REGIS CORP 10-K

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 (the Company) franchises, owns and operates beauty salons. As of June 30, 2022, the Company franchised, owned or held ownership interests in 5,576 locations worldwide. Our locations consisted of 5,500 system-wide North American and International salons, and in 76 locations where we maintain a non-controlling ownership interest. Each of the Company's salon concepts generally offer similar salon products and services and serve the mass market. As of June 30, 2022, we had approximately 630 corporate employees worldwide. See discussion within Part I, Item 1 of this Form 10-K. On June 30, 2022, the Company sold its Opensalon Pro (OSP) software-as-a-service solution to Soham Inc. for a purchase price of $20.0 million in cash plus up to an additional $19.0 million in cash contingent upon the number of salons that migrate to Soham's Zenoti product as their salon technology platform. The Company received $13.0 million in proceeds in June 2022. The remaining $7.0 million of the purchase price is subject to holdbacks including $4.0 million of the proceeds retained in escrow to be paid upon completion of the Company’s refinancing, $1.0 million once the Company ends its arrangement with its former third-party salon technology provider in December 2022 and $2.0 million of proceeds held back until general indemnity provisions are satisfied within 18 months from closing. As a result of the sale, the Company classified the OSP business as discontinued operations in the financial statements as discussed in Note 3 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. 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 2022 2021 (Dollars in thousands) Salons sold to franchisees 110 748 Cash proceeds received $ — $ 8,437 Loss from sale of salon assets to franchisees, net $ (2,334) $ (16,696) The Company shifted its product business from a wholesale model to a third-party distribution model as part of its asset-light transformation. In fiscal year 2022, the Company exited its distribution centers and ceased selling products to franchisees. Going forward, franchisees will source product from a third-party distribution partner and the Company receives a royalty payment based on franchisee purchases. This change has significantly decreased both the Company's franchise product revenue and general and administrative expense, 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 years 2022 and 2021, the Company experienced the following charges related to the plan to exit the distribution centers: Fiscal Years 2022 2021 Financial Statement Caption (Dollars in thousands) Inventory reserve (1) Inventory reserve $ 7,655 $ — Inventory valuation adjustment (2) Company-owned salon expense 2,823 12,068 Gain from disposal of distribution center assets Interest income and other, net — (14,997) ____________________________________________________________________________ (1) Includes charges in the third and fourth quarter of fiscal year 2022 associated with the liquidation of distribution center inventory, which primarily related to reserving for personal protective equipment acquired as a result of the COVID-19 pandemic. (2) Due to the reduction in company-owned salons, the Company cannot redistribute inventory from closed salons causing an increase to the reserve. Also included in fiscal year 2021 was the write-off of marketing and promotional items. 30 Table of Contents RESULTS OF OPERATIONS The Company reports its operations in two operating segments: Franchise salons and Company-owned salons. COVID-19 Impact: During fiscal years 2022 and 2021, the global coronavirus pandemic (COVID-19) had an adverse impact on operations. The COVID-19 pandemic continues to impact salon guest visits and franchisee staffing, resulting in a significant reduction in revenue and profitability. In response to COVID-19, the Company received Canadian rent relief, Canadian wage relief and U.S. employee retention payroll tax credits. In fiscal years 2022 and 2021, the Company received the following amounts in rent and wage assistance: Fiscal Years 2022 2021 Financial Statement Caption (Dollars in thousands) Canadian rent relief Rent $ 1,235 $ — Canadian wage relief Company-owned salon expense 1,966 1,629 U.S. employee retention payroll tax credit Company-owned salon expense — 1,547 Additionally, in December 2021, the Company paid $2.5 million of social security contributions that had been deferred under the CARES Act. The ultimate impact of the COVID-19 pandemic in both the short- and long-term is not currently estimable due to the uncertainty surrounding the duration of the pandemic, the emergence and impact of new COVID-19 variants and changing government restrictions. Additional impacts to the business may arise that we are not aware of currently. System-wide results Our results are impacted by our system-wide sales, which include sales by all points of distribution, whether owned by our franchisees or the Company. 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 2022 2021 SmartStyle 5.7 % (26.7) % Supercuts 22.1 (25.8) Portfolio Brands 11.2 (24.8) Total 14.8 % (25.8) % ____________________________________________________________________________ (1) Fiscal years 2022 and 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. 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. 