REGIS CORP 10-Q

Item 1. Financial Statements REGIS CORPORATION CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited) (Dollars in thousands, except share data) September 30, 2020 June 30, 2020 ASSETS Current assets: Cash and cash equivalents $ 84,969 $ 113,667 Receivables, net 35,916 31,030 Inventories 57,695 62,597 Other current assets 20,057 19,138 Total current assets 198,637 226,432 Property and equipment, net 49,994 57,176 Goodwill (Note 9) 227,896 227,457 Other intangibles, net 4,500 4,579 Right of use asset (Note 10) 728,464 786,216 Other assets 42,337 40,934 Total assets $ 1,251,828 $ 1,342,794 LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Accounts payable $ 49,648 $ 50,918 Accrued expenses 57,018 48,825 Short-term lease liability (Note 10) 129,643 137,271 Total current liabilities 236,309 237,014 Long-term debt, net (Note 11) 177,500 177,500 Long-term lease liability (Note 10) 629,328 680,454 Long-term financing liabilities (Note 11) 27,658 27,981 Other non-current liabilities 91,492 94,142 Total liabilities 1,162,287 1,217,091 Commitments and contingencies (Note 7) Shareholders’ equity: Common stock, $ 0.05 par value; issued and outstanding 35,665,783 and 35,625,716 common shares at September 30, 2020 and June 30, 2020, respectively 1,783 1,781 Additional paid-in capital 20,596 22,011 Accumulated other comprehensive income 7,951 7,449 Retained earnings 59,211 94,462 Total shareholders’ equity 89,541 125,703 Total liabilities and shareholders’ equity $ 1,251,828 $ 1,342,794 _______________________________________________________________________________ The accompanying notes are an integral part of the unaudited Condensed Consolidated Financial Statements. 3 REGIS CORPORATION CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited) For The Three Months Ended September 30, 2020 And 2019 (Dollars and shares in thousands, except per share data amounts) Three Months Ended September 30, 2020 2019 Revenues: Service $ 36,408 $ 141,941 Product 24,749 45,656 Royalties and fees 17,956 28,017 Franchise rental income (Note 10) 32,283 31,424 Total revenue 111,396 247,038 Operating expenses: Cost of service 28,523 90,482 Cost of product 16,369 26,327 Site operating expenses 13,239 32,942 General and administrative 26,148 40,625 Rent (Note 10) 13,225 24,264 Franchise rent expense 32,283 31,424 Depreciation and amortization 7,376 9,380 Long-lived asset impairment 5,824 — TBG mall location restructuring (Note 3) — 1,500 Total operating expenses 142,987 256,944 Operating loss ( 31,591 ) ( 9,906 ) Other (expense) income: Interest expense ( 3,762 ) ( 1,439 ) Loss from sale of salon assets to franchisees, net ( 662 ) ( 5,860 ) Interest income and other, net 114 171 Loss from continuing operations before income taxes ( 35,901 ) ( 17,034 ) Income tax benefit 635 2,856 Loss from continuing operations ( 35,266 ) ( 14,178 ) Income from discontinued operations, net of taxes (Note 3) — 373 Net loss $ ( 35,266 ) $ ( 13,805 ) Net loss per share: Basic and diluted: Loss from continuing operations $ ( 0.98 ) $ ( 0.39 ) Income from discontinued operations 0.00 0.01 Net loss per share, basic and diluted (1) $ ( 0.98 ) $ ( 0.38 ) Weighted average common and common equivalent shares outstanding: Basic and diluted 35,908 36,249 _______________________________________________________________________________ (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 unaudited Condensed Consolidated Financial Statements. 4 REGIS CORPORATION CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS (Unaudited) For The Three Months Ended September 30, 2020 And 2019 (Dollars in thousands) Three Months Ended September 30, 2020 2019 Net loss $ ( 35,266 ) $ ( 13,805 ) Foreign currency translation adjustments 502 ( 403 ) Comprehensive loss $ ( 34,764 ) $ ( 14,208 ) _______________________________________________________________________________ The accompanying notes are an integral part of the unaudited Condensed Consolidated Financial Statements. 5 REGIS CORPORATION CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Unaudited) For the Three Months Ended September 30, 2020 And 2019 (Dollars in thousands) Three Months Ended September 30, 2020 Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income Retained Earnings Total Shares Amount Balance, June 30, 2020 35,625,716 $ 1,781 $ 22,011 $ 7,449 $ 94,462 $ 125,703 Net loss — — — — ( 35,266 ) ( 35,266 ) Foreign currency translation — — — 502 — 502 Stock-based compensation — — ( 1,225 ) — — ( 1,225 ) Net restricted stock activity 40,067 2 ( 190 ) — — ( 188 ) Minority interest — — — — 15 15 Balance, September 30, 2020 35,665,783 $ 1,783 $ 20,596 $ 7,951 $ 59,211 $ 89,541 Three Months Ended September 30, 2019 Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income Retained Earnings Total Shares Amount Balance, June 30, 2019 36,869,249 $ 1,843 $ 47,152 $ 9,342 $ 265,908 $ 324,245 Net loss — — — — ( 13,805 ) ( 13,805 ) Foreign currency translation — — — ( 403 ) — ( 403 ) Stock repurchase program ( 1,504,000 ) ( 75 ) ( 26,281 ) — — ( 26,356 ) Exercise of SARs 276 — — — — — Stock-based compensation — — 1,807 — — 1,807 Net restricted stock activity 182,511 9 ( 1,798 ) — — ( 1,789 ) Minority interest — — — — 40 40 Balance, September 30, 2019 35,548,036 $ 1,777 $ 20,880 $ 8,939 $ 252,143 $ 283,739 _______________________________________________________________________________ The accompanying notes are an integral part of the unaudited Condensed Consolidated Financial Statements. 