REGIS CORP 10-Q

Item 2. 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 consolidated 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. This MD&A should be read in conjunction with the MD&A included in our June 30, 2022 Annual Report on Form 10-K and other documents filed or furnished with the SEC during the current fiscal year. MANAGEMENT'S OVERVIEW Regis Corporation (NYSE:RGS) is a leader in the beauty salon industry. As of September 30, 2022, the Company franchised, owned or held ownership interests in 5,494 worldwide locations. Our locations consisted of 5,418 system-wide North American and international salons, and 76 locations in which we maintained a non-controlling ownership interest less than 100 percent. Regis’ franchised and corporate locations operate under concepts such as Supercuts ® , SmartStyle ® , Cost Cutters ® , Roosters ® and First Choice Haircutters ® . Regis maintains an ownership interest in Empire Education Group in the U.S. As of September 30, 2022, the Company had 608 employees worldwide. Merchandising Strategy As part of the Company's transformation to focus on managing and nurturing brands, and in line with its capital-light business, the Company adopted a new merchandise strategy to shift its product business from a wholesale model to a third-party distribution model. Management expects the change will positively impact franchisees by providing them access to industry-leading pricing, loyalty programs, promotional benefits, educational assets, and ongoing support. The Company will receive a rebate from the third-party distributors which is included in fees on the interim unaudited Condensed Consolidated Statement of Operations. As a result of the change, product sales to franchisees will continue to decrease and are expected to provide less revenue and costs in fiscal year 2023 as compared to prior year. CRITICAL ACCOUNTING POLICIES The interim unaudited Condensed Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the interim unaudited Condensed 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 interim unaudited Condensed 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 interim unaudited Condensed Consolidated Financial Statements. Our significant accounting policies can be found in Note 1 to the Consolidated Financial Statements contained in Part II, Item 8 of the June 30, 2022 Annual Report on Form 10-K, as well as Notes 1 and 2 to the unaudited Condensed Consolidated Financial Statements contained within this Quarterly Report on Form 10-Q. We believe the accounting policies related to the valuation of goodwill and the valuation and estimated useful lives of long-lived assets are most critical to aid in fully understanding and evaluating our reported financial condition and results of operations. Discussion of each of these policies is contained under "Critical Accounting Policies" in Part II, Item 7 of our June 30, 2022 Annual Report on Form 10-K. Our policies related to revenue recognition guidance can be found in Note 2 to the unaudited Condensed Consolidated Financial Statements. 21 RESULTS OF OPERATIONS 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 our franchisees or the Company. While we do not record sales by franchisees as revenue, and such sales are not included in our unaudited Condensed 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 by concept are detailed in the table below: Three Months Ended September 30, 2022 2021 Supercuts 8.9 % 30.5 % SmartStyle (3.2) 17.0 Portfolio Brands 3.6 18.5 Consolidated system-wide same-store sales (1) 4.5 % 23.2 % _______________________________________________________________________________ (1) 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. Quarterly 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. 22 Condensed Consolidated Results of Operations (Unaudited) The following table sets forth, for the periods indicated, certain information derived from our unaudited Condensed Consolidated Statement of Operations. The percentages are computed as a percent of total consolidated revenues, except as otherwise indicated, and the increase (decrease) is measured in basis points. Three Months Ended September 30, 2022 2021 2022 2021 2022 ($ in millions) % of Total Revenues (1) (2) Increase (Decrease) (1) Royalties $ 17.2 $ 16.6 27.9 % 21.7 % 620 Fees 2.6 2.3 4.2 3.0 120 Product sales to franchisees 0.4 8.0 0.6 10.4 (980) Advertising fund contributions 8.3 8.1 13.4 10.5 290 Franchise rental income 30.3 33.8 48.9 44.0 490 Company-owned salon revenue 3.1 8.0 5.0 10.4 (540) Cost of product sales to franchisees 0.5 7.6 125.0 95.0 3,000 General and administrative 14.4 20.8 23.3 27.1 (380) Rent 1.8 1.7 2.9 2.2 70 Advertising fund expense 8.3 8.1 13.4 10.5 290 Franchise rent expense 30.3 33.8 48.9 44.0 490 Company-owned salon expense 3.0 7.9 4.8 10.3 (550) Depreciation and amortization 1.3 1.5 2.1 2.0 10 Long-lived asset impairment — 0.2 — 0.3 (30) Operating income (loss) (3) 2.5 (4.9) 4.0 (6.4) 1,040 Interest expense (3.8) (3.1) (6.1) (4.0) (210) Loss from sale of salon assets to franchisees, net — (1.1) — (1.4) 140 Other, net (0.5) (0.2) (0.8) (0.3) (50) Income tax (expense) benefit (4) — — (1.5) 0.5 N/A Income (loss) from discontinued operations 3.3 (1.1) 5.3 (1.4) 670 Net income (loss) (3) 1.5 (10.4) 2.4 (13.5) 1,590 _______________________________________________________________________________ (1) Variances calculated on amounts shown in millions may result in rounding differences. (2) Cost of product sales to franchisees is computed as a percent of product sales to franchisees. (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 tax basis point change is noted as not applicable (N/A) as the discussion within MD&A is related to the effective income tax rate. 23 Three Months Ended September 30, 2022 Compared with Three Months Ended September 30, 2021 Consolidated Revenues Consolidated revenues are comprised of royalties, fees, advertising fund contributions, product sales to franchisees, franchise rental income and company-owned salon revenue. Consolidated revenue decreased $14.9 million, or 19.4%, for the three months ended September 30, 2022. Royalty revenue increased $0.6 million in the three months ended September 30, 2022 due to higher average royalty rates. The overall decrease in revenue is due to the decrease in company-owned salon revenue of $4.9 million due primarily to salon closures and to the decline in product sales to franchisees of $7.6 million. During the twelve months ended September 30, 2022, 30 salons were sold to franchisees and 370 and 22 system-wide salons were closed and constructed, respectively (2023 Net Salon Count Changes). Royalties During the three months ended September 30, 2022, royalties increased $0.6 million, or 3.6%, primarily due to higher average royalty rates partially offset by a decrease in franchise salon count. Fees During the three months ended September 30, 2022, fees increased $0.3 million, or 13.0%, primarily due to the rebate from the Company's third-party distributor, which is a new source of revenue. See Note 2 to the unaudited Condensed Consolidated Financial Statements. Product Sales to Franchisees Product sales to franchisees decreased $7.6 million, or 95.0%, during the three months ended September 30, 2022, primarily due to the Company's shift in its product business to a third-party distribution model. Advertising Fund Contributions Advertising fund contributions increased $0.2 million, or 2.5%, during the three months ended September 30, 2022, primarily due to the increase in Supercuts system-wide sales. Franchise Rental Income During the three months ended September 30, 2022, franchise rental income decreased $3.5 million, or 10.4%, primarily due to lower franchise salon count. Company-owned Salon Revenue During the three months ended September 30, 2022, company-owned salon revenue decreased $4.9 million, or 61.3%, due to the decrease in company-owned salons as a result of a decrease in salon count and a decline in product sales. Cost of Product Sales to Franchisees The 3,000 basis point increase in cost of product as a percent of product revenues during the three months ended September 30, 2022 was primarily due to the Company reducing prices to liquidate distribution center inventory. 24 General and Administrative The decrease of $6.4 million, or 30.8%, in general and administrative expense during the three months ended September 30, 2022 was primarily due to lower administrative and field management compensation resulting from headcount reductions and a decrease in expenses associated with the distribution center closures in fiscal year 2022. Rent Rent expense did not change significantly year over year. There was a benefit of $1.1 million in fiscal year 2022 related to Canadian COVID-19 rent relief, which was offset by the net reduction in the number of company-owned salons in fiscal year 2023. Advertising Fund Expense Advertising fund expense increased $0.2 million, or 2.5%, during the three months ended September 30, 2022, primarily due to the increase in Supercuts system-wide sales. Franchise Rent Expense During the three months ended September 30, 2022, franchise rent expense decreased $3.5 million, or 10.4%, primarily due to lower franchise salon count. Company-owned Salon Expense Company-owned salon expense for the three months ended September 30, 2022 decreased $4.9 million, or 62.0%, primarily due to the reduction in company-owned salons and a decline in product sales, partially offset by $0.6 million of Canadian wage relief received in fiscal year 2022. Depreciation and Amortization The decrease of $0.2 million, or 13.3%, in depreciation and amortization during the three months ended September 30, 2022 was primarily due to lower asset retirement obligations ("white boxing" salons at lease end) and the net reduction in company-owned salon count. Long-Lived Asset Impairment In the three months ended September 30, 2022, the Company did not record a long-lived asset