31 Table of Contents 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, and the increase (decrease) is measured in basis points. Fiscal Years 2022 2021 2022 2021 2022 (Dollars in millions) % of Total Revenues (1) Increase (Decrease) Royalties $ 65.8 $ 52.4 23.8 % 12.7 % 1,110 Fees 11.6 10.2 4.2 2.6 160 Product sales to franchisees 15.1 56.7 5.5 13.8 (830) Advertising fund contributions 32.6 22.0 11.8 5.3 650 Franchise rental income 130.8 127.4 47.4 30.9 1,650 Company-owned salon revenue 20.2 143.0 7.3 34.7 (2,740) Cost of product sales to franchisees (2) 17.4 43.8 115.2 77.2 3,800 Inventory reserve 7.7 — 2.8 — N/A General and administrative 65.3 96.4 23.7 23.4 30 Rent 9.4 40.8 3.4 9.9 (650) Advertising fund expense 32.6 22.0 11.8 5.3 650 Franchise rent expense 130.8 127.4 47.4 30.9 1,650 Company-owned salon expense 22.0 141.2 8.0 34.3 (2,630) Depreciation and amortization 6.2 21.7 2.2 5.3 (310) Long-lived asset impairment 0.5 13.0 0.2 3.2 (300) Goodwill impairment 13.1 — 4.7 — N/A Operating loss (3) (28.9) (94.7) (10.5) (23.0) 1,250 Interest expense (12.9) (13.2) (4.7) (3.2) (150) Loss from sale of salon assets to franchisees, net (2.3) (16.7) (0.8) (4.1) 330 Interest income and other, net (0.3) 15.9 (0.1) 3.9 (400) Income tax (expense) benefit (4) (2.0) 5.4 (4.5) 5.0 N/A Loss from discontinued operations, net of taxes (39.4) (10.1) (14.3) (2.5) (1,180) Net loss (3) (85.9) (113.3) (31.1) (27.5) (360) ____________________________________________________________________________ (1) Cost of product sales to franchisees is computed as a percent of product sales to franchisees. (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. 32 Table of Contents Fiscal Year Ended June 30, 2022 Compared with Fiscal Year Ended June 30, 2021 Consolidated Revenues Consolidated revenues are primarily comprised of royalties, fees, advertising fund contributions, product sales to franchisees, franchise rental income and company-owned salon revenue. Consolidated revenues decreased $135.7 million, or 33.0%, during fiscal year 2022. Royalty revenue increased $13.4 million during fiscal year 2022 due to higher franchise system-wide sales and a higher average franchise salon count during the year. The overall decrease in revenue is due to the sale of company-owned salons to franchisees, the closure of company-owned salons which contributed $105.4 million to the decline and the reduction in product sales to franchisees of $41.6 million. During fiscal year 2022, 110 salons were sold to franchisees, net of buy backs, and 360 and 21 system-wide salons were closed and constructed, respectively (2022 Net Salon Count Changes). Additionally, our sales continue to be challenged by labor issues with active stylists and stylist hours worked below pre-COVID levels. Royalties During fiscal year 2022, royalties increased $13.4 million, or 25.6%, primarily due to a higher average franchise salon count and higher franchise system-wide sales. Fees During fiscal year 2022, fees increased $1.4 million, primarily due to the rebate from the Company's third-party distributor included in fees, which was a new source of revenue in fiscal year 2022. Training revenues also increased year over year. See Note 2 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. Product Sales to Franchisees Product sales to franchisees decreased $41.6 million, or 73.4%, during fiscal year 2022, primarily due to the Company's shift in its product business to a third-party distribution model. The Company expected revenue from product sales to decrease significantly during fiscal year 2022 and expects it to continue to decrease in fiscal year 2023. Advertising Fund Contributions Advertising fund contributions increased $10.6 million, or 48.2%, during fiscal year 2022, primarily due to a higher average franchise salon count in fiscal year 2022 and system-wide sales and an increase in the contribution rate that had been reduced in the first half of fiscal year 2021 in response to COVID-19. Franchise Rental Income During fiscal year 2022, franchise rental income increased $3.4 million, or 2.7%, primarily due to a higher average franchise salon count. Company-owned Salon Revenue During fiscal year 2022, company-owned salon revenue decreased $122.8 million, or 85.9%, due to the decrease in company-owned salons as a result of the sale of salons to franchisees and salon closures, a decline in product sales, and exiting our third-party logistic revenue associated with the closure of our warehouses in fiscal year 2022. Cost of Product Sales to Franchisees The 3,800 basis point increase in cost of product as a percent of product revenue during fiscal year 2022 was primarily due to the Company reducing prices to liquidate distribution center inventory. Inventory Reserve During fiscal year 2022, the Company recorded an inventory reserve charge of $7.7 million related to distribution center inventory, primarily consisting of personal protective equipment the Company no longer believes is marketable. During fiscal year 2021, the Company recorded an inventory reserve charge of $12.1 million, which was included in company-owned salon expense in connection with our distribution center exit strategy. 