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, 2023, the Company franchised or owned 4,863 salons in North America and the United Kingdom. Each of the Company's salon concepts generally offer similar salon products and services and serve the mass market. As of June 30, 2023, we had 435 corporate employees worldwide. See discussion within Part I, Item 1 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 is as follows: Fiscal Years 2023 2022 2021 (Dollars in thousands) Salons sold to franchisees 1 110 748 Cash proceeds received $ — $ — $ 8,437 Loss from sale of salon assets to franchisees, net $ — $ (2,334) $ (16,696) On June 30, 2022, the Company sold its Opensalon ® Pro (OSP) software-as-a-service solution to Soham Inc. The Company received $13.0 million in proceeds in June 2022 and received an additional $5.0 million in proceeds in fiscal year 2023, offset by a $0.5 million transaction fee. The Company expects to receive an additional $2.0 million of proceeds held back for general indemnity provisions in December 2024 and additional proceeds as salons migrate to the Zenoti platform. 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. 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. Franchisees 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 2023, 2022 and 2021, the Company experienced the following charges related to the exit of the distribution centers: Fiscal Years 2023 2022 2021 Financial Statement Caption (Dollars in thousands) Inventory reserve (1) Inventory reserve $ 1,228 $ 7,655 $ — Inventory valuation adjustment (2) Company-owned salon expense — 2,823 12,068 Gain from disposal of distribution center assets 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. 27 Table of Conte n t s RESULTS OF OPERATIONS The Company reports its operations in two operating segments: Franchise salons and Company-owned salons. COVID-19 Impact: The global coronavirus pandemic (COVID-19) had an adverse impact on operations. As a result, the Company received Canadian rent relief, Canadian wage relief, U.S. employee retention payroll tax credits and a grant from the state of North Carolina. In fiscal years 2023, 2022 and 2021, the Company received the following financial assistance: Fiscal Years 2023 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 North Carolina COVID-19 grant Other, net 1,106 — — Additionally, in both December 2022 and December 2021, the Company paid $2.5 million of social security contributions that had been deferred under the CARES Act. 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. In fiscal year 2023, a net 600 franchise salons have closed, which reduces future royalty income. The following table summarizes system-wide revenue and system-wide same-store sales (1) by concept: Fiscal Years 2023 2022 2021 (Dollars in millions) System-wide revenue $ 1,230.5 $ 1,228.5 $ 1,086.0 Supercuts 6.9 % 22.1 % (25.8) % SmartStyle (2.5) 5.7 (26.7) Portfolio Brands 5.5 11.2 (24.8) Total system-wide same-store sales 4.4 % 14.8 % (25.8) % ____________________________________________________________________________ (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. 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. 28 Table of Conte n t s Consolidated Results of Operations The following table sets forth, for the periods indicated, certain information derived from our Consolidated Statements 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. Variances calculated on amounts shown in millions may result in rounding differences. Fiscal Years 2023 2022 2021 2023 2022 2021 2023 2022 (Dollars in millions) % of Total Revenues (1) Increase (Decrease) Royalties $ 66.0 $ 65.8 $ 52.4 28.4 % 23.8 % 12.7 % 460 1,110 Fees 11.3 11.6 10.2 4.8 4.2 2.6 60 160 Product sales to franchisees 2.8 15.1 56.7 1.2 5.5 13.8 (430) (830) Advertising fund contributions 31.7 32.6 22.0 13.6 11.8 5.3 180 650 Franchise rental income 111.4 130.8 127.4 47.7 47.4 30.9 30 1,650 Company-owned salon revenue 10.1 20.2 143.0 4.3 7.3 34.7 (300) (2,740) Cost of product sales to franchisees 3.5 17.4 43.8 125.0 115.2 77.2 980 3,800 Inventory reserve 1.2 7.7 — 0.5 2.8 — (230) N/A General and administrative 50.8 65.3 96.4 21.8 23.7 23.4 (190) 30 Rent 9.2 9.4 40.8 3.9 3.4 9.9 50 (650) Advertising fund expense 31.7 32.6 22.0 13.6 11.8 5.3 180 650 Franchise rent expense 111.4 130.8 127.4 47.7 47.4 30.9 30 1,650 Company-owned salon expense 8.8 22.0 141.2 3.8 8.0 34.3 (420) (2,630) Depreciation and amortization 7.7 6.2 21.7 3.3 2.2 5.3 110 (310) Long-lived asset impairment 0.1 0.5 13.0 — 0.2 3.2 (20) (300) Goodwill impairment — 13.1 — — 4.7 — (470) N/A Operating income (loss) (2) 8.8 (28.9) (94.7) 3.8 (10.5) (23.0) 1,430 1,250 Interest expense (22.1) (12.9) (13.2) (9.5) (4.7) (3.2) (480) (150) Loss from sale of salon assets to franchisees, net — (2.3) (16.7) — (0.8) (4.1) 80 330 Other, net 1.4 (0.3) 15.9 0.6 (0.1) 3.9 70 (400) Income tax benefit (expense) (3) 0.7 (2.0) 5.4 5.5 (4.5) 5.0 N/A N/A Income (loss) from discontinued operations 4.0 (39.4) (10.1) 1.7 (14.3) (2.5) 1,600 (1,180) Net loss (2) (7.4) (85.9) (113.3) (3.2) (31.1) (27.5) 2,790 (360) ____________________________________________________________________________ (1) Cost of product sales to franchisees is computed as a percent of product sales to franchisees. (2) Total is a recalculation; line items calculated individually may not sum to total due to rounding. (3) 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. 