impairment — 40,164 —
Amortization of debt discount and financing costs 1,839 398 275
Other non-cash items affecting earnings (351) (539) (903)
Changes in operating assets and liabilities (1):
Cash flows from investing activities:
Proceeds from sale of company headquarters — 8,996 —
Costs associated with sale of assets to franchisees (261) (2,089) —
Proceeds from company-owned life insurance policies 1,200 — 24,617
Net cash (used in) provided by investing activities: (2,099) 61,029 87,788
Cash flows from financing activities:
Borrowings on revolving credit facility 10,000 213,000 —
Repayments of revolving credit facility (589) (125,500) —
Proceeds from sale and leaseback transactions — — 28,821
Minority interest buyout (562) — —
Distribution center lease payments (724) (769) (378)
Effect of exchange rate changes on cash and cash equivalents 477 (284) 35
Cash, cash equivalents and restricted cash:
_______________________________________________________________________________
(1)Changes in operating assets and liabilities exclude assets and liabilities sold or acquired.
The accompanying notes are an integral part of the Consolidated Financial Statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS DESCRIPTION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Description:
Regis Corporation (the Company) franchises technology-enabled hairstyling and hair care salons throughout the United States (U.S.), Canada, Puerto Rico and the United Kingdom (U.K.). The business is evaluated in two segments, Franchise salons and Company-owned salons. See Note 15 to the Consolidated Financial Statements. Salons are located in leased space in strip shopping centers, malls or Walmart.
COVID-19 Impact:
During fiscal years 2021 and 2020, the global coronavirus pandemic (COVID-19) had an adverse impact on operations, including government-mandated salon closures in the fourth quarter of fiscal year 2020 and other prolonged closures, particularly in California and Ontario, in fiscal year 2021. The COVID-19 pandemic continues to impact salon guest visits resulting in a significant reduction in revenue and traffic. As a result, COVID-19 has and may continue to negatively affect revenue and profitability.
Consolidation:
The Consolidated Financial Statements include the accounts of the Company and its subsidiaries after the elimination of intercompany accounts and transactions. All material subsidiaries are wholly owned. The Company consolidates variable interest entities where it has determined it is the primary beneficiary of those entities' operations.
Variable Interest Entities:
The Company has interests in certain privately-held entities through arrangements that do not involve voting interests. Such entities, known as a variable interest entities (VIE), are required to be consolidated by its primary beneficiary. The Company evaluates whether or not it is the primary beneficiary for each VIE using a qualitative assessment that considers the VIE's purpose and design, the involvement of each of the interest holders and the risk and benefits of the VIE. As of June 30, 2021, the Company has no VIE's where the Company is the primary beneficiary.
The Company has an investment in Empire Education Group, Inc. (EEG). During fiscal year 2020, the Company signed an agreement to sell its interest in EEG to the other shareholder. The transaction is expected to close in fiscal year 2022, at which time the Company expects to record an immaterial non-operating gain. Until the transaction closes, the Company continues to account for EEG as an equity investment under the voting interest model. The Company has granted the other shareholder of EEG an irrevocable proxy to vote a certain number of the Company's shares such that the other shareholder of EEG has voting control of EEG's common stock, as well as the right to appoint four of the five members of EEG's Board of Directors. The Company wrote off its investment balance in EEG in fiscal year 2016.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Use of Estimates:
The preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Due to the economic disruption caused by the COVID-19 pandemic, the Company faces a greater degree of uncertainty than normal in making judgments and estimates needed to apply the Company's significant accounting policies. Actual results and outcomes may differ from management's estimates and assumptions.
Cash, Cash Equivalents and Restricted Cash:
Cash equivalents consist of investments in short-term, highly liquid securities having original maturities of three months or less, which are made as a part of the Company's cash management activity. The carrying values of these assets approximate their fair market values. The Company primarily utilizes a cash management system with a series of separate accounts consisting of lockbox accounts for receiving cash, concentration accounts that funds are moved to, and several "zero balance" disbursement accounts for funding of payroll and accounts payable. As a result of the Company's cash management system, checks issued, but not presented to the banks for payment, may create negative book cash balances. There were no checks outstanding in excess of related book cash balances at June 30, 2021 and 2020.