33 Table of Contents General and Administrative The decrease of $31.1 million, or 32.3%, in general and administrative expense during fiscal year 2022 was primarily due to lower administrative and field management compensation resulting from headcount reductions and a decrease in expenses associated with the distribution centers closed in fiscal year 2022. Rent The decrease of $31.4 million, or 77.0%, in rent expense during fiscal year 2022 was primarily due to the net reduction in the number of company-owned salons. Additionally in fiscal year 2022, the Company accrued less rent deemed uncollectible from franchisees. Partially offsetting the decrease was a $0.9 million broker fee incurred in fiscal year 2022 related to exiting the Company's distribution centers. Advertising Fund Expense Advertising fund expense increased $10.6 million, or 48.2%, during fiscal year 2022, primarily due to a higher average franchise salon count in fiscal year 2022 and system-wide sales and an increase in the contribution rate that had been reduced in the first half of fiscal year 2021 in response to COVID-19. Franchise Rent Expense During fiscal year 2022, franchise rent expense increased $3.4 million, or 2.7%, primarily due to a higher average franchise salon count. Company-owned Salon Expense Company-owned salon expense decreased $119.2 million, or 84.4%, during fiscal year 2022, primarily due to the reduction in company-owned salons, a reduction in the inventory reserve charge and a decline in product sales. Depreciation and Amortization The decrease of $15.5 million, or 71.4%, in depreciation and amortization during fiscal year 2022 was primarily due to the net reduction in company-owned salon count and no depreciation expense in fiscal year 2022 related to the distribution center assets that were derecognized in fiscal year 2021. Long-Lived Asset Impairment In fiscal year 2022, the Company recorded a long-lived asset impairment charge of $0.5 million, which represents a right of use (ROU) asset impairment charge of $0.5 million. In fiscal year 2021, the Company recorded a long-lived asset impairment charge of $13.0 million, which included a ROU asset impairment of $9.5 million. The decrease in long-lived asset impairment was primarily due to more salon ROU assets being impaired in prior periods. Goodwill Impairment During fiscal year 2022, the Company recorded a goodwill impairment charge of $13.1 million. See Note 1 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. Interest Expense The $0.3 million decrease in interest expense during fiscal year 2022 was primarily due to interest incurred in fiscal year 2021 related to the financing liabilities associated with our sale leasebacks. Interest expense is expected to increase in fiscal year 2023 as fees related to the credit amendment signed in the first quarter of 2023 are amortized as interest expense over the new term of the credit agreement. Additionally, under the terms of the amended credit agreement, we expect interest expense to increase in the fourth quarter of fiscal year 2023. 34 Table of Contents Loss from Sale of Salon Assets to Franchisees, net The $14.4 million decrease in the loss from the sale of salon assets to franchises, net during fiscal year 2022 was primarily due to fewer salons sold in fiscal year 2022. Interest Income and Other, net The decrease of $16.2 million in interest income and other, net during fiscal year 2022 was primarily due to the $15.0 million gain associated with the leases for the Company's distribution centers that was recognized in fiscal year 2021. Income Tax (Expense) Benefit During fiscal year 2022, the Company recognized tax expense of $(2.0) million, with a corresponding effective tax rate of (4.5)%, compared to recognizing a tax benefit of $5.4 million, with a corresponding effective tax rate of 5.0% during fiscal year 2021. See Note 10 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. Loss from Discontinued Operations, net of Income Taxes In fiscal year 2022, the loss from discontinued operations includes the loss from the sale of OSP, including goodwill derecognition of $38.4 million, partially offset by proceeds from the sale. In fiscal year 2021, loss from discontinued operations includes the income generated from OSP software subscriptions. See Note 3 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. In fiscal year 2023, we expect to record gains relate to discontinued operations as we receive cash related to the release of holdbacks of the purchase price in connection with the sale of OSP. 35 Table of Contents 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 Part II, Item 8, of this Form 10-K. Significant results of continuing operations are discussed below with respect to each of these segments. Franchise Salons Fiscal Years 2022 2021 2022 (Dollars in millions) Increase (Decrease) (1) Royalties $ 65.8 $ 52.4 $ 13.4 Fees 11.6 10.2 1.4 Product sales to franchisees 15.1 56.7 (41.6) Advertising fund contributions 32.6 22.0 10.6 Franchise rental income 130.8 127.4 3.4 Total franchise revenue (1) $ 255.8 $ 268.7 $ (12.9) Franchise same-store sales (2) 15.0 % (24.5) % Operating loss $ (11.8) $ (24.6) $ 12.8 _______________________________________________________________________________ (1) Total is a recalculation; line items calculated individually may not sum to total due to rounding. (2) Franchise same-store sales in fiscal year 2022 and 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. 