29 Table of Conte n t s Fiscal Year Ended June 30, 2023 Compared with Fiscal Year Ended June 30, 2022 Royalties During fiscal year 2023, royalties increased $0.2 million, or 0.3%, primarily due to higher average royalty rates and improved system-wide same-store sales, mostly offset by a decrease in franchise salon count. Fees During fiscal year 2023, fees decreased $0.3 million, or 2.6%, primarily due to a decrease in terminated development agreements year over year, partially offset by an increase in the fee received from the Company's third-party distribution partner. Product Sales to Franchisees Product sales to franchisees decreased $12.3 million, or 81.5%, during fiscal year 2023, primarily due to the Company's shift in its product business to a third-party distribution model. Advertising Fund Contributions Advertising fund contributions decreased $0.9 million, or 2.8%, during fiscal year 2023, primarily due to the decrease in franchise salon count, partially offset by improved system-wide same-store sales. Franchise Rental Income During fiscal year 2023, franchise rental income decreased $19.4 million, or 14.8%, primarily due to the decrease in franchise salon count. Company-owned Salon Revenue During fiscal year 2023, company-owned salon revenue decreased $10.1 million, or 50.0%, due to the decrease in company-owned salon count and a decline in product sales. Cost of Product Sales to Franchisees The 980 basis point increase in cost of product sales to franchisees as a percent of product revenue during fiscal year 2023 was primarily due to the Company reducing prices to liquidate distribution center inventory. Inventory Reserve During fiscal year 2023, the Company recorded an inventory reserve charge of $1.2 million related to slow moving products. During fiscal year 2022, the Company recorded a total inventory reserve charge of $10.5 million, of which $7.7 million was recorded in inventory reserve and $2.8 million was recorded in company-owned salon expense on the Consolidated Statements of Operations. See Note 1 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. General and Administrative The decrease of $14.5 million, or 22.2%, in general and administrative expense during fiscal year 2023 was primarily due to lower administrative and field management compensation resulting from headcount reductions, lower legal and professional fees and a decrease in expenses associated with the distribution centers closures in fiscal year 2022. Rent The decrease of $0.2 million, or 2.1%, in rent expense during fiscal year 2023 was primarily due to the net reduction in the number of company-owned salons, partially offset by a $1.2 million benefit in fiscal year 2022 related to Canadian COVID-19 rent relief. Advertising Fund Expense Advertising fund expense decreased $0.9 million, or 2.8%, during fiscal year 2023, primarily due to the decrease in franchise salon count, partially offset by improved system-wide same-store sales. 30 Table of Conte n t s Franchise Rent Expense During fiscal year 2023, franchise rent expense decreased $19.4 million, or 14.8%, primarily due to the decrease in franchise salon count. Company-owned Salon Expense Company-owned salon expense decreased $13.2 million, or 60.0%, during fiscal year 2023, primarily due to the reduction in company-owned salon count, a decline in product sales and an inventory reserve charge of $2.8 million in fiscal year 2022 included in company-owned salon expense. These decreases were partially offset by $2.0 million of Canadian COVID-19 wage relief received in fiscal year 2022. Depreciation and Amortization The increase of $1.5 million, or 24.2%, in depreciation and amortization during fiscal year 2023 was primarily due to a $2.6 million accelerated depreciation charge in the second quarter of fiscal year 2023 related to the consolidation of office space within the Company's corporate headquarters, partially offset by lower asset retirement obligations ("white boxing" salons at lease end) and the net reduction in company-owned salon count. Long-Lived Asset Impairment In fiscal year 2023, the Company recorded a long-lived asset impairment charge of $0.1 million, and in fiscal year 2022, the Company recorded a long-lived asset impairment charge of $0.5 