6 REGIS CORPORATION CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) For The Three Months Ended September 30, 2020 And 2019 (Dollars in thousands) Three Months Ended September 30, 2020 2019 Cash flows from operating activities: Net loss $ ( 35,266 ) $ ( 13,805 ) Adjustments to reconcile net loss to net cash provided by operating activities: Non-cash adjustments related to discontinued operations — ( 470 ) Depreciation and amortization 6,087 7,863 Salon asset impairments — 1,517 Long-lived asset impairment 5,824 — Deferred income taxes ( 384 ) ( 3,821 ) Loss from sale of salon assets to franchisees, net 662 5,860 Stock-based compensation (Note 5) ( 1,225 ) 1,807 Amortization of debt discount and financing costs 438 69 Other non-cash items affecting earnings 4 ( 23 ) Changes in operating assets and liabilities, excluding the effects of asset sales (1) ( 5,006 ) ( 12,477 ) Net cash used in operating activities ( 28,866 ) ( 13,480 ) Cash flows from investing activities: Capital expenditures ( 3,811 ) ( 4,899 ) Proceeds from sale of assets to franchisees 3,735 37,945 Costs associated with sale of salon assets to franchisees ( 125 ) ( 1,019 ) Net cash (used in) provided by investing activities ( 201 ) 32,027 Cash flows from financing activities: Repurchase of common stock — ( 28,247 ) Taxes paid for shares withheld ( 187 ) ( 1,808 ) Distribution center lease payments ( 238 ) ( 248 ) Net cash (used in) financing activities ( 425 ) ( 30,303 ) Effect of exchange rate changes on cash and cash equivalents 88 3 Decrease in cash, cash equivalents, and restricted cash ( 29,404 ) ( 11,753 ) Cash, cash equivalents and restricted cash: Beginning of period 122,880 92,379 End of period $ 93,476 $ 80,626 _______________________________________________________________________________ (1) Changes in operating assets and liabilities exclude assets and liabilities sold. The accompanying notes are an integral part of the unaudited Condensed Consolidated Financial Statements. 7 REGIS CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The unaudited interim Condensed Consolidated Financial Statements of Regis Corporation (the "Company") as of September 30, 2020 and for the three months ended September 30, 2020 and 2019, reflect, in the opinion of management, all adjustments necessary to fairly state the consolidated financial position of the Company as of September 30, 2020 and its consolidated results of operations, comprehensive loss, changes in equity and cash flows for the interim periods. Adjustments consist only of normal recurring items, except for any discussed in the notes below. The results of operations and cash flows for any interim period are not necessarily indicative of results of operations and cash flows for the full year. The accompanying unaudited interim condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all disclosures required by accounting principles generally accepted in the United States of America (GAAP). The unaudited interim Condensed Consolidated Financial Statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2020 and other documents filed or furnished with the SEC during the current fiscal year. Impact of the COVID-19 Pandemic on Business Operations: During the period ended September 30, 2020, the global coronavirus pandemic ("COVID-19") had an adverse impact on operations, including the closure of all salons in California for the majority of the quarter due to government-mandated closures. These restrictions were lifted in September and as of September 30, 2020, system-wide salons are approximately 95 % open. Management is evaluating the future of the unopened salons, including potential closures. The COVID-19 pandemic continues to impact salon guest visits leading to a significant reduction in revenue. 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. Salon Long-Lived Asset and Right of Use Asset Impairment Assessments: 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 the 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 September 30, 2020. See Note 10 for further discussion related to the right of use asset impairment. Judgments made by management related to the expected useful lives of long-lived assets and the ability to realize undiscounted cash flows in excess of the carrying amounts of such assets are affected by factors such as the ongoing maintenance and improvement of the assets, changes in economic conditions, and changes in operating performance. As the ongoing expected cash flows and carrying amounts of long-lived assets are assessed, these factors could cause the Company to realize material impairment charges. A long-lived asset impairment charge, including right of use and salon property and equipment, of $ 5.8 million was recorded in the three months ended September 30, 2020, and is separately stated on the unaudited Condensed Consolidated Statement of Operations. Of the total $ 5.8 million long-lived asset impairment charge, $ 4.6 million was allocated to the right of use asset and $ 1.2 million was allocated to salon property and equipment. A long-lived salon property and equipment asset impairment charge of $ 1.5 million was recorded during the three months ended September 30, 2019, and is recorded in Depreciation and Amortization in the unaudited Condensed Consolidated Statement of Operations. 