Restricted cash within other current assets primarily relates to consolidated advertising cooperatives funds, which can only be used to settle obligations of the respective cooperatives and contractual obligations to collateralize the Company's self-insurance programs. The self-insurance restricted cash arrangement can be canceled by the Company at any time if substituted with letters of credit. The table below reconciles the cash and cash equivalents balances and restricted cash balances, recorded within other current assets on the Consolidated Balance Sheet to the amount of cash, cash equivalents and restricted cash reported on the Consolidated Statement of Cash Flows:
(Dollars in thousands)
Restricted cash, included in other current assets 9,961 9,213
Total cash, cash equivalents and restricted cash $ 29,152 $ 122,880
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Receivables and Allowance for Doubtful Accounts:
The receivable balance on the Company's Consolidated Balance Sheet primarily includes accounts and notes receivable from franchisees, credit card receivables and receivables related to salons sold to franchisees. The balance is presented net of an allowance for expected losses (i.e., doubtful accounts), related to receivables from the Company's franchisees. The Company monitors the financial condition of its franchisees and records provisions for estimated losses on receivables when it believes franchisees are unable to make their required payments based on factors such as delinquencies and aging trends. The allowance for doubtful accounts is the Company's best estimate of the amount of probable credit losses related to existing accounts and notes receivables. As of June 30, 2021, 2020 and 2019, the allowance for doubtful accounts was $7.8, $6.9 and $2.0 million, respectively. The allowance for doubtful accounts increased in fiscal year 2021 due to lower franchisees sales increasing the risk of default. See Note 2 to the Consolidated Financial Statements.
Inventories:
Inventories of finished goods consist principally of hair care products for retail product sales. A portion of inventories are also used for salon services consisting of hair color, hair care products including shampoo and conditioner and hair care treatments including permanents, neutralizers and relaxers. Inventories are stated at the lower of cost or market, with cost determined on a weighted average cost basis.
Physical inventory counts are performed primarily in the fourth quarter of the fiscal year for salons and throughout the year at the distribution centers. Product and service inventories are adjusted based on the physical inventory counts. During the fiscal year, cost of retail product sold to salon guests is determined based on the weighted average cost of product sold, adjusted for an estimated shrinkage factor. The cost of product used in salon services is determined by applying an estimated percentage of total cost of service to service revenues. These estimates are updated quarterly based on cycle count results for the distribution centers, service sales mix, discounting, special promotions and other factors.
The Company has inventory valuation reserves for excess and obsolete inventories, or other factors that may render inventories unmarketable at their historical costs. In fiscal year 2021, the Company announced it would transition away from its wholesale product distribution model in favor of a third-party distribution model. As a result, the Company plans to exit its two distribution centers in fiscal year 2022. To facilitate the exit, the Company is selling inventory at discounts and disposing of hard to sell products. Additionally, the reduction in company-owned salons decreases the Company's ability to re-distribute inventory from closed locations to other salons to be sold or used. These two factors resulted in a significant increase in inventory write-offs and an overall increase in the inventory valuation reserve during fiscal year 2021. The fiscal year 2021 non-cash inventory write-off charge of $12.1 million was recorded to Cost of product in the Consolidated Statement of Operations. The inventory valuation reserve as of June 30, 2021 and 2020 was $11.8 million and $1.2 million, respectively.
Property and Equipment:
Property and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation of property and equipment is computed using the straight-line method over their estimated useful asset lives (i.e., 30 to 39 years for buildings, 10 years or lease life for improvements and three to ten years or lease life for equipment, furniture and software). Depreciation expense was $17.1, $31.8 and $31.9 million in fiscal years 2021, 2020 and 2019, respectively. Depreciation expense for fiscal year 2021 includes $4.7 million of asset retirement obligations, which is a cash expense. Fiscal years 2020 and 2019 had no asset retirement obligations.
The Company capitalizes both internal and external costs of developing or obtaining computer software for internal use. Costs incurred to develop internal-use software during the application development stage are capitalized, while data conversion, training and maintenance costs associated with internal-use software are expensed as incurred. Estimated useful lives range from three to seven years.
Expenditures for maintenance and repairs and minor renewals and betterments, which do not improve or extend the life of the respective assets, are expensed. All other expenditures for renewals and betterments are capitalized. The assets and related depreciation and amortization accounts are adjusted for property retirements and disposals with the resulting gain or loss included in operating income. Fully depreciated or amortized assets remain in the accounts until retired from service.
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Right of Use Asset, Lease Liabilities and Rent Expense:
At contract inception, the Company determines whether a contract is, or contains, a lease by determining whether it conveys the right to control the use of the identified asset for a period of time. If the contract provides the Company the right to substantially all of the economic benefits from the use of the identified asset and the right to direct the use of the identified asset, the Company considers it to be, or contain, a lease. The Company leases its company-owned salons and some of its corporate facilities under operating leases. The original terms of the salon leases range from 1 to 20 years with many leases renewable for an additional 5 to 10 year term at the option of the Company. In addition to the obligation to make fixed rental payments for the use of the salons, the Company also has variable lease payments that are based on sales levels. For most leases, the Company is required to pay real estate taxes and other occupancy expenses.