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 2023, the Company did not record a goodwill impairment charge, and 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 $9.2 million increase in interest expense during fiscal year 2023 was primarily due to the increase of $1.1 million in amortization of fees related to the credit amendment that was signed in the first quarter of fiscal year 2023 and a higher weighted average interest rate on outstanding borrowings, including non-cash paid-in-kind interest of $1.0 million. Loss from Sale of Salon Assets to Franchisees, net There was one salon sold in fiscal year 2023 compared to 110 in fiscal year 2022, which resulted in a $2.3 million improvement in the loss from sale of salon assets to franchises, net. Other, net Other, net improved $1.7 million in fiscal year 2023, primarily due to a $1.1 million grant received from the state of North Carolina related to COVID-19 relief and a class action settlement. Income Tax Benefit (Expense) During fiscal year 2023, the Company recognized an income tax benefit of $0.7 million, with a corresponding effective tax rate of 5.5%, compared to recognizing income tax expense of $2.0 million, with a corresponding effective tax rate of (4.5)% during fiscal year 2022. See Note 10 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. Income (Loss) from Discontinued Operations In fiscal year 2023, the Company recorded income from discontinued operations of $4.0 million and in fiscal year 2022, the Company recorded a loss from discontinued operations of $39.4 million. Income in fiscal year 2023 is primarily due to the receipt of $5.0 million sales proceeds offset by a $0.5 million transaction fee and other expenses from the sale of OSP. The loss in fiscal year 2022 includes the loss from the sale of OSP, including goodwill derecognition of $38.4 million, partially offset by proceeds from the sale. See Note 3 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K. 31 Table of Conte n t s 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 2023 2022 2021 2023 2022 (Dollars in millions) Increase (Decrease) (1) Royalties $ 66.0 $ 65.8 $ 52.4 $ 0.2 $ 13.4 Fees 11.3 11.6 10.2 (0.3) 1.4 Product sales to franchisees 2.8 15.1 56.7 (12.3) (41.6) Advertising fund contributions 31.7 32.6 22.0 (0.9) 10.6 Franchise rental income 111.4 130.8 127.4 (19.4) 3.4 Total franchise revenue (1) $ 223.2 $ 255.8 $ 268.7 $ (32.6) $ (12.9) Franchise same-store sales (2) 4.4 % 15.0 % (24.5) % Franchise adjusted EBITDA $ 22.8 $ 7.7 $ (29.4) $ 15.1 $ 37.1 Total franchise salons 4,795 5,395 5,563 (600) (168) _______________________________________________________________________________ (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. 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, 2023 Compared with Fiscal Year Ended June 30, 2022 Franchise Revenue Franchise revenue decreased $32.6 million during fiscal year 2023. The decrease in franchise revenue was primarily due to the decrease in franchise rental income as a result of lower salon count and the decrease in product sales to franchisees due to the Company's shift to a third-party distributor model. During fiscal year 2023, franchisees purchased one salon from the Company and constructed (net of relocations) and closed 15 and 616 franchise salons, respectively. Franchise Adjusted EBITDA During fiscal year 2023, franchise adjusted EBITDA totaled $22.8 million, an improvement of $15.1 million compared to fiscal year 2022. The improvement is primarily due to a decrease in general and administrative expense. 32 Table of Conte n t s Company-Owned Salons Fiscal Years 2023 2022 2021 2023 2022 (Dollars in millions) (Decrease) Increase (1) Total revenue $ 10.1 $ 20.2 $ 143.0 $ (10.1) $ (122.8) Company-owned salon adjusted EBITDA $ (1.8) $ (9.5) $ (47.5) $ 7.7 $ 38.0 Total Company-owned salons 68 105 276 (37) (171) _______________________________________________________________________________ (1) Total is a recalculation; line items calculated individually may not sum to total due to rounding. Fiscal Year Ended June 30, 2023 Compared with Fiscal Year Ended June 30, 2022 Company-owned Salon Revenue Company-owned salon revenue decreased $10.1 million in fiscal year 2023, primarily due to decrease in company-owned salon count and a decline in product sales in salons. Company-owned Salon Adjusted EBITDA During fiscal year 2023, Company-owned salon adjusted EBITDA improved $7.7 million, primarily due to the closure of unprofitable salons. Fiscal year 2023 also benefited from a $1.1 million grant received from the state of North Carolina related to COVID-19 relief. 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. 