8 Goodwill: As of September 30, 2020 and June 30, 2020, the Franchise reporting unit had $ 227.9 and $ 227.5 million, respectively, of goodwill. For further information, see Note 9 of the interim unaudited Condensed 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. An interim impairment analysis was not required in the three months ended September 30, 2020. The Company performs its annual impairment assessment as of April 30. For the fiscal year 2020 annual impairment assessment, due to the impact of the COVID-19 pandemic, the Company elected to forgo the optional Step 0 assessment and performed the quantitative impairment analysis on the Franchise reporting unit. The Company compared the carrying value of the reporting unit, including goodwill, to the estimated fair value. The result of the assessment indicated that the estimated fair value of the Company's reporting unit exceeded its carrying value by approximately 50 percent. For the goodwill impairment analysis, management utilized a combination of both a discounted cash flows approach and a market approach. The key assumptions utilized in the analysis were the number of salons to be sold to franchisees and using the discount rate. If a future triggering event occurs or if during the Company's annual impairment assessment the fair value of the Franchise reporting unit has decreased significantly, it may result in a non-cash impairment charge to reduce the carrying value of goodwill. Depreciation: Depreciation expense in the three months ended September 30, 2020 includes $ 1.3 million of asset retirement obligations, which are cash expenses. Additionally, in the three month period ended September 30, 2020, the Company recognized a $ 1.0 million incremental charge in depreciation expense that related to a prior period. Management evaluated the effect of this out-of-period adjustment on the three months ended September 30, 2020, as well as the previous period in which the charge should have been recognized and concluded for both quantitative and qualitative reasons that the adjustment is not material to the periods affected. 9 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 by the Company to franchisees are included within product revenues in the unaudited Condensed 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 unaudited Condensed Consolidated Statement of Operations. This 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 the lease on behalf of franchisees and entering into a sublease arrangement with the franchisee. The Company recognizes franchise rental income and expense when it is due to the landlord. The following table disaggregates revenue by timing of revenue recognition and is reconciled to reportable segment revenues as follows: Three Months Ended September 30, 2020 Three Months Ended September 30, 2019 Franchise Company-owned Franchise Company-owned (Dollars in thousands) Revenue recognized at a point in time: Service $ — $ 36,408 $ — $ 141,941 Product 13,742 11,007 13,105 32,551 Total revenue recognized at a point in time $ 13,742 $ 47,415 $ 13,105 $ 174,492 Revenue recognized over time: Royalty and other franchise fees $ 13,447 $ — $ 17,592 $ — Advertising fund fees 4,509 — 10,425 — Franchise rental income 32,283 — 31,424 — Total revenue recognized over time 50,239 — 59,441 — Total revenue $ 63,981 $ 47,415 $ 72,546 $ 174,492 10 Information about receivables, broker fees and deferred revenue subject to the revenue recognition guidance is as follows: September 30, 2020 June 30, 2020 Balance Sheet Classification (Dollars in thousands) Receivables from contracts with customers, net $ 28,306 $ 22,991 Accounts receivable, net Broker fees $ 20,442 $ 20,516 Other assets Deferred revenue: Current Gift card liability $ 2,530 $ 2,543 Accrued expenses Deferred franchise fees unopened salons 37 77 Accrued expenses Deferred franchise fees open salons 5,679 5,537 Accrued expenses Total current deferred revenue $ 8,246 $ 8,157 Non-current Deferred franchise fees unopened salons $ 11,398 $ 11,855 Other non-current liabilities Deferred franchise fees open salons 33,550 33,623 Other non-current liabilities Total non-current deferred revenue $ 44,948 $ 45,478 Receivables relate primarily to payments due for royalties, franchise fees, advertising fees, rent, franchise product sales and sales of salon services and product paid by credit card. The receivables balance is presented net of an allowance for expected losses (i.e., doubtful accounts), primarily related to receivables from franchisees. The following table is a rollforward of the allowance for doubtful accounts for the period: Balance as of June 30, 2020 $ 6,899 Provision for doubtful accounts (1) 2,289 Provision for franchisee rent (2) 512 Write-offs ( 297 ) Balance as of September 30, 2020 $ 9,403 _______________________________________________________________________________ (1) The provision for doubtful accounts is recognized as General and administrative expense in the unaudited Condensed Consolidated Statement of Operations. (2) The provision for franchisee rent is recognized as Rent expense in the unaudited Condensed Consolidated Statement of Operations. Broker fees are the costs associated with using external brokers to identify new franchisees. These fees are paid upon the signing of the franchise agreement and recognized as General and administrative expense over the term of the agreement. The following table is a rollforward of the broker fee balance for the period: Balance as of June 30, 2020 $ 20,516 Additions 703 Amortization ( 777 ) Write-offs — Balance as of September 30, 2020 $ 20,442 11 Deferred revenue includes the gift card liability and deferred franchise fees for unopened salons and open salons. Gift card revenue for the three months ended September 30, 2020 and 2019 was $ 0.3 and $ 0.8 million, respectively. Deferred franchise fees related to open salons are generally recognized on a straight-line basis over the term of the franchise agreement. Franchise fee revenue for the three months ended September 30, 2020 and 2019 was $ 1.6 and $ 1.2 million, respectively. Estimated revenue expected to be recognized in the future related to deferred franchise fees for open salons as of September 30, 2020 is as follows (in thousands): Remainder of 2021 $ 4,391 2022 5,734 2023 5,558 2024 5,099 2025 4,737 Thereafter 13,710 Total $ 39,229 12 3. TBG RESTRUCTURING AND DISCONTINUED OPERATIONS: In October 2017, the Company sold substantially all of its mall-based salon business in North America, representing 858 salons, to The Beautiful Group (TBG), who operated these locations as franchise locations until June 2019. In June 2019, the Company entered into a settlement agreement with TBG regarding the North American salons, which, among other things, substituted the master franchise agreement for a license agreement. The Company classified the results of its mall-based business as discontinued operations in the unaudited Condensed Consolidated Statement of Operations. Included in discontinued operations in fiscal year 2020 are adjustments to actuarial assumptions related to the discontinued operations. Other than the items presented in the unaudited Consolidated Statement of Cash Flows, there were no other significant non-cash operating activities or non-cash investing activities related to discontinued operations for the three months ended September 30, 2020 and 2019. For the three months ended September 30, 2019 the Company recorded $ 1.5 million of TBG restructuring charges that relate to the Company assisting TBG with operating expenses to mitigate the risk of default associated with TBG's lease obligations. In the second quarter of fiscal year 2020, TBG transferred 207 of its North American mall-based salons to the Company. The 207 North American mall-based salons transferred were the salons that the Company was the guarantor of the lease obligation. In the United States, the transfer was consummated in connection with an assignment for the benefit of TBG US's creditors. The transfer of the 207 mall-based salons occurred on December 31, 2019, and the operational results of these mall-based salons are included in the unaudited Condensed Consolidated Statement of Operations. The assets acquired and liabilities assumed were not material to the unaudited Condensed Consolidated Balance Sheet. As of September 30, 2020, prior to any mitigation efforts which may be available, the Company remains liable for up to approximately $ 18 million related to its mall-based salon lease commitments on the 104 salons that remain open, which is a $ 5 million reduction from June 30, 2020. The commitments are included in our lease liabilities. 4. EARNINGS 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 (RSAs), restricted stock units (RSUs) and stock-settled performance units (PSUs). The Company’s diluted earnings per share is calculated as net loss divided by weighted average common shares and common share equivalents outstanding, which includes shares issued under the Company’s stock-based compensation plans. Stock-based awards with exercise prices greater than the average market price of the Company’s common stock are excluded from the computation of diluted earnings per share. For the three months ended September 30, 2020 and 2019, there were 310,557 and 902,478 common stock equivalents of dilutive common stock, respectively, excluded in the diluted earnings per share calculations due to the net loss from continuing operations. The computation of weighted average shares outstanding, assuming dilution, excluded 1,834,999 and 391,531 of stock-based awards during the three months ended September 30, 2020 and 2019, respectively, as they were not dilutive under the treasury stock method. 