The Company leases salon premises in which the majority of its franchisees operate and has entered into corresponding sublease arrangements with franchisees. All lease costs are passed through to franchisees. The Company records the rental payments due from franchisees as franchise rental income and the corresponding amounts owed to landlords as franchise rent expense on the Consolidated Statement of Operations.
For salon operating leases, the lease liability is initially and subsequently measured at the present value of the unpaid lease payments at the lease commencement date, including one lease term option when the lease is expected to be renewed. The right of use asset is initially and subsequently measured throughout the lease term at the carrying amount of the lease liability, plus initial direct costs, less any accrued lease payments and unamortized lease incentives received, if any. The Company's consolidated ROU asset balance was $611.9 and $786.2 million as of June 30, 2021 and 2020, respectively. For leases classified as operating leases, expense for lease payments is recognized on a straight-line basis over the lease term, including the lease renewal option when the lease is expected to be renewed. Generally, the non-lease components, such as real estate taxes and other occupancy expenses, are separate from rent expense within the lease and are not included in the measurement of the lease liability because these charges are variable.
The discount rate used to determine the present value of the lease payments is the Company's estimated collateralized incremental borrowing rate, based on the yield curve for the respective lease terms, as the interest rate implicit in the lease cannot generally be determined. The Company uses the portfolio approach in applying the discount rate based on the original lease term.
Certain leases provide for contingent rents that are determined as a percentage of revenues in excess of specified levels. The Company records a contingent rent liability in accrued expenses on the Consolidated Balance Sheet, along with the corresponding rent expense in the Consolidated Statement of Operations, when specified levels have been achieved or when management determines that achieving the specified levels during the fiscal year is probable.
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Salon Long-Lived Asset and Right of Use Asset Impairment Assessments:
A lessee's ROU asset is subject to the same asset impairment guidance in ASC 360, Property, Plant, and Equipment, applied to other elements of property, plant, and equipment. The Company has identified its asset groups at the individual salon level as this represents the lowest level that identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. Poor salon performance in fiscal year 2020 and 2021, primarily due to the COVID-19 pandemic, resulted in ASC 360-10-35-21 triggering events. As a result, management assessed underperforming salon asset groups, which included the related ROU assets, for impairment in accordance with ASC 360.
The Company assesses impairment of long-lived salon assets and right of use assets at the individual salon level, as this is the lowest level for which identifiable cash flows are largely independent of other groups of assets and liabilities, when events or changes in circumstances indicate the carrying value of the assets or the asset grouping may not be recoverable. Factors considered in deciding when to perform an impairment review include significant under-performance of an individual salon in relation to expectations, significant economic or geographic trends, and significant changes or planned changes in our use of the assets. The first step is to assess recoverability, and in doing that, the undiscounted cash flows are compared to the carrying value. If the undiscounted estimated cash flows are less than the carrying value of the assets, the Company calculates an impairment charge based on the difference between the carrying value of the asset group and its fair value. The fair value of the salon long-lived asset group is estimated using market participant methods based on the best information available. The fair value of the right of use asset is estimated by determining what a market participant would pay over the life of the primary asset in the group, discounted back to June 30, 2021. See Note 6 for further discussion related to right of use asset impairment.
The first step in the impairment test under ASC 360 is to determine whether the long-lived assets are recoverable, which is determined by comparing the net carrying value of the salon asset group to the undiscounted net cash flows to be generated from the use and eventual disposition of that asset group. Estimating cash flows for purposes of the recoverability test is subjective and requires significant judgment. Estimated future cash flows used for the purposes of the recoverability test were based upon historical cash flows for the salons, adjusted for expected changes in future market conditions related to the COVID-19 pandemic, and other factors. The period of time used to determine the estimates of the future cash flows for the recoverability test was based on the remaining useful life of the primary asset of the group, which was the ROU asset in all cases.
Step two of the long-lived asset impairment test requires that the fair value of the asset group be estimated when determining the amount of any impairment loss. For the salon asset groups that failed the recoverability test, an impairment loss was measured as the amount by which the carrying amount of the asset group exceeds its fair value. The Company applied the fair value guidance within ASC 820-10 to determine the fair value of the asset group from the perspective of a market-participant considering, among other things, appropriate discount rates, multiple valuation techniques, the most advantageous market, and assumptions about the highest and best use of the asset group. To determine the fair value of the salon asset groups, the Company utilized market-participant assumptions rather than the Company's own assumptions about how it intends to use the asset group. The significant judgments and assumptions utilized to determine the fair value of the salon asset groups include: the market rent of comparable properties, the asset group's projected sales for properties and a discount rate.