33 Table of Conte n t s LIQUIDITY AND CAPITAL RESOURCES Following the amendment of the Company's credit agreement in August 2022, the facility matures in August 2025. In addition to a $10.0 million minimum liquidity covenant, 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 8 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 until maturity of the credit agreement in August 2025. In conducting the Company’s current operations, all cash in excess of the amounts needed to support existing operating activities is used to pay the interest on the amounts outstanding under the credit agreement, and we are periodically borrowing additional amounts to cover these operating and interest expense costs. As of June 30, 2023, cash and cash equivalents were $9.5 million, with $8.7 and $0.8 million within the United States and Canada, respectively. As of June 30, 2023, the Company's borrowing arrangements include a $172.3 million term loan and a $55.0 million revolving credit facility with a $10.0 million minimum liquidity covenant that expires in August 2025. As of June 30, 2023, the unused available credit under the revolving credit facility was $33.3 million and total liquidity per the agreement was $42.8 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. Additionally, on February 3, 2021, the Company filed a $150.0 million shelf registration and $50.0 million prospectus supplement with the Securities and Exchange Commission 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. 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 2023, the Company did not issue shares under the prospectus supplement. As of June 30, 2023, 9.3 million shares have been cumulatively issued for $38.4 million, and $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 performance of the business, the level of investment needed to support its business strategies, credit facilities and borrowing arrangements, and working capital management. The Company has a disciplined approach to capital allocation, which focuses on ensuring we can meet our interest obligations and investing in key priorities to support the Company's strategic plan as discussed within Part I, Item 1. Additional information about the Company's current use of cash is described under "Sources of Liquidity." Cash Requirements The Company's most significant contractual cash requirements as of June 30, 2023 were lease commitments and interest payments. See Notes 6 and 8 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K for further detail. 34 Table of Conte n t s Cash Flows Cash Flows from Operating Activities During fiscal year 2023, cash used in operating activities was $7.9 million. Cash used in operations improved due to lower general and administrative expense resulting from a reduced headcount, a $1.1 million cash grant received from the state of North Carolina related to COVID-19 relief, $0.6 million received related to COVID-19 employee retention credits and less cash used for working capital. Cash used in fiscal year 2023 included a $2.5 million payment of previously deferred social security contributions. Cash Flows from Investing Activities During fiscal year 2023, cash provided by investing activities of $4.0 million was primarily related to cash received of $5.0 million from the sale of OSP, partially offset by a $0.5 million transaction fee. Cash Flows from Financing Activities During fiscal year 2023, cash used in financing activities of $2.1 million was primarily as a result of debt refinancing fees of $4.4 million, partially offset by a net $2.3 million borrowing under the Company's revolving credit facility. 35 Table of Conte n t s 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 2023 2022 2023 2022 (Fiscal year) (Interest rate %) (Dollars in thousands) Term loan 2026 9.54% N/A $ 172,268 $ — Deferred financing fees (6,471) — Term loan, net 165,797 — Revolving credit facility 2026 9.54% 5.50% 10,000 179,994 Paid-in-kind interest 1,033 — Total long-term debt, net $ 176,830 $ 179,994 In August 2022, the Company amended its credit agreement and extended the maturity to August 2025. Under the amendment, the $295.0 million revolving credit facility was converted to a $180.0 million term loan and reduced commitments under the revolving credit facility to $55.0 million, with the minimum liquidity covenant reduced to $10.0 million from $75.0 million. The 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. Total liquidity and available credit under the revolving credit facility, as defined by the agreement, were $42.8 and $33.3 million, respectively, as of June 30, 2023. As of June 30, 2023 and 2022, the Company had $176.8 and $180.0 million, respectively, of net outstanding borrowings. The agreement utilizes an interest rate margin that is subject to annual increases. The margin applicable to term secured overnight financing rate (SOFR) loans was 3.875% through March 27, 2023. Effective March 27, 2023, the margin increased to 6.25%, of which 4.25% is paid currently in cash and 2.00% is 