13 5. SHAREHOLDERS’ EQUITY: Stock-Based Employee Compensation: During the three months ended September 30, 2020, the Company granted various equity awards including restricted stock units (RSUs) and performance-based restricted stock units (PSUs). A summary of equity awards granted is as follows: For the Three Months Ended September 30, 2020 Restricted stock units 246,634 Performance-based restricted stock units 62,290 The RSUs granted to employees during the three months ended September 30, 2020 vest in equal amounts over a three-year period subsequent to the grant date, cliff vest after a three-year period or cliff vest after a five-year period subsequent to the grant date. The PSUs granted to employees have a three-year performance period ending June 30, 2023 linked to the Company's stock price reaching a specified volume weighted average closing price for a 50 day period that ends on June 30, 2023. The PSUs granted have a maximum vesting percentage of 200 % based on the level of performance achieved for the respective award. Total compensation cost for stock-based payment arrangements totaling $( 1.2 ) and $ 1.8 million for the three months ended September 30, 2020 and 2019, respectively, was recorded within General and administrative expense on the unaudited Condensed Consolidated Statement of Operations. The benefit recorded in the three months ended September 30, 2020 was due to the forfeiture of awards related to the departure of the Company's CEO, resulting in an expense reversal of $ 2.4 million. Share Repurchases: During the three months ended September 30, 2020, the Company did no t repurchase shares under the previously approved stock repurchase program. During the three months ended September 30, 2019, the Company repurchased 1.5 million shares for $ 26.4 million under the previously approved stock repurchase program. At September 30, 2020, $ 54.6 million remains outstanding under the approved stock repurchase program. 14 6. INCOME TAXES: A summary of income tax benefits and corresponding effective tax rates is as follows: For the Three Months Ended September 30, 2020 2019 (Dollars in thousands) Income tax benefit $ 635 $ 2,856 Effective tax rate 1.8 % 16.8 % The recorded tax provision and effective tax rate for the three months ended September 30, 2020 were different than what would normally be expected primarily due to the impact of the deferred tax valuation allowance. The recorded tax provision and effective tax rate for the three months ended September 30, 2019 were different than what would normally be expected primarily due to the impact of the deferred tax valuation allowance and global intangible low-taxed income ("GILTI"). The Company is no longer subject to IRS examinations for years before 2014. Furthermore, with limited exceptions, the Company is no longer subject to state and international income tax examinations by tax authorities for years before 2012. 7. COMMITMENTS AND CONTINGENCIES: The Company is a defendant in various lawsuits and claims arising out of the normal course of business. Like certain other large retail employers, the Company has been faced with allegations of purported class-wide consumer and wage and hour violations. Litigation is inherently unpredictable, and the outcome of these matters cannot presently be determined. Although the actions are being vigorously defended, the Company could in the future, incur judgments or enter into settlements of claims that could have a material adverse effect on its results of operations in any particular period. The Company is a defendant in two wage and hour lawsuits in California. The first, a class action in US District Court, alleges various violations of the California Labor Code, including, but not limited to failure to pay wages, failure to permit rest breaks, failure to pay all wages due on termination of employment, waiting time penalties, failure to provide accurate wage statements and violation of the business and professions code. This case has been preliminarily settled, pending approval of the court and class, for $ 2.1 million. The second, a class action filed in California Superior Court, alleges various violations of the California Labor Code as well as PAGA penalties. Barring successful objection from plaintiffs’ attorneys to the first class action, the second case will be subsumed into the first case’s settlement. As of June 30, 2020 and September 30, 2020, $ 2.1 million was included within accrued expenses on the unaudited Condensed Consolidated Balance Sheet related to these class action lawsuits. In addition, our existing point of sale system supplier has challenged the development of certain parts of our technology systems in litigation brought in the Northern District of California, case No. 20-cv-02181-MMC. We have vigorously denied the allegations made by this third-party supplier and have asserted certain counterclaims against the third party. However, the dispute regarding our ownership and involvement of certain key personnel may be costly and distracting, and the outcome is currently uncertain. The Company has not recorded an expense related to damages in connection with these matters because any potential loss is not currently probable or reasonably estimable under U.S. GAAP. Additionally, the Company is unable to reasonably estimate the range of loss, if any, that may result from these matters. 