The fair value of the salon long-lived asset group is estimated using market participant methods based on the best information available. The significant judgments and assumptions utilized to determine the fair value of the salon asset groups include: the market rent of comparable properties, the asset group's projected sales for fiscal years 2021 through 2023, and a discount rate. The Company engaged a third-party valuation specialist to assist with the research related to inputs used in their determination of the fair value of the ROU asset, which included providing information related to significant inputs and assumptions utilized in the measurement of the impairment loss.
For fiscal year 2021, the Company recognized a long-lived asset impairment charge of $13.0 million, which included $9.5 million related to ROU assets on the Consolidated Statement of Operations. For fiscal year 2020, the Company recognized a long-lived asset impairment charge of $22.6 million, which included a right of use asset impairment of $17.4 million. A long-lived asset impairment charge was not recognized in fiscal year 2019. The impairment loss for each salon asset group that was recognized was allocated among the long-lived assets of the group on a pro-rata basis using their relative carrying amounts. Additionally, the impairment losses did not reduce the carrying amount of an individual asset below its fair value, including for the ROU assets included in the salon asset groups. Assessing the long-lived assets for impairment requires management to make assumptions and to apply judgment which can be affected by economic conditions and other factors that can be difficult to predict. The Company does not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions it uses to calculate impairment losses for its long-lived asset, including its ROU assets. However, the ultimate severity and longevity of the COVID-19 pandemic is unknown; therefore, if actual results are not consistent with the estimates and assumptions used in the calculations, the Company may be exposed to future impairment losses that could be material. Our projections of future operating performance do not anticipate future salon closures due to the COVID-19 pandemic. See Note 6 to the Consolidated Financial Statements.
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Goodwill:
As of June 30, 2021 and 2020, the Franchise reporting unit had $229.6 and $227.5 million of goodwill and the Company-owned reporting unit had no goodwill for both periods. See Note 5 to the Consolidated Financial Statements. The Company assesses goodwill impairment on an annual basis as of April 30, and between annual assessments if an event occurs, or circumstances change, that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Goodwill impairment assessments are performed at the reporting unit level, which is the same as the Company's operating segments. In fiscal year 2020, the Company adopted ASU 2017-04, which simplified the test for goodwill impairment. Under this accounting standard, the Company performed its interim impairment test and annual impairment tests by comparing the fair value of a reporting unit to its carrying amount. The Company then records an impairment charge for the amount that the carrying amount exceeds the fair value. This eliminates Step 2 from the goodwill impairment test to simplify the subsequent measure of goodwill. Prior to the adoption, the goodwill assessment involved a one-step comparison of the reporting unit's fair value to its carrying value, including goodwill (Step 1). If the reporting unit's fair value exceeded its carrying value, no further procedures were required. However, if the reporting unit's fair value was less than the carrying value, an impairment charge was recorded for the difference between the fair value and carrying value of the reporting unit.
In applying the goodwill impairment assessment, the Company could assess qualitative factors to determine whether it is more likely than not that the fair value of the reporting units was less than its carrying value (Step 0). Qualitative factors could include, but were not limited to, economic, market and industry conditions, cost factors and overall financial performance of the reporting unit. If after assessing these qualitative factors, the Company determined it is "more-likely-than-not" that the carrying value was less than the fair value, then performing Step 1 of the goodwill impairment assessment was unnecessary.
The carrying value of each reporting unit is based on the assets and liabilities associated with the operations of the reporting unit, including allocation of shared or corporate balances among reporting units. Allocations are generally based on the number of salons in each reporting unit as a percent of total company-owned salons or expenses of the reporting unit as a percent of total company expenses.
The Company calculates estimated fair values of the reporting units based on discounted cash flows utilizing estimates in annual revenue, service and product margins, fixed expense rates, allocated corporate overhead, franchise and company-owned salon counts, proceeds from the sale of company-owned salons to franchisees and long-term growth rates for determining terminal value. Where available and as appropriate, comparative market multiples are used in conjunction with the results of the discounted cash flows. The Company engages third-party valuation consultants to assist in evaluating the Company's estimated fair value calculations.
Following is a description of the goodwill impairment assessments for each of the fiscal years:
Fiscal 2021
During fiscal year 2021, the Company did not experience any triggering events that required an interim goodwill analysis. The Company performed its annual impairment assessment as of April 30. For the fiscal year 2021 annual impairment assessment, the Company performed a Step 1 impairment test for the Franchise reporting unit. The Company compared the carrying value of the Franchise reporting unit, including goodwill, to the estimated fair value. The results of this assessments indicated that the estimated fair value of the Company's Franchise reporting unit significantly exceeded the carrying value.
