Item 7. Management’s Discussion and Analysis
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)
2021 2020 2019 2021 2020
(Dollars in thousands)
Salons sold to franchisees 748 1,475 767 (727) 708
Cash proceeds received $ 8,437 $ 91,616 $ 94,787 $ (83,179) $ (3,171)
(Loss) gain on venditions, excluding goodwill derecognition $ (16,696) $ 49,660 $ 69,973 $ (66,356) $ (20,313)
Non-cash goodwill derecognition — (76,966) (67,055) 76,966 (9,911)
(Loss) gain from sale of salon assets to franchisees, net $ (16,696) $ (27,306) $ 2,918 $ 10,610 $ (30,224)
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
Gain from disposal of distribution center assets (Note 8) Interest income and other, net Corporate (14,997)
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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
2021 2020 2019
SmartStyle (26.7) % (5.5) % 1.0 %
Supercuts (25.8) (4.2) (0.2)
Portfolio Brands (24.8) (3.7) (0.8)
Total (25.8) % (4.4) % (0.1) %
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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
2021 2020 2019 2021 2020 2019 2021 2020
(Dollars in millions) % of Total Revenues (1) Basis Point (Decrease) Increase
Service revenues $ 108.1 $ 331.5 $ 749.7 26.0 % 49.5 % 70.1 % (2,350) (2,060)
Product revenues 91.5 137.6 225.6 22.1 20.5 21.1 160 (60)
Franchise royalties and fees 88.1 73.4 93.8 21.2 11.0 8.8 1,020 220
Franchise rental income 127.4 127.2 — 30.7 19.0 — 1,170 N/A
Cost of service (2) 79.1 222.3 452.8 73.2 67.1 60.4 610 670
Cost of product (2) 79.2 84.7 128.8 86.6 61.6 57.1 2,500 450
Site operating expenses 51.5 71.5 141.0 12.4 10.7 13.2 170 (250)
General and administrative 105.4 131.0 177.0 25.4 19.6 16.6 580 300
Rent 40.9 76.4 131.8 9.9 11.4 12.3 (150) (90)
Franchise rent expense 127.4 127.2 — 30.7 19.0 — 1,170 N/A
Depreciation and amortization 22.7 37.0 37.8 5.5 5.5 3.5 — 200
Long-lived asset impairment 13.0 22.6 — 3.1 3.4 — (30) N/A
TBG restructuring — 2.3 21.8 — 0.3 2.0 (30) (170)
Goodwill impairment — 40.2 — — 6.0 — (600) N/A
Operating loss (3) (104.2) (145.3) (22.1) (25.1) (21.7) (2.1) (340) (1,960)
Interest expense (13.8) (7.5) (4.8) (3.3) (1.1) (0.4) (220) (70)
(Loss) gain from sale of salon assets to franchisees, net (16.7) (27.3) 2.9 (4.0) (4.1) 0.3 10 (440)
Interest income and other, net 15.9 3.4 1.7 3.8 0.5 0.2 330 30
Income tax benefit (3) 5.4 4.6 2.1 4.6 2.6 9.6 N/A N/A
Income from discontinued operations, net of taxes — 0.8 5.9 — 0.1 0.6 (10) (50)
Net loss (3) (113.3) (171.4) (14.2) (27.3) (25.6) (1.3) (170) (2,430)
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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
2021 2020 2019
(Dollars in thousands)
Franchise salons:
Product excluding TBG $ 56,699 $ 50,411 $ 42,915
TBG product — 2,010 16,990
Total franchise product 56,699 52,421 59,905
Royalties and fees 88,057 73,402 93,761
Franchise rental income 127,392 127,203 —
Total, Franchise salons 272,148 253,026 153,666
Franchise same-store sales (decrease) increase (1) (24.5) % (4.4) % 0.3 %
Company-owned salons:
SmartStyle $ 48,657 $ 203,361 $ 208,531
Supercuts 23,055 54,121 383,380
Portfolio Brands 71,253 159,221 323,462
Total, Company-owned salons 142,965 416,703 915,373
Company-owned salon same-store sales decrease (2) (33.4) % (4.4) % (0.4) %
Consolidated revenues $ 415,113 $ 669,729 $ 1,069,039
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
2021 2020 2019 2021 2020
(Dollars in millions) Increase (Decrease)
Revenue
Product $ 56.7 $ 50.4 $ 42.9 $ 6.3 $ 7.5
Product sold to TBG — 2.0 17.0 (2.0) (15.0)
Total Product $ 56.7 $ 52.4 $ 59.9 $ 4.3 $ (7.5)
Royalties and fees (1) 88.1 73.4 93.8 14.7 (20.4)
Franchise rental income 127.4 127.2 — 0.2 127.2
Total franchise salons revenue (2) $ 272.1 $ 253.0 $ 153.7 $ 19.1 $ 99.4
Franchise same-store sales (3) (24.5) % (4.4) % 0.3 %
Operating income $ 40.7 $ 35.2 $ 36.4 $ 5.5 $ (1.2)
Operating loss from TBG — (2.3) (20.2) 2.3 17.9
Total operating income (2) $ 40.7 $ 32.9 $ 16.1 $ 7.8 $ 16.7
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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
2021 2020 2019 2021 2020
(Dollars in millions) Increase (Decrease)
Total revenue $ 143.0 $ 416.7 $ 915.4 $ (273.7) $ (498.7)
Operating (loss) income $ (70.0) $ (96.1) $ 58.3 $ 26.1 $ (154.4)
Total company-owned salons 276 1,632 3,108
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:
June 30,
Maturity Dates 2021 2020 2021 2020
(Fiscal year) (Interest rate %) (Dollars in thousands)
Revolving credit facility 2023 5.00% 5.50% $ 186,911 $ 177,500
Long-term financing lease liability 2034 N/A 3.30% — 16,773
Long-term financing lease liability 2034 N/A 3.70% — 11,208
$ 186,911 $ 205,481
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 to
Capitalization
2021 91.6 %
2020 62.0 %
2019 26.8 %
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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