15 8. CASH, CASH EQUIVALENTS AND RESTRICTED CASH: The table below reconciles the cash and cash equivalents balances and restricted cash balances, recorded in other current assets from the unaudited Condensed Consolidated Balance Sheet to the amount of cash, cash equivalents and restricted cash reported on the unaudited Condensed Consolidated Statement of Cash flows: September 30, 2020 June 30, 2020 (Dollars in thousands) Cash and cash equivalents $ 84,969 $ 113,667 Restricted cash, included in Other current assets (1) 8,507 9,213 Total cash, cash equivalents and restricted cash $ 93,476 $ 122,880 _______________________________________________________________________________ (1) 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. 9. GOODWILL: The table below contains details related to the Company's goodwill: Franchise Reporting Unit (Dollars in thousands) Goodwill, net at June 30, 2020 $ 227,457 Translation rate adjustments 439 Goodwill, net at September 30, 2020 $ 227,896 16 10. LEASES 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. Total rent expense includes the following: For the Three Months Ended September 30, 2020 2019 (Dollars in thousands) Minimum rent $ 9,721 $ 19,184 Percentage rent based on sales 73 1,298 Real estate taxes and other expenses 2,662 3,307 Lease termination expense (1) 5,551 — Lease liability benefit (2) ( 6,061 ) — Corporate segment rent 722 285 Franchise segment non-reimbursable rent 557 190 Total $ 13,225 $ 24,264 _______________________________________________________________________________ (1) During the three months ended September 30, 2020 and 2019, the Company terminated the leases for 131 and 37 company-owned salons, respectively, before the lease end dates. Lease termination fees include $ 3.1 million of future lease payments for underperforming salons that management closed without a termination agreement. Lease termination fees also includes $ 2.5 million of early termination payments to close salons before lease end date and relieve the Company of future lease obligations. The early termination payments will save the Company approximately $ 2 million in future minimum rent plus associated real estate taxes and other lease expenses. (2) Upon termination of previously impaired leases, the Company derecognized ROU assets of $ 7.1 million and lease liabilities of $ 10.3 million that resulted in a net gain of $ 3.2 million. In addition, the Company recognized a benefit from lease liabilities decreasing in excess of previously impaired ROU assets. The benefit recognized was $ 2.9 million and $ 0 in the three months ended September 30, 2020 and 2019, respectively. 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 the 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 unaudited Condensed Consolidated Statement of Operations. For the three months ended September 30, 2020 and 2019, franchise rental income and franchise rent expense were $ 32.3 and $ 31.4 million, respectively. These leases, generally with terms of approximately 5 years, are expected to be renewed on expiration. For franchise and company-owned 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 (ROU) 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 $ 728.5 and $ 786.2 million as of September 30, 2020 and June 30, 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. 17 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 original lease term. The weighted average remaining lease term was 6.85 and 6.87 years and the weighted-average discount rate was 3.98 % and 3.95 % for all salon operating leases as of September 30, 2020 and June 30, 2020, respectively. 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. As a result of the COVID-19 pandemic and the related salon closures that occurred during the fourth fiscal quarter of 2020, the Company determined that a triggering event had occurred pursuant to ASC 360-10-35-21 given that there had been a significant adverse change in the business climate that could affect the value of its salon long-lived asset groups combined with a significant adverse change in the extent or manner in which the salon long-lived groups were being used. As a result, management assessed all 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 that the fair value of the asset group be determined when calculating 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 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 based on recently negotiated leases as applicable, the asset group’s projected sales for fiscal years 2021 through 2023 for properties with no recently negotiated leases, 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. In the fourth quarter of fiscal year 2020, the Company recorded a total long-lived asset impairment charge of $ 22.6 million in the Consolidated Statement of Operations, including $ 17.4 million related to the right of use asset in the salon asset groups. 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 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 and 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. In the three months ended September 30, 2020, the Company recognized a long-lived impairment charge of $ 5.8 million, which included $ 4.6 million related to the right of use assets, in the unaudited Condensed Consolidated Statement of Operations. The impairments recorded for the three months ended September 30, 2020 were primarily the result of triggering events identified on certain underperforming salons, salons that were identified in the quarter to close, and certain salons where franchisees are unable to fulfill their rent obligations. 