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Fiscal 2020
During the third quarter of fiscal year 2020, the Company determined a triggering event occurred, resulting in quantitative impairment tests performed over the goodwill. This determination was made considering the reduced sales and profitability projections for the reporting units, driven by the COVID-19 pandemic and related economic disruption.
The triggering event experienced in the third quarter impacted both reporting units of the business, Franchise and Company-owned. The Company engaged a third-party valuation specialist to perform an impairment analysis on the Franchise reporting unit of the business. The Company-owned reporting unit is comprised of a portfolio of salons that the Company intends to sell to franchisees or close in the short-term as part of the transition to a fully-franchised model. As a result, the Company-owned reporting unit has a limited life which allows the Company to perform its own impairment analysis on the Company-owned reporting unit.
For the goodwill impairment analysis, management utilized a combination of both a discounted cash flows approach and market approach to evaluate the Franchise reporting unit, and the discounted cash flows approach to evaluate the Company-owned reporting unit. The discounted cash flow models reflect management's assumptions regarding revenue growth rates, economic and market trends including deterioration from the current COVID-19 pandemic, cost structure, and other expectations about the anticipated short-term and long-term operating results of the reporting units. For the Franchise reporting unit, the number of salons to be sold to franchisees and the discount rate of 13 percent were significant assumptions utilized in the discounted cash flow. For the Company-owned reporting unit, proceeds from the sale of salons to franchisees and number of salon venditions were the significant assumptions utilized in its discounted cash flow.
As a result of the impairment testing, the Franchise reporting unit was determined to have a fair value that exceeded carrying value by approximately 50 percent. The Company-owned reporting unit was determined to have a carrying value in excess of its fair value, resulting in a goodwill impairment charge of $40.2 million. Prior to the COVID-19 pandemic, the Company had been derecognizing Company-owned goodwill as part of the calculation of gain or loss on the sale of salons to franchisees. The Company-owned reporting unit has no remaining goodwill, so there will be no further derecognition of Company-owned goodwill. The Company performed its annual impairment assessment as of April 30, 2020 and noted no significant changes to the carrying value or the fair value of the Franchise reporting unit, which would indicate that the headroom dropped below the 50 percent determined as of March 31, 2020.
If a future triggering event analysis or the Company's annual impairment assessment indicates the fair value of the Franchise reporting unit has potentially fallen below more than the 50 percent headroom, we may be required to perform an updated impairment assessment that may result in a non-cash impairment charge to reduce the carrying value of goodwill.
Assessing goodwill for impairment requires management to make assumptions and to apply judgment, including forecasting future sales, future salon sales to franchisees and selecting appropriate discount rates, which can be affected by economic conditions and other factors that can be difficult to predict. The Company does not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions it uses to calculate impairment losses of goodwill. However, if actual results are not consistent with the estimates and assumptions used in the calculations, or if management is unable to expand its franchise base, the Company may be exposed to future impairment losses that could be material.
Fiscal 2019
During fiscal year 2019, the Company did not experience any triggering events that required an interim goodwill analysis. The Company performed its annual impairment assessment as of April 30. For the fiscal year 2019 annual impairment assessment, due to the transformational efforts completed during the year, the Company elected to forgo the optional Step 0 assessment and performed the quantitative impairment analysis on the Franchise and Company-owned reporting units. The Company compared the carrying value of the reporting units, including goodwill, to their estimated fair value. The results of these assessments indicated that the estimated fair value of the Company's reporting units exceeded their carrying value. The Franchise reporting unit had substantial headroom and the Company-owned reporting unit had headroom of approximately 20 percent.
Investments In Affiliates:
The Company has equity investments in securities of certain privately held entities. The Company accounts for these investments under the equity or cost method of accounting. The Company's investments have no value as of June 30, 2021 and 2020.
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Self-Insurance Accruals:
The Company uses a combination of third-party insurance and self-insurance for a number of risks including workers' compensation, health insurance, employment practice liability and general liability claims. The liability represents the Company's estimate of the undiscounted ultimate cost of uninsured claims incurred as of the Consolidated Balance Sheet date.
The Company estimates self-insurance liabilities using a number of factors, primarily based on independent third-party actuarially-determined amounts, historical claims experience, estimates of incurred but not reported claims, demographic factors and severity factors.