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. Fiscal Year Ended June 30, 2022 Compared with Fiscal Year Ended June 30, 2021 Franchise Revenues Franchise revenues decreased $12.9 million during fiscal year 2022. The decrease in franchise revenue was primarily due to the decrease in product sales to franchisees due to the Company's shift to third-party distributors, partially offset by higher royalties and advertising fund contributions due to a higher average salon count and increase in system-wide sales. During fiscal year 2022, franchisees purchased 110 salons from the Company and constructed (net of relocations) and closed 21 and 299 franchise salons, respectively. Franchise Operating Loss During fiscal year 2022, franchise salon operations generated operating losses of $11.8 million, and generated an operating loss of $24.6 million during fiscal year 2021. The operating loss improved during fiscal year 2022 compared to the prior comparable period due to the increase in royalties and decrease in general and administrative expense and rent, partially offset by the $13.1 million goodwill impairment charge. 36 Table of Contents Company-owned Salons Fiscal Years 2022 2021 2022 (Dollars in millions) (Decrease) Increase (1) Total revenue $ 20.2 $ 143.0 $ (122.8) Operating loss $ (9.5) $ (70.0) $ 60.5 Total company-owned salons 105 276 _______________________________________________________________________________ (1) Total is a recalculation; line items calculated individually may not sum to total due to rounding. Fiscal Year Ended June 30, 2022 Compared with Fiscal Year Ended June 30, 2021 Company-owned Salon Revenues Company-owned salon revenues decreased $122.8 million in fiscal year 2022, primarily due to the 2022 Net Salon Count Changes. Company-owned Salon Operating Loss During fiscal year 2022, company-owned salon operating loss improved $60.5 million, compared to the prior comparable period. The improvement in the loss during fiscal year 2022 was primarily due to reduced general and administrative expense primarily related to salaries, a decrease in long-lived asset impairment and the exiting of loss-generating company-owned salons. We expect losses associated with the company-owned segment to decrease as we reduce the number of remaining salons through closures or lease buyouts . 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. 37 Table of Contents LIQUIDITY AND CAPITAL RESOURCES In August 2022, the Company reached an agreement to amend its credit agreement and extend the maturity to August 2025 from March 2023. Under the amendment, the revolving credit facility was converted to a $180.0 million term loan and $55.0 million revolving credit facility with the minimum liquidity covenant reduced to $10.0 million from $75.0 million. The amended credit agreement includes typical provisions and financial covenants, including minimum EBITDA, leverage and fixed-charge coverage ratio covenants, the latter two of which are not tested until December 31, 2023. See additional discussion under Financing Arrangements and Note 8 and Note 16 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. Sources of Liquidity Funds generated by operating activities, available cash and cash equivalents and our borrowing agreements are our most significant sources of liquidity. The Company believes it has sufficient liquidity, cash on hand and borrowing capacity, to meet its obligations in the next twelve months and beyond. As of June 30, 2022, cash and cash equivalents were $17.0 million, with $14.9 and $2.1 million within the United States and Canada, respectively. As of June 30, 2022, the Company's borrowing arrangements include a $277.5 million five-year revolving credit facility that expires in March 2023, of which $81.9 million was available as of June 30, 2022. The Company's liquidity per the agreement includes the unused available balance under the credit facility, unrestricted cash and cash equivalents and the shortfall in the gap in expected proceeds from the sale of salon assets of $20.9 million as of June 30, 2022. Total liquidity per the agreement was $119.8 million compared to a minimum liquidity covenant of $75.0 million as of June 30, 2022. See additional discussion under Financing Arrangements and Notes 8 and 16 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. 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 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 franchisees. 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. During fiscal year 2022, the Company issued 9.3 million shares and received net proceeds of $37.2 million. 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 strategic plan as discussed within Part I, Item 1. Cash Requirements The Company's most significant contractual cash requirements as of June 30, 2022 were lease commitments. See Note 6 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K for further detail. Additionally, the Company is committed to purchasing $1.8 million of Designline inventory in the first quarter of fiscal year 2023. This inventory will be sold to our third-party supplier and customers. 