impairment charge and in the three months ended September 30, 2021, the Company recorded a long-lived asset impairment charge of $0.2 million. The decrease in long-lived asset impairment was primarily due to more salons being impaired in prior periods. Interest Expense The $0.7 million increase in interest expense for the three months ended September 30, 2022 was primarily due to the amortization of fees related to the credit amendment that was signed in the first quarter of fiscal year 2023 and a higher interest rate on outstanding borrowings. Loss from Sale of Salon Assets to Franchisees, Net There was one salon sold in the three months ended September 30, 2022 compared to 81 in the three months ended September 30, 2021, which resulted in a $1.1 million decrease in the loss from sale of salon assets to franchisees, net. 25 Other, Net The decrease of $0.3 million in other, net during the three months ended September 30, 2022 was primarily due to a higher foreign exchange loss in the three months ended September 30, 2022. Income Tax (Expense) Benefit During the three months ended September 30, 2022, the Company recognized tax expense of $0.03 million, with a corresponding effective tax rate of (1.5%), as compared to recognizing a tax benefit of $0.05 million, with a corresponding effective tax rate of 0.5% during the three months ended September 30, 2021. See Note 5 to the unaudited Condensed Consolidated Financial Statements. Income (Loss) from Discontinued Operations In the three months ended September 30, 2022 and 2021, the Company recognized a gain from discontinued operations, net of income taxes of $3.3 million and a loss of $1.1 million, respectively. The gain in fiscal year 2023 is primarily due to receipt of $4.0 million in sales proceeds, which were previously held back. See Note 3 to the unaudited Condensed Consolidated Financial Statements. 26 Results of Operations by Segment Based on our internal management structure, we report two segments: Franchise and Company-owned salons. See Note 12 to the unaudited Condensed Consolidated Financial Statements. Significant results of continuing operations are discussed below with respect to each of these segments. Franchise Three Months Ended September 30, 2022 2021 Increase (Decrease) (1) (Dollars in millions) Royalties $ 17.2 $ 16.6 $ 0.6 Fees 2.6 2.3 0.3 Product sales to franchisees 0.4 8.0 (7.6) Advertising fund contributions 8.3 8.1 0.2 Franchise rental income 30.3 33.8 (3.5) Total franchise revenue (1) $ 58.8 $ 68.8 $ (10.0) Franchise same-store sales (2) 4.6 % 23.7 % Operating income (loss) $ 4.1 $ (3.9) $ 8.0 Total franchise salons 5,323 5,587 (264) _______________________________________________________________________________ (1) Total is a recalculation; line items calculated individually may not sum to total due to rounding. (2) Franchise same-store sales 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. Quarterly 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. Franchise Revenue Franchise revenues decreased $10.0 million during the three months ended September 30, 2022. The decrease in franchise salon revenue during the three months ended September 30, 2022 was primarily due to the decrease in product sales to franchisees due to the Company's shift to third-party distributors and franchise rental income. During the twelve months ended September 30, 2022, franchisees purchased 30 salons from the Company and constructed (net of relocations) and closed 21 and 315 franchise salons, respectively. Franchise Operating Income (Loss) During the three months ended September 30, 2022, franchise salon operations generated operating income of $4.1 million and generated operating losses of $3.9 million during the three months ended September 30, 2021. Operating income improved primarily due to higher royalty revenue and decreased general and administrative expense and rent. 27 Company-owned Salons Three Months Ended September 30, 2022 2021 Decrease (1) (Dollars in millions) Total revenue $ 3.1 $ 8.0 $ (4.9) Operating loss $ (1.6) $ (1.0) $ (0.6) Total company-owned salons 95 179 (84) _______________________________________________________________________________ (1) Total is a recalculation; line items calculated individually may not sum to total due to rounding. Company-owned Salon Revenue Company-owned salon revenues decreased $4.9 million during the three months ended September 30, 2022, primarily due to the 2023 Net Salon Count Changes and a decline in product sales in salons. Company-owned Salon Operating Loss During the three months ended September 30, 2022, company-owned salon operating loss increased $0.6 million, compared to the prior comparable period. The increase in the loss during the three months ended September 30, 2022 was primarily due to the Company receiving Canadian COVID-19 rent and wage relief benefits of $1.7 million in fiscal year 2022, partially offset by the closure of loss-generating salons. 