Although the Company does not expect the amounts ultimately paid to differ significantly from the estimates, self-insurance accruals could be affected if future claims experience differs significantly from historical trends and actuarial assumptions. For fiscal years 2021, 2020 and 2019, the Company recorded decreases (increases) in expense for changes in estimates related to prior year open policy periods of $3.6, $3.1 and $(1.3) million, respectively. The Company updates loss projections quarterly and adjusts its liability to reflect updated projections. The updated loss projections consider new claims and developments associated with existing claims for each open policy period. As certain claims can take years to settle, the Company has multiple policy periods open at any point in time.
As of June 30, 2021, the Company had $6.8 and $12.7 million recorded in current liabilities and non-current liabilities, respectively, related to the Company's workers' compensation and general liability self-insurance accruals. As of June 30, 2020, the Company had $8.5 and $20.3 million recorded in current liabilities and non-current liabilities, respectively, related to the Company's workers' compensation and general liability self-insurance accruals.
Revenue Recognition and Deferred Revenue:
Franchise revenues primarily include royalties, advertising fund fees and initial franchise fees. Royalties and advertising fund revenues represent sales-based royalties that are recognized as revenue in the period in which the sales occur. The Company defers franchise fees until the salon is open and then recognizes the revenue over the term of the franchise agreement. See Note 2 to the Consolidated Financial Statements.
Product sales by the Company to its franchisees are included within product revenues on the Consolidated Statement of Operations and recorded at the time product is delivered to franchise locations.
Company-owned salon revenues are recognized at the time when the services are provided. Product revenues are recognized when the guest receives and pays for the merchandise.
Classification of Expenses:
The following discussion provides the primary costs classified in each major expense category:
Cost of service— labor costs related to salon employees and the cost of product used in providing service.
Cost of product— cost of product sold to guests, labor costs related to selling retail product, the cost of product sold to franchisees and reserve for excess and obsolete inventory.
Site operating— direct costs incurred by the Company's salons, such as advertising, workers' compensation, insurance, utilities and janitorial costs.
General and administrative— costs incurred to support franchise operations, costs associated with field supervision, costs associated with salon training, distribution centers and corporate offices (such as salaries and professional fees).
Consideration Received from Vendors:
The Company receives consideration for a variety of vendor-sponsored programs. These programs primarily include volume rebates and promotion and advertising reimbursements.
With respect to volume rebates, the Company estimates the amount of rebate it will receive and accrues it as a reduction to the cost of inventory over the period in which the rebate is earned based upon historical purchasing patterns and the terms of the volume rebate program. A quarterly analysis is performed in order to ensure the estimated rebate accrued is reasonable and any necessary adjustments are recorded.
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Distribution Costs:
Distribution costs are incurred to store, move and ship product from the Company's distribution centers to salons and includes distribution center overhead. Such distribution costs related to product shipped to company-owned locations are included in site operating expenses in the Consolidated Statement of Operations. Distribution costs, including distribution center overhead, related to shipping product to franchise locations totaled $12.1, $8.6 and $7.7 million during fiscal years 2021, 2020 and 2019, respectively, and are included within general and administrative expenses on the Consolidated Statement of Operations.
Advertising and Advertising Funds:
Advertising costs consist of the Company's corporate funded advertising costs, the Company's advertising fund contributions and franchisee's advertising fund contributions. Corporate funded advertising costs are expensed as incurred. The Company has various franchising programs supporting certain of its franchise salon concepts. Most maintain advertising funds that provide comprehensive advertising and sales promotion support. All salons are required to participate in the advertising funds for the same salon concept. The Company administers the advertising funds in accordance with franchise operating and other agreements. Advertising fund contributions are expensed when the contribution is made.
The Company's advertising costs are included in site operating expenses in the Consolidated Statement of Operations and consist of the following:
Fiscal Years
(Dollars in thousands)
Advertising fund contributions from company-owned salons 897 3,715 12,929
_____________________________________________________________________________
(1)Fiscal year 2020 includes the refunding of $14.9 million of previously collected cooperative fees to franchisees as a direct result of the COVID-19 pandemic.
The Company records all advertising funds as assets and liabilities within the Company's Consolidated Balance Sheet. As of June 30, 2021 and 2020, approximately $9.9 and $4.3 million, respectively, representing the advertising funds' assets and liabilities were recorded within total assets and total liabilities in the Company's Consolidated Balance Sheet.
Stock-Based Employee Compensation Plans:
The Company recognizes stock-based compensation expense based on the fair value of the awards at the grant date. Compensation expense is recognized on a straight-line basis over the requisite service period of the award (or to the date a participant becomes eligible for retirement, if earlier). The Company uses fair value methods that require the input of subjective assumptions, including the expected term, expected volatility, dividend yield and risk-free interest rate.