38 Table of Contents Cash Flows Cash Flows from Operating Activities During fiscal year 2022, cash used in operating activities was $38.6 million. Cash used in operations improved due to higher royalties, lower general and administrative expense, lower rent and the exiting of loss-generating company-owned salons. These improvements were partially offset by $2.5 million of social security contributions that had been deferred under the CARES Act and $3.6 million of costs related to our debt refinancing. Quarter-over-quarter cash use improved throughout fiscal year 2022. Cash used in operating activities was $12.3, $12.1, $10.0 and $4.3 million in the first, second, third and fourth quarters, respectively. We expect cash use in first quarter of fiscal year 2023 to increase due to approximately $5.0 million of costs paid in connection with the credit amendment and approximately $2.8 million of bonus payments. Cash Flows from Investing Activities During fiscal year 2022, cash provided by investing activities of $7.7 million was primarily related to cash received of $13.0 million from the sale of OSP, partially offset by capital expenditures primarily related to developing the OSP software. In the first quarter of fiscal year 2023, we expect to receive approximately $4 million related to the release of purchase price holdbacks in connection with the sale of OSP. Additionally, due to the sale of OSP, we expect capital expenditures to decrease in fiscal year 2023. Cash Flows from Financing Activities During fiscal year 2022, cash provided by financing activities of $29.4 million was primarily a result of net proceeds of $37.2 million related to the issuance of common stock and a net $6.9 million paydown on the Company's revolving credit facility. The additional purchase price of approximately $4 million expected to be received in the first quarter of fiscal year 2023 will be used to repay the term loan as required by the credit agreement. 39 Table of Contents Financing Arrangements Financing activities are discussed in Note 8 and Note 16 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 consist of the following: June 30, Maturity Dates 2022 2021 2022 2021 (Fiscal year) (Interest rate %) (Dollars in thousands) Revolving credit facility 2023 5.50% 5.00% $ 179,994 $ 186,911 As of June 30, 2022 and 2021, the Company had $180.0 and $186.9 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 $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 $119.8 million as of June 30, 2022. See Note 8 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. 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 the Secured Overnight Financing Rate (SOFR) 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 August 2022, the Company amended its credit agreement. Under the amendment, the revolving credit facility was converted to a $180.0 million term loan and $55.0 million revolving credit facility. The amendment also extends the maturity date to August 31, 2025 and includes, among other things, financial covenants, including minimum EBITDA, leverage and fixed charge coverage ratios and a minimum liquidity covenant which was reduced from $75.0 million to $10.0 million. The amendment also eliminates the $115.0 million incremental loan facility. See additional discussion in Note 16 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. Our debt to capitalization ratio, calculated as the principal amount of debt as a percentage of the principal amount of debt and shareholders' (deficit) equity at fiscal year-end, was as follows: As of June 30, Debt to Capitalization (1) 2022 120.8 % 2021 91.6 % _______________________________________________________________________________ (1) Excludes the long-term lease liability as that liability is offset by the ROU asset. The increase in the debt to capitalization ratio as of June 30, 2022 compared to June 30, 2021 was primarily due to the decrease in shareholders' (deficit) equity as a result of the loss from operations. 40 Table of Contents Contractual Obligations and Commercial Commitments On-Balance Sheet Obligations Our debt obligations are primarily composed of our revolving credit facility at June 30, 2022. Non-current deferred benefits of $6.3 million includes $1.8 million related to a non-qualified deferred salary plan, a salary deferral program of $2.3 million and a bonus deferral plan of $2.2 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. Recent trends in system-wide revenue over the past few years 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. We cannot predict the timing or amount of future payments related to these contracts. See Note 11 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. As of June 30, 2022, 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. As of June 30, 2022, the applicable margin for loans bearing interest at SOFR 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. Under the amended credit facility entered into in August 2022, the applicable margins for the loans bearing interest are subject to annual increases. The margin applicable to loans bearing interest at SOFR will initially be 3.875%. Effective March 27, 2023, the margin will increase to 6.25%, of which 4.25% will be paid currently in cash and 2.00% will be paid in kind (PIK) interest (added to the principal balance and thereafter accruing interest). Effective March 27, 2024, the margin will increase to 7.25%, of which 4.25% will be paid currently in cash and 3.00% will be PIK interest. The margin applicable to base rate loans will be 100 basis points (1.00%) less than the margin applicable to SOFR loans. See Note 16 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. 