28 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 $295.0 million 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 Note 9 to the unaudited Condensed Consolidated Financial Statements. 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 September 30, 2022, cash and cash equivalents were $9.5 million, with $8.3 million and $1.2 million within the United States and Canada, respectively. As of September 30, 2022, the Company's borrowing arrangements include a $180.0 million term loan and a $55.0 million revolving credit facility that expires in August 2025. As of September 30, 2022, the unused available credit under the revolving credit facility was $38.3 million, the credit agreement has a minimum liquidity covenant of $10.0 million, and total liquidity per the agreement was $47.8 million. See Note 9 to the unaudited Condensed Consolidated Financial Statements. Additionally, 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 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 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 the three months ended September 30, 2022, the Company did not issue shares under the prospectus supplement. During the three months ended September 30, 2021, the Company issued 8.1 million shares and received net proceeds of $32.2 million. On September 29, 2021, the Company sold 1.2 million shares for net proceeds of $5.0 million, which settled on October 1, 2021. As of September 30, 2022, $11.6 million remains outstanding under the share issuance program. Uses of Cash The Company closely manages its liquidity and capital resources. The Company's liquidity requirements depend on key variables, including the level of investment needed to support its business strategies, the performance of the business, credit facilities and borrowing arrangements, and working capital management. The Company has a disciplined approach to capital allocation, which focuses on investing in key priorities as discussed within Part I, Item 1 of our Annual Report on Form 10-K for the fiscal year ended June 30, 2022. Cash Requirements The Company's most significant contractual cash requirements as of September 30, 2022 were lease commitments and interest payments. See Note 8 to the unaudited Condensed Consolidated Financial Statements for further lease commitment detail. Additionally, the Company is expecting to pay $2.5 million in deferred social security contributions in the second quarter of fiscal year 2023. 29 Cash Flows Cash Flows from Operating Activities During the three months ended September 30, 2022, cash used in operating activities was $5.1 million compared to $12.3 million in the prior year. Cash used in operations improved due to higher royalties and lower general and administrative expense. Cash Flows from Investing Activities During the three months ended September 30, 2022, cash provided by investing activities of $3.3 million, primarily related to cash received of $4.0 million from the sale of OSP, net of a $0.5 million transaction fee. During the three months ended September 30, 2021, cash used in investing activities of $1.5 million was primarily due to capital expenditures, primarily related to internally-developed capitalized software. Cash Flows from Financing Activities During the three months ended September 30, 2022, cash used in financing activities was $3.8 million, primarily as a result of debt refinancing fees of $4.3 million, partially offset by a net $0.6 million borrowing under the Company's revolving credit facility. During the three months ended September 30, 2021, cash provided by financing activities was $40.8 million, primarily as a result of net proceeds related to the issuance of common stock. Financing Arrangements See Note 9 of the Notes to the unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2022 and Note 8 of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2022, for additional information regarding our financing arrangements. Debt to Capitalization Ratio Our debt to capitalization ratio, calculated as the principal amount of debt as a percentage of the principal amount of debt and shareholders' deficit at fiscal quarter end, was as follows: Debt to Capitalization (1) September 30, 2022 119.8 % June 30, 2022 120.8 % _______________________________________________________________________________ (1) Excludes the long-term lease liability as that liability is offset by the ROU asset. The decrease in the debt to capitalization ratio as of September 30, 2022 as compared to June 30, 2022, was primarily due to the improvement in shareholders' deficit as a result of net income in the quarter. 