The Company estimates the likelihood and the rate of achievement for performance sensitive stock-based awards at the end of each reporting period. Changes in the estimated rate of achievement can have a significant effect on the recorded stock-based compensation expense as the effect of a change in the estimated achievement level is recognized in the period the change occurs.
Interest Income and Other, Net:
In December 2019, the Company sold the land and buildings associated with the Company's former headquarters for proceeds of $9.0 million, resulting in a net gain on sale of $2.5 million, which was recorded in Interest income and other, net on the Consolidated Statement of Operations.
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Sales Taxes:
Sales taxes are recorded on a net basis (rather than as both revenue and an expense) within the Company's Consolidated Statement of Operations.
Income Taxes:
Deferred income tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the Consolidated Financial Statements or income tax returns. Deferred income tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities using currently enacted tax rates in effect for the years in which the differences are expected to reverse.
We recognize deferred tax assets to the extent we believe these assets are more likely than not to be realized. The Company evaluates all evidence, including recent financial performance, the existence of cumulative year losses and our forecast of future taxable income, to assess the need for a valuation allowance against our deferred tax assets. While the determination of whether or not to record a valuation allowance is not fully governed by a specific objective test, accounting guidance places significant weight on recent financial performance.
The Company has a valuation allowance on its deferred tax assets of $192.5 and $122.4 million at June 30, 2021 and 2020, respectively. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make necessary adjustments to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.
Significant components of the valuation allowance which occurred during fiscal year 2021 are as follows:
•The Company recognized a tax loss on its investment in Luxembourg and established a corresponding valuation allowance of $34.4 million.
Significant components of the valuation allowance which occurred during fiscal year 2020 are as follows:
•In connection with the Coronavirus Aid, Relief and Economic Security Act (CARES Act), NOLs resulting from accounting periods which straddled December 31, 2017 are now considered definite-lived NOLs. Therefore, the Company established a valuation allowance against the U.S. NOLs generated during its fiscal year 2018 and recorded a net tax expense of $14.7 million.
•The Company determined that it no longer had sufficient U.S. indefinite-lived taxable temporary differences to support realization of its U.S. indefinite-lived NOLs and its existing U.S. deferred tax assets that upon reversal are expected to generate indefinite-lived NOLs. As a result, the Company recorded an additional $17.0 million valuation allowance on its U.S. federal indefinite-lived deferred tax assets.
•The Company recognized a capital loss and established a corresponding valuation allowance of $14.9 million on investment outside basis previously impaired for financial accounting purposes.
The Company reserves for unrecognized tax benefits, interest and penalties related to anticipated tax audit positions in the U.S. and other tax jurisdictions based on an estimate of whether additional taxes will be due. If payment of these amounts ultimately proves to be unnecessary, the reversal of these liabilities would result in tax benefits being recognized in the period in which it is determined that the liabilities are no longer necessary. If the estimate of unrecognized tax benefits, interest and penalties proves to be less than the ultimate assessment, additional expenses would result.
Inherent in the measurement of deferred balances are certain judgments and interpretations of tax laws and published guidance with respect to the Company's operations. Income tax expense is primarily the current tax payable for the period and the change during the period in certain deferred tax assets and liabilities.
See Note 10 to the Consolidated Financial Statements.
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Net Loss Per Share:
The Company's basic earnings per share is calculated as net loss divided by weighted average common shares outstanding, excluding unvested outstanding restricted stock awards and restricted stock units. The Company's dilutive earnings per share is calculated as net income divided by weighted average common shares and common share equivalents outstanding, which includes shares issuable under the Company's stock option plan and long-term incentive plan and dilutive securities. Stock-based awards with exercise prices greater than the average market value of the Company's common stock are excluded from the computation of diluted earnings per share. Due to the Company's net loss, basic and dilutive earnings per share are equal.
Comprehensive Loss:
Components of comprehensive loss include net loss, foreign currency translation adjustments and recognition of deferred compensation, net of tax within shareholders' equity.
Foreign Currency Translation:
The Consolidated Balance Sheet, Consolidated Statement of Operations and Consolidated Statement of Cash Flows of the Company's international operations are measured using local currency as the functional currency. Assets and liabilities of these subsidiaries are translated at the exchange rates in effect at each Balance Sheet date. Translation adjustments arising from the use of differing exchange rates from period to period are included in accumulated other comprehensive income within shareholders' equity. Statement of Operations accounts are translated at the average rates of exchange prevailing during the year. During fiscal years 2021, 2020 and 2019, the foreign currency gain (loss) included in loss from continuing operations was $0.3, $(0.1) and $0.1 million, respectively.