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 any 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, 2022. 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. 41 Table of Contents Dividends In December 2013, the Board elected to discontinue declaring regular quarterly dividends. Share Issuance Program In February 2021, the Company filed a $150.0 million shelf registration statement and $50.0 million prospectus supplement with the SEC under which it may offer and sell, from time to time, up to $50.0 million worth of its common stock in "at-the-market" offerings. As of June 30, 2022, the Company has issued 9.3 million shares for net proceeds of $37.2 million. 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, 2022, 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 2022, the Company did not repurchase any shares. As of June 30, 2022, 30.0 million shares have been cumulatively repurchased for $595.4 million, and $54.6 million remained authorized for repurchase. The Company does not anticipate repurchasing shares of common stock for the foreseeable future. 42 Table of Contents CRITICAL ACCOUNTING POLICIES The Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States. 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, 2022 and 2021, the Franchise reporting unit had $174.4 and $229.6 million of goodwill, respectively, and the Company-owned segment had no goodwill at either period. See Note 5 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. 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, franchise salon counts, long-term growth rates and discount rates for determining terminal value. During fiscal year 2022, our estimates of annual revenue and salon counts were decreased to reflect recent trends in the business and, in fourth quarter, the removal of OSP revenues and expenses from our forecast. In addition, discount rates have increased during this period to reflect changes in the market interest rates. 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. 43 Table of Contents Long-Lived Assets, Excluding Goodwill The Company follows the guidance in ASC 360, Property, Plant, and Equipment and applies the guidance to property, plant, and equipment as well as right of use (ROU) assets. 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 2022 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. 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. The second step of the long-lived asset impairment test requires that the fair value of the asset group be estimated when determining the amount of any impairment loss. For the salon asset groups that failed the recoverability test, an impairment loss was measured as the amount by which the carrying amount of the asset group exceeds its fair value. The Company applied the fair value guidance within ASC 820-10 to determine the fair value of the asset group from the perspective of a market-participant considering, among other things, appropriate discount rates, multiple valuation techniques, the most advantageous market, and assumptions about the highest and best use of the asset group. To determine the fair value of the salon asset groups, the Company utilized market-participant assumptions based on the best information available, 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 and a discount rate. For fiscal years 2022 and 2021, the Company recognized long-lived asset impairment charges of $0.5 and $13.0 million, respectively, which included $0.5 and $9.5 million, respectively, related to ROU assets on the Consolidated Statement of Operations in Part II, Item 8, of this Form 10-K. The impairment loss for each salon asset group that was recognized was allocated among the long-lived assets of the group on a pro-rata basis using their relative carrying amounts. Additionally, the impairment losses did not reduce the carrying amount of an individual asset below its fair value, including for the ROU assets included in the salon asset groups. Assessing the long-lived assets for impairment requires management to make assumptions and to apply judgment which can be affected by economic conditions and other factors that can be difficult to predict. The Company does not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions it uses to calculate impairment losses for its long-lived asset, including its ROU assets. However, actual results may not be consistent with the estimates and assumptions used in the calculations, the Company may be exposed to future impairment losses that could be material. 44 Table of Contents 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 $201.7 and $192.5 million at June 30, 2022 and 2021, 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 2022 are as follows: • The Company determined that it no longer had sufficient U.S. state indefinite-lived taxable temporary differences to support realization of its U.S. state indefinite-lived NOLs and its existing U.S. deferred tax assets that upon reversal are expected to generate state indefinite-lived NOLs. As a result, the Company recorded a $4.1 million valuation allowance on its U.S. state indefinite-lived deferred tax assets. 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. 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. 45 Table of Contents