18 As of September 30, 2020, future operating lease commitments, including one renewal option when leases are expected to be renewed, to be paid and received by the Company were as follows: Fiscal Year Leases for Franchise Salons Leases for Company-owned Salons Corporate Leases Total Operating Lease Payments Sublease Income to be Received from Franchisees Net Rent Commitments Remainder of 2021 $ 91,189 $ 27,006 $ 1,329 $ 119,524 $ ( 91,189 ) $ 28,335 2022 113,131 29,362 1,410 143,903 ( 113,131 ) 30,772 2023 102,742 24,084 1,447 128,273 ( 102,742 ) 25,531 2024 92,788 20,019 1,484 114,291 ( 92,788 ) 21,503 2025 81,429 15,795 1,522 98,746 ( 81,429 ) 17,317 Thereafter 209,092 46,949 7,818 263,859 ( 209,092 ) 54,767 Total future obligations $ 690,371 $ 163,215 $ 15,010 $ 868,596 $ ( 690,371 ) $ 178,225 Less amounts representing interest 87,533 19,456 2,636 109,625 Present value of lease liabilities $ 602,838 $ 143,759 $ 12,374 $ 758,971 Less current lease liabilities 98,546 29,900 1,197 129,643 Long-term lease liabilities $ 504,292 $ 113,859 $ 11,177 $ 629,328 Excluding the option period, the Company's operating lease commitments as of September 30, 2020 were approximately $ 360 and $ 100 million for franchise salons and company-owned salons, respectively. 19 11. FINANCING ARRANGEMENTS: The Company’s long-term debt consists of the following: Revolving Credit Facility Maturity Date September 30, 2020 September 30, 2020 June 30, 2020 (Fiscal Year) (Interest rate %) (Dollars in thousands) Revolving credit facility 2023 5.50 % $ 177,500 $ 177,500 At September 30, 2020, cash and cash equivalents totaled $ 85.0 million. As of September 30, 2020, the Company has $ 177.5 million of outstanding borrowings under a $ 295.0 million revolving credit facility. At September 30, 2020, the Company has outstanding standby letters of credit under the revolving credit facility of $ 18.7 million, primarily related to the Company's self-insurance program. The unused available credit under the facility was $ 98.8 million as of September 30, 2020. The Company's liquidity, which includes the unused available balance under the credit facility and unrestricted cash and cash equivalents, totaled $ 183.8 million as of September 30, 2020. The revolving credit facility has a minimum liquidity covenant of $ 75 million. As of September 30, 2020, the Company had cash, cash equivalents and restricted cash of $ 93.5 million and current liabilities of $ 236.3 million. The Company was is in compliance with all covenants and other requirements of the financing arrangements as of September 30, 2020 and believes it will continue to be in compliance for at least one year from our filing date. 20 Sale and Leasebacks The Company’s long-term financing liabilities consists of the following: Maturity Date Interest Rate September 30, 2020 June 30, 2020 (Fiscal Year) (Dollars in thousands) Financial liability - Salt Lake City Distribution Center 2034 3.30 % $ 16,604 $ 16,773 Financial liability - Chattanooga Distribution Center 2034 3.70 % 11,054 11,208 Long- term financing liability $ 27,658 $ 27,981 In fiscal year 2019, the Company sold its Salt Lake City and Chattanooga Distribution Centers to an unrelated party. The Company is leasing the properties back for 15 years with the option to renew. As the Company plans to lease the property for more than 75% of its economic life, the sales proceeds received from the buyer-lessor are recognized as a financial liability. This financial liability is reduced based on the rental payments made under the lease that are allocated between principal and interest. As of September 30, 2020, the current portion of the Company’s lease liability was $ 1.0 million, which was recorded in accrued expenses on the unaudited Condensed Consolidated Balance Sheet. The weighted average remaining lease term was 13.4 years and the weighted-average discount rate was 3.46 % for financing leases as of September 30, 2020. As of September 30, 2020, future lease payments due are as follows: Fiscal year Salt Lake City Distribution Center Chattanooga Distribution Center (Dollars in thousands) Remainder of 2021 $ 870 $ 613 2022 1,171 829 2023 1,186 842 2024 1,200 854 2025 1,215 867 Thereafter 10,683 8,414 Total $ 16,325 $ 12,419 The financing liability does not include interest. Future lease payments above are due per the lease agreement and include embedded interest. Therefore, the total payments do not equal the financing liability. Total interest expense for the financing lease was $ 0.3 million for the three months ended September 30, 2020. 