30 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 Class A common stock in "at-the-market" offerings. During the three months ended September 30, 2022, the Company did not issue shares under the prospectus supplement. As of September 30, 2022, 9.3 million shares have been cumulatively issued for $38.4 million, and $11.6 million remains outstanding under the share issuance program. Share Repurchase Program In May 2000, the Board approved a stock repurchase program with no stated expiration date. Since that time and through September 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 depend on many factors, including the market price of the common stock and overall market conditions. During the three months ended September 30, 2022, the Company did not repurchase any shares. As of September 30, 2022, 30.0 million shares have been cumulatively repurchased for $595.4 million, and $54.6 million remains outstanding under the approved stock repurchase program. 31 SAFE HARBOR PROVISIONS UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This Quarterly Report on Form 10-Q, as well as information included in, or incorporated by reference from, future filings by the Company with the Securities and Exchange Commission and information contained in written material, press releases and oral statements issued by or on behalf of the Company contains or may contain "forward-looking statements" within the meaning of the federal securities laws, including statements concerning anticipated future events and expectations that are not historical facts. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements in this document reflect management's best judgment at the time they are made, but all such statements are subject to numerous risks and uncertainties, which could cause actual results to differ materially from those expressed in or implied by the statements herein. Such forward-looking statements are often identified herein by use of words including, but not limited to, "may," "believe," "project," "forecast," "expect," "estimate," "anticipate," and "plan." These uncertainties include a potential material adverse impact on our business and results of operations as a result of the COVID-19 pandemic, including any adverse impact from variants; consumer shopping trends and changes in manufacturer distribution channels; changes in regulatory and statutory laws including increases in minimum wages; laws and regulations could require us to modify current business practices and incur increased costs; changes in economic conditions; changes in consumer tastes, fashion trends and consumer spending patterns; compliance with New York Stock Exchange listing requirements; reliance on franchise royalties and overall success of our franchisees’ salons; the return of sales at franchise locations to pre-pandemic levels; new merchandising strategy that utilizes third-party preferred supplier arrangements; our franchisees' ability to attract, train and retain talented stylists and salon leaders; the success of our franchisees, which operate independently; our ability to manage cyber threats and protect the security of potentially sensitive information about our guests, franchisees, employees, vendors or Company information; the ability of the Company to maintain a satisfactory relationship with Walmart; marketing efforts to drive traffic to our franchisees' salons; the successful migration of our franchisees to the Zenoti salon technology platform; our ability to maintain and enhance the value of our brands; reliance on information technology systems; reliance on external vendors; the use of social media; failure to standardize operating processes across brands; exposure to uninsured or unidentified risks; the effectiveness of our enterprise risk management program; compliance with covenants in our financing arrangement, access to the existing revolving credit facility, and we may face an accelerated obligation to repay our indebtedness; our capital investments in technology may not achieve appropriate returns; premature termination of agreements with our franchisees; financial performance of Empire Education Group, Inc.; the continued ability of the Company to implement cost reduction initiatives and achieve expected cost savings; continued ability to compete in our business markets; reliance on our management team and other key personnel; the continued ability to maintain an effective system of internal controls over financial reporting; changes in tax exposure; the ability to use U.S. net operating loss carryforwards; potential litigation and other legal or regulatory proceedings could have an adverse effect on our business; or other factors not listed above. Additional information concerning potential factors that could affect future financial results is set forth under Item 1A on Form 10-K. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. However, your attention is directed to any further disclosures made in our subsequent annual and periodic reports filed or furnished with the SEC on Forms 10-K, 10-Q and 8-K and Proxy Statements on Schedule 14A. 32 Item 3. Quantitative and Qualitative Disclosures about Market Risk We are exposed to market risk from changes in interest rates and changes in foreign currency exchange rates. There has been no material change to the factors discussed within Part II, Item 7A in the Company's June 30, 2022 Annual Report on Form 10-K.