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Accounting Standards Recently Adopted by the Company:
Simplifying the Test for Goodwill Impairment
In fiscal year 2020, the Company adopted ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350)" for the interim impairment test performed due to the triggering event noted above, for the quarter ended March 31, 2020. Under this accounting standard, the Company performed its interim impairment test and annual impairment tests by comparing the fair value of a reporting unit to its carrying amount. The Company then records an impairment charge for the amount that the carrying amount exceeds the fair value. This eliminates Step 2 from the goodwill impairment test to simplify the subsequent measure of goodwill.
Leases
In fiscal year 2020, the Company adopted ASU 2016-02, "Leases (Topic 842)" and all subsequent ASUs that modified Topic 842 using the modified retrospective method and elected the option to not restate comparative periods in the year of adoption. The Company also elected the package of practical expedients that do not require reassessment of whether existing contracts are or contain leases, lease classification or initial direct costs. The Company has also made an accounting policy election to keep leases with an initial term of 12 months or less off of the Consolidated Balance Sheet.
Under adoption of Topic 842, the Company recorded a right of use asset and lease liability of $980.8 and $993.7 million, respectively. The difference between the assets and liabilities are attributable to the reclassification of certain existing lease-related assets and liabilities as an adjustment to the right of use assets. The decrease in the right of use asset and lease liability from July 1, 2019 to June 30, 2021 was due to lease modifications, impairment and salon closures.
The lease liability reflects a present value of the Company's current minimum lease payments for existing operating leases primarily relating to real estate leases, over a lease term which may include one option, if the options are reasonably assured of being exercised, discounted using a collateralized incremental borrowing rate. The Company uses the portfolio approach in applying the discount rate.
The accounting guidance for lessors remained largely unchanged from previous guidance with the exception of the presentation of rent payments that the Company passes through to franchisees (lessees). These costs are generally paid by the Company and reimbursed by the franchisee. Historically, the costs had been recorded on a net basis within rent expense in the Consolidated Statements of Operations, but are now presented on a gross basis upon adoption of the guidance. See Note 6 for further information about our transition to Topic 842 and the newly required disclosures.
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2. REVENUE RECOGNITION:
Revenue Recognition and Deferred Revenue:
Revenue recognized at point of sale
Company-owned salon revenues are recognized at the time when the services are provided. Product revenues for company-owned salons are recognized when the guest receives and pays for the merchandise. Revenues from purchases made with gift cards are also recorded when the guest takes possession of the merchandise or services are provided. Gift cards issued by the Company are recorded as a liability (deferred revenue) upon sale and recognized as revenue upon redemption by the customer. Gift card breakage, the amount of gift cards which will not be redeemed, is recognized proportional to redemptions using estimates based on historical redemption patterns. Product sales to franchisees are included within product revenues in the Consolidated Statement of Operations and recorded at the time product is delivered to the franchisee. Payment for franchisee product revenue is generally collected within 30 to 90 days of delivery.
Revenue recognized over time
Franchise revenues primarily include royalties, advertising fund cooperatives fees, franchise fees and other fees. Royalty and advertising fund revenues represent sales-based royalties that are recognized in the period in which the sales occur. Generally, royalty and advertising fund revenue is billed and collected monthly in arrears. Advertising fund revenues and expenditures, which must be spent on marketing and related activities per the franchise agreements, are recorded on a gross basis within the Consolidated Statement of Operations. This treatment increases both the gross amount of reported franchise revenue and site operating expense and generally has no impact on operating income and net income. Franchise fees are billed and received upon the signing of the franchise agreement. Recognition of these fees is deferred until the salon opening and is then recognized over the term of the franchise agreement, typically ten years. Franchise rental income is a result of the Company signing leases on behalf of franchisees and entering into a sublease arrangement with the franchise. The Company recognizes franchise rental income and expense when it is due to the landlord.
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The following table disaggregates revenue by timing of revenue recognition and is reconciled to reportable segment revenues as follows:
Franchise Company-owned Franchise Company-owned Franchise Company-owned
(Dollars in thousands)
Revenue recognized at a point in time:
Revenue recognized over time:
Information about receivables, broker fees and deferred revenue subject to the revenue recognition guidance is as follows:
(Dollars in thousands)
Deferred revenue:
Current
Gift card liability $ 2,240 $ 2,543 Accrued expenses
Deferred franchise fees unopened salons 40 77 Accrued expenses
Deferred franchise fees open salons 5,884 5,537 Accrued expenses
Total current deferred revenue $ 8,164 $ 8,157
Non-current
Deferred franchise fees open salons 32,365 33,623 Other non-current liabilities
Total non-current deferred revenue $ 38,936 $ 45,478
72