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 term SOFR loans. See additional discussion in Note 8 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, including paid-in-kind interest accrued, as a percentage of the principal amount of debt and shareholders' deficit at fiscal year-end, was as follows: As of June 30, Debt to Capitalization (1) 2023 125.1 % 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, 2023 compared to June 30, 2022 was primarily due to the increase in shareholders' deficit as a result of the net loss. 36 Table of Conte n t s Contractual Obligations and Commercial Commitments On-Balance Sheet Obligations Our debt obligations are primarily composed of our credit agreement at June 30, 2023. Non-current deferred benefits of $6.0 million includes $1.8 million related to a non-qualified deferred salary plan, a salary deferral program of $2.0 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. Declines in system-wide revenue in certain brands over the past few years have 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, 2023, 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 Under the credit agreement 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 was 3.875% through March 27, 2023. Effective March 27, 2023, the margin increased to 6.25%, of which 4.25% is paid currently in cash and 2.00% is 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 8 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. 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, 2023. 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. 37 Table of Conte n t s Dividends The Company has not declared a quarterly dividend payment since December 2013. 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. During fiscal year 2023, the Company did not issue shares under the prospectus supplement. As of June 30, 2023, 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 June 30, 2023, 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 2023, the Company did not repurchase shares. As of June 30, 2023, 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. 38 Table of Conte n t s CRITICAL ACCOUNTING POLICIES AND ESTIMATES 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, 2023 and 2022, the Franchise reporting unit had $173.8 and $174.4 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 as of April 30, and between annual assessments if an event occurs, or circumstances change, that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Goodwill impairment assessments are performed at the reporting unit level, which is the same as the Company's operating segments. 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 each reporting unit is based on the assets and liabilities associated with the operations of the reporting unit, including allocation of shared or corporate balances among reporting units. Allocations are generally based on the number of salons in each reporting unit as a percent of total 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 and company-owned 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. 39 Table of Conte n t s 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 2023, 2022 and 2021 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 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. 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 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. The fair value of the salon long-lived asset group is estimated using market participant methods based on the best information available. The fair value of the right of use asset is estimated by determining what a market participant would pay over the life of the primary asset in the group, discounted back to June 30, 2023. During fiscal years 2023 and 2022, the Company recognized long-lived asset impairment charges of $0.1 and $0.5 million, respectively, related to ROU assets on the Consolidated Statements of Operations in Part II, Item 8 of this Form 10-K. During fiscal year 2021, the Company recognized a long-lived asset impairment charge of $13.0 million, which included $9.5 million related to ROU assets on the Consolidated Statements 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 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 assets, including its ROU assets. If actual results are not consistent with the estimates and assumptions used in the calculations, the Company may be exposed to future impairment losses that could be material. 40 Table of Conte n t s 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 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 $202.2 and $201.7 million at June 30, 2023 and 2022, 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. In fiscal year 2022, 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. 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. 41 Table of Conte n t s