21 12. FAIR VALUE MEASUREMENTS: Fair value measurements are categorized into one of three levels based on the lowest level of significant input used: Level 1 (unadjusted quoted prices in active markets); Level 2 (observable market inputs available at the measurement date, other than quoted prices included in Level 1); and Level 3 (unobservable inputs that cannot be corroborated by observable market data). Assets and Liabilities Measured at Fair Value on a Recurring Basis As of September 30, 2020 and June 30, 2020, the estimated fair value of the Company’s cash, cash equivalents, restricted cash, receivables, accounts payable, debt and long-term financial liabilities approximated their carrying values. The estimated fair values of the Company's debt and long-term financial liability are based on Level 2 inputs. Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis We measure certain assets, including the Company’s equity method investments, tangible fixed and other assets, and goodwill, at fair value on a nonrecurring basis when they are deemed to be other than temporarily impaired. The fair values of these assets are determined, when applicable, based on valuation techniques using the best information available and may include quoted market prices, market comparables, and discounted cash flow projections. The following impairments were based on fair values using Level 3 inputs: For the Three Months Ended September 30, 2020 2019 (Dollars in thousands) Long-lived asset impairment (1) 5,824 1,517 _______________________________________________________________________________ (1) See Note 1 to the Condensed Consolidated Financial Statements. 22 13. SEGMENT INFORMATION: Segment information is prepared on the same basis that the chief operating decision maker reviews financial information for operational decision-making purposes. The Company’s reportable operating segments consisted of the following salons: September 30, 2020 June 30, 2020 FRANCHISE SALONS: SmartStyle/Cost Cutters in Walmart Stores 1,428 1,317 Supercuts 2,423 2,508 Signature Style 1,212 1,217 Total North American salons 5,063 5,042 Total International salons (1) 163 167 Total Franchise salons 5,226 5,209 as a percent of total Franchise and Company-owned salons 80.0 % 76.1 % COMPANY-OWNED SALONS: SmartStyle/Cost Cutters in Walmart Stores 629 751 Supercuts 170 210 Signature Style 405 505 Mall-based (2) 104 166 Total Company-owned salons 1,308 1,632 as a percent of total Franchise and Company-owned salons 20.0 % 23.9 % OWNERSHIP INTEREST LOCATIONS: Equity ownership interest locations 80 82 Grand Total, System-wide 6,614 6,923 _______________________________________________________________________________ (1) Canadian and Puerto Rican salons are included in the North American salon totals. (2) The mall-based salons were acquired from TBG on December 31, 2019. They are included in continuing operations under the Company-owned operating segment from January 1, 2020. As of September 30, 2020, the Franchise operating segment is comprised primarily of Supercuts ® , SmartStyle ® , Cost Cutters ® , First Choice Haircutters ® , Magicuts ® and Roosters ® concepts and the Company-owned operating segment is comprised primarily of SmartStyle ® , Supercuts ® , Cost Cutters ® , and other regional trade names. 23 Financial information concerning the Company's reportable operating segments is shown in the following tables: For the Three Months Ended September 30, 2020 Franchise Company-owned Corporate Consolidated (Dollars in thousands) Revenues: Service $ — $ 36,408 $ — $ 36,408 Product 13,742 11,007 — 24,749 Royalties and fees 17,956 — — 17,956 Franchise rental income 32,283 — — 32,283 Total revenue 63,981 47,415 — 111,396 Operating expenses: Cost of service — 28,523 — 28,523 Cost of product 10,678 5,691 — 16,369 Site operating expenses 4,510 8,729 — 13,239 General and administrative 8,724 2,977 14,447 26,148 Rent 557 11,946 722 13,225 Franchise rent expense 32,283 — — 32,283 Depreciation and amortization 274 5,082 2,020 7,376 Long-lived asset impairment 610 5,214 — 5,824 Total operating expenses 57,636 68,162 17,189 142,987 Operating income (loss) 6,345 ( 20,747 ) ( 17,189 ) ( 31,591 ) Other (expense) income: Interest expense — — ( 3,762 ) ( 3,762 ) Loss from sale of salon assets to franchisees, net — — ( 662 ) ( 662 ) Interest income and other, net — — 114 114 Income (loss) from continuing operations before income taxes $ 6,345 $ ( 20,747 ) $ ( 21,499 ) $ ( 35,901 ) For the Three Months Ended September 30, 2019 Franchise Company-owned Corporate Consolidated (Dollars in thousands) Revenues: Service $ — $ 141,941 $ — $ 141,941 Product 13,105 32,551 — 45,656 Royalties and fees 28,017 — — 28,017 Franchise rental income 31,424 — — 31,424 Total revenue 72,546 174,492 — 247,038 Operating expenses: Cost of service — 90,482 — 90,482 Cost of product 10,280 16,047 — 26,327 Site operating expenses 10,426 22,516 — 32,942 General and administrative 8,357 10,150 22,118 40,625 Rent 190 23,789 285 24,264 Franchise rent expense 31,424 — — 31,424 Depreciation and amortization 160 6,107 3,113 9,380 TBG mall location restructuring 1,500 — — 1,500 Total operating expenses 62,337 169,091 25,516 256,944 Operating income (loss) 10,209 5,401 ( 25,516 ) ( 9,906 ) Other (expense) income: Interest expense — — ( 1,439 ) ( 1,439 ) Gain from sale of salon assets to franchisees, net — — ( 5,860 ) ( 5,860 ) Interest income and other, net — — 171 171 Income (loss) from continuing operations before income taxes $ 10,209 $ 5,401 $ ( 